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ACCOUNTANT

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THE PAKISTAN D
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Magazine of The Institute of Chartered Accountants of Pakistan

WHEN
BUSINESS
STANDS STILL

SPECIAL REPORT Complete Chronology of


GLOBAL CREDIT CRISIS
9 17
CONTENTS

PAGE# PAGE#

WHEN BUSINESS A CRITICAL ANALYSIS OF


ACCOUNTING PRACTICES
Volume 43 Issue 4 October-December 2009 STANDS STILL PREVAILING IN THE MUTUAL
FUNDS IN PAKISTAN
Publications Committee

22 37
Chairman and Chief Editor
Adnan Zaman

Members
Abdul Rashid
Abdul Wahid
Adnan Ahmad Mufti
Aijaz Ahmed
Altaf Noor Ali
Asad Feroze
Heena Irfan Ahmed
Jehan Zeb Amin PAGE#
M. Amir Afzal Rana
PAGE#
M. Fahim A. Rauf
Muhammad Rehan Razzak
Mutee-ur-Rehman Mirza
SPECIAL
Omar Mustafa Ansari REPORT
Raheel Abbas Rizvi Reporting on the
Advisor Publications
Long-Term
Rana Mustansir Sustainability of
The Council
Public Finances
President
Abdul Rahim Suriya, FCA

Vice Presidents Living in a Bubble


Mohammad Abdullah Yusuf, FCA
Pervez Muslim, FCA
The Credit Crisis at
Your Fingertips
Members
Adnan Zaman, FCA
Ahmad Saeed, FCA
Ch. Nazir Ahmad Asad, FCA
Hafiz Mohammad Yousaf, FCA
Khalid Rahman, FCA EDITOR'S LETTER 2 Auditor’s Report in Pakistan
Muhammad Ayub Khan Tarin PRESIDENT'S PAGE 3 Muhammad Asif Iqbal, FCA 24
Nadeem Yousuf Adil, FCA
Naeem Akhtar Sheikh, FCA JOIN THE DISCOURSE 5
Rafaqat Ullah Babar, FCA Complexities and Absence of Uniform
COVER STORY
Rashid Rahman Mir, FCA Valuation Process of Intellectual
Salman Ali Shaikh
When Business Stands Still
Assets Valuation
Shaikh Saqib Masood, FCA Aamir Jan Muhammad, FCA 9
Sohail Ahmad Mohammad Hanif Ajari, FCMA 30
Waqar Masood Khan
Yacoob Suttar, FCA Financial Leadership in an Age of
Advanced Fee Fraud
Zahid Iqbal Bhatti, FCA Turbulence
Saima Batool & Wasi Ahmed 34
Khursheed Kotwal, FCA 12
Executive Director
Moiz Ahmad, FCA
Audit File
No Strategy Without Operations
Secretary Sadia Kaleem, ACA 35
Rana Mustansir 15
Shoaib Ahmed, ACA
Living in a Bubble 37
Publication Coordinator ARTICLES
Asad Shahzad The Credit Crisis at Your Fingertips
A Critical Analysis of Accounting Practices
Prevailing in the Mutual Funds in Pakistan
Editorial Office IN HOUSE
The Pakistan Accountant Muhammad Rashid Zafer, ACA 17
Chartered Accountants Avenue, Clifton, Case Vignette 55
Karachi-75600 (Pakistan) World in Focus 57
Phone: 99251636-39 Fax: 99251626
Reporting on the Long-Term Sustainability
Books 59
E-mail: asad.shahzad@icap.org.pk of Public Finances
Website: www.icap.org.pk Last Page 60
Ian Sanderson, FCA (E&W) 22

The Pakistan Accountant Oct-Dec 2009 1


Editor’s Letter
EDITORÊS LETTER

WHEN BUSINESS A few years ago the US based *Financial Executives Research Foundation did
a study on what operational people thought about their financial counterparts.
STANDS STILL More than 50% respondents described their finance managers as ‘corporate
police’. If the Chief Financial Officer is perceived as a prosecutor would his
managers come to him for help?

One of the tenets of the Sarbanes Oxley Act is that boards should have an active
role in strategy. Incidentally, most board members come with operational
backgrounds. Thus, the CFO needs to bring his strategy to the board in a way
that allows the board to align themselves with his strategy.

Traditionally, accountants’ role in strategic planning has been


confined to the implementation phases where strategies are
converted into budgets. May be that’s because strategic
planning requires managers to throw the rule book out the
window; something accountants are not programmed to do.

Times are changing, though. Professional accountants are


standing up and being counted for as strategic decision makers.
Strategic planning defines a business’s mission, evaluates its
strengths and weaknesses, identifies opportunities and threats,
and realigns resources to achieve the goals of the business. This
is where all those advanced quantitative techniques and NPV calculations start
to make sense. Add to that an understanding of the profit implications of
goodwill, brand recognition and other intangible assets, and you have an
accountant who can greatly benefit the planning process.

But if finance managers really want to be seen as strategic business thinkers


they must shift their traditional emphasis on compliance to a long term
perspective to analyze the performance of their enterprise. They must seek to
learn from their operational business partners who possess process knowledge.
Whether in manufacturing or in services accountants must participate fully in
establishing processes. They must learn to embrace organizational diversity and
be willing to take creative risk.

Most important, they must realize that at its core any enterprise is a collection of
people and, therefore, business strategy must define the collective intelligence
and aspirations of all those people. The relationship between people, process
and product must be sustained at all costs.

The game of bridge is often referred to as the game of strategy. It’s part science,
part math, part logic. Like business. But bridge is also very human, where instinct
matters more than reason. Just as business strategy should be; where business
acumen doesn’t override human potential. It develops it.

Adnan Zaman

* The Financial Executives Research Foundation (FERF) was established in 1944 to perform impartial
and independent research on financial management and reporting.

The Pakistan Accountant Oct-Dec 2009 2


President’s Page
P R E S I D E N T Ê S PAG E

WHEN BUSINESS During my years with the pharmaceutical industry, the term Big Pharma sounded
very intimidating. Big Pharma defines the concentration of the large
STANDS STILL pharmaceutical companies. In contrast to small and medium sized local
companies, these companies coordinate and manage a complex network of
alliances and partnerships between them.

Whatever the structure of the pharmaceutical industry in Pakistan, it seems that


Big Pharma will have a significant role in determining business practices. The
pharmaceutical industry has been one of the most profitable industries for many
years and is considered a recession proof industry. Local pharmaceuticals could
generate considerable revenue from exports over time if the
government provides a business friendly atmosphere to this
sector.

Another area where local pharmaceutical companies can


compete internationally is outsourcing. China is now being
ranked as the number one location for pharmaceutical
outsourcing in Asia followed by India, Korea and Taiwan. These
countries are emerging not only as low-cost production locations
but also as locations with market potential and research and
development capacity.

The government needs to devise a strategy for the local pharmaceutical industry
to compete and make the most of the opportunities available to Asian countries.
This is a critical growth opportunity that this industry can not afford to miss.

Some companies continually face tremendous challenge in creating profitable


growth. Then there are other companies that achieve sustained growth in both
revenues and profits. Numerous business studies of high growth
companies over the years have shown that the difference between high growth
and low growth lays in the way these companies approach strategy.

Less successful companies take the beaten path: the conventional model of
always staying ahead of the competition. Successful companies on the other
hand take the road less traveled: they innovate. They don’t compare themselves
to rival companies; they don’t try to match or beat competitors. They don’t allow
competitors to set parameters for their success. They use their competitors’
strengths not to identify their own weaknesses, but to build on comparative
advantages.

They believe in their core strengths and add value to them. They put aside
conventional thinking and deliver a package that their customers would highly
value. Successful companies monitor their competitors, but they do not do things
in response to what the competition is doing. They do not scramble for
incremental share. They aspire to create their unique value in whatever they are
doing.

Abdul Rahim Suriya

The Pakistan Accountant Oct-Dec 2009 3


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DISCOURSE
Does IT Matter?*
This issue’s topic is:

“The differentiation is not in IT itself which is


everywhere and increasingly less expensive these
days, but in the new practices it enables.”
Brown & Hagel

As technology diffuses in to every aspect of


organizational life, IT is fast becoming a commodity.
With more companies investing heavily in IT and
with more and more IT products being standardized
and their cost falling, should Information Technology
be viewed merely as a commodity or as an enabler
of new business practices?

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IT is no longer a black box. IT is an integral part of the enterprise
functionalities and a board needs to understand the overall
architecture of its company’s IT applications portfolio. Having
worked for an Institute for Corporate Governance for nearly three
years now, this brings me to highlight the importance of IT
Governance, the lack of which has led to various IT project failures.

It does matter on who is sitting behind the wheel. No doubt, Lack of interest at the Board level in IT related decisions led to
living in this vibrant era without IT is even hard to imagine but the failures resulting in substantial financial loss such as Disney
making this tool to be used as a best business practices Corporation’s “go.com” project shut down after $878 million in
enabler is an art, which practically very few organizations have expenditure, Nike’s $400 million investment in software which
was subsequently written off as a disaster and the Australian
learnt so far. However, at least through IT’s widespread
Customs Imports Control System when customs insisted on
availability at affordable price this is now not an elite
going live with its own systems, the industry was not ready and
commodity for a few entrepreneurs. Its best business
the ports effectively closed down for three weeks until the old
practices features can be utilized by any entrepreneur at his systems were brought back into action.
discretion.
Hence IT does matter.
Amer Jan
GM Finance (South) PTCL Jahanara Sajjad Ahmad
Karachi United Arab Emirates

The Pakistan Accountant Oct-Dec 2009 5


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IT is definitely not a commodity as commodity is something AMC we believe in the same strategy and think out of the box
which is supplied/provided without qualitative differentiation. IT to design new products based on the latest technology available.
on the other hand can make or break an organization as it has
become such an integral part of corporate framework. Faisal Nadeem Mangroria
Head of Internal Audit & Compliance
Khwaja Kamran Shah ABL Asset Management Company Limited
Consolidation Manager Group Corporate Finance Karachi
Dubai
The collapse of geographic boundaries has made the world a
Yes, IT matters a lot. Specifically speaking about the banking global village, thus business must acknowledge the need for
industry, technology has the biggest and most critical role not Information Technology. IT has challenged the more orthodox
only in innovative product development but also in providing ways of business practices. It revolves around the automated
swift customer services. IT has completely changed the thought processes that require little or no human intervention. This in
process of the bankers where every product, process and turn has eliminated repetition of tasks, risks involved due to
activity is conceived keeping in view its technological elements negligence of timely upgrades and extensive paper-intensive
and the amount of support it provides from conception to business applications that result in the accumulation of
production. unnecessary bulk. Thus IT cannot be viewed as a mere
commodity.
From the simplest of the consumer banking products to the most
sophisticated structured products and from archival to audit In a nutshell, IT has caught on in the form of a communication
process, IT has revolutionized everything. Though few would still revolution for modern day business and revolutionized more or
argue that IT is a luxury and the cost associated is still relatively less all business sectors around the globe, thereby changing old
high. However, in the longer run and in a broader perspective IT business practices.
has reduced cost considerably with automation of processes.
Zaryab Hyder
All in all, IT is an integral element of modern day business and it Manager | Assurance
cannot flourish without IT. Ernst & Young Ford Rhodes Sidat Hyder
Karachi
Syed Raheel Hashmi
Head - Quality Assurance | Operational Risk Management In my opinion how IT is viewed depends a lot on the way it is
Noor Islamic Bank being implemented by an organization.

Even when an organization merely involves IT for automation of


I support the point of view that IT enables business practices.
its operation without any business process re-engineering, it is
The most relevant example of this is the system of transactions
required to mould some of its processes accordingly.
and payments through credit cards. The use of credit cards
increases purchasing power resulting in overall increase in But if IT is implemented in its true spirit it forces organizations to
business activities, and this system of credit cards was not device a number of new business processes, adopt best
possible without the help of IT. practices and re-engineer their existing processes. Only in that
way can IT act as enabler and not as a commodity.
Jamil Ahmed
Lahore Ayesha Ashfaq
Assistant Manager Corporate Finance
Information Technology is already viewed as an enabler of Ministry of Petroleum and Natural Resources
business practices in meeting strategic requirements and Islamabad
sustaining competitive advantage. In current e-business world,
information technology is the catalyst for creating entirely new IT does matter but it’s being over-emphasized in current times.
business models. It is not only part of the fabric of the So much so that we are more concerned about the left and right
organization, causing companies to restructure business margins of a report and less concerned about the message that
models, but IT has also changed the way they manage customer matters more.
relationships, work with their business partners, and form
strategic alliances with competitors. In this new economy, Saleem Ahmed
companies must leverage the enormous opportunities Senior Manager | Audit & Assurance
continually created by technological advances to meet M. Yousuf Adil Saleem & Co. Chartered Accountants
the strong demands of complex information networks, an
IT is bringing wide ranging and significant changes to business
increasingly dynamic global economy, and a ‘never-satisfied’
practices. Not only are the traditional operational methods of
customer.
procurement, manufacturing, distribution and sales being
Qaiser Vakani modified to bring in effective and efficient techniques into play,
Group Consolidation Manager SThree Management Services but the back end support systems in an organization including
finance, human resource and administration are also evolving to
I’ve always considered IT as an enabler of new business the changing business processes. Be it a market segmentation
practices. Having served in the financial services industry since study or an efficient production process, a balance sheet
2001, I’m confident that the growth of this industry over the past forecast or employee performance appraisal, IT continues to
several years has been achieved because of new IT practices enable new dynamic practices to the operating business
across the business either through online account activity, environment.
mobile banking, credit or debit card. Going forward, we will see
further differentiation in financial products based on IT’s Sibtain Shabbir Hussain
innovations. Soon you will find people managing entire Manager Treasury | Lakson Tobacco Company Limited
businesses sitting at home, thanks to IT once again. At ABL Karachi

The Pakistan Accountant Oct-Dec 2009 6


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Certainly, the topic is interesting. How could IT be considered as security and most importantly, the need for a sense of how IT
a mere commodity, when businesses all around the globe are leverages the overall organizational strategy.
GLOBAL today, thanks to the rapid development of IT services.
Therefore, IT is a tool for business development and enabler in Syed Shahid Abbas Rizvi
the true sense of the word. Mobilink
Islamabad
Abdul Sattar Tabbani
Karachi Nobody can doubt the horizons that IT has opened businesses
to. IT usually does not of itself materialize as a product of
The principal role that information technology has performed in modern business but it surely leads to differentiation through a
the past has been the operational and management support. But competitive edge over rivals. In the last three to four decades IT
recently the use of information systems as competitive weapons has transformed from mere data processing to Business
is accelerating. Among the classic cases of strategic information Intelligence.
systems are the computerized reservation systems of airlines,
the cash management system of financial institutions, and the There are many examples of business failure where IT is
order entry system of the supply chain sector. The companies involved, but fact finding exercises reveal that what was missing
have now begun using information systems practices was management. It would not be wise to spend millions of
rupees to keep abreast of the latest technology. What matters is
strategically to reap significant competitive advantage.
the alignment of IT Strategy within the Corporate Strategy.
Muhammad Arshad Hasan
Chief Financial Officer Lahore School of Economics On the other hand IT as a product has put companies like IBM
Lahore and Microsoft in Fortune 500’s top 50 rankings. In the early
nineties, who knew that web based companies like Google,
Does IT Matter? implies that IT has dramatically changed the Yahoo etc. would become the big guns of the corporate world.
role of business, its leveling effect on competition, and the
practical implications for business managers and IT suppliers. Imran-ul-Haq
The vital role of ERP, other IT solutions and hardware Lahore
combination also enables businesses to introduce new
IT has changed the way companies carry out many important
concepts, new processes, new products and even capture new
activities, but it has also led managers to invest cash into risky
markets. I believe that a company has to employ IT considering
and misguided initiatives. As IT has become more standardized
its present and future needs to the extent that they make its
and more affordable, it has been transformed from a proprietary
operations efficient, deliver a better customer experience and technology that companies can use to gain an edge over their
gain a competitive advantage. rivals into an infrastructural technology that is shared by all
competitors.
Haroon Sulaman
Manager Audit & Systems Sitara Textile Industries Limited
Owais Mukati
Faisalabad
Karachi
“The differentiation is not in IT itself which is everywhere and
increasingly less expensive these days, but in the new practices
it enables.”
A N A L Y S I S
This is completely true. IT has permeated all walks of our lives.
It has not only changed the way we do business but also the way In the year 2000, nearly half of US corporate spending was on
we operate in society and interact with each other. The advance Information Technology. Companies were making huge
of social networking and Web 2.0 has completely transformed investments, particularly in e-business initiatives, in an attempt
the concept of human interaction though at the cost of personal to achieve competitive and strategic advantages. However,
privacy. these projects never produced significant benefits. Indeed, many
were never completed. Then there was a significant fall in
IT has allowed businesses to break new frontiers in all respects spending on technology. NASDAQ collapsed and eyebrows
from materials management to marketing. It has made were raised and questions were asked whether IT was dead or
organizations more nimble, flexible, customer focused and whether it would continue to be a source of dramatic, even
highly efficient. It has also questioned whether the profession of transformational change.
accountancy is there for the long haul given the advancements
in IT, though this would perhaps be something to be debated In this backdrop Nicholas G.Carr’s essay “IT Doesn’t Matter”
separately. appeared in the May 2003 issue of the Harvard Business Review
claiming that “ technology’s potential for differentiating one
M A Shaikh company from the pack – its strategic potential – inexorably
London diminishes as it becomes accessible and affordable to all.”

IT has indeed changed the way everything used to be done. The thrust of Carr’s argument was:
What needs our attention though is that we don’t get carried  IT has ceased to be a scarce good and can now be acquired
away with the IT drive by adopting IT for the sake of IT. Each step from the marketplace like any other commodity.
towards automation and IT should be well calculated with clear
objectives, modalities and risks in mind. While IT addresses  Businesses had overestimated the strategic value of IT and
many issues, it brings with it new risks in the areas of systems in their desire for acquiring business value had significantly
integration, data migration, disaster management, information overspent on technology.

The Pakistan Accountant Oct-Dec 2009 7


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 Whole industries rather than any one competitor would processes, and has positively affected organizations at the
benefit from these changes. strategic, tactical and operational service delivery levels. The
rewards from this transformation have not been evenly
Based on the above analysis Carr concluded that IT has lost its distributed; those who had the insight and ability to create
strategic value and that businesses instead of seeking economic value have benefited the most.
advantage through technology should manage their IT
infrastructures in a way that would reduce capital investment and Furthermore, IT developments have not reached a plateau. We
operating costs and that they should ensure the reliability and will continue to see better and more innovative software
security of their systems by employing effective risk products. However, to gain a significant strategic advantage
management techniques. companies will also have to make innovations in businesses
practices.
Not surprisingly, “IT Doesn’t Matter” generated an enormous
amount of debate. It drew criticism from Bill Gates and others in Ahmad Saeed Kirmani
the IT industry that had prospered and flourished by marketing Karachi
the strategic value of technology.

Those who disagree with Carr argue that:

 IT does not matter in isolation. It only matters in the context Dear Members
of a concerted effort to innovate based on new possibilities
and opportunities created by the technology: Thank you very much for taking time out to answer our
DISCOURSE question.
IT networks and the Internet have made it possible for
companies to extend their operations globally. New The number of responses this question has generated proves
entrants have joined many industries and have focused the significance of Information Systems in providing a
on taking strategic advantage of the economics competitive advantage.
associated with IT.
The crux of this debate is that IT by itself may not provide a
IT has enabled industry’s transaction costs to decrease
business with a strategic advantage, but IT creates
continually, making it possible for the firms to make
possibilities that can only be fully exploited when the
products and services that were not feasible in the past.
business is ready to change its practices. Technology will
make a business or a service more efficient only when the
The Internet has made the explosive growth of small
right people are continually working to improve the right
businesses possible.
processes.
The management of information intelligence and
collaboration among individuals, groups, and Once again you have helped us maintain the vibrancy and
organizations has improved dramatically. decorum of this open discussion forum.

 Unlike commodities like rice and steel, where the processing Please continue participating.
operations are well understood and the economic advantage
lies in being able to source the commodity at lower cost, Publications Department, ICAP
managerial capabilities are needed to create value with
technology.

 On its own IT may not confer strategic differentiation, but it


certainly creates opportunities that were not previously Members are requested to send in their comments with their
economically available. Companies that see and act on name, town and membership number, via email in care of
these possibilities before others do will continue to asad.shahzad@icap.org.pk
differentiate themselves in the marketplace and reap with the word DISCOURSE
economic rewards. However, the insight required to harness in the subject heading.
this potential will never be evenly distributed. Therein lays
the opportunity for significant strategic advantage. Responses will be edited for purpose of clarity and space.

 To extract value from IT companies need to make * The two Harvard Business Review articles that became the basis for
innovations in business practices: improving cost savings this DISCOURSE are:
and efficiencies, making better organizational structures,
products and services, creating strategic advantage through IT Doesn’t Matter by Nicholas Carr, Editor-at-Large for the Harvard
partnerships, and providing new IT-based services to extend Business Review, HBR, May 2003; and
the customer value propositions.
A response to Carr’s article, titled Does IT Matter?, by John Seely
 IT developments have not reached the saturation point and Brown former Chief Scientist at Xerox, and Management Consultant
we would see more and better innovations. and author John Hagel, in the Letters to the Editor section of Harvard
 The need to pay more attention to IT risks is undisputable, Business Review, HBR, July 2003.
but the risks do not exceed the advantages.

The quantum leap promised by those marketing strategic use of


technology may not have materialized, however, Information
Technology has made it possible for businesses to improve their

The Pakistan Accountant Oct-Dec 2009 8


WHEN
COVER STORY

WHEN
BUSINESS
BUSINESS
STANDS
STANDS
STILL
STILL
In comparison to external factors, internal factors
are leading indicators and have more influence on
business collapse in general.

Aamir Jan Muhammad, FCA

The Pakistan Accountant Oct-Dec 2009 9


COVER STORY

E
xternal economic and other factors are beyond the managed through defined processes and not by few individuals’
control of any entrepreneur and generally he cannot whims and impulsive ideas. There is an old saying “if it ain’t
help it in overcoming those factors, rather only take broke don’t fix it”. Businesses sometimes become victim of
internal measures to mitigate the negative influence of undue influence of high management over decision making.
these factors to limit the risk of loss to the business at tolerable Chief executives are sometimes so obsessed with their own
level. However, certain businesses lose momentum and ideas that they are not willing to listen to any arguments against
consistency mainly due to complacency by reaching a certain them or take into account risks associated with the project. For
level and through experimenting new impulsive ideas based on example, getting into a totally different line of business with no
whims without chalking out a proper business plan or taking into relation to existing business products and services, business
account calculated risk associated with the implementation of mergers and demergers, discontinuing old product lines and
new ideas. replacing them with new products without market survey,
introduction of new product to wrong market segment,
In the paragraphs that follow we will outline the major internal overspending on established brands, getting into price wars
factors which lead to the demise of profitable business entities: while compromising the company’s profit margins etc.

N OT AC C E P T I N G C O M PE T I T I VE C H A N G E
Most enterprises, especially those enjoying monopoly in their
products, become the victim of egoistic managerial mindsets
and after the emergence of any competition close their eyes to it
and gradually lose market share. Contrary to this newcomers act
more aggressively with new customer focused ideas and better
service providing mindset and gradually capture the market
through competitive edge over its monopolistic entrepreneur and
in the long run become the true market leader in a competitive
economic environment.

Theoretically speaking, it seems obvious that a strong business


enterprise with a thorough market share would be in a better
position to outclass its new competitor by adopting changed
customer focused strategies. However, in practice it does not
happen as entrepreneurs who are enjoying guaranteed sale of
their products at desired margins fail to accept the reality of
competition by assuming that conditions will remain the same
whether or not they react in a positive fashion to the changed
market conditions. This slackness of entrepreneurs leads to
gradual decline of their businesses and in most of the cases,
total collapse.

Prime examples in Pakistan are some big business enterprises


that either closed down, or lost their market share, or grappled
with huge losses. For instance, one of the largest multinational
electrical companies operating in Pakistan with a strong brand
image and market share in electrical products closed down its
manufacturing units and substantially lost its business share to
local competition. One of the largest multinational companies
dealing in tea lost market share to a local competitor even after
merger with another big company, and the monopoly of a
multinational dealing in cooking oil and related products market
was also captured by new local businesses. On the international
front the recent bankruptcy of renowned automobile companies
are some examples.
O R G A N I Z AT I O N A L S T R U C T U R E
The most common factor amongst major big companies losing
market share or giving free space to the new entrants is mainly People are the key resource of any organization and the key to
due to the fact that they were unable to retain their customers by destroying any business enterprise is to destabilize the
offering them products and services matching changing organization structure of that company. Though this basic factor
demands and consequently failed to satisfy their customers. is not considered that important in many established business
This rule of constant change applies to all facets of life and organizations but this is the key for the long term survival and
obviously to businesses as well. Those entrepreneurs who growth of any business entity working in any economy of the
realize this factor and constantly work on continuous world.
improvement to delight customers through their competitive
products and services never fall victim to business crisis. Think for a while a company with a defined organogram of all
departments with reporting hierarchy, defined cadres, justified
DECISION MAKING ON IMPULSE pay structure at all levels, job descriptions, key performance
indicators (KPIs), assigned SMART targets at all individual
In the long run only those businesses survive which are levels, succession plans, performance appraisals, reward and

The Pakistan Accountant Oct-Dec 2009 10


COVER STORY

reprimand mechanism and above all proper communication of company’s business is the brain drain of employees through
company’s objectives to all levels from bottom to top. implementation of disorganized Voluntary Separation Schemes
(VSS). Downsizing of staff without chalking out future placement
Under this organized scenario everybody knows their role and needs in terms of skilled human resource becomes a slow
would be satisfied with their job at the end of the day by realizing poison for the business and in the long run seriously affects the
the fact that their performance is being judged and he/she has a continuity of the business. In large organizations where VSS are
defined career path. Contrary to this if these mentioned factors offered those with skills and job opportunities in the market are
are missing in the organization, no matter how skilled and the first to opt for the scheme as it gives dual benefits to them.
talented people working with that company are, overwhelmed Consequently, if general VSS is offered then at the end of the
with work everybody would just be passing the buck around to process the company is left with employees less in demand both
safeguard their jobs and at the end of the day company within and outside the company. Personally speaking, and
objectives would not be achieved. based on the author’s work experience, most of the VSS
schemes, though it is difficult to quantify its intangible
Another related aspect which has a critical impact on a consequences, are not well planned and have resulted in a brain
drain of key human resource which subsequently affects the
company’s performance.

CONCLUSION
In all facets of life basics play the key role. In the current global
economic scenario the rule of “survival of the fittest” applies
whereby entrepreneurs need to keep their business fit for all
environments by bringing innovation to products and services in
line with changing market trends.

For the long term survival of business enterprise in the


competitive times, regardless of size and nature, entrepreneurs
need to implement certain basics to achieve their prime objective
i.e. to earn profits from the business on a continuous basis.

Four basic factors must be considered as vital signs for business


continuity in the long run:

 Positive financials;
 Customer satisfaction;
 Effective processes; and
 Trained human resource & business infrastructure.

To achieve the business’s financial objectives, entrepreneurs


need to have satisfied customers. To retain satisfied customers
he needs to device processes which can deliver desired
products and services to customers on a continuous basis with
a concept of customized products and services. Furthermore, to
implement these business processes business need skilled

To achieve the business’s


human resource and infrastructure to deliver the desired results.

financial objectives,
Conclusively, if we reverse this series of factors in ascending
order we come to know that two factors i.e. skilled human

entrepreneurs need to have


resource and business structure, and defined processes are
leading factors and if these are effectively in place then the other

satisfied customers. To retain


two factors i.e. customer satisfaction and positive financials are
guaranteed.

satisfied customers he needs to


device processes which can
Business survival is wrapped in this golden strategy of retaining
existing customers and attracting new customers without

deliver desired products and


compromising on quality of products and services with an
ensured positive bottom line. If these basic factors are properly

services to customers on a
followed and implemented, rest assured the business will
survive and thrive in good times and bad.

continuous basis with a concept


of customized products and
services.
Aamir Jan Muhammad
General Manager Finance – South,
Pakistan Telecommunications Corporation Limited (PTCL).

The Pakistan Accountant Oct-Dec 2009 11


COVER STORY

Financial
Leadership in an
Age of Turbulence
Khursheed Kotwal, FCA

Introduction financial crisis was that there was too rebalance the portfolio, channelling some
much focus on short term revenue resources on innovation efforts that have
Recessions are like hurricanes: they hit generation rather than a more sustainable the potential to pay off handsome
different areas with different intensities. long term approach to profit and value dividends.

Business Analysis
How a company responds will depend on creation. The CFO can play a critical role
how sensitive the industry is to the in promoting a more balanced approach
downturn and the strength of its strategic to risk and reward. This includes
and financial positions. The strengthening the management and When the business environment
repercussions of the market meltdown company wide understanding of the risks becomes more uncertain there is a
continue to reverberate around the and funding costs associated with greater need to understand how the
financial services sector. The financial particular products and trading strategies. business is performing and where it is

New Ways of Working


crises around the world in the past two spending the money. A lot more
years has been very challenging for information covering the full range of
everyone and more so for the finance operations from the organization’s
community. Businesses need to work differently and exposure to currency movements,
find new ways of working. Recession and information analysis on the company’s
In Pakistan, as well, the past two years the turbulent times that follow offer many supply chain and logistics operations, risk
have been challenging with deteriorating companies an ideal chance to move exposures on investment decisions, the
political, and security conditions and a ahead of competitors. To seize these organization’s liquidity position, its net
number of economic challenges like low opportunities major activities would debt position etc. is required.
GDP growth, high inflation, and massive include clarifying strategies, shifting
devaluation of the rupee. The purchasing resources to core activities, aggressively Also in the current environment there is
power of the consumer has also managing costs and cash flows, greater pressure on organizations to
deteriorated, thus putting more pressure increasing revenues and margins and produce accurate and timely information
on companies to operate efficiently and preparing bold moves. Not every action that provides an informed view of
make value offerings. However, currently will apply to every company. In turbulent business performance and expected
times people tend to get very risk averse trading conditions. The accuracy and
the GDP growth has started to improve
which sometimes may lead to moving the reliability of business information has
and inflation is more controlled.
become critical and the finance
Key Learnings
corporate innovation portfolio exclusively
towards short term which is relatively risk community is seen to drive value through
free. In such times companies need better planning and improving the
One of the key learnings from the current financial expertise to guide them to accuracy of business forecasting. The

The Pakistan Accountant Oct-Dec 2009 12


COVER STORY

need for forward looking information and The consumer is not able to pay such management. As volumes decline, every
more refined business forecasting is very prices. A proper review of supply chain effort needs to be made to pull working
essential. costs and alternative options of capital out of the system. Through a very
resourcing the business should be systematic month in month out focus on
The CFO and finance teams can play a evaluated. Under such circumstances working capital and reviews of orders and
very important role by making sure that looking at avenues of cost savings and inventory levels, the focus should be on
correct and timely analysis is done to business efficiencies are also critically the reordering of raw materials. Stronger
understand the changing environment important. control and understanding of working
and evaluate whether there is a need to capital, better focus and accuracy with
review new operating and financial Also, in a difficult economic environment, cash forecast position, transparency and
metrics in the light of the environment. proper forecasting and planning are understanding across the balance sheet,

Managing Costs
important. Because of the sharpness with and debt reduction have become critically
which things decline and depending on important to the survival of the
how deep the declines were, a lot of organizations.
When profit margins are significant big companies around the world were forced
companies may not be as focused on to make relatively abrupt and drastic The financial crisis has created a
cost- what they now need is really strong moves in order to deal with the loss of bottleneck in the banking and cash
business analysis to reduce the business sales and loss of volume by reducing the system and refocused organizations on
waste and look for cost efficiencies in finance operations. Cash liquidity is the
workforce.

Working Capital Management


controlling costs. In times of stability these primary reason why many businesses fail
companies may not be too concerned in the current environment which explains
about costs because they have more fat the refocus on financial operations.
in the profit margin. During a recessionary One of the biggest roles that the finance
profit there is pressure on the margins. community can play is the working capital Who is in a position to provide this sort of

The Pakistan Accountant Oct-Dec 2009 13


COVER STORY

guidance to the business? It is the finance to provide the necessary advice,


community that can with its insights, oversight and business challenge.
knowledge and acumen be able to help
chalk out a clear direction. Better understanding would certainly

Empowerment & Challenges


improve the finance team’s ability to
recognize threats and identify
opportunities while ensuring their input
In many firms the finance teams may lack is taken seriously by boards and
sufficient licence, willingness and business teams. There are growing
acceptance to challenge business talent shortages and, therefore, it
decisions. Encouraging this vital input will would be unrealistic to expect finance
require the mandate of the board. personnel to have comparable
Effective transparency, scrutiny and technical know how to front office
oversight are essential in maintaining the teams across all business areas. A
checks and balances needed to good CFO should be able to see
safeguard the business and ensure through the complexity and be willing
sustainable returns. Empowerment to to challenge trading teams if they
challenge exposures even if it goes believe the company is facing
against the prevalent strategic thinking is unacceptable risks. This calls for the
important. CFO and his team to have an

Risk Management
enquiring mindset and probing
analytical skills.
It is the finance community’s responsibility
A key consideration is whether some
to balance desired profit with acceptable
of the complexity that has grown
levels of risk. Hence, quantifying the risk
around certain products is necessary
and the ability to evaluate and
let alone beneficial. If a qualified
communicate the risk requires developing
finance professional cannot fathom the
new processes to mitigate the risk quickly
intricacies and related jargon
and efficiently. These are areas where the
surrounding a particular product, then
CFO can add value to the business.
it may not be a safe enough bet
Effective Control
anyway. This underlines the
importance of finance’s involvement in
Effective control demands the ability to product development and investment
cut through the complexity and recognize strategies from the outset. A key part
dangerous exposure and flawed trading of this input should be helping to set
strategies. If the finance team has key parameters and looking at how to
reservations about decisions they should realize sustainable trading profits
have the necessary mandate, confidence rather than simply pursuing short term
and ear of senior management to mark to market gains. Hence, in such
challenge them. cases the CFO should hire accounting
specialists who are often embedded in
Performance & Reward trading teams to help structure deals.

Gearing compensation packages to Conclusion

The recent financial crises


process improvement and sustainable
delivery of goals could accelerate In summary, the role of the CFO, in

have raised questions


turnaround time and free time for greater addition to finance areas, cuts right
strategic input. Finance heads & teams across the organization. They are focused

about whether the finance


can play a role in the long term on short term survival, navigating the

professionals understand
development of systems for aligning business through economic turmoil,
compensation to risk adjusted measures ensuring the organization’s finance

enough about the


and longer term value creation to protect operations are strong, and making sure
custodial issues- controls framework,

technicalities and risks


shareholder value. They are instrumental
in encouraging the right behaviour by protection of business assets, capital

associated with today’s


developing Balanced Scorecards and structures - are effective. They recognize
the growing importance of strong

complex structured
monitoring performance. This encourages
everyone to pull together and helps to regulatory controls, maintaining investor

products to provide the


embed a culture of sustainable business confidence and relations. They continue
growth and profitability. to balance these demands while steering

necessary advice,
organizational strategy and ensuring that
Competence/ Challenges
oversight and business
the finance teams provide the right
analysis and information that the business

challenge.
The recent financial crises have raised requires.
questions about whether the finance
professionals understand enough about Khursheed Kotwal
the technicalities and risks associated has recently started her own financial and
management consultancy.
with today’s complex structured products

The Pakistan Accountant Oct-Dec 2009 14


No Strategy
COVER STORY

Without
Operations:
A Simulated Case Study of Starware International
Rana Mustansir

Operations activities must support corporate strategy if firms bringing the end product to the customers. However, there are
aspire to gain competitive advantage also challenges that the firm faces in the successful
implementation of Total Quality Management such as availability
PART I of resources, unrealistic business objectives, and establishment
FACTS OF THE CASE
of effective supplier channels.

Starware International is engaged in the manufacturing and sale Country factors also affect the plant’s operational capability.
of a range of good quality household and commercial ceramic Manufacturing is constantly disrupted owing to major power
ware. In addition to the local market the company exports to breakdowns, plant breakdown, and labor unrest.

Operational Practices at Starware International


customers like Harrods in the United Kingdom, IKEA in the
United States, CIS and Central Asia.
I. THE BULLWHIP EFFECT
The factory handles ceramic production from the initial process
One dimension of the supply chain is the Bullwhip Effect which
of grinding minerals for formulating various color glazes to the
derives its name from the action of a whip where the end moves
final firing with decals decoration.
faster than the handle. It is the repetition of over and under
supply of materials down the supply chain causing major
Starware International has a multi-source, single layer supply
problems in coordinating the network.
chain with a focus on price. Regular raw materials such as clay,
grinding minerals, color glazes, decal and packing material are
Starware operations are marred by the Bullwhip Effect owing to:
purchased from several independent local suppliers on long
term contracts with an agreed price for a minimum period of one
a) Under supply
year. For import of a specified German chemical product, the
Chemical shipments are stuck in customs for weeks. This
company has a long standing relationship with four shortlisted
delays arrival of goods to the manufacturing plant by several
alternate suppliers with C & F price included.
days. Frequently, furnished material is out of specification
and has to be rejected.
Typical to most developing countries Starware employs
intermediate technology with production methods alternating
b) Over supply
between capital and labor intensive processes.
Master production schedule (MPS) goes off target lowering
material consumption, ultimately resulting in excess
There is a lot of emphasis at Starware on the integration of
inventory.
quality within the management system, especially in terms of
II. PROBLEMS IN PRODUCTION CONTROL
A multi-source, single layer supply chain means: Starware’s production system is one of mass customization,
• the manufacturer has many suppliers for the same part so producing low cost, high quality outputs in high variety. The core
sources can be switched in case of supplier failure; capabilities of Starware are focused on cutting costs by
• the suppliers are played off against each other which promoting efficiency and producing high quality product at low
means the purchaser (manufacturer) can drive down unit cost.
prices through competitive tendering;
• the manufacturer is the dominant party Starware’s production control system is material requirements
planning (MRP) where work and material are pushed through to

The Pakistan Accountant Oct-Dec 2009 15


COVER STORY

try and pre-empt demand, as opposed to Just-in-Time (JIT) compete in a global market. At this time Japanese techniques
which operates with work instructions deriving from customer were having a huge impact on manufacturing. The Toyota
demand which pulls material through the system. Production System (TPS) had become the flag bearer of
operational efficiency. TPS was established based on two
The firm is able to customize its product range to suit the needs concepts:
of different customer groups without a cost penalty. Yet,
production at Starware suffered from: i) The first is called jidoka, loosely translated as ‘automation
with a human touch’ which means that quality must be built
a) Over-production in during the manufacturing process such that when a
Production in Starware was for more than what was required problem occurs, the equipment stops immediately preventing
(large lot production) and before it was required (push defective products from being produced.
production). Over-production results in higher storage costs,
excessive lead times, and makes detecting defects quite ii) The second is the concept of Just-in-Time (JIT). Making only
difficult. what is needed, when it is needed, and in the amount
needed so that each process produces only what is needed
b) Waiting by the next process in a continuous flow.
The plant experienced waiting when goods were not moving
due to poor material flow and long production runs, as when Based on the basic philosophies of jidoka and Just-in-Time,
a production order was waiting for machine availability. Toyota was efficiently and quickly producing vehicles of sound
quality, one at a time, to fully satisfy customer requirements.
c) Unnecessary Inventory
As a direct result of overproduction and waiting, the plant had By 1990, management guru Peter Drucker had postulated that in
excessive inventory which lead to increased lead times and the modern manufacturing era, world class will be based on
limited floor space. Batch processing caused inventory influx.
Statistical Quality Control, a flexible manufacturing system, an
The push system left excessive finished goods and work in
integrated supply chain, and manufacturing economics.
process, and buffers between unsynchronized production
operations.
Based on that hypothesis, small and medium sized businesses
in developing countries need to acquire additional capabilities in
d) Product Defects
order to compete in the international business arena: managing
Defects occurred in internal production, in supplier
in scarce supply conditions; identifying local supply sources; and
parts/materials, during final testing, and would be discovered
training unskilled and semi-skilled workers. Local firms like
by customer after delivery.
Starware could become world-class if they understand that what
they need is an enduring approach to competition.

However, to become truly world class firms like Starware will


PART II
ANALYSIS OF THE CASE
have to broaden their capabilities to include such factors as the
establishment of strong brands, economies of scale, and market

Operations Management is a Strategic Activity


dominance.

The goal of Starware’s manufacturing strategy should not be to


In a 1997 study researchers Sven Horte and Hakan Ylinenpaa
make short-term choices between cost, quality and flexibility, but
found that favorable sales performance resulted when there was
to differentiate itself from its competitors through innovation and
a good fit between a firm’s and its customer’s perception of the
building on the firm’s unique skills and capabilities.
strengths of a product. Conversely, when firms had high opinions
about their competitive strengths but their customers did not
share this opinion, sales performance was negative. That would be possible only when it starts to view operations as
a strategic activity. The operations strategy must be designed in
That was exactly the case with Starware International. The plant such a way that all decisions relevant to system design,
was running under capacity due to tough competition and low planning, control and supervision work to accomplish the
market penetration caused by high flow of Chinese finished manufacturing mission of the company.
products at comparatively very low prices. Cost of production at
the plant was very high owing to high materials and energy As Harvard University researchers Hayes and Pisano say, ‘A
costs, high rupee dollar parity, and import duties and tariffs on company should think of itself as a collection of evolving
raw material. Still the plant continued to manufacture a product capabilities, not just as a collection of products and businesses.’
that the buyer did not want. Thus, the firm showed great skill in
making a product for which there was little demand.
This case study was developed as part of an International
During the 1970s and 1980s, global markets had become so
Operations Management module for Royal Holloway College,
competitive that firms began to reevaluate their manufacturing
UK. It has been adapted for The Pakistan Accountant.
strategies on the basis of the four competitive priorities: cost;
quality; delivery/service; and flexibility. They realized that instead Drucker, Peter E. “The Emerging Theory of Manufacturing,” Harvard Business
of making tradeoffs on these priorities they could compete on Review, May-June 1990, pp. 94-102.
several competencies.
Hayes R. and Pisano, G. (1994) “Beyond World-Class: The New Manufacturing
Strategy” in Harvard Business Review, January-February, pp.77-86.
The term ‘world-class’ manufacturing emerged in the 1980s
following the 1986 publication of World Class Manufacturing: Horte, Sven Ake, and Ylinenpaa, Hakan,( 1997), The firm’s and its customers’
The Lessons of Simplicity Applied by Richard J. Schonberger. A views on order-winning criteria, International Journal of Operations and Production
company was said to be world-class if it had the ability to Management, Volume 17, Issue 10

The Pakistan Accountant Oct-Dec 2009 16


ARTICLES

ACCOUNTING PRACTICES
A C R I T I C A L A N A LY S I S O F

PREVAILING IN THE MUTUAL


FUNDS IN PAKISTAN
Muhammad Rashid Zafer, ACA

Introduction these open ended funds are different from a limited liability
The operational modalities of collective investment schemes company where the share capital once issued is not repayable
more commonly referred to as mutual funds and the presence in the normal course, and the same are traded in the secondary
of some peculiar requirements of the Non Banking Finance market. This continuous entry and exit of the unit holders poses
Companies and Notified Entities Regulations, 2008 (NBFC a unique accounting issue prevailing in the open ended mutual
Regulations) poses some accounting issues which are normally funds in Pakistan i.e. 1the recognition of ‘Element of Income and
not encountered in the limited liability companies. Capital Gains (Element) included in the prices of units issued
and redeemed’ in the income statement of the open ended
In this article we will try to critically analyze the accounting mutual funds.
treatment of the following issues that are prevailing in the
mutual funds in Pakistan: What is Element?
Before discussing the prevailing accounting treatment of
 Element of Income and Capital Gains (specific to open Element it is necessary to understand the nature of Element.
ended funds only) The units of open ended funds are issued and redeemed on the
 Compulsory distribution of ninety percent of the accounting basis of Net Asset Value (NAV) which is computed by dividing
income to the equity participants of the mutual funds the net assets of the open ended fund by the number of
(applicable to open ended funds, closed end schemes and outstanding units at any particular time. When a unit holder
investment companies) redeems one unit from an open ended fund the amount he gets
represents the current values of the net assets of the open
ELEMENT OF INCOME AND CAPITAL GAINS ended fund which also include a portion of income and capital
As most of the readers of this journal are aware that open ended gains that the open ended fund has earned till the time of
mutual funds continuously offer their units for sale and similarly redemption. Similarly, in order to purchase one unit of open
these units can be redeemed at any time and in this aspect ended fund a person has to pay the current values of the net

The Pakistan Accountant Oct-Dec 2009 17


ARTICLES

assets of the open ended fund which also include a portion of  On redemption of units the Element that pertains to
income and capital gains that the open ended fund has earned unrealized gains that forms part of unit holders’ fund is
till the time of purchase of units. This portion of income and included in the distribution statement as a deduction from
capital gains that is paid and received at the time of redemption the amount available for distribution and the Element that
and purchase of units respectively is termed as Element. pertains to all other income and capital gains is recorded as
expense with corresponding impacts on unit holders’ fund.
Current Treatment of Element in the Financial Statements of the
Open Ended Funds The reason for this bifurcation of Element is that since the
Currently there are two practices that are prevailing regarding unrealized gains on available for sale financial assets do not
the recognition of Element which can be summarized as follows: impact the income statement therefore, the impact of Element
that pertains to unrealized gains on available for sale financial
Practice 1 assets should also not be taken in the income statement.
 The Element on issue of unit is recorded as income with
the corresponding effect in unit holders’ fund. Why Element is Recognized?
The Element is recognized in order to prevent the dilution of
 The Element on redemption of units is recorded as expense income and distribution of income already paid out on
with the corresponding impact on unit holders’ fund. redemption. To further elaborate this, suppose that on
redemption from open ended fund a person gets Rs.101 in which
Re.1 represents the income and capital gains earned by the
open ended fund. If this Re.1 is not recorded as an expense the
income statement will show Re.1 as profit and at the time of
distribution it will be distributed to the unit holders despite the
fact that this Re.1 has already been paid to the unit holder on
redemption. Similarly, a person pays Rs.101 for one unit of the
open ended fund in which Re.1 represents the amount of income
already earned by the mutual fund. If this Re.1 is not recorded as
income in the income statement the amount of profit available for
distribution to the existing unit holder will dilute as one additional
unit has been issued which will participate in the income of the
existing unit holder. The following illustrations will help to
understand the impact of Element on the financial statements:

EXAMPLE 1 - WITHOUT RECOGNITION OF ELEMENT

Net Assets & NAV


Date Net assets Units NAV
1-Jan-09 1,000 10 100
2-Jan-09 1,010 10 101
Issuance of Units 202 2
1,212 12 101
Redemption of Units (101) (1)
1,111 11 101

The Element is recognized


INCOME STATEMENT

in order to prevent the


Income & Capital Gains 10.00

dilution of income and


Distributable Income Per Unit Before Issuance

distribution of income
and Redemption of Units (Rs.10÷10) 1

already paid out on


Distributable Income Per Unit After Issuance

redemption.
but Before Redemption of Units (Rs.10÷12) 0.83

Distributable Income Per Unit After Redemption


but Before Issuance of Units (Rs.10÷9) 1.11
Practice 2 UNIT HOLDERS' FUND
The Element is divided into two parts by separating the Element
that pertains to unrealized gains that forms part of unit holders’ Opening Net Assets 1,000
fund (i.e. unrealized gains on available for sale financial assets) Issuance of Units 202
and the Element that pertains to all other income and capital Redemption of Units (101)
gains. 1,101
Net Income 10
 On issue of units the Element pertaining to unrealized gains Net assets 1,111
that forms part of unit holders’ fund is included in the
distribution statement as amount available for distribution In the above example, if distribution of profit is made on Jan 02,
and the Element that pertains to all other income and capital 2009 before the issuance and redemption of units then Rs.10 will
gains is recorded as income with corresponding impacts on be available for distribution and each unit holder will get Re.1.
unit holders’ fund. However, if two units are issued (ignoring the redemption) the

The Pakistan Accountant Oct-Dec 2009 18


ARTICLES

amount available for distribution on Jan 02, 2009 will be Rs.10 issue and redeem units without diluting the income available for
whereas the number of units will have been increased from 10 to distribution to the unit holders and to prevent the distribution of
12 as a result the per unit distribution will be Re.0.83 which income which has been paid to the unit holders at the time of
results in dilution of income available for distribution to the redemption.
existing unit holders due to issuance of two new units. Similarly,
if one unit is redeemed (ignoring the issuance of units) on Jan Is the Current Treatment of Element in Accordance with the
02, 2009 the amount available for distribution will be Rs.10 and Financial Reporting Framework Applicable on Open Ended
if distribution is made on Jan 02, 2009 each unit holder will Mutual Funds?
2
receive Rs.1.11 whereas actually Rs.9 should have been Paragraph 70 of the Framework for the Preparation and
distributed to the unit holders i.e. Re.1 per unit as the portion of Presentation of Financial Statements (the Framework) defines
the income attributable to one unit i.e. Re.1 has already been income and expenses as follows:
paid to the unit holder at the time of redemption.
“Income is increases in economic benefits during the accounting
EXAMPLE 2 – WITH RECOGNITION OF ELEMENT period in the form of inflows or enhancements of assets or
decreases of liabilities that result in increases in equity, other
Net Assets & NAV
than those relating to contributions from equity participants.”
Date Net assets Units NAV
1-Jan-09 1,000 10 100
“Expenses are decreases in economic benefits during the
2-Jan-09 1,010 10 101
accounting period in the form of outflows or depletions of assets
Issuance of units 202 2
or incurrences of liabilities that result in decreases in equity,
1,212 12 101
other than those relating to distributions to equity participants.”
Redemption of Units (101) (1) 101
Since the units of open ended funds are classified as equity
1,111 11 101
instruments in accordance with the requirements of International
Accounting Standard 32 therefore, in accordance with the
INCOME STATEMENT
definition of income and expense any contribution from or
Income & Capital Gains 10 distribution to the equity participants i.e. unit holders cannot be
Element of Income on Issuance of Units 2 classified as income or expense.
Element of Income on Redemption of Units (1)
11 If we analyze the examples above it will be clear that the
Element is created from the contributions received from the
Distributable Income per Unit Before equity participants i.e. the unit holders at the time of issuance of
Issuance and Redemption of Units (Rs.10÷10) 1 units and distributions made to the equity participants i.e. the unit
holders at the time of redemption of units. Therefore, the
Distributable Income per Unit After Element should not be recognized in the income statement as it
Issuance but Before Redemption of Units (Rs.12÷12) 1 failed to meet the definition of income and expense.

Distributable Income per Unit After In addition, paragraph 33 of International Accounting Standard
Redemption but Before Issuance of Units (Rs.9÷9) 1 32 interalia states that “If an entity reacquires its own equity
instruments, those instruments (‘treasury shares’) shall be
UNIT HOLDERS' FUND deducted from equity. No gain or loss shall be recognised in
profit or loss on the purchase, sale, issue or cancellation of an
Opening Net Assets 1,000 entity’s own equity instruments…”
Issuance of Units 202
Redemption of Units (101) It will be interesting to note that the recognition of Element in the
Element of Income on Issuance of Units (2) income statement results in two different treatments for the same
Element of Income on Redemption of Units 1 item i.e. the amount of income paid at the time of redemption
Net Income 11 (Element) is treated as expense whereas the amount of income
Net assets 1,111 distributed as dividend at the time of distribution is treated as
appropriation of profits.
In the above example, if distribution of profit is made on Jan 02,
2009 before the issuance and redemption of units then Rs.10 will Here one argument can be made that since Schedule V to the
be available for distribution and each unit holder will get Re.1. If NBFC Regulations which sets out the disclosure requirements
two units are issued (ignoring the redemption) the amount for the financial statements of the open ended mutual funds list
available for distribution on Jan 02, 2009 will be Rs.12 whereas ‘element of income and capital gains’ in the disclosure
the number of units will have been increased from 10 to 12. As requirements of the income statement therefore, the same
a result the per unit distribution will remain same and no dilution should be included in the income statement. The answer to this
will occur in the income available for distribution to the existing argument is that Schedule V outlines the disclosure
unit holders due to issuance of two new units. Similarly, if one requirements and most readers will agree that disclosure
unit is redeemed (ignoring the issuance of units) on Jan 02, 2009 requirements spell out the type and contents of certain
the amount available for distribution will be Rs.9 (10-1) and if information that needs to be disclosed in the financial
distribution is made on Jan 02, 2009 each unit holder will get statements. The disclosure requirements cannot be and should
Re.1. As a result the amount paid at redemption will not be not be construed as accounting treatment of the items of the
distributed again. financial statements. It implies that firstly we have to evaluate
whether an item meets the criteria to be included in the income
It is clear from the above that the recognition of Element is statement or balance sheet as per the applicable financial
inevitable in order to enable the open ended fund to continuously reporting framework and once it meets the criteria the same

The Pakistan Accountant Oct-Dec 2009 19


ARTICLES

should be disclosed in accordance with the disclosure complying with the requirements of the financial reporting
requirement. This point is further supported by the fact that in framework applicable on the open ended funds.
case of prevailing Practice 2 enumerated above a portion of
Element is included in the distribution statement despite the fact COMPULSORY DISTRIBUTION OF PROFITS TO THE
that as per Schedule V the element is listed in the disclosure EQUITY PATICIPANTS
requirement of income statement.
Regulation 63 of the NBFC Regulations interalia states that “An
In view of the above it can be safely concluded that Element Asset Management Company on behalf of a Collective
does not meet the definition of income or expense as it results Investment Scheme shall, for every accounting year, distribute
from contributions and distributions to the equity participants i.e. by way of dividend to the unit holders, certificate holders or
the unit holders of the open ended fund. Therefore, the same shareholders, as the case may be, not less than ninety per cent
should not be recognized as income or expense. of the accounting income of the Collective Investment Scheme
received or derived from sources other than unrealized capital
SUGGESTED TREATMENT OF ELEMENT gains as reduced by such expenses as are chargeable to a
Collective Investment Scheme under these Regulations.”
As already mentioned above, the recognition of Element is vital
for the open ended funds. However, since it does not qualify to In order to comply with the above mentioned requirement all the
be included in the income statement a question now arises as to mutual funds distribute ninety percent of the income. However,
what should be the correct treatment of Element? The answer to since the distribution is approved by the board of directors after
this question is very simple i.e. since the Element is basically the year end the same is treated as a non-adjusting event after
contributions from and distributions to the equity participants it the balance sheet date in accordance with the requirement of
should be directly included in the distribution statement or the International Accounting Standard 10. However, one thing which
retained earnings rather than routing through the income is being ignored in this treatment is that the distribution of income
statement. The following example will help to illustrate its is obligatory and not at the discretion of the mutual funds as
application: specified in the above mentioned Regulation. This element of
obligation on the mutual funds meets the definition of liability as
Net Assets & NAV stipulated in the Framework which defines liability as “A liability
Date Net assets Units NAV is a present obligation of the entity arising from past events, the
1-Jan-09 1,000 10 100 settlement of which is expected to result in an outflow from the
2-Jan-09 1,010 10 101 entity of resources embodying economic benefits.” Further,
Issuance of Units 202 2 100 paragraph 60 of the Framework interalia states that “An
1,212 12 101 essential characteristic of a liability is that the entity has a
present obligation. An obligation is a duty or responsibility to act
Redemption of Units (101) (1) 100 or perform in a certain way. Obligations may be legally
1,111 11 101 enforceable as a consequence of a binding contract or statutory
requirement.”
DISTRIBUTION STATEMENT

Income & Capital Gains 10 It is clear from the above that in case of income, compulsory
Element of Income on Issuance of Units 2 distribution of ninety percent income is a present obligation of
Element of Income on Redemption of Units (1) the mutual funds enforced on it by the NBFC Regulations and as
evident it will result in outflow of resources embodying economic
Amount Available for Distribution 11 benefits therefore, the same should be accounted for as liability
and should not be treated as a non-adjusting event after the
Distributable Income per Unit Before balance sheet date.
Issuance and Redemption of Units (Rs.10÷10) 1
Further, if we analyze the offering documents of the mutual funds
Distributable Income per Unit After we will note that almost all the mutual funds, in some form or the
Issuance but Before Redemption of Units (Rs.12÷12) 1 other, have specifically stated in their offering documents that
ninety percent of the income will be distributed to the equity
Distributable Income per Unit After participants in order to avail the benefit of tax exemption
Redemption but Before Issuance of Units (Rs.9÷9) 1 available under Clause 99 Part 1 of the Second Schedule to the
Income Tax Ordinance 2001, which interalia requires that any
UNIT HOLDERS' FUND income derived by a mutual fund shall be exempt from tax if not
less than ninety per cent of its accounting income of that year, as
Opening Net Assets 1,000 reduced by capital gains whether realized or unrealized, is
Issuance of uUnits 202 distributed amongst the equity participants. For the convenience
Redemption of Units (101) of readers following is an extract from the offering document of a
1,101 mutual fund:
Element of Income on Issuance of Units (2)
Element of Income on Redemption of Units 1 “Notwithstanding the tax rates stated under Clause XXX above,
Undistributed Income 11 the accounting income of the Fund will be exempted from tax if
Net assets 1,111 not less than 90% of the accounting income of the accounting
period is distributed amongst the Unit Holders. The 90% of the
It is clear from the above illustration that the objective of accounting income shall be calculated after excluding capital
recognition of Element, i.e. to prevent the dilution of income and gains whether realised or unrealised. XXX Fund will seek to
to prevent the distribution of income already paid to the unit comply with the requirements of tax exemption and distribute at
holders at the time of redemption, can be achieved by least 90% of the accounting income, calculated after excluding
recognizing it directly in the distribution statement while capital gains to the Unit Holders.”

The Pakistan Accountant Oct-Dec 2009 20


ARTICLES

on the next day will be Rs.101 (assuming only one unit holder).
3
International Accounting Standard 37 (IAS 37) defines However, if we record liability for distribution of ninety percent
constructive obligation as: income the NAV will be Rs.100.1 only. If the unit holder redeems
his units he will get only Rs.100.1 whereas actually he should
“A constructive obligation is an obligation that derives from an receive Rs.101.
entity’s actions where:
In view of the above it is suggested that a joint committee of The
(a) by an established pattern of past practice, published Institute of Chartered Accountants of Pakistan and the Mutual
policies or a sufficiently specific current statement, the Fund Association of Pakistan should be formulated to consider
entity has indicated to other parties that it will accept the issue in order to formulate a solution which caters to the
certain responsibilities; and operational modalities of the open ended funds while complying
with the applicable financial reporting framework.
(b) as a result, the entity has created a valid expectation on
the part of those other parties that it will discharge those DISCLAIMER:
responsibilities.” The views expressed in this article are solely my personal
views and not of the company I represent.
If we analyze the above statement of the offering document in
light with the definition of constructive obligation it will be clear
that the above statement creates a constructive obligation on the 1
For the sake of simplicity the Element of loss and capital loss
mutual fund to distribute ninety percent of the accounting income is not discussed in this article.
and Para 14 of IAS 37 interalia requires that a provision shall be 2
International Financial Reporting Standards Bound Volume
recognized when an entity has a present obligation (legal or
2007
constructive) as a result of a past event. 3
International Financial Reporting Standards Bound Volume
From the above discussion it is clear that distribution of ninety 2007
percent income creates an obligation on the mutual funds which
needs to be recognized as a liability or as a provision on the
balance sheet however, in case of open ended funds since the
units are issued and redeemed on a continuous basis the
recognition of compulsory distribution as a liability may create Muhammad Rashid Zafer
issues in the issuance and redemption of units on the basis of Senior Manager Trustee & Custodial Operations with the Central Depository
Company (CDC) of Pakistan Limited. Readers can contact him at
NAV. For example if an open ended fund started its operation rashidzafer@yahoo.com
from Rs.100 and on the next day it earned Re.1 as profit the NAV

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The Pakistan Accountant Oct-Dec 2009 21


ARTICLES

Reporting on the
Long-Term
Sustainability of
PUBLIC FINANCES
Ian Sanderson FCA (E&W)

P
akistan is one of over 80 countries with plans in place expectancy increases it is becoming increasingly onerous for
to issue IPSAS (International Public Sector countries to pay the nationally funded pension benefits and
Accounting Standards) or IPSAS-similar financial healthcare costs of its ageing population. In response to the
statements within its public sector. Pakistan is being costs associated with an ageing population many countries are
supported financially by the World Bank as it exploring ideas of delaying the age when its citizens can receive
attempts as a first step to meet the requirements of the cash nationally funded pensions in an effort to reduce costs. One can
basis IPSAS before eventually progressing towards producing also consider the effects of the recent worldwide credit crisis and
full accruals based financial statements within its public sector. the cost incurred by many governments in bailing out their
economies, and in particular their banks; who will ultimately bear
Long-term sustainability of public finances these costs and when?
The IPSAS Board is the body responsible for setting accounting
standards in the public sector. While it aims for convergence with Clearly taxpayers and investors have an interest in long-term
International Financial Reporting Standards issued by the fiscal sustainability and how it will be funded, as does the IPSAS
International Accounting Standards Board, full convergence is Board which believes that public sector financial reports should
impossible because of the unique nature of the public sector. include both historical looking financial statements as well as
“prospective financial and other information about the reporting
An example of a difference between public and private sector entity’s future service delivery activities and objectives, and the
financial reporting needs can be demonstrated through the resources necessary to support those activities”.
recent release of an IPSAS Board consultation paper which
looks at “Reporting on the Long-Term Sustainability of Public Benefits of long-term sustainability reporting
Finances”. Currently many countries issue long-term sustainability
predictions looking from 50 to 75 years into the future. Such
Inter-generational fairness of fiscal policy predictions are typically carried out by economists, statisticians,
Reporting on the long-term sustainability of public finances and budget and policy specialists working in their national
involves an examination of the extent to which a government’s Ministries of Finance or Treasuries.
policies under its current legal framework can be met in the
future, assuming certain fiscal constraints, principally related to To a large extent long-term sustainability reports should prove to
levels of taxation. The issues addressed in the paper are be more interesting to most people than historic looking financial
becoming increasingly of interest as people become more aware statements. While historic financial statements typically cover a
of concepts such as the “inter-generational fairness” of fiscal single year and are subject to variations in the short-term
policy which means that our children and their children will economic cycle, forward looking predictions will help smooth out
ultimately bear the cost for fiscal decisions taken today. the peaks and troughs of economic cycles. From a fiscal
perspective governments can cover short-term fiscal deficits
An example of the inter-generational fairness of fiscal policy through borrowing, but over the long-term the chances of
involves the costs associated with an ageing population. As life funding continuous fiscal deficits through borrowing reduces,

The Pakistan Accountant Oct-Dec 2009 22


ARTICLES

and governments must take submitted to me by the


the unpopular political decision Treasury for examination” in
to raise taxation. To be most the government’s annual
beneficial long-term budget. This examination
sustainability reporting should includes looking at factors
be based on current used in estimates such as the
government policy; this will trend rate of growth and then
allow stakeholders to see the concluding on them. At least
long-term effect of current an independent review and
policies and anticipate what examination gives a little
remedial action must be put in more comfort in the reliability
place to create a balanced set of information presented.
of accounts in the long-term.
However, in many developing
Practical issues countries issues of
There are practical difficulties verification will prove more
in producing reliable long-term difficult to address because
fiscal sustainability reports, the future growth patterns may
most obvious being the be harder to estimate and the
reliability of estimates that infrastructure required to
reach well into the future. Even produce and validate long-
when producing historical term fiscal models may not
looking financial statements a currently exist.
key difficulty is the estimation of
provisions where an entity has Comparing like-with-like
a present obligation as a result There are also interesting
of a past event, such as paying technical issues that
the pensions of currently surround the qualitative
employed staff. Under long- characteristic of comparability
term sustainability reporting when producing long-term
estimates are taken a step sustainability reports. Many
further. You must estimate the governments produce

Clearly taxpayers and investors have an interest


future costs (e.g. health, financial statements which

in long-term fiscal sustainability and how it will


welfare, pension) of a are based on the concept of

be funded, as does the IPSAS Board which


population which may not yet control. From a financial
be born, and then try to reporting perspective control

believes that public sector financial reports


estimate the tax that will be requires the demonstration of

should include both historical looking financial


paid by that same hypothetical both the power to govern the

statements
population. financial and operating
policies of another entity (at
Although the future is hard, if least at the strategic level)
not impossible, to predict the and to benefit from the
information to be included in activities of another entity.
long-term financial sustainability reports must still have the However, in long-term fiscal sustainability reporting the concept
qualitative characteristics necessary to achieve the financial of control is often absent; many government entities which may
reporting objectives of holding people accountable for decisios not be strictly under the control of government (such as utility
made and for making optimal resource allocation, political and providers) will appear in sustainability reports. This means that
social decisions. The IPSAS Board considers the qualitative comparing historical financial statements with long-term financial
characteristics of financial reporting to be relevance, faithful predictions is not comparing like-with-like.
representation, timeliness, understandability, comparability and
verifiability. It becomes more difficult to attain these Improved future decision making
characteristics the longer you look into the future. For many people the question of whether long-term sustainability
reports should appear together with historical financial
Verifying the future statements is probably an irrelevance. Many people and
Just how do you verify what will happen in the distant future? investors, especially in developing countries, would simply like to
Future government revenues and costs are based on numerous have access to reliable long-term sustainability projections which
factors revolving around the relationship between labour and will allow them to make better informed personal or business
capital. In terms of labour, how productive will it be in the future? decisions. While historical financial statements are used for
What will future fertility and mortality look like, will people move accountability purposes, forward looking financial reports have
to, or leave the country? In terms of capital how productive will it the much more interesting potential to effect the life decisions of
be in the future - how much more technologically advanced will individuals.
the world become? Then there are other factors which will have
an impact on productivity – how much will climate change and
what will be its environmental impact upon economic growth?
Ian Sanderson
In the United Kingdom, the Comptroller and Auditor General is Fellow of the Institute of Chartered Accountants
required to, “examine and report on conventions and in England and Wales
assumptions underlying the Treasury’s fiscal projections that are

The Pakistan Accountant Oct-Dec 2009 23


AUDITOR’S
ARTICLES

REPORT IN
PAKISTAN
Muhammad Asif Iqbal, FCA

1. THE SCOPE OF AN AUDIT OF SEPARATE assurance about whether the financial statements as a
FINANCIAL STATEMENTS ARISING FROM THE whole are free from material misstatement, whether due
REQUIREMENTS OF COMPANIES ORDINANCE, 1984 to fraud or error in order to express an opinion on the
truth and fairness of the financial statements.
Section 255 of the Companies Ordinance, 1984 requires the
auditor to make a report on the company’s financial statements 2.2 Compliance with ISAs and ICAP Code of Ethics
to the shareholders that must state whether they have obtained The auditor is required to comply with:
all the information and explanations which to the best of their
knowledge and belief were necessary for the purposes of the a. all ISAs and International Auditing Practice
audit and that whether, in the auditor’s opinion: Statements (IAPs) that are relevant to the audit; and
b. ICAP Code of Ethics of Chartered Accountants.
 proper books of accounts as required by the Companies c. Other pronouncements issued by ICAP like ATRs etc.
Ordinance, 1984 have been kept by the company;
 the financial statements are in agreement with the books ISAs require the auditor to plan and perform an audit with
of accounts as referred above and have been prepared professional skepticism recognizing that circumstances
in accordance with the requirements of the Companies may exist that cause the financial statements to be
Ordinance, 1984; materially misstated.
 the financial statements give a true and fair view of the
company’s state of affairs, its profit or loss and its ISAs and the Code of Ethics contain basic principles and
cashflows and changes in equity in accordance with the essential procedures together with related guidance such
as the following.
approved accounting standards as applicable in Pakistan;
 the expenditure incurred during the year was for the  Planning
purposes of the business;  Understanding the company and its environment
 the business conducted, investments made and (including internal controls)
expenditure incurred during the year were in accordance  Identifying and assessing the risks of material
with the objects of the company; and misstatement through understanding the company’s
 Zakat deductible at source under the Zakat and Usher internal control system.
Ordinance, 1980 (XVIII of 1980), was deducted by the  Responding to assessed risks by determining the
company and deposited in the Central Zakat Fund nature, timing and extent of audit procedures.
established under section 7 of that Ordinance.  Materiality considerations in planning and performing
the audit.
The Companies Ordinance, 1984 requires the auditor to prepare
Auditor’s Report in accordance with Form – 35A which mandates The nature of these Standards requires an auditor to
the auditor to conduct the audit in accordance with the exercise professional judgment in applying them.
requirements of the International Standards on Auditing as Moreover, ISAs establish requirements in relation to
applicable in Pakistan. those areas of the auditor’s work where it is particularly
important that the views of auditors and users of financial
2. THE REQUIREMENTS OF THE INTERNATIONAL statements, regarding the nature and extent of work to be
STANDARDS ON AUDITING (ISAS) AND THE ICAP performed, are aligned. Such areas include:
REGARDING CONDUCT OF AUDIT OF THE
 Going concern.
SEPARATE FINANCIAL STATEMENTS
 The auditor’s responsibility to consider fraud in an
2.1 Overall objective audit of financial statements.
In conducting an audit of financial statements, the overall  Consideration of laws and regulations in an audit of
objectives of the auditor is to obtain reasonable financial statements.

The Pakistan Accountant Oct-Dec 2009 24


ARTICLES

2.3 Scope of an audit of financial statements  The report should be dated as of the completion date
An audit involves performing procedures to obtain audit of the audit which should not be before the financial
evidence about the amounts and disclosures in the statements are approved by the Board of Directors.
financial statements. The procedures selected depend  Since auditor’s responsibility is to report on the
on the auditor’s judgment, including the assessment of financial statements as prepared and presented by
the risks of material misstatement of the financial management, the auditor should not date the report
statements, whether due to fraud or error. In making earlier than the date on which the financial statements
those risk assessments, the auditor considers internal are signed or approved by management.
control relevant to the entity’s preparation and fair  The report should be signed in the name of the firm
presentation of the financial statements in order to alongwith the name of the engagement partner.
design audit procedures that are appropriate in the Additionally, the report should contain the date and
circumstances, but not for the purpose of expressing place of the signing auditor(s).
an opinion on the effectiveness of the entity’s internal
control. An audit also includes evaluating the 3.1 Unqualified opinion
appropriateness of accounting policies used and the An unqualified opinion should be expressed when the
reasonableness of accounting estimates made by auditor concludes that the financial statements give a
management, as well as evaluating the overall true and fair view (or are fairly presented, in all material
presentation of the financial statements. respects), in accordance with the identified reporting
framework.
3. OPINION ON THE FINANCIAL STATEMENTS
3.2 Modified Opinions
The opinion on the financial statements should be based on a
review and assessment of the conclusions drawn on the audit 3.2.1 Matter of emphasis
evidence obtained during the audit work.  In certain circumstances, the audit report may be
modified by adding an emphasis of matter paragraph
The audit report as prescribed by ISAs should: to highlight a matter affecting the financial statements
which is included in a note to the financial statements
 Contain a clear written expression of opinion on the that more extensively discusses the matter. The
financial statements taken as a whole. addition of such an emphasis of matter paragraph
 Have an appropriate title. does not affect the audit opinion. The paragraph
 Be appropriately addressed as required by the would preferably be included after the opinion
circumstances of the engagement and local paragraph and would ordinarily refer to the fact that
regulations (if any). the audit opinion is not qualified in this respect.
 Identify the financial statements of the entity that have  The addition of a paragraph emphasizing a going
been audited, including the date of and period concern problem or significant uncertainty is ordinarily
covered by the financial statements. adequate to meet the reporting responsibilities
 Include a statement that the financial statements are regarding such matters. However, in extreme cases,
the responsibility of the entity’s management and a such as situations involving multiple uncertainties that
statement that the responsibility of the auditor is to are significant to the financial statements, the auditor
express an opinion on the financial statements based may consider it appropriate to express a disclaimer of
on the audit. opinion instead of adding an emphasis of matter
 Describe the scope of the audit by stating that the paragraph.
audit was conducted in accordance with ISAs and  In addition to the use of an emphasis of matter
other relevant local laws. paragraph for matters that affect the financial
 Include a statement that the audit was planned and statements, the auditor may also modify the audit
performed to obtain reasonable assurance about report by using an emphasis of matter paragraph,
whether the financial statements are free of material preferably after the opinion paragraph, to report on
misstatement. matters other than those affecting the financial
 Describe the audit as including: statements. For example, if an amendment to other
information in a document containing audited financial
Examining, on a test basis, evidence to support statements is necessary and the entity refuses to
the financial statement amounts and disclosures. make the amendment, the auditor should consider
Assessing the accounting principles used in the including in the audit report an emphasis of matter
preparation of financial statements. paragraph describing the material inconsistency.
Assessing the significant estimates made by
management in the preparation of the financial 3.2.2 Qualified / Adverse / Disclaimer opinions
statements. The auditor may not be able to express an unqualified
Evaluating the overall financial statement opinion when either of the following circumstances
presentation. exists and, in auditor’s judgement, the effect of the
Include a statement that the audit provides matter is or may be material to the financial
reasonable basis for the opinion. statements:
Clearly state in the audit opinion that the financial a. there is a limitation on the scope of work; or
statements give a true and fair view (or are b. there is a disagreement with management
presented fairly, in all material respects) in regarding the acceptability of the accounting
accordance with the financial reporting framework policies selected, the method of their
and, where appropriate, whether the financial application or the adequacy of financial
statements comply with statutory requirements. statement disclosures.

The Pakistan Accountant Oct-Dec 2009 25


ARTICLES

The circumstances described in (a) could lead to a the auditor should express a qualified or adverse
qualified opinion or a disclaimer of opinion. The opinion as appropriate.
circumstances described in (b) could lead to a qualified  If the auditor concludes that the going concern
opinion or an adverse opinion. assumption used in the preparation of the financial
statements is inapprpropriate and therefore the
 A qualified opinion should be expressed when the financial statements are misleading, the auditor
auditor concludes that an unqualified opinion cannot should express an adverse opinion (ISA 570).
be expressed but the effect of any disagreement with
management, or limitation on scope is not material
4. COMMUNICATING WITH THOSE CHARGED WITH
and pervasive as to require an adverse opinion or
disclaimer of opinion. A qualified opinion should be GOVERNANCE
expressed as being “except for” the effects of the ISA 705 (paragraph 28) requires that when the auditor expects
matter to which the qualification relates.

to modify the opinion in the auditor’s report, the auditor shall
A disclaimer of opinion should be expressed when the
communicate with those charged with governance (Board of
possible effect of a limitation on scope is so material
Directors) the circumstances that led to the expected
and pervasive that the auditor has not been able to
obtain sufficient appropriate evidence and accordingly modification and the proposed wording of the modification.
are unable to express an opinion on the financial
statements. As explained under ISA 705-A25, communicating with those
 An adverse opinion should be expressed when the charged with governance the circumstances that lead to an
effect of a disagreement is so material and pervasive expected modification to the auditor’s opinion and the proposed
to the financial statements that the auditor concludes wording of the modification enables:
that a qualification of the report is not adequate to
disclose the misleading or incomplete nature of the a. The auditor to give notice to those charged with
financial statements. governance of the intended modification(s) and the
 Whenever the auditor expresses an opinion that is reasons (or circumstances) for the modification(s);
other than unqualified, a clear description of all the b. The auditor to seek the concurrence of those charged
substantive reasons should be included in the report with governance regarding the facts of the matter(s)
and, unless impracticable, a quantification of
giving rise to the expected modification(s), or to
possible effect(s) on the financial statements.
 confirm matters of disagreement with management as
When there is a limitation of scope on the work that
requires expression of a qualified opinion or a such; and
disclaimer of opinion, the audit report should describe c. Those charged with governance to have
the limitation and indicate the possible adjustments to opportunity, where appropriate, to provide the auditor
the financial statements that might have been with further information and explanations in respect
determined to be necessary had the limitation existed. the matter(s) giving rise to the expected
 Where the auditor disagrees with management about modification(s).
matters such as the acceptability of accounting
policies selected, the method of their application, or 5. SUMMARY
the adequacy of disclosures in the financial
statements, if such disagreements are material to the 5.1 Audit opinion
financial statements, the auditor should express a
qualified or an adverse opinion. When the auditor issues an audit opinion, the auditor
considers which type of audit opinion is appropriate in a
The table below (as given ISA 705-A1) illustrates how
particular situation. The following flow chart endeavors to
the auditor’s judgment about the nature of the matter
explain the situations that need to be considered in
giving rise to the modification, and the pervasiveness
issuing modified opinion i.e. opinion with emphasis of
of its effects or possible effects on the financial
statements, affects the type of opinion to be matter paragraph, qualified opinion, disclaimer of opinion
expressed. or adverse opi nion.

Nature of Matter Giving Auditor’s Judgment about the Pervasiveness


Rise to the Modification of the Effects or Possible Effects on the
See FLOWCHART 5.1 on Page No. 28
Financial Statements
Material but Not Pervasive Material and Pervasive
5.2 Matters that do affect audit opinion
Financial statements are Qualified opinion Adverse opinion
materially misstated When the auditor decides to issue modified opinion other
Inability to obtain sufficient Qualified opinion Disclaimer of opinion
appropriate audit evidence
than emphasis of matter paragraph, i.e. qualified opinion,
disclaimer of opinion and adverse opinion, the auditor
3.2.3 Going Concern needs to consider the following in each of these modified
The report should be modified by adding a paragraph to opinions issued:
highlight a material uncertainty regarding going concern
of the entity. However, in the following circumstances, the  Criteria on which modified audit opinion is issued
auditor should express a qualified or adverse opinion, as  Requirements of qualification paragraph
appropriate:  Appropriate place of qualification paragraph in audit
opinion
 If adequate disclosure about the going concern  Impact of qualification paragraph on other paragraphs
uncertainty is not made in the financial statements, of audit opinion

The Pakistan Accountant Oct-Dec 2009 26


ARTICLES

The above are described in the table below:


5.3 Going concern
Matters that Do Affect Opinion When the auditor concludes that going concern issue
Effect of the matter is material to the F/S exists, the auditor satisfied himself whether emphasis of
matter paragraph is sufficient or the auditor needs to
Qualified opinion Disclaimer of opinion Adverse opinion issue qualified opinion, disclaimer of opinion or adverse
Crteria • Disagreement with • Limitation on • Disagreement with opinion. The decision is based on the situation. The
management re: scope management re: following table lists the criteria, requirements of
• acceptability of • Effect of limitation • acceptability of qualification paragraph, disclosure required in the
accounting policies on scope is accounting financial statements, appropriate place of qualification in
selected material and policies selected
audit opinion and impact of qualification on other
• Method of their pervasive • method of their
application application
paragraphs of the opinion.
• adequacy of F/S • adequacy of F/S
disclosure disclosure See FLOWCHART 5.3 on Page No. 29
• Limitation on scope • Effect of
• Effect of disagreement or disagreement is 5.4 Emphasis of matter paragraph for other than going
limitation on scope not so material and concern problem
material and pervasive pervasive
• Discloses
misleading or Following table shows the criteria, requirements of
incomplete nature qualification paragraph, its appropriate place in the audit
of F/S opinion and impact on other paragraphs of the opinion.

Other than Going Concern Problem


Qualification • Clear description of • Clear description of • Clear description of Emphasis of matter paragraph
paragraph limitation on scope limitation on scope the disagreement
• Quantification of possible • Quantification of • Quantification of Criteria • Significant uncertainty exists and
effect unless impracticable possible effect possible effect
• Reference to more unless unless whose resolution is dependent
extensive discussion in impracticable impracticable upon future events that may affect
note, if any • Reference to more • Reference to more F/S
• Indicate possible extensive extensive • Outcome of uncertainty depends on
adjustments necessary had discussion in note, discussion in note,
if any if any
future actions or events
limitation not existed
• Indicate possible that are not under direct control of
adjustments the entity but may affect F/S
necessary had Qualification
limitation not paragraph • Add “without qualifying our opinion”
existed
• Highlight
• The event; and
Appropriate • Add paragraph before • Add paragraph • Add paragraph • State ultimate outcome cannot be
place opinion paragraph before disclaimer before opinion presently determined
opinion paragraph paragraph
• No provision for any liability that
Impact on For limitation on scope • In first paragraph • In opinion result has been made in the F/S
other • In auditors responsibility change the words paragraph add Appropriate • Include after opinion paragraph and
paragraphs paragraph add “except as “we have audited” “because of the place before other reporting responsibility
discussed in the following to “we were effects of the
paragraph”. For limitation Impact on other No impact
engaged to audit” matters discussed
on scope only • Omit the sentence in preceding paragraphs
• In opinion paragraph add stating the paragraph, the F/S
“except for the effects of responsibility of the do not give a true
such adjustment, if any, as auditors and fair view”
might have been • Scope of audit
determined to be paragraph omitted
necessary had we been or amended
able to satisfy ourselves as • Add paragraph
to (state limitation) discussing the
scope limitation
For inappropriate accounting • In place of opinion
method paragraph state
• In opinion paragraph add “because of the
significance of the Muhammad Asif Iqbal
“except for the effect on the
F/S of the matter referred
matters discussed Director Technical Services of ICAP
in the paragraph so
to in the paragraph so and and so above, we
so above” or any other do not express an
appropriate wordings on opinion on the F/S
the basis of each of the Note:
circumstances
For inappropriate disclosure
The author is extremely grateful to Mr. Usman Ghani Akbani for
• In opinion paragraph add allowing him to reproduce section 5 of the article from his
“except for the omission of
the information included in
presentation which he delivered at ICAP SMP Workshop on
the paragraph so and so
March 14, 2009. Further, the author is also thankful to Mr.
above”” Farrukh Rehman, Mr. Arslan Khalid and Ms. Farheen Mirza for
their support in finalizing this article.

The Pakistan Accountant Oct-Dec 2009 27


ARTICLES

FLOWCHART 5.1

The Pakistan Accountant Oct-Dec 2009 28


ARTICLES

FLOWCHART 5.3

The Pakistan Accountant Oct-Dec 2009 29


ARTICLES

COMPLEXITIES AND
ABSENCE OF UNIFORM
VALUATION PROCESS
OF INTELLECTUAL
ASSETS VALUATION
Mohammed Hanif Ajari, FCMA

Having worked for globally renowned pharmaceutical accountants, academics, consultants, regulators, tax authorities
companies engaged extensively in Research & Development, and valuation thought-leaders. But there is no general
production of active pharmaceuticals, formulation of agreement or consensus among them on how the valuation of
pharmaceutical products, and in addition to this deploying their intangibles should be conducted. Several attempts have been
resources in marketing and distribution activities, I have noticed made in the past decade to develop uniform standards of valuing
that there is an increasing recognition that ideas, knowledge, intangibles but none has had a visible impact on IP valuations or
know-how, innovations and other intangibles are fundamental has significantly improved the quality and consistency of IP
sources of value in business. But identifying and measuring that valuation reports. Why not? What are the major issues that have
value is a complicated process with numerous non standard prevented the development of intellectual assets valuation
modules and methods currently available to do so. In the case of standards?
Intellectual Asset Management, Intellectual Property, a valuable
form of intangible to the business and financial communities, Out of the various attempts made previously to harmonize the
there is particular interest in improving the consistency, quality standard of IP valuations none were successful which can affect
and usefulness of valuations. their value. With the greater understanding at hand, and given
the importance of IP to an increasing number of businesses, it
Asia, with its conglomerates of the world’s emerging countries, seems it is time to investigate three fundamental questions
has always been something of an enigma for intellectual relating to standardizing IP valuations:
property owners. On the one hand, it is one of the most
economically dynamic regions of the world, where increasingly 1. Does it make sense to standardize IP valuations?
prosperous populations have more money to spend than ever
before. While on the other hand, it is also a continent in which 2. If so, what should be the standard?
piracy and counterfeiting are rife, and where, in general,
governments, courts and enforcement agencies have been slow 3. How valuation standards are formulated and implemented
to tackle the difficulties rights owners face. The problem, successfully?
therefore, is a tricky one. Should rights owners fully engage in
Asian markets for the potential they offer in terms of increased The answers to these questions depend on the perspective of
opportunities, or should they choose to stay out because of the the person asked and the professional communities within which
risk that IP thieves could undermine substantial investments, they operate. The different, and sometimes narrow, interests and
while the authorities stand by and do little to help? One of the focus of each community have made it impossible for them to
other important reasons behind this fiasco in Asia is lack of agree on any one standard for IP valuation. Further, the
understanding of the valuation of intellectual assets to a greater tendency of businesses to consider IP valuation mainly within
extent even with the exponential increase in the impact of market the context of the financial accounting paradigm has been a
capitalization due to the presence of intangibles. major obstruction to the development of believable and useful
valuation standards.
Valuation of intellectual assets is a matter of immense
importance to a large number of professional communities, Although standardization affects assorted communities, the one
which include business people, valuation professionals, most directly affected is the IP valuation community itself. For

The Pakistan Accountant Oct-Dec 2009 30


ARTICLES

this reason it seems reasonable to begin an examination of In contrast to technical standards organizations, professional
standardization through the eyes of this community. For credible standards organizations spotlight the ethics, methods and
views on the three fundamental questions above, I have practices in specific professions. Examples include the
reviewed the literature and material printed on this subject by the accounting profession (in North America they are the US
respected academics and practitioners who have made Financial Accounting Standards Board (FASB), the Canadian
significant intellectual contributions to the field of intellectual Institute for Chartered Accountants (CICA) and Mexico’s
property valuation, both in theory and in practice. This article Instituto de Contadores Publicos); the legal profession - the
presents the condensed views of a panel of experts in professional standards committees of the national bar
Intellectual Asset Management. No one from the intellectual associations; and the medical profession - the professional
community has written all of the ideas in a single paper, although standards committees of the national medical associations; to
there is a complete consensus on the basics. The consensus is name but a few.
on the need for standardized valuations.

Standards and Standardization


Each profession establishes its own standards, some relating to
ethics, others to methods of operation and still others to specific
practices. Unfortunately there is no specific focus on valuation
There are two broad types of which is the core issue today.
standards: rule-based standards and Particularly the recent meltdown in
principle-based standards (I refer to global finance market has authenticated
standards in this context to mean market capitalization directly or inversely
guidelines and definitions, such as related to the presence of intangibles on
ISO9000 for quality systems and the balance sheet of the companies.
ISO14000 for environment). Rule-
based standards are often found in Is the IP valuation community
environments where there is both a sufficiently organized and unified to
need and a capability to enforce the warrant the establishment of either a
standard. Principle-based rule-based or a principle-based set
standards are often used in of standards such as those
professional environments where described above? The IP
definition and understanding of valuation communities have
accepted professional portrayed different arguments,
behaviour enforcement is the each with its own perspective.
focus. It is a scrappy community
populated by people trained
Traditionally, there has been in accounting, economics
a periphery between and finance; IP valuation
technical standards has not yet achieved the
organizations and degree of structure
professional standards necessary to call itself a
organizations, although profession. A standard
the lines between them for IP valuation
are beginning to smear. developed around the
On the technical side, context of any one of its
perhaps the premier constituents (accounting,
organization is the International economics or finance) could be
Organization for Standardization entirely wrong for the others.
(ISO) established to: “Facilitate the Standards are more easily implemented
international coordination and when they are toughened. A good
unification of industrial standards.” ISO example of underpinning is found in the
is made up of member bodies that are Canadian accounting profession, which
“most representative of standardization” uses four main sets of standards:
in their countries. Only one organization
from each country is accepted for membership in the ISO. So, for 1. Financial reporting standards - standards for measurement
example, in the United States the member body is the American and disclosure.
National Standards Institute (ANSI); in Canada it is the Canadian 2. Auditing standards - dealing with matters concerning the
Standards Council; and in Japan it is the Japanese Standards process of auditing.
Association.
3. Ethical standards - a code of professional conduct for
accountants.
The need for an ISO standard is usually expressed by an
4. Certification standards - defining the body of knowledge and
industry sector, which communicates this need to an ISO
national member body. The latter proposes the new standard to the competencies that accountants are expected to possess.
the ISO as a whole. Once the need for an international standard
has been documented and formally agreed, the first phase The first two sets of standards are the responsibility of an
involves defining the technical scope of the future standard. This independent standards-setting organization and the profession
phase is usually carried out in working groups of technical itself manages the latter two. The four different categories of
experts from countries interested in the subject matter. Although standards are mutually reinforcing. The auditing standards
the ISO and its member bodies have typically focused on reinforce the financial reporting standards; the ethical and
technical and industrial standards, they have more recently certification standards ensure that accountants are qualified and
become involved with management systems standards. motivated to live up to the financial and auditing standards since

The Pakistan Accountant Oct-Dec 2009 31


ARTICLES

failure to maintain one’s knowledge or to act ethically can cut a on ensuring that IP valuations be conducted within unique
career short. In short, standards of practice or performance may frameworks associated with their different perspectives and IP
work best when they can be developed in recital with other contexts. The panel largely, but not unanimously, agreed that an
standards that reinforce the desired conduct. IP valuation standardization process should be led by the IP

What is the generic process for valuing intangibles?


valuation community. The arguments for standardization are
identified as follows:

Whether projecting price or worth, professionals who seek to 1. The need to create a common language: The terms often
value IP follow a nonspecific process. Before doing any used in the valuation of intangibles are not used uniformly.
calculations they identify the factors that define the context of the The word value itself is used to mean several different things.
valuation at issue. They identify the method that will be used, A standard should define the relevant terminology in order to
the key parameters concerned, the data required for the provide clarity in communications and minimize the chances
calculation and information about the markets, as well as any of misunderstanding.
external factors deemed to be relevant. Professional valuators 2. The need to improve the consistency of valuations and
recognize that valuation is as much an art as a science, meaning valuation reports: Because there are so many methods and
that while there are protocols and

The reasons for standardizing IP


so many IP valuators, with
accepted procedures (the different professional training and

valuations depend largely on the


science), the decisions that levels of understanding, there is
precede calculation are perhaps little consistency in how

perspective of the person asked. People Some include background


more essential to a successful IP valuations are conducted and
valuation activity than the what IP valuation reports contain.

outside the IP valuation community - for information,


calculations themselves. Making
those judgments (the art) is the sources of data

example, regulators, tax authorities and judgments. Others provide little


inherent in the process and must used and the details of business
be considered in any

accounting standards setters - answer


standardization procedure. more than the type of IP being
valued and a value estimate. IP

differently from those inside it.


Factors identified for generic valuation standards could
process of valuation are:- improve consistency by defining
what a standard IP valuation
1. The purpose of the valuation report should contain.
estimate (e.g. tax, external performance reporting, sale, 3. The need to minimize unethical and incompetent valuations:
licensing or litigation) as well as any purposes for which the Professional valuators are implicitly entrusted to use their
valuation specifically may not be used. professional knowledge and skill to provide the best
2. Identification of the beholder, the person from whose valuation estimate possible. But some intentionally abuse
perspective the valuation estimate is viewed (e.g. external that trust; while others may be well-intentioned but lack
beholders, such as potential investors, shareholders, knowledge and experience. Standards would help to
prospective purchasers; or internal beholders, such as the minimize unethical and incompetent valuations by defining a
CEO, the CFO, chief legal officer, licensing officer, chief R&D set of ethical principles and behaviours to which IP valuators
officer). are expected to adhere.
3. The definition of value used; for example, worth - value in 4. The need to define required valuator knowledge: People who
use to a specific beholder; or price - a historical or future
are new to the field of IP valuation may lack an adequate
estimated selling price. Any premises that should be
understanding of the nature of IP - the special considerations
understood to affect value (e.g. whether the business is a
related to valuing IP, how IP is used in business and the
going concern, or has filed for bankruptcy and so on).
different kinds of value it can provide. In the absence of
4. Timeframe of the value estimate (past, current or future).
standards defining the level of knowledge and know-how
5. The standard of measurement (market capitalization, value
necessary for valuing IP, such people blithely enter where
in exchange, value in an accounting framework).
others fear to tread. A standard could require or recommend
6. The unit of measurement (for example, currency, indices,
a particular level of knowledge and understanding on the part
ratios, vectors).
of the valuator.
Why should IP valuations be standardized?
5. The need to let clients and users of a valuation know what to
expect: Clients and users of valuation results should know
The reasons for standardizing IP valuations depend largely on something about IP value and valuation, as well as what to
the perspective of the person asked. People outside the IP expect from the person conducting the valuation. This might
valuation community - for example, regulators, tax authorities include educational information about the value and
and accounting standards setters - answer differently from those valuation of intangibles, examples of what a valuation report
inside it. Regulators are interested in leveling the playing field, is expected to contain, information about the level of
ensuring that IP valuation information is understandable and knowledge required of IP valuators and information about
available to all interested parties. Tax authorities want IP what the profession has codified as its code of ethics.
valuations to be consistent, credible and conducted in accord
with their own standards; financial accountants need valuations Experts in the international Intellectual Asset Management arena
to comply with Generally Accepted Accounting Principles have laid three major arguments against standardization:
(GAAP) or International Financial Reporting Standards (IFRS).
But professional IP valuators, people inside the IP valuation 1. The number of factors that are specific to each intangible
community, have different concerns. The focus of IP valuation makes standardizing their valuations impossible.
professionals is on improving the quality and consistency of IP 2. Standardization could oversimplify what is inherently a
valuations; whereas the focus of those outside the community is complex process.

The Pakistan Accountant Oct-Dec 2009 32


ARTICLES

3. We should avoid arriving at only one view of valuation - one community. Developing any standard from the collective
that is North American or European centric, for example. perspective of such a broad field of interested entities and
Such a singular view of IP valuation could cause people to individuals will be difficult. One practical alternative appears to
make assumptions about the value of IP that are not be the potential development of IP valuation standards from the
necessarily valid in all corners of the world. perspective of the IP valuation community, the group most

What can be standardized?


directly concerned with the quality and consistency of valuation
results. Other interested groups, individuals and organizations
might adapt that standard to meet the needs of their own
Information material available suggests the following key factors communities.
need to be considered while arriving at a consensus for
development of standard guidelines in ascertaining uniform Although there are several conclusions one may draw from the
practices for establishing IP valuation. preceding discussion, two are unequivocal:

1. Ethical guidelines for valuators: There are currently no 1. IP valuation standards would be useful, particularly if they
generally agreed ethical standards to which valuators in the were focused on principles rather than on detailed rules.
IP valuation community must adhere. There are individual 2. At a minimum, such standards should focus on improving
professional groups within the IP community that have both the quality and the consistency of IP valuations and
developed standards of behaviour for their members, but valuation reports.
these are neither accepted nor necessarily practiced beyond
the borders of the groups’ membership lists. On the question of how such standards might be developed and
2. Terminology: Too frequently, valuation reports contain terms implemented, however, there is not yet a clear path. There is not
and phrases that are undefined, ambiguous or unique to an yet an IP valuation profession, or even a common understanding
industry or area of business. A glossary or dictionary of of what or who constitutes the IP valuation community. Still, it
commonly used terms would minimize misunderstandings. appears that business and regulatory communities have a need
3. The identification of elements that constitute the context of and a desire for some sort of standard for valuation activity and
the valuation: It is now common wisdom in the IP performance. Perhaps it is time to discuss whether to formalize
management community that IP (and other intangibles) are an IP community (as distinct from the broader valuation and
operationally passive, having no value by themselves. It is assessment community) as a step towards the ultimate
only when these intangible assets are teamed with other development of an IP valuation profession.
(often tangible) assets, operational capabilities or uses that
their value can be realized. The context within which an IP Because there is no single organization capable of credibly and
asset is used defines the nature and amount of value it can effectively sponsoring an IP valuation standardization effort, a
provide to a specific owner or user. Although our consortium of several potential sponsoring bodies could be
understanding of context is still evolving, the panel provided created to provide the necessary oversight. Although today the
an understanding of the elements that currently appear to IP valuation community is a community in name only, the
define it (Standards could require that the context of an IP importance of IP valuations and the concomitant desirability of
valuation be included in any valuation report). an IP valuation profession mean that the development of an IP
4. The content of a valuation report: Clients often complain that profession should be a topic for future discussion.
IP valuations are inconsistent. In part, this is true because
there is no broad agreement on the appropriate or necessary As Vice President of the Institute of Cost & Management
content. An IP valuation standard could list appropriate and Accountants of Pakistan, and as member and advisor on the
desirable content categories with examples. board of the South Asian Federation of Accountants the author
strongly recommends that the SAFA board should take up this
How should valuation standards be created and implemented issue as a challenge and acclimatize member countries with this
successfully? Several items are deemed to be particularly valuable subject.
important in developing IP valuation standards that are viewed as
credible by professionals within and outside the IP field. These Reference material from the works of:
are: oversight of the standards development process; broad- 1. Dr. Daan Andriessen, Professor of Intellectual Capital at In Holland University
based professional participation; and an understanding of the and author of Weightless Wealth
steps to be followed during the standards development process. 2. Dr. Baruch Lev, Professor of Accounting and Finance at New York University;
author of two books and many articles on intangibles and their value
How to organize:- Although the large number of concerned 3 Rob McLean, President of Matrix Links, author of Re-Discovering
stakeholders in this effort creates the possibility for an unwieldy Measurement , and adviser to the Canadian accounting profession on
intellectual capital and value measurement
organization, the panel did not provide specifics on how the
4 Russell Parr, President of Intellectual Property Research Associates Inc
effort might be organized. The panel agreed that a steering
(IPRA); author and co-author of 10 books on intangibles and valuation
group should guide the process, though it did not agree on its 5 Gordon Smith, Chairman AUS, Inc., author and co-author of several books on
make-up. One view was that the steering group should comprise IP valuation; Adjunct Professor and director of IP Institute at Pierce Law
only members of the IP valuation community, working closely 6 Dr. Alexander Wurzer, Managing Director of PATEV; Director of the Institute for
with a more widely constituted working group made up of Intellectual Property Management at Steinbeis University, and author of
members of stakeholder organizations. The counterview was several books and articles on IP valuation
that the steering group should include both IP valuation
community members and other stakeholder representatives. Mohammed Hanif Ajari
Vice President of the Institute of
Summing up:- The valuation of intellectual property is more Cost & Management Accountants of Pakistan and
complex than valuation of real or tangible property. Numerous Director Strategic Development with
business, academic, regulatory and professional bodies and Getz Pharma (Pvt.) Limited
individuals have a stake in the valuation of IP. They view it
through lenses that are polarized by the needs of their own

The Pakistan Accountant Oct-Dec 2009 33


ARTICLES

Advanced Fee Fraud


Saima Batool & Wasi Ahmed

Advanced Fee Fraud is a criminal made with the fraudster posing as senior  Forged Documents: Many forged
offence. The ‘scam’, as it is now widely government officials, a victim or official-looking documents.
known, is initiated by syndicates with dependant of government’s abuse of
members in different parts of the world human rights. They claim that they are in  Strong Ties: Claims are made that the
possession of a large other parties are employed in, or have
amount of money. strong ties with the government, the
The proposal usually Central Bank of the country, or
involves the transfer dependants of a dead or living victim
of the money to a of the government’s human rights
bank account outside abuse.
of Nigeria, to that of
the targeted victim. A  Huge Sums of Money: The deal
plausible or always involves the transfer of huge
sympathetic sums of money usually in dollars
explanation is usually either kept in a secret vault or account
given for the transfer, known only to the fraudster.
although they
basically appeal to  No Risk: The victims are usually told
the intended victim’s that there is no risk involved.
strategically located to implement their greed usually with a promise of a sizeable
different tasks to ensure the success of percentage of the money transferred, as a  Bank Details: The bank details of the
the deals. As the name of the crime commission for the use of the bank victim are requested and some
implies, the fraudsters through deception account. personal documents.
obtain money or goods from the victims in
advance in lure of promised financial If the intended victim is interested in the  Advance Fee: Finally an advance fee
benefits accruable to the victims after the deal, they are requested to forward a is usually required to either pay for
conclusion of the ‘deal’. variety of paperwork which generally some legal fees, transfer fees, or to
includes blank company letterheads bribe government or bank officials.
We should also note here that the deals which are duly signed, blank invoices,
are usually not legal; there are always telephone and fax numbers, and The Internet has not only brought about
indications of bribes to be paid to some especially bank account details; these development in communications and
government or bank officials, evasion of being required to effect the transfer of the commerce and all other facets of human
official tax and other illegal activities to money into the bank account. endeavors, but it has also provided a
ensure the success of the deal. What platform for criminals to take advantage
usually attracts the victims to co-operate
with the fraudsters are the attractive
F E AT U R E S O F T H E S C A M of unsuspecting members of the public
using a faster and cheaper means of
financial benefits they hope to gain at the LETTERS communication. Unlike other criminal
end of the deal, thus in the real sense activities, crime on the Internet has no
both the fraudsters and the victims have  Urgency: The letter will stress the boundaries. Hence, a scam letter can
wrong motives. urgency of the matter. be sent from any country to any part of
the world, posing challenges to law
The scam is initiated with the fraudster  Confidentiality: The confidential
enforcement agencies all over the
contacting a targeted victim, either by fax, nature of the transaction is always
world.
phone or e-mail and a proposal or request stressed.

The Pakistan Accountant Oct-Dec 2009 34


ARTICLES

AUDIT FILE
Sadia Kaleem, ACA

A. Please see that followings are in your


Audit Files:
22. Policy regarding staff retirement 42. Stock in trade is distinguished as
benefits Raw Material, Finished Goods and
23. Working papers reflect the Work in Progress.
1. Engagement letter conclusions drawn from the audit 43. Audit program for stock in trade and
2. Evidence of audit planning evidence. P&L items. Evidence of audit
3. Audit program relating to the Profit 24. Working papers are properly working paper reference or any
and Loss account items referenced or cross referenced conclusions drawn by auditor.
4. Documentation of internal control 25. Verified existence of all motor 44. Work is performed for verification of
and risk assessment procedures. vehicles & original documents valuation of stock based on lower
5. Extract of minutes of Board of 26. Certified & updated copy of of cost or NRV and evidenced
Directors meetings relating to Fixed Memorandum and Articles is on the 45. Valuation sheets of stock in trade
Assets. permanent file. mentions the rates at which the
6. Letter of representation 27. Cash flow statement is signed by valuation was made.
7. A copy of financial statements the Board of Directors. 46. Physical count papers of stock in
approved by Board of Directors 28. Sales and purchase cut off tests trade and stores are available.
8. Direct confirmations for finance are applied by the auditors. 47. The auditor attended the physical
lease, trade debtors & trade
29. Contribution to Provident Fund by stock count or an alternative
creditors.
the company procedures was carried out.
9. Evidence in respect of advances,
30. Management letter is sent by the 48. Information is provided of Financial
stock in trade and debtors.
auditors. Instruments as per IAS 32.
10. Bank confirmation letters
31. Evidence is documented in the 49. The financial statements include the
11. Confirmation from tax advisor
working papers indicating the statement of compliance with IAS as
12. Reconciliations of figures sent to
which party does not agree. weaknesses in the accounting and applicable in Pakistan as required by
13. List of banks and legal advisors internal control systems. para 91a and 94 of IAS 1.
from its client. 32. The letter of representation is dated. 50. Corporate Governance Compliance
14. Confirmation from legal advisors. 33. Disclosure requirements with review checklist or evidence of
15. Disclosure checklist regards to the date of authorisation work done in this respect.
16. Supervisor has initials on the of financial statements 51. Details of disposal of fixed assets
working papers. 34. Tax deducted at source is and names of persons to whom
17. Going concern and Subsequent separately disclosed. disposals were made, is provided in
review checklists are reviewed by a 35. Note on the status of tax the financial statements.
supervisor. assessments is disclosed. 52. Fraud and Error review checklist
18. The basis of conclusion on which 36. Work is performed by the auditors 53. Sales and purchases were only
the auditor issued an emphasis to review any impairment of assets. traced to the sales tax challans. On
para on going concern is 37. Working papers for : a working paper, the auditor
documented. 38. Provision for taxation observed that sales vouchers
19. Exceptions noted during audit are 39. Cash flow statement (supports) are not available.
properly disposed off. 40. Statement of Changes in Equity 54. Notes to the accounts are signed
20. Number of employees is disclosed. 41. Audit evidence exists for by the Board of Directors.
21. The amount of deferred tax is comparison of cost and Net 55. Sales tax payable is not merged
provided and the related reasoning Realisable Value of stock in trade. with other liabilities.

The Pakistan Accountant Oct-Dec 2009 35


ARTICLES

56. Audit ticks and work done is 82. Related parties are identified. 104. Subsequent events review was
documented on working papers. 83. Sufficient and adequate audit performed on 14.08.03, whereas
57. Audit evidence exists for creditors, evidence is available in respect of audit report was signed on 22.08.03.
other income, financial changes, Capital Work in Progress. 105. Direct confirmations are received in
and administrative and selling 84. Auditor has documented the respect of Advances- Capital Work
expenses. reasons for classifying Advance in Progress.
58. Work to prove that auditors against repurchase of land 106. Sufficient and adequate audit
performed procedures to verify amounting to Rs. 25m outstanding evidence in respect of provision for
existence and valuation of stock. for three years as an advance slow moving and obsolete spares.

B. Please see that following


Working papers are not with an ex- rather than classifying it as a fixed

checklist/details or workings are in


partner who has left the firm asset.

Audit File:
because of dispute. 85. The maximum amount outstanding
59. Surplus on revaluation of fixed
as receivable at the end of any
assets is recorded properly. 1. Knowledge about client business
month during the year is disclosed.
60. An engagement letter is issued for 2. Directors meeting relating to Fixed
86. Movement of accumulated
first time audit. Assets.
depreciation is disclosed as
61. Knowledge of the company or its 3. Physical cash counts are done.
operations is documented. required by IS –16 Property, Plant
4. Separate permanent file..
62. Preliminary judgement for and Equipment. 5. Analytical review procedures at the
materiality levels is considered. 87. Depreciation methods used are planning stage.
63. Audit programs disclosed. 6. Audit sampling techniques are
64. Evidence of review of work or 88. Depreciation is charged at revalued adopted while selecting items for
conclusions drawn. amounts. testing.
65. Letter of representation 89. Auditor’s judgement on the change 7. Audit report is in accordance with
66. Subsequent events review checklist rate of depreciation is documented Form 35-A.
is available. in the working papers. 8. Preliminary judgement relating to
67. Lease agreements 90. Sales tax payable and other materiality level for audit purposes
68. No work for Corporate Governance statutory dues are disclosed is considered.
compliance separately. 9. Work is performed for valuation of
69. Letter of representation is not signed 91. Movement in the provision for stock in trade.
only by Chief Financial Officer. doubtful debt balance is disclosed. 10. EPS is disclosed in Profit & loss
70. Letter of representation was signed 92. Note relating to transactions with Account.
five days before the date of the associated undertakings / related 11. Letter of representation is not
audit report. parties is disclosed. signed only by Chief Executive.
71. Letter of representation was signed 93. Sufficient and appropriate audit 12. Unclaimed dividend is not disclosed
by one director and was dated a evidence exists in respect of as unpaid dividend.
day before the date of the audit Director’s Loan account & direct 13. The original copy of accounts is not
report. confirmation is obtained. on the auditor’s letterhead.
72. Material variances in analytical 94. Extracts of the minutes of the Board 14. Balance Confirmations are
review is recorded or discussed. of Directors meetings are in file. addressed to the firm, not to entity.
73. Last page of the notes to the 15. Working papers are reviewed.
95. Working for deferred taxation was
financial statements of the 16. Extent of verification performed is
not available in the working papers.
approved copy is signed by the documented in it.
96. Letter of representation is dated. It
Chief Executive and Director. 17. From banks if some securities are
is on the company’s letterhead.
74. Audit Report is dated before Letter not disclosed, reason must be
of Representation. 97. Note on status of pending /
documented.
75. Audit evidence is in file regarding disputed tax assessments is 18. Disclosure of future minimum lease
staff retirement gratuity, amount disclosed as required by payments.
payable to associated undertakings Companies Ordinance, 1984. 19. Procedures are performed to
76. Break down is available for long- 98. Advance tax deductions are shown ascertain the going concern
term deposits.. as a separate line item rather than assertion.
77. Donations are disclosed separately under receivables. 20. Working paper on going concern
as required by Companies 99. Some confirmation letters received review are developed and auditors’
Ordinance, 1984. from third parties were not judgement regarding
78. Audit sampling techniques are specifically addressed to the firm. appropriateness of going concern
adopted even if extensive testing 100. Letter of representation was dated assumption is documented
on random basis was performed 18.07.03, whereas the audit report 21. Following items are classified as
79. Unrecognised deferred tax liability was signed on 09.10.03. It was required by the Companies
is disclosed as required by signed only by the General Ordinance 1984:
Companies Ordinance, 1984. Manager Finance.  Land - Freehold / Leasehold
80. Current maturity of long term 101. Auditor’s report is addressed to the  Buildings - Freehold /
deposits is disclosed as current shareholders of the company. Leasehold
liability. 102. Evidence of physical verification of 22. Disclosure are made for
81. Auditors issued the Review Report share certificates of short term  Trade Debtors (considered
to the members on Statement of investments good/ doubtful)
Compliance with Practice of Code 103. Advance to directors shown as part  Advances (considered good/
of Corporate Governance. of Current Assets. doubtful ).

The Pakistan Accountant Oct-Dec 2009 36


PRELUDE
2003 The Beginning of the End
It all started in June 2003 when US Federal Reserve Chairman Alan Greenspan
lowered the Fed’s key rate to 1%, the lowest in 45 years. In the same month
the US unemployment rate reached a then cyclical peak of 6.3% and held
there until June 2004.
US monetary policy was intentionally eased between 2001 and 2004. The
Federal Reserve believed that monetary policy should respond aggressively to
pre-empt the threat of consumer price deflation. Monetary policy in Australia,
Canada and much of Europe was also easy at this time.
However, according to Dr. Stephen Kirchner, a Research fellow at the Center for
Independent Studies, unintentionally this policy prompted the US government
to subsidize financial risk-taking by home-buyers and financial institutions. As
housing prices stopped rising and low introductory mortgage rates ended,
buyers began defaulting on their loans. Many of the loans backed bonds that
were sold to investors around the world.
By 2006 lenders had already made $640 billion in subprime loans. By the
summer of 2007, the first signs of the subprime crisis had started to appear. By
late August of the same year defaults on subprime mortgages had started to
occur, much earlier in the mortgage process.
The signs of a weakening mortgage credit market were rapidly emerging.

The Pakistan Accountant Oct-Dec 2009 38


enforcement investigations into The company lost $704 million in 2007
collateralized debt obligation (CDO) and another $893 million during the
practices. first quarter of 2008.

CDO is an investment-grade security July 31, 2007


backed by a pool of bonds, loans and
“The worst thing that ever happened to

2007
other assets. CDOs are unique in that
they represent different types of debt Bear Stearns.”
and credit risk often referred to as
‘tranches’ or ‘slices’. Each slice has a The two Bear Sterns hedge funds that
different maturity and risk associated had reported losses on July 17 file for
January 3, 2007 with it. The higher the risk, the more Chapter 15 bankruptcy. Bear Stearns
the CDO pays. winds down the funds and liquidates all
Ownit Mortgage Solutions Inc., which of their holdings.
owed Merrill Lynch around $93 million,
July 9, 2007
files for Chapter 11 bankruptcy. August 1, 2007
Private equity firms* start raising
February 7, 2007 money to buy bad mortgage debt at Two civil lawsuits are filed against Bear
deeply discounted rates. Sterns for misleading investors about
HSBC, London releases a statement the extent of exposure of the two hedge
about a slump in its Mortgage Services funds to subprime debt.
Credit Suisse releases a report stating
operations owing to increased
CDO losses could total up to $52 billion.
delinquencies of US subprime August 3, 2007
However, analysts say that did not pose
mortgages. HSBC is Europe’s largest
any systematic risk to banks. The Germans get dragged in
bank.
* Apollo, Blackstone, and TPG, Marathon Asset
The bank is unable to refinance because Management, GSC Group, Pimco, and Fortress A German government-led bailout of IKB
of falling equity prices. Investment Group are some of those active in the Deutsche Industriebank results in state-
market. owned KfW assuming up to €1 billion in
February 10, 2007 losses.
July 17, 2007
G7 Finance Ministers meet in Essen, KfW and other banks agree to guarantee
Germany. On top of their agenda is the In a letter to investors, two Bear Stearns
hedge funds specializing in subprime up to €8.1 billion in liquidity to cover
lack of regulation of hedge funds. the loss in value of Industriebank’s
debt announce that each fund has lost
at least 90% of its value. The two funds subprime US investments.
April 3, 2007
had $1.6 billion in investor capital.
New Century Financial Corp. defaults on August 9, 2007
$8.4 billion in loan repayments and files Both funds had used ‘AAA’ rated … and then the French
for Chapter 11. tranches of subprime, mortgage-backed
securities. BNP Paribas SA, France’s largest bank,
New Century had made $51.6 billion in
freezes assets on three investment funds
subprime loans in 2006 making it the Typically, hedge fund managers are with €1.6 billion in capital. The assets
2nd largest subprime lender in the US. compensated with management fees of could not be fairly valued due to their
1-2% on assets and incentive fees of exposure to the US subprime market.
Goldman Sachs, Morgan Stanley, and 20% of all profits. This entices them to
Bank of America all backed New leverage more and more. During the
Century Financial Corp. which In its biggest intervention in overnight
credit crisis they used this leverage to rates since September 11, 2001, the
originated more than $75 billion in buy more CDOs than they could pay for
high-cost loans between 2005 and European Central Bank injects €95 billion
with capital alone. into the Eurozone banking system.
2007.
July 18, 2007 August 10, 2007
May 2007
US Federal Reserve Chairman Ben Central banks in Europe, Asia, and the
At the peak of the bull market in May Bernanke acknowledges that the Fed
2007, Royal Bank of Scotland teamed up Americas inject $300 billion over 2 days
and other regulators had failed to
with Fortis and Santander to launch a to prevent a credit market seizure.
control aggressive mortgage lenders.
€71 billion hostile bid for ABN Amro.
The deal brought RBS to its knees and The US Federal Reserve injects $38
Bernanke estimates that the fallout from
became a symbol of the credit crisis. billion into the banking system, and the
the US subprime crisis could be up to
Fred Goodwin, CEO of RBS, was blamed European Central Bank injects over €150
$100 billion.
for his role in leading the UK to billion in an attempt to steady the
economic disaster. Eurozone credit markets.
July 24, 2007
June 27, 2007 Countrywide Financial, America’s biggest August 16, 2007
subprime mortgage lender, says the
US Securities & Exchange Commission problems with subprime mortgages Countrywide Financial Group loses more
Chairman, Christopher Cox, testifies to were starting to spread to conventional than half its stock value and borrows
Congress that the SEC has opened 12 home loans. $11.5 billion to avoid bankruptcy.

The Pakistan Accountant Oct-Dec 2009 39


Fitch drops Countrywide’s credit rating October 16, 2007 Following this announcement, shares in
to BBB+ and Moody’s to Baa3. Freddie Mac and Fannie Mae drop
Owing to writedowns linked to subprime
28.7% and 24.8% respectively.
mortgages, Citigroup’s profits drop 57%
The Group announces 90% of new loans
from the same quarter in 2006.
would meet Fannie Mae and Freddie November 23, 2007
Mac standards. Around the same time in October record Two French banks pledge $1.5 billion to
levels of foreclosures are expected in bailout French bond insurer CIFG, on the
US mortgage lenders Fannie Mae and the US with $350 billion in adjustable- verge of losing its AAA rating.
Freddie Mac were ‘government rate mortgages (ARMs) in the
sponsored’ private companies set up to marketplace. A worldwide freeze in November 27, 2007
help segments of the mortgage market credit market activities is evident.
run smoothly. The Abu Dhabi Investment Authority
Approximately 80% of U.S. mortgages purchases $7.5 billion worth of
August 24, 2007 issued to subprime borrowers were convertible securities with an 11%
adjustable-rate mortgages. ARM is a coupon from Citigroup.
In an attempt to restore investor
confidence Bank of America buys $2 type of mortgage in which the interest
rate paid by the borrower is based on a Freddie Mac announces a $6 billion
billion in preferred shares of share issue to cover more losses from
Countrywide Financial. benchmark plus an additional spread.
mortgages.
October 25, 2007
August 26, 2007 German state-owned KfW doubles its
Merrill Lynch announces a $2.24 billion balance sheet risk provisions from their
Sachsen Landesbank emerges as the
third quarter loss. bailout of IKB to €4.8 billion in expected
second German bank needing a bailout.
losses.
Merrill Lynch has written down $7.9
German public sector bank Landesbank billion on CDOs and subprime
Baden-Württemberg (LBBW) agrees to KfW says IKB’s subprime portfolio had
mortgages, the largest writedown in the significantly deteriorated since the
buy Sachsen for €250 million. credit crisis so far.
bailout in August. KfW had initially
September 14, 2007 assumed €1 billion in losses from its
On October 31, Merrill Lynch CEO Stan
bailout of IKB.
Rumors about a larger bank purchasing O’Neal resigns with a severance
giant British mortgage lender Northern package of $160 million.
November 29, 2007
Rock are afloat.
October 26, 2007 Slowdown in UK housing market
The Bank of England extends emergency Countrywide Financial announces a $1.2
funding to Northern Rock after investors billion third quarter loss, its first loss in Bank of England releases data showing
withdraw their support. 25 years. mortgage approvals have fallen to their
lowest level since 2005.
September 15, 2007 Countrywide has written down about
$1 billion. Slowdown begins in the UK housing
Lehman Brothers collapses in the market. UK housing prices have fallen by
world’s biggest bankruptcy. 0.8% in November, the largest drop in
November 12, 2007
12 years.
As banks around the world struggle to Three major US banks, Citigroup, Bank
issue debt, several emergency rescue of America, and JP Morgan Chase, agree United States lowers its growth forecast
mergers are struck. Bank of America to buy $75 billion in weak debt as for 2008 from 3.1% to 2.7% owing to the
spends $44.4 billion on Merrill Lynch. In purchaser of last resort. housing and credit markets decline
the UK, Lloyds TSB takes over HBOS for combined with high oil prices.
$21.9 billion, and the British Citigroup is the largest bank in the US.
government takes over 70% control of Total job cuts at Bear Stearns come to
RBS. November 13, 2007 around 1500 which is more than 10% of
Bank of America says it will have to its workforce.
September 26, 2007 writeoff $3 billion in bad debt. The bank
In its attempt to inject liquidity in to the also says it will spend $600 million December 3, 2007
banking system the Bank of England supporting some of its funds because of Moody’s announces ratings cut on debt
announces an auction of £10 billion of possible liquidity problems. of up to $116 billion.
emergency three-month funds at 6.75%
and agrees to accept bank mortgages as November 15, 2007
Much of this debt was on account of
collateral. Barclays confirms a $1.6 billion structured investment vehicles (SIVs)
writedown on their subprime holdings that relied heavily on the subprime
No bids are received. and warns of more writedowns. market.

October 1, 2007 November 21, 2007 December 6, 2007


Swiss bank UBS announces a $3.7 billion Freddie Mac announces a $2 billion loss George W. Bush announces plans to
writedown. in mortgage defaults and credit losses. help homeowners in trouble by freezing

The Pakistan Accountant Oct-Dec 2009 40


interest rates on subprime loans for five December 21, 2007 balance sheet; $6.88 billion of which will
years. come from the Government of
After a run on assets, Friends Provident,
Singapore Investment Corporation.
a UK commercial property fund with
Royal Bank of Scotland (RBS) announces
£1.2 billion, freezes withdrawals and
it expects to write down £1.25 billion January 16, 2008
tells investors it could take up to six
due to exposure to the US subprime months to get their money out. JP Morgan Chase says it has cut its
market. investments in the US subprime market
This is the first property fund to freeze by $1.3 billion.
December 10, 2007 withdrawals since the last UK property
UBS announces $10 billion more in crash 15 years ago. Wells Fargo reports a 37% loss in net
writedowns associated with their income for its fourth quarter.
subprime holdings and a capital
injection of $11.5 billion from the January 17, 2008
Singapore government and an unnamed Lehman Brothers announces plans to
Middle East investor. cut another 1,300 jobs in its domestic
mortgage division in addition to the
December 12, 2007

2008
2,500 lost already.
In order to provide more liquidity to the
credit markets, the US Federal Reserve Moody’s Investor Services hints large
creates a Term Auction Facility (TAF) bond insurers could lose their AAA
designed to allow banks to get Fed January 8, 2008 ratings.
funds by pledging all sorts of collateral. Jimmy Cayne retires as CEO of Bear
TAF is open to all depository The two largest bond insurers Ambac
Stearns and President Alan Schwartz and MBIA fall 52% and 31% respectively.
institutions believed to be financially takes over as CEO.
sound.
Ambac is the world’s second largest
January 9, 2008 monoline insurer.
The Federal Open Market Committee
also approves swap agreements to World Bank releases its Global Economic
Prospects study forecasting worldwide Merrill Lynch reveals a net loss of $7.8
provide $20 billion to the European
economic growth at 3.3% in 2008. The billion for 2007 compared to a $7.5
Central Bank and $4 billion to the Swiss
study says strong growth in emerging billion net profit in 2006.
National Bank.
markets will help to turn around the
effects of the global credit crisis. Merrill’s had a $14.1 billion writedown
Swap agreements are reciprocal on investments related to subprime
currency arrangements approved for up MBIA, the world’s largest bond insurer, mortgages.
to six months. slashes its dividend by more than 60%
and announces plans to raise $1 billion January 18, 2008
December 18, 2007 in debt to raise liquidity.
After a run on assets, Scottish Aegon
The European Central Bank allocates becomes the second property fund
$502 billion to banks at a below market Monoline insurers such as MBIA and
forced to freeze withdrawals and
interest rate to cut the cost of lending AMBAC write a single type of insurance
announce investors may have to wait up
between commercial and retail banks. contract, usually for bonds or asset-
to a year to get their money back.
backed securities. Since these insurers
The ECB was one of five central banks to have AAA debt ratings, the bonds also
January 19, 2008
inject liquidity into the market. have a AAA debt rating, regardless of
the financial health of the borrower. Fitch downgrades Ambac from AAA to
December 19, 2007 AA.
January 11, 2008
Morgan Stanley announces $9.4 billion A ratings downgrade could mean billions
in writedowns from subprime losses and Merrill Lynch and Citigroup announce
of dollars in writedowns on Ambac
receives a capital injection of $5 billion plans to seek additional capital from
guaranteed securities and force banks to
from a Chinese sovereign wealth fund to sovereign wealth funds.
cough up more capital to cover the
cover them. Citi looks to go back to the Abu Dhabi increased risks.
Investment Authority while Merrill eyes
December 20, 2007 the Kuwait Investment Authority. January 21, 2008
For the first time in its 84 year history Ambac’s downgrade has huge
Bear Stearns reports a quarterly loss of January 15, 2008 implications
$854 million with a fourth quarter Citigroup reports a $9.83 billion loss in
writedown of $1.9 billion on its the fourth quarter resulting from an As a result global stock markets in
mortgage holdings. $18.1 billion writedown on its subprime London and Europe suffer the biggest
mortgage-related exposure. one day loss since September 11, 2001.
CEO Jimmy Cayne and other top
executives do not receive a bonus for Citi also announces it would raise $12.5 FTSE 100 index falls 5.5% wiping out £76
2007. This makes headline news. billion in new capital to shore up its billion in market value as investors sell

The Pakistan Accountant Oct-Dec 2009 41


off equity for the safety of government January 30, 2008 Ambac, MBIA, and Financial Guarantee
bonds. Insurance Company (FGIC).
Role of credit rating agencies comes in
to question This is in response to a possible credit
Troubled bond insurer ACA Capital faces
collapse if it can not come up with at rating downgrade of the monolines
least $1.7 billion to pay policy claims. European leaders meet in London for a that insure the bonds. Ambac declines
credit crunch summit. They ask credit the offer.
ACA had written insurance on $69 rating agencies and big audit firms to
billion in corporate and mortgage debt help restore confidence in financial Credit Suisse announces its writedowns
securities but announced that its claims markets. on subprime mortgage exposure totaled
paying base was only about $425 million. 2 billion Swiss francs for 2007.
Credit ratings are widely used in Basel II
ACA’s trading partners, including some capital requirements and in assessment February 13, 2008
of the world’s largest banks, had of acceptable collateral in liquidity
operations by central banks. Data from Japanese financial watchdog,
entered in to a ‘forbearance Financial Services Agency (FSA), shows
agreement’ to waive all collateral Japanese subprime writedowns reached
requirements, policy claims, and February 3, 2008
$5.6 billion in 2007.
termination rights until February 19. The auction-rate security market starts
faltering as dealers stop taking unsold February 14, 2008
January 22, 2008 securities in auctions.
Commerzbank, Germany’s second
Panic sets in global credit markets largest bank, announces record profits in
Financial regulators from the world’s
leading economies meet in Amsterdam 2007 despite $1.1 billion in subprime
The US Federal Reserve cuts interest writedowns.
rates by 75 basis points which is the to discuss markets’ dependence on
largest cut in over two decades. credit ratings.
Swiss bank UBS confirms a $4 billion loss
in 2007 on $18.4 billion in subprime
Owing to $5.21 billion in writedowns on G-7 finance ministers agree on a more
writedowns as well as $26.6 billion in
subprime mortgage guarantees Ambac universal enforcement of Basel II
exposure to risky mortgages.
Financial reports a record loss of $3.26
billion. February 7, 2008 February 15, 2008
Regulatory pressure builds up on the
January 24, 2008 Moody’s pulls its AAA rating from
agencies Financial Guarantee Insurance Company.
The United States Congress agrees on a
$150 billion economic stimulus package In response to regulatory pressure February 17, 2008
to save the US economy from slipping Standard & Poor’s releases a reform
into recession. plan focusing on four main areas: Nationalization of Northern Rock
governance reforms to address conflicts
The package includes tax refunds of of interest; examining the accuracy of British government takes over the
$300 to $1,200 to over 117 million credit ratings; increased ratings beleaguered Northern Rock, UK’s fifth
American families. transparency; and more information to largest mortgage lender, after two
investors. private sector bids fail —- one from
Congress also raises the mortgage Northern Rock’s management, the other
purchase limit for Fannie Mae and February 8, 2008 from Richard Branson’s Virgin
Freddie Mac from $417,000 to consortium.
$625,000. Deutsche Bank reports profits of $9.4
billion for 2007. UK Chancellor of the Exchequer Alistair
January 26, 2008 Darling says the two private offers to
CEO Josef Ackermann says he did not buy out the bank are insufficient to
Financial Times announces that Bank of expect any more writedowns from
America (BofA) and Countrywide are in ensure pay back of loans.
subprime portfolios, after the third
merger talks to create the largest quarter €2.2 billion including leveraged
mortgage lending group in the US. Northern Rock owed the Bank of
loans, but says the bank still had England £25 billion in loans after a run
exposure to leveraged loans. on the bank in September 2007.
Analysts say the acquisition of
Countrywide could cost BofA $30 February 11, 2008
billion in addition to the $2 billion it The inter-bank lending market was the
invested in Countrywide’s preferred G-7 Finance Ministers meet in Tokyo to main source for Northern Rock’s
shares in August, 2007. determine that write-off losses on US liquidity before the US subprime
subprime mortgages could reach up to mortgage fallout which deteriorated
January 29, 2008 $400 billion. The ministers ask banks to credit conditions and investor
provide full disclosure on the losses. confidence.
In a joint investigation of accounting
fraud and insider trading, the US February 12, 2008 February 18, 2008
Securities & Exchange Commission and
the Federal Bureau of Investigation (FBI) Billionaire Warren Buffett offers to take Loans given by the US Federal Reserve
crack down on fourteen lenders and more than $800 billion of municipal through the Term Auction Facility reach
investment banks. bonds backed by three monolines: $50 billion in one-month funds raising

The Pakistan Accountant Oct-Dec 2009 42


fears that the collateral given for these In response to its AAA downgrading by fraction of what the bank was once
loans was increasing the Fed’s exposure Moody’s and S&P, Ambac announces worth.
to the credit crisis. plans to issue $1.25 billion in new
shares and $250 million in equity-linked To avoid a fire sale the Federal Reserve
The Fed views Term Auction Facility as instruments. A consortium of large Bank agrees to fund up to $30 billion of
a means to channel liquidity instead of banks will purchase most of these Bear’s long-term assets.
the discount window which could shares.
trigger investor concern. The Bear Stearns collapse raises
FGIC sues German bank IKB on charges concerns about the instability of the
February 23, 2008 of providing misleading information that credit default swap market. In mid-
Citigroup, Wachovia, Barclays, Royal exposed FGIC to $1.9 billion in liabilities 2007, the CDS market was worth $45
Bank of Scotland, Societe Generale, BNP and a ratings downgrade. trillion, more than twice the size of the
Paribas, UBS, and Dresdner are in talks US stock market. Commercial banks
to inject $2 to $3 billion in Ambac to March 11, 2008 were most active in the CDS market
avoid a ratings downgrade. with the top 25 banks holding more
The Federal Reserve offers primary than $13 trillion.
The European Commission and the dealers up to $200 billion in treasury
International Monetary fund prepare to securities for 28 days in return for AAA March 17, 2008
introduce voluntary guidelines for rated private mortgage backed securities
(MBSs) as collateral. UBS reduces its balance sheet by $520
governance and transparency in billion after adjusting the Bear Stearns
sovereign wealth funds (SWFs). sale price.
The loans are implemented through a
Several SWFs invested heavily in banks new Term Securities Lending Facility for
investment banks. March 18, 2008
during the credit crisis raising fears their
motivations were more strategic than Lehman Brothers and Goldman Sachs
commercial.* As on February 18, 2008 the move announce profits for the first quarter
underscores that the collateral would better than what analysts had expected.
* According to IMF estimates, state increase the Fed’s exposure to the credit
owned funds control about $1,900 to crisis; defaults on the MBS would March 24, 2008
$2,900 billion in global funds. ultimately be borne by taxpayers.
Morgan Chase raises its price on Bear
February 28, 2008 Stearns to $10 per share after the
March 12, 2008
original merger at $2 per share falls
AIG announces a $5.2 billion fourth In an interview with CNBC, Bear Stearns through because of opposition by Bear
quarter loss in 2007, its second CEO Alan Schwartz denies rumors about Stearns shareholders.
consecutive quarter of losses. the hedge fund’s liquidity position and
blames stock variability of the last few March 26, 2008
Most of these losses are a result of days on market speculation.
AIG’s $11.12 billion (pretax) in It transpires that of all the Asian banks
writedowns. AIG has written $78 billion the Bank of China has the largest
March 13, 2008 exposure to subprime mortgages. The
in credit default swaps (CDS). CDS is
like an insurance contract where a Bear Stearns reports a $2 billion drop in Bank announces increased growth in
company promises to cover certain liquid assets among rumors of illiquidity, securitization holdings despite a $1.3
securities in the event of default. reflecting a loss of $15 billion in cash billion writedown.
and cash equivalents in two days. March 27, 2008
March 3, 2008
A $22 billion mortgage-backed hedge Moody’s announces it would hold back
HSBC reports a $17.2 billion loss on
fund run by Carlyle Capital Corporation ratings unless mortgage lenders
writedowns of its US mortgage portfolio.
collapses. Remaining assets would be provided more transparent borrower
March 5, 2008 taken up by banks for repayment of information such as borrower income,
debts. The fund was slightly leveraged employment and occupancy, and
France’s largest retail bank, Credit with $31 in debt per every $1 in equity. property value.
Agricole, announces a €857 million loss
after writedowns of €3.3 billion on its UK Financial Services Authority releases
March 14, 2008 an internal report highlighting oversight
exposure to the credit crisis. The loss is
much worse than Agricole’s forecast in Bear Stearns and JP Morgan Chase failures of Northern Rock. FSA
December 2007. discuss permanent financing agreement. announces beefing up capacity to
Bear Stearns shares trade at $30. oversee the complex financial models
March 10, 2008 banks use to assess risk.
March 16, 2008 The main errors highlighted in the
Bear Stearns stocks drop amid rumors of
liquidity problems. The collapse of Bear Stearns, once one report were: extraordinarily high
of the biggest investment banks on turnover of FSA staff directly
Lehman Brothers cuts 5% of its Wall Street. supervising Northern Rock; inadequate
workforce across all lines of business. numbers of staff assigned to Northern
Total job loss at Lehman comes to 5,425 JP Morgan Chase announces it will Rock; and very limited direct contact
employees. acquire Bear Stearns for $2 per share, a with Rock executives.

The Pakistan Accountant Oct-Dec 2009 43


March 31, 2008 running at $70-$100 billion a quarter The $7 billion would come from an
from 2005 to 2007. offering of common stock and
US Treasury Secretary Henry Paulson convertible preferred shares. Wachovia
announces a blueprint on a long term The securities backing ABS are assets also announces a dividend slash of 41%
regulatory model with a three tier such as auto loans, leases, credit card and 500 job cuts.
regulatory framework: debt, a company’s receivables, royalties
and so on, and not mortgage-based April 17, 2008
One focused on market stability across securities.
the entire financial sector ; one focused Merrill Lynch reveals first quarter losses
on safety and soundness of institutions Morgan Stanley releases a report saying of $1.96 billion compared to a $2.1
supported by a federal guarantee; and investment banking revenues would fall billion profit in 2007. The bank says it
one focused on protecting consumers 20% in 2008 excluding the expected $75 plans to cut 4,000 jobs worldwide.
and investors. billion in further writedowns.
Merrill’s writedowns from subprime
Gordon Brown and George W. Bush April 7, 2008 mortgages in first quarter of 2008
announce plans to establish a UK-US amount to $4.5 billion, added to $24
working group to enhance cooperation The Concise Oxford English Dictionary billion in writedowns from 2007.
between US and UK regulators. adds ‘subprime’ and ‘credit crunch’ to
the new words included in its next April 18, 2008
A month after being nationalized edition.
Citigroup, the largest US bank, reports a
Northern Rock announces plans to repay first quarter $5.11 billion loss off a $12
£23 billion in loans to the Bank of Credit crunch is defined as ‘a severe
shortage of money or credit’. billion write down on subprime loans.
England by laying off one-third of its The bank announces another 9,000 job
staff, halving its balance sheet, and cuts.
shedding 60% of its mortgage holders. Subprime is defined as ‘a credit or loan
arrangement for borrowers with a poor
credit history, typically having April 22, 2008
April 1, 2008
unfavourable conditions such as high In a move to unblock interbank lending
Banks improve balance sheets by interest rates’. Bank of England offers to acquire UK
selling off leveraged loans and ridding banks’ mortgage-backed securities for
themselves off mortgage backed April 8, 2008 up to three years in return for treasury
securities bills.
The International Monetary Fund
releases its Global Stability Report which
UBS announces a $19 billion first projects the new estimate on credit Royal Bank of Scotland announces a
quarter writedown on its US holdings, crunch losses upwards of $945 billion. deeply discounted £12 billion rights
and a rights offering of $13.1 billion to issue in attempt to raise capital to cover
help offset the writedown. The Financial Times reports that £5.9 billion in writedowns on its April-
Citigroup is in negotiations with private June investments.
UBS shares fell 83% in 2007 following equity firms to sell $12 billion in loans to
$18 billion in writedowns. shrink its balance sheet and exposure to The rights issue is the largest in UK
the subprime crisis. corporate history and the writedowns
Deutsche Bank announces a $3.9 billion are the largest yet for a British bank.
first quarter writedown linked to its April 9, 2008
leveraged loan portfolio which including April 23, 2008
exposure to commercial real estate, half Washington Mutual, the largest savings
and loans bank in the US, announces it In the US writedowns across the
of it in the United States. financial system from subprime related
will raise $7 billion from outside
investors to cover losses arising from its assets exceed $200 billion and are set to
April 2, 2008 rise.
subprime mortgages.
EU proposes changes to Basel II capital
requirements including rules to limit the The investors are led by private equity Big US financial groups raise more than
risk stemming from large bank group, TPG, which will provide $2 $28 billion in capital markets. The 20
exposures, harmonization of definitions billion. The investment will come in the largest US banks have raised in excess
of hybrid capital, capital requirements form of an additional 176 million of of $80 billion in capital since October
for default risks in banks’ trading books, new shares of stock. 2007.
and technical changes to the
securitization framework. April 11, 2008 US Securities & Exchange Commission
draws up rules to govern credit rating
The Council for Mortgage Lenders (CML) agencies.
Bank for International Settlements
warns that mortgage lending in the UK
releases a report saying complex debt
could go down by 50% if fresh liquidity Wall Street bankers say the worst of the
securities used to repackage asset- is not injected into the market.
backed bonds will likely disappear as a crisis is over.
result of the credit crisis. April 14, 2008 April 24, 2008
The report further says that issuances of Wachovia announces plans to raise $7 With $5 billion in US leveraged loans,
collateralized debt obligations of asset- billion in capital after reporting a first Deutsche Bank prepares another
backed securities (ABS) had been quarter loss of $393 million. multibillion dollar sale making it the

The Pakistan Accountant Oct-Dec 2009 44


third big sale in April after Citi led the May 13, 2008 CDOs backed by risky mortgages. This
way with a $12 billion sale. downgrade could put CIFG in violation
The Financial Times releases a table of
of its regulatory capital requirements,
writedowns showing worldwide bank
Banks are trying to sell a backlog of potentially leading to insolvency.
writeoff totaling almost $450 billion
about $100 billion in leveraged loans since January 2007.
they’re holding. May 22, 2008
The table breaks down the total for Following investigation, Moody’s
May 1, 2008 each of the world’s major banks. declares that faulty computer models
had incorrectly rated up to $4 billion of
Credit markets are deteriorating fast. complex debt products as AAA. Moody’s
MBIA announces a $2.4 billion loss as a
Increasing cost of credit is making it stock price falls 16%.
result of write downs on CDS, more than
difficult to do business. US home prices twice that of analyst estimates. MBIA
drop 15.8%. stock lost more than 80% of its value in The Institute of International Finance*
2007. proposes that banks that have not
Citigroup raises $4.5 billion in equity written off their bad debts be allowed to:
offering. The Article lists capital raisings. May 14, 2008 use historical rather than market prices;
and
Freddie and Fannie: “thinly capitalized, sell assets after two years instead of
May 6, 2008
highly leveraged, and a systemic risk to holding until maturity.
Swiss Reinsurance Co., the world’s taxpayers”
biggest reinsurer, announces FASB and IASB do not support this
writedowns of $782 million while Freddie Mac announces it will raise $5.5 proposal saying it would be dangerous
restructuring credit default swaps. billion in capital. to change the rules at a time when
transparency was imperative.
UBS sells $15 billion of subprime In its first offer to help Freddie Mac and
mortgage debt to US asset manager Fannie Mae the US Office of Federal The Financial Services Authority, UK
Housing Enterprise Oversight lowers announces it will factor in banker pay
BlackRock at a 25% discount from its
surcharges on Freddie Mac’s regulatory structures when considering overall risk
face value of $20 billion.
capital requirements. Freddie Mac’s to a financial institution.
shares rise 9% with the announcement.
BlackRock, 49.8% owned by Merrill
The Basel II Accord enables regulators
Lynch, manages about $1,360 billion in A report by Fitch Ratings says banks to impose additional capital charges for
assets including $29 billion from the have written off 80% of their subprime incentive structures that promote risky
Bear Stearns bailout. losses. The report estimates total losses behavior.
on subprime mortgages and CDOs could
The deal signifies that private investors reach $400 billion. To cover $19 billion in first quarter
are willing to place bets on subprime writedowns UBS offers stockholders
debt to gain when the market turns May 15, 2008 deeply discounted rights issue to raise
around. These investors are betting Barclays UK announces a £1 billion $15.5 billion.
that the valuation techniques are credit writedown and confirms its first
valuing the debt below what it is quarter profits would be lower than in * The Institute of International Finance is an alliance of
worth. 2007. 300-plus companies including banks.

May 9, 2008 May 21, 2008 May 25, 2008

Owing to a writedown of $9.11 billion A Financial Times investigation uncovers The International Accounting Standards
that owing to a computer coding error, Board invites bankers and regulators to
on the revaluation of its credit default
Moody’s had awarded an incorrect AAA form a new working group to look in to
swap portfolio, AIG reports first quarter the problems of valuing securities in an
net loss of $7.81 billion. AIG Holding rating to billions of dollars of complex
illiquid market.
Company is downgraded to AA-. debt products.
The current model of ‘fair value’
AIG also announces it will raise $12.5 Top Moody executives were aware of
accounting has caused banks to write off
the problem in early 2007 but did
billion in capital through a stock offering more than $300 billion in bad debt.
nothing until January 2008.
to generate liquidity. Critics of fair value believe the debt will
be written back up when markets
The glitch was significant because most
May 12, 2008 rebound and this swing is contributing
high powered investors require 2 AAA
to the lack of confidence in financial
HSBC reports $3.2 billion in subprime ratings before investing and Moody’s
markets.
writeoffs in the first three months of provided the second rating after
2008. Standard and Poor’s.
May 29, 2008
HSBC now ranks fourth among big banks Moody’s Investors Service downgrades After a final price of $10 per share JP
with total writedowns behind Citibank, French bond insurer CIFG from A1 to Morgan Chase completes its acquisition
UBS, and Merrill Lynch. Ba2 due to its increased writedowns on of Bear Stearns.

The Pakistan Accountant Oct-Dec 2009 45


June 6, 2008 in suspect mortgage practices that The bank’s main regulator is the US
caused roughly $1 billion in losses. Office of Thrift Supervision which failed
The credit crisis has exposed over to recognize IndyMac’s risky lending
The Operation yields 406 defendants
reliance on credit ratings for evaluating practices.
in144 cases.
securities. Rating agencies published
higher ratings for complex financial July 13, 2008
June 25, 2008
products.
Barclays announces a £4.5 billion shares US Treasury concedes a large injection
Standard & Poor’s downgrades MBIA issue to boost its capital ratios which are of public funds to save Freddie Mac and
and Ambac, the two largest bond some of the lowest in Europe. Qatar Fannie Mae from insolvency.
insurers, from AAA to AA owing to Investment Authority, an SWF, and
further deterioration of US mortgage chairman of Qatar Holding finance half Investors, including large hedge funds,
markets and the CDOs insured by the of the offering. employ the take-under strategy in the
monolines. belief that the government will bail
Countrywide shareholders vote to them out to protect the financial
This downgrade could cause further approve the attempted takeover by market.
writedowns of up to $10 billion for Bank of America.
banks like Citigroup, Merrill Lynch and Take-under strategy means to short sell
UBS with the most exposure to these July 1, 2008 the stock causing share price to fall
monolines. further, and then investing the
A government bailout of Freddie Mac proceeds in the company’s debt.
US Federal Reserve approves Bank of and Fannie Mae is imminent. Federal
America takeover of Countrywide researchers say the bailout could cost
July 14, 2008
Financial. American taxpayers up to $25 billion.
July turns out to be the worst month US Treasury Secretary Henry Paulson
June 13, 2008 for mortgage-backed bonds since the outlines a three point plan to save
beginning of the subprime crisis. Freddie Mac and Fannie Mae:
Following an inquiry by the SEC,
Standard & Poor’s also announces errors UK Treasury announces new guarantee i) the Treasury will be authorized to
in rating models, but says the glitch did scheme raising deposits covered from increase the current $2.25 billion
not affect the ratings of the debt. £35,000 to £50,000 hoping to prevent lines of credit to Freddie and Fannie;
any runs on the banks. ii) the Treasury will have the power to
June 16, 2008 purchase equity in the companies if
US SEC announces plans to overhaul July 4, 2008 necessary; and
regulation governing credit rating iii)the entities will have access to
US private equity group TPG pulls out of
agencies by disallowing them to rate the borrowing from the Fed’s discount
a deal to invest £179 million in UK
securities that they help design, and window.
mortgage lender Bradford & Bingley
increasing disclosure requirements for after Moody’s accords B&B one of the
these agencies such as requiring them lowest ratings of any of the large July 16, 2008
to flag complex securities which could European banks. Wells Fargo, the fifth largest US bank,
be risky for investors. reports better than expected second
July 8, 2008 quarter earnings with $1.51 billion in
Incidentally, the SEC itself relies on writeoffs and a 10% increase in
credit ratings with explicit references to Shares in Fannie Mae and Freddie Mac
plunge around 20% as investors sell off dividends.
ratings in its market rules which
assume that securities with high credit their shares after a Lehman Brothers
report that accounting changes Martinsa-Fadesa, one of Spain’s largest
ratings are liquid and have lower price property companies, files for bankruptcy
volatility. proposed by the FASB could force
Freddie and Fannie to bring securitized after failing to raise equity to complete a
mortgages back onto their balance €4 billion debt refinancing with banks.
Lehman Brothers reports a $2.8 billion
second quarter loss. President Joe sheets resulting in a total of $75 billion
in regulatory capital charges. La Caixa, the largest Spanish bank,
Gregory and CFO Erin Callan resign. announces a €700 million loan
July 10, 2008 exposure.
June 19, 2008
For the love of money! Barrat Developments, one of the UK’s July 17, 2008
largest house builders, warns job cuts in
the house building sector could reach Richard Holbrooke, a director at the
In the first criminal charges brought American International Group (AIG),
about in the credit crisis, Ralph Ciofi and 60,000 of the 300,000 employees
employed directly or indirectly. resigns after two straight quarters of
Matthew Tannin, two former Bear financial losses.
Stearns hedge fund managers, are
arrested for securities fraud and insider July 12, 2008
Merrill Lynch announces writedowns of
trading. The two funds had collapsed in US bank IndyMac, with assets of $32 $9.4 billion primarily on its mortgage
July 2007. billion, closes down after being unable related assets and hedges with troubled
to meet withdrawal demands by bond insurers.
The US Federal Bureau of Investigation customers.The bank’s rescue is
(FBI) cracks down with its ‘Operation estimated to cost between $4 and $8 Merrill has posted a loss of almost $19
Malicious Mortgage’ on anyone involved billion. billion in the last four quarters. Merrill

The Pakistan Accountant Oct-Dec 2009 46


also announces a selloff of $8 billion in July 29, 2008 The UK government is taking on £3.4
assets to raise much needed capital. billion in extra risk to help bail out
Trade partners of SCA, an insolvent
Northern Rock in a debt to equity swap
bond insurer, agree to drop their claims
JP Morgan Chase posts a net income of which meant investors would get the
in exchange for cash to allow the
$2 billion despite $2.4 billion in £3.4 billion back only if Northern Rock
monoline to avoid being taken over by
writedowns in the second quarter of is sold into the private sector, or it
the US insurance regulator. The trade
2008. repatriates excess capital.
partners include Merrill Lynch and 13
other banks.
Goldman Sachs announces earnings of August 7, 2008
$2.1 billion.
July 30, 2008 AIG shares drop 19.1%, its biggest daily
July 19, 2008 US SEC extends its ban on ‘naked short- drop in 39 years, after announcement of
selling’ on Fannie Mae, Freddie Mac and a higher than expected $5.4 billion
Citigroup announces losses of $2.5 second quarter loss.
17 large bank stocks.
billion after second quarter write downs
of $7.2 billion in bad debt. Barclays offloads £6.3 billion in troubled
Naked short- selling allowed investors
to bet on a stock falling without having loans and securities in a move to
This is significantly better than the $3.67 transfer the risk of the credit crunch off
to pay interest leading to increased
billion in losses predicted by analysts. its balance sheet.
speculation.
Citigroup shares jump 7.7% on the
news. Investors were still willing to buy debt
July 31, 2008
assets affected by the credit crunch.
July 21, 2008 Deutsche Bank reveals total writedowns
of $7.8 billion for 2008. Without figuring August 8, 2008
Bank of America (BofA) announces
in the write downs Deutsche would have
better than expected second quarter Fannie Mae announces a $2.3 billion
an income 16% less than the second
earnings of 72 cents a share with second quarter loss and slashes its
quarter of 2007.
writeoffs totaling $3.6 billion. dividend.
The European Commission outlines a
July 22, 2008
plan to subject credit rating agencies to Citigroup and Merrill Lynch agree to buy
US Congressional Budget Office says the a single supervisory regime in order to up to $20 billion in auction-rate
US Treasury would have to cover $100 operate in Europe. securities (ARS) after pressure from
billion in losses if the mortgage market regulators claiming banks had continued
keeps getting worse. US mortgage rates In an 80 page complaint Massachusetts’ to sell ARS as liquid instruments.
reach their highest levels in a year. Secretary of State, William Galvin,
accuses Merrill Lynch of fraud in their Royal Bank of Scotland announces a
Wachovia declares an $8.9 billion dollar selling techniques of auction-rate £691 million loss, the third largest in UK
second quarter loss, the largest in the securities (ARS) by avoiding towarn banking history with £5.9 billion in write
company’s history. investors of the risks of ARS. downs.

July 23, 2008 ARS are long-term debts issued by August 9, 2008
municipalities and others whose
US House of Representatives passes a UBS reaches an agreement with
interest rates are set at bank-backed
rescue plan for Freddie Mac and Fannie regulators to repurchase $19 billion in
auctions.
Mae allowing the government to ARS debt. The agreement also settles
guarantee up to $300 billion in the civil lawsuits brought by Andrew
August 4, 2008
mortgages refinanced through the Cuomo against UBS.
Federal Housing Administration. The credit crisis extends to Asia
August 10, 2008
The Basel Committee on Banking HSBC, UK cautions that the credit crisis
Supervision proposes incremental risk is starting to leak over into Asia with Financial Times reports that the Royal
charge (IRC) which would make it more signs of slowdown in India and Vietnam. Bank of Scotland is involved in a sale of
costly for banks to hold structured debt $8 billion in loans from their balance
products that helped exacerbate the David Aufhauser resigns as general sheet. The buyout is led by private
credit crisis. counsel to UBS’s investment banking equity firms Apollo, Blackstone, and
division after Andrew Cuomo had TPG.
IRC would also apply to investment accused him along with other top level
banks. UBS officials for selling their personal Buyers are expected to make up to 30%
holdings in auction rate securities on on the deeply discounted loans.
July 24, 2008 insider information.
These deals are structured in such a
New York State Attorney General
August 5, 2008 way that the private equity companies
Andrew Cuomo files charges against UBS
are at risk for the first losses of up to
executives for selling more than $21 Northern Rock, the British nationalized
million of their personal holdings of mortgage lender, expects to report first 20 cents on the dollar, but then any
auction-rate securities and falsely half losses of $500 million tied to bad additional losses are shared with the
marketing them as safe and liquid. debts in mortgage. banks.

The Pakistan Accountant Oct-Dec 2009 47


August 11, 2008 September 13, 2008 the effects of Lehman Brothers
bankruptcy. Bank of England says it
A Moody’s report shows the default rate Bank of America considers a joint would offer £5 billion of extra reserves
on UK subprime mortgages increased takeover bid of Lehman Brothers with JC to help stabilize the markets.
from 7.3% in the second quarter of 2007 Flowers and China Investment Co., a
to 10% in the second quarter of 2008. Chinese Sovereign Wealth Fund (SWF). A deal between AIG and New York
insurance regulators allows the
UK mortgage lenders predict a 20% drop The US Treasury and Federal Reserve insurance company to access $20 billion
in housing prices by the end of 2009. refuse to use public funds to close a of assets from its subsidiaries in an
Data from the UK Building Societies attempt to add liquidity and prevent a
Association shows that mortgage rescue for Lehman Brothers, as opposed credit downgrade.
repayments outstripped new loans by to the government bailout of Bear Yet, all the major rating agencies
£700 million in June bringing net lending Stearns. downgrade AIG’s long term debt
in the mortgage market in the negative. triggering billions of dollars in collateral
Analysts highlight three important payments on its derivative trades, in
August 13, 2008 differences between Lehman and Bear addition to the billions AIG owed to its
Stearns:
UK inflation rate exceeds bank interest trading partners. AIG is bankrupt.
rate for the first time in twenty seven i) business mix differs from Bear’s,
ii) less systematic risk with Lehman’s AIG’s largest trading partner was
years.
failure; and Goldman Sachs. The minute AIG went
iii)Fed’s emergency liquidity facility to bankrupt, Goldman Sachs lost $20
Bank of England is expected to respond
allow Lehman to wind down business billion in CDS exposure to AIG.
by raising interest rates to control
inflation instead of lowering them in a way that will not cause shocks to
the markets. September 16, 2008
further to ease the credit crunch.
US Federal Reserve announces it will
August 27, 2008 September 14, 2008 lend AIG $85 billion in emergency funds
Merrill Lynch is in talks to be acquired with a 79.9% government stake in the
Bloomberg reports total losses related
by Bank of America after BofA removed company to prevent existing
to the failure of the US subprime
itself from the bidding for Lehman shareholders from benefiting from the
mortgage market have topped $500 bailout.
billion, with banks raising $352.6 billion Brothers.
to cover their writedowns. AIG executives would be replaced and
American International Group (AIG)
seeks to raise $10-20 billion in equity the $85 billion bridge loan would be
September 7, 2008 repaid by selling off assets.
from private investors to shore up its
Subprime mortgage collapse wipes out balance sheet.
more than $17 trillion in global equity Russian central bank injects $14.16
value. AIG also petitions the Fed to borrow billion in emergency one-day funds in an
from its discount window after ratings effort to stabilize the money market,
US government takes control of Freddie agencies threaten to downgrade AIG. after a 20% drop in trading on its two
Mae and Fannie Mac by injecting $100 stock exchanges Micex and RTS.
billion to ensure the troubled mortgage September 15, 2008
lenders would be able to meet their AIG, the world’s largest insurance September 17, 2008
debts. company, goes bankrupt. Lehman files The first time since 1994 the net asset
for bankruptcy. value of a money market fund managed
The government also says it would buy by US Reserve Management Corporation
mortgage bonds backed by the Lehman Brothers files for Chapter 11 drops to 97 cents, i.e. below $1 per
companies starting with $5 billion and bankruptcy after acquisition talks with share.
provide unlimited liquidity until the end Bank of America break down.
of 2009. RMC had written down $785 million
Ten* of the world’s largest banks agree held in Lehman Brothers debt to zero.
Current shareholders face the prospect to pool $70 billion in a liquidity fund to
of massive dilution. Freddie and Fannie mitigate the expected failure of Lehman Financial Services Authority and UK
have $5,400 billion in outstanding Brothers.
government agree to waive competition
liabilities and guarantee three-quarters rules to allow a £12 billion takeover of
*Bank of America, Barclays, Citigroup, Credit Suisse,
of all new US mortgages. Deutsche Bank, Goldman Sachs, JP Morgan Chase, HBOS, UK’s largest savings institution, by
Merrill Lynch, Morgan Stanley, and UBS. Lloyds TSP.
September 11, 2008
Bank of America agrees to acquire The merged bank would have around
Lehman Brothers announces plans to Merrill Lynch for $50 billion. The all
sell off its asset management unit and 28% of the mortgage loan market and
stock transaction signals that investment 50% of the savings market.
spinning-off $30 billion of troubled banks were scrambling to find partners
property assets after Lehman reported after the fall of Lehman.
its worse loss ever of $3.9 billion for the September 18, 2008
third quarter spurred by $7.8 billion in European Central Bank (ECB) allots €30 Following the AIG bailout, Interbank
credit related writedowns. billion in one-day liquidity to counter lending in the US and UK falls.

The Pakistan Accountant Oct-Dec 2009 48


Central banks from around the world public to support the $700 billion operations of Wachovia, the sixth
announce $180 billion in emergency government bailout plan, or risk a long largest lender in the US for $2.2
liquidity. and painful recession. billion.The takeover will turn Citi into
the largest retail bank in the US with
September 19, 2008 September 26, 2008 more than $600 billion in deposits and
WaMu becomes the biggest bank more than 4,300 branches.
In response to the Russian government’s
pledge to pump $100 billion in liquidity failure in US history
FDIC agrees to provide a cap on losses
the Russian stock market gains 30% of Wachovia’s $312 billion mortgage
after suspension of trading for two days. US regulators seize the assets of
Washington Mutual (WaMu), the sixth portfolio. In return FDIC will receive a
largest US bank, which had lost a $12 billion stake in Citi in the form of
Standard & Poor’s downgrades Russia’s warrants and preferred shares. Citi will
economic outlook from positive to quarter of its share value the day
before. be responsible for the first $42 billion
stable.
in losses with the FDIC covering any
Financial Services Authority approves WaMu had failed to auction itself to additional losses.
ban on short-selling of financial stocks in potential buyers becoming the biggest
the UK until January 16, 2009. bank failure in US history. US Federal Reserve more than doubles
its swap lines with the European Central
US Treasury announces it will provide up JP Morgan acquires WaMu’s troubled Bank and other central banks from $290
to $50 billion from the Exchange assets, bank deposits, and mortgage billion to $620 billion.
Stabilization Fund to insure money portfolio from the federal government
market mutual funds in an attempt to for $1.9 billion. The European Central Bank along with
prevent a run on the funds. Money the governments of the Netherlands,
market funds hold more than $3,400 UK government nationalizes Bradford & Belgium, and Luxemburg agree to pitch
billion in investor funds. Bingley after retail savers withdraw tens in €11.2 billion to nationalize Fortis, the
of millions of pounds in recent days. European banking and insurance giant.
Treasury Secretary Henry Paulson urges
Congress to pass legislation to allow the Spanish bank, Santander, agrees to buy Hypo Real Estate, one of Germany’s
government to buy up to $700 billion B&B’s £21 billion deposit book and biggest lenders, is rescued by the
worth of toxic mortgage securities from branch network for around £600 million. German government and other banks
the banks. after a €50 billion liquidity crisis. HRE
September 28, 2008 sells off €15 billion of assets to help
September 21, 2008 cover the liquidity shortfall.
After WaMu’s seizure, its leftover
Russian finance ministry announces holding company, Washington Mutual
$24.21 billion in additional funds to the The government of Iceland takes control
Inc., files for Chapter 11 bankruptcy of Glitnir, the country’s third largest
banking system in the form of three listing more than $8 billion in total
month bonds. More Russian banks are bank. The government had injected
debts. €600 million of equity into the bank.
given access to budget funding.
At the World Economic Forum in Tianjin, Neuberger Berman, the asset
September 22, 2008
China policymakers discuss the need for management arm of Lehman Brothers
Australia, Taiwan, and the Netherlands a set of international accounting Holdings, is sold to Bain Capital and
announce ban on short-selling. standards, policing of the CDS market, Hellman & Friedman for $2.15 billion.
and greater international cooperation
US Federal Reserve approves Goldman between regulators. A month before Lehman’s collapse,
Sachs and Morgan Stanley as bank Carlyle was prepared to pay $7 billion
holding companies, subjecting them to September 29, 2008 for Neuberger which would have
the Fed’ capital requirements. These allowed Lehman to buy back the asset.
were the last two large standalone Known as the ‘bailout bill’, the
investment banks. Emergency Economic Stabilization Act
was put to the US House of September 30, 2008
September 24, 2008 Representatives. The Act allowed the Ireland guarantees around €400 billion
Treasury to spend up to $700 billion on of liabilities and €100,000 of individual
Goldman Sachs announces it will receive the Troubled Assets Relief Program
a $5 billion capital infusion from Warren deposits of six of its largest banks.
(TARP) to buy and hold troubled loan-
Buffett’s Berkshire Hathaway, and raise based assets, many of which are tied to
an additional $2.5 billion from public Dexia, a Franco-Belgian bank specializing
slumping home prices in the US. in local authority finance, gets a €6.4
sale of common shares.
billion capital injection from various
The US House of Representatives votes European governments including €3
Rumors about insufficient liquidity at
against the $700 billion bailout bill billion from Belgium, €3 billion from
the Bank of East Asia, Hong Kong causes
proposed by the Treasury. France, and €376 million from
a run on the bank. BEA denies the
rumors. Luxembourg.
In response, the S&P 500 Index falls
8.8%, its worst drop since 1987 and the The governments contend Dexia’s
September 25, 2008 Dow Jones Industrial Average falls 778 failure would have caused
In a televised address US President points—its worst points decline ever. unacceptable systematic risk to their
George W. Bush pleads with the US Citigroup agrees to buy the banking financial systems.

The Pakistan Accountant Oct-Dec 2009 49


October 1, 2008 force ailing banks into bankruptcy, and Federal Reserve extends $740 billion
to take over housing loans held by banks via dollar swap lines to 14 central
End of an era: Structured Investment
and put them into a government banks, including those in South Korea
vehicles (SIVs) are the latest casualty of
housing fund. and Singapore.
the credit crisis
BNP Paribas takes over Fortis from the The credit crisis begins to dig its claws in
With $27 billion in managed funds, to Japan as Yamato Life files for
Belgian government for €14.5 billion
Sigma Finance in the US becomes the bankruptcy becoming the first direct
making BNP the largest bank in the
last of the structured investment Japanese victim of subprime. Yamato
Eurozone.
vehicles (SIV) to be liquidated after JP Life had $2.7 billion in liabilities at the
US Federal Reserve is in the process of
Morgan cuts its last funding line. time of the filing.
creating a central clearing house for
credit default swaps.
SIVs are debt funds that borrow short- October 11, 2008
term commercial paper and lend long October 7, 2008
at a higher interest rate; the credit Dow Jones Industrial Average caps its
crunch prevented financing of long- Dow Jones Industrial Average falls below worst week ever with the highest
term debt. The SIV industry had once 10,000 for the first time since 2004. volatility day in its 112 year history.
controlled over $400 billion. Paper losses on US stocks total $8.4
Iceland nationalizes Landsbanki, the trillion from the market highs in 2007.
MBIA files a lawsuit charging second largest bank in the country and
Countrywide Financial (which has been turns to Russia for a €4 billion loan to October 13, 2008
acquired by Bank of America) for help stabilize its financial situation. French president, Nicolas Sarkozy,
fraudulently inducing MBIA to guarantee pledges €360 billion in liquidity to
billions of dollars in its mortgage bonds. Spain announces the formation of a French banks including €320 billion in
€30-50 billion emergency fund to guarantees for new bank debt and a €40
October 3, 2008 provide liquidity by buying Spanish bank billion fund for recapitalizing lenders.
assets. Spanish government announces
The revised bailout plan passes through it will increase its guarantees for bank
the US House of Representatives and is Spain announces up to €100 billion of
deposits from €20,000 to €100,000. guarantees for new debt issued by
signed into law by President Bush.
Amendments in the bill include an commercial banks in 2008.
Russia injects $37 billion in long-term
increase in the FDIC insurance on bank subordinated loans into state controlled
deposits. UK government starts its nationalization
banks through Russia’s two largest state process by injecting £37 billion in the
banks, VTB and Sberbank. nation’s three largest banks by owning a
October 4, 2008
majority share in RBS and over a 40%
Wells Fargo announces it will pay $15.1 October 8, 2008 share in Lloyds and HBOS.
billion in an all-share offer to purchase For the first time since September 11,
Wachovia after the $2.2 billion 2001 the European Central Bank and the In a coordinated move the US Federal
government engineered deal with US Federal Reserve work together to Reserve, European Central Bank, the
Citigroup falls through. bring a half-point rate cut to stop the Bank of England and Swiss National
damage from the credit crisis. Bank announce they will provide
Citigroup says it plans to file for an unlimited liquidity at a pre-fixed interest
injunction to prevent the deal or UK government launches a £400 billion rate for dollars over periods of seven
substantial damages from Wells Fargo. rescue plan to help restore confidence in days, one month, and 84 days.
the financial markets by investing £50
October 6, 2008 billion in the banking industry, Bank of Italy announces it will provide
French President, Nicolas Sarkozy, hosts guaranteeing £250 billion of new bank €40 billion in treasury bills to banks to
an emergency summit on the global debt, and adding £100 billion to the refinance inferior assets that can not be
existing Bank of England short-term loan currently used as collateral.
financial crisis in Paris where leaders of
France, Germany, UK, and Italy agree scheme.
Germany approves a plan to inject €500
that Europe will not allow any bank to
UK government declares it will sue billion into credit markets, and the
fail.
Iceland to recover all UK customer Dutch government announces it will
deposits in Icesave, the failed internet guarantee interbank lending up to €200
Bank of America agrees to settle claim
bank that was nationalized. Icesave has billion.
of predatory lending charges against
recently acquired Countrywide Financial. about 300,000 UK customers.
October 14, 2008
BofA says around 400,000 borrowers
will benefit from the deal. The Swedish division of Iceland’s largest The US taps in to its $700 billion bailout
bank, Kaupthing, receives a SK5 billion fund to inject $250 billion of public
Danish government announces plan to loan from Sweden’s central bank. money into the US banking system by
guarantee all banking deposits and taking an equity position in banks that
October 10, 2008 choose to participate in the program in
some inter-bank loans, in return for
which the country’s banks must Spillover effects are felt in Asia. South exchange for certain restrictions such as
establish a rescue fund of $6.5 billion. Korean banks are seen as the most executive compensation.
Iceland passes legislation allowing vulnerable in Asia due to their
government to nationalize, merge, or dependence on foreign funding. US Bank of America, JPMorgan Chase, Wells

The Pakistan Accountant Oct-Dec 2009 50


Fargo, Citigroup, Merrill Lynch, Goldman The won and Seoul stock market fall October 24, 2008
Sachs, Morgan Stanley, Bank of New prompting South Korea to announce
AIG has borrowed a total of $90.3 billion
York Mellon and State Street agree to plans to raise spending and cut taxes to
of the $123 billion rescue fund set up by
participate to receive half of the total stabilize its economy.
the government. The money has been
funds. used to pay off bad debts incurred by
Singapore and Malaysia both announce AIG’s CDSs.
The plan also allows the FDIC to blanket guarantees on bank deposits
temporarily guarantee the senior debt until December 2010. October 26, 2008
of all FDIC-insured institutions and
increase access to funding for October 19, 2008 International Monetary Fund announces
businesses by announcing further details a proposed $16.5 billion loan to Ukraine
South Korean government announces a to mitigate the effects of the global
of the commercial paper funding facility.
$130 billion rescue package for its banks credit crisis.
and companies. The government will
United Arab Emirates’ ministry of
inject $750 million into the Industrial Kuwait guarantees all local bank deposits
finance adds a $19 billion in liquidity to
Bank of Korea to help enhance its and suspends trading in Gulf Bank, the
domestic banks bringing the total to
capital base. nation’s second largest bank, after some
$32.7 billion.
clients dealing in derivatives refused to
October 20, 2008 honor their commitments. This action
Japan announces a plan to help steady
the Japanese market by lifting The €500 billion German bank rescue was the first of its kind in Kuwait.
restrictions on companies buying back fund is up and running but a €10 billion
their shares, strengthening disclosure on limit may be set for a single bank along October 27, 2008
short selling, and temporary suspension with a €5 billion maximum value of Bank of Korea cuts interest rates by 75
of the sale of government-owned stocks. assets per bank. basis points and says it would buy up to
$7 billion of bank bonds to provide
The Australian government unveils a Iceland seeks a $6 billion rescue package more liquidity.
$10.4 billion stimulus package to help from the International Monetary Fund
pensioners, low and middle income to help stabilize its economy. The central bank agrees to allow
families, and first time home buyers exporters to borrow dollars to pay for
withstand the economic slowdown. The French government announces it foreign exchange losses and small
will inject €10.5 billion into France’s six companies to roll over foreign-currency
October 15, 2008 largest banks Credit Agricole, BNP debt for one year.
Paribas, Societe Generale, Credit
Greece announces a €28 billion package
Mutuel, Caisse d’Epargne, and Banque October 28, 2008
to support the banking sector including
Populaire. According to Bank of England estimates
guarantees for up to €15 billion of
medium-term lending and €8 billion of the world’s financial firms have now lost
Sweden announces a $205 billion $2.8 trillion as a result of the global
special government bond issues.
program to stabilize its financial system credit crisis.
and boost liquidity.
October 16, 2008
Chairman Gulf Bank resigns over
Citigroup announces a third quarter loss October 21, 2008 derivative losses and a run on Kuwait’s
of $2.8 billion after receiving a $25 second largest bank, which is the first
US Federal Reserve announces it will
billion injection from the US publicly known bank run in the Middle
spend $540 billion to purchase short-
government. East.
term debt from money market mutual
funds to help unfreeze the credit
Switzerland agrees to fund a vehicle World Bank, IMF and the European
markets making it easier for businesses
designed to hold up to $60 billion of Union agree to provide Hungary $1.3
and banks to obtain loans.
toxic debt held by UBS, and also injects billion, $15.7 billion, and $8.1 billion
€3.9 billion to help recapitalize UBS. The respectively. This is the largest
UK announces plans for a £3 billion loan
Swiss government will own almost 10% international rescue package for one
to the government of Iceland to help
of UBS. country and the first for an EU member
unfreeze the assets of over 300,000
British savers who had deposits with country since the crisis began. The
Credit Suisse declines government Hungarian economy was heavily
Icesave.
assistance to turn to private equity to dependant on foreign financing.
raise SFr10 billion, making it the best
October 22, 2008
capitalized financial institution in US Federal Reserve announces a
Europe. Wachovia announces third quarter temporary reciprocal currency
losses of $23.9 billion. arrangement with the Reserve Bank of
October 17, 2008 New Zealand. The swap agreement will
The run on the bank before its sale to help ease pressures in the US dollar
European Union leaders sign off on a short-term funding markets.
joint $2.7 trillion bank bailout plan after Wells Fargo included depositor’s
a 2-day summit in Brussels. New withdrawal of more than $26 billion or
24% of their deposits, the biggest loss October 29, 2008
international supervisory boards for at
least 30 of the world’s largest banks are any bank has impaired since the The Fed, the Banco Central de Brazil, the
considered. beginning of the credit crisis. Banco de Mexico, the Bank of Korea,

The Pakistan Accountant Oct-Dec 2009 51


and the Monetary Authority of Two of Brazil’s largest banks agree to the $410 billion remaining in the $700
Singapore announce a temporary swap merge. Itaú Holding Financeira SA, billion TARP.
line between the banks. Brazil’s second largest non-state bank,
will purchase its smaller rival, Unibanco, Instead, the Treasury evaluates a
Kuwaiti parliament votes to guarantee to create Latin America’s largest bank. recapitalization scheme to provide a
around $86 billion all bank deposits of Contrary to analysts’ expectations, Swiss match of public funds to any funds
all local and foreign banks. Re, one of the world’s largest reinsurers, financial institutions are able to raise
announces a $263 million loss with a from private investors.
October 31, 2008 289 million Swiss francs writedown on
As a corollary to the subprime, global its credit default swap portfolio during November 14, 2008
credit card revenues decline 40% as the quarter.
S&P downgrades Turkey’s sovereign
rising unemployment and job cuts force credit outlook from stable to negative.
borrowers to default November 5, 2008
Turkey’s request for IMF assistance
Expecting to earn up to $550 billion by seems inevitable.
Citigroup announces a $1.4 billion loss end 2008, the US Treasury offers its first
on securitized credit card loans in the “bailout bond” which will reach maturity After announcing a quarterly loss of
third quarter of 2008. $25.3 billion, Freddie Mac asks the US
in three years at a fixed rate of interest
every six months. government for access to $13.8 billion
Credit card loans were largely
from the $200 billion facility created at
securitized in the same way mortgages
Bond insurers MBIA and Ambac the time of nationalization of Freddie
had been.
announce losses of $806.5 million and and Fannie.
Back-door Bailout for Big Banks $2.43 billion leading to a likely credit
rating downgrade. There is speculation Fannie Mae reports a $29 billion
Flashback November 2008 on whether the two would be able to quarterly loss and asks for more than
get anything from the $700 billion TARP. $100 billion to stay afloat.
The New York Federal Reserve bought
out, for about $30 billion, credit default November 9, 2008 November 15, 2008
swaps that AIG had sold on toxic debt
securities to banks including Goldman AIG receives a revised $150 billion G20 meets in Washington DC to focus
Sachs Group, Merrill Lynch & Co., government bailout plan to reduce its on five policy measures: i) strengthen
Societe Generale and Deutsche Bank. interest payments and give it more time transparency and accountability; ii)
to sell assets. The total rescue package improve regulation; iii) promote market
Fast Forward February 2010 given to AIG now amounts to $150 integrity, iv) reinforce cooperation; and
billion. v) reform international institutions.
The US Congressional Committee on
Oversight and Government Reform is November 10, 2008 November 17, 2008
currently hearing the case of AIG’s
bailout, which involved a secretive Eastern Europe is most affected by the In the second round of TARP
group deploying billions of dollars to crisis because of large current account disbursements, US Treasury gives out
favored banks operating with little deficits and external financing needs $33.6 billion to 21 banks bringing total
public or government oversight. payout so far to $158.56 billion.
Fitch downgrades emerging markets of
November 1, 2008 Bulgaria, Hungary, Kazakhstan, and November 24, 2008
J.P. Morgan Chase announces a plan to Romania.
Total capital infusion in to Citigroup
restructure $70 billion in mortgages for comes to $45 billion
an estimated 400,000 borrowers Fitch also revises long-term foreign
defaulting on payments. currency ratings for South Korea,
US Federal Reserve, Treasury and
Mexico, Russia, and South Africa from
Federal Deposit Insurance Corporation
November 3, 2008 stable to negative.
agree to cover remaining losses for
South Korea announces plans to pump Citigroup after the bank agrees to
November 11, 2008
an extra $11 billion into their economy absorb the first $29 billion of a pool of
in 2009. Economic growth in the country With little presence in retail banking, $306 billion identified toxic assets held
has fallen to its lowest level in a decade. American Express converts to a bank by it.
holding company which would give it
HBOS, UK’s largest mortgage lender, permanent access to low-cost Federal November 25, 2008
reveals writedowns of £5.18 billion for Reserve funds, but stricter regulatory
US Federal Reserve pledges $800 billion
the nine months ending in September and capital requirements.
more
including £457 million on HBOS’s
$600 billion will be used to buy
exposure to Lehman Brothers and Out of total assets of $127 billion,
Washington Mutual. mortgage bonds issued or guaranteed
AmEx has only $7.2 billion in retail
by Fannie Mae, Freddie Mac, Fannie
deposits.
November 4, 2008 Mae and Ginnie Mae, and the Federal
November 12, 2008 Home Loan Banks.
Generally considered immune to the
credit crisis, Latin American banks US Treasury Secretary Henry Paulson The other $200 billion will be used to
suffer from sharp currency declines abandons plan to buy toxic assets with fund the term asset-backed securities

The Pakistan Accountant Oct-Dec 2009 52


loan facility (Talf) which will lend money December 22, 2008 economic forecasts for the next two
to holders of AAA-rated securities that years admitting it could face deflation.
Worldwide M&As suffer
are backed by student loans, auto loans, The bank also planned to inject capital
credit card loans, and small business into the markets by buying corporate
At $3,280 billion, worldwide mergers
loans. debt to allow businesses to raise money.
and acquisitions are down 29% from
Japan announces a $16.7 billion
2007 owing to lack in financing,
November 30, 2008 stimulus package. China announced the
valuation fluctuation, and widespread
slowest growth of 7.7% in seven years,
World Bank launches a Debt risk aversion.
and South Korea reported the first
Management Facility (DMF) to help low
decline in quarterly economic growth
income countries achieve debt stability. China cuts interest rates to 5.31%, its
fifth cut in the last three months. In an since the Asian financial crisis.
Governments of Austria, Belgium,
Canada, The Netherlands, Norway, and effort to restore China’s high growth
rate People’s Bank of China reduces its A study by the Boston Consulting Group
Switzerland make initial commitments of
capital reserve requirement by 50 basis showed market value of the world’s
$12 million to the facility.
points. banks has depleted by $5.5 trillion
equivalent to 10% of the world’s GDP.
December 9, 2008
Russia is the first G8 country to receive US Treasury Secretary Timothy Geithner
a ratings downgrade introduced his $2 trillion Financial
Stability Plan in an attempt to clean up
S&P downgrades Russia to BBB citing the US financial system. US Treasury
depletion of forex reserves and possible also announced details of its Capital
difficulties in meeting external financing Assistance Program (CAP) that included

2009
needs. running stress tests on banks to
determine if they will require additional
In order to prevent US creditor lawsuits, capital.
Landsbanki, the nationalized Iceland The beginning of 2009 saw the rest of
bank, files for Chapter 15 bankruptcy in the world engulfed in the recession UK government announced its Asset
the US. that hit the advanced economies. There Protection Scheme (APS) to insure $712
were calls from policymakers to clean billion of banks’ toxic assets. APS aims to
December 16, 2008 up the banking sector to prevent increase lending without having to fully
Goldman Sachs reports a $2.12 billion worldwide recession. nationalize the banking system. Royal
fourth quarter loss its first quarterly loss Bank of Scotland reported a £24.1
since it became a publicly traded January-March 2009 billion loss for 2008, the largest
company in 1999. corporate loss in Britain’s history. UK
Credit Crisis Continues to Take Root in government released plans to inject
Asia. £25.5 billion into RBS, and to absorb
December 17, 2008
£325 billion of its toxic assets into the
In a surprise move, the US Federal Central banks around the world cut Asset Protection Scheme.
Reserve lowers interest rates to a range interest rates to record lows —- near
of 0-0.25. zero in the US and Japan while pumping An Asian development Bank study
trillions of dollars, known as quantitative showed the value of global financial
December 19, 2008 easing, in to the banking system to help assets tumbled $50 trillion in 2008. The
restore credit flows. African Development Bank (AfDB) set up
Collapse of Detroit Three - General
Motors, Chrysler & Ford a $1.5 billion emergency bailout fund to
In January the IMF warned that “the help alleviate the impact of the global
world economy is facing a deep financial crisis in Africa.
President George W. Bush announces recession.” Towards the end of January,
plans to lend $17.4 billion to General IMF announced a significant downward
Motors and Chrysler with $13.3 from April-June 2009
adjustment in its forecasts for global
TARP. economic growth. By now, the IMF had A modest second half comeback in
contributed $50 billion to member most of the world
IMF outlines a plan to loan $2.4 billion countries in response to the global
to Latvia. financial crisis. G20 leaders pledge $1.1 trillion to fight
the global financial crisis with $750
Bank of Japan cuts interest rates to In the first quarter of 2009 US GDP sank billion in additional funding for the IMF,
0.1%. 6.4%. Unemployment in the United $250 billion for world trade financing,
States jumped to 7.2%, its highest in 16 and $100 billion for multilateral
December 20, 2008 years. Jobs were being lost at a pace of development banks.
S&P downgrades credit ratings of eleven 700,000 per month. Eurozone saw a
of the world’s largest banks including JP 2.5% slide in GDP, a potential 10 percent The Financial Accounting Standards
Morgan Chase, Bank of America, Wells annualized drop in the first quarter, the Board (FASB) announced a relaxation in
Fargo, Citigroup, Morgan Stanley, worst on record. mark-to-market rules. The changes will
Goldman Sachs, Barclays, Credit Suisse, allow companies more discretion in
Deutsche Bank, Royal Bank of Scotland, Japan’s economy was falling at a rate of accounting for toxic assets allowing
and UBS. 14.2%. The Bank of Japan reduced banks to value their distressed assets

The Pakistan Accountant Oct-Dec 2009 53


higher. The mark-to-market rule had $622 billion to Eurozone banks at the have been blamed for awarding
been blamed by many to have current key rate of 1 percent which excessively high ratings on mortgage-
exacerbated the credit crisis by forcing reflected continued funding problems in backed bonds that turned out to be
banks to write down their assets. Eurozone banks amid expectations that almost worthless. These agencies make
the region’s economy will begin money by charging the bond issuers to
IMF’s Financial Stability Report recovering in 2009. evaluate the risks of their debt offerings,
projected total writedowns on US which in the aftermath of the credit
originated assets to reach $4 trillion. US July-September 2009 crisis, has been criticized as a potential
car maker Chrysler filed for Chapter 11 conflict of interest.
US economy expanded at a 2.2% pace in
bankruptcy and announced partnership
the third quarter after four quarters of
with Italy’s Fiat marking Fiat’s The US Securities & Exchange
contraction. Japan grew at a more
reentrance into the US car market. Commission approves a ratings agency
moderate pace of 1.3% in July to
as a Nationally Recognized Statistical
September. Eurozone saw a sluggish
Stress test results for the 19 largest U.S. Rating Organization (NRSRO) which
0.4% growth over the quarter after five
banks are released. Nine banks including signifies that a ratings agency is credible
quarters of contraction. China saw a
JP Morgan Chase, Goldman Sachs and and reliable. European securities
slowdown but avoided recession. Built
MetLife, are found to be adequately regulators and bankers have long
on stimulus cash and bank lending,
capitalized. Of the 10 most vulnerable pressured the SEC to break up the three
China’s third quarter growth was 8.9%.
banks GMAC, Wells Fargo, Bank of agencies’ monopoly, or make them
America and Citigroup, as well as several more accountable for issuing bogus
Common problems arising from the
large regional banks like Keycorp and ratings.
credit crisis are identified as ineffective
SunTrust Banks lack capital to withstand
integration of risk into decision making,
the worst-case scenario simulations.
a lack of alignment between companies’
These banks are asked to prepare Entries for Living In a Bubble have been
strategies and appetites for risk, and a
capital-raising plans by June 8 which will drawn from news reports, press releases and
lack of timely data. According to
be implemented by November 9. statements from the following sources:
Accenture’s 2009 Global Risk
Management Survey 85% of corporate
Under worst-case assumptions, experts www.associatedpress.com
executives believed their companies
put potential losses at $600 billion and www.news.bbc.co.uk
needed to overhaul their approaches to
the likely mortgage failure rate at 1 in 10. www.bloomberg.com
managing risk.
www.businessweek.com
Since its March 2009 low, the MSCI www.money.cnn.com
emerging markets index gained 68
October-December 2009 www.sec.gov/news/press
percent compared with a 43 percent In October the IMF projected global www.europa.eu/rapid
gain in the developed markets index growth at 3.1% in 2010, after an www.imf.org/external/pubs
though there are still significant estimated 1.1% global contraction in www.financialstability.gov/latest
reductions in capital flow, export 2009. Economists said whatever bad www.ft.com
demand, and foreign investment. assets have been resolved have almost www.nytimes.com
entirely been placed on the books of www.reuters.com
In the largest manufacturing bankruptcy governments and central banks in places www.marketwatch.com
in American history, US automaker like Dubai , Mexico , Spain , Greece , the www.cnbc.com
General Motors filed for Chapter 11 UK and the Baltic states, even at state www.ustreas.gov/press/releases/reports
bankruptcy. level in the US . Japan announced its www.time.com
worst performance in 30 years as its www.guardian.co.uk
Eurozone GDP saw a 2.5% overall economy shrank by 3.3% in the fourth
decline. German economy contracted quarter.
4%. This was the worst recession in Living In aBubble:
Europe since World War II. Industrial By November the impact of the financial The Credit Crisis at Your Fingertips
production was down 21.6%. Eurozone crisis had its most severe impact on
banks needed to writedown $283 billion countries where the pre-crisis excesses This Special
more by end 2010. Rising corporate had been greatest, i.e. the US and the Report provides
default and falling property prices were UK among the G7 countries. According a chronology of
cause for concern. to the IMF the levels of GDP and fiscal events leading
revenue in these countries will not up to, and
Ten US banks are allowed to exit the return to the previous path. In the case culminating in,
TARP including American Express, of UK , the IMF forecasts that the crisis the recent
Goldman Sachs, Morgan Stanley and will raise the ratio of net public debt to global credit
JPMorgan Chase. Altogether they will GDP by close to 50 percentage points crisis.
return $68.3 billion, more than a between 2007 and 2014.
quarter of the federal bailout money Due care has
issued by TARP since October 2008. In the context of the global credit crisis, been taken to
Chinese leaders proposed expanding the role of credit ratings agencies has ensure accuracy
IMF Special Drawing Rights for use as also come under a lot of fire. The three of dates, events,
international reserve currency to biggest ratings agencies ----Moody’s, and analysis.
counter the role of the dollar. Standard & Poor’s and Fitch --- control
The European Central Bank lent a record over 90% of the market. These agencies

The Pakistan Accountant Oct-Dec 2009 56


IN HOUSE

CASE VIGNETTE

When Your High Potential


Female Employees Start
to Leave
In researching her forthcoming book Top Talent: Keeping
Performance Up When Business Is Down*, author Sylvia
Ann Hewlett, an economist and founding president of the Center
According to Hewlett talented people, both men and women are
looking for intellectually and professionally challenging careers
instead of a traditional vertical career path. “When they don’t
for Work-Life Policy, found that in the wake of last year’s financial know how to articulate those desires or think they won’t be
crash, high-powered women were more than twice as likely as satisfied by their current employer, they’ll look elsewhere.”
men — 84 percent compared with 40 percent — to be seriously
thinking about leaving their jobs. In 1991, Deloitte & Touche got a wake-up call about its efforts to
retain women professionals. While it was recruiting almost as

Myth Busted!
Research shows that the presence of women in senior positions many women as men, the

Most women who


in any organization translates in to higher productivity, higher company had a much higher
return on investment, and greater resilience to downturns. A turnover rate for women. When

leave their jobs do


recent study from London Business School shows that when they looked harder, they found that

not leave to spend


work teams are split 50-50 between men and women, most women weren’t leaving to
productivity goes up. raise families; they were leaving

time with their


after having weighed their

family, but because


Women are better lateral thinkers, and they bring compassion unpromising career options in
and idealism to the workplace. Summarizing how valuable Deloitte’s male-dominated culture.

they no longer feel


women are to business, The Economist recently wrote:

challenged by or
CEO Mike Cook made a business
“The recent financial crisis proved that the sorts of qualities that case for change. Deloitte held

passionate about
men pride themselves on, such as risk-taking and bare-knuckle mandatory, two-day, intensive

their work.
competition, can lead to disaster. Lehman Brothers would never workshops for its 5,000 US
have happened had it been Lehman Sisters.” managers to deliberate on what
was discouraging high-performing
Intel created career development workshops aimed squarely at women from staying. Deloitte’s
retaining one of its most at-risk populations: mid-level female gender gap in turnover has now nearly vanished, and the
engineers. Data collected from exit interviews had revealed that number of women partners and directors is the highest among
many of these talented technologists were leaving not to spend the Big Five. Gender and cultural diversity have enabled Deloitte
time with their family but because they no longer felt challenged to grow faster than any of its competitors.
by or passionate about their work. * Source: Harvard Business online

The Pakistan Accountant Oct-Dec 2009 55


cccc
IN HOUSE

WORLD IN FOCUS

SBP Announces
Monetary Policy for Jan-Feb;
Keeps Interest Rates
Unchanged
Pakistan maintained its discount rate at 12.5 percent

SBP projected CPI inflation for the current fiscal between


11 and 12 per cent, compared to 20.5 per cent last year.
Rise in cotton production and growth in textile sector have
led to increased exports. Large-scale manufacturing sector
grew by 0.7 per cent in November, compared to minus 20
per cent in March.

Overall balance of payments has posted a surplus of $1.4


billion during the first half of the current fiscal, compared to
a deficit of $4.8 billion during the same period last year.

Sustained improvement in the balance of payments would


depend significantly on the timing and scale of projected
foreign inflows, especially the officials flows pledged in
Tokyo by Friends of Pakistan.

State Bank of Pakistan announced its monetary policy on SBP Governor Salim Raza said monetary growth was
January 30 keeping its benchmark interest rate unchanged for expected to be around 14.5 per cent for the current financial
the next two months as inflation soars due to higher power tariffs year. The governor dismissed worries about the decline in
and delay in receiving aid from Friends of Pakistan. The rupee’s value vis-à-vis the dollar, saying 3.5 per cent
domestic inflationary cycle is expected to hike over the next deprecation was not very significant, considering that all major
three months with the increase in utility rates. State Bank of currencies had seen a fall in their value against the dollar.

The Pakistan Accountant Oct-Dec 2009 57


IN HOUSE

DP World to Open Port Qasim Ben Bernanke Appointed Federal Reserve Chairman
for Another Term
DP World will be opening Port Qasim in Karachi this year. DP
CEO Mohammad Sharaf has declined to say what the added The US Senate backed Ben Bernanke for a second four year
capacity would be. As part of its international strategy DP World, term as Chairman of the Federal Reserve, but he continues to
one of the world’s largest port operators, is focusing on emerging face significant challenges. Bernanke’s political standing has
markets which have remained more resilient to the global taken a beating during the past several weeks, which might
downturn. make it more difficult for him to defend the central bank and
maintain its independence.

Obama ‘Crisis Tax’ Threatens Recovery of European Banks


A ‘crisis tax’ proposed by the Obama administration would cut
substantially into bank earnings across Europe and could
sidetrack the sector’s recovery according to analysts and
industry officials.

Under the new tax proposals, financial institutions with balance


sheets above $50 billion would be assessed a fee equal to 0.15
percent of certain assets. About 15 international firms fall under
that umbrella.

Europe’s three biggest economies were quick to distance


themselves from the proposal given that the European banks
which would be affected by this levy did not get bailouts in the
United States and lack many of the guarantees their U.S.
competitors received.

German Chancellor Angela Merkel said she favored a financial


In the last 12 months DP World has opened new terminals in transaction tax, Britain said the problems in the United States
Djibouti and Vietnam and has seen added capacity from port were uniquely its own, and France said a tax on bonuses was
expansion in Kochi and Peru. the most efficient response to it.

Pakistani Businesses Pledge Projects at FoDP Deutsche Bank was named as likely to be one of the European
banks most affected, given its U.S. exposure.

Break Up the Banks, Says Nouriel Roubini


Led by Foreign Minister Shah Mahmoud Quraishi, a delegation
of Pakistani businessmen has pledged to offer private-public
sector projects to international investors in Dubai. The UAE
hosted the Public-Private Partnership conference in Dubai under Nouriel Roubini, the economist credited with predicting the
financial meltdown well before others, says big banks must be
the aegis of Friends of Democratic Pakistan (FoDP). The
split up.
conference is expected to provide an excellent opportunity to
local businesses and foreign investors to directly obtain and
The New York University economist told business and political
provide information.
leaders at the World Economic Forum in Davos, that the Obama

Real Estate Speculation Raises Bubble Fears in


administration’s planned reforms of banks is a good first step,

China
and it should lead to the separation of commercial banking from
investment banking around the world.

China’s property prices rose at the fastest pace in 18 months in Emerging Markets To Be Hit As Foreign Investors Pull Out
December with residential and commercial real estate prices in
70 cities climbing up to 7.8 percent from a year earlier signaling Foreign investors withdrew nearly $1 billion from emerging
market stock funds in the week ended February 3, the most in
the risk of asset bubbles. Home prices have become excessive
over a year, according to global fund tracker EPFR Global. This
in some coastal cities with newly built apartments in Shanghai
included $516 million from Asian equities including Japan.
climbing 9.2 percent.
Worsening public debt concerns in Europe and doubts of a US
As a crackdown measure on speculation, Chinese Premier Wen recovery are driving foreign investors away from risky equities
Jiabao pledged to stabilize property prices and keep housing forcing them to pull out funds from emerging markets such as
affordable through taxation, differentiated interest rates and land India where their portfolio holdings total almost $73 billion.
regulations. Greece, Spain and Portugal are among the three European
countries where there is mounting public pressure and threats of
Analysts say the tightening focus will be on the luxury housing social unrest driven by risks of a sovereign default.
segment and speculative buying, not on so called ‘ordinary’
housing. If the market cools to the extent that no one’s buying Meanwhile, India’s $1.3 trillion economy is being strongly driven
then the 2010 economic growth target will be jeopardized. Real ahead by domestic demand and investment. Morgan Stanley
estate investment is equivalent to almost 10 percent of China’s has raised its forecast for India’s economic growth to 8.5 percent
economic output. in 2010-2011 from 8 percent earlier.

The Pakistan Accountant Oct-Dec 2009 58


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L A S T PAG E

Breaking the
Bank Nouriel Roubini, the economist credited with predicting the
financial meltdown well before others, says big banks must be
split up. Roubini expects the Obama administration’s planned
reforms of banks to lead to the separation of commercial
banking from investment banking around the globe.

The Obama administration is getting tough with the six largest


US banks with total assets worth more than 60 percent of GDP.
The existing business model encourages excessive risk taking
by banks. Former Federal Reserve Chairman Paul Volcker has
proposed restrictions on banks similar to those contained in the
Glass-Steagall Act of 1933.

The Glass-Steagall Act separated commercial and investment


banking. The Act was repealed in 1999 allowing institutions such
as Goldman Sachs and Morgan Stanley to transform into bank
holding companies from securities firms to get cheap funding
from the US Federal Reserve’s TARP program during the recent
financial crisis. Additionally, if Glass-Steagall had not been
repealed Bank of America would not have been able to acquire
Merrill Lynch.

Policymakers are now calling for a prohibition on proprietary


trading by commercial banks. They are also calling for an
increase in banks’ capital requirements so that the banks hold at
least 20 to 25 percent of assets in core capital. In the US there
are calls to amend the Riegle-Neal Interstate Banking Act of
1994 which set a size cap so that no bank could have more than
10 percent retail deposits.

The US House of Representatives is planning to reinstate Glass-


Steagall. Critics of Glass-Steagall say it would be impractical to
roll back the evolution of many financial institutions into global
trading and banking giants over the past decade, with Goldman
Sachs’ finance chief David Viniar saying, “Glass-Steagall went
away a long time ago.” Whether it’s coming back remains to be
seen.

The Pakistan Accountant Oct-Dec 2009 60