34453
REPORT ON THE OBSERVANCE OF STANDARDS AND CODES (ROSC)
Pakistan
ACCOUNTING AND AUDITING

March 31, 2005

Contents
Executive Summary
Preface
I.      Introduction and Background
II.     Institutional Framework
III.    Accounting Standards as Designed and as Practiced
IV.     Auditing Standards as Designed and as Practiced
V.      Perception of the Quality of Financial Reporting
VI.     Policy Recommendations
                                      EXECUTIVE SUMMARY
 Pakistan has made progress in closing the gap between local requirements for corporate financial
 reporting and international standards by adopting International Financial Reporting Standards (IFRS)
 and International Standards on Auditing (ISA). Over the past few years, this has contributed to
 significant improvements in corporate financial reporting. Despite such achievements, there are still
 varying compliance gaps in both accounting and auditing practices. These gaps are likely to stem from
 inadequate technical capacities of the regulators, absence of implementation guidance, lack of
 independent oversight of the auditing profession, and shortcomings in professional education and
 training.

 This report provides an assessment of accounting and auditing practices in Pakistan with reference to
 the requirements of the IFRS, issued by the International Accounting Standards Board (IASB), and
 ISA, issued by the International Federation of Accountants (IFAC). This assessment is positioned
 within the broader context of the country’s institutional framework and capacity needed to ensure the
 quality of corporate financial reporting. Building on the past achievements, greater efforts are
 necessary for strengthening the capacity of the regulators and ensuring compliance with applicable
 standards and codes.

 The principle-based policy recommendations outlined in this report are aimed for the consideration of
 appropriate authorities in Pakistan. These recommendations will be used as inputs in developing a
 Country Action Plan, geared toward strengthening the corporate financial reporting regime in Pakistan.
 The objectives of these recommendations are to consolidate the prior achievements, improve
 knowledge base among auditors and the preparers of financial statements, and strengthen the
 monitoring and enforcement mechanisms for ensuring compliance with applicable standards and
 codes. The recommendations include improving the capacity of regulators and professional bodies,
 upgrading accountancy education and training with focus on practical application of IFRS and ISA,
 issuing and disseminating implementation guidance on applicable standards, instituting a system for
 independent oversight of auditing profession, developing simplified SME reporting requirements,
 upgrading the licensing procedure of professional accountants and auditors, and enhancing the delivery
 of continuing professional education. These recommendations are expected to pave the way in
 achieving further improvements in the country’s corporate financial reporting practices. This will also
 create a more successful working environment for professional accountants and auditors in Pakistan,
 many of who are capable of rendering world-class services.
                                            PREFACE

There is a broad agreement among members of the international financial community that the
observance of international standards and codes are pivotal in strengthening national and
international financial architecture. In a world of integrated capital markets, financial crises in
individual countries can imperil international financial stability. This provides a basic public goods
rationale for minimum international standards which would benefit both international and
individual national systems. At the international level, international standards enhance transparency
as well as multilateral surveillance. They help to better identify weaknesses that may contribute to
economic and financial vulnerability, foster market efficiency and discipline, and ultimately
contribute to a global economy that is more robust and less prone to crisis. At the national level,
international standards provide a benchmark that can help identify vulnerabilities as well as guide
policy reform. To best serve these objectives, however, the scope and application of such standards
needs to be assessed in the context of a country's overall development strategy and tailored to
individual country circumstances.

Following the Asian financial crisis in 1997, the international community recognized the real need
to assess the degree to which a country observes the internationally recognized standards and
codes. The World Bank and the International Monetary Fund (IMF) instituted Reports on the
Observance of Standards and Codes (ROSC) that assesses key areas in a country’s economic well-
being: accounting and auditing, anti-money laundering and combating the financing of terrorism,
banking supervision, corporate governance, data dissemination, fiscal transparency, insolvency and
creditor rights, insurance supervision, monetary and fiscal policy transparency, payments system,
and securities regulation.

The ROSC Accounting & Auditing (A&A) review focuses on the institutional framework
regulating the accounting and auditing practices, comparability of national accounting and auditing
practices with international standards and best practices using International Financial Reporting
Standards (IFRS) and International Standards on Auditing (ISA) as benchmarks, and evaluating the
effectiveness of enforcement mechanisms for ensuring compliance with applicable standards and
codes. The final draft report is submitted to the country authorities for comment, approval, and
permission to publish. Once agreed, the report is published on the World Bank’s website. An
overview of the ROSC A&A Program and a detailed presentation of the methodology are available
at http://www.worldbank.org/ifa/rosc_aa.html

The ROSC A&A review exercise was carried out in Pakistan during the period from October to
December 2004 through a participatory process involving various stakeholders. The stakeholders
include the Securities and Exchange Commission of Pakistan, State Bank of Pakistan, Institute of
Chartered Accountants of Pakistan, Institute of Cost and Management Accountants of Pakistan,
banks, leasing companies, insurance companies, state-owned enterprises, audit firms, stock
exchanges, finance companies, corporate accountants, and academics. Relevant stakeholders
provided detailed comments on the draft report, delivered to the authorities on March 31, 2005.
The report was updated on the basis of comments from relevant in-country stakeholders and
feedback from participants in a dissemination workshop held in Islamabad on November 17, 2005.

The Pakistan ROSC A&A was prepared by a World Bank team comprising Ismaila B.Ceesay –
Senior Financial Management Specialist and Task Leader (SARFM); M. Zubaidur Rahman –
Program Manager and Study Advisor (OPCFM); Humayun Murshed (international consultant); and
Furqan Saleem (national consultant).
                         I. INTRODUCTION AND BACKGROUND

1.       This report is based on an assessment of accounting and auditing practices in the
Islamic Republic of Pakistan. It forms part of a joint initiative between the World Bank
and the International Monetary Fund (IMF) on Reports on the Observance of Standards
and Codes (ROSC). The assessment focuses on the strengths and weaknesses of corporate
accounting and auditing practices in Pakistan and involves a review of both mandatory
requirements and actual practice. It uses International Financial Reporting Standards
(IFRS)1 and International Standards on Auditing (ISA) as benchmarks and draws on recent
global experiences and best practices in the field of corporate financial reporting and audit
regulation. The assessment used a diagnostic template developed by the World Bank to
facilitate collection of information, which was complemented by the findings of a due
diligence exercise, based on a series of meetings with key stakeholders conducted by
World Bank staff. The intended audience of this report includes national and international
market participants who have an interest in the corporate financial reporting regime of
Pakistan.

2.     With a population of about 159 million, Pakistan has a per capita gross national
income (GNI) of US$520, and poverty still remains a serious concern.2 However, the
country has made strides in improving a deteriorating macroeconomic situation. In 2004
gross domestic product (GDP) grew by an estimated 6.4 percent. The financial sector grew
during fiscal year (FY) 2002-03 adding assets of about US$9.1 billion, accounting for
almost 85 percent of GDP.3 The private sector dominates the financial sector, representing
an asset share of 52 percent. There are 40 banks and 54 insurance companies operating in
Pakistan. As of September 2003, commercial banking assets amounted to 54 percent of
GDP.4 The asset structure in the insurance sector is heavily skewed toward state-owned
insurance companies in both life and general insurance;5 the total assets in this sector have
grown by about 15 percent during FY2002-03.

3.      The Government of Pakistan has undertaken a broad agenda of stabilization and
structural reform to privatize public sector enterprises, strengthen public and corporate
governance, and reform the banking sector. Foreign exchange reserves continue to grow,
supported by export growth and steady remittances by Pakistanis working overseas. The
improvements in governance of public entities, relatively stable foreign exchange rate, fall
in the interest rates, and the expectation of the continuation of improvement in the business
climate has begun to show up in increased foreign investment, particularly in the textile
and oil and gas sectors.6

1
  IFRS refers to all standards and related interpretations issued by the International Accounting Standards
   Board (IASB) and its predecessor the International Accounting Standards Committee (IASC), which
   issued International Accounting Standards (IAS). In this report, IFRS also refers to IAS.
2
  The World Bank in Pakistan, Country Brief, September 2004.
3
  Financial Sector Assessment Report 2003, State Bank of Pakistan.
4
  Pakistan: Financial System Stability Assessment, including ROSC reports on monetary and financial policy
   transparency, banking supervision, and securities regulation; International Monetary Fund, 2004.
5
  The share of one of the state-owned insurance companies, State Life Insurance Corporation, was 70.5
   percent of the total assets of the entire industry during FY2002-03.
6
  Pakistan Country Update, www.worldbank.org.pk.


Pakistan—Accounting and Auditing ROSC                                                               Page 1
4.       There are 663 companies listed in the country’s premier securities market, Karachi
Stock Exchange,7 with a market capitalization of US$25 billion.8 Trading in Pakistan’s
stock markets is highly concentrated. Although the stock market is relatively small in size,
its role can be of paramount importance for the consolidation of the private sector, which
in turn can help support, the country’s economic growth. High-quality corporate financial
reporting practices are crucial for enhancing investors’ confidence and orderly operation of
the securities market.

5.       Foreign direct investments in Pakistan exceeded US$800 million during FY2002-
   9
03. International investors call for comparable financial information from countries
competing for foreign investments. This requires that the corporate sector in Pakistan
comply with internationally acceptable standards and codes. Pakistan has created a
statutory framework to regulate business activities, including establishment of regulatory
institutions for enforcing accounting and auditing standards and codes. In order to ensure
high-quality corporate financial reporting, appropriate enforcement mechanisms need to be
in place.

                            II. INSTITUTIONAL FRAMEWORK
                                    A. Statutory Framework

6.     The Companies Ordinance sets primary requirements for financial reporting
of all companies incorporated in Pakistan. The Companies Ordinance requires the
preparation, presentation, and publication of financial statements, including disclosures
and auditing of all companies incorporated in Pakistan. In addition to the various
provisions pertaining to financial reporting, the Fourth Schedule of the Ordinance lays
down the form, content, and certain disclosure requirements for preparing financial
statements for listed companies, while the Fifth Schedule outlines the same for non-listed
companies.10 It is mandatory for group incorporated companies in Pakistan to prepare
consolidated financial statements in accordance with IFRS requirements.11

7.       Under the Companies Ordinance it is obligatory for all companies to present
their financial statements in accordance with IAS notified in the government gazette
by the SECP. The Securities and Exchange Commission of Pakistan (SECP) has notified
that all IASs except IAS 29 Financial Reporting in Hyperinflationary Economies and IAS
41 Agriculture are applicable for the listed companies. The International Accounting
Standards Board (IASB) has issued and made applicable a number of IFRS, which have
not yet been notified by the SECP. As a result, full compliance with SECP-notified
standards may not necessarily result in full compliance with IASB-issued accounting


7
   There are three stock exchanges operating in Pakistan, the largest, Karachi Stock Exchange; Islamabad
   Stock Exchange; and Lahore Stock Exchange. With a few exceptions, almost all companies registered with
   the Islamabad and Lahore Stock Exchanges are registered in Karachi Stock Exchange.
8
   Annual Report 2004, Karachi Stock Exchange Ltd.
9
   Data from the Embassy of the Islamic Republic of Pakistan, USA. www.embassyofpakistan.org
10
   Various provisions of the Companies Ordinance, including the Fourth Schedule have already been revised
   in compliance with the requirements of IFRS.
11
   Section 237 of the Companies Ordinance.


Pakistan—Accounting and Auditing ROSC                                                              Page 2
standards. Immediate steps should be taken for notification of all accounting standards and
interpretations issued by the IASB till date.

8.      The enforcement of accounting and auditing standards by the Registrar of
Companies is largely constrained by inadequate technical capacity. The Registrar of
Companies, which is housed at the SECP, is empowered to enforce provisions of the
Companies Ordinance, including inspection of books of accounts. There are 8 Company
Registration Offices operating in Pakistan.12 Only 17 qualified accountants are available in
the Registrar of Companies, hardly enough to monitor and enforce the compliance of
applicable requirements and standards for about 44,000 companies incorporated
throughout Pakistan. Efforts are underway to improve SECP’s capacity with respect to
qualified accountants.

9.       The Companies Ordinance outlines obligations of company directors with
regard to the preparation of annual financial statements. Company directors are
responsible for timely preparation of annual financial statements and present these
statements at the annual general meeting of the shareholders. The audited financial
statements along with the company directors’ report should be filed with the Registrar of
Companies within one month of holding the annual general meeting. The directors’ r eport
must include several mandatory disclosures. Failure by the director to comply may lead to
a fine or imprisonment or both.13 However, private limited companies are not mandated to
file their audited financial statements with the Registrar of Companies.

10.     There are additional reporting requirements for listed companies. The
Companies Ordinance requires that each listed company prepare quarterly financial
statements and file these statements with the SECP, Registrar of Companies, and Stock
Exchange. Failure to comply may lead to a fine not exceeding 100,000PKR against a
director, including the chief executive officer (CEO) and chief financial officer (CFO).
Furthermore, the Company Ordinance grants authority to the SECP to request any
additional accounts and reports deemed necessary toward regulating the listed
companies.14

11.    The Companies Ordinance spells out audit requirements for companies
incorporated in Pakistan. Audit requirements include the procedures relating to
appointment and removal of auditors, including duties, responsibilities, and obligations in
performing audit functions. It is mandatory to appoint a practicing member of ICAP for
auditing any public limited companies, including their subsidiaries and private companies
with paid up capital of 3 million PKR or more. However, the Ordinance is silent on who
can audit other private limited companies.15




12
   These offices are located in Faisalabad, Islamabad, Karachi, Lahore, Multan, Peshawar, Quetta, and
   Sukkur.
13
   Section 236 of the Companies Ordinance.
14
   Section 246 of the Companies Ordinance.
15
    Many stakeholders perceive this legal limitation as a contributing factor for weak monitoring and
   enforcement of standards for many closely held family companies with a substantial business size.


Pakistan—Accounting and Auditing ROSC                                                          Page 3
12.     The Monitoring and Enforcement Department of SECP is responsible for
enforcing IFRS compliance by listed companies. Listed companies are required to
comply with SECP requirements with respect to corporate accounting and disclosures. In
pursuance of the authority granted under the Companies Ordinance [subsection (3),
Section 234], SECP issues special regulatory orders prescribing mandatory IFRS
application to listed companies. The Enforcement and Monitoring Department uses a
standard checklist format in order to ensure compliance with applicable accounting and
disclosure requirements. Strengthening SECP capacity would improve its monitoring and
enforcement function.

13.    The Securities and Exchange Commission of Pakistan Act (1997) protects
investors and regulates the securities market. In order to protect investors’ interests,
SECP issues listing requirements that specify disclosures applicable to listed companies, in
addition to other applicable auditing and accounting requirements.

14.     The SECP has mandated the audit committee and the rotation of auditors for
listed companies. The board of directors of every listed company is required to establish
an audit committee, comprising not less than three members, including the chairman. The
majority membership of the committee is to be drawn from the non-executive directors of
the company. The audit committee among its responsibilities makes recommendations to
the company’s board on the appointment of external auditors, audit fees, and provision of
non-audit services by the auditors. Such recommendations require shareholders’ approval
at the annual general meeting. The SECP has mandated rotation of audit firms for all listed
and non-listed banks, non-banking finance companies (NBFCs), modarabas and insurance
companies. It has also mandated rotation of audit engagement partners for other listed
companies. In both cases, the rotation must be made after every five years.

15.     The Banking Companies Ordinance empowers the State Bank of Pakistan
(SBP) to regulate financial reporting by banks and similar financial institutions . The
accounting and auditing requirements as outlined in the Banking Companies Ordinance are
in addition to those set by the Companies Ordinance, SECP, and Stock Exchange. The SBP
has prescribed formats for financial statements, including disclosure requirements that each
bank must follow. Due to the exemption granted to financial institutions from the
applicability of IFRS 39 and 40 these formats are deviating from full compliance with
IFRS. All banks and development financial institutions (DFIs) must publish audited annual
financial statements and file those statements with the SBP within three months of the
financial year-end. The financial statements of all banks and DFIs must be audited by the
selected qualified auditors from the list empanelled with SBP.16 Exercising the authority
conferred by Section 35(3) of the Banking Companies Ordinance, SBP issues guidelines
for the auditors, primarily for the purpose of prudential regulations. Bank auditors are
required to hold meetings with the SBP inspectors before commencement of their on-site
inspection. Also inspectors are required to share their concerns with the respective auditors

16
     In preparing the panel of audit firms, SBP considers the size of the firm, its audit experience, and ICAP-
     rated quality control. There are three categories of paneled audit firms: Category A can conduct audits of
     all banks and DFIs; category B can audit the banks and DFIs with total assets (net of contra items) up to 50
     billion PKR or having up to 99 branches; and category C can conduct audits of the banks and DFIs with
     total assets (net of contra items) below 5 billion PKR or having below 10 branches.


Pakistan—Accounting and Auditing ROSC                                                                     Page 4
upon completion of the inspection. Furthermore, the auditors are required to send copies of
the Management Letter and any other letters to bank management; and to the SBP within
one week of issuance of such letters.

16.    In compliance with SBP requirement, banks and similar financial institutions
publish their quarterly financial statements in newspapers. Through a circular issued
in 2004, the Banking Supervision Department of the SBP has made it mandatory for all
banks and DFIs to publish their unaudited quarterly financial statements and limited audit
reviewed half-yearly financial statements in a newspaper.

17.    The Insurance Ordinance of 2000 regulates the financial reporting practices of
insurance companies. Insurance companies, operating in Pakistan must comply with the
requirements of the Insurance Ordinance 2000 in preparing and presenting their financial
statements. The Ordinance empowers the SECP to monitor and enforce the applicable laws
and standards, including the accounting and auditing for the insurance companies. The
audit functions of insurance companies must be carried out by an ICAP member. The
auditor is appointed from the SECP-approved panel. The audited financial statements of
insurance companies should be submitted to the SECP within 4 months of the financial
year-end. As per the Insurance Ordinance, the actuarial certification must be obtained
whether the insurer’s reserves adequately meet all liabilities.

18.     The Non-Banking Financial Companies Department of SECP regulates the
non-banking financial institutions in Pakistan, including their accounting and
reporting. This department is responsible for regulating investment banks, leasing
companies, discount houses, housing finance companies, and venture capital companies. It
is authorized to monitor and enforce the accounting and auditing requirements for the non-
banking financial institutions as set by the Non-Banking Finance Company Rules 2003.
The financial statements of the non-banking financial institutions must be audited by the
ICAP member.

19.     The Stock Exchange Listing Rules require all listed companies to present
interim financial statements. The Stock Exchange Listing Rules require all listed
companies to publish unaudited quarterly financial results, according to a prescribed
format, and be circulated among the shareholders along with directors’ review on the
quarterly affairs of the listed company. These quarterly financial statements do not require
auditing, while the half-yearly financial statements are subject to a limited scope review by
the professional auditors.

20.     Tax law entails companies to submit audited annual financial statements with
their tax returns. The Income Tax Ordinance 2001 requires companies to submit their
audited annual financial statements along with the annual tax return. The companies derive
corporate income for tax purposes after adjusting relevant figures from their general
purpose financial statements, as per applicable provisions and allowances under the
Income Tax Ordinance.

21.    Certain laws and regulations in Pakistan call for taking into account some
Islamic tenets in corporate accounting and auditing. The Government of Pakistan has


Pakistan—Accounting and Auditing ROSC                                                  Page 5
put in place various legislative enactments in order to take into account the application of
Islamic doctrines in preparation and presentation of financial statements. Such enactments
include ordinances for regulating the financial reporting practices of Modaraba
companies17 and incorporating auditors’ opinion with regard to payment of zakat.18
Moreover, the SBP is in the process of formulating a separate set of prudential regulations
for the Islamic banks operating in Pakistan. Islamic banks with 1-2 percent of the total
assets do not constitute a significant part of the banking sector.

22.    Federal laws covering state-owned enterprises (SOEs) authorize the
Controller General of Accounts to regulate SOE accounting functions and the
Auditor General of Pakistan to conduct SOE audits. The Controller General regulates
the accounting and reporting functions of the SOEs, while the Auditor General is
responsible for their audit functions. However, ICAP members, in addition to the Auditor
General, will conduct audits of SOEs, which are incorporated under the Companies
Ordinance.19 The audit conducted by the Auditor General’s office primarily focuses on
compliance of rules in carrying out financial management of those enterprises. The
government personnel responsible for providing guidance on accounting functions and
conducting auditing of the SOEs largely lack exposure of relevant public sector accounting
and auditing pronouncements of the IFAC. Nevertheless, the corporatized SOEs are
making efforts to align their accounting and auditing in line with international standards.

23.       In pursuance of the Companies Ordinance, SECP has mandated the cost
audit in certain sectors. In pursuance of the provision of Section 258 of the Companies
Ordinance, the SECP has mandated the cost audit for the listed companies involved in
cement, sugar, edible oil products, and processing. The cost audit entails preparation of
statements with regard to production capacities and inventories.20 These statements are

17
    Modaraba represents a form of partnership where one party provides the funds while the other party
   provides expertise and management. Any profits accrued are shared between the two parties on a pre-
   agreed basis, whereas the loss is borne by the provider of the capital. According to the Financial Sector
   Assessment Report 2003 of the SBP, the Modaraba sector has shown a declining share in total assets in the
   FY2003 despite the fact that Modarabas constitute the largest group in the non-banking financial
   institutions of Pakistan. The Modaraba companies are regulated through the Modaraba Companies &
   Modarabas (Flotation & Control) Ordinance 1980.
18
   Zakat is a form of giving to the people who are less fortunate. It is obligatory for all Muslims to pay 2.5
   percent of their wealth and assets each year. The Government of Pakistan has promulgated the Zakat and
   Usher Ordinance 1980 to administer the zakat. Section 255 of the Companies Ordinance requires that
   auditors must include in their reports whether or not zakat was deducted by the company and deposited it
   in the central zakat fund.
19
   In a 1968 circular, the Government of Pakistan mandated that the appointment of chartered accountants as
   auditors for the SOEs should be rotated once every five years. However, there are no other criteria for
   appointment of SOE auditors. There exists some confusion about the role of the Auditor General of
   Pakistan in conducting SOE audits. For example, the Pakistan Telecommunication Company Ltd (PTCL),
   a majority state-owned enterprise, refused to allow the Auditor General to audit on the grounds that such
   audit should be conducted according to the Companies Ordinance. The Auditor General contends that his
   department is responsible for the PTCL audit in accordance with the provisions of the Constitution of
   Pakistan.
20
   These statements include (a) a statement of production capacity of the plant delineating between machine
   hours and production units, actual capacity utilization, and reasons for any variance thereof; and (b) a
   statement of inventory as at the financial year-end in terms of quantity and cost distinguishing between
   inventory of raw materials, work-in-progress, and finished goods.


Pakistan—Accounting and Auditing ROSC                                                                  Page 6
required to be signed by the CEO and CFO of the company. The members of ICAP and the
Institute of Cost and Management Accountants of Pakistan (ICMAP) are eligible to
perform the cost audit functions. Within 60 days of appointment, the cost auditor is
mandated to finalize the report and submit it to the SECP. The company is required to
submit an explanation to the SECP with regard to any audit qualification within 30 days of
submission of report by the cost auditor.

                                        B. The Profession

24.     The self-regulated Institute of Chartered Accountants of Pakistan oversees the
accountancy profession in Pakistan. The ICAP was established by the Chartered
Accountants Ordinance in 1961. The Government of Pakistan (GoP) is in the process of
revising the current ordinance. The revision includes, among others, vesting more power to
the ICAP for taking disciplinary actions against its members for violating code of ethics
and professional norms. This professional body was modeled on the Institute of Chartered
Accountants of England and Wales. ICAP acts both as an examining body for awarding
chartered accountancy qualifications and the licensing and disciplinary authority for
members engaged in public practice. ICAP is a member of the International Federation of
Accountants (IFAC), South Asia Federation of Accountants (SAFA), and Confederation of
Asia Pacific Accountants (CAPA). The ICAP membership is 3,377 (July 2004 figures) of
which about 17 percent are engaged in public practice.

25.     The ICAP Council, assisted by various committees of volunteer members,
governs organization. The Council is the supreme body through which the ICAP
functions and is comprised of 12 elected members and 4 persons nominated by the Federal
Government. The major statutory functions of the Council include designing and
implementing policies regarding student enrollment, including administering education,
training, and examination; programs for members’ professional development; ensuring
adherence to professional ethics and standards; and disciplinary action against erring
members. The Council elects the ICAP president, who also becomes the chief executive
officer, to a one-year term.

26.     The ICAP allows its practicing members to associate with two audit firms .
The by-laws of the Chartered Accountants Ordinance 1961 allows its members, while
already in practice under a sole proprietorship firm, to join as a partner in another audit
firm. Various stakeholders perceive that such an arrangement may promote “sleeping”
partners—joining a firm in name only without actual work—to meet firm-size limits in
order to gain business.

27.    The ICAP has set the minimum fee for conducting audits. Like many other
countries, audit fee is a sensitive issue. Auditors often complain about the low audit fee in
Pakistan. ICAP has prescribed a minimum fee schedule, which members are required to
follow in rendering audit services.

28.    The Institute of Cost and Management Accountants of Pakistan is actively
involved in financial reporting process and cost audit. The ICMAP is an autonomous
body established in 1966 with a similar governance structure to the ICAP. The total


Pakistan—Accounting and Auditing ROSC                                                  Page 7
number of members of this professional body is 2,190 (July 2004 figures). Most ICMAP
members work in industry and are involved in the preparation of corporate financial
statements. In addition, some ICMAP members provide cost audit services to companies
falling within certain manufacturing industry sectors (as described in Para 23).

29.     There are cases when management tends to shift the responsibility for
preparing financial statements on the auditors. Some stakeholders, including auditors,
have cited few instances when company management has either partly or fully shifted the
responsibility for preparation of financial statements on the auditors. This may be due to
the lack of qualified professionals available for preparing financial statements and
corporate management’s misperception about the role of auditors. The latter point arises
from company directors’ lack of knowledge on auditing procedures, thus impairing
significantly their fiduciary responsibility. In order to be compliant with the independence
rules, auditors should not audit the financial statements that they prepare. Preparation of
financial statements is the responsibility of corporate management.

30.     The large international accounting firm networks have strong presence in
Pakistan. The local members/affiliates of international accounting firm networks audit
about 40 percent of the listed companies, leaving the remaining market share to the local
firms. The internationally affiliated firms audit most of the banks and insurance
companies. Three local audit firms have undertaken about 20 percent of listed companies’
audit. Several local firms have established network in major cities of the country.

31.     Members of the ICAP are required to follow the Code of Ethics. The ICAP
Code of Ethics for Chartered Accountants was revised in 2003 in line with the IFAC Code
of Ethics for Professional Accountants, which was issued in November 2001. The ICAP
must implement an effective mechanism to enforce this Code. More stringent disciplinary
actions and effective periodical audit for members are necessary to monitor for detecting
ethical misconduct or violations.

32.     The ICAP lacks adequate technical resources. The ICAP is dependent on
volunteer members and should reduce this need by employing adequate full-time qualified
personnel. Increasing the technical resources will help the ICAP in better discharging its
IFAC membership obligations, including supervision of members and implementing
ethical standards and disciplinary procedures.

33.    Professional indemnity insurance is not required by law. Some practicing
auditors who work for affiliates of international accounting firm networks in Pakistan are
covered by professional indemnity insurance. While auditors are subject to civil liability,
they are not required by law to take professional indemnity insurance. This has created an
environment of unconcern toward risks of malpractice suits by auditors in many cases.
Professional indemnity insurance is not a well known concept in Pakistan. Most insurance
companies do not have this product. However, it is possible to obtain professional
indemnity insurance coverage at an exorbitant price which seems to be beyond the capacity
of most of the audit practitioners in Pakistan.




Pakistan—Accounting and Auditing ROSC                                                 Page 8
34.     Many stakeholders perceive that auditors’ involvement in both audit and tax
advocacy may threaten auditor independence. In Pakistan statutory auditors are not
specifically prohibited from providing some non-audit services, including tax advocacy
and representation before tax authorities21. There is a strong perception among the various
stakeholders that such involvement may pose a threat to auditors’ independence.

35.     One of the British professional accountancy bodies has a discernible presence
in Pakistan. There is a perception among the stakeholders that the professional
qualifications for the Association of Chartered Certified Accountants (ACCA) of the
United Kingdom are becoming increasingly popular in Pakistan, primarily due to its
international marketability. The ACCA membership is 779 (December 2004 figures). A
qualified ACCA member is entitled to obtain exemption from the foundation courses in the
ICAP professional examination. There is a tendency among some of the aspiring
accountants to obtain both ICAP and ACCA professional qualifications.

                             C. Professional Education and Training

36.     ICAP follows a modular approach in conducting the education and
examination of professional accountants.          The curriculum consists of six modules
covering 21 subjects spread over three levels: foundation, intermediate and professional.
Each student before registering with ICAP is required to pass the Pre-Entry Proficiency
Test. The minimum qualification for entering students is a Higher Secondary Certificate
(or A levels). Bachelor’s degree holders and post-graduates, with a defined minimum
score, are exempt from the Pre-Entry Proficiency Test.22 Upon passing the Pre-Entry,
students register with ICAP for the foundation level and get tutorial supports from any of
the ICAP registered accounting training centers. A student cannot advance to the next
higher level without passing the previous level. There is no limit on the number of attempts
that the students can make in order to pass the examination.

37.     Practical training is a prerequisite for the ICAP membership.              Prior to
obtaining full ICAP membership, a candidate is required to have four years of practical
training under the guidance of a qualified chartered accountant.23 This training
requirement starts after completing foundation-level curriculum. In order to guide trainee
students, a chartered accountant must be in practice for minimum of three years with audit
experience in 25 entities. There is a general perception that the range and depth of
practical knowledge gained in training varies with the size of accountancy firms that act as
training provider. However, the current system of monitoring the quality and ability of
practical training providers is sometimes constrained by the lack of adequate ICAP
resources24.




21
    An ICAP appointed committee has reviewed this in line with IFAC requirements and presented its
   recommendations to the SECP for its approval.
22
   This includes first division bachelors degree holders and post-graduates with second division.
23
   ICAP is considering revising this requirement of training period bringing down it to three and a half years.
24
   ICAP has recently introduced new training regulations, which are largely in line with IES 5 ‘ Practical
   Training Requirement’.


Pakistan—Accounting and Auditing ROSC                                                                   Page 9
38.     ICAP has set mandatory continuing professional education requirements.
Currently ICAP members are required to accumulate 25 credit hours of continuing
professional education. From July 2005 this requirement will increase to 30 credit hours
and from July 2006 onwards it will be 40 credit hours in one year or 120 credit hours in
total in three years. However, ICAP needs to strengthen its mechanism with regard to the
enforcement of continuing professional education as a requirement of professional
membership so that the qualified professional accountants gain up-to-date knowledge on
recent developments in financial reporting, auditing, and other related topics.

39.     Professionals working in small accountancy firms find it difficult to stay
updated on recent developments in accounting and auditing. These practitioners are
constantly struggling to keep their client base and earn enough to stay afloat. In most
cases, they do not have the money and time for training programs. Many practitioners in
small- and medium-size firms in Pakistan are also handicapped by their lack of access to
current literature on the applicable accounting and auditing standards. Such a situation may
limit the quality of auditing in the country.

40.     The trainee accountants cannot cope with the stipend they receive during their
training period. The trainee stipend is based on a scale prescribed by the ICAP and
correlated with the passing of different modules. Minimum monthly stipends prescribed
by ICAP ranges from 1,750 PKR (less than US$30) to 5,000 PKR (approximately US$83).
By comparison across the country, a newly qualified chartered accountant’s salary ranges
from US$700 to US$1,000 per month.

41.     Many entrants to the profession lack adequate knowledge in English and
communication. In opinions expressed to the ROSC team, many stakeholders felt that
entrants lack adequate knowledge in English with adverse affects on the quality of their
work. Although ICAP-sanctioned instruction is in English, in order to adequately prepare
students, ICAP training arrangements should focus on interpersonal and communication
skills and skills in forming professional judgments, in parallel with development of
technical and functional skills.

42.      University courses in accountancy do not focus on teaching IFRS or ISA. The
institutions of higher learning in Pakistan do not focus on IFRS and ISA in their bachelor’s
and graduate degree programs in accountancy. The curricula are mainly restricted to
teaching accounting technicalities and basic procedural aspects of auditing. Thus the
students do not obtain required exposure of international best practices with regard to
accounting and auditing. Moreover, most accounting textbooks, used for teaching lack
adequate focus on the international dimension of accounting and auditing.

43.     Both academic and professional education in accounting lack adequate
coverage on professional values and ethics. Formal education can significantly enhance
aspiring accountants’ awareness of ethical problems and can influence their reasoning and
judgment with respect to ethical dilemmas. For this reason, the IFAC recommends
teaching professional ethics separately in the prequalifying education of professional




Pakistan—Accounting and Auditing ROSC                                                Page 10
accountants.25 However, in Pakistan, neither the academic institutions nor the professional
accounting bodies provide adequate coverage on ethical dimensions in their curricula.
ICAP teaches business ethics as part of other courses while professional ethics is not
taught as a separate subject.

44.     ICAP examination is not in full conformity with IFAC education standard.
Based on responses to questions and interviews with various stakeholders, the ROSC team
resolved that ICAP examination focuses more on academic and technical knowledge-
related aspects than on practical issues of IFRS and ISA, including the judgment to be
exercised by auditors in real-life circumstances. Such knowledge testing of aspiring
accountants does not comply adequately with IFAC requirements26 and fails to provide
ample assurance that certified accountants have the required professional skills to carry out
independent audits successfully.

                       D. Setting Accounting and Auditing Standards

45.      With the recommendation of ICAP, SECP adopts IFRS in Pakistan. SECP
promulgates accounting standards in Pakistan based on the recommendations of ICAP.27
After completion of the due process when IASB issues a particular standard, the ICAP
starts its own due process. On receipt of the final standard from the IASB, the Professional
Standards and Technical Review Committee of ICAP reviews the standard and
recommends whether the ICAP Council forwards it to the SECP. Having deliberations in
the Council, ICAP advices the SECP to adopt the particular standard. Once adopted by
SECP through official notification in the government gazette, the standard becomes
mandatory for observance by the companies. The adoption process in Pakistan adheres to
total adoption of IFRS.

46.     ICAP adopts International Standards on Auditing as national standards.
ICAP issues ISA for mandatory observance by its members. Upon receipt from the IFAC,
the exposure draft is sent to ICAP members for comments. These comments are returned
for consideration by IFAC. When the final standard is issued, ICAP adopts the standard.
The ISAs are adopted in Pakistan without any modification.

47.     Lack of adequate number of qualified professionals and lengthy due process
encumbers timely adoption of new IFRS and incorporation of any subsequent
revisions. Currently ICAP lacks fulltime qualified professionals for undertaking efforts in
effectively facilitating the standards setting process.28 At present SECP also takes a long

25
    IFAC International Education Standard (IES) 4, Professional Values, Ethics, and Attitudes. IFAC
   Educational Guideline No. 10, Professional Ethics for Accountants: The Educational Challenge and
   Practical Application.
26
   IFAC International Education Standard (IES) 6, Assessment of Professional Capabilities and Competence,
   which states, inter alia, that the examination should “require a significant portion of the candidate’s
   responses to be recorded form” and “cover a sufficient amount of the whole range of professional
   knowledge, professional skills, and professional values and attitudes”.
27
   However, there is no legal obligation on the part of SECP to seek recommendation from the ICAP in
   adopting IFRS.
28
   Since SECP relies on professional advice from the ICAP in promulgating standards, it is important that
   ICAP have adequate qualified personnel in facilitating the standard setting process.


Pakistan—Accounting and Auditing ROSC                                                             Page 11
time to complete its official endorsement process after receiving inputs from ICAP. These
factors attribute in hindering timely adoption of new standards, including incorporating
changes in the existing standard in line with IASB pronouncements.

              E. Ensuring Compliance with Accounting and Auditing Standards

48.     The SECP reviews financial statements of selected listed companies for
monitoring compliance with international standards; however its effectiveness is
constrained by lack of technical expertise. The SECP reviews financial statements of
listed companies. Upon identification of violations of established accounting and
disclosure requirements, SECP is authorized to initiate punitive actions against both
preparers and auditors. So far SECP has identified few cases of noncompliances that draw
such sanctions as issuing letters of admonition and levying fine. Despite some success in
monitoring and enforcement a few years ago when this mechanism was launched, at
present a shortage of technically qualified human resources makes it difficult to conduct
proper monitoring activities. In essence, lack of adequate technical capabilities limits full
investigation by SECP in cases when material noncompliances might have taken place.
However, the SECP continues its efforts to increase the number of qualified accountants
and to improve its monitoring and enforcement capacity.

49.     No effective mechanism exists to enforce requirements of accounting and
financial reporting for the nonlisted companies. The enforcement mechanism for
accounting and financial reporting of nonlisted companies is virtually nonexistent in
Pakistan. Absence of mandatory filing of annual financial statements with the Registrar of
Companies by the private limited companies makes it almost impossible to review the
level of compliances. The Companies Ordinance is also unclear on who can audit the
private limited companies with paid up capital of below 3 million PKR. Furthermore,
SECP lacks adequate technical capacity to identify accounting and auditing violations.29

50.    The Stock Exchanges in Pakistan do not undertake monitoring and
enforcement activity with respect to accounting and auditing standards .           Listed
companies are required to submit their financial statements to the Stock Exchange. The
Stock Exchanges in Pakistan are satisfied with the timely issuance of audited financial
statements by these companies, without having any arrangement in place to systematically
carry out monitoring of compliance with the applicable accounting and financial reporting
requirements.

51.    Financial statements prepared by insurance companies need effective
monitoring and enforcing actions. The Insurance Ordinance 2000 vested power in the
SECP to regulate the financial reporting of insurance companies. In reality, SECP lacks
technical capability to exercise these powers.

52.    The SBP’s Department of Banking Supervision needs to enhance its technical
capacity in monitoring and enforcing accounting and financial reporting
requirements. Primarily to ensure compliance with prudential regulations, SBP officials
conduct both offsite and onsite supervision of banks and DFIs. With respect to the general
29
     Refer to paragraph 8.


Pakistan—Accounting and Auditing ROSC                                                 Page 12
purpose financial reporting by these institutions, SBP examines financial statements,
approves the appointment of statutory auditors, reviews any communication from the
statutory auditors, and holds meetings between banking supervision staff and a bank’s
statutory auditors. In the recent past, there are few instances when the SBP has taken
punitive measures against auditors for noncompliances.30 However, there is still a need for
enhancing SBP’s technical capabilities, particularly in terms of practical application of
accounting and auditing standards, with regard to monitoring and enforcement of financial
reporting requirements.

53.     As a self-regulator, ICAP introduced the Quality Control Review (QCR) of
audit firms.       An independent review mechanism can ensure that audit firms have
adequate quality control arrangements in place for compliance with IFAC requirements of
quality assurance of audit firms. In 1987, ICAP introduced QCR, under the guidance of a
committee drawing all of its membership from ICAP. Recently, ICAP converted this
committee into a board, where it has included representative from the Central Board of
Revenue (CBR), Karachi Stock Exchange (KSE), SBP, Auditor General, and Accountant
General offices. Efficiency of the QCR is constrained by non-availability of adequate
number of experienced reviewers. The ICAP publishes results of the quality review
naming the audit firms. Based on the review, either a ‘satisfactory’ or ‘nonsatisfactory’
certification is given. As of 28 February 2005; 95 practicing accounting firms in Pakistan
got ‘satisfactory’ rating’31 and their names were published in the ICPA’s website.
However, the website does not mention the name of the firms, who obtain
‘nonsatisfactory’ rating. During the period between July 2003 and June 2004, QCR of 30
practicing accounting firms were conducted and out of which 5 cases were referred to the
ICAP’s Investigation Committee for their “prima facie negligence”32 In accordance with
the SECP requirement, an audit firm receiving a nonsatisfactory certification cannot audit
listed companies. Nevertheless, such reviews should not rule out instituting a system of
independent oversight of audit profession in Pakistan. Moreover, putting in place an
arrangement of independent oversight will enhance stakeholders’ confidence with regard to
accounting and auditing practices in the country. Recently the ICAP has also launched a
Financial Statements Review (FSR) Program, under which it is planning to review the
financial statements of all listed companies in order to determine compliance with
applicable standards.

54.     The slow legal process often discourages regulators from taking legal recourse
in enforcing compliance with financial reporting requirements. Generally, the process
of adjudicating cases in Pakistan is slow. Regulators are often discouraged from taking
legal action when enforcing sanctions against violators. Furthermore, the penalties
specified in the Companies Ordinance for various noncompliances, in many cases, are not
commensurating with the nature and magnitude of the offences.

55.   Nonavailability of implementation guidance is constraining full compliance of
accounting and auditing standards. In Pakistan, neither the professional nor other

30
   This includes downgrading the audit firm from higher to the lower category and barring the audit firm from
   conducting bank audit for a certain period of time.
31
   See www.icap.org.pak
32
   The Institute of Chartered Accountants of Pakistan Annual Report 2004, p. 14.


Pakistan—Accounting and Auditing ROSC                                                                Page 13
organizations issue guidance on implementation of IFRS and ISA. This has contributed, in
some cases, to the knowledge gap among preparers and auditors of financial statements.
Consequently, it raises a possibility of applying the standards in inconsistent manner and
resulting in the compliance gaps between IFRS and ISA requirements and actual practices.
Lacking access to modern audit practice manuals, many audit practitioners are unable to
deal with important concepts, such as audit risk, audit planning, internal control,
materiality, documentation, going concern and quality control. With ICAP-implemented
guidance, the auditors can audit with applicable rules and standards. This guidance should
incorporate cases and illustrations, relevant to Pakistan focusing on industry-specific
experiences.


        III. ACCOUNTING STANDARDS AS DESIGNED AND AS PRACTICED

56.     With the adoption of IFRS, Pakistan has attempted to close the gap between
local and international standards. Pakistan has adopted most of the applicable
IAS/IFRS, except IAS 29, Financial Reporting in Hyperinflationary Economies, and IAS
41, Agriculture Although adoption of most IFRSs has tended to close the gap between
local and international standards, lack of uniformity in application still risks a gap between
IFRS and actual practice.

57.    The application of IFRS is sometimes influenced by taxation consideration.
The ROSC team found instances where preparers of general purpose financial statements
departed from IFRS and followed tax rules in choosing the method of accounting
treatment. For example, some companies’ IFRS-based financial statements reported
finance lease as operating lease. The companies sometimes manage their profits in order to
minimize taxation liabilities, an approach that is noncompliant with IFRS. However, the
auditors of these companies did not qualify their audit opinion referring this issue.

58.     The deferral of implementing IAS 39 by the State Bank of Pakistan has
restricted full compliance with IFRS by the banks and similar financial institutions.
The SBP has deferred application of IAS 39 for banks and DFIs until December 200633.
Deferment of IAS 39 has created differences in accounting treatment in certain areas by the
banks, which among others, lead to noncompliances primarily with respect to adoption of
fair vale, and treatment of gains and losses of derivative contracts.

59.    The mandatory application of all IFRS for all companies tends to burden the
small and medium-sized enterprise (SME). Given the substantial increase and
complexities of IFRS, it is not possible for SMEs to ensure full compliance with all the
requirements of IFRS. In reality, these SMEs do not have adequate technical capabilities
and resources to ensure compliance with complicated reporting requirements.




33
     The deferment of implementing IAS 39 was on the basis of recommendation of a joint committee
     comprising representatives of banks, ICAP, and SBP.


Pakistan—Accounting and Auditing ROSC                                                     Page 14
60.     Despite significant improvements in corporate financial reporting practices in
Pakistan in recent years, there still exists evidence of “compliance gaps.” 34 The World
Bank ROSC team reviewed the IFRS-based financial statements of 53 listed companies.
Some financial statements had a high degree of compliance, while several cases of
accounting policies, presentations, and disclosures failed to comply fully with IFRS
requirements. The tendency was to demonstrate compliance in form rather than in
substance. In addition to the sample reviews, facilitated discussions held with experienced
corporate accountants, academics, professional auditors, and financial analysts indicated
several areas, where the actual practices diverge from the applicable standards. Examples
of some deficiencies found in the reviewed IFRS-based financial statements include the
following:

       •   Inventory valuation. Failing to follow all requirements related to measuring and
           disclosing inventories at the lower of either cost or market value.
       •   Segment reporting. No adequate disclosure of information focusing on both
           business and geographical segments.
       •   Revenue recognition. Nonadherence of applicable accounting policy on revenue
           recognition, for instance, in case of installment sales revenue was recognized on a
           cash basis rather than accrual basis.
       •    Related party transaction. Not disclosing the nature and extent of control by the
           related parties.
       •   Investment property. Land and buildings meeting the criteria of investment
           property are generally classified as fixed assets and recorded at cost minus
           accumulated depreciation; instead of using either the cost or fair value model as
           prescribed by IAS 40.
       •   Disclosure and presentation of preference shares. Preference shares issued by
           banks, irrespective of conditions contained in the issue have been shown as part of
           equity, instead of classification as financial liability.
       •   Effects of changes in foreign currency translation. Nonadherence to requirement
           that foreign currency exchange gains or losses arising from balance sheet date
           revaluations should be shown in the income statements.
       •   Property, plants, and equipment. In case of revaluation of fixed assets, detailed
           disclosure was not made. Also showing the major costs of improvement in fixed
           assets as an expense, instead of capitalization. Furthermore, it appeared that in
           calculating depreciation of assets, useful life was not properly taken into account.
       •   Accounting for leases. Treating finance lease as operating lease and not adhering
           to the IFRS requirement of valuation of finance lease using the present value of
           future cash flows.
       •   Employee benefits. Not recognizing the liability for employee benefits on accrual
           basis. Moreover, nondisclosure as to whether actuarial or any other forms of
           valuation had been made to quantify outstanding liabilities for post-employment
           benefits.
       •   Deferred taxation. Not disclosing the tax effects related to assets that were
           revalued to the amount in excess of the historical costs or a previous revaluation.


34
     Compliance gaps refer to the deviation of actual practice from the applicable accounting standards.


Pakistan—Accounting and Auditing ROSC                                                                      Page 15
    •   Impairment of assets. Not undertaking impairment tests of tangible and intangible
        assets on the balance sheet date.
    •   Earning per share. Using different interpretations on how to provide supporting
        data on calculation of basic earnings per share and diluted earnings per share.
    •   Additional disclosure by banks. No disclosure of aggregate amounts included in
        the balance sheet for loans and advances on which interest is not being accrued.
        Also nondisclosure of classification of assets into long and short term.


        IV. AUDITING STANDARDS AS DESIGNED AND AS PRACTICED

61.     To better understand the actual auditing practices, the ROSC team interviewed
practicing auditors and experienced accountancy professionals and had facilitated
discussions with the partners representing large and medium-sized audit firms.

62.    Adoption of International Standards on Auditing has closed the standard gap;
however, the application of these standards differs among various audit firms. In
many cases, auditors do not follow risk-based approach focusing on critical assertions. The
large firms and some medium-sized firms are better equipped to apply international
standards. Many firms are unable to comply with ISAs when faced with unaffordable
expense of skills development. Also various stakeholders opined for increased audit
supervision by audit partners and senior staff which would lead to improving uniform
application of auditing standards.

63.     Despite some auditors have qualified their audit opinions, it is more common
to issue “subject to/except for” audit opinions with a list of observations . The ROSC
team found cases, where auditors gave qualified opinion in the audit report. However, in
most cases, auditors tend to avoid “adverse or disclaimer” opinions and prefer to issue
“subject to/except for” audit opinions together with a list of audit observations, appearing
either in the audit report or in notes to accounts. These inappropriately qualified opinions
can mislead or confuse the users of the financial statements. This is an apparent violation
of IFAC-issued ISA 700, Auditor’s Report on Financial Statements, which states that
auditors should take into account collective effect of all the qualifications in preparing their
audit opinion on “true and fair view.” Instead of conveying apparently positive opinions,
subject to one or more observations, the auditors should provide disclaimers or adverse
opinions, where appropriate, for ensuring compliance with applicable auditing standards,
as well as providing a clearer understanding to users.

64.     Lack of understanding by directors and members of the management about
the purpose of audits sometimes makes it difficult for auditors to obtain appropriate
audit evidence. Many auditors claimed that some directors and members of the top
management often fail to appreciate adequately the purpose and value of auditing.
However, such a situation limits access to evidence to form professional judgments.
Despite the arduous efforts by some auditors to carry out audits as per international
standards and best practices, they view this situation as a major constraint in discharging
their professional responsibilities.


Pakistan—Accounting and Auditing ROSC                                                    Page 16
        V. PERCEPTION OF THE QUALITY OF FINANCIAL REPORTING

65.      There have been recent qualitative changes in financial reporting, however
further improvements are needed. Financial reporting practices are generally perceived
to have improved significantly over the past years; although the need for strengthened
enforcement mechanisms exists in order to achieve further improvement of quality in
corporate financial reporting. Discussions with various institutional investors, regulators,
financial analysts, bankers, and academics revealed that the corporate financial reporting
regime has experienced significant improvements in Pakistan over the past 4 to 5 years.
Contrary to this, stakeholders also expressed their concerns with audit quality, in
particular, the issue of independence of many practicing auditors. They strongly agreed
that strengthening enforcement mechanisms would help ensure compliance with IFRS and
ISA, auditors’ independence, and adherence to the professional code of ethics. Many
stakeholders in Pakistan feel that strengthened enforcement mechanisms would better
utilize the available professional capabilities of accountants, many of whom are capable of
producing financial statements of an international standard.

66.     Many stakeholders commended regulators’ role during recent years for
improving the quality of financial reporting. A majority of the interviewed stakeholders
praised the initiatives undertaken by the SECP, SBP and ICAP geared toward improving
the quality of financial reporting in Pakistan. Stakeholders viewed that mandatory
application of IFRS, monitoring and enforcement of standards and introduction of QCR
were important steps toward establishing a sound corporate financial reporting regime. For
further improvement in enforcement process, most regulators and some professionals
agreed to the need for creating independent oversight for the auditing profession, in line
with recent developments in many developed and emerging market economies. During
ROSC-facilitated discussion with a sample of audit firms and other stakeholders, there was
a broader agreement that adherence to audit standards and code of ethics varied across the
levels of profession.


                            VI. POLICY RECOMMENDATIONS

67.     The policy recommendations outlined in this section emerge from the review of
accounting and auditing practices in Pakistan, as well as the valuable inputs received from
the various stakeholders. These primarily principle-based recommendations are expected to
provide inputs in preparing a detailed Country Action Plan geared toward the sustainable
high-quality corporate financial regime in Pakistan. The recommendations are aimed at the
country’s implementation authorities. The following have been taken into account while
designing the policy recommendations:

        ▪   Building on current achievements so that the implementation of reform will
            strengthen the system toward achieving high-quality corporate financial
            reporting.



Pakistan—Accounting and Auditing ROSC                                                Page 17
           ▪    Achieving greater financial transparency in the corporate sector and limiting tax
                evasion through ensuring proper calculation of corporate profits.
           ▪    Promoting a gradual process of improvement, whereby the public interest
                entities will lead the reform process.35
           ▪    Strengthening the country’s financial architecture aimed at reducing the risks of
                financial market crises and their allied negative impacts.

68.     Strengthen the monitoring and enforcement mechanism.                    High-quality
financial reporting cannot be ensured alone by adopting international standards. To a large
extent, the quality depends on the designing and implementation of proper monitoring and
enforcement system. There are three crucial links in the enforcement process, and each
must be strengthened. First, company directors with legal obligations to prepare the
financial statements must ensure that accounting staff apply standards properly. Second,
statutory auditors must discharge their professional responsibilities independently in order
to provide assurance that financial statements comply with all applicable standards and
portray “true and fair” view of enterprises’ conditions and results of the operations. Third,
both self-regulatory organizations and statutory regulators must ensure proper compliance
with the standards and consistently take actions against violators. To ensure effective
enforcement, the regulators in particular, need adequate capacity, authority, and
independence. Since they cover a wide range of sophisticated and complicated activities,
their actions should not be constrained by lack of appropriate human and financial
resources. Having taking into account that the monitoring and related activities launched
by SECP a few years ago resulted in a significant improvement in the quality of financial
reporting by the listed companies, further improvements can be expected to result from
increased efforts to enforce the applicable standards. Pakistan has already made progress
in the enforcement process, this need to be consolidated by further strengthening the
enforcement mechanism through increasing capacity of the regulators and granting them
more authority in dealing with infractions of accounting and auditing standards.

69.     Take steps for improving the capacity of regulators. Generally ineffective
regulatory regimes provide a false sense of security to stakeholders; therefore, it is
important to strengthen the capacity of the regulators. The SECP and SBP should further
strengthen their capacities to conduct in-depth review of corporate financial statements for
determining the degree of compliance with the applicable standards, not only in
appearance but also in substance. Capacity improvement of these regulators should focus
on recruiting technically qualified personnel, practical training on implementation of IFRS
and ISA, and providing administrative support and logistics arrangements. Furthermore,
these regulators should be independent and should have enough authority to impose
administrative sanctions for infractions.


35
     Public interest entities may be defined by the nature of their business, size, and number of employees; or
     by their corporate status by virtue of their range of stakeholders. Examples may include listed companies,
     banks and similar financial institutions, insurance companies, and large enterprises. The large enterprises
     may be defined as individual enterprises and groups of enterprise that meet any two of the following three
     thresholds should be considered as public interest entities: (a) total number of employees exceeding [a
     number to be decided in consultation with the country stakeholders]; (b) total assets on the balance sheet
     exceeding [amount to be decided in consultation with stakeholders]; and (c) total turnover exceeding
     [amount to be decided in consultation with stakeholders].


Pakistan—Accounting and Auditing ROSC                                                                   Page 18
70.     Introduce an arrangement for independent oversight of the auditing
profession. Auditors have distinct obligations to all stakeholders, including shareholders,
regulators, and public at large, to ensure that the financial statements are prepared in
compliance with applicable standards and best practices. Discharging this obligation in an
appropriate fashion contributes significantly in strengthening Pakistan’s financial
architecture, including an enhanced confidence of investors. In view of recent worldwide
developments in regulating the auditing profession, there is a need for reviewing the
current ICAP-instituted system of quality review of auditors. Indeed, there is a growing
realization among the international community that the audit profession’s self-regulatory
arrangements and authority to impose sanctions should be balanced with adequate and
independent oversight system. Any independent oversight arrangement should be focused
on developing nascent quality assurance system to ensure that auditors comply with all
applicable auditing and ethical standards and independence requirements. It should work
independently of the audit profession and have ample authority to impose appropriate
sanctions. Since the SECP’s mandate includes monitoring and regulating compliance with
international standards in financial reporting and auditing, the proposed independent
oversight arrangement would, in Paksistan’s case, be best located within the Commission
as one of its core independent activities. The oversight of audit profession may be
consolidated with current activities of SECP concerning monitoring and enforcement of
corporate financial reporting requirements.

71.      “Financial Reporting Oversight Unit” may be established within the
organizational framework of SECP.36 An advisory committee may be formed to guide
activities of this unit. The advisory committee may consist of experienced professionals
and high level representatives of relevant institutions. Main activities of the oversight unit
would include the following:

▪      Audit Practice Review. Specialists of the oversight unit will be responsible for
conducting practice reviews of the auditors of public interest entities, ensuring each firm is
reviewed at a reasonable regular interval. After completion of first time review,
recommendations should be provided to the audit firms for overcoming detected
shortcomings concerning quality assurance arrangements. The practice review should
evaluate an audit firm’s quality assurance arrangements, its audit approach, and the
working papers with regard to selected audit engagements. Robust practice review
methodologies should be developed by the oversight unit in collaboration with the ICAP.

▪      Review of financial statements. SECP’s current activities concerning monitoring
and enforcement of applicable accounting standards should be brought under purview of
the oversight unit. This is mainly because non-compliance with applicable accounting
standards, specifically in the areas of recognition and measurement, can be better
understood by accessing audit working papers. From this perspective, it is important that
the review of financial statements to monitor compliance with accounting standards is
linked with the audit practice review work.



36
     The participants in a dissemination workshop held in Islamabad on November 17, 2005 unanimously
     agreed to have an arrangement for independent oversight of the audit profession.


Pakistan—Accounting and Auditing ROSC                                                        Page 19
▪       Investigation. Valid complaints against auditors and audit firms, and any
irregularities identified from the reviews of financial statements and audit practices should
be investigated.

▪       Disciplinary power. Following reviews, steps should be taken for appropriate
sanctions on audit firms for preventing noncompliance with auditing requirements. The
oversight unit may inter alia have the powers to issue warnings, impose fines and
penalties, and restrict particular auditor(s) from carrying out statutory audit of public
interest entities.

72.     Strengthen capacity of ICAP. The governance structure of ICAP needs to be
strengthened in line with recent international developments for regulating the accountancy
profession and role of professional bodies. In this regard, necessary steps should be taken
to fully comply with IFAC’s seven Statements of Membership Obligation.

73.     Strengthen capacity of ICMAP to function as a premier professional body of
management accountants in the region. In order to augment the training provision for
existing and potential corporate accountants, ICMAP’s capacity should be strengthened
with primary focus on management accounting issues. Since the members of ICMAP, in
their capacity as corporate accountants, mainly work on preparation of financial
statements, it will be important to equip them with detailed knowledge of the practical
application of IFRS. The capacity improvements should focus on up-to-date teaching
materials and training of instructors by establishing cooperation arrangement with the
Chartered Institute of Management Accountants (CIMA) in the United Kingdom.

74.     Upgrade the procedure for obtaining license by the accountants and auditors
engaged in public practice. The ICAP should streamline its licensing procedure by
aligning its professional examination and training arrangements with IFAC education
guidelines, such as International Education Guideline (IEG) 9, Prequalification,
Education, Assessment of Professional Competence, and Exposure Requirements of
Professional Accountants; and IEG 10, Professional Ethics for Accountants. ICAP should
also effectively monitor that registered accounting education tutors and practical training
providers provide adequate exposure to the practical aspects of all applicable standards and
codes. Furthermore, ICAP should develop a sound mechanism for renewing practice
license of the auditors in public practice on the basis of their periodic performance
evaluation.

75.     Improve the delivery of the continuing professional education. The ICAP
should organize high-quality training programs/workshops to enable the accountants and
practicing auditors to gain exposure to the practical application of IFRS, ISA, and IFAC-
issued Code of Ethics for Professional Accountants. To meet requirements of continuing
professional education, practitioners should be encouraged to attend such training
programs across the country.

76.     Take steps for improving academic and professional curriculum and
education. In adopting IFRS and ISA, Pakistan has set challenging and demanding
objectives for itself. This requires a need for ensuring high-quality education and training


Pakistan—Accounting and Auditing ROSC                                                 Page 20
on the international standards. Immediate steps should be taken in consideration of the
following recommendations:

           ▪   Review and update the accounting curricula to incorporate IFRS and ISA at
               institutions of higher learning. Teaching should focus on the practical
               implementation aspects of these standards using illustrations and cases. The
               ethical issues embedded in business management, auditing, corporate finance
               should be incorporated in the curricula. Furthermore, emphasis should be
               placed in teaching English and communication skills and developing critical-
               thinking ability of students.
           ▪   Arrange retraining of university and college teachers for improving their
               knowledge base for teaching IFRS and ISA.
           ▪   Review the curriculum for adequate coverage of professional ethics. Business
               ethics should be taught as a separate subject for the professional accountants.
           ▪   Provide IFRS training to tax officials. As IFRS net income is the starting point
               of the accounting and tax reconciliation, tax personnel should have a sound
               understanding of IFRS.

77.    Develop simplified accounting and reporting requirements for the SMEs.
Since IFRS is not appropriate in all circumstances for the SMEs, the standard setters in
Pakistan should consider developing simplified SME reporting standards. Lessons may be
taken from the region37 as well as from the current work of International Accounting
Standards Board (IASB) on the application of IFRS to the SMEs.

78.      Rationalize the Companies Ordinance for improving the compliance culture.
Take steps to rationalize provisions of the Companies Ordinance with regard to mandatory
IFRS application only to public interest entities, requiring the nonlisted companies to file
their audited annual financial statements to the Registrar of Companies, clarifying the
eligibility criteria of auditors for the private limited companies, providing for putting in
place an arrangement for independent oversight for the auditing profession, and granting
more authority to the regulators for imposing administrative sanctions.

79.    Issue practical application guidance on IFRS and ISA. The ICAP should issue
implementation guidance on IFRS and ISA illustrating local cases. Interpretations on IFRS
and ISA should be issued in consultation with the International Financial Reporting
Committee (IFRC) of IASB and the International Auditing and Assurance Standards Board
(IAASB) of IFAC. The ICAP should ensure all interpretations and other guidance should
be promptly available to its members.

80.    Introduce awareness programs for improving the degree of compliance with
IFRS requirements. The ICAP and SECP should work jointly to design awareness
programs highlighting the significance of compliance with accounting and auditing
standards. Shareholders, directors, and top officials from the corporate sector should be
briefed adequately on their responsibilities with regard to their roles in ensuring
37
     Institute of Chartered Accountants of Sri Lanka (ICASL) has adopted a set of simplified reporting
      requirements for the SMEs.


Pakistan—Accounting and Auditing ROSC                                                          Page 21
compliance with standards and enforcement process, including legal implications. Also,
benefits of compliance with standards and best practices should be highlighted in such
programs. In addition, these programs should include cases focusing on emerging
international developments and the role of transparent financial reporting in attracting both
strategic and portfolio investors.

81.    Prescribe guidance to ensure adequate ethical standard and independence of
auditors.    ICAP should consider the following for ensuing ethical standard and
independence of practicing auditors in line with international best practices:

    ▪   Prohibiting the practicing auditors from preparing the financial statements of their
        clients.
    ▪   Discouraging auditors’ involvement in providing both audit services and tax
        advocacy for the same client.
    ▪   Prescribing a “cooling-off” period for partners and senior and other managers of an
        audit firm before they are allowed to join a company with which they have done
        audit work. Reciprocally, a similar “cooling-off” provision should be applied to
        staff of an audit firm’s client company before joining that audit firm.


                           ABBREVIATIONS AND ACRONYMS
                ACCA     Association of Chartered Certified Accountants (United Kingdom)
                CEO      chief executive officer
                CFO      chief financial officer
                CAPA     Confederation of Asia Pacific Accountants
                CBR      Central Board of Revenue
                DFI      development financial institution
                FY       fiscal year
                GDP      gross domestic product
                GNI      gross national income
                GoP      Government of Pakistan
                IAASB    International Auditing and Assurance Standards Board
                IAS      International Accounting Standard
                IASB     International Accounting Standards Board
                ICAP     Institute of Chartered Accountants of Pakistan
                ICMAP    Institute of Cost and Management Accountants of Pakistan
                IEG      International Education Guideline
                IFAC     International Federation of Accountants
                IFRC     International Financial Reporting Committee
                IFRS     International Financial Reporting Standards
                IMF      International Monetary Fund
                ISA      International Standard on Auditing
                KSE      Karachi Stock Exchange
                PKR      Pakistan Rupee
                QCR      Quality Control Review
                ROSC     Reports on Observance of Standards and Codes
                SAFA     South Asia Federation of Accountants
                SBP      State Bank of Pakistan
                SECP     Securities and Exchange Commission of Pakistan
                SME      Small and medium enterprise
                SOE      state-owned enterprise



Pakistan—Accounting and Auditing ROSC                                                      Page 22