Pak Accountant July Sept2011

EDITOR’S LETTERAdnan Zaman 2

PRESIDENT’S PAGERashid Rahman Mir 3

COVER STORYAnnual Report – A Means forCorporate Governance and TransparencyAbdul Rahim Suriya & Haroon Tabraze 4

Facilitating CorporateAmalgamations & MergersQaisar Mufti 9

Remodeling Corporate ReportingFrameworkMuhammad Ali 13

CAPA - Improving Public SectorFinancial Management in theAsia-Pacific Region 16

OTHERS ARTICLES Plan the Business PlanningMuzammil Bhelim 21

The Role of SMPs in Greening SmallBusinessSylvie Voghel 23

Partnering Employees to Share-Ownership for Good Governanceand GrowthAthar H. Zaidi & Mubeshir Ali 25

Taxation Issues in Islamic BankingOmar Mustafa Ansari & Salman Haq 28

Ethics in the WorkplaceFarheen Mirza 31

Living within means!Altaf Noor Ali 34

Tax Savings through InvestmentsRahim Khakhiani 38

Volume 44 Issue 3 JULY-SEP 2011

4ANNUAL REPORT A Means forCorporateGovernance andTransparency

13RemodelingCorporateReportingFramework

The Role of SMPsin Greening SmallBusiness

23Taxation Issues inIslamic Banking

28

Editorial OfficeChartered Accountants Avenue, Clifton,Karachi-75600 (Pakistan)Phone: 99251636-39 Fax: 99251626E-mail: [email protected]: www.icap.org.pk

Publications CommitteeChairman and Chief EditorAdnan Zaman, FCA

Members Altaf Noor Ali, ACAAsad Feroze, ACAHeena Irfan Ahmed, ACAM. Amir Afzal Rana, ACAM. Fahim A. Rauf, FCAMutee-ur-Rehman Mirza, FCAOmar Mustafa Ansari, FCA

The CouncilPresidentRashid Rahman Mir, FCA

Vice PresidentsKhalid Rahman, FCA Nazir Ahmad Chaudhri, FCA MembersAbdul Rahim Suriya, FCAAdnan Zaman, FCA Ahmad Saeed, FCAHafiz Mohammad Yousaf, FCAMohammad Abdullah Yusuf, FCAMuhammad AliMuhammad Ayub Khan TarinNadeem Yousuf Adil, FCA Naeem Akhtar Sheikh, FCA Pervez Muslim, FCARafaqat Ullah Babar, FCASalman Siddique Shaikh Saqib Masood, FCAWaqar Masood KhanYacoob Suttar, FCAZahid Iqbal Bhatti, FCA

SecretaryShoaib Ahmed, ACA

Publication Coordinator Asad ShahzadZehra Hassan

EDITOR’S LETTER

Page 2

The Pakistan AccountantJul-Sep 2011

For ages Corporates have been infamously known for their stoneheartedness and ruthless behavior, however slowly the perception isbeing changed, primarily due to the Corporate and the public bothunderstanding and accepting each others jurisdiction.

With financial scandals rocking the comfortable sailingand jolting the public out of their reverie, calls for betterreporting and better management compelled theCorporates to rethink their game plan. BeingAccountants our premier interest lies in the reporting, asour profession binds us to protect and safeguardaccountability and transparency. The recent trend ofaccounting for future is a welcome move as it enables thestakeholders to access complete information and makeinformed decisions.

The content of a corporate report enables thestakeholder to assimilate data elements from disparate source systemsthat together should provide a clear picture of the company’s abilityto execute its strategy. The quality of a corporate report is judged byhow well the end user draws out the rational inferences. If the contentis limited to the extent that the end user is only able to view discretedata elements without seeing those data elements in context, then thevalue of the content is dubious. Likewise, if the content of the reportfails to combine both financial and nonfinancial data it is quite likelythat the end user may be misled by the corporate report.

We accountants have to broaden our horizons and adapt to thechanges in the financial and corporate world. As more and moreaccounting functions become automated, accountants and financialanalysts who can add value to the business they serve by way of beingbusiness managers and able to think strategically will have much betterprospects than those who stick to keeping the books.

The Pakistan Accountant is a medium through which we grow togetherand a regular feature of the journal, “join the discourse” thrives on ourcontribution and provides an opportunity for us to voice our opinionas well as be more aware of the perceptions of the society we live in.We look forward to hearing from you in future.

Adnan Zaman

Editor’s Letter


Page 3

PRESIDENT’S PAGE

Change is imminent when the mindset of the people changes.Throughout the history of our profession we have witnessed numerouschanges, some catering to our needs, some in response to changingtimes and some in response to the public’s demand.

An example is when in the nineteenth century the publicinterest in the corporate sector led to its reinvention andconcentrating more on transparency, accountability aswell as being socially accountable. During the century thecorporate sector, developed and created the need andframework for proper reporting and transparency toensure public confidence. The idea of being accountablewith greater emphasis given on the relevancy, timelinessand reliability of data settled in with the passage of thecentury making it a regular norm.

Today globally, the corporate have changed their game, the idea ofbeing responsible to the stakeholders and the public in general hasgradually sunk in. Corporates are willingly sharing more informationwith stakeholders. As accountants we must appreciate that informationshared should be meaningful, timely and clearly communicate thecomplete picture to the stakeholders. In just over ten years, corporatesustainability reporting has shifted from voluntary to the vital.Sustainability reports, often called corporate social responsibility oreven integrated reports, now contain more detailed performancemetrics and reflect the priority companies have given to measuring andmanaging the impact of their operations. Global standards have alsoplayed an important role in the development of sustainability reportingand performance management.

We at ICAP remain committed towards enhancing and providingavenues for our professionals to develop their competencies at thesame time realise the need of initiating the process change a fineexample is the Best Corporate &Sustainability Reports Awards, throughthe decade the awards have managed to inspire and inculcate withinthe Corporates to improve upon financial reporting and becomingmore transparent.

Rashid Rahman

President’s Page

The corporate sector in Pakistan has had its fair share ofcorporate failures, scams and scandals - Taj Company,Mehran Bank , Islamic Investment Bank various HousingCooperative Societies Schemes, and other numerousfinance companies have deprived thousands of smallinvestors of their life-savings. In the not so distant past,nationalized banks have written off billions of rupees byway of bad loans. These scams bear similarity to thosehappening across borders; with the largest occurring inUSA. The victim in most cases being the general public,leads to a hue and cry over regulating the companies.After ENRON and other similar cases, financial expertsfrom world over sat together to formulate a strategy andcame to a conclusion which the medical professiondiscovered decades ago: “prevention is better than cure”.Thus the concept of corporate governance was born.

HISTORY

At independence, Pakistan inherited the political heritageof the United India including the Indian CompaniesConsolidation Act, 1913, which was duly adopted. The Act

remained in force till 1984 when the CompaniesOrdinance 1984 was promulgated. It is still remains inforce, although amendments are usual and regularfeature.

The corporate sector in Pakistan is primarily regulated bythe Securities and Exchange Commission of Pakistan(SECP) through the Companies Ordinance, 1984. Variousspecific laws to regulate specialized corporate entities arein place i.e. Modaraba Companies and Modarabas(Floatation and Control) Ordinance, 1980, State Bank ofPakistan Act 1956, the Insurance Ordinance, 2000 etc.

ICAP’S ROLE

One of the main developments in corporate governancein Pakistan has been the formulation of a Code ofCorporate Governance (CCG). The Code was developedon the initiative of the Institute of Chartered Accountantsof Pakistan (ICAP) after the members passed a resolutionin the Fifth All Pakistan Chartered Accountants’Conference held in December 1998. A committee was

Corporate Governance

Abdul Rahim Suriya, FCAHaroon Tabraze, FCA

COVER STORYThe Pakistan Accountant

Jul-Sep 2011

Page 4

later formed which included representatives from variousstakeholders i .e . KSE , SECP etc and a set o frecommendat ions were formulated. Theserecommendations after being exposed to members ofICAP and the general public in 2001 were taken up bySECP for processing and made part of the respectivelisting regulations of the three stock exchanges. In 2004,Pakistan Institute of Corporate Governance (PICG) wasestablished with the objective to provide enablingenvironment for the implementation of CCG issued by theSECP. ICAP was one of the founding members along withSECP, SBP, stock exchanges in Pakistan, banking andinsurance associations, apex bodies of the corporatebusinesses, FPCCI, Institute of Corporate Secretaries andNon-Bank Financial Institutions (NBFIs) and the leadingbusiness educational institutions like LUMS and IBA.

In 2008 ICAP developed a Guide (MIES-19) in Partnershipwith the Center for International Private Enterprise (CIPE),and PICG. The Guide establishes principles and practicesaimed at helping directors of family owned companies inimproving governance.

TRANSPARENCY

The buzz word in today’s business is transparency.Illustratively, standing outside a window would provideyou with a view of what is in the room. A transparentwindow will give you a complete and detailed view, whilea window with dark tinted glass might not show you thedirt and grime inside. Using the analogy, a financial reportshould be such that the reader can see inside-out of thecompany.

The publication of timely annual report which fulfils therequirement of Companies Ordinance is an importanttool for promoting accountability and transparency in theCorporate Reporting. Of course transparency is importantonly when shareholders are diverse and widespread i.e.in listed entities. Detailed information is not expectedfrom closely held or family owned companies. The lastdecade has witnessed the financial disclosuresincreasingly getting improved through internationalaccounting standards and IFRSs to achieve thetransparency desired by the readers. However thenumbers are only quantitative; they lack the descriptionof qualitative factors. The operational management fortheir decision making still prepare a different set ofmanagement accounts. However ManagementCommentary along with financial numbers is necessaryfor a better understanding of the operating results andfinancial/investing activities of the business

ROLE OF PROFESSIONAL INSTITUTES

For the last 11 years the Joint Committee of ICAP andICMAP has been organizing the Best Annual RepotCompetition with the objectives:

w to encourage and give recognition to excellencein annual corporate reporting; and

w to promote corporate accountability andtransparency through the publication of :

• timely;• factual information; and• reader friendly information.

It is interesting to note that there although is no specificlaw requiring an entity to produce and publish annualreport there are various statutes that require the contentsembodied in it. According to the International Standardon Auditing # 720 the Annual Report is defined as “Anentity ordinarily issues on an annual basis a documentwhich includes its audited financial statements togetherwith the auditor’s report thereon. This document isfrequently referred to as the “annual report”.

However in order to encourage transparency and betterand relevant reporting from companies throughadditional disclosures, ICAP and ICMAP launched the BestCorporate Reporting Awards. The awards are given tocompanies as an acknowledgement for voluntarilyproviding relevant and timely information to thestakeholders to help them make economic decisions. Anelaborate ‘Criteria’ which has evolved over the years, isused as a basis to evaluate best reports. The criteria for2011 includes certain information in addition to thedisclosures required by corporate laws in practice, suchas:

Ref. Criteria

2.0 Disclosures of information required by the IFACManagement Commentary

2.1 Description of nature of business including amacro-level (e.g. industry, main markets, and legalenvironment) and a micro-level (e.g. businessmodel, product portfolio) discussion.

2.2 Explanation of management's objectives and itsstrategies for meeting those objectives includingpriorities for action and addressing threats andopportunities of market trends.

2.3 Description of the entity's most significant:

2.4 Resources, including an analysis of liquidity, cashflows, financing arrangements, human capital andcapital structure, including any inadequacies inthe capital structure and plans to address suchinadequacies;

a) Risks, including strategic, commercial operational and financial risks; and

b) Relationships, which are likely to affect performance and value of the entity

c) Description of the entity's financial and non-financial performance (results) and the future prospects, including whether the performance may be indicative of the future performance.

d) Description of critical performance measures and indicators which management uses to measure performance of the entity against stated objectives of the entity and whether the indicators used currently will continue to be relevant in the future.

A n n u a l R e p o r t a n d G o o dC o r p o r a t e G o v e r n a n c e

COVER STORY

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2.6 Market share information preferably from anindependent source

4.2 Summary of the Cash Flow Statement for 6 years

4.4 Vertical and Horizontal analysis of Balance Sheetand Profit and Loss Account for 6 years

4.5 Statement of Value Added and how distributed

4.6 Investors' Relations section on the corporatewebsite

5.4 Comprehensiveness of corporate information

5.6 Definition and glossary of terms / Calendar ofmajor events during the year

6.3 Board structure and its committees

6.4 Chairman of the Board other than the CEO

6.5 Information on other Board Committees, theirterms of reference and the number of meetings

6.6 Salient features of the Audit CommitteeCharter/Terms of Reference

6.7 Name of independent directors / non-executivedirectors

6.8 Profile of each director including engagement inother entities

6.9 Non- executive directors on the Audit Committee

6.10 Organization Chart

6.11 Disclosure of criteria to evaluate Board'sperformance

6.12 CEO performance review

It is pertinent to note here that the ‘Criteria’ not onlycomprises of mandatory requirement of CompaniesOrdinance 1984, and the code of corporate governance,it also encourages adopting international best practices.The Joint Committee of ICAP and ICMAP always looks outfor new trends in information sharing and one item thatstands out is the concept of ‘Management Commentary’.

Management Commentary is a narrative reportaccompanying, but not part of, the financial statements.It tells the story about the company’s performance andfinancial conditions as seen through the eyes of themanagement. The commentary describes both financialand non-financial information, and is a basis ofunderstanding for the reader by providing a context tointerpret the financial position, operating environment,and key indicators of the company.

The International Accounting Standards Board (IASB)which is the independent standard-setting body of theIFRS Foundation, had set up a project team comprisingrepresentatives from the national standard setters inGermany, New Zealand, United Kingdom, and fromCanadian Institute of Chartered Accountants, to examinethe potential for issuing a formal guidance onmanagement commentary.

Subsequently, a practice statement was issued on 8thDecember 2010. Sir David Tweedie, Chairman of the IASB,said on the occasion:

“Management commentary is one of the mostinteresting parts of the annual report. Itprovides management with an opportunity toadd context to the published financialinformation, and to explain their futurestrategy and objectives. It is also becomingincreasingly important in the reporting of non-financial metrics such as sustainability andenvironmental reporting.

The publication of this Practice Statement willbenefit both users and preparers by enhancingthe international consistency of this importantsource of information”.

The Practice Statement applies only to managementcommentary and not to other information presented ineither the financial statements or the broader financialreports. It should be applied by entities that presentmanagement commentary which relate to financialstatements prepared in accordance with IFRSs.

A good management commentary should providemanagements view not only on what has happened, butalso management;s reasoning of its occurrence, , as wellas an estimate of future, based on the past events.

A good commentary should not repeat what is in thefinancial statements, rather should clarify and describethe implications.

PURPOSE

The IFRS Practice Statement Management Commentaryprovides a broad, non-binding framework for thepresentation of management commentary that relates tofinancial statements that have been prepared inaccordance with International Financial ReportingStandards (IFRSs).

The Practice Statement is not an IFRS. Consequently,entities applying IFRSs are not required to comply withthe Practice Statement, unless specifically required bytheir jurisdiction. Furthermore, non-compliance with thePractice Statement will not prevent an entity’s financialstatements from complying with IFRSs, if they otherwisedo so.


Jul-Sep 2011

Page 6

Management Commentary

VARIANCES WITH PREVIOUS YEAR TARGETS

Management should explain how and why theperformance of the entity is short of, meets or exceedsforward-looking disclosures made in the prior periodmanagement commentary. For example, if managementstated targets for future performance in previousreporting periods, it should report the entity’s actualperformance in the current reporting period and analyzeand explain significant variances from its previouslystated target as well as the implications of those variancesfor management’s expectations for the entity’s futureperformance.

WHAT DOES MANAGEMENT COMMENTARY INCLUDE

Focus of the management commentary depends on thefacts and circumstances of the entity. It generally includes:

1. Nature of Business: a. The knowledge of the business in which a company is engaged, its external environment including a discussion of the industry sector to which company belongs.

b. A discussion of primary and secondary markets and company’s position in the market

c. The legal, regulatory and economic environment that may have an influence on thecompany as well as on the market in which the company operates.

d. The company’s structure, organization, products, services, business processes and distribution channels.

2. Objectives and Strategies:a. A discussion on strategies adopted by the company, and their respective results

b. Likelihood of continuing these strategies and estimated results in future

3. Resources:a. The most important resources available to company including human, and capital resources

b. The company’s ability to sustain and maintain these resources in future

c. A discussion on company’s strategy on how to generate resources in future

4. Relationshipsa. Significant relationships of the company with stakeholders

b. How these relationships effect the performanceand value of the company

c. How these relationships are managed and strengthened

5. Risks:a. A discussion on the risk identification process adopted by the management.

b. Plans and strategies of how to mitigate materialrisks and uncertainties

c. Negative consequences and potential opportunities related to material risks

6. Results and prospectsa. A clear description of the entity’s financial and non-financial performance

b. Management’s assessment of entity’s prospectsc. Analysis of the managements objectives and strategies with the entity’s result

d. Comparison of current performance with prior periods to help understand the extent to whichpast performance may be indicative of the future prospects

7. Performance measures and indicatorsa. Narrative description of the effects of key financial indicators

b. Explanation of why and how past performance differs with current performance

c. Explanation of any change in the relevance of performance measurement indicators

MANAGEMENT COMMENTARY VERSUS DIRECTORS REPORT:

The difference: In this context it is important to note that“management here means the people responsible fordecision making and oversight of the entity. They mayinclude executive employees, key managementpersonnel and members of a governing body.

Management commentary is not directors’ report,although it is usually assumed to be so. Managementcommentary is recommendatory but not mandatory.After all it is not IFRS.

The Directors’ report generally consists of review andtrend analysis of the performance of the company over aperiod of time. It covers the performance limited to theearnings and distributions over the period. In contrast theManagement Commentary is aimed at providing theusers information regarding strategies established toachieve the targets. Furthermore it also requiresmanagement to provide an analysis of any shortcomingsin the achievements with reference to these strategiesfollowed by the management. In fact the managementcommentary requires such information for the users toanalyze the sustainable growth of the entity includinginformation related to the available resources and futurestrategy to maintain and or enhance according to theneeds in future.


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COVER STORY

Futuristic information

Management commentary should communicatemanagement’s perspective about entity’sdirection. It should include forward lookinginformation when it is aware of trends,uncertainties or other factors that might affectthe entity’s liquidity, capital resources, revenuesand results.

Management should also disclose theassumptions used in providing forward lookinginformation as well as the Management’sassessment of the entity’s prospects in the lightof current period results.

The Pakistan AccountantJul-Sep 2011 COVER STORY

Page 8

information which is now addressed by the ManagementCommentary:

w Explanation of strategies for meetingmanagement's objectives e.g. threats andopportunities of market trends.

w Analysis of liquidity, cash flows, financingarrangements, human capital and capitalstructure and the company’s ability to maintainthese resources and strategy on how to generateresources in future.

w Description of the entity's most significantrelationships, which are likely to affectperformance and value of the entity and howthese relationships are managed andstrengthened.

w Description of the entity's most significant risksand related consequences and opportunities andplans and strategies to mitigate material risks anduncertainties.

w Description of critical performance measures andindicators which management uses to measureperformance of the entity against statedobjectives of the entity.

w Narrative description of the effects of keyfinancial indicators.

w Explanation of why and how past performancediffers with current performance

There are few areas of Management Commentary which

are neither part of Companies Ordinance / Code ofCorporate Governance nor in the Criteria for BestCorporate Report for 2011. Management should disclosein order to bring more transparency:

w The information that is important to managementin managing the business

w Perspective of the entity’s direction

w Forward looking information when managementis aware of trends, uncertainties or other factorsthat could affect the entity’s liquidity, capitalresources, revenues and the results of itsoperations. Forward looking information may benarrative explanations or quantitative includingprojections or forecasts.

w How and why the performance of the entity is

short, meets or exceeds forward lookingdisclosures made in the prior periods.

w Significant changes in an entity’s objectives andstrategies from the previous period or periods.

w Risk plans and strategies for bearing risk ormitigating risks and effectiveness of thesestrategies. Principal risks facing the entity shouldcover both exposures to negative consequencesand potential opportunities.

w The significant relationships that the entity haswith stakeholders, how those relationships arelikely to affect the performance and value of theentity, and how those relationships are managed.

w The relationship between the entity’s results,management’s objectives and management’sstrategies for achieving those objectives.

w Significant changes in financial position, liquidityand performance compared with those of theprevious period or periods.

w Analysis of the prospects of the entity which mayinclude targets for financial and non-financialmeasures. For targets, if quantified, managementshould explain the risks and assumptionsnecessary for users to assess the likely hood ofachieving those targets

w Why the results from performance measures havechanged over the period or how the indicatorshave changed.

GAP with BCR CriteriaAbout the Authors:

Abdul Rahim Suriya is a fellow member of

ICAP and ICMAP. He is past President of

ICAP and presently a council member. He

has over 27 years experience in Accounting,

Auditing, Corporate Finance and Operational

Management. He is a professional trainer on

the subject of “Finance for Non Finance

Executives” and has recently authored a book

on “A guide to Business Decision Making”. He

is a practicing CA and runs his firm

"A.R.Suriya and Co, Chartered Accountants

". For details visit www.arsuriya.com

Haroon Taberez is a fellow member of the

Institute of Chartered Accountants of Pakistan

(ICAP) and Director of Technical Services at

the Institute.

Merchant Banks’ functioning is multi-dimensional. Theycater un-bridged gap between supply and demand ofinvestible funds. The banks help enterprises in raisingfunds and investors to invest their money. In newsecurities offerings and managing funds, merchantbanks play an important role. These are also referred asinvestments banks. Role of a merchant banker is dynamicin the wake of diverse nature of services offerings. Amerchant banker has to devise instruments of financingfor commercial propositions in accordance withrequirements of his customers. Merchant banks do notaccept deposits from public like ordinary commercialbanks.

Role of merchant banks in equities and debt instruments’private placements, market making, mergers, acquisitionsand corporate structuring is pervasive. Also acting asunderwriters of both listed and non-listed securities, thebanks assist individuals, companies, institutions andgovernments in raising funds. Sales force of the banks callon high-net-worth investors to suggest trading ideas. Tofit specific requirements, trading desks in merchant banksprice and execute trade, structure new products.

Merchant banks operations extend beyond issuemanagement to project and corporate counseling,portfolio management, consultancy on sick units,providing and procuring venture capital, leasingfinancing, trusteeship for instruments of redeemablecapital, arranging international finances etc. At times, asdivisions of commercial banks, non-banking financialinstitutions, financial and corporate consultants,merchant banking activities thrive.

A Merchant Bank in USA is subject to Securities &Exchange Commission (SEC) and Financial IndustryRegulatory Authority (FINRA) regulations. In Pakistan theyare under the discipline of Securities & ExchangeCommission of Pakistan (SECP) in terms of Non-BankingFinancial Companies Rules and Regulations (NBFIs Rules).In India, Securities & Exchange Board of India (SEBI)regulates these banks. UK has the Securities & InvestmentBoard (SIB), under Financial Services Act, 1986, with widepowers to put in place fair practices on the part of allthose engaged in investment or merchant bankingbusiness like stock brokers, jobbers, unit trust managers,

life insurance agents, pension funds managers andfinancial consultancy.

In common day to day reference, terms like ‘takeovers’,‘mergers’, ‘amalgamations’, ‘acquisitions’ etc. areconsidered synonyms exchange. Acquisitions andMergers (AM) involve transfer of an entire undertaking forshares of the transferee company-given in exchange tosubsisting shareholders in the ratio of their holding. AMare strategic decisions that can introduce a paradigm shiftof business. On rejuvenations of enterprises AM havevolumes to tell. They help usher rejuvenation at a paceand volume internal developments would normally not.Of the activities merchant banks get into AM is a coreactivity.

In the melee, as a mater of course, AM appear great onpaper. However, real test is after these are put in place,when people from different organizations collaborate toturn the plans into action and finally into results. Value isnot created until after the combinations. Due to this,despite pressure for a quick secretive go that surroundsalmost all AM decisions, managers of the game, whichinclude consultants and advisers of the exercise, do notmake their decisions lightly.

FINANCIAL STATEMENTS PROVIDE KICK START

Financial statements present condensed position of adate and summarized operating results for a period.Personal judgment is enshrined in financial statementswith conventions in deciding:- a particular method or combination of methods

to estimate depreciation, depletion, amortizationor provision for receivables no longer collectible.

- compile merchandise inventory figures.- choose the method of inventory valuation for

purposes of charge to cost. - record certain expenditure as capital instead of

revenue and vice versa.

Facilitating Corporate

Amalgamations& MergersQaisar Mufti


Page 9

COVER STORY

Operations presented by financial statements arehistorical in nature which can hardly be used for analysisof segments and phases of business during the operatingperiod. For an AM exercise relatively deeper informationand segmental data, both with regard to financialposition and operations would be called for. FinancialRatios are used to compare return relationships. Throughthese, risk and returns of different entities can becompared by investors and creditors. A merchant bankneeds these to make intelligent investment and creditdecisions. To gauge feasibility or efficacy of a proposition,merchant banks engrossed in AM exercises apply manytests, based on techniques drawn from differentdisciplines.

ROLE FINANCIAL RATIOS PLAY

Analysis of financial ratios would always be there. Theratios categorized from different angles provide profile ofa company’s economic properties, its strength and itsoperating, financial and investment characteristics. Thesenormally are:

1. Activity analysis.2. Liquidity analysis.3. Term-debt and solvency analysis.4. Profitability analysis.

Knowledge gained through accounting ratios is used tothe end of:

- testing efficiency of operations,- determining investment value of the enterprise

concerned, and- deciding whether financial and operating policies,

methods or practices should be continued oraltered.

INFLEXIBLE ARITHMETICAL EXERCISES

The process of evaluation can not possibly be reduced toinflexible arithmetical exercises. Too much reliance onmechanical means may not be good. All ratios orindicators have their limitations. Ratios do not alwayshave something definite to say. Technical analysis may notbe effective where capital is small.

Accounting ratios and equations do not have to be usedin isolation. Judgment will have to be based on judiciousdiscretion taking into account all the relevant factors.Such factors would include quality and integrity of themanagement, present and prospective competition andyield on a scrip comparable with share of the companybeing analyzed. Not to be overlooked will be thepossibilities of ‘window dressing’ of accounts beingexamined.

DOSE FOR CHANGE

Going into financial ratios by merchant banks would alsobe with the view point of exploring their alteration giventhe identified ‘dose of change’ after AM. For example, thedoers of an AM exercise would consider steps which goto alter the gross profit margin. They could look intoreducing the operating profit percentage throughpegging-up percentage allocations for marketingoverheads by pushing-up incentives for the marketingforce. This process may be to target increase in volume of

operating profit.

An expert assisting an AM exercise can not afford toignore state of:

- production and marketing strategies, - changing price levels and- fixed and variable costs complexions

on profitability and financial health of the enterprise. Hecan not be oblivious of similar ratios obtaining in other(competitive) business concerns. It is study on this patternwhich decides whether sales should be augmented,production pattern reshuffled and capacity should beincreased to bring down cost, particularly fixedcomponent of cost, and whether outside financing wouldbe required to push-up level of operations.

In the planning process prices and / or sorts of costs areprojected at the desired points with a view to put in placemachinery to achieve the targets.

Hereinafter are cited some ratios, projection of change inwhich may be in pursuance with an AM plan. What followsis neither a scientific outline for ratios modification norenumerated are all the steps under each head. Engagingattention of the AM team, this is listing of ideas for probeunder each heading.

This scribe is aware that information on a number ofpoints hereinabelow, the AM team may not eventually beable to have.

GROSS PROFIT TO SALES

- whether service industry, industrial or commercialactivity.

- graph of market share enjoyed by the entity.- effect of changes in duties and taxes on gross

profit margin. - competitive strength of the company and

obsolescence.- stability of the company - % decline in sales to

erode gross profit.- reliance on associated / group companies for

business.- prospects of increase in gross profit margin.- depreciation, depletion and amortization

methodology. - weightage and segment to sales and gross profit.- sensitivity associated with governmental policies. - strategic depth of sales revenue.- cyclical trends associated with business of the

entity.

OPERATING PROFIT TO SALES

- sensitivity of marketing overheads in relation tosales.

- efficacy of subsisting marketing relatedincentives.

- trends of administration & marketing overheadsratio to sales.

- factors leading to variation in marketingexpenses, fixed & variable components ofmarketing expenses.


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COVER STORY

NET PROFIT TO SALES

- spread between operating and net profit margins. - percentages of cash and credit sales in total sales

and terms for credit sales.- impact of increase or decrease of days allowed to

pay for sale on credit. - amount of interest against short term borrowing

charged to operations.- net profit if there were no financial overheads.

FINANCIAL OVERHEADS AS % SALES AND CAPITALIZATION

- purposes for which term loans utilized and suchloans in the pipeline.

- term loans as percentage of fixed assets, cushionexisting for further borrowing and impact of suchborrowing on profitability.

- possibilities of utilization of short-term loans asterm loans and vice versa.

- impact of cash dividend in view of the related taxshield missing, particularly when the funds areborrowed for such payment

- chances of swapping between types / forms offinancing.

- implications of further issue of instruments ofredeemable capital / debentures.

- evaluating impact of: = decrease in credit sales. = increase in credit sales

on financial overheads, cash flows and profit.

PROFIT AFTER TAX PROFIT TO EQUITY

- characteristics of shares and instruments ofredeemable capital issued:

(a) for consideration other than cash, wholly or partly.

(b) traded at a premium or discount.(c) option for conversion or otherwise.

- tax concessions available or existing and timeframe for such availability.

- post re-organizations, reconstructions,amalgamations or changes otherwise in capitalstructure.

- current and previous liabilities included in taxcomputations and tax related contingences.

- impact of tax in relation to segment-wise profit. - profit arising from normal operations and tax

shields associated with different incomecategories.

- possible changes in accounting policies and theireffect on profitability.

- tax holidays existing or possible and other taxincentives.

- deferred tax / tax rebates available and availed. - claims on equity e.g. conversion of redeemable or

preferred capital into ordinary shares, stockoptions to employees and right options releasedor to be released to shareholders.

- prospects for reduction in tax with change in

corporate structure or presentation of taxinformation.

EARNING PER SHARE

- past years’ trend. - past years’ trend of other companies in the same

business. - EPS of companies in general.- EPS with all financial overheads written back.- EPS with cost of long term borrowings written

back. - major shareholders of the company, nature of

their business and support flowing from them tothe company.

- sensitivities associated with earnings –comparison with industry averages andimpediment with removal of which earning couldimprove.

- effective rate of the company’s EPS in view ofright issues made and stock dividends declared.

- high & low stock market quotations for shares &debentures of the company and their averageprices during last six months.

- management’s perception of risk factors. - material contracts in force and in offing. - review of capital available – additions or

surplusage.

DEBT EQUITY RATIO

- industry relevance:= conventional or non-conventional industry. = consumption goods or capital good relevance. = production or service industry, fragility associated with production and delivery.

= whether licence required for setting-up a project likewise and effective cost of licence.

- total loans in relation with total assets and assetsunder lenders’ lien.

- sale prospects of assets and their estimated (sale)value in relation with the investment proposed.

- soundness of lenders, prospects of postponement/ rescheduling / restructuring of debts.

- status of debt servicing.- debt service coverage computation and

determining debt servicing capacity.

BREAK EVEN

- break even point in units and value AM.- break even point as % of enterprise’s capacity

subsisting and capacity utilized.- investment required to lower the fixed cost per

unit by:= increasing capacity operations.= up-gradation etc. of production process.

CURRENT ASSETS

- complexion of current assets. - characteristics associated with inventories

forming current assets of the business:= seasonal availability. = perishability.= obsolescence. = price variation associated with purchase timings.

= storage cost and delicacies associated with storage.

= stocks consumption as % of cost & cost as % of sales.

= do the stocks consist of items of daily use? Whether the stocks are commonly traded and used.

- peculiarities with accounts receivables:= uncollectibles as % of all receivables booked, position obtaining and trend in the past.

= cost of receivables collection as % of receivables booked.

= receivables’ likely quantum when incentives areassociated with sale against cash.

= availability of finance against receivables from commercial banks and otherwise.

= possibilities of securitization of receivables.

SHORT-TERM INVESTMENTS

- possibilities of conversion into spot cash,effectiveness of discount offer for early cashrealization and availability of credit againstpledge of instruments of investment.

CURRENT LIABILITIES

- forms of availability of short term credit and termsthereof.

- terms associated with accounts payable,implications of extension in the credit period andavailability of credit for payables’ settlement.

- installments of term loans and interest formingpart of current liabilities:= debt servicing obligations as % of current liabilities and as % of resources generation.

= possibilities of down shift in impact of debt servicing.

A former Chairman of ICAP and ICMAP Joint Committee& Development Banker, the author is a corporate & salestax counsel.


Jul-Sep 2011

Page 12

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Page 13

COVER STORY

Many investors believe that Management spendssignificant time aggregating and recalculating data frominternal sources to construct the information demandedby regulatory reporting.

It is like the creation of a large building, which analystsand investors then spend a lot of time deconstructing sothey can see the building blocks. This process is wastefuland ineffective. Corporate reporting should be moreinformative and accessible. But can it provide theinformation investors want without swamping them inunnecessary detail?

High-quality information on corporate activity is anessential ingredient for the successful functioning oftoday’s capital markets and the societies in which theyoperate. There is significant potential to enhance thequality of companies’ reporting by taking a more top-down, investor centric approach to determining whatinformation is reported externally.

The current reporting model has been dominated fordecades by financial information. While financialinformation is obviously and critically important, itprovides only one part of the picture of overall business

performance, and has a built-in bias towards recordingthe short-term results of companies, giving too littleemphasis to their longer term value potential. This facthas been understood by both preparers and users offinancial information, and most companies and investorsnow go to significant lengths to capture and analyze abroader information set.

Remodeling CorporateReporting Framework

Muahmmad Ali, ACA

Investors are clear that

‘corporate reporting’ is not

just about the numbers. They

also want access to greater

contextual information and

key underlying data points.

Due to absence of alignment of external reporting withinternal management information, the most technicallyable within the corporate and investor communities arefinding it difficult to decipher the performance messageof many financial reports. Sophisticated users of thecurrent corporate reporting model typically pay attentiononly to parts of the information conveyed by companies(compiled at great cost to those companies) and havelittle choice but to turn to non-company sources tocontinue populating their analytic models. The concernis growing as the societies’ expectations of the corporatesector increase; companies are by necessity aware of theneed to be more transparent and more elaborative intheir reporting – understanding that this is an intrinsicpart of their license to operate. This makes reporting acritical business activity – box-ticking compliance is nolonger an option.

It has been observed among leading companies thatcontextual narrative reporting helps to cut through thecomplexity and partial opacity of today’s financialreporting.

While much effort is being committed on a global basisto create consistency around financial reporting, therehas been little focus on creating consistency across theother key elements of information, the contextual andnon-financial elements. These areas have tended to fallunder the jurisdiction of individual countries and, notsurprisingly, there is substantial variation in theserequirements. In part, this divergence reflects differingcultural and societal expectations, but given theimportance of contextual and non-financial informationto investors, is this sustainable position in a globaleconomy?

Collaboration in developing a framework for reportingmay over time facilitate a more efficient flow ofinformation from preparers to users.

Current narrative reporting tends to focus onperformance outcomes (such as changes in turnover andcustomer retention). This is just one important elementof the value chain of a business. Perhaps more importantare the front-end elements of the value chain, whichexplain how management intend to create value. In thiscontext, investors value information explaining acompany’s markets (for example, changing customerdemographics), an outline of its strategy (such asobjectives around improving customer penetration) andresources and relationships needed to implementstrategy (for example improved processes to engage withcustomers). This information is even more valuable whenit includes quantified metrics and comparative datashowing relative performance against competitors, aswell as goals and targets – all of which the highest scoringcompanies are providing.

Gaining a real understanding of performance requiressome key elements of information and a depth of analysisthat gets below the surface. Growth is one element. Howhave revenues and profit grown year-on-year? How muchis due to organic growth rather than acquisitions?

What has been the impact of price and volume changes?And what part have currency movements played?

The evolving reporting requirements andguidance being introduced around corporatereporting has made companies tofundamentally rethink their reporting framework.

TOP TIPS CHECK LIST

Setting the Scene: An analysis of a company’s market environment,including a discussion of expected future trends andfactors.

w Ensure that your reporting covers the mostrelevant aspects of your market place –competitive, regulatory and macro-economic

. w Wherever possible adopt a forward-looking

orientation by explaining the future trends and

Differing narrative reportingrequirements

Historically, most jurisdictions have createdguidance for the narrative reporting thataccompanies financial statements. Many havenow adopted or are in the process of adoptingthe US Securities and Exchange Commission(SEC) practice of mandating certain disclosures.The goal of much of the regulation is thatreporting should be clear, comprehensible andcomplete – in a word, transparent.

However, specific mechanisms adopted toachieve this aim vary widely, from the SEC’sdetailed rules on the content of Management’sDiscussion and Analysis to the broaderdisclosure frameworks in place in many otherreporting jurisdictions. Those broaderframeworks tend to identify the type of contentto be included in narrative reporting rather thandefining the content itself.

The narrative reporting landscape in UK islargely driven by the Business Review legislationfor all quoted companies along with the ASB(Accounting Standard Board) best practicestatement called OFR (Operating and FinancialReview) to improve the quality of reporting.

International Accounting Standard Board (IASB)has published an International FinancialReporting Standard (IFRS) Practice StatementManagement Commentary, a broad, non-binding framework for the presentation ofnarrative reporting to accompany financialstatements prepared in accordance with IFRS.


Jul-Sep 2011

Page 14

factors likely to impact on your marketenvironment.

w Support qualitative statements with quantifiableevidence.

Strategy is the bedrock: Clear identification of a company’s objectives and thestrategic plans in place to deliver them.

w Outline company strategy

w Make strategic statements highly visible.

w Ensure that actions/resources identified asimportant to business success are adequatelyreflected in the strategy.

w Remember that performance against strategyhappens over time – there is value in reiteratingplans/actions from previous years, and progressmade.

w Where possible, include specific targets for eachstrategic priority.

w Be balanced – if targets have not been met,explain why, and what is now being done to meetthem.

Communicating the measures of success: Communicate the measures used to assess strategicsuccess, either through the use of Key PerformanceIndicators (KPIs) or other clearly-defined measures.

w Clearly identify KPIs in the report.

w Align these KPIs to strategic priorities and the keyresources necessary to deliver on the strategy.

w Ensure an appropriate balance between financialand non-financial KPIs is maintained, in line withstrategic priorities.

w Where appropriate, support each KPI with adefinition, prior-year comparisons, benchmarkdata and targets for the forthcoming year.

w Be consistent year-on-year – if KPIs have changed,explain why.

Mapping out the principal risks: An assessment of how well companies have focused onthose risks that are key to company success.

w Be realistic about how many risks are ‘key’.

w Differentiate between company/industry-specificand general risks.

w Explain how each risk is identified, monitored andmanaged.[‘through the eyes of management’]

w Where possible provide quantitative analysis tosupport any statements on risk management.

w Provide an assessment of the company’s overallrisk profile, analysed between likelihood of therisk occurring and its impact.

Segment reporting – comparing apples with apples: How well companies detail their strategies andperformance by segment, and align this information withthe overall group.

w Ensure the segment analysis represented in thenarrative section of the report reflects the waymanagement runs the group. [‘through the eyesof the management’]

w Clearly explain how each segment is delivering ongroup strategic priorities.

w Highlight any segmental strategic priorities thatdiffer from those of the group as a whole.

w Where possible, provide group KPIs by segmentand support them with relevant segment-specificKPIs.

Investors and other stakeholders demand formore in-depth information underscores theimportance of creating a ‘light touch, principles-based framework’ one which establishes, at ahigh level, the scope of information that needsreporting.

Concluding Remarks:Companies do provide what some call‘contextual and non-financial information’about their performance and prospects – buttop reporters provide a great deal more thanaverage ones. From the investor community’sperspective, there is plenty of room forimprovement. From the companies’perspective, enriching their narrativepresentations and accompanying metrics offersthe opportunity to provide a view ‘through theeyes of management’ that investors wouldhighly value.

Does that mean creating bulkier reports, withmore cost and more effort that may be betterapplied elsewhere? While adhering to regulatoryrequirements, companies have enough latitudeto make choices. They can delete routine butsuperfluous disclosures. They can provideinsights and related numbers that managementalready uses to operate the business. Taking atop-down, investor-centric approach may be thefuture where corporate reporting is concerned.To that end, it’s important to know the broadsituation today.

Muhammad Ali ACA is an Asst. Manager at KPMG TaseerHadi & Co. The readers are welcome to contact the authorto discuss any part of this article on email:[email protected]


Page 15

COVER STORY

The Confederation of Asian and PacificAccountants (CAPA), the regionalorganisation representing professionalaccounting organisations in the Asia-Pacific region, in May 2011 staged asuccessful conference in titled“Improving Public Sector FinancialManagement” in Seoul, Korea. TheConference was co-organised with theKorean Institute of Certified PublicAccountants (KICPA), and supported byvarious international and Koreanorganizations. Sponsorship wasprovided by the Korean Big 4Accounting firms.

The key theme of the conference wasstrengthening accounting in the publicsector. The Conference programprovided an overview of theInternational Public Sector AccountingStandards (IPSAS), as well as regional case studies. Theexperiences of countries in various stages of transitionfrom cash-based accounting to accrual-based accountingbrought a real hands–on perspective to the program.More than 120 participants from 19 countries in the Asia-Pacific region, ranging from public servants, professionalsin practice and aid agencies to academics, attended theConference.

CAPA President, Keith Wedlock stated that theConference represented a significant event as the first ofits kind organised by CAPA. “We were very happy to beable to engage many high quality, influential, andinternational speakers for this Conference, includingrepresentatives from the Korean, Japanese and Chinesegovernments, and the IPSAS Board. Leadingorganisations such as the Japanese Institute of CertifiedPublic Accountants, New Zealand Institute of CharteredAccountants, Australian accounting bodies, ACCA, theChartered Institute of Public Finance and Accountancy(CIPFA), the World Bank, and the Asian Development Bank(ADB) were prominent.”

CAPA Chief Executive, Brian Blood also commented thatthe public sector was an increasingly important area offocus in CAPA’s strategy and activities. “In achieving ourobjectives and supporting the objectives of the globalprofession, CAPA recently issued a Position Statementreflecting our commitment to public sector financialmanagement. This Conference supports our stand in thisimportant area. CAPA is looking at opportunities to stage

similar regional Conferences in the near future or otheractivities demonstrating our commitment in this area.”

The Conference opened with an address by DirectorGeneral, Jaeseek Park, from the Ministry of Strategy andFinance of Korea. He presented an overview of the KoreanGovernment’s accounting reform system and the three-year roadmap towards a new accounting system. A casestudy of the Korean government’s journey ofimprovement delivered by Sang Ro Kim, Senior Officer atthe National Accounting Standards Centre of Korea setout the key steps.

The case for ‘Strengthening Accounting in the PublicSector’ was put from two different perspectives, firstly byTony Hegarty of the World Bank, then by ProfessorAndreas Bergmann, Chair of the IPSAS Board. Hegartystated that the World Bank has a vision of ‘a world free ofpoverty’, and for this to be achieved, governments mustbe held accountable for using resources economically,efficiently, and effectively. “To that end, the financialmanagement capacity of partner countries must beenhanced to provide reasonable assurance over the useof donor funds,” he added.

Professor Bergmann reflected that financial crises arecaused by a lack of transparency, and stressed that theaccounting profession has the methods and concepts toimprove that transparency and decision-making throughthe usage and guidance of IPSAS, ultimately reinforcingaccountability – a key responsibility for legislators and

ImprovingPublic SectorFinancial ManagementIn The Asia-Pacific Region

1st and 2nd from left - KICPA President, Ou-Hyung Kwon, and Director General, Jaeseek Parkseated with speakers


Jul-Sep 2011

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Page 17

COVER STORY

public officials. According toProfessor Bergmann, the full suite ofIPSAS standards has been developedfor world-wide application to deliverthat transparency and accountabilityto citizens. This theme was latercovered by Tadashi Sekikawa, amember of the IPSAS Board, whogave an overview of both the accrualand cash basis of accounting,particularly where IFRS standards donot effectively address public sectorissues, for example, revenue andtransfer revenue recognition.

Participants agreed that thehighlight of the Conference was thesession ‘Journey to Improvement’ –a series of five case studies withdiscussions ranging from the NewZealand experience over sometwenty years, the mid streamposition of Japan, to the contemporaneous programs ofKorea and China. Further, the case examples ofdeveloping nations including Lesotho and Nigeriareinforced the involvement of the profession andeducation as facilitators of change. These were latersupplemented by case studies from a UK perspective inthe session on ‘Managing the Transition to Accruals’.

Importantly, the Conference presented a range of issuesand processes that are the building blocks in improvingpublic sector financial management. They are:

w Any change in the public sector financialmanagement process needs a clear vision andwill of legislators and senior officials towards theimperative for accountability, transparency, andgood governance. This is usually implementedwith legislation to mandate the transition toenable better decision-making in public sectorundertakings, improved financial systems,guidance, and reporting.

w The proposed change processes must be well-plannedwith due regard for all stakeholders, andimportantly, allowing realistic time horizons.

w It is crucial to have financial information systemsto enable management information to be readilyutilised and facilitate drawing ofagency level information into central orconsolidated whole of governmentaccounts; and such systems requiresignificant capital investment,programmed implementation, andeducation for users.

w The process of integration andreconciliation of financial informationwith cash based budgetary systems isextremely important at an agency leveland whole of government level, andappropriate systems must bedeveloped to facilitate critical budgetsand forecasts.

w Education of public sector managers during theprocess of change is critical to ensure success.Similarly, legislators must be involved in theeducation process to understand the implicationsof information they are dealing with.

w An oversight body should be appointed toensure agencies perform in the transition, toprovide technical and practical implementationsupport, research, and consultation on a day-to-day basis.

w Supreme Audit Institutions have a critical role insupporting public sector governance,accountability, and compliance. They must takeactive roles with agencies and centralgovernment in all aspects of financialmanagement, improvement processes, andeducation, with experience in identifying areas forimprovement and providing suggestions forrectification.

w Similarly, as in the private sector, parliamentaryaudit committees or Public Accounts Committeesmust play a key role in ensuring that the processof financial management, reporting, and auditingare first rate.

Left to right - Prof. In Ki Joo with Tony Hegarty and Andreas Bergmann, taking questionsfrom the audience

Seated left to right – Brian Blood, CAPA Chief Executive, and Sang Ro Kim, SeniorOfficer of the Korean National Accounting Standards Centre; standing - Lou Hong,Deputy Director General from the Treasury Department, Ministry of Finance

presenting China’s case study

While discussions have been steered towards accrualaccounting being the solution for public sectoraccounting, the cash basis is utilised in many jurisdictionsand is recognised through certain IPSAS standards. Whilstthe financial reporting benefits are significant,experienced public sector financial managers see someof the greatest gains as being able to determine the truecost of programs and activities, as indicated by NeilWallace of the ADB in the concluding session. Ultimately,this delivers better information for economic planningand decision-making at both the agency and whole ofgovernment levels.

The accounting profession has significant internationalexperience and capacity to support the development ofpublic sector financial managers. Access to internationalexperience, benchmarking, and support should besought through engagement with organisations such asIPSAS, the International Federation of Accountants (IFAC),and CAPA which could facilitate sharing of knowledgewith other experienced nations.

The Conference was followed by a high-level Roundtablediscussion hosted by the National Accounting StandardsCentre of Korea and attended by representatives fromgovernment departments of participating countries,

CAPA representatives from correspondingcountries, conference speakers and expertsfrom the profession. The Roundtable provideda great opportunity to share experiences.

Materials from the Conference are available inthe library section of the CAPA website at thisaddress:http://www.capa.com.my/article.cfm?id=496

POSITION STATEMENT

The Confederation of Asian and PacificAccountants (CAPA) fully supports andencourages the convergence towardsInternational Public Sector AccountingStandards (IPSAS) by all member countries inthe Asia/Pacific region to assist in theimprovement of public sector financial

management.

Users of financial reports produced by the private sectorhave, for many years, demanded and supported thedevelopment of globally accepted high quality financialreporting standards. These users have included regulatorsand central government agencies. This has resulted in anincreasing number of countries adopting andimplementing IFRS as the financial reporting norm for theprivate sector.

Concurrently there is a growing international movementto improve financial reporting in the public sector. Thishas resulted in many countries initially adopting cashbased accounting; moving to a more sophisticatedaccrual basis for financial reporting; and finally a numberare adopting and implementing accrual based IPSAS.

Improving the quality of financial reporting in the publicsector is viewed by CAPA as critical in addressing the hugerisks, such as unexpected sovereign debt crisis situationsthat may remain obscured, when robust accounting andreporting techniques are not used in the public sector.

From a public interest perspective the more effectivemonitoring of financial performancewithin public sector entities is critical.CAPA supports accrual based financialreporting as the only means to providethe necessary high quality, transparentreporting of public sector activities andposition.

Achievement of this ensures that thesame high standards of financialreporting are applied by both the privateand public sectors of an economy – thusleading to better informed decisionmaking at both the micro and macrolevels.

CAPA therefore calls for governments inthe Asia/Pacific region to fully recognisethe need for robust financial systems, andto lead changes in public sectoraccounting and reporting to supportenhanced public sector financialmanagement.

Left to right – speakers Tony Dale, Alan Edwards, and Hidetaka Tabata takingquestions from audience

Participants at the Roundtable discussion


Jul-Sep 2011

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Page 21

OTHER ARTICLES

Planning is considered as the tool of success whether youtalk about business management, country affairs or war.But point is how better planning may be done to get thebetter results. Process of Planning consists of preparing acourse of action step by step to achieve some specificgoal by effectively utilizing the available resources andcome up with set of direction and within time constraints.A plan is like a map. When following a plan, we can alwayssee how much progress towards goal and how far fromthe destination, knowing where it is essential for makinggood decisions on where to go or what to do next.

As Planning is a complex process, how better planningcan be done to get the best is of the utmost importance,it brings achievable objective estimates in do-able timeframe with effective and efficient utilization of availableresources otherwise strategic or annual business planningmay have defects, misdirected estimates and timeconsuming exercise leading to adverse impact onbusiness.

In any business model, planning besides other risk factors(e.g. competition) and initiatives (e.g. new launch) startsprimarily with sales volume and all other aspects areplanned to get the primary objective of any organizationi.e. profit or maximize the value for shareholders.

Following are the major segments in planning from salesvolume planning moving next to raw material,

production, manpower, supply chain / resources, financialplanning and external environment.

Sales volume: Total volume estimates with break downin packs and flavors

Raw material: Required materials estimates based on thesales volume

Production: Capacity and shifts availability(manufacturing and outsource decisions)

Manpower: needed manpower based on permanent andcontract labor availability

Supply chain: All needed resources starting right fromstorage to vehicles to make the sales

Financials: Profitability right from gross revenue,discounts, cost of sales and expenses to bottom line

External environment: Competitive edge andGovernment regulations etc.

Primarily, the above referred segments depends on theapproach of Bottom Down or Bottom Up, meant whethertargets / estimates coming from top management anddrilled down to desired results or estimates worked outbased on current and forecasted trends from lower leveland cascaded in the desired results then fine tune by topmanagement.

Plan theBusiness PlanningMuzammil Bhelim, ACA

The Pakistan AccountantJul-Sep 2011 OTHER ARTICLES

Page 22

Next deciding factor is really important whether to go foreach segment of planning in isolation or at central levelwork out the plan for all functions collectively.

In Isolated functional planning, each functionindividually estimates and finally all segment are mergedto develop one plan. Each function at its own work out allrisks and benefits which finally translated in financials.Following diagram No.1illustrates this concept:

Diagram No.1

Centralized planning on the other way looks at the eachabove referred planning segment at centralized levelcollectively based on the available / targeted resourcestaking in to account the primary objective ofmaximization of profit or shareholder’s value.

Optimization of resources is the key factor in centralizedplanning as one window approach taking into accountthe input from all functions. Concept moves like asestimates or initiatives coming from the functionimmediately tested by translating in financials and inbroad objective of the organization while covering all therisks, if found as per the targeted objective keep in theplan otherwise sent back for further improvement to thefunction with the recommendations e.g. if sales volumeplanning is considered it may be sent back to salesfunction to fix as per the profitable packs and ifconsidering the supply chain it may be reconsidered interms of increasing the efficiency and reducing therequirement of resources through optimization to get thedesired profitability. Diagram No. 2 illustrates thisconcept:

Plan tone should be based on the clearly identifiableobjectives in terms of short and long run which requiresdifferentiation between strategic and annual operationalaspects of the plan separately. Annual Plan should havethe reflection of the long term strategic objective.

Next aspect is to Plan the Planning/Financial model withall best possible historic and forecasted information to besought from the functions and to be best fit in thebusiness environment for foreseeable future. Key is to

eliminate the redundantinformation which mightconsume major planning time.Modeling need to have majorlylinked variable informationshowing impact on the desiredresults so that any KPI change inthe model would automaticallyevaluate the impact in terms ofdeliverable results instantly.

Planning of phasing of theestimates / objectives is utmostimportant before the final

implementation of the plan which normally taken care ofin the planning / financial model. Here keys are theattainable time frame and most important considerationof business and product seasonality. Normally based onthe seasonality volumes and financials are tuned so thatactual vs. plan gap is narrowed down to best possiblelevel.

Finally the implementation of the plan with all custodianfunctions with clear objectives and time frame isnecessary and constant follow up is necessary as directionmay need to be corrected at any point in time for thesuccessful implementation of the plan.

Whole planning exercise besides the normal procedureof estimates, counter any foreseeable risks and initiativesheavily depend on how good interaction is in progressbetween the functions and planning team and how openfunctions and organization is to make any change basedon the results coming from the centralized resultsevaluation.

All above referred aspects if turn in right direction andhaving plan your planning will definitely lead to set the

right direction, saving time consumption andabove all will answer all your upcomingquestions when you will compare the actualvs. plan job ahead to come in future.

M. Muzammil Behlim is a CharteredAccountant and Masters in Economics fromPakistan and working for Aljomaih PEPSI SaudiArabia as Budgeting & Planning Manager.

The readers are welcome to contact the authorto discuss any part of this article on email:[email protected]

Diagram No.2


Page 23

OTHER ARTICLES

INTRODUCTION

While the significant challenges posed by sustainabledevelopment and sustainability have been wellrecognized for some time, management of thesechallenges has yet to become a core competency of mostorganizations—big and small. Why? First, while awarenessamong business leaders is growing, many are not eco-literate. They do not recognize the environmental benefitsof making environmentally sustainable business choices,including reducing their carbon footprint, andcontributing to cleaner water and better air quality.Second, many business leaders do not believe that theenvironment is a legitimate business concern. Many donot realize that with minimal investment in more efficienttechnology and simple changes in human behavior, theirorganizations can reap significant cost savings.

Fortunately, there are signs that things are changing.According to a recent research study, conducted by theAmerican Institute of Certified Public Accountants, theChartered Institute of Management Accountants, and theCanadian Institute of Chartered Accountants, small- andmedium-sized entities (SMEs) are placing greateremphasis on developing a sustainability strategy as itbecomes increasingly linked to business performance.

However, most SMEs that are moving towardsustainability seem to be doing so in response to marketpressures in the supply chain—large corporate customersare imposing requirements on their SME suppliers as acondition of their purchase order to reduce their own

carbon footprint and/or fulfill their environmentalreporting obligations. But there are other reasons toembrace the green agenda.

WHY SHOULD SMES EMBRACE THE GREEN AGENDA?

There is mounting scientific evidence that business needsto embrace the green agenda by adopting moresustainable business practices, including thedevelopment and implementation of more eco-efficientproducts and services. And, small business should not beexempt.

Why? Small business is the cornerstone of most—if notall—national economies. According to data from theOrganisation for Economic Cooperation andDevelopment (OECD), the SME sector accounts for themajority share of private sector GDP, economic growth,and employment in OECD economies and beyond, and,consequently, has a carbon footprint comparable withthat of the listed-company sector.

Some claim the SME sector is often ignored or given lowpriority when solutions or tools to address business issuesare designed. It is argued that the tools makers and policyshapers are typically the large corporate players andgovernments, and “small” is not typically part of theirrepertoire. Yet, given their cumulative environmentalimpact, small businesses need to be a part of the solution.To do so, they may need the help of their most trustedbusiness advisor, the professional accountant.

Sylvie Voghel, SMP Committee Chair (see bio) and Paul Thompson, Deputy Director, SME and SMP Affairs, IFAC

This article examines the relevance of integrated reporting to small business and highlights how small- and medium-sized practices (SMPs) can help small businesses improve their environmental performance.

The Role ofSMPsin Greening Small Business


Page 24

HOW CAN PROFESSIONAL ACCOUNTANTS HELP SMESGREEN THEIR BUSINESSES?

SMPs are well positioned to take advantage of SMEs’increasing demand for value-added business advisoryservices, including sustainable business advice (see TheRole of SMPs in Providing Business Support to SMEs). Assmall businesses themselves, SMPs understand andappreciate the needs of their SME clients, including theneed for tools that are affordable and practical.

SMPs also appreciate the need for their small businessclients to formalize their operations to instill bettermanagement control, which can help SMEs become moreeco-efficient, do more with less and, hence, increase andgreen their bottom line. For example, accountants canadvise on the benefits of reducing energy costs, fromsimple behavioral changes aimed at eliminating waste, toinvestment in new equipment and alternate sources ofenergy.

SMPs can also advise SMEs on developing anEnvironmental Management System (EMS), whichenables an organization of any size or type to identify andcontrol the environmental impact of its activities,products, or services; set and achieve environmentaltargets; and demonstrate that these targets have beenachieved. Implementing an EMS should lead to costsavings and a reduction in the organization’s carbonfootprint. Business advisory in this area can include:

1) informing clients about the value of an EMS, andconnecting them to tools to help them get started; and2) helping them prepare, for example, an EnviroReadyReport, to demonstrate the presence of a robust andcredible EMS and help position them as good corporatecitizens; and 3) help SMEs meet the reporting needs oftheir large, listed suppliers who often have to meetcertain requirements, such as compliance with theInternational Organization for Standardization’s ISO14001 dealing with EMS.

In addition, in the next few years, increasing numbers ofSME owner-managers will be retiring and seeking to selltheir businesses. Buyers are likely becoming morediscerning when it comes to the green credentials ofpotential purchase targets.

All this opens opportunities for SMPs to build on theirexisting relationships and offer sustainable businessadvice, helping clients to comply with sustainablereporting and any attendant assurance requirements,green their business, improve their bottom line, andattract new clients or buyers.

WHAT TOOLS CAN SMPS USE TO HELP SMES GREEN THEIRBUSINESS?

IFAC’s Sustainability Framework (Section 2.1) includes anumber of relatively simple steps that SMEs can take tolower costs through minimizing waste. SMPs can helptheir SME clients implement these measures. For SMEsseeking to implement a business excellence framework,

a universally applicable tool is the InternationalOrganization for Standardization’s standard, ISO 14001(see above).

SMPs interested in supporting SMEs on the path tosustainability should download the IFAC SMPCommittee’s free Guide to Practice Management for Useby Small- and Medium-Sized Practices, which offersguidance and tools spanning a range of topics.

HOW CAN SMPS AND SMES INFLUENCE POLICY MAKERS?

The International Integrated Reporting Committee (IIRC)recently released its Discussion Paper, Towards IntegratedReporting - Communicating Value in the 21st Century. Thepaper presents the rationale for integrated reporting,offers initial proposals for the development of aninternational integrated reporting framework, andoutlines next steps toward its creation and adoption. Whyshould SMEs and SMPs respond to this paper? Integratedreporting will allow organizations to release moreinclusive and useful reports on all aspects of performance,including environmental, social, and governance, as wellas economic, in a concise and user friendly format. Thisinformation will allow organizations to provide anassessment of the long-term viability of an organization,as well as meet the needs of investors and otherstakeholders.

Comments are encouraged from various stakeholders,including reporting organizations, investors, employees,1and assurance providers. Of most relevance to SMEs andSMPs is question 4 on the applicability of integratedreporting (IR) to SMEs and the initial focus of integratedreporting on larger companies. Tell the SMP Committeewhat you think by responding to this question on itsDiscussion Board.

[INSERT MEMBER BODY RESOURCES]IFAC RESOURCES

The following resources (all free of charge) are accessiblevia IFAC’s SMP Committee website at www.ifac.org/SMP.

w Publications—Guide to Practice Management forSmall- and Medium-Sized Practices (PM Guide)and accompanying User Guide, The Role of SMPsin Providing Business Support to SMEs, andSustainability Framework

w Quarterly eNews and Relevant Links: BusinessAdvisory

For translations of the PM Guide (both completed and inprogress), filter by language in the Publications andResources area of the IFAC site:www.ifac.org/publications-resources.

Copyright © October 2011 by the International Federationof Accountants (IFAC). All rights reserved. Used withpermission of IFAC. Contact [email protected] forpermission to reproduce, store, or transmit thisdocument.

1 Comments can be submitted to [email protected] orthrough www.theiirc.org by December 14, 2011.

OTHER ARTICLESThe Pakistan AccountantJul-Sep 2011

Page 25

Savvy companies that aspire for the engagement not justof their shareholders but also of a wider circle ofencompassing customers, employees, communities,suppliers, business partners and relevant non-governmental organizations can be competitive in theshort-term and more sustainable in the long-term ascompared to those which focus exclusively on thefinancial bottom line. Good business is, by its very nature,socially responsible business. It is argued that ifemployees have an ownership stake they will be are morecommitted to the company. This leads to motivation andefforts, hence to productivity and profitability.

The question both for business and government is howto engender such participation and involvement and,specifically, whether this can be brought about throughemployee shareholding, when such individualshareholdings, taken separately, are insignificant in termsof the overall share capital of the enterprise?

Even by pooling the voting rights – although notnecessarily the actual ownership – of their shares, anemployee shareholder trust could represent a significantvoice.

However, some mechanism is needed to translateindividual employee shareholding stakes into a collectivevoice that can deliver results, both in terms ofrepresenting the interests of employees and inconvincing employees that their shareholding gives thema stake in the enterprise. Such a move could haveimportant beneficial effects for corporate performanceand hence economic growth. It could also have significantwelfare effects in terms of enriching the experience ofworking life. Main reasons and issues need to beaddressed before considering sharing ownership plansare:

The following are some of the reasons for having asharing ownership plan:

w Link between work and reward: If you are going to

ask the most from your employees, they will expectsomething in return. Increasingly, pay is notenough. A plan that rewards employees with ashare of the fruits of their labor draws a directconnection between work and reward.

w Culture of ownership: When employees arerewarded based on their contributions to thecompany's success, they feel like owners. Asowners, employees have more incentive to increasethe company's profitability. However, this strategywill work only if a culture of understanding thecompany's challenges and contribute to thesolutions has been created over time. Open two-way communication, flat management structureand employee involvement foster such a culturefaster.

Following are the issues to be considered when creatinga sharing ownership plan:

w Empower employees to succeed: Employees mustbe able to make decisions that will have an impacton their bonus. "It [profit sharing] is not worth

Partnering Employeesto Share-Ownership for

GoodGovernanceand GrowthS. Athar Hussain Zaidi, FCA and Mubeshir Ali, ACA

Page 25

Introduction


Page 26

much, unless there's participation in decisionmaking," says Bob Nelson, president of NelsonMotivation Inc. in San Diego, Calif., and author of1001 Ways to Reward Employees.

w Clear objectives: Before developing a partnershipplan, any organization needs to have definedobjectives in place; is it employee recruitment?Retention? Do you want liquidity for your equity?Do you want to boost production, or perhaps, youwant a little of everything. The answers will helpyou choose the right plan for your company.

w Know your industry:Old economy businesses mayhave actual profits to share. New economyenterprises may be years from that, so stock optionscarry more appeal. If your workforce is young andwell educated, immediate stock awards providemore motivation. Older workers may be moreinterested in plans geared toward retirement.

w Stage of business development: At the startupstage, a company may want to protect cash andoffer stock options. At a rapid-growth or maturestage, when a company has become profitable,stock-option awards, cash and stock bonuses, orprofit sharing become possible.

Employee participation within the workplace is generallyregarded as important in generating and sustainingloyalty and commitment to the organization. Establishingand sharing a company ethos and culture is seen as adesirable outcome for organizational success. One reasonfor this is that attempting to secure effort from employeesvia supervision is at best costly and often difficult if notimpossible. Incentive schemes may be impracticablewhere results depend on team effort. To work, incentivesin this case need to go beyond simply appealing toindividual calculations of the costs and benefits to theemployee of deploying greater effort – since such acalculation would often result in the employee decidingrationally to “free ride” and still benefiting from thecollective incentive scheme. Instead, such schemes need

to be designed to engender collective trust andcommitment.

Shared ownership by employees has long been thesubject of corporate and public policy discussions. Giventhe advantages, meaningful employee participationthrough the particular route of ownership stakes hastaken a number of forms over time and in differenteconomies.

Is participation actually enhanced by ownership? Doemployee participation and employee share ownershiphave the same results? To be successful over the longterm, companies need to innovate both in what theyproduce or offer and in the way in which they produce orthe processes they adopt. The active participation of theworkforce is seen as increasingly important in theseprocesses, particularly in high value added sectors and inthe “new economy.” On the other hand, the short-terminterests of shareholders may get dividend rather thanresearch and development and other innovativeinvestments; the payback from which may not only beuncertain but also, at best, long term.

Cost cutting strategies and work intensification canbolster profitability in the short term, in the longer termdeveloping participatory and representative mechanismsmay prove increasingly important. While it is widelyrecognized that “flexible” employees are important forfirms’ competitiveness, the above work found that suchpractices need to be complemented with adequateinvolvement mechanisms including reward systems andtraining, without which they could result simply in anincreased intensification of work.

EMPLOYEE SHARE OWNERSHIP

From individual point of view, it makes more sense to holdshares in a company other than the one for which youwork, otherwise, should that company go bankrupt, theindividual risks losing his or her savings as well as theirjob. To advocate the holding of shares in the company forwhich the individuals actually work therefore requires twothings. First, there needs to be a good reason foradvocating such a decision. That is, one must beconvinced that mechanisms exist to ensure that the sortof potential benefits associated with such ownership.There must be a visible outcome in terms of companyperformance that follows as a result of suchshareholdings. Otherwise, the employees would be betteroff holding shares in other different companies.

Second, if the mechanisms are in place to ensure thatthere is a potential benefit then employees should beencouraged to take and hold on such ownership stakes,rather than taking stakes in enterprises other than the onefor which they work.

POLICY IMPLICATIONS

Employee shareholder trusts could be used to solve theproblem of the owners of listed companies (shareholders)who normally have no interest in the long-term successor otherwise of the firm. As far as the company isconcerned, institutional shareholders come and go. Anemployee shareholder trust would be there for the longhaul. They really would have an interest in the goodgovernance and long-term success of the firm. The policyimplications of the above discussion are twofold.First, the tax incentives for employee shareholders could


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OTHER ARTICLES

be further developed with the specific aim ofencouraging employee shareholders to activelyparticipate in trusts that provide a collective voice withinthe organization. Such a voice could have a positiveimpact on the performance of companies and therebythe economy as a whole. Without a belief that suchindividual collective shareholdings are contributing in ameaningful way towards a collective voice, there may notbe the necessary commitment from the individualemployee shareholders to hold on to those shares.Indeed, they might in this case be better advised to selland re-invest in some different sectors of the economy.

There could be ways in which the specifics of how the taxincentives currently operate might be improved. Moreimportantly, the reference to “approved” collectiveshareholdings is important. The current criteria forapproving trusts could be extended so that schemeswould be designed and operated in a manner that wasclearly open and democratic, and whose objectives wereto operate in the best interests of the company, ratherthan just to maximize financial returns to the individualshareholder.

Second, such schemes are only likely to develop andoperate successfully if a body is established to ensure thatthis happens, along the lines of the existing supporter’sdirect unit.

The remit of such an organization would go beyond whatis currently offered by the Treasury and Inland Revenue.It would allow the appropriate legal and other structuresto be developed and to be then provided to any suchcollective employee-shareholding group. But it wouldalso actively seek to enable each group to benefit fromthe experience of others in using such holdings to providean effective collective voice at work.

EMPLOYEE SHARE SCHEME IN PAKISTAN

Section 14 Of Income Tax Ordinance, 2001 has a set ofrules that an owner must obey to avoid paying hefty taxeson his or her contracts. In this section “Employee ShareScheme” means any agreement or arrangement underwhich a company may issue shares in the company to:

(a) An employee of the company or an employee ofan associated company; or

(b) The trustee of a trust and under the trust deed thetrustee may transfer the shares to an employee ofthe company or an employee of an associatedcompany.

Provision of this section would apply in Employee ShareScheme as follows:

w The grant is not a taxable event: The value of aright or option to acquire shares under anemployee share scheme granted to an employeeshall not be chargeable to tax. However,consideration received against disposal of right oroption would be taxable under the head “Salary” inthe year in which disposal will take place.

w Taxation begins at the time of exercise:Where, ina tax year, an employee is issued with shares underan employee share scheme including as a result of

the exercise of an option or right to acquire theshares, the amount chargeable to tax to theemployee under the head “Salary” for that year shallinclude the fair market value of the sharesdetermined at the date of issue, as reduced by anyconsideration given by the employee for the sharesincluding any amount given as consideration forthe grant of a right or option to acquire the shares.For example, if an employee is granted 100 sharesof Stock A at an exercise price of Rs.25, the marketvalue of the stock at the time of exercise is Rs.50.The amount included in the salary income on thecontract is Rs.2,500 (Rs.50 – Rs.25 x 100).

w The sale of the security triggers another taxableevent: If the employee decides to sell the sharesimmediately (or less than a year from exercise), thetransaction will be reported as a Capital gain (orloss) and will be subject to tax at ordinary incometax rates and vary from different holding patterns.If the employee decides to sell the shares a yearafter the exercise, the sale will also be reported as acapital gain (or loss) and the tax will be reduced toa maximum level or would be exempt from taxsubject to certain conditions.

CONCLUSION

The philosophy to partnering employees in thebusiness is that if the employees feel that theyhave a stake in the enterprise or organization inwhich they work, they will be more committedto work. This in turn will bring positiveoutcomes in terms of productivity andorganizational performance. This is time-testedtheory and is based upon simple logic whichevery sane manager acknowledges. Partneringemployees creates significant links betweenprogressive human resource practices thatpromote participation and involvement,corporate performance and organizationaloutcomes on the one hand and getting taxationbenefit of holding such participation by theemployees on the other.

_____________________About the authors:

Athar Hussain is a senior finance professional in Iran, afellow member of the Institute, on the visiting faculty ofvarious institutions - professional bodies and universities,lecturing in various management disciplines.

Mubeshir Ali Kazmi, M.Com, ACA is a CFO and CompanySecretary in Pakistan and on the teaching faculty of anumber of institutions.

The readers are welcome to contact the authors to discussany part of this article on email:Athar Hussain: [email protected],Mubeshir Ali: [email protected]


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During the last decade, Islamic banking has emerged asa full fledged industry with its own contribution not onlywith reference to the Shariah compliant banking but alsoto the economy and socio-economic system of thesociety. The regulatory regime in general and varioustaxation regulations in particular have so far been unableto focus on this specific group of economy.

With the introduction of the 7th Schedule to the IncomeTax Ordinance, 2001, an omnibus provision was insertedwhich was apparently aimed to provide level playing fieldto the Islamic finance industry in line with the measurestaken by various countries including the UK. Nevertheless,such provision is a little bit confusing or rather badlydrafted and as a result has not provided the overallcomfort to the industry, as may have originally beenplanned. Additionally, this provision is for the Islamicbanking institutions only and do not deal with theircustomers or other Islamic financial institutions.

This article is intended to summarize few taxation relatedissues being faced by Islamic banks along with theidentification of possible practical solutions.

SALES TAX – MURABAHA TRANSACTIONS

As a general principle, sales tax under the Sales Tax Act,1990 (the ST Act) is not applicable on Murabahatransactions. However, there still remains an issue

regarding payment of sales tax at the time of purchase /import of such goods and passing-on of the same to theeventual purchaser.

If a Murabaha transaction is not subject to the Sales Tax,it means that the input tax that is paid by the Islamic bankwhile importing / purchasing the goods can not bepassed on to the customer, who legally can not claim thesame.

At present, contrary to the Shariah principles as laid downby the State Bank of Pakistan (SBP), generally the supplierof such goods raises the invoice in the name of thecustomer, whose actual capacity is of the agent and notthe Islamic bank being the purchaser in the first leg of thetransaction. Accordingly, generally speaking the customergets the benefit of the input tax, which otherwise can notbe termed technically correct.

Proposed SolutionProper amendment should be brought about in the SalesTax Law which should permit the Islamic bank to pass-onthe input tax paid on purchases / import of taxablesupplies to the customer.

SALES TAX EXEMPTION – OTHER TRADE BASED MODES

Other trade based modes of financing, such as Salam,Istisna, Musawwama, Istijrar and Sale in Wakalatul

Taxation Issues in

Islamic BankingOmar Mustafa Ansari, FCA & Salman Haq, ACA


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OTHER ARTICLES

Istithmar are not provided with any specific exemption ortreatment vis-à-vis sales tax. As a result the banks offeringthese products are subject to risk of levy of sales tax onsupply of goods in these trade based mode of financing.

Another issue in respect of these transactions is in respectof sales tax at the time of purchase of such goods by theIslamic bank. Practically speaking, it has been witnessedthat when the bank purchases an item for sale to anotherperson; it does not receive a sales tax invoice identifyingthe input tax. In other words, generally these transactionsare net off sales tax, which technically is an issue as towhether this is a genuine sale or not.

Proposed SolutionAs in the case of Murabaha transaction, the Federal Boardof Revenue (the Board) may consider ousting thesetransactions from the scope of the term “supply” asdefined under the Sales Tax law.

The Board may also consider introducing a specialprocedure whereby the Islamic Bank may pass-on theInput Tax in relation to Islamic financing products to itscustomers. This would also provide a level playing field tothe Islamic banks as compared with conventionalbanking.

SALES TAX – UNITS OF DIMINISHING MUSHARAKA

In Diminishing Musharaka (DM) transaction, when thegoods sold by the Islamic bank are subject to sales taxthere is a risk of levy of sales tax on such supply.Particularly, the issue gains more importance if it is thecommon practice of the Islamic bank is selling such goodson a more frequent basis.

Academically speaking, DM is a hybrid form of leasingtransaction. However, it is not generally called leasing, soit is not clear whether it is enjoying the exemption fromsales tax applicable to leasing transactions.

In addition, even if it is considered exempt or not subjectto sales tax, there would remain an issue with regard tothe mode of transfer of input tax paid to the customer.

Proposed SolutionThe provisions of Sales Tax law should be madeinapplicable to DM transactions.

WITHHOLDING INCOME TAX – AGENCY

In most of the Islamic finance transactions, there isinvolvement of agent for purchase, sale, possession,negotiation and payment or recovery. The role of theseagent differ from one transaction to another and incertain cases these agents are entitled to a fixed / variablyagency commission / fee which, at times, (as in the caseof Salam, Istisna, and Wakalatul Istithmar transactions) isfairly material.

Agency commission is subject to withholding taxgenerally at 10% of the gross amount and is normallyconstrued as a final discharge of the tax liability of theagent.

Proposed SolutionBeing part of an overall Islamic financing transaction, theagency commission received by the agent should bemade subject bottom line profit taxation. Hence, the taxwithheld from payment of such commission should be

treated as an advance payment of tax rather than a finaldischarge of the tax liability of the agent.

WITHHOLDING INCOME TAX – IMPORTS

In case of import Murabaha, it is the Islamic bank thatshould be the importer-on-record and all the duties andtaxes should be borne by it. However, practicallyspeaking, it is the customer who is the importer-on-record and accordingly all the duties and taxes at importstage are paid / borne by the customer. Such anarrangement is normally undertaken so that the customercould avail the benefits of the duties and taxes that arepaid at import stage. From a Shariah perspective however,this situation results in an issue, as to whether the risksand rewards are actually transferred or not.

If we wish to correct the situation then there must besome methodology available under the Income TaxOrdinance, 2001 whereby the Islamic bank has the optionto transfer the duties and taxes that it has paid at importstage to the customer.

Proposed SolutionThe withholding tax provisions under the Income TaxOrdinance, 2001 are not applicable on banks (includingIslamic bank) as per the Seventh Schedule to theOrdinance. Accordingly, in respect of Murabahatransactions the Board may consider issuing a clarificationthat in respect of imports it would be the customer whowould be the importer on record and hence responsiblefor taxes and duties.

WITHHOLDING INCOME TAX – TRADE BASED MODES

Receipts to banks are not subject to withholding tax.However, when the Bank purchases the goods; there is arequirement of withholding tax at the time of payment.

Generally the Banks do not deduct this withholding taxand instead, either the customer deducts it and pays itinto government treasury or the bank pays it separatelythrough the customer in the treasury and two differentpay orders are made i.e. first for payment to supplier (netof withholding tax) and second for payment ofwithholding tax into government treasury. In either case,officially it is not the Bank who is withholding tax; ratherit is the customer who is withholding tax on record.

Proposed SolutionThe Board may consider issuing a clarification that inrespect of purchases made by Islamic banks forundertaking Islamic financing arrangements, it would bethe customer / supplier who will be the deducting agentsin respect of taxes and duties.

WITHHOLDING INCOME TAX - IJARAH

In case of assets purchased for Ijarah transaction, tax iseither collected at import stage, or deducted at the timeof making payment in respect of local purchases.

In either case, the withholding tax is deducted (orgenerally should be deducted) in the name of the Bank,which is recoverable by the bank or adjustable aftersubmission of annual return. Particularly, in case of carsthe invoice etc. are in the name of the bank.


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On the other hand if the invoice is in the name of thecustomer, then from Shariah perspective there are issues.In addition, the deduction of withholding tax in the nameof the customer results in a situation that the pricing ofthe asset is inappropriate.

Proposed SolutionThe Board may consider issuing a clarification that it is theultimate customer “and not the bank”, who would besubject to deduction / collection of tax in respect of Ijarahtransaction.

INCOME TAX – SALE AND LEASE BACK

In conventional financing, a sale and lease back transactionis regarded as a finance transaction and accordingly, any gainon sale does not attract any income tax.

Nevertheless, in Islamic finance the situation is a bitdifferent. Here you can not classify this transaction as amere financing transaction.

In addition, in case of Ijarah transaction, the asset isactually sold and then the lease transaction is a merelease in which the asset does not appear on the balancesheet of the lessee in line with the treatment specified byIFAS – 2. Accordingly, it is a risk that this gain can besubject to tax at corporate rate in the hand of the lessee.

Proposed SolutionIn order to provide level playing field with conventionalbanking, Ijarah transaction should also be regarded as inthe nature of sale and lease back arrangement and hencenot subject to withholding tax under Section 153 of theIncome Tax Ordinance 2001. Similarly, gain or loss ondisposal of asset for the purpose of leasing it back underIslamic modes shall not be considered a taxable gain /expense for the purpose of computation of income of thecustomer. On the other hand, the lease rentals on Ijarahtransactions shall be allowed for tax purposes afterdeducting the proportionate effect of such gain.

PROPERTY TRANSACTIONS – STAMP DUTY

In Islamic finance transaction where transfer ofimmovable property is involved, there is an issue ofdouble stamp duty.

Most common of these transactions are DM transactionsfor housing and corporate DM transactions involving landand building.

In these transactions, in the first stage, the Bank becomesthe owner, and in the second stage the Bank sells theproperty to the customer generally in monthly, quarterlyor annual units. If both the transactions are registeredseparately, then at both the stages, stamp duty has to bepaid. However, to avoid this situation, the Banks allowsthe customer to directly register the property in its name.If we want to correct this treatment, then we need toavoid risk of double levy of stamp duty.

Even today, there is a risk that since there are two differentsale transactions so the relevant authorities may claimseparate duty for both the stages.

Proposed SolutionProper amendments should be made in the Stamp Actwhich should levy Stamp duty only once in relation toIslamic financing transactions.

CONCLUSION

The objective of this article is to identify few significantissues for the benefit of Islamic banks and regulators. It isnot intended to provide final solutions and conclusionson all such issues, and instead it is just focused on a fewmajor issues and to convince the stakeholders that thereis a need to commence a dialogue on the same. It is alsoworth noting that other associated industries in theIslamic finance sector, like the Modarabas and the Takafulare also facing a few similar issues which also need to beaddressed.

We suggest that SBP and PBA should now take this matterseriously and take it to the FBR and the Ministry of Financein order to enable a smooth supporting environment forIslamic banking institutions. On the other hand, thegovernment officials should also look into this matter andtry to support this important industry which has evolvedas a requirement of the constitution of Pakistan and thewishes of the founder of the nation in line with his speechon the occasion of the inauguration of SBP. The industryis not asking for any preferential treatments. What it allneeds; is a real and comfortable level playing field.

About the Authors:

Omar Mustafa Ansari, FCA is working with Ernst & YoungFord Rhodes Sidat Hyder as Partner / Head of IslamicFinancial Services Group. Omar’s expertise is providingservices to IFIs including Audits, Shariah-Audits, CorporateFinance, Transactions / Product Structuring, Accountancy,Training, MicroFinance, Risk Management & Development/ Review of Manuals and Systems. He has authored twobooks, “Managing Finances - A Shariah Compliant Way”and “Islamic Microfinance Bank: Working Model” (in Urdu)and has contributed numerous articles. He is a regulartrainer on Islamic finance. Omar is a member of variouscommittees for Islamic finance and Takaful formed byICAP, SECP and SBP.

Salman Haq, ACA is working as Partner Tax with Ernst &Young Ford Rhodes Sidat Hyder. He has dealt withnumerous taxation issues for Islamic financial institutionsfrom time to time, and have advised them on varioustaxation aspects. He also has a diverse experience ofproviding advisory on international tax matters includingcross border transactions, transfer pricing, investmentappraisals and Afghanistan tax matters.


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OTHER ARTICLES

Farheen Mirza, ACAManager Technical Services

Ethics must be absolute that is you must take themseriously enough to override any human rationalization,weakness, ego, or personal faults. Unfortunately we areliving in a world where we only need ethics in a time ofcrisis, the rapid solution to problems in such times.

In the ethics of crisis, the focus of morality is not on ourlife as a whole, but on a difficult situation we are currentlyin and don't know how to solve it. Ethics is questionedonly when we are in a crisis, in dire straits. The ethics ofcrisis does not realize the interconnection of what we areand what we do. Instead of the ethics of crisis, we needthe ethics of values. Now the question is what is thedifference between the two?

The ethics of crisis is: what should I do, and the ethics ofvalues is: what should I be? What is of Value to me?

Ethics is a requirement for human life. It is our means ofdeciding a course of action. Without it, our actions wouldbe random and aimless. Ethics is not something outsideus, it is not a something at all, but our own life thatdepends on what kind of person we want to be.Therefore, ethics is not a part of life. It is human lifeobserved as a whole and in a special way by which we,

using our own beliefs and values, change ourselves intosomething better than we used to be.

ETHICS INTHEWORKPLACE

Ethics is not something

outside us, it is not a

something at all, but our

own life that depends on

what kind of person we

want to be.

The word ethics is derived from the Greek word ethos, which means "character," and

from the Latin word mores, which means "customs." According to Aristotle, one of the

first great philosophers who study ethics - ethics was more than a moral, religious, or

legal concept. He believed that the most important element in ethical behavior is

knowledge that actions are accomplished for the betterment of the common good.


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WORKPLACE ETHICS

Workplace Ethics is a set of formal and informal standardsof conduct that people use toguide their behavior at work.Workplace ethics set the standardfor right and wrong, developethical culture, making policiesmore efficient and the workplacemore orderly.

It is commonly understood thatthere are ethics and then there areworkplace ethics. Often we don’tstop to realize that there is nodifference between personalethics and workplace ethics.Ethics are the same whether atwork or in personal life, after allethics are about making choicesthat may not always feel good likethey benefit us but are the "right"choices to make.

We’ve all heard these rules to liveby: Don’t hurt, don’t steal, don’tlie, and the more famous “Do unto others as you wouldhave done to you.” In our personal lives most people tryto follow these rules. Ethics are often thought of by manyas something that is related to the personal side of life andnot to the workplace side.

In an organization, workplace behavior ethics should bea core value. Ethics in the workplace help the organizationto grow and prosper. It brings leadership, work cultureand literacy. Aside from doing the right thing, conductingourselves ethically has great rewards and returns. Beingethical is essential to fixing problems and improvingprocesses. It is needed to establish baseline measures andincrease efficiencies. Most importantly, it is essential tohaving strong working relationships with employees,allow for respect to be extended to each person withinthe organization, and promote customer relationshipsthat are based on honesty and integrity.

It is also imperative that ethics for a workplace should bedeveloped in such a way that the foundation of it willnever shake or succumb to the evils of devious minds.

SELF-REFLECTION

Let’s say that I believe that it isimportant to be an honestperson. What do I do when Imake an error at work? Do Iadmit it or do I cover my errorand hope that no one findsout? I may rationalize, “If I tellmy boss, he will bedisappointed in me. I may notget that raise that is comingup next month. There is noharm in not telling him.”

We humans tend to weigh thebenefits and consequences ofour actions and we look forthe path of least resistance,where we will suffer the

fewest consequences. When we are deciding what to dowith our error, we need to ask ourselves, “Do I really valuehonesty like I say I do? If I am willing to lie to cover up myerror, what am I really valuing?” When we lie to cover upour error, we are doing so to protect ourselves from theconsequences of our actions. So, what is the greater valueto us, honesty or self-protection?

The importance of being ethical must be even moreemphasized if you are a leader or a manager. Leadersmust always be cognizant of the fact that they are in a“fishbowl” and how they behave is clearly visible to others.Whatever they do will not only be seen by others, but maybe duplicated as well. So it is important that “walk the talk”rule should be followed.

ETHICS PROGRAM

Ethical guidelines, in the form of policies andpractices give employees the basic toolsthey need to take informed risks on behalfof their organizations. The real function of anethics program is to allow basically goodpeople to do the right thing and succeed.This is the essence of a healthy workenvironment because the top-qualitypeople you want to hire are those who arelooking for more than a job - they want tofeel good about their work and about theintegrity of the organization they work for.

Ethics programs and practices leads to havemore positive organizational outcomes, lessfrequently observed misconduct andgreater employee satisfaction. It has directimplications for sustaining a productivework environment, attracting and keepinggood employees, and maintainingcompany’s reputation among keystakeholders. It also tells employees thattheir company is heading in a positivedirection.

Workplace ethics set

the standard for right

and wrong, develop

ethical culture, making

policies more efficient

and the workplace

more orderly.


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OTHER ARTICLES

ETHICAL PRINCIPLES ARE THE NEED OF THE TIME

Workplace is one of the most important places in ourlives. We spend almost one-third to half of our life inworkplace, that too during the primetime of our lives,therefore, the atmosphere in the workplace has a directbearing on our health and happiness. Any chaotic anddiscordant workplace that does not follow any ethicalprinciples will be at the mercy of the whim and fancy ofits occupants. This is not only harmful to the workplacebut also reduces its efficiency.

Multi-cultured and multi-ethnic workplaces of 21stcentury makes the workplace more confusing andrequires charting out definite ethical principles that tendsto minimize, if not eliminate, friction amongst theworkforce and protect company’s assets. The diversity inthe workplace and the freedom of expression makes itnecessary to set boundaries that should not be crossedduring interpersonal behavior and the course of duty.Ideal ethical principles in the workplace must abide by

the organizational culture, strategic goals of theorganization, and value individual freedom and diversity.

WORKPLACE ETHICS PRINCIPLES

Irrespective of the working conditions, and the nature ofwork and workforce, some ethical principles must befollowed by every employee to enhance the workplaceharmony and in turn productivity. Some of them are:

w Integrity: Personal integrity of the employees isvery important and must be honored at any cost.

w Objectives: Clear understanding of Company’objectives by each employee and clarity in theirrole to achieve it.

w Responsibility: Every employee should have asclear sense of responsibility.

w Respect: It is evident that every employee shouldrespect seniors as well as subordinates and theirviews too.

w Professionalism: It should be shown by all at alllevels.

w Confidentiality: It is a prime responsibility ofevery employee to keep the confidentiality of thedata of the organization they are working for.

w Fairness: There must be fairness in every activityundertaken in the company. This fairness instills alot of confidence and belief among theemployees

w Openness: there must be freedom of expressionto everyone that will instill the sense ofbelongingness and worth among the employees.

w Equal employment opportunity: There must beno discrimination between male and female atthe time of hiring and during job at all levels.

w Behavior: A clear guidelines for interpersonalbehavior must be set and taught toemployees.

If important ethical principles in theworkplace are drawn, it benefits hugely tothe company not in terms of increasedproductivity but it will also make theworkplace more beautiful, harmonious andconducive to personal as well asorganization’s growth.

MANAGEMENT ACTION

In today’s highly competitive, performance-driven business climate, only ethicalprinciples/ regulations are not enough. Thereal test of these principles comes from theresulting action. It takes a determined,company-wide effort, beyond insertingthese words in an employee manual to makeit happen.

First, management must lead by example. Good ethicsshould be most noticeable at the top. Every employeemust be accountable to the same rules.

Second, a corporate values or ethics initiative must be"sold" and "marketed" aggressively throughout acompany. Every forum and medium should be used tospread the good message. Of course, it will only becredible if the company is practicing what it preaches.

Third, training must be provided to get everyone on thesame page. It's easy to ignore a motivational speech orpass by a poster, but spending time learning about theissues will have a lasting impact.

Fourth, both the employee and the company must be init for the long haul. The commitment to promote ethicsin the company should be extended to the nextgeneration of employees.

In the end, it’s all about beginning with our personal andcollective understanding of ethics. The focus on soundethics and the existence of the ethical management in theworkplace is an important way to ensure the long-termeffectiveness of governance structures and procedures,and avoid the need for whistle- blowing.


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Thinking of saving a trip to my physician and his fee whichis getting hefty everyday, I politely downloaded thesymptoms of my ailment to a fellow passenger whointroduced himself as a doctor and sought his opinion. Bygolly, I gasped when told that he was a veterinary andwould gladly take my questions on anything wrong withany of my pets.

I guess it must be easier learning about handling andaddressing corporate financial needs than personal ones.If not, why wouldn’t they teach you to be financiallyindependent at the time of retirement in this era ofunlimited spending venues, highly available plastic credit,high-inflation low-purchasing power and shrinkingearning opportunities.

As finance professionals and en route to becoming achartered accountant, one learns a lot about handlingand addressing corporate financial needs but in the endit remains for an average individual to create means forachieving personal and family financial goals over a life-time.

One crude reality of life is that as long as we live we needmoney at every step to take care of ourselves and ourdependants. Our spending patterns are life-long whereasour earning capacity is not.

For most of us, as salaried professionals, our earningsremain more or less constant after reaching a certainstage in career and comes to an end as we attainretirement age. How should one prepare to be financiallyindependent at the time of attaining retirement is an

individual question that requires an individual financialstrategy and its application, but at its root lies animportant question.

“Am I living within my means?” Quite rightly you may wellbe one of those prudent enough to pose this question toyourself regularly. However are you among those whoreally take the trouble of finding out if you are actuallyliving within your means?

If not, it is just about the right time to learn about yourown financial situation. Even if you very comfortableearning-wise, it still pays many times over not to fumbleon your way and to be six by six on this important aspectof life. For average blogs, it is very important for each oneof us to refresh and apply in life the discipline of living withinour means.

NET WORTH:

The best evidence of finding out if you are actually livingwithin your means is by putting it on a piece of paperwhat you own and what you owe. Whatever thedifference between the two is your networth.

Your networth may be positive or negative depending onyour earning and spending patterns.

Positive networth is the result of living within your means(savings in layman terms) which take the form of assetsyou own such as cash, local and foreign bank balance,amounts receivable from others, balance in yourprovident fund, investments in shares, certificate ofinvestments, saving deposits, house, motor vehicles, etc.

Money i sn ’ t eve r y th ing a s l ong a s you have enough o f i t . - Ma l co lm Fo rbes

Living within means!Altaf Noor Ali, ACA


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Do take a pencil and paper and prepare a list of assets.

You now need to prepare another list of amount owed toothers such as personal loans, company loans, amountsowed on credit cards etc. Sum up the list and you get thetotal amount of what you owe to others (liabilities, inaccounting terms).

What if your assets are exactly equal to liabilities, that is,the result of reducing assets from liabilities is exactly zero?Well, it simply means that the assets you have have beensponsored (or financed) with courtesy to your creditors.

Also, that e you have nothing to worry

If you are young, try to maintain maximum distancebetween your hands and your wallet, and only spendwhat you have in cash. Count your TOP TEN vices thatrequire constant finances. I will tell you what: quitsmoking cigarettes (without starting cigars), its good foryour heart, your wallet, and the environment; don’t worryabout the financial well-being of cardiologist, hospitalsare working on over 100% capacity, so good that you willnot be visiting any of them anytime sooner. Now you gofigure out the rest of the nine vices.

If your net worth figure is a positive figure, it is ‘an’indication of the fact that you have been living withinyour means. Your net worth figure represents the amountthat you have been able to save. Congratulations.However before thumping yourself take a good look inthe mirror and relate your net worth to your age to drawcorrect conclusions about its adequacy. In my view yournetworth is inverse to the number of hairs on your head.

More seriously, your net worth should be equal to five toten times of your yearly income by the retirement age.

Example:Mr. A wishes to have an income of Rs. 1,200,000per annum when he retires after few years. He expects theyearly return on national saving schemes to be around12% when he retires. These facts mean that at the time ofretirement the net worth of Mr. A must be atleast Rs. 10million so that he derieves his target income, if he decidesto convert his money in cash and keeps it in nsc.

If your net worth figure is negative or zero, welcome to ahuge club of individuals who would like to follow theadvice of living within their means but who need to bringin some discipline in their financial affairs.

Zero or negative networth is understandable for a youngperson who has only finished studies and started earning.However, for a person in his thirties low net worth shouldbe cause of concern whereas for a person in his fifties orabove, it can be a source of absolute financial insecurity.The underlying lesson is that the earlier you start savingand building your net worth the better it is.

IMPROVING NETWORTH:

There are three major strategies for improving your networth. The first is to earn more, the second is to reduceyour spending and the third is a combination of earningmore and spending less.

May be at this instant the most practical and result-oriented strategy for you is to reduce your spending.Afterall every rupee saved is more than a rupee earned, ifyou take the impact of the tax. Here is how to do it.

ELIMINATE EXPENSIVE DEBT: BE DEBT-FREE

Yes, I know that life is boring without having yourcreditors praying for your well-being and recovery of theamount owed; settle the amount and you won’t probablyhear from them ever. The regular visits your creditors payyou also strengthen the social fabric of a society, speciallywhen you are a defaulter. This is not only true for ourbeloved government but for us as well.

To bring some order in your financial house, your firstpriority should be to repay the money borrowed on highinterest rates. A sense of urgency on this front will reducethe outstanding amount with every repayment. Equallyimportant is that it will neutralise the high financialcharges that you have been incurring for ‘renting’ theseborrowed funds.

The piece of paper on which you wrote your assets andliabilities will also be handy in identifying the ones mostexpensive to keep and plump for a goodbye from ourfinancial life.

Our goal is to identify the funds that are costing us themost in terms of percentage so that we can repay themfirst to take the venom out of financial charges we pay.

Lovers with credit card as valentines can rightly expectthe balances outstanding on credit cards to featureprominently in the list for priority repayment.

You need to make yourself understand that any furtherincrease in the amount owed by you today will bring youeven more financial misrey tomorrow. If necessary, vowto ‘freeze’ the existing balance. Resist the temptation forreaching to your wallet and taking out your credit card atevery payment opportunity if they feature high on yourlist. You also need to focus your attention on how to bringthe outstanding amount to zero.

A basic method for computing monthly repayment figureis to take the total outstanding amount and divide it byconvenient number of installments. For example if Rs.100,000 is payable on your credit card, it can be dividedin installments of Rs. 10,000 each. It will take you atleastten months to repay the whole amount. The term ‘atleat’recognises that the outstanding balance will continue toattract financial charges but each repayment will result inlower financial charges in the next month. You must beaware that it will take you more than ten months to clearthe balance.

Once you repay the balance in full and make it a habit toclear the balance in full every month, you will find that acredit card statement appears to be at its best for a creditcard holder without debit balance from previous monthsand financial charges. I actuall know a person whoinvariably deposits more than the due amount on his


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card, to take care of his future purchases. His previousmonths’ balance is in credit rather than a debit balance(amount owed). Most people, however, dread the day thecard-statement arrives in the mail. They do not even feellike opening it. The note of caution here is that the blindlove affair with credit cards can be expensive and itsalways recommended that you remain loyal to only onecredit card at a time. Have the audacity to cancel the rest.

One of my friends, deep in debt at one point, on settlingit, as a matter of gratitude, has those expired cards framedand hanged them on the wall with the caption: “Rest inpeace, you look better here than in my wallet”.

Another option available to you to reduce your financialcharges is to be on a look out for replacing expensive debtwith a less expensive one. The balance transfer facilityoffered by various banks can be useful in replacing debtowed on credit cards.

The moral of above story is to start repaying high costloan immediately, and stop only after reducing yourliabilities significantly. If you devote some time inpreparing net worth statement at regular intervals, youwill find that your net worth will increase because ofreduced financial charges, all other things remaining thesame. In the end, the most recommended strategy for alltimes is to be debt-free.

AVOID UNPLANNED PURCHASES:

Soft purchases. How many times it happens that we goout to buy one thing and return with ten different things?It is not to say that those ‘extras’ were not required, butthe question is that if they were required so badlyhowcome you did not went out to purchase them in thefirst place?

The examples of above situations are buying groceries,eating out, buying clothes or going out. Have you evernoticed that we all end up paying almost double of whatwe initially estimate in our minds?

The point is that most of us have become slaves to ourneeds and harbor uncontrolled desire for immediategratification. In this age of communication, the fact is thatwe are so much bombarded with consumerism that weare literally seduced by marketing and create an artificialneed and that sure is the most indisciplined phase anindividual can get to. Also common is to find compulsiveshoppers who are restless till the pockets are empty.

The way out is to always prepare a list of items requiredwith quantities when going out for any kind of shoppingand then sticking to it. No big issue in adjusting thequantities but no purchases should be made withoutthinking about it carefully in advance.

There may be thousand other ways to economise on each

item of spending depending on situation but pausing towatch out everything coming with the word‘sale/discount/win a vacation, prize etc’ is not one of them.

The last point that I wish to emphasis is about ‘significantbut invisible’ spending like buying clothing accessories,stationery, birthday cards etc. By careful of spendingmoney on things which do not appear to be expensive inisolation but when you add them up they become‘sizeable’.

Mega and Major purchases. Its again a fact of life thateach one of us is involved in once in a lifetime financialpurchase like buying a new home or major purchases likea car, television, DVD, stereos, refrigerators, camcorders,cameras, computers or any other consumer product.

The suggested approach in such situations is to carefullyassess your needs and to think of options. If there is nooption but to buy, the best way is first to go out and seewhat is available. Internet is an emerging source of suchfact-finding. Even if you find what you are looking for, tryto defer purchasing it for a week. This one week acts as acooling period. After one week, if you are still forpurchasing it, then by all means go ahead and buy it.

The key principle here is to defer your major purchases tothe last extent possible. It should not be seen as denial ofsomething but as a process that eventually benefits you.Even better is that you share your approach in advancewith others involved in the decision, such as your spouseor children. Such understanding is critical and will saveyou from saying ‘what the heck, I can afford it!’ andrushing you into a decision which is a dangerouspretention. Patience is the key word in such decisions. Ifyou hear yourself making such statements often thenseriously consider to change the settings of decision tominimise undue pressure on yourself. If you don’t, you willprobably give in and regret one more wish of yours!

FINAL WORD:

Spending money is possibly easiest of things. One canalso ignore the importance of living within means andcontinue to earn from one hand and spend the same fromthe other, hoping to hit a treasure one fine day. On theother hand, those who accept the reality of life prepare tosynchronise earning capacity with spending pattern tosave something for rainy days.

By no means our advice is for anyone to be a miser.Throughout we have emphasised the need to improvethe quality of our spendings by being moderate andvigilant. It is possible to enjoy life within the confines ofits financial realities.


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As the global economy is struggling to get out of thecurrent recessionary cycle, it has become a challenge formost governments around the world to manage theirpublic finance either through increasing the revenues orby cutting expenditures. Since a major chunk ofgovernment’s revenue come in the form of direct taxes,which is squeezed due to dismal profitability ofcompanies thereby, forcing governments to increase taxincidents on individuals.

Pakistan is of no exception, the nation recently facedmassive dent due to unprecedented floods, which testedtheir emotional and economic strengths, where a vastmajority of them have succumbed to their adversities.While it is arguable to gauge government’s capacity towhether such eventuality in future, the tendency is clear,which is to pass on the burden to the population indespair. The very nature of the skewed tax structure of thecountry, with the tax base is languishing at only around 2million registered tax payers out of total masses of 170million, many with considerable incomes at their disposal,does not pay taxes, calls the salaried class to manage their

taxes legally. The overall tax incidence on salaried class ison the rise for quite some time as we have seen by theimposition of IDP taxes couple of years back and reducingthe threshold for maximum tax rate (20%) on salariedindividuals from Rs. 8.65 million to Rs. 4.55 million only inthe last budget.

Fortunately, Pakistani tax laws provide some reliefs in theform of tax credits and rebates, though their awarenessin the taxpayers remains low for host of reasons rangingfrom socio economic conditions to the general level ofapathy. If the tools for tax credit and rebates are effectivelyutilized, they can bring annual savings of more than Rs.360,000 (total tax saving for 20% tax slab) for a high tiersalaried individuals drawing in excess of Rs. 4.55 millionin annual salaries and other taxable benefits and morethan Rs.132,000 (total tax saving for 10% tax slab) forindividuals drawing an annual salary of around Rs. 1.2million.

The Finance Act, 2010 also removed the exemptionavailable on capital gains on listed securities including

Rahim Khakiani, ACA

Tax Savings throughInvestments……


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mutual funds, though there are avenues open tominimize / avoid its incidence. From pure legalisticperspective, section 37A has been inserted in the IncomeTax Ordinance, 2001 to make way for capital gains taxes.Through the income from this source is made taxableform the current financial year beginning from July 01,2010, their incidence has been kept low and only shortterm capital gains are being charged to tax currently. Asper the amendments in tax laws, persons realizingcapital gains with the holding period of less than6 months have to pay 10% on such gains, whilefor the holding period of between six monthsand one year, the same would be taxableat 7.5% on such gains and on holdingperiod beyond one year, the capitalgains are not taxable. The sametax principles are applicableon mutual funds, with theonly difference is thatthe tax on capitalgains on mutualfunds aresubject tobe withheldby assetmanagementcompanies. Anindividual, while filing his /her return of income for thatyear can adjust the lossesunder this head and determinetheir final tax liability. In case ofany unabsorbed losses under thishead, the same are not allowed tobe carried forward to thesubsequent years.

While the capital gains are madetaxable, there are many ways; onecan reduce / avoid its incidence byinvesting smartly. As by now we are aware thatcapital gains are treated as a separate block of income asdefined in the income tax laws and are subject tomaximum 10% on the gains, the tax incidence is still verylow considering the corporate tax rate of 35% andmaximum tax slab of 20% for the salaried individual. Inaddition, the holding period restrictions as explainedabove can be viewed as a blessing in disguise for thereason to make us disciplined in the manner andapproach, we save our money. It is pertinent to be saidwithout argument that a Systematic Investment Plan(SIP), whereby a reasonable portion of our incomes areparted every month for investment purposes serve as amaster key for most of investor profile types. Fortunately,many products based on mutual funds offer a SIP basedapproach for investment as per individual’s risk appetiteand investment goals. SIP on one hand gives us a stableaverage cost of investments by avoiding the unfavorablemarket timing to be entered into and on the other, doesprovide us the flexibility to withdraw money withouttaxes, provided that we are into this habit for quite sometime.

Despite the fact that there are inadequate state basedsocial safety nets for individuals, saving habits in Pakistanis not promising as evident from the low ratio of only 4.6%

of banking deposits invested into mutual funds, which isaround 11% in the neighboring India. One cannot deny

the fact that financial independence withadequate savings at hand can give relieffrom many miseries. Every year, weshould be asking ourselves: “Howmuch money we saved last year andwas that adequate enough to achieveour financial goals?” If we cannotanswer this question then we should

recognize that we are fallingbehind and therefore,

are at risk. It isunfortunate thatour money is lying

in bank accountsand does not recognize

the fact that over timemoney losses its value due to higherrate of inflation and that on anaverage banking deposits give areturn of only 5-10% per annum andon top of it, bank profits are taxableat 10%. Also many people due toreligious beliefs place their moneyin current accounts, which generallydoes not give any return and are at

greatest risk of depletion in value of moneyover time.

The Mutual Fund Industry, though still evolving inPakistan has come a long way by developing manyinnovative solutions to suit individual investors of bothconventional and shariah-compliant mindsets. A typicalmoney market fund, which normally invests around 70%in short term government papers, gives around12%annualized return without any restrictions on the holdingperiod, with less risk than a PLS banking account. A savvyindividual could easily distinguish the benefits ofinvesting in mutual funds as compared to placing fundsin bank accounts.

To emphasize the foregoing discussions on the taxcredits/rebates, capital gain taxes, SIP based investmentsand benefit of investing in mutual funds over bankdeposits, following illustration will make the case andclarifies the discussions.

ILLUSTRATION:

Mr. Hypothetical earns an annual salary of Rs. 1.2 million.Following is his other information:

w Age: 35 years.w Annual income: Rs. 1.2 million, growing @ 10% per

annum.w Annual expenditure: Rs. 0.84 million, growing @ 15%

per annum.w Current savings: Rs. 2 million, placed in a PLS Saving

Bank Account earning interest @ 8% per annum.w Annual donations to approved charitable

institutions: Rs. 0.05 million.

w Annual mark-up on house loan: Rs.0.30 million.


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Investment possibilities:

His risk profiling determines his asset allocation as follows:

* Weighted Average Return on Investments

His savings can be placed in bank deposits or in mutual funds and pension funds in accordance with his risk profileand financial planning can be done based on the following scenarios:

To conclude, we can say that adequate tax planning can do wonders to one’s overall financial planning and a SIP basedinvestment approach could serve as an icing on the cake. Life is full of eventualities and unforeseen adversities, sowhy do not we prepare an adequate plan for it. The key to success is to start early to help meet our financial goalsi.e.professional education and marriage of our children, old age sickness and retirement.

Documents

Pak Accountant July Sept2011