Ican Journal June 2011

Chartered
T h e
N e p a l
June 2011
Volume13 No4
Accountant
Journal of the Institute of Chartered Accountants of Nepal

Chartered
Accountant
T
(Quarterly Journal of The Institute of Chartered Accountants of Nepal)
CONTENTS
E d i t o r i a l
B o a r d
CA. Sunir Kumar Dhungel

CA. Sudarshan Raj Pandey
CA. Bishnu Prashad Bhandari
CA. Prakash Basyal
CA. Santosh Kumar Jha
CA. Prakriti Tuladhar
CA. Bikram Khadka
CA. Santosh Ghimire
RA. Kedar Nath Paudel
Mr. Binod Neupane
Chairman
Member
Editor
Member
Member
Member
Member
Member
Member
Secretary
Binaya Paudel
Editorial Support
Editorial
President's Message
Auditing Profession In Question
Revenue Recognition Customer Loyalty Program
11
Risk Management in Banks and Financial

Institutions (BFIs) A Challenge
13
Branch Offices
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Nepalese Banking Crisis Explained
16
Design, Layout & Printed by:

Format Printing Press Kathmandu, Nepal
Market Risks for the Banks and Financial

Institutions
21
Following Macro-Prudentialism
24
An Overview of Privatization in Nepal
26
The Institute of Chartered Accountants of Nepal,

Babar Mahal, P O Box 5289, Kathmandu, Nepal
Tel. No. 4269130, 4258569 Fax No. 4258568
E-mail: ican@ntc.net.np
Website: www.ican.org np
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(if received by self)
Opinions expressed by the contributors in this journal are their own

and do not necessarily represent the views of the Institute. Member
Bodies of Safa may quote or reprint any part of this Journal with due
acknowledgement. For others, solicitation is expected.
News
Trade Finance: Factoring & Forfaiting

Services
33
Preparing for 2012: A Journey to ifrs
38
Information System Audit- An Introduction 42
International Financial Reporting

Standards (ifrs) Certification Course
73
Member Service Department and

Professional Development Department
75
Understanding Asian Perspectives on

Leadership
44
Education Department
75
Successful Business Negotiation
51
Examination Department
76
International News
77
IFAC Update
78
Nepal Standard on Auditing 705

Modificationsto the Opinion in the
Independent Auditors Report
56
Editorial
IFRS and our preparation
Since the mid-year 2012 is knocking our door, its high time for accounting and auditing
professionals to be ready for complying with the commitments towards IFRS. Auditors as well
as preparers of the Financial Statements must be well aware in advance for challenges and
opportunities coming up with the implementation of IFRS. Looking over the contemporary
status, following recommendatory steps should be considered, wherein, the inputs from various
stakeholders are equally important.
The Institute of the Chartered Accountants of Nepal (ICAN) and Accounting Standard Board
(ASB), working together, should finalize the concrete plan for the implementation of IFRS.
Coordination of ICAN with Nepal Government for the necessary changes in law is quite
important. The role of Nepal Government and the Regulatory Bodies for IFRS implementation
is crucial and the same should be well defined in advance.
Identification and analysis of significant provisions of IFRS which has material implication
as per prevalent conditions of Nepal and dissemination of such provisions to the public, is
equally important. ICAN has to continue its lead role in this regard.
Intensive trainings, workshops and seminars are to be organized in order to make aware to
the members of the Institute about the IFRS provisions and their implications. Our institutes
certification course in coordination with the Institute of Chartered Accountants of India (ICAI)
is indeed a welcome step.
Auditors as well as preparers of Financial Statements should contribute for IFRS
implementation from their individual end. Relevant education and courses are additive.
Entities should try to make their accounting system more robust by analyzing the possible
impact of IFRS implementation and plan for it.
All professional colleagues, lets discuss in all forums about IFRS implementation and initiate for
the preparation and implementation of IFRS from the Fiscal Year 2012-13.
As this will be the last issue from the current editorial board, we would like to take this
opportunity to welcome the new editorial committee members and wish them all the best for the
year ahead.
Similarly, the editorial team would like to thank all the contributors of the articles, ICAN
staffs, printing press, advertising entities who supported us for the journal with their ideas and
information, without which we could not have been able to publish the journal.
Finally, we request the readers to provide timely feedback and suggestions so that we can
improve further and make our journal more educational and professional one in our upcoming
issues.
Editorial Board
Pr e si d e n t ' s M e s s age
Dear Colleagues,
First of all I would like to take this opportunity to thank vicepresident, council members, past presidents, coordinators and
members of all the committees, Nepal Government- specially
Ministry of Finance and Auditor General Office, all the staffs
of ICAN and everybody else who helped me in the successful
completion of my tenure as the President of the ICAN.
This year we organized the CPE training in various parts of
Nepal likeDhangadi, Nepalgunj, Narayanghat and Pokhara
besides Kathmandu with the aim to strengthen the professional
skills of members all over Nepal. During those trainings, we
also had the opportunity to organize interaction programs with
the members outside Kathmandu. Such interaction provided
platform to understand their needs, grievances and we also
shared the future plans and action plans of the Institute with
the members. At the same time, there was interaction program
with the local industrialists and business man which enabled
ICAN to spread the awareness on the significance and role of
accounting and auditing in the business environment. Also
focusing to the members in the mid western and far western
part of Nepal we have arranged for renewal of membership
and firms in their own place. For this, our few staffs will be
at Mahendra nagar, Nepalgunj and Dhangadi for certain days. I
am sure this facility will help the members at those parts to do
the renewals in time and also reduces the trouble of travelling
all the way to Kathmandu for the renewals. I request all the
members to use this opportunity and encourage such initiative
from our end so that we can expand such activities in future
too.
Student facilities are much elaborated with the attempts to
prepare and circulate more relevant and latest study materials.
More focus is put on maximizing the book pool in the Institute
Library so that maximum students can benefit from the same.
Recently, ICAN organized the Information System Audit (ISA)
Course and IFRS certification course under technical assistance
of ICAI for the interested members. The ISA was course entirely
based on the curriculum developed by ICAI for its members,
such technical cooperation from ICAI has to some extent
assured the recognition of our members by ICAI. Similarly the
IFRS certification course, inaugurated by the President of ICAI,
Mr. Amarjeet Chopra proved to be huge success. The entire
resource persons for the course were the esteemed delegates
from ICAI who were experts in their deliveries. We want to thank on

behalf of all participants to such technical assistance from ICAI and
look forward for same in future also.
I am glad to inform that your Institute in process of preparing a
handbook on the code of ethics for all its members which will be
ready soon for distribution. Also the same book will be published in
Nepali Language next year. I really want to thank the coordinator and
members of the Code of Conduct Committee for putting this together
for all of us. Similarly I also want to thank the entire Disciplinary
Committee for their endless efforts for successfully tackling the
complaints regarding the misconduct of the members. In my tenure
the committee judged and finalized 23 complaints.
My representation at various international platforms like IFAC meeting,
CAPA meeting and World Congress of Accountants organized in Malaysia
and SAFA Board meeting and SAFA Committees Meetings in Pakistan
and similarly CAPA meeting and IPSAS Conference in Korea will
undoubtedly ensure the role of ICAN at international arena and such
learning experiences will definitely add on the development plans and
improvements in the Institute.
The significance of the accounting and auditing professionals
totally depends upon the development, expansion and continuous
improvement of the accounting and auditing profession. So it is up
to us to maintain and boost the glory of profession with our ethical
approach and professionalism.
With the commitment that I will be always associated with the
development of this prestigious Institution, I want to thank all of you
once again.
Thanks a lot.
Sunir Kumar Dhungel

President
AUDITING
Auditing Profession In Question:
Need Redefinition or Explanation or Acting Ethically

CA. Nanda KishorE Sharma*
What the auditors do, what they say they are doing and what people understand about
what they do? The dilemma continues. The auditing profession, no doubt, is in a
critically important transition period, and a period of self examination. These quotes
can be seen in the headlines of the Worlds biggest Financial Magazines and Dailies now-adays. It is equally prevalent in the Nepalese context too. Then the big question is What
are the practices that are diluting audit quality and creating misunderstanding among the
stakeholders? This article tries to provide answers to these questions.
Background
It is interesting to know that despite
increasingly stringent legislation
aimed at combating fraud and
increased enforcement efforts by
regulators, the World, no matter
whether it is highly regulated
USA or scarcely regulated Nepal,
is hardly seeing any reduction in
the number of financial frauds.
Instead it is increasing by the day.
The issue that is coming under
scrutiny is the conduct of auditors,
who are entrusted to express their
opinion on the fair presentation
of the financial statements,
more prominently than the audit
committee, which is supposed
to maintain good governance
within the organization or the
management which is entrusted
with the responsibilities of designing
and implementing sound financial
management and internal control
system to prevent and detect error and fraud and

safeguard assets and sufficient disclosures in their
financial statements.
Why auditors and only the auditors are the first one to
be blamed for misstatement in financial statements or
their inability to report on financial frauds? Is it fair? It
is important to dwell into pertinent issues that surround
whole act of auditing and expectation there-form.
What is an Audit?
Audit, as per Oxford Dictionary, is an official inspection
of an organizations accounts, typically by an
independent body. It lacks why it is done but stresses on
independence of the act.
In fact, the word auditor has its origin in the Latin
word audire which means to hear. Thus, the word
auditor in Latin means the hearer. This refers that
at its inception, auditing is a process when a person
calling out the quantity of the merchandise from his
records during the cross checking and the other person
listen to that and check the actual physical quantity.
For a long time, the auditing profession remained a one
* Mr. Sharma is a Chairman of Nepal Auditing Standard Board.
AUDITING
to one cross check on the correctness (and not really

the fairness) of the financial statements and other
financial information.
With the increase in the volume and geographical
spread of trade and commerce throughout the world,
coupled with the socio-economic development of
the society, auditing as a profession also evolved and
found an irreplaceable stronghold in the society. This
compelled the owners to look for additional financial
resources from outside their pocket and entrusting the
funds in the hands of professionals to manage the same
properly and face the competition. This led to:
a) Divorce between managements and owners, and
b) Use of the Financial Statements by the potential
investors located on far corner of the earth (within
or outside country).
Thus, the obvious remoteness of the users of the
financial information from the source of generation of
such information made it inevitable that the financial
information shall carry utmost credibility and the audit
can provide this credibility of the financial information
and cement the ever vulnerable trust between the
management and the investors that exists due to
actual and prospective conflict of interest facing the
management in discharging their stewardship function.
Auditing is, therefore essential to protect the users
of the financial information, including the regulators,
government, from the economic consequences of using
the unreliable information.
However, there are certain myths or misunderstanding
of the society with respect to the roles and
responsibilities of an auditor. In our society, an audit is
still considered to be a guarantee as to the correctness
of the financial statements, efficiency and effectiveness
with which the management has managed the affairs of
the organization, and it is a guarantee as to the future
viability of the organization. This confusion has been
deeply rooted in the mind of all, including higher level
1
2
3
4
government officials and even some of the auditors,

because of the fact that:
a) Changing roles (or definition) of auditing has not
been well discussed and provided in any legislation,
including the Company Act, and
b) The term certification of financial statement has
been widely used in The Chartered Accountants
Act, 1997 (especially in Chapter 8) as the job to be
carried out by the auditor.
What are auditing standards?
Auditing standards, in a simplest way, are best practices
that an auditor uses in performance of its attest
function. Auditing standards are framed to ensure
probity, integrity and quality in the professionals work,
essential for ensuring the confidence of society in the
financial information being reported by the business
enterprises.
As per Preface to the Nepal Standards on Quality
Control, Auditing, Review, other assurance and related
services, Nepal Standards on Auditing (NSAs)1, Nepal
Standards on Review Engagement (NSREs)2, Nepal
Standards on Assurance Engagements (NSAEs)3 and Nepal
Standards on Related Services (NSRSs)4 are collectively
referred to as Nepal Standards on Auditing (Engagement
Standards). These standards are used by the auditor
depending upon the circumstances (need, purpose and
requirement) and the level of assurances expected
out of the auditors work. Thus, it should be borne in
mind that applicability of which standards depend upon
costs associated with the benefits derived from such an
exercise, i.e.:
Purpose (general or specific and level of assurance), and
Cost incurred by auditor in applying those standards.
According to the Glossary of Terms to the Auditing
and Assurance Standards, an assurance engagement
is an engagement in which a practitioner expresses
a conclusion designed to enhance the degree of
These are applied in the audit of historical financial statements

These are applied in the review of historical financial statements
These are applied in assurance engagements dealing with subject matter other than historical financial statement
These are applies to compilation engagements, engagements to apply agreed upon procedures to information and other related services
engagements, as specified by AuSB.
The Nepal Chartered Accountant | March 2011
AUDITING
As per Nepal Framework for Assurance Engagements, the nature of services, their comparative level of assurances
and report provided are as given below:
Auditing
Related Services
Nature of Service
Audit
Review
Agreed-upon procedures
Compilation
Level of assurance
provided
High, but not

absolute
Moderate
No
No
Report provided
Positive assurance
Negative
assurance
Factual findings of
procedures
Identification
of information
compiled
confidence of the intended users other than the

responsible party about the outcome of the evaluation
or measurement of a subject matter against a criteria.
Accordingly, two types of assurance engagements a
practitioner is permitted to perform are, i) a reasonable
assurance engagement5 and ii) a limited assurance
engagement6. Similarly, two types of related service
engagement a practitioner can perform without
providing any assurance report are, i) as per the
procedures prescribed by the engaging party and ii)
compilation of the financial statements as per the
prescribed reporting framework.
Need for redefining

Following critical facts were noticed during last year:
a) Most of the countries, including developed nations,
were facing difficulty in applying Auditing Standards
and Reporting Standards in engagements in all
types of entities, due to the costs associated with
applying those standards and the level of assurance
expected from such exercise (expressed in the
World Congress of Accountants held in Malaysia in
2010).
b) Audit reports issued for more than 30,000 schools
and 5,000 local bodies by the auditors after
preparing the financial statements themselves on
the basis of limited records available, and
c) A high level government official expressing his

dissatisfaction about the way financial statements
were certified by the auditor (without looking
into transactions with fake VAT invoices)
Following queations can be raised about what the
auditors do and what is expected of them, based on
above facts:
a) Is it necessary to apply full set of high level auditing
standards in all types of entity?
b) Can the cost of compliance with all relevant
auditing standards be compensated to the auditors
of local bodies and schools?
c) Can auditors of schools and local bodies apply all
auditing standards in a situation where internal
control system does not exist at all and accounts
are not maintained properly?
d) Is it the auditors only to be blamed for fake VAT
invoice transactions certification?
e) Do we really have understood the real meaning of
auditing and level of assurance it provides to
users due to its own inherent limitations?
Way forward
It is no doubt that the accountancy professions
reputation for being ethical has been called into
question many times. What I feel is that this is due to
couple of reasons, as cited below:
5 The objective of a reasonable assurance engagement is a reduction in assurance engagement risk to an acceptably low level in the
circumstances of engagement as the basis for positive form of expression of practitioners conclusion.
6 The objective of a limited assurance engagement is a reduction in assurance engagement risk to a level that is acceptable in the
circumstances of the engagement, but where that risk is greater than for a reasonable assurance engagement, as the basis for a negative
form of expression of the practitioners conclusion.
The Nepal Chartered Accountant | March 2011
There is lack of clarity of the meaning and purpose of

audit and available auditing standards, and
Confusion of the requirement for high level auditing and
costs associated with their compliances.
But it goes without mentioning here the provisions of
Section 151 of the Company Act, 20637 and Section 37 of
the Cooperative Act, 20488. It can be opined that every
penny of the public money spent must be audited and
we look for high level assurance of its fair presentation
in the financial statements. But, are we getting this
and are auditors complying with ethical requirements
or can they comply in full in the given situation? Of
course not. Thus, we shall do what can be done and use
available resources in fulfilling the requirement. Thus,
lets apply Compilation Engagement Standards (NSRS
4410) in Primary Schools and VDCs, Review Engagement

Standards (NSRE 2400) at District Level, full scope
auditing standards at National Level and auditing is
not a certifying activity but an assurance providing
activities based on the assessment and evaluation of
the controls and use of reporting framework by the
management of the entity.
ICAN in association with AuSB can organize awareness
activities regarding the auditing, its limitation and
application of various standards in carrying out
assurance engagements in the given circumstances.
ICAN shall also implement quality assurance process
(Peer Review) to enhance ethical compliance by its
members and credibility of the jobs carried out by
them.
7 Nepal government by way of notification in official gazette may exempt private limited companies with prescribe level of transactions from
complying with provision of Part: 8: Auditing.
8 Cooperatives shall get their account reviewed by the registrar or approved auditors within 3 months of expiry of the financial year.
10 The Nepal Chartered Accountant | March 2011
ACCOUNTING
"Revenue Recognition
- Customer Loyalty Program"
CA. Santosh Ghimire *
Background
Customer Loyalty Program (IFRIC
13) was issued by the International
Financial Reporting Interpretations
Committee (IFRIC) as an Interpretation
and accounting treatment for
recognition of revenue in case of
Loyalty scheme. Customer Loyalty
Schemes are used to give customers
incentives to buy goods or services.
Entities provide their customers with
incentives by providing awards credits
as a part of sales transaction. Examples
of customer loyalty schemes are airline
and hotel loyalty schemes and credit
card reward schemes.
Scheme may operate in different ways
for example;
Customer may be required to
accumulate a specified minimum
numbers(or value) of points, before
they can redeem them;
Points may be linked to the
individual purchases or groups of
purchases
The Scheme may be operated by
the supplier or third party
Awards may be goods or services
from the supplier and/or rights to
goods or services from a third party
Previously, the accounting treatments
of the loyalty programmes were
not consistent and many companies
used to treat the cost of redeeming
award credits or points as marketing expenses. For any

loyalty arrangements that fall within the scope of the
Interpretation, IFRIC 13 explicitly prohibits the treatment
of recognizing the full consideration received as revenue
at the time of initial sale.
Scope
All loyalty schemes may not fall under the scope of
loyalty program as per this interpretation. IFRIC 13
applies only when both of the following conditions are
met:
a. the entity grants award credits (or points) to its
customers as part of a sales transaction, i.e. a sale
of goods or rendering of services
b. subject to meeting any further qualifying conditions,
the customers can redeem the points in the future
for free or discounted goods or services
If a department stores grant customers one loyalty point
with every Rs. 1000 they spent on garments and they
can redeem the points for free garments then IFRIC 13
applies to the department. However, distribution of
money of vouchers or any sort of promotion that is
not linked with the sales transactions is not under the
scope of the IFRIC 13. Hence, the most important thing
is granting of awards as a part of sales transaction which
the customer can redeem in future.
Accounting treatment
IFRIC 13 requires entities to account for award credits
as a separately identifiable component of the sales
transaction(s) in which they are granted. The fair value
of the consideration received or receivable is allocated
between the award credits and the other components
of the sale. The consideration allocated to the award
credits is measured by reference to their fair value, i.e.
Mr.Ghimire holds a Diploma in IFRS from ACCA, UK and currently working with Ncell Private Limited.
The Nepal Chartered Accountant | March 2011 11
ACCOUNTING
the amount for which the award credits could be sold

separately.
a. Awards provided by supplier
If the entity supplies the awards itself, it recognizes
the consideration allocated to award credits as revenue
when award credits are redeemed and the entity fulfill
its obligations to supply awards. The amount of revenue
recognized is to be based on the number of award credits
that have been redeemed in exchange for awards in
relation to the total number expected to be redeemed.
Example: A department store has following loyalty
program as below;
a Customer who are member of the department store
are granted one point for every Rs. 1000 of purchase
b Members can redeem those points against future
purchases which is 100 points for Rs. 100 of value of
goods.
10,000 points were granted during the year. Management
expects that at least 8,000 points will be redeemed
eventually where as only 5000 points were redeemed
during the year end.
In the above case, Revenue allocated to the points
awarded is (10,000* 100/100) Rs. 10,000
recognizes this net amount as revenue when the third

party is obliged to supply the awards and entitled to
receive consideration for doing so.
If the entity is collecting the consideration on its own
account, i.e. acting as a principle, it measures its revenue
as the gross consideration allocated to the award credits
and recognizes the revenue when it fulfills its obligations in
respect of the awards.
Fair value of award credits

The Interpretation requires the consideration allocated to
award credits to be measured by reference to their fair
value the amount for which the award credits could be
sold separately.
If the fair value is not directly observable, it must be
estimated, e.g. by reference to the fair value of the
awards for which they could be redeemed.
That fair value is adjusted to take into account the fair
value of awards that would be offered to customers
who have not earned award credits from an initial sales
transaction and the proportion of the award credits
expected to be redeemed.
If there is a range of awards from which customers
may choose, the fair value of the award credits will
reflect the fair values of the range of available awards,
weighted in proportion to the frequency with which
each award is expected to be selected.
To be recognized during the year (5000/8000*10,000)

Rs. 6,250

--------------- IFRIC-13 in Nepalese context
Nepal is in dire need for professionals on IFRS as it is
Deferred Revenue Rs. 3,750

==========
moving towards the convergence of IFRS very shortly.
Further, there is no accounting standard in place that
B. Awards provided by third party
resembles the accounting treatment on Customer Loyalty
It may so happen that a third party supplies the awards,
Program and hence, there can be a significance implication
in such case the entity is required to assess whether it
on revenue recognition and reporting after complying the
is collecting the consideration allocated to the award
IFRIC-13. Following are the few steps that can be done
credits on its own account or on behalf of the third party. in advance to avoid the surprises from the application of
In other words, it must assess whether it is acting as
IFRIC-13.
principal in the transaction or as an agent for the third
party.
Identification of Customer Loyalty Scheme in practice
Analyzing the scope of IFRIC-13 and find out if they are
Acting as an agent i.e. if the entity is collecting the
within the scope
consideration on behalf of the third party, an entity must Review of accounting treatment as per existing
measures its revenue as the net amount retained
practice and as per IFRS
on its own account, i.e. the difference between the
Analyzing the implication on revenue recognition
consideration allocated to the award credits and the Analysis of the overall impact on the particular Industry
amount payable to the third party for supplying the
in advance.
awards; and
banking
"Risk Management in Banks and Financial

Institutions (BFIs) - A challenge"
CA. PRATIGYA PANDEY*
Background
Risk Management
Recent failures of Nepal Share

Markets Finance Ltd and Peoples
Finance Limited have come as
a rude awakening to Nepalese
financial sectors and consumers.
Nepal Rastra Bank, Banks and
Other Financial Institutions along
with retail consumers have found
important space in news and media
since the past few months. Nepalese
economy, which was believed to be
unaffected by global economic crisis
of 2009, is experiencing the same
phenomenon today. The crisis in the
case of Nepal was led by uneven
and artificial boom of real estate
sector and capital market, which
gradually started to slow down
due to tightening of loans to those
sectors by the banks and financial
institution in response to Nepal
Rastra Banks new regulations.
Eventually NRB started to blame
the crisis as arising out of poor risk
management by banks and financial
institutions. Now the question arises
what led to the so called financial
crisis? Why was the crisis not
forecasted? Where did banks, NRB
or Government failed to manage
risk?
All the financial institutions face different types of

risks which may have adverse effects on business.
Risk taking is an inherent element in banking business
and, profits are the rewards for successful risk taking.
Hence, risk and profit has a positive correlation. But, on
the other hand, poorly managed risk may lead to huge
cost to the banks which in fact may lead to bankruptcy.
Furthermore, poorly managed risks also endanger the
safety of the banks depositors. Risks are considered
warranted when they are understandable, measurable,
controllable and within a banks capacity to readily
withstand adverse results. Sound risk management
systems enable banks to take risks knowingly, and
reduce risks where appropriate and strive to prepare for
a future, which by its nature cannot be predicted.
Possible Causes
The major cause behind the crisis has been a hotly
debated issue. Is the crisis the outcome of liquidity
crisis or it is something more than just a liquidity crisis?
It is a very complex question as no single cause is solely
responsible for current crisis. Rather, it is the outcome
of combination of various components, which was not
properly, addressed by banks themselves as well as by
the regulators and the government. In other terms,
we may call this a result of poor risk management in
banking system.
In laymans term, the current crisis may be the outcome
of following few elements. The below mentioned causes
* Ms. Pandey is a CA member of ICAN.
banking
are illustrative list of causes. They need to be taken as

inclusive and not exhaustive list of examples:
i. High expectation of investors, managers

Few years back, financial sector was the most lucrative
investment venture which infact led to mushrooming of
banks in a small economy like Nepal. Even the regulator,
Nepal Rastra Bank issued license to many banks and
financial institutions without properly examining the
needs and without proper justifications. Instead NRB
should have focused on increasing the number of
branch access all over the country, of the then existing
financial institutions, rather than providing operating
license to a large number of financial institutions.
With easy access to the most lucrative sector, the
investors started to dream radical returns from
the investment made in banks and other financial
institutions. The investors should have realized that, as
in most investments, there will not be any immediate
significant returns even in the most lucrative sector.
This did not happen and hence, high expectation led to
the profit centered business, which actually shadowed
the risk management and long term sustainability.
ii. Stiff competition leading the business mal

practices.
High expectation of investors coupled with rapid
growth of banks and financial institutions, playing
in a constricted 600 billion market led to unhealthy
competitions which in turn lead to increasing cost of
deposits. The increasing cost of deposits then led to
massive increments in the interest rates of loans and
advances, which eventually led to money becoming
too scarce. The combination of all these then led to
defaults in loan repayments later on.
iii. Poor Corporate Governance.

Corporate governance has always been a major
issue, especially in institutions which have failed. As
majority of the institutions failure has resulted from
misappropriation of banks fund by the BOD and the top
management.
iv. Assets and Liabilities maturities mismatch

(poor balance sheet management)
Banks are the intermediaries, who collect the deposits
from the public, and provide that fund to people who
need money for business ventures, projects etc. The

shareholders have only 10-15% share of resources.
Therefore, the depositors money should be distributed
in such a manner that when the depositors come to
claim their savings, banks should be able to generate
funds from their assets and pay back to the depositors.
Technically, assets liabilities maturities need to be
balanced so that banks do not face liquidity problem.
However, in reality proper management of assets
liabilities maturities is difficult, the gap created thus,
leads to liquidity problem. Normally, negative gap in
short term liabilities are experienced more. In other
words, long term assets are acquired by short term
funds. The current situation of banks and financial
institutions is the same. Their funds are blocked in
long terms assets like real estate loans, which is not
realizing cash these days.
v. Business Concentration
Another cause of the crisis is the business
concentrations on both sides of balance sheet viz.
deposit and lending concentrations. It is required
that banks resources and utilizations are diversified in
such a manner that failure of one component, sector
of economy, has less affect on the banking business.
Current real estate collapse is the centre of financial
crisis. It is believed that out of total lending of
commercial banks, 25% of total loans have been made
to the real estate sectors. When the situation was good,
real estate sector was the most profitable sector for
the banks. But, as of now, the scenario is completely
negative. Real Estate loans have become the biggest
headache for banks, leading to losses and defaults.
Similarly, prior to real estate loans, loans against
shares also held significant lending portfolio of banks,
which was also highly profitable for banks as long as
the investors served interest. However, Nepal Rastra
Banks decision last year to tighten loans against shares
affected the stock market and the banking sectors
performance.
vi. Illiquid Market

Whenever an institution fails, liquidity becomes the
main reason. It is well said that no institution is closed
only due to losses because losses arises from business
cycle, and are reversible over a period of time.
However, if there is a liquidity problem, survival of an
banking
institution becomes very difficult. Liquidity problem

may arise due to combination of various risks leading
to loss of faith of public. Current liquidity problem,
in Nepalese economy, is said to be due to massive
investment in overvalued real estate sectors and the
tightening policies of NRB in the sector. Likewise,
troubled stock market was also one of the reasons for
liquidity crisis. Liquidity crisis was also started due
to non-issue of government budget spending in time,
enactment of Anti Money Laundering Act requiring
disclosure of source of income in deposits, real estate
transactions etc. There is also opinion that funds are
going out of Nepal as capital flight.
Lesson Learnt
With this onset of financial crisis, we should be able to
accept the fact that Corporate Governance should be
given priority, and it should be understood that financial
indiscipline invites crisis sooner or later.
Besides, it should be understood that, excessive
concentration in a particular sector is risky even though
that sector is highly profitable. Portfolio should be
manageable and inherent risk in the portfolio should
be addressed all times. The real estate boom and even
the stock market boom in Nepal were always taken as
artificial and almost everyone used to predict that real
estate will fail. But nobody knew, when? Finally, we
have witnessed the bitter failure.
We have also experienced constructive inspections

and reviews by Nepal Rastra Banks these days. Nepal
Rastra Bank has issued Risk Management Guideline
2010 in order to simplify risk management practices
in banks. Besides, off site monitoring and onsite
inspection by Nepal Rastr Bank has also been effective
these days which is a very good sign so as to prevent
financial failures. Lets be positive for the better risk
management in banks in the days to come.
Conclusion
Failure teaches a lot. Our system has started to witness
outcome of financial indiscipline. Now, time has
come to accept the reality and realize that we are in
trouble. Blaming to each other especially Nepal Rastra
Bank to Banks and Banks to the Nepal Rastra Bank and
government is not the solution. Boom and financial
slow down are part of business cycle which tend to
repeat in years. However, the most important thing is
to be ready and prepared for the possible problem. Risk
Management is only one solution to this. Timely review
and inspection by Nepal Rastra Bank, self management
of the risks by the bank management itself are felt
desperately.
Risk Management is actually

necessary
Recent failures of financial system have forced all
the financial players to realize the truth that risk
management is actually a crucial element. Central
bank, financial institutions and government should now
be proactive rather than reactive and experimental.
Here are some of the some of the simple ways of
managing risk:
- Follow Corporate Governance Norms
- Diversification of risk assets portfolio
- Proper internal control
- Proactive top management
- Proper management information system
- Mergers and Consolidation of Financial Institutions
banking
Nepalese banking crisis explained

Chandan Sapkota*
Nepal has been struggling to maintain

macroeconomic balance for a couple
of years now. Low growth rate, high
unemployment, balance of payments
deficit, ballooning trade deficit, and
high and sticky inflation are some of
the pressing existing macroeconomic
challenges. Now, add to that list
banking and liquidity crises
engendered largely by the bank and
financial institutions (BFIs) themselves
and to some extent by Nepal Rastra
Bank (NRB), the central bankand its
disastrous consequences in and beyond
the banking system.
The NRB ignored the unhealthy
competition, questionable lending
to few sectors, and governance in
financial sector. In doing so it let new
BFIs pop up without even evaluating if
the economy needs so many of them,
and took damage control measures
of late. Meanwhile, the BFIs engaged
in unhealthy and imprudent lending
out of desperation to survive amidst
cutthroat competition, which is getting
nasty by the day. The BFIs inability to
effectively cope with the pressure to
increase deposit and lending, and to
attain unsustainable profit targets is
leading to a situation where all profits
are private but losses are social, i.e.
taxpayers pay the cost of reckless
business practices of the BFIs in the
form of expensive rescue packages.
Without deep structural changes in the banking

industry, Nepal will see many Northern Rock moments
and eventually a disastrous Lehman moment as well.
The tendency to seek short term, quick returns against
long term viability and sustainability is leading the BFIs
in a path of self-destruction. For a healthy banking
industry, Nepal needs fewer but stronger BFIs with
sound corporate governance. Furthermore, there has
to be an enhancement of regulatory and supervisory
capabilities of NRB. The playing field has gotten
unnecessarily congested amidst less than proportionate
growth rate in the number of depositors vis--vis BFIs.
Northern Rock and Lehman moments

When Vibor Bikas Bank (VBB) knocked on the doors
of Nepal Rastra Bank (NRB) on June 9, 2011 to either
inject money in the development bank or to take over
management, it rattled the banking industry and the
already suspicious depositors. There were rumors and
anticipation that due to excessive loan exposure to
real estate, housing and construction sectors bank and
financial institutions (BFIs) will land in the red sooner or
later (Sharma, 2011).
The sudden move by Vibor made depositors panic and
policymakers scurry to find a way to avert a Lehman
momentthe day when US investment bank Lehman
Brothers collapsed (September 15, 2008) and triggered
the global financial crisis that was ensued by the global
economic crisis. In Nepals banking history, the rescue
of Vibor is a Northern Rock momentthe day when the
Bank of England extended emergency financial support
to the troubled mortgage lender on September 17, 2007
and saved it from collapsing.
* Mr. Sapkota is a researcher at South Asia Watch on Trade, Economics and Environment (SAWTEE), Kathmandu
banking
Brief history of BFIs growth

The initiation of formal banking system in Nepal
commenced with the establishment in 1937 of Nepal
Bank Limited (NBL), the first Nepalese commercial
bank. The countrys central bank, Nepal Rastra Bank
(NRB) was established in 1956 by an Act of 1955,
after nearly two decades of NBLs existence. A decade
after the establishment of NRB, Rastriya Banijya Bank
(RBB), a commercial bank under the ownership of
the Government of Nepal was established. After the
financial liberalization in the 80s, a third commercial
bank in Nepal, or the first foreign joint venture bank,
was set up as Nepal Arab Bank Ltd (now NABIL Bank
Ltd) in 1984. Following this, two foreign joint venture
banks, Nepal Indosuez Bank Ltd (now Nepal Investment
Bank) and Nepal Grindlays Bank Ltd (now Standard
Chartered Bank Nepal Ltd) were established in 1986
and 1987 respectively.
In 1983 and 1993 there were two and eight commercial
banks respectively. By January 2006, there were 17,
including joint ventures. There were 4 development
banks in 1993, which swelled to 29 in 2006. Finance
companies came into existence in 1992 and by January
2006, they numbered 63.
Figure 1: Number of BFIs in Nepal, 1980-2010
of the past decade.
Status of BFIs
As of mid-July 2010, total assets and total deposits
in banking sector amounted Rs 996.1 billion and Rs
795.3 billion respectively. The total loans amounted
to Rs 622.6 billion. The market share of total deposits
of commercial banks has declined from 85.6% in midJuly 2008 to 79.4% in mid-July 2010, when the share
of development banks, finance companies, and other
BFIs was 9.7%, 10% and 0.9% respectively (Ministry of
Finance, 2011). In the last three years, there has been
a slight decrease in deposits in commercial bank but
increase in development banks and finance companies
(see Figure 2).
Meanwhile, of the total loans, commercial banks
market share has declined from 78.6% in mid-July 2008
to 74.2% in mid-July 2010. During the same period,
the share of total loans of development banks, finance
companies and other BFIs was 10.6%, 12.8% and 2.4%
respectively.
As of April 2011, NRB data shows that the total deposits
at commercial banks stand at around Rs 642 billion. Of
the total commercial banks deposits, demand deposits,
savings deposits, and fixed deposits stand at 12%, 36%,
and 52% respectively. They have liquid funds of Rs 114
billion (cash in hand Rs 16.2 billion, and deposits with
NRB Rs 39.3 billion). More than Rs 110 billion is invested
in real estate by the commercial banks alone. Over 72%
of commercial banks credit flows against fixed assets.
Figure 2: Market share of total deposit and lending (%),
mid-July 2010
Source: Authors compilation using Bank and Financial

Statistics 2010 and Economic Survey 2010/11
Currently, there are over 308 BFIs, including 31
commercial banks, 87 development banks, 80 finance
companies, and 21 microfinance institutions.
The growth in number of BFIs is unprecedented and not
warranted by the economic and banking fundamentals
banking
Meanwhile, the BFIs sanctioned easy loans to real estate

and housing sector borrowers without assessing their
capacity to honor interest and principal payments in
time. It led to rapid rise in demand for real estate and
housing construction in urban areas and an escalation of
its prices. When the abnormally high prices started to
fall, the borrowers were unable to pay back interest and
principal in time, leading to a shortfall of liquidity in the
banking industry.
Source: Economic Survey 2010/11

As a share of gross domestic product (GDP), total
deposit, total credit (including claims on government)
and private sector credit are 51%, 54.9% and 43.6%,
respectively (Nepal Rastra Bank, 2011). Per person
deposit as of mid-April 2011 was Rs 20,100 and per
person loan was Rs 19,000 (Ministry of Finance, 2011).
Commercial banks deposit interest rate ranges from
2-12% and loans 7-18%. Interbank lending rate ranges
between 10 to 14%. Right now, the interest spread,
which is the difference between lending and deposit
rates, is also high. The wider it is, the more worrisome
the state of BFIs. Likewise, the high inter-bank rate
shows that the banks themselves are reluctant to lend
money to each other. Some of the BFIs are yet to meet
the revised capital adequacy ratio, which is the ratio of
a banks capital to its risks, laid out by the NRB, keeping
in mind their increasing vulnerability to excessive loan
exposure to just a few sectors (Nepal Rastra Bank,
2010b).
Banking troubles simplified
Simultaneously, category B, C and D1 BFIs were finding it

hard to borrow more from category A BFIs because the
inter-bank lending rate was almost above the average
of BFIs normal lending rates. Worse, some BFIs have
prepared a negative list to not lend money to BFIs which
they think are on the verge of collapse. The liquidity
crunch was, to a minor extent, also compounded by
the governments inability to mobilize development
expenditure, the big institutional depositors decision
to pull out mature deposits from fledging BFIs, and a
slowdown in deposits growth rate.
The combined effect of all these factors hit hard banks
such as Vibor that had substantial loan exposure to few
sectors, compelling them to seek NRBs intervention. In
effect, there is a serious erosion of confidence on the
banking system, and a surge in demand for commodities
like gold and silver.
Two bubbles
By overlooking the need for having a limited number
of BFIs, the evolving depositor base, and financial
penetration over the years, the NRB let too many BFIs
to pop up. It created a BFI bubble. This was followed
by intense competition of not only between banks in
the same category but also between BFIs in different
categories, leading to an informal war in offering high
deposit rates and lending without differentiating markets,
products, and borrowers creditworthiness. It reflected
bad corporate governance, and a lack of innovation and
R&D in the sector. The resulting lending surge in real
estate and housing markets unnaturally swelled their
prices, leading to a real estate and housing bubble.
Without a proportional increase in depositor base

and diversification of investment portfolios, the
unnatural growth in the number of BFIs led to cutthroat
competition in enticing depositors (institutional,
government and individual) and borrowers. Buoyed by
rising remittances, the former were incentivized to
Causes of liquidity and banking crises
deposit cash at high interest rates rather than looking for
There have been misleading and incongruous arguments
alternative sources of investment, which is lacking right
floating around about the causes of the ongoing liquidity
now due to political instability and various non-economic
and banking crisis. They are made by stakeholders who
constraints.
1 Category A, B, C and D means commercial bank, development bank, finance companies, and micro-finance development banks.
banking
fail to see how their vested interest and incompetence

is jeopardizing the future of the banking industry, and is
potentially derailing an already unstable economy.
First, bankers and businessmen are arguing that delayed
budget and disbursement of development expenditures
are causing liquidity crisis. This argument does not hold
much water. It is true that budgets have been coming out
late for two years now, and there has not been normal
flow of money from the Ministry of Finance and other
Ministries to the respective corners of the country via
BFIs. This has definitely limited liquidity in the banking
system. But it in itself is not the main cause. Instead,
it is a minor stimulant to the liquidity crisis. If delay in
development expenditure is the cause, then why did
Nepal not have liquidity crisis when similar episodes
occurred in the past?
Second, the withdrawal of large amount of money by
institutional depositors, especially NRB and Nepal Army,
has drastically reduced reserves in BFIs, especially
category B and C, vaults and squeezed available liquidity.
This again is a stimulant to the liquidity problem, not its
main cause. If just by pulling out a few millions of mature
deposits by institutional depositors puts the BFIs in
trouble, then there is something wrong with the way they
are doing business. It points to bankers incompetence
and inability to run BFIs.
Third, while some argue that people are either stashing
money at home or are investing in commodities like gold
and silver, others assert that the compulsion to divulge
source of income on transactions above Rs 1 million is
restricting deposits. Again, both are not the real causes,
but stimulant to the liquidity crisis. These arguments
are trumpeted by certain businessmen who are afraid of
divulging their sources of income and dutifully pay taxes
to the government.
Fourth, some argue that a decline in reserves, precisely
monetary base (which is equal to currency in circulation
and reserves of banks held in central bank), due to a
slowdown in growth of remittances, led to a situation
where credit growth was higher than deposit growth.
They assert that it is resulting in a liquidity crisis, and
to return to normal, the NRB should purchase bonds
and treasury bills and lower cash reserve ratio and the
already high capital requirements (all of which will help
increase liquidity). Of all the arguments, this holds some
truth. But increasing liquidity without correcting the

distorted market would only postpone the inevitable.
The main cause is that Nepal has too many BFIs catering
to too few customers (note that a 2006 study on financial
penetration shows that only 26 percent of households
in Nepal have bank accounts (Ferrari, Jaffrin, & Raj,
2006)), meaning that in order to survive and meet
ever-increasing profit targets, the BFIs have to have
constant flow of money from all sources, that also in
higher proportion than previous flows. The competition
to attract deposits and give out loans intensified with
the increase in the number of BFIs, who competed
without much product and market differentiation.
Without considering total deposits and their ability to
fulfill demand for withdrawls, the BFIs lent unsustainable
amount of loans to earn quick returns to meet profit
target before the annual general meeting of shareholders
and directors. This translated into real estate and
housing sectors bubble, which sucked in as much as Rs
110 billion of commercial banks deposit.
Buoyed by easy finance and loans, real estate
transactions and housing complexes rose rapidly.
Sometimes artificial demand was created just to jack
up prices. This is evident from the fact that our shaky
economic fundamentals do not justify multifold increase
in land prices in a matter of days. Moreover, money is
pumped into this sector without properly assessing risks
and the ability of borrowers to repay loans. The BFIs are
hardly distinguishing between normal and subnormal
loans. There is little product and market differentiation.
This was assuaged by NRBs easy monetary policy,
lax supervision (by near-retiring officials who had
expectations of moving into private sector banking) and
inflow of remittances, which is approximately one-fourth
of GDP right now.
This created market disequilibrium, i.e. the supply of
real estate and housing complexes outstripped demand,
leading to decline in prices by as much as 30 percent. As
prices dipped, borrowers are and will be unable to honor
principal and interest payments on time, forcing the BFIs
to restructure loans and variably increase lending rates.
This in turn led to and is leading to buyers canceling
bookings even after paying the minimum required
down payment. Soon the major urban centers will see
ghost apartments, i.e. empty apartments waiting for
customers to either buy or rent them. This will ultimately
banking
hit the BFIs even harder unless it goes fundamental

restructuring and consolidation.
Were we warned?
Many financial and economic analysts failed to perceive
the rapid changes happening in the banking sector.
Similarly, business journalists utterly failed to even read
clues of troubles starting more than a decade ago when
the now liquidated Nepal Development Bank (NDB) was
put under management review, and when the number of
BFIs increased multifold in a matter of just five years.2
It might be unsurprising because a majority of business
journalists in Nepal do not actually have training in
economics and business. They take on-the-job training
on business reporting and are behind the curve in
fathoming the economic fundamentals and troubles.
That being said, some observers, journalists, analysts,
and bankers did perceive the looming crises. The
warning bell rang when the issue of willful defaulters
and excessive non-performing loans of BFIs popped up
in 2006.
Moving forward
The NRB cannot afford to play such a cat-and-mouse
game each time the BFIs irresponsibly increase credit
without assessing the creditworthiness of borrowers and
their deposit growth.
The repeated introduction of refinancing facilities will
not resolve the recurrent problem. It will only defer the
inevitable restructuring of the entire banking sector.
Meanwhile, one way or the other, the cost of such
refinancing facilities will have to be paid by taxpayers.
It is tantamount to bailing out troubled BFIs who got
into the mess due to their own incompetence, not due
to the publics desire to withdraw deposits and invest
in commodities like gold and silver, and durables. There
is a problem of moral hazard in the BFIs, i.e. they are
recklessly lending to earn quick profits and by knowing
that if they go belly up, the government will bail them
out.
For the short term, the NRB should use all its tools
to increase liquidity so that anxious depositors are
calmed down. This should be followed by concrete

steps to consolidate our banking system. The Nepali
banking industry has to go back to oligopoly, which is
characterized by few banks but many depositors and
borrowers market structure, if things are to get normal.
International financial experience shows that few and
strong BFIs with tight supervision lead to a less crisis
prone financial system (Allen, 2011). Few but strong
BFIs with tight supervision would lead to reduction in
operating expenses, healthy competition, economics of
scale and innovation in the banking industry.
For a long term solution, Nepal should have something
like a Troubled BFI Relief Program. It could be a
powerful body within NRB whose main purpose would
be to rescue and restructure troubled BFIs so that the
problem is not systemic, and depositors are not induced
to run on BFIs. It could be given the authority to sell
assets, change management, force merger or acquisition,
and hold the majority of shares of troubled BFIs until
they return to a healthy state. It would consolidate
the banking sector, and potentially lead to fewer but
healthier BFIs that are innovative in providing services to
the public, and also not take excessive risks to derail the
entire economy.
If troubled BFIs seek help from the NRB or the
government, then they should be directed to use the
facilities provided through this program. When they do,
they should be forced to undergo structural changes.
The program could have authority to sell assets, change
management, force merger or acquisition, and hold
majority of shares until it returns to a healthy state,
among other measures after the BFIs knock on its doors
for assistance.
A program like this one is needed because the NRB cannot
simply extend loans and refinancing facilities at the
expense of taxpayers money and by increasing money
supply each time BFIs get into trouble. Meanwhile, the
BFIs also cannot inflict damage to third party due to their
own shortcomings. This could be a permanent solution to
the recurring problem. It should last as long as the BFIs
and banking system are not cleaned. Later on it could be
given more teeth such as supervisory or advisory role in
fine-tuning of banking sector.
2 See Sapkota, 2009a; Sapkota, 2009b; Sapkota, 2011; Sapkota, 2007 for further discussion on the developments in the banking industry.
banking
Market risks for the Banks and

Financial Institutions
CA. TULASI RAJ RISAL*
Market risk is broadly defined as the

volatility in the economic value of or
in the income derived from, the banks
positions due to movement in market
prices .It includes interest rate risk,
spread risk, FX risk, funding liquidity
risk, asset liquidity risk and equity
risk. It is one of the parts of financial
risk that comprises of Market risk and
Credit risk. The banks objective is to
limit and control those risks as much as
possible. Components of market risk
are as hereunder
Interest rate risk:

Interest rate risk is the volatility in the
economic value of, or in the income
derived from, the bank's positions
due to adverse movements in market
yields or the term structure of interest
rates. Exposure to interest rate risk
occurs due to differences in repricing
and maturity characteristics of the
different asset, liability and hedge
instruments.
In measuring and managing interest
rate risk, the bank refers to the
relevant key principles of the Basel
Committee on Banking Supervision
(BCBS). According to BCBS', the main
sources of interest rate risk are:
Repricing risk. Banks As financial intermediaries,

encounter interest rate risk in several ways. The
primary and most often discussed form of interest
rate risk arises from differences in the maturity (for
fixed rate) and repricing (for floating rate) of bank
assets, liabilities and off balance-sheet positions
(OBS). While such repricing mismatches are
fundamental to the business of banking, they can
expose a bank's income and underlying economic
value to unanticipated fluctuations as interest rates
vary. For instance, a bank that funded a long-term
fixed rate loan with a short-term deposit could face
a decline in both the future income arising from the
position and its underlying value if interest rates
increase. These declines arise because the cash
flows on the bank are fixed over its lifetime, while
the interest paid on the funding is variable, and
increases after the short-term deposit mature".
Yield curve risk. "Repricing mismatches can also
expose a bank to changes in the slope and shape
of the yield curve. Yield curve risk arises when
unanticipated shifts of the yield curve have adverse
effects on a bank's income or underlying economic
value. For instance, the underlying economic value
of a long position in 10-year government bonds
hedged by a short position in 5-year government
notes could decline sharply if the yield curve
steepens, even if the position is hedged against
parallel movements in the yield curve".
Basis risk. "Another important source of interest
rate risk (commonly referred to as basis risk) arises
from imperfect correlation in the adjustment of
* Mr. Rijal is a CA member of ICAN.
banking
the rates earned and paid on different instruments

with otherwise similar repricing characteristics.
When interest rates change, these differences can
give rise to unexpected changes in the cash flows
and earnings spread between assets, liabilities and
OBS instruments of similar maturities or repricing
frequencies. For example, a strategy of funding a
one-year loan that reprices monthly based on the
one month US Treasury Bill rate, with a one-year
deposit that reprices monthly based on one month
LIBOR, exposes the institution to the risk that the
spread between the two index rates may change
unexpectedly".
Optionality. "An additional and increasingly
important source of interest rate risk arises from
the options embedded in many bank assets,
liabilities and OBS portfolios. While banks use
exchange-traded and OTCoptions in both trading
and non-trading accounts, instruments with
embedded options are generally mort important in
non-trading activities. They include various types
of bonds and notes with call or put provisions,
loans which give borrowers the right to prepay
balances, and various types of non-maturity
deposit instruments which give depositors the
right to withdraw funds at any time, often without
any penalties. If not adequately managed, the
asymmetrical payoff characteristics of instruments
with optionality features can pose significant risk
particularly to those who sell them, since the
options held, both explicit and embedded, are
generally exercised to the advantage of the holder
and the disadvantage of the seller. Moreover, an
increasing array of options can involve significant
leverage, which can magnify the influences (both
negative and positive) of option positions on the
financial condition of the firm".
The bank's objective: not hold nor grant any option that
would open an exposure to repricing, yield curve or
basis risk.
Funding-Lending spread risk:

This risk is the volatility in the economic value of, or
in the income derived from, the bank's positions due
to movements in the funding or lending spread of
the bank. Borrowers generally view the swap curve
as the best anchor point for assessing the bank's
competitiveness in the lending business. As a result,

standard floating rate benchmarks employed by the
bank to measure its funding and lending spread are
EURIBOR (for EUR) and LIBOR (for USD and GBP).
Spread risk can manifest itself in a variety of ways, as
any maturity mismatch of the assets and liabilities of
the bank will imply a future refinancing or reinvesting
need, which may occur under adverse funding spread
conditions for the bank. These conditions include
contractual maturity mismatches between asset and
liability cash flows; prepayments of loans, shortening
the effective maturities of assets; buy-backs, shortening
the effective maturities of liabilities.
The bank's exposure to spread risk mainly results from
its core activities - lending and funding. Because it
derives from the evolution of the bank's own credit
quality and spread, it cannot be hedged with contracts
with third parties. Reducing maturity mismatches will
mitigate it, but option exposures will remain unhedged.
Foreign exchange risk:

The FX risk is the volatility in the economic value of,
or in the income derived from, the bank's positions due
to adverse movements of FX rates. The bank is exposed
to FX risk whenever there is a currency mismatch
between its assets and liabilities. FX risk also comprises
the effect of unexpected and unfavourable changes
in the value of future cash flows caused by currency
movements, such as the impact of FX rate changes on
the bank's future lending intermediation revenue.
An important management parameter is the gearing
ratio of the Bank:
Gearing ratio =
Bank's_commitments
subscribed_capital
If the Euro exchange rate against other currencies

varies, then the equivalent value in Euro of the loans
and guarantees (denominated in those currencies) will
change. If the Banks commitment is changing, the
gearing ratio is also changing. Therefore FX rate change
can impact the gearing ratio.
The bank can seek to eliminate FX risk by avoiding or
closing all undesired FX positions, or maintaining them
within the predefined limits.
banking
Funding liquidity risk:

Funding liquidity risk is the volatility in the economic
value of, or in the income derived from, the bank's
positions due to inability to meet payment obligations
out of readily available liquid resources. Such an
inability may force the bank to borrow at unattractive
conditions. As such, the funding liquidity risk for
the bank is related to the cost of borrowing and to
capital market conditions. It is also closely linked to
the uncertainties of loan disbursements. In contrast
to commercial banks, an investment bank cannot rely
upon liquidity source from the deposits of clients nor
recourse to central banks. The bank has to maintain
sufficient level of liquid assets and spread the maturity
dates of its placements according to the forecasts of
liquidity needs.
Asset liquidity risk:

Asset liquidity risk is the volatility in the economic
value of, or in the income derived from, the bank's
positions due to inability to execute a transaction in the

market at the prevailing prices. Such an inability may
force early liquidations of assets at unattractive prices
when it would be better to avoid such liquidations. This
risk is tied to the size of the position compared to the
liquidity of the instrument being sold.
Equity risk:
Equity risk is the volatility in the economic value of, or
in the income derived from, the bank's positions due
to the change in valuation of equity investments, in
particular a reduction in value compared to the price
paid or attributed to the equity investment at the time
of the initial acquisition or commitment.
Normally a bank is mostly exposed to a marginal equity
risk due to exceptional strategic activities: such as
venture capital investments or shares that have been
received in the context of a financial restructuring of a
publicly-quoted or privately held company the Bank has
lent to.
ECONOMY
Following Macro-prudentialism
Tejesh Pradhan, Williams College, MA, Undergraduate in Economics and Mathematics
The global financial crisis of

2008/09 has shown how modern
financial innovations can give
rise to regulatory arbitrage.
Securitization of assets became a
way to get around the regulatory
capital requirements by booking
assets off the balance sheets of
regulated financial institutions
(Calomiris 2009). Originators
could maintain less capital
per unit risk associated with
sanctioned loans. Highly leveraged
institutions undermined the entire
financial system leading to the
worst downturn since the Great
Depression (Persaud 2009a). In
light of this experience, some
economists have argued that proper
implementation of macro-prudential
measures can prevent instances of
financial instability and evasion of
regulatory restrictions. While microprudential regulation concerns
itself with protection of individual
entities, macro-prudential
regulation aims to stabilize the
financial system as a whole (Persaud
2009a). Macro-prudential approach
is perhaps the best option to reduce
the effect of financial turbulence on
the society.
Macro-prudential regulation recognizes the pro-cyclical

effects of constant regulatory requirements on the
credit market throughout the business cycle (Persaud
2009b). It requires banks and bank-like institutions to
dynamically respond to macroeconomic alterations.
Accordingly, it tightens capital requirements during
booms when market price based risk approximation
falls and loosens requirements in busts when the risk
measurement is high. Moreover, it is a good response
to systemic risk created collectively by individually
prudent institutions. It checks the homogenous behavior
of financial institutions (such as high interconnected
risk-taking during expansionary period and constricted
lending in recession) as the business cycle proceeds.
It matches prudential tools to individual institutions
on the basis of the institutions contribution to the
system-wide risk (Borio 2009). It recognizes that some
institutions are systemically more important than
others. Thus, an institutions role in the financial system
determines the austerity of macro-prudential regulation
under which it has to function.
Macro-prudential regulation can reduce future
occurrences of economic crises. It limits financial
leverage and emphasizes the importance of liquidity
buffers (Persaud 2009a). It cushions banks and financial
institutions from unwanted economic shocks at risky
times by increasing liquidity and base capital adequacy
requirements during safer periods. Macro-prudential
strategy sets an upper and lower bound for aggregate
asset value and remains constant so long as the value
does not move out of the established band. So, banks
* Tejesh Pradhan, Williams College, MA, Undergraduate in Economics and Mathematics.
ECONOMY
have to set aside enough assets per risk generated

by any credit lending. Furthermore, it links liquidity
buffers to the maturity mismatch of an institutions
assets and liabilities. Macro-prudential regulation
promotes the use of safe sources of financing (Persaud
2009a). It reduces the possibility of a liquidity black
hole during slow periods of growth (Persaud 2009b).
Hence, macro-prudential regulation not only dampens
the consequences of recession but also avoids financial
stress for longer periods.
Likewise, macro-prudential regulation facilitates proper
risk management by passing on risks to those who are
capable of holding it (Persaud 2009a). Unlike microprudential regulation that makes individual banks to
maintain more capital to tackle risk independently,
macro-prudential regulation allows smooth flow of risk
to banks with better risk-hedging capacity. It focuses
on effectively absorbing risk rather than trading it
and thus spreads the risk throughout the financial
system. Besides, it promotes better information
exchange. For instance, Shelf Bankruptcy requires
systemically important banks and financial institutions
to provide detailed explanations of how they would
overcome their insolvency in short period of time
(Rajan 2009). This pre-planned resolution prepares the
economy to confront systemic failure. It will prevent
implementation of regulatory response in an uncertain
environment during and after the crisis. This is how
macro-prudential regulation can make the financial
system more crisis-resistant.
Despite the benefits of macro-prudential regulation to
the economy, its execution may be difficult. Advocates
of macro-prudential regulation should bear in mind
its cost and feasibility. Regulators should carefully
forecast the direction of any risk changes and define
the standards of regulation accordingly. One major
concern lies in the regulators ability to accurately
predict the current position of the business cycle. Early
identification of cyclical deviation is very important

since regulation should be well timed for it to be
effective. Inaccuracy in identifying cyclical deviation
and time lags in implementing macro-prudential
regulation can create social costs related to lack or
excess of lending and low or high capital requirement
(Calomiris 2009). In addition, regulators need to
correctly quantify the expected loss arising from
systemic failures and evaluate whether that potential
loss needs a regulatory response. Macro-prudential
regulations should be implemented only if the cost
associated with financial imbalance is greater than that
of regulatory reaction (White 2004).
The primary objective of macro-prudential structure
is to lessen the economic costs related to deviation of
the business cycle. Symmetrical application of macroprudential regulation over the business cycle is its
distinguishing feature (White 2004). Macro-prudential
regulation responds to systemic consequences of
homogenous institutional behavior throughout the
business cycle. It enables the economy to better absorb
unwanted shocks and fortifies the financial system to
overcome periods of financial distress. It reduces the
economys reliance on big institutions with high equity
during crisis by wisely spreading risk throughout the
financial system. It can delay if not prevent economic
crisis such as the one we have been going through for
the last couple of years. Nevertheless, the difficulty in
defining the standards of macro-prudential regulation
increases with the sophistication of modern financial
systems. Policymakers should thoughtfully construct
a strong (macro-prudential) regulatory backbone to
prevent the economy from falling in harsh economic
condition. Prudential authorities should constantly
supervise banks and financial institutions to maintain
discipline in the financial sector. And more importantly,
individual financial institutions should set aside their
self-interest, co-operate and abide by the well-defined
macro-prudential regulatory framework.
ECONOMY
An Overview of
Privatization in Nepal
Gyan Mani Adhikari*
Concept
Indeed, the word privatization
which is of recent origin is attached
with different dimensions of
the economy. Privatization, as
perceived by many economists
and researcher, is precondition
of market liberalization and
globalization. Generally,
privatization means leaving the
economy from government control
to market. Broadly defined,
privatization implies the strategy or
the process which transfers an asset
or enterprise totally or partially,
which is owned or controlled either
directly or indirectly by the state to
the private sector. More specifically,
it is the transfer of majority
of ownership of state-owned
enterprises to private sector by the
state following liquidation (Kikeri,
1994:24).
Privatization has become a central
feature of the economic policies
in many countries in the present
era irrespective of their political
systems. The underlying intent of
privatization is to improve industry
performance by increasing the role
of market forces (Beesley, 1996:30). In other words,

the prime purpose of privatization is to make industries
competitive by shifting the control or ownership of the
means of production from state to common people so
that these enterprises are no more under the political
domain. In a broader sense, privatization is deployment
of an array of actions geared to expose the scope of
private sector activity.
In summary, it can be said that the term privatization
reveals a condition of shifting the ownership of an
enterprise wholly or partially form public (government)
to private sector or an action to restraint the
government to participate in industry or trade as
previously. It is also connected with the liberalization
policy and the process of globalization as well. It is
a tool to open the door for creating the environment
of competition. Privatization is a necessary (but not
sufficient) condition for the creation of a market
economy.
Global Scenario
In the 18th century, the classical thoughts form the
notion of invisible hand of Adam Smith to supply
creates its own demand of J.B. say assumed dominant
role of market forces which help produce increased
goods and services in the competitive environment of
the economy. However, the impact of great depression
of 1930s (failure of laissez, faire doctrine), full state
intervention in economic activities by the Soviet Union,
* Mr. Adhikari is a Lecturer of Patan Multiple Campus, TU.
ECONOMY
China and other socialist/communist economies and

planned economic development approaches of the
developing countries justified the role of government
in economic activities. Form 1930s to the mid of
1970s, most of the developing countries followed
state intervention policies and these many economic
activities were governed through public enterprises
(PEs).
However failures and poor performance of PEs and
increased efficiency of private sector even in the
developing countries impelled the government
to squeeze its hand and transfer the role to the
private sector. Beside this, most notable, during
1980s institutions such as the IMF, World Bank and
regional development banks have advised government
in developing countries to privatize their stateowned enterprises as part of their overall structural
adjustment reforms, which are reinforced by domestic
challenges: the need to adjust to rapidly changing
market forces, create jobs, raise income levels
and increase productivity and efficiency in order
to compete in the global economy. Since then the
privatization movement developed so rapidly that
governments all around the world are encouraging
private sectors to participate in providing goods and
services.
During 1977-2001, about 3535 privatization was done
in 100 countries that generated government revenue
of over 1,127 billion dollars. This reveals that the
privatization is an international phenomenon.
Types and Modalities of

Privatization:
Generally, privatization seems as the sales of public
enterprise to private only. But in broader and true
sense, privatization is not limited on the sale of PEs
merely. On the basis of the methods and ways applied
at enforcing the privatization.
There are many ways of privatization. It can take any
of the following modalities:
1) Divestiture: sale of shares or assets by open tender
2) Break up: Selling or spinning off section of large
public enterprise
3) Liquidation: Legally chose down the public
enterprise
4) Marginalization: Freezing or gradual reduction of
the operations of a public enterprise
5) Privatization of management through contract,

leasing, confessional agreement etc.
These methods are seemed as common elsewhere in
the world where privatization is recognized. These
methods are major classifications of privatization.
However, there is no standard formula for privatization.
The method of privatization will vary from country to
country and case to case.
Hence, privatization doesnt include solely the sale of
PEs, many methods and ways fall within the modalities
of privatization.
Objectives of Privatization:
The objectives of privatization vary depending on a
range of national characteristics, relative size of public
and private sectors degree of development, political
and industrial relation environment etc. The objectives
of privatization can be pointed out as follows:
Political Objectives: (i) To adhere to pro-private and
pro-market ideology (ii) To comply with lender/donor
condition lines (iii) To establish property rights (iv) To
win votes by cutting taxes (v) To widen share ownership
Macroeconomic Objectives: (i) To liberalize the
economy (ii) To enable more integration into the
international economy (iii) To increase efficiency
and competitiveness (iv) To develop national capital
markets (v) To develop a strong private sector as the
engine of growth (vi) To attract private capital for
infrastructure development (vii) To repay state debts
or reduce borrowing (viii) To redirect subsidies to other
areas of state spending
Managerial Objectives: (i)To commercialize
management behaviors (ii) To gain access to external
techniques, skills, knowledge (iii) To provide personal
incentives for managers, employees (iv) To enable
attacks on union organization and agreements (v)
To enable staff cuts and pay systems changes (vi) To
externalize problems of service efficiency and quality
Institutional Objectives: (i) To redirect the
administrative capacity of the state (ii) To undermine
corrupt use of state resources (iii) To serve links
between politicians and management
ECONOMY
Microeconomic Objectives: (i) To increase efficiency,

performance and productivity (ii) To enable
diversification (iii) To gain access to international
capital and markets (iv) To introduce or increase
competition
Distributional Objectives: (i) To create profitable
opportunities for politicians (ii) To legitimize corrupt
use of state resources (iii) To compensate for losses (to
previous owners or others) (iv) To expand markets for
private capital and companies
Privatization programme must satisfy two criteria;
first it must seek to withdraw the government from
activities more suited to private enterprises and where
the original objectives of public enterprises are fully
achieved. Second it must design and implement sensible
and effective regulatory and pro-competitive laws that
would encourage productive and allocative efficiency
among the enterprises in the economy.
The must important objective of privatization should
be to contribute to economic growth and that other
objectives should be regarded as secondary. Economic
growth is what lifts people out of poverty and creates
the opportunities for all of society to have better
livelihoods.
Arguments for Privatization

These include:
Raising revenue for the government: The revenue
gained form the sale makes it possible for the
government to reduce its need to borrow and to cut
tax rates without reducing its own spending. Extra
government revenue may also arise in the form of
higher corporation tax receipts if the privatized
concerns become more profitable.
Increased competition: It is argued that the private
sector has the spur of competition since inefficiency is
punished with bankruptcy. A failed firm will go out of
business and resources will be reallocated in line with
consumer demand whereas state enterprises cannot
go bankrupt because the government guarantees their
borrowings.
A private sector firm may have to compete in financial
markets for funds and has to persuade banks, and other
financial institutions or its shareholders that its plans

are viable.
Greater competition may also be created in the product
market if an industry, which was run as a monopoly
under state ownership, is split into competing parts, for
example, separate telecommunication firms operating
in competition with each other.
Increased efficiency
Managers of privatized firms will be freed from political
control and interference-they will be able to charge
the prices they regard as commercially appropriate and
to make the investments they think will produce the
right return. The stock market may also put pressure on
private sector firms to be more efficient. If they are not
performing well their share price will fall and they will
run the risk of being taken over by another firm.
Wider share ownership

The broadening of share ownership may be another
aim of privatization. The idea is to shift ownership
away from the state and large institutions towards
individuals.
Cost push inflation may be reduced

Private sector managers may be more reluctant to
concede wage rises not matched by higher productivity
and may be less willing to accept inefficient working
practices.
Arguments against Privatization

These include:
Long term loss of revenue

Whilst selling off profitable assets raise revenue for
the government in the short term, it loses the future
profits from these industries. Indeed privatization has
been likened to selling off the family silver. If the
loss of profits is greater than any rise in corporation
tax resulting from the privatization, future government
borrowing requirements may be larger.
Competition in product markets may not be

increased
If a public sector monopoly is replaced by a private
sector monopoly then, other things being equal,
competition will not increase. In case of a natural
monopoly it is difficult to provide competition.
ECONOMY
Market forces may not ensure great efficiency

Privatized firms, if they have a high degree of monopoly
power, are likely to be able to earn supernormal profits
even if they are inefficient. The stock market may also
fail to put pressure on the firm to become efficient.
Monopolies and oligopolies are likely to be able to rely
heavy on retained profess for their investment finance
and their large size is likely to prevent other firms from
being able to take them over.
Loss of potential revenue from the sale of

privatized concerns
It is thought that in the past some state concerns were
sold off too cheaply. Evidence for this was provided
by the sharp rise in price of share the day after shares
were sold in many former state concerns. Whilst this
provided a speculative gain for the purchasers there
was a corresponding sacrifice in revenue for the state
and taxpayers. In practice it is difficult to set the price
of shares in privatized industries at the appropriate
level.
Private sector firms may not act in the public

interest
Private sector firms do not take into account
externalities. They are also unlikely to base their output
and pricing decisions on considerations of equity.
Loss of government control over the economy

The governments ability to influence pay, prices and
output decisions directly will be reduced.
PRIVATIZATION IN NEPAL
Most of the PEs were established during 1960s in Nepal.
The history of PEs dates back to 75 years, by 1956 there
existed only Raghupati Jute Mill and Nepal Bank Limited
(NBL). This reveals that PEs in Nepal have a recent
origin. When Nepal introduced planning for economic
development in the middle of 1950s, the government
was compelled to establish enterprises because the
private sector was not well developed. There were
not many industries in the private sector. There was
not even inception of corporate culture. Peoples
aspirations were rising. Goods and services needed to
be produced.
In the light of this fact, a number of public enterprises

focusing on sugar, cigarettes, agricultural related
services and financial services were established.
Most of the PEs were funded mainly through foreign
assistance provided by the donor countries, particularly
China, Russia and India. Unlike in other countries,
the establishment of there enterprises in Nepal was
not guided by specific objectives rather they were
established as an attempt to solve the problems arising
out of a particular situation, opportunities arising out
of receipts of foreign aid, and the existence of a very
weak private sector incapable to undertake even the
most elementary productive and distributive function
(Reejal, 1995).
During 1960 to 1990 around 60 PEs came into existence
operating in manufacturing, public utilities, trading,
financial and social service sector. These enterprises
played a dominant role in the production of cigarettes,
cement and sugar. These products contributed 6 percent
to the gross Domestic product (GDP) in 1990/91.
About 70 thousand people were believed to have been
employed in these enterprises (Acharya, 2000). Despite
these benefits accruing to the economy, PEs were also
adding costs to the government.
End of the 1970s the Nepalese planners and policy
makers realized the limitations of the government and
need was felt to mobilize the private sector for the
expansion of industrialization in the economy. In the
mid of 1980s, Nepal took up the Structural Adjustment
Program (SAP) from the World Bank and International
Monetary Fund (IMF), both the World Bank and the IMF
emphasized on the privatization of public enterprises.
Similarly, the Seventh Plan of Nepal (1985/86-1989/90)
reiterated the intention of removing excess government
control on the day to day affairs of PEs. During this
period, the government also showed its intention in
divestiture of share of 12 PEs. But, due to fearing
popular backlash, these activities were never executed.
After the reinstatement of the democratic government
in the early 1990s privatization got momentum.
A policy paper on privatization was issued by
government of Nepal in 1991 which laid down the
policies, modalities and administrative mechanism for
ECONOMY
privatization of PEs. In 1992, government reached an

agreement with IMF for structural economic reform,
under which privatization of PEs was one of the major
agenda. In 1994, the Privatization Act came into force.
According to this Act: the objectives of privatization
are to (i) increase productivity of the enterprises by
enhancing their efficiency (ii) reduce the financial
and administrative burden of the government, (iii)
promote private sectors participation in the national
development; and (iii) generate additional revenue for
the government.
Similarly, according to this Act, the following
modalities can be adopted for privatization: (i) Assets
and Business sale (ii) Equity sale (iii) Liquidation
(iv) Management contract (v) Leasing of Assets (vi)
Other depending upon the recommendation of the
privatization committee
Nepal has decided for a gradual process of privatization.
Therefore, privatization of PEs has been done in phases.
Under the first phase, government decided to privatize
three PEs viz., Bhrikuti Paper Mill, Harisiddhi Brick and
Tile Factory and Bansbari Leather and shoe factory in
FY1991/92. The then government was charged to sell
these enterprises in the kaudi ko dam (extremely low
prices) by Nepalese people. In the second phase 14 PEs
were selected in 1993. Likewise, 23 PEs were selected
for the third phase (1997-2002) of privatization. By the
end of ninth plan (1997-2002), the government had
set the target to privatize 30 different PEs of Nepal
but the government had totally failed to do so. It is
also to be noted that only 31 PEs were privatized till
FY 2008/2009. Thus, it reveals that despite strong
commitment of government toward privatization, the
pace of privatization is very slow in Nepal.
The government of Nepal has recognized privatization
of PEs as an integral component of its economic
liberalization and open market economic policy.
Beginning from FY 1992/93 to FY 2008/09, 31 PEs have
been privatized.
Problems of Privatization in Nepal

The privatization process in Nepal is suffering from
several constraints. The major problems could be
summarized as follows:
1. Ignorance of the People: Almost fifty percent of

the total population is illiterate who even do not know
what privatization is. They just follow their leaders
who themselves do not know privatization well. The
publications on privatization do not reach the people;
the worst scenario is that people involved in some form
of business/trade also are not aware of privatization.
2. Social Problems: Both the people and the political
parties have negative attitude towards privatization.
3. Less developed capital market: Capital market of
Nepal is in very early stage, so it cant smoothly absorb
all the shares floated in the market especially when
the number is large. Most of the general people are
not familiar with the transactions in the share market.
Consequently, the shares of Candidate Company cant
be floated in the market rather the interested strategic
investors have to be sought.
4. Ill health of public enterprises: Most of the public
enterprises are being operated in a very bad condition.
There is no timely repair and maintenance of plant
and equipment. Work culture has collapsed in these
enterprises. All employees are involved in politics
directly or indirectly.
5. Lack of investors interests: There is dearth of
genuine investors in Nepal. In order to privatize some
of the public enterprises, in the past, the government
published notices several times inviting submission of
proposals but, in some cases, only one or two proposals
were submitted. On the one hand, it may be because
of scarcity of investors, particularly big investors and
on the other hand, most of the investors are involved
in easy money making such as, trading of foreign
goods which brings the investors higher profit margin.
As a result, by investing in privatization of the public
enterprises, they do not want to bear relatively more
risk, put more effort and get lower return. Moreover,
some of the investors want to invest in the industries
but they lack the essential know-how.
As mentioned above, most of the Nepalese investors are
of small capacity both financially and technically and
cannot run big enterprises. They are in development
process so they will take some time to be capable of
bidding relatively big enterprises.
ECONOMY
6. Employee related problems: In all the privatized

enterprises, employee related issues are disturbing all
important players, the top management, the employees
and even the local residents. None of them are
satisfied.
7. Small size of market: The size of the most of
Nepalese companies and the market are very small in
comparison to international standards. So there is no
large profit on investment. As a consequence, foreign
investors are not attracted for investment in these
enterprises.
8. Lack of monitoring and evaluation system: In all
the privatized enterprises, it was common complaint
from all sides, whether the investor, employees or the
local resident, that the government never came back
after privatization. They all want the government to
cooperate and monitor the initial functioning of the
enterprises so that the transition could be smooth and
succeeded in long run.
9. Political instability
Political instability was another major problem for
the past few years. Governments were changed many
times. Each government has had its own priorities,
which differed from each other regarding privatization.
It harmed the privatization process.
10. Delaying Problem: In the present context, the
privatization process has become very lengthy and
time consuming. From the moment the privatization
study starts, from the top management to the lowest
level employees, all start unwanted activities in the
enterprises. Strikes and demonstration are normal
events in the enterprise. Misuse of machines, plants,
equipment, other properties and companys funds is just
normal. As a result, the condition of the company goes
on deteriorating everyday. Eventually, by the time the
bid notice for privatization of the company is published,
the condition of the company becomes so bad that
most of the potential bidders preclude themselves
from bidding. Those bidders, who submit the bid, offer
such a low price that the government feels difficulty to
accept the proposal. An important reason for such an
unfortunate situation is the unnecessary delaying in the
privatization process.
11. Formation of privatization committee: Formation

of the privatization committee is another source
of problem. According to the privatization Act, the
government has to nominate two members of the
House of Representatives for this committee. In order
to promote consensus among the political parties the
government usually nominates one member from the
opposition party. Since political parties differ in their
views regarding privatization, some members of the
committee try to escape from taking decision or prefer
to delay the process. This was one of the major reasons
why privatization of Himal Cement Company took
unnecessarily long time.
12. The problems of over capitalization: The present
condition of all public enterprises whether profit making
or loss bearing, is not satisfactory. In most cases, their
account is not updated; records of assets and liabilities
are not accurate and updated. Their plants and
machines are not properly repaired and maintained.
13. Privatization fund: Privatization fund is another
source of criticism. According to the prevailing law,
all the money received by the government should
be deposited in the government regular account.
But the sales proceeds of public enterprises are
deposited in deposit account. The explanation behind
this is that there are several expenditures during the
privatization process for which fund cant be available
immediately from the regular government account.
So these expenditures are borne from this account.
This arrangement has made the privatization process
relatively faster and flexible. But Auditor Generals
office has shown serious concern about it.
14. Corruption, lack of transparency and good
governance are also the major problem of privatization
in Nepal.
Despite these problems encountered in the process of
privatization, the awareness level of the people has
considerably increased in the recent years. People feel
that competition can reduce the cost of service by
improving efficiency and productivity. This indicates
that people will slowly welcome privatization.
Concluding Remarks
Although the privatization process is continuously
gaining momentum in Nepal, it riddled with
ECONOMY
many inefficiencies and unnecessary bureaucratic

interference. The issues such as the question of
continuation of service or redundancy for labour,
choice of investors, problems of debt burden and even
the method of privatization have been attracting the
attention of the general public. The inappropriate
decision- making relating to the above aspects
would result in the inefficiency of the privatized
PEs in future. The essence of transparency during
privatization process would avoid the hurdles in proper
decision- making process. If the privatization process
is transparent, it gains public support Corollary, cooperation from the government is of paramount
importance to the success of privatization. While it is
important to continue privatize PEs, it is equally vital
to reform and reorient the relevant government offices.
If Nepal wants to go for effective privatization process,
it needs to closely look and expedite the following
strategic measures.
i. Need strong political commitment,
ii. Need of continuity and consistency in the
privatization process,
iii. Privatization committee (established under
privatization Act, 1993) should be made more
vigilant,
iv. Restructuring of operational efficiency of PEs prior
to privatization,
v. Need of in-depth study and proper homework
regarding the privatization modalities,
vi. Continuation of the government role as regulatory
and monitoring body after the sale of PEs i.e. by
upgrading the status of privatization cell,
vii. Need to educate employees and labour about
benefits of privatization scheme,
viii. Need to develop strong capital and share market,
ix. Need to adequately prepare and market publicize
its process to bring public awareness, and
x. Need to update PEs information on accounting,
financial and market details
FINANCE
Trade Finance: Factoring &

Forfaiting Services
CA. Asmita Gorkhali *
Introduction
Trade finance refers to financing
international trading transactions.
Trade finance is a short-term
credit availed by a bank to their
borrower for importing and
exporting activities. It includes
various kinds of loans, advances
and facilities required for imports
and exports deals. Basically, trade
finance includes everything that
is related with financing trading
activities. Since such deals are
made on foreign trade, it involves
transactions of foreign exchange.
The economics of these trade
finance facilities depends on local
currency and foreign currency
interest rates, the ruling forward
terms, exchange rate movement,
Central Banks regulations and
guidelines, etc. A typical service
offering from a bank under trade
finance may include Letters
of credit (LC), import bills for
collection, shipping guarantees,
import financing, performance
bonds, export LC advising, LC
confirmation, LC checking and
negotiation, pre-shipment export
finance, export bills for collections,
invoice financing, trade credit
insurance, export factoring, forfaiting and others.

Factoring and forfaiting is a source of trade finance
which enables exporters to get funds from the
institution called factor and forfaiter on transferring
the right to recover the debts from the importer.
FACTORING SERVICES
Factoring services started in the United States of
America in the 1920s and were introduced to the other
parts of the world in the 1960s. Today there are more
than 900 companies offering factoring services in more
than 50 countries and has become popular all over
the world. Factoring is a financial service covering the
financing and collection of accounts receivables in
domestic as well as in international trade. It is a money
market instrument. It is an arrangement in which
receivables on account of sale of goods or services are
sold to the factor at a certain discount. As the factor
gets title to the receivables on account of the factoring
contract, he becomes responsible for all credit control,
sales ledger administration and debt collection from the
customers.
The three parties directly involved are: the seller (one
who sells the receivable), the debtor (customer), and
the factor (the specialized institution). Under this
arrangement, the seller sells book debts represented by
one or more of its invoices in favor of a third party at
a discount to obtain cash. The receivable is essentially
a financial asset associated with the debtor's liability
to pay money owed to the seller (usually for work
performed or goods sold). The sale of the receivables
* Ms. Gorkhali is working in Nepal Rastra Bank as an Assistant Director.
FINANCE
essentially transfers ownership of the receivables to

the factor, indicating the factor obtains all of the rights
and risks associated with the receivables. Accordingly,
the factor obtains the right to receive the payments
made by the debtor for the invoice amount and must
bear the loss if the debtor does not pay the invoice
amount. Usually, the debtor is notified of the sale of
the receivable and debtor's consent is obtained for the
factoring arrangement. The factor bills with its stamp
mark on the original invoices to the debtor and make
all collections. The factoring can be with recourse or
without recourse. Under without recourse factoring
credit insurance facility is offered to the client. The
cost of without recouse factoring is more than the cost
for with recourse factoring. Under factoring margin is
kept in the range of 5 percent to 20 percent normally.
In other words, usually about 80 to 95% of the invoice
value is provided as pre-finance by the factor to the
supplier which is known as prepayment. Remaining
amount of the value of invoice is paid to the supplier
(client) after collection of money from the customer
and after deducting his own charges.
There are three principal parts to the factoring
transaction; (i) the advance i.e. a percentage of the
invoice face value that is paid to the seller upon
submission of the invoices, (ii) the reserve i.e. the
remainder of the total invoice amount held until the
payment by the debtor is made and (iii) the fee i.e. the
service cost or interest charges or both associated with
the transaction which is deducted from the remaining
amount before making final payment to the seller
against the reserve. The factor's overall profit is the
difference between the price it paid for the invoice and
the money received from the debtor, less the amount
lost due to non-payment.
Factoring is a method used by a firm to obtain
cash when the available cash balance held by the
firm is insufficient to meet current obligations and
accommodate its other cash needs, such as new orders
or contracts. In this way more money is made available
for investment. The factor will only purchase solid
credit worthy invoices and often turns away average
credit quality customers. Accordingly, Factoring occurs
when the rate of return on the proceeds invested in
production exceed the costs associated with Factoring
the Receivables.
Functions of the Factor

Broadly speaking the main functions of the factor are as
under :
1. To provide finance against book debts, say upto 90
per cent of the invoice value immediately. Thus
the client gets funds immediately for his working
capital.
2. To collect cash against receivables on due date from
the customers of the clients and furnish reports to
the client.
3. To undertake sales ledger administration (i.e.
accounting work) for the client in respect of clients
transactions with its customers.
4. Under the non-recourse factoring arrangement,
should the customer become financially insolvent
and cannot pay up, the factor provides protection
to the client against bad debts on all approved
invoices. Thus the factor provides debt insurance
facility to the client against possible losses arising
from insolvency or bankruptcy of the customer.
5. Factor also provides other information such as sales
analysis and overdue invoice analysis which enable
the client to run the business more effectively.
Besides, the factor also provides relevant expertise
in the areas of marketing, finance, etc., to the
client.
Benefits of Factoring to Clients

1. Under the factoring arrangement the client receives
prepayment upto 80-90 per cent of the invoice
value immediately and the balance amount after
the maturity period. This helps the client to
improve cash flow position which enables him to
have better flexibility in managing working capital
funds in an efficient and effective manner. Besides
this, such arrangement also improves the ability
of the client to develop sales to credit worthy
customers.
2. If the client avails the services of the factor
in respect of sales ledger administration and
collection of receivables, he need not have any
administrative set up for this purpose. Naturally
this will result into a substantial saving in time and
cost of maintaining own sales ledger administration
and collecting receivables from the customer.
3. When without recourse factoring arrangement
is made, the client can eliminate the losses on
account of bad debts. This will help him to
FINANCE
concentrate more on maximizing production and

sales. Thus it will result in increase in sales,
increase in business and increase in profit.
4. The client can avail advisory services from the
factor by virtue of his expertise and experience in
the areas of finance and marketing. This will help
the client to improve efficiency and productivity
of his organization. Besides, with the help of
data base, the factor can make readily available
information regarding product design/mix, prices,
market conditions etc., to the client which could be
useful to him for business decisions.
Need for Export Factoring

Export factoring services are offered to the exporters
(clients) who sell their products or services to the
importers (customers in other countries) on open
account terms having a credit period ranging from 60
to 180 days. Many exporters find it difficult to evaluate
creditworthiness of potential importers due to lack of
information and data. On account of various reasons,
they also experience difficulties to recover dues from
import customers on maturity dates. This poses the
problem of credit risk. All these problems in respect of
export trade can be solved by offering export factoring
services to the exporters. Use of such services will
help exporters to sell goods or offer services in abroad
on open account terms and eliminate credit risk as
well. Such facilities will help exporters to expand the
business with the existing customers and search new
markets for the business.
Differences from bank loans

Factoring differs from a bank loan mainly in three ways.
First, the emphasis is on the value of the receivables
i.e. credit worthiness of the debtor not the credit

worthiness of the seller (client). Secondly, factoring
is not a loan it is the purchase of a financial asset
(the receivable). Finally, a bank loan involves two
parties whereas factoring involves three. While bank
lending is cheaper than factoring, the key terms and
conditions under which the small firm must operate
differ significantly.
Cost of Factoring
Duel pricing structure comprising services charges
and discount charges (Interest charges) is followed.
Service fee is levied for the work involved in
administering the sales ledger as well as protection
against bad debts. It is calculated as a percentage of
gross value of the invoices factored and is assessed on
the criteria such as gross annual sales volume; number
of customers; number of invoices and credit notes;
and degree of risk represented by the customer. The
service fee for factoring may ranges from 0.30 per
cent to 0.75 per cent and it would be higher when
non-recourse arrangements are made. Discount charge
(interest charge) is levied on the advance provided
by the factor and is computed on the basis of prime
lending rate of banks plus premiums for credit risk
basis. It is calculated on a day-to-day basis on the
advances outstanding.
Types of Factoring Services

The various types of factoring arrangement can be
classified as full servicing factoring (without recourse
factoring services), recourse factoring, maturity
factoring, invoice discounting and agency discounting.
The aforesaid classification of various factoring
arrangements along with the type of services provided
under each classification has been tabulated as under:
FACTORING SERVICES DELIVERED
SN
TYPES
Finance
Collection of
Accounts
Sales Ledger
Administration
Credit Protection
Full Factoring
Yes
Yes
Yes
Yes
With recourse factoring
Yes
Yes
Yes
No
Maturity factoring
No
Yes
Yes
Yes
Invoice discounting
Yes
No
No
No
Agency factor
Yes
No
No
Yes
FINANCE
FORFAITING SERVICES
Forfaiting is a specific form of export trade finance.
Forfaiting is the purchase of receivables/ debtors along
with availed negotiable instruments like promissory
note or bills of exchange due on a specific date to
be matured in future and arising from the exports
of goods on credit. At its simplest the receivables
should be evidenced by a promissory note, a bill of
exchange, a deferred-payment letter of credit, or
a letter of guarantee. Thus it is a source of trade
finance which enables exporters to get funds from the
institution called forfaiter on transferring the right
to recover the debts (export receivables) from the
importer. Payment in respect of export receivables
which is further evidenced by debt instrument like bill
of exchange or promissory notes must be guaranteed
by the importers bank and is normally receivable in
any major convertible currency. As the receivables are
usually guaranteed by the importer's bank, the forfaiter
frees the exporter from the risk of non-payment by
the importer. The debt instruments are purchased by
the forfaiter at a specific but fixed discount rate. This
facility is always provided with non-recourse feature
to the seller (viz. Exporter). Full value of export
receivables i.e. 100 percent of the contract value is
taken into account. Normally all exports of capital
goods and other goods made on medium to long term
credit are considered for providing finance through
forfaiting arrangement. Now-a-days, in many developed
countries, a forfaiter provides finance even in respect
of commodity exports wherein the credit period is upto
180 to period above 360 days.
Benefits of Forfaiting Services

The benefits accruing to the exporter are numerous.
Few of these benefits are stated below:
1. Exporter can convert export transaction under
deferred payment arrangement into a cash
transaction. Thus he can improve his own liquidity
position.
2. Since the forfaiter takes all risks, naturally exporter
is relieved of the risks arising out of the default
by the buyer (importer) as well as political risks,
exchange risks, transfer risks, and commercial risks
and improving cash flows.
3. Since the forfaiting is a fixed rate contract, the
exporter is hedged against interest rate risk and
exchange rate risk.
4. Exporter gets finance upto 100 per cent of the

contract value (which is to be reduced to the extent
of forfaiting cost at settlement).
5. Exporter is freed from credit administration and
collection problems.
Cost of Forfaiting Services

Three elements relate to the pricing of a forfaiting
transaction are the discount rate, days of grace and
commitment fee. The discount rate charged by the
forfaiter is based on the following factors: (i) charge
for the credit extended or finance provided which is
the main element and is roughly equivalent to the
forfaiters own costs of raising the money, (ii) charge
based on the risk of interest rate and exchange rate
movements in the currency in which the credit is
extended, (iii) charge based on the sovereign risk,
political risk and transfer risk e.g. the probability of
a change of government and imposition of exchange
controls preventing the discharge of the debt and
(iv) charge based on the credit risk attached to the
importer as well as availor. Discount rate, the interest
element, usually quoted as a margin over LIBOR. It
forms a larger portion of cost of forfaiting service. Days
of grace, added to the actual number of days until
maturity for the purpose of covering the number of
days normally experienced in the transfer of payment,
applicable to the country of risk. Commitment fee,
applied from the date the forfaiter is committed to
undertake the financing, until the date of discounting.
Differences between Factoring and Forfaiting

Services
1. Factoring services is mainly meant for financing and
collection of receivables arising from short term
credit transactions say upto 180 days where as
forfaiting is meant for financing credit transactions
of having deferred credit period of more than 1
year.
2. Factoring arrangement can be with or without
recourse whereas forfaiting transaction is always
without recourse.
3. Factoring services can be considered either for
domestic transaction or for export transaction
whereas forfaiting is always for export transactions.
4. Factoring is done on the strength of sales invoices
only where as forfaiting involves use of negotiable
instruments like bill of exchange or promissory note.
FINANCE
5. In factoring arrangement, a margin of 5 to 20

percent is kept whereas a forfaiter discounts the
entire sale value of the export transaction without
keeping any margin.
6. Factoring services include sales ledger,
administration, collection of receivables and other
advisory services whereas forfaiting is a pure
financial arrangement.
7. Factoring is done on whole turnover basis, whereas
forfaiting can be done on transaction basis.
NEED FOR GUIDELINES FOR FACTORING

SERVICES & FORFAITING SERVICES BY
NEPAL RASTRA BANK
Nepal Rastra Bank has not issued any guidelines subject
to which banks can undertake factoring services. In
order to facilitate factoring services Nepal Rastra
Bank should make arrangement for licensing factoring
services and should issue guidelines in this regard which
should cover areas some of which are as discussed here:
1. Banks should frame an appropriate policy on
factoring services with the approval of their Boards.
2. As activities like factoring services requires skilled
personnel and adequate infrastructure facilities,
it should be undertaken only by certain selected
branches of banks. This will have to be suitably
published for the benefit of banks customers.
3. The activities like factoring services shall be treated
on par with loans and advances and therefore
should accordingly be given the risk weight of 100%
for calculation of Capital Adequacy Ratio. Further
the directives on asset classification and loan loss
provisioning, accounting policies and arrangements
regarding financial statement presentation would
also be applicable to the portfolio of factoring.
4. Single Obligor Limit fixed as a percentage of banks
core capital should also applicable be to individual
borrower and a group of borrowers availing this
credit facilities.
5. Banks shall maintain a balanced portfolio of
financing receivables under factoring services visa-vis the aggregate credit portfolio. The exposure
towards prepayment in respect of purchase of
receivables under factoring services should not
exceed a certain fixed percentage of total gross
loans and advances as on the date of previous year
balance sheet.
In a fashion similar to factoring services there is also a

need to make appropriate policy and issue guideline by
Nepal Rastra Bank with regard to forfaiting services and
licensing arrangement for forfaiter to undertake such
fund based facilities by commercial banks.
CONCLUSION & RECOMMENDATION

Though factoring and forfaiting services have been
introduced in International trade finance long time
ago it is still quite a new concept/ product in Nepal.
There is an abundant scope for such services but it is
not widely known in the country. Banks are advocated
for the introduction of factoring and forfaiting services
and can come forward with this concept to Nepal
Rastra Bank and reap the benefits of factoring services.
In order to facilitate factoring and forfaiting services
Nepal Rastra Bank should make licensing arrangement
and should issue guidelines in these regards which
should cover areas such as formulation of appropriate
policy, need of skilled and trained personnel, adequate
infrastructure facilities, risk weight percentage for
Capital Adequacy Ratio computation, applicability
of directives on asset classification and loan loss
provisioning, income recognition, determination of
single obligor limit, maximum exposure in the portfolio
of loans and advances and so on. Central bank may also
make arrangement to provide permission to commercial
banks to offer forfaiting services by acting as an agent
or a facilitator between Nepalese exporter and the
forfaiting agency operating in some other country.
Factoring is generally assisted where there is good
credit and other information available about local
companies from sources such as credit information
bureau and business registries. In Nepal, such sources
are generally lacking, so one separate but parallel
objective in promoting factoring may be to promote
the development of credit information bureaus and
accurate business registries. The bedrock on which
factoring lies is each countrys laws governing contract
between parties and assignment of receivables. For
factoring services to flourish, these laws need to be
clear and well-tested as to enforceability. In addition
there is also need for the dissemination of knowledge
about factoring and forfaiting services among Nepalese
sellers/ exporters, through which it may be possible
to create awareness about it and subsequently raise
demand for the same.
IFRS
Preparing for 2012: A Journey to IFRS

CA. Paramananda Adhikari*
Abstract
"Think thousand times before taking a decision,
but never turn back even if you get thousand
difficulties after such decision". Adolf Hitler
In fact, all we are in total agreement with
this line and there is little time with us to
do so much. To begin with this that within a
period of not more than a year i.e. 16 July
2012, all companies listed in Nepal Stock
Exchange (NEPSE) will be changing their
existing accounting records and reporting
practices using a single set of global standards
i.e. International Financial Reporting Standard
(IFRS). This aims to improve the harmonization
of company financial information and to raise
the quality and reliability of financial reporting.
Harmonization means making all the accounting
records in similar with IFRS and eliminates the
differences of local GAAP. The use of IFRS is
becoming so widespread that it has already
been applied in over 120 Countries. Across
the globe, companies have now aggressively
started globalizing their scope of operations
and IFRS is increasingly becoming the need
of the hour. This article reflects more about
the convergence process and the adoption of
IFRS-1. The objective of IFRS-1 is to provide a
consistent framework within which entities can
start to apply IFRSs. Moreover, IFRS-1 requires
for retrospective application of each IFRS
* Mr. Adhikari is Technical Director at ICAN.
Key Words: IAS/IFRS, NAS, Harmonization, Adoption,

Convergence, Comparative Informations, GAAP, SME
Standards
Adoption vs Convergence
Although in common parlance, many of us are
using Adoption of IFRS and Convergence with IFRS
interchangeably within the same platform. However,
still there has been confusion over these terms.
Therefore, there exists a significant difference between
the two, which advisers, auditors, employees as well as
all users of IFRS must understand to implement.
Simply, Adoption of IFRS means that the country
applying IFRS would be implementing IFRS in the
same manner and would be fully compliant with the
guidelines issued by International Accounting Standard
Board (IASB). On the other hand, Convergence with
IFRS means that the Accounting Standard Board of
the respective country applying IFRS in compatible
with them. Thus, countries converging with IFRS may
departure to a certain extent from the IFRS. From this
difference, it is believe that convergence with IFRS
cannot eliminate all the differences between the two
sets of Standards.
Convergence: Issues and Outcome

Convergence of Nepal Accounting Standards with
IFRS is the long-term goal; however, that number
of issues must be address before convergence to be
achieved, including the accounting of taxation, fair
value accounting, revenue recognition and many other
ifrs
areas and educating the preparers of the financial

statements. For example, there is a strong link not only
in our country, but also in many countries, between the
results shown in the financial report and the income
subject to tax.
The Council of the Institute of Chartered Accountants
of Nepal (ICAN) in its 133 Meeting has decided to adopt
stage-wise approach for implementation of IFRS for
financial reporting. Although, at the initial stage IFRS
will apply only to listed companies from 16 July 2012,
however other public companies have to move down
the IFRS road on 16 July 2013 and all other companies
from 16 July 2014 onwards. Reporting under IFRS
will have many positive outcomes such as improving
the harmonization of company financial information,
encourages companies to recognize fair value
accounting, revenue recognition, intangible assets such
as patents, intellectual property etc. This will increase
transparency and more understanding of the value
of the business to the investors and uniform financial
reporting system around the world.
Convergence Process
The move to IFRS is a major challenge for everyone
involved in financial reporting, the preparers, users,
practitioners, investors and students too. IASB
developed IFRS-1 to provide guidance for entities
adopting IFRS for the first time by an explicit and
unreserved statement of compliance with IFRS. IFRS1 requires entities preparing their first IFRS financial
statements to present an opening IFRS statement
of financial position i.e., the starting point for their
accounting in accordance with IFRS. In general, IFRS1 requires entities to apply, retrospectively, all IFRS
standards effective at the end of their first IFRS
reporting period. This means that the opening IFRS
statement of financial position and the comparative
financial statements must be prepared in accordance
with the recognition, measurement, presentation and

disclosure requirements.
The convergence process to IFRS is a complex and
time-consuming. The entities need to understand the
IFRS financial statements before going to convergence
process. Firstly, the entities should assess their existing
practices. Secondly, comparison should be made with
the IFRS and identify the differences between existing
local GAAP with IFRS provisions. This may need to
change the existing accounting system (IT accounting
system too) of the entities. Thirdly, prepare the team
with adequate expertise to prepare the financial
statements adopting IFRS.
Implementation of IFRS will require in-depth knowledge
on the treatment of asset and liabilities. Assets
and liabilities recognized under local GAAP that do
not qualify for recognition under IFRS needs to be
eliminated from the opening balance sheet. For
example, proposed dividend recognized as liability
under local GAAP can not be disclosed as liability in
IFRS. Therefore, this item should be eliminated in the
opening IFRS balance sheet.
The convergence process involves restatement of
opening balance sheet, restating balance sheet
and income statement/profit and loss account for
comparative information, and preparation of IFRS
financial statement. IFRS requires at least one year
of comparatives to present. Therefore when an entity
follows IFRS for the first time in its financial statements
for the year end 15/07/2013, it needs to give the
financial information for the year ended 15/07/2012 as
a comparative. This comparative information also needs
to comply with IFRS. Therefore the opening balance
sheet of the comparative year i.e. balance sheet as at
17/07/2011 needs to comply with IFRS. The following
diagram shows the roadmap to convergence process
from existing local GAAP to IFRS.
Opening Balance Sheet
Comparatives Information
Date of Reporting
2068/04/01
(2011/07/1)
2069/03/31
(2012/07/15)
2070/03/31
(2013/07/15)
IFRS
Impact on Financial Statements

The changeover from local GAAP to IFRS in 2012
will require Listed Public Companies to apply IFRS
to its financial statements for the reporting period
ending 2013/07/15. If the company presents only one
comparative period, the retrospective application
of IFRS means that it will restate the following for
differences between local GAAP and IFRS.
The Financial Statements for the comparative
period ending 2012/07/15 and
The Statement of Financial Position as at
2011/07/17
In its opening IFRS, Statement of Financial Position as at
2011/07/17, the company must:
Recognize all assets and liabilities required by IFRS
Derecognize all assets and liabilities not permitted
by IFRS
Classify all assets, liabilities and components of
equity in accordance with IFRS and
Measure all assets and liabilities in accordance with
IFRS
Education and Training

There has been and will continue to be a major
education and training requirement to familiarize
with IFRS the companies preparing accounts, the
auditors reporting on them and the users interpreting
them. There needs lot of preparation, training and
publicity requirements within this very short period.
Without knowing the conceptual framework of IFRS
and its proper application, the effort may be futile.
The training approach should be clear and stepwise to
understand the provisions under IFRS easily and their
practical application. Proper coordination, regular
communication and interactions within the regulators
should require for smooth convergence.
The change in financial reporting system will have
major implications not just for listed companies within
a year but also their advisers, auditors, employees,
investors as well as users of the financial statements.
Nepal Accounting Standards (NAS) developed by
Accounting Standards Board (ASB) are based on
International Accounting Standards. However, there
are some differences/changes between our NAS, also
called the National Standards with IAS/IFRS, which are
extensive and those changes will require for adjustment
at the time of convergence to make harmonization

with IFRS. Therefore, IFRS will bring significant changes
to report the Statement of Financial Position/Balance
Sheet, and Income Statement/Comprehensive Income
Statement.
To date ICAN has conducted two training programs on
IFRS to meet the timeline of 16 July 2012. The initiation
was with 5 days program from June 16-20, 2010 and the
next one was recently concluded 7days (i.e. in between
3 to 19 June 2011) certification course in IFRS with the
technical support from the ICAI. Such training programs
should continue in the days ahead to give insights
in IFRS, focusing more importantly to the corporate
accountants who have the principal responsibility to
produce financial statements.
Is IFRS applicable to all the

companies?
If we have looked the data of the registered companies
in Nepal, we found that over 98% are private limited
companies. Altogether 85,277 number of companies
were registered with the Office of the Registrar of
Companies (ROC) up to 31 Jestha 2068 (14 June 2011)
out of which 83,980 are private limited and rest 1,297
are public limited companies. From this fact, it is clear
that the substantial companies are small and privately
owned companies and system of reporting should be
relevant to their needs and understandable to the
users.
IASB has issued International Financial Reporting
Standards for SMEs (IFRS for SMEs) on 9 July 2009, which
seems more likely to the companies that are not listed
with the Stock Exchange. This would be cost effective
to them for easy implementation since IFRS for SMEs
is the simplified version of full IFRS. Full IFRS may be
inappropriate for many such companies because of the
very different reporting requirements for the users of
SMEs. The SMEs financial reports used to be the owners
themselves or the banks for making lending decisions or
monitoring loan/credit agreements.
Further, the full IFRS will be needlessly complex and
costly for small companies/enterprises. There could,
however be disclosure reductions for unlisted, small and
privately owned companies and some of the complex
measurements in full IFRS need not be imposed to
ifrs
them. IFRS for SMEs is only 230 pages as against the Full
IFRS of 2,855 pages. Thus, it is significantly reduced
and simplified version of Full IFRS and is geared toward
small and private company reporting. Full IFRS have
more than 3,000 items in the disclosure checklist
whereas roughly 10% of full IFRS disclosures i.e. 300
disclosures under IFRS for SMEs. These are some of
the justified reasons that the full IFRS is not going to
produce a usable report to such SMEs. The long-term
implications for small companies may be many more.
Hence, the Accounting Standard Board and ICAN should
coordinate and work together to implement the IFRS for
SMEs which has not more stringent provisions unlike full
IFRS.
Conclusion
The countdown to the conversion of IFRS grows ever
closer in the case of listed companies and there has
been immediate challenges facing by them. It is very
much crucial that entities/companies that maintain
the accounting records, prepares the financial
statements and accounting professionals who examines
these financial statements ensure that they have
the right skills and processes in place so that the
financial statements will be reliable. Preparers must
understand the choices and requirements under IFRS-1
in order to effectively prepare for the changeover to
IFRSs. Careful planning to avoid any surprise changes
is the most important point. Therefore, timing is
the most important and crucial factor and we should
acknowledge it. Time never wait us rather we should
follow it. Timing is essence. Well begun is half done!
ICT
Information System Audit

- An Introduction
CA. Pushpendra Singh*
Background
Organizations today, are largely
dependent upon the computerized
system for recording, processing and
storing their organizational data. From a
simplest of forms like using MS Word to
draft a business letter to sophisticated
data processing like e-banking, the
computers have a dominant presence. As
the organizations use of computerized
system grew, it also increases the
system complexity and the higher
possibility of control lapses. With the
larger dependency on computerized
systems, cases are being heard of every
now and then relating to control lapses
resulting in a hefty sum of losses to the
organization. Just imagine the volume
of loss that a bank may have to endure
where there is a system lapse in its
ATM Machine or in its Electronic Fund
Transfer and the perpetrators have the
monopoly to act upon their wish.
authorized users (Confidentiality); and

The information provided by the system would always
be accurate, reliable and on time (Integrity).
Hence, to address the above mentioned concern, the
concept of Information system audit (ISA) evolved over the
years. In simple terms, ISA is a control mechanism for those
who depend upon computerized systems for their various
organizational needs. ISA has been defined as the process of
collecting and evaluating evidence to determine whether a
computer system safeguard assets, maintains data integrity,
allows organizational goals to be achieved effectively, and
uses resources efficiently.
Computerized System of an Organization
Information Systems Auditing
Impact
Information System
Auditing
With a widespread use of computers in
an organizational workplace, there was
an inevitable need that the computer
systems installed within an organization
were immune to all sorts of deficiencies
relating to integrity and security. People
were concerned about whether or not:
The computerized systems would
be available for the business at all
times when required (Availability);
The information in the systems
would be disclosed only to
* Mr. Singh is Technical Joint Director at ICAN.
Improved Safeguarding of Assets

Improved Data Integrity
Improved System Effectiveness and Efficiency
Figure: Impact of the ISA on Organization
Objectives of ISA
ISA enables the organizations to achieve three major
objectives as per below:
l

Safeguarding of Assets
ISA has an objective of safeguarding the assets of an
organization.The information system of an organization
is a composed system of hardware, software, facilities,
people(knowledge), data files, system documentation
and supplies. As such, they are exposed to various
iCT
sorts of threats, such as, hardware getting damaged

maliciously, propriety software and the contents of
data files getting stolen etc. These assets are often
concentrated in one or smallnumber of locations,
such as a single disk. As a result, asset safeguarding
becomes an especially improtant.
l Data Integrity
Data integiry implies that the data has the attributes
of being complete, accurate, reilable and available.
Data integrity is essential for an organization in all
its decision making and operational activities. If data
integrity is not maintained, an organization no longer
has a true presentation of itself or events. Moreover,
if th integrity or an organizations data is low, it could
suffer from a loss of competitive advantage. Hence, this
prerequisite is addressed by the very objetive of ISA.
l System Effectiveness and Efficiency
Another important objective of ISA is to determine
wheter or not the installed information system within
an organization is effective and efficient. System
effectiveness implies that given system fulfills the
users needs as expected whereas an efficient infomaion
system uses minimum resources to achieve its required
objectives. Information systems consume various
resuorces: machine, time, peripherals, system software
and labor that are generally scarce and different
application systems usually compete for their use.
l

ISA Professionals
ISA is conducted by the professionals having obtained
the license of IS Auditor from the professional
institute, ISACA (Information Systems Audit and Control
Association). ISACA is an international professional
association that deals primarily with IT Governance
and is an affiliate member of International Federation
of Accountants (IFAC). ISACA currently serves more
than 95,000 members and professionals holding ISACA
certifications in more than 160 countries. ISACA offers
Certified Information Systems Auditor (CISA) as a
professional certification for ISA. Apart from ISACA,
several countries have their own ISA certifications as
well. For e.g.: India has its own Information System
Audit course that is sponsored by the Institute of
Chartered Accountants of India (ICAI).
ISA Methodology
ISA methodology is backed up by the traditional auditing
to a larger extent. The phenomenon of assessing internal
control system, identifying risk areas, gathering evidences
and their evaluation applied in traditional auditing are

also used under ISA. Further, the concept of examining
information systems with a skeptical mind, always with
a view to questioning the capability of an information
system to safeguard assets, maintain data integrity and
achieve effectiveness and efficiency in resource utilization
are also borrowed from traditional auditing.
Nepalese Perspective
There is an ever growing use of computer systems in the
Nepalese organizations. From a national level commercial
bank to a local departmental store, there is a dominant
presence of computer system used as a means of data
processing. Under such a scenario, there is an unavoidable
need for information system security, primarily:
To safeguard from the consequences of losing the data
resources;
To safeguard from the computer abuse;
To safeguard the valuable computer hardware,
software and maintain knowledgeable personnel;
To minimize the possibility of computer errors;
For the proper allocation of available resources; and
To maintain data privacy.
ISA places a systematic control on use of the computerized
systems. It is because of this very feature, ISA is required
in todays hi-tech system of office operation. However,
as of date, the regulatory system of Nepal does not have
any provision that addresses the need to conduct the ISA.
Further, there is a lack of awareness amongst the users
regarding the significance of the ISA. Except for some
commercial banks, we can hardly find any organization
having done the ISA in Nepal.
With the growing dependency on computerized system,
it is high time that the regulators introduce the statutory
provision for the mandatory conduct of ISA. To start with,
the main players of the financial systems may be mandated
to have the ISA at regular intervals. For instance, the banks
and financial institutions may be mandated to have the ISA
of their laid down systems. Then the requirement may be
stretched to the securities dealers (upon implementation
of central depository systems), insurance companies,
government organizations and so on.
There is no doubt that the computerized systems are
highly prone to security threats and we know that the loss
of the systems may harm the organizations at its worst.
Hence, there is no better preventive measure from such
losses than to conduct an ISA, before its too late.
LEADERSHIP
UNDERSTANDING ASIAN
PERSPECTIVES ON LEADERSHIP:
WESTERN THEORIES AND DIVINE GUIDANCE
Prof. Dr. Khawaja Amjad Saeed*
Email: kamjadsaeed@yahoo.com
PRELUDE
21st century is said to belong
to Asia. Currently, Europe is in
big financial problems. Several
European Union countries have
resorted to very heavy borrowing
resulting into economic difficulties,
if not collapse. Greece has suffered
a lot. Ireland is in big trouble and
European Union is struggling to
offer some bail out packages. The
struggle is on and one wonders how
long it will take before European
countries will come out of the
woods. Starting with sub-prime
crisis in USA, the economic and
financial problems assumed greater
heights. Over three hundred
banks became bankrupt. The
grand umpire of Leyman Brothers
came to a grinding halt. Enron
met with a big debacle and USA
leadership is struggling to offer
series of bail outs for financial and
economic rehabilitation of USA.
Unemployment has already reached
around 10%. Their leadership is
wondering what to do to pull USA
out of the financial crisis. As against
this backdrop, silver lining exists in Asia with high

performance of Asian Tigers, great success achieved
by Japan and recent sustainable growth of GDP of high
order in China and India with other Asian countries also
trying to perform well. The paradigm is now changing
and the landscape of Asia through their solid leadership
which is much better providing better results. In this
background, this paper presents a brief of Western
Theories of leadership which now need to be revisited
and the Divine guidance provided by God (occasionally
referred to Allah) will be presented for the readers
to explore new heights with outstanding dimension of
leadership revealed to us by Allah through Holy Prophet
(PBUH) based on guidance included in Al-Quran.
CONSTITUENTS
This paper has been divided into following parts:
Part I: Asian Scene.
Part II: Western Leadership Theories.
Part III: Divine Guidance for Leadership.
Part- IV: Leadership in Islam: Selected Dimensions.
Part V: Way Forward.
Each of the above aspects are now reviewed.
PART-I:
ASIAN SCENE
Asia is hytrogenous. Poverty levels are different. There

are varying in literacy rates. Even there are large
size populated countries like China and India having a
population of one billion people and a small country
* The author is Professor Emeritus and Principal, Hailey College of Banking & Finance, University of the Punjab,
Lahore, Pakistan.
LEADERSHIP
like Maldives having a population of around three

hundred thousand persons. Some of these countries,
are maintaining sustainable high growth rates namely;
China ( 9-11%), India (7-8%), Pakistan (around 7% on
an average of 4 years during 2003-2007 etc. Several
civilizations live in Asia. Lord Budhahs guidance on
leadership is driving many countries to achieve high
success e.g. Taiwan and Thailand etc. Confucis School
of Thought is being propagated and practiced in several
Asian countries e.g., South Korea and Singapore etc.
Leadership in India is driven by Hinduism and Jainism.
Muslim world is also scattered e.g., Indonesia, Malaysia,
Bangladesh, Pakistan, Afghanistan and Middle Eastern
countries etc. Leadership in general is influenced
by their great leaders who are playing role models.
Comparative study of these requires extensive and
independent research. However, this paper will review
basic Western Leadership Theories and also present
Divine guidance to shape the leadership styles in their
roles as effective and dynamic leaders on a comparative
basis.
The author has been greatly inspired by a message
which emanated from World Economic Forum, Davos,
Switzerland which called for a study of Inter-faith
Dialogue. With this background, this paper presents a
humble effort on initial lines to embark upon a debate
for studying the Western Theories of Leadership and
the gift of God through the last book Al-Quran revealed
by Him through the Holy Prophet (PBUH) before 1432
years.
PART II:
THEORIES
WESTERN LEADERSHIP
The concept of leadership is generally believed to

include organizing a group of people for achieving
common goals for an enterprise.
Several Western Theories alongwith the redeeming
features are summarized in Box No.1.
Box No. 1.
WESTERN LEADERSHIP THEORIES
S/No
Theories
Main Features
TRAIT THEORY
There is a comprehensive list of

traits which ought to be possessed
by a Leader. Four traits include
physical, intellectual, personal
and social. Common consensus is
on five traits namely; intelligence,
social maturity, inner-motivation,
achievement drive and human
relation attitude.
BEHAVIORAL
APPROACH
The emphasis is on the result

of effective role behaviour. The
leader is expected to have three
skills namely; Technical, Human
and Conceptual.
SITUATIONAL
APPROACH
The emphasis is on the situation

in which leadership is exercised.
Basically four factors are
important namely; cultural
environment, difference between
individuals, difference between
jobs and difference between
organizations.
ELECTIVE
APPROACH
This approach considers three

variables namely; traits of
leaders, situational variables,
types of followers. The effort is
to integrate all the above three
variables to study a leadership
pattern.
The current emphasis is on thinking, feelings & interrelationship and outward behaviour characteristics.
Some of the power bases used by leaders include:
legitimacy reward, coercion, referent and expertise.
Generally three styles of leadership are operating
namely, autocrative, participative and paternalistic.
Decision techniques include application of statistics,
optimizing models, information models and simulation.
Personal qualities of leaders for decision-making are
influenced by experience, judgment, innovation and
quantitative techniques.
PART-III: DIVINE GUIDANCE FOR

LEADERSHIP
Islamic guidance for leaders has many sources. The vital
ones are Al-Quran, the Last Revealed Book from God
and Sunnah, Seerat of Holy Prophet (PBUH). However,
for interpretation and further advice, scholars continue
to seek guidance known as Ijtehad. An extensive
research is needed for reviewing tremendous amount
LEADERSHIP
of knowledge which is available from the foregoing

sources. However, this paper is an initial effort to draw
Gods directives and guidance drawn from Al-Quran
regarding some important aspects of leadership. In
this respect, the author plans to continue research in
other areas focusing on leadership in future. This paper
has been exclusively developed from Divine guidance
included in Al-Quran.
In Al-Quran, God has stated that He sent Torah and
Gospel earlier and later sent upon Prophet Muhammad
(PBUH) Al-Quran in truth. The relevant verse in this
respect is quoted below.
He has sent upon you [ O Muhammad ], the Book
in truth, confirming what was before it. And He
revealed the Torah and Gospel. (1)
From the above Quranic verse, while recognizing the
earlier revelations through the foregoing two revealed
books, God has clearly mentioned the last Book AlQuran from which guidance for leadership is to be
sought as He emphasized that this Book is in truth.
Therefore, this paper has been developed seeking
inspiration from the Divine guidance in respect of
leadership.
PART-IV: LEADERSHIP IN ISLAM:

SELECTED DIMENTIONS
Study of leaders have several dimensions. These,
broadly speaking has multi faceted aspects Some
significant ones have been selected for developing this
paper from Al-Quran. These include:
Box No. 2:
Leadership In Islam: Selected Dimensions
S / No
Dimensions
01
Aim for the Leader
02
Leaders: Men of Understanding
03
Global Leadership
04
Leadership Maintaining Balance
05
Shaping Leaders Behaviour
06
Accountability
07
Leaders Role for Change
08
Leaders Role: Avoiding Wastage
09
A criteria for True Leadership
10
Leadership Through Consultation
11
Leaders to Rely on Allah
12
Leaders Achieving Success
13
Leaders for Anti-Hoarding Practices
14
Austerity for Guidance of Leaders
15
Leader as a Trustee
16
Verification of Information by Leader
17
Honesty as a Trait for Leader
18
Leader Born out of Command of Allah
Eighteen dimensions have been identified with twenty

four citations from Al-Quran. These are reviewed with
brief commentary now.
Dynamic and forward looking role from managerial
angle has been spelled out by God in Al-Quran by giving
candid emphasis in respect of the following:
1:
AIM FOR THE LEADER
God encourages that a leader must have a clear cut

aim so that he spells out his vision and mission for the
guidance of his followers. Inspiration in this respect has
been drawn the following verse:
And We did not create the heaven and the earth
and that between them aimlessly. That is the
assumption of those who disbelieve, so woe to those
who disbelieve from the Fire. (2)
2:
LEADERS - MEN OF UNDERSTANDING
The quality of understanding of a leader is a

prerequisite from Gods viewpoint. Indeed, He has
promised to give wisdom to such people. In this respect,
relevant verse from Al-Quran is quoted below:
He gives wisdom to whom He wills, and whoever
has been given wisdom has certainly been given
much good. And none will remember except those of
understanding.(3)
3:
GLOBAL LEADERSHIP
God has emphasized that there should be a nation in

the world who should invite people to undertake all
such steps which are right and forbids them what are
wrong. Accordingly, if this spirit is implemented by
national leadership, success will follow.
In this respect, relevant verse from Al-Quran is quoted
below:
LEADERSHIP
And let there by (arising) from you a nation

inviting to (of that is) good, enjoying what is right
and forbidding what is wrong, and those will be
successful. (4)
Based on the above verse, it is clear that there is a
Divine guidance for establishing organizational aspects
for encouraging and persuading people across the board
to implement all actions which are in the right direction
and demotivate people by forbidding them not to resort
to wrong actions. A leaders role is significant in this
dimension.
4:
LEADERSHIP MAINTAINING BALANCE
God has guided us to maintain a balance during our

behaviour as a leader. This ought to be reflected in
decision-making roles by a leader. In this respect,
relevant verse from Al-Quran is quoted below:
And the heaven He raised and imposed the
balance. That you not transgress within the
balance.
And establish weight in justice and do not make
deficient the balance. (5)
5:
SHAPING LEADERS BEHAVIOUR
God has guided the one who fears from Him. According
to many scholars, if this spirit is indoctrinated in the
leader and subsequently reflected in the behaviour of
followers, the outcomes will be very positive namely;
self-control, no frauds, no corruption, no act of
immorality, healthy life and rational behaviour. Indeed,
fear of God is a Panacea for several ills which we find
in the society. In this respect, relevant verse from AlQuran is quoted below:
And remember the favour of Allah upon you
and His covenant with which He bound you when
you said, We hear and we obey, and fear
Allah Indeed, Allah is knowing of that within the
breasts. (6)
6:
ACCOUNTABILITY
Self-accountability has been encouraged in Islam. The

foundation of this is a belief in Hereinafter. In several
Quranic verses God has stated that every action / deed

which is performed by anyone (whether good or bad)
is being recorded and accounted for. Moreover, on the
Day of Judgment, balance sheet in this respect will be
transparently presented by God to everybody. God has
stated that on the above Day of Judgment, mouth will
be sealed, the hands will speak to God of whatever
actions were taken in the past and the feet will stand
testimony to what had been done in the life time by an
individual.
In respect of the above two thoughts namely; proper
accounting and presentation of balance sheet, two
relevant verses from Holy Quran are quoted below:
So whoever does an atoms* weight of good will see
it. And whoever does an atoms weight of evil will
see it. (7) (* or weight of small ant )
That Day, we will seal over their mouths, and their

hands will speak to Us, and their feet will testify
about what they used to earn. (8)
Another verse from Al-Quran in respect of guidance of
self-accountability is quoted below:
For each [ religious following ] is a [ prayer ]
direction toward which it faces. Source to [ all that
is ] good. Wherever you may be. Allah will bring you
forth [ for judgment ] all together. Indeed, Allah is
over all things competent. (9)
Another verse from Al-Quran is also quoted below:
To Allah is your return . He [ i.e. Allah ] knows
what they conceal and what they reveal Indeed,
He is knowing of that within the breasts All is in a
clear register. (10)
7: LEADERS ROLE FOR CHANGE
A leader is expected to serve as a catalyst for change.
Rather than living with status-quo, improvements and
innovation only follow if change is introduced. A leader
must prepare the followers, in this respect, and seek
guidance from Allah. In this respect, relevant verse
from Al-Quran is quoted below:
LEADERSHIP
Indeed, Allah will not the change the

condition of a people until they change what is in
themselves. (11)
Based on above, leadership role in transformation will
be the outcome.
8:
LEADERS ROLE: AVOIDING WASTEGE
One major cause of loss in business and industry is

waste. There is a tremendous scope of eliminating and
uprooting the causes of wastage which can beef up
bottom line of an enterprise. Wasteful practices are
anti-productivity and reduce profits. There is a Divine
guidance to leaders to ensure that a framework is
developed whereby wastage is avoided. In this respect,
two verses from Al-Quran are quoted below:
And give the relative his right, and [ also ] the poor
and the traveler, And do not spend wastefully (12)
Indeed, the wasteful are brothers of the devils, and

ever has Satan been to his Lord ungrateful. (12)
Accordingly, the zero defect philosophy is borne out of
above.
9:
A CRITERIA FOR TRUE LEADERSHIP
Allah likes leaders who are the most righteous ones.

This is a singular criteria spelled out by Him in AlQuran. Accordingly, the liking of Allah is not being extra
rich or dirty rich who plunder wealth and accumulate it
through wrongful methods. Quranic vers in this respect,
is quoted below:
O mankind, indeed We have created you from male
and female and made you peoples and tribes that
you may know one another. Indeed, the most noble
of you in the sight of Allah is the most Righteous of
you. Indeed, Allah is Knowing and Acquainted. (13)
Based on the above spirit, God promises to raise some
above the others in their ranks as they emerge as
outstanding leaders. In this respect, relevant verse from
Al-Quran is quoted below:
And have raised some of them above others in

degrees [of rank] that they may make use of one
another for service. (14)
10: LEADERSHIP THROUGH

CONSULTATION
Rather than behaving in dictatorial / authoritative
style, Allah encourages the leaders to resort to
consultation. Accordingly, Consultative Management is
in accordance with the Islam. In this respect, relevant
verse from Al-Qurah is quoted below:
So pardon them and ask forgiveness for them
and consult them in the matter. And when you have
decided, then rely upon Allah. Indeed, Allah loves
those who rely [ upon Him ]. (15)
11:
LEADERS TO RELY ON ALLAH
Allah encourages lenient behaviour rather than dealing

followers with rudeness. He encourages people to rely
upon Him. Therefore, the believers are encouraged
to inculcate the spirit in them so that favour of Allah
may be showered on them through His blessings. In this
respect, relevant verse from Al-Quran is quoted below:
So by mercy from Allah, [ O Muhammad ], you
were lenient with them. And if you had been rude
[ in speech ] and harsh in heart, they would have
disbanded from about you. So pardon them and ask
forgiveness for them and consult them in the matter.
And when you have decided, then rely upon Allah.
Indeed, Allah loves those who rely [ upon Him ].
(16)
12:
LEADERS ACHIEVING SUCCESS
Allah encourages leaders to obey Him and to obey his

Messenger (Prophet Muhammad) (PBUH) and those
in authority among you. However, in case of any
disagreement over anything, He directs leaders to refer
the matter to Allah and His Messenger by believing in
Him and Day of Judgment. Accordingly, He promises
the achievement of the best results. In this respect,
relevant Quranic verse is quoted below:
LEADERSHIP
O you who have believed, obey Allah and obey the

Messenger and those in authority among you. And if
you disagree over anything, refer it to Allah and the
Messenger, of you should believe in Allah and the
Last Day. That is the best [ way ] and best in result.
(17)
In another Quranic verse, He has directed leaders that,
for achieving success in life, the prerequisite is that one
should believe in Allah and fear Him and always seek
the mean of requesting His favours and blessings. In this
O you who have believed, fear Allah and seek the
means [of nearness] to Him and strive in His cause
that you may succeed.(18)
13: LEADERS FOR ANTI-HOARDING

PRACTICES
Malpractices in business generally occur from hoarding
of goods. Free interplay of demand and supply is not
allowed to function properly. Consequently, there is
social destabilization. Inflation is caused and social evils
continue to grow. Allah has warned painful punishment
for those who resort to hoarding of goods. In this
And those who hoard gold and silver and spend
it not in the way of Allah give them tidings of a
painful punishment. (19)
14: AUSTERITY FOR GUIDANCE OF

LEADERS
Austerity management has been advocated by Allah.
Conspicuous consumption is totally discouraged and
leaders are directed to follow guidance on spending as
per following Quranic verse:
And they ask you what they should spend. Say,
The excess [beyond needs]. (20)
15:
Leader as a Trustee
A leader is expected to behave like a trustee on behalf

of beneficiaries and also inculcate this spirit amongst
his followers. The malpractices of grabbing, plundering,
looting others wealth / property, specially that of

orphans, is a misdirected action and is forbidden by
Divine advice contained in the following verse of AlQuran:
And do not approach the orphans property except
in a way that is best [ i.e. intending improvement ]
until he reaches maturity. And give full measure and
weight in justice. We do not charge any soul except
[ with that within ] its capacity. And when you speak
[ i.e. testify ], be just, even if [ if concerns ] a near
relative. And the covenant of Allah fulfill. This has
He instructed you that you may remember. (21)
16: VERIFICATION OF INFORMATION BY

LEADER
A leader is expected to verify the information before
sharing it with his followers. This can lend credibility
to his stature and pave the way for compliance. In this
respect, verse from Al-Quran is quoted below:
And do not pursue that of which you have no
knowledge. Indeed, the hearing, the sight and the
heart about all those [ one ] will be questioned.
(22)
17:
HONESTY AS A TRAIT FOR LEADER
Several traits have been stressed as an integral part for

a leader. Amongst them, Allah has identified honesty
as a singular trait to be possessed by leaders. In this
And weigh with an even [i.e. honest] balance. (23)
18: LEADER BORN OUT OF COMMAND

OF ALLAH
A leader is required to follow Command of Allah and be
inspired by His guidance. In this respect, relevant verse
from Al-Quran for compliance is quoted below:
And We made them leaders guiding by Our

Command. And We inspired to them the doing of
good deeds, establishment of prayer, and giving of
Zakah; and they were worshippers of Us. (24)
LEADERSHIP
PART-V: WAY FORWARD

While lot of literature exists on Western Theories of
leadership, a humble effort has been made in this paper
to present Divine guidance given before 1432 years
governing the behaviour, traits, approach, dimensions,
roles etc. from God contained in the last Book Al-Quran
revealed by Him. This paper can serve the spirit of
Interfaith Dialogue so that the Western Scholars may
get enlightened regarding the message of God and try
to reflect on various ideas shared in this paper straight
from the Holy Book, Al-Quran.
Accordingly, dialogue and debate can continue for
improving the overall role of leaders in their decisionmaking styles for the betterment of followers to
achieve high performance and help accomplish vision
and mission of an enterprise.
NEGOTIATION
SUCCESSFUL BUSINESS NEGOTIATION

CA. HARI KUMAR SILWAL*
Meaning of negotiation
Negotiation is a technique and a
process used by almost every person
or organization to ease a so-called
difficult situation aiming for a winwin outcome through a joint effort
of the parties.
Negotiation is a discussion between
two or more parties/disputants who
are trying to work out solution to
their deals/problems.
Negotiation:
i. Is a communication process
ii. Is to put deal together or
resolve the conflicts
iii. Is a voluntary exercise
iv. Is a non-binding process
v. Allows parties retain control
over outcome and procedure
vi. Has possibility of wide range of
solutions
vii. Has possibility of maximizing
joint gains
Negotiation as one of
the ADR tools
Alternative Dispute Resolution (ADR)
is a method of solving dispute,
which, by its name, says that it is
different from conventional method
of solving dispute like litigation and
court cases. Under ADR, disputes are settled through

counseling and mutual discussion. Parties to the dispute
and their people look for alternatives and options
jointly and move forward towards positive conclusion.
ADR has the following main tools/methods where
negotiation is one of the most common one:
i. Arbitration,
ii. Conciliation,
iii. Mediation,
iv. Mini trial and
v. Negotiation
Are we negotiators?
President of the USA late Mr. John F. Kennedy once
rightly said never fear to negotiate, never negotiate
out of fear. Many people hesitate to negotiate issues/
deals that has been pending for long time. They are not
aliens who negotiate international political conflicts,
trade and patent/ copyright disputes, hostages,
border issues etc. Despite the time taken, most of the
physical, political and legal fights have been solved
through negotiation. Those negotiations are done by
those who came up and said its too much to fight. We
all are losing for nothing, why not look into the issue
from a different angle in a positive way. Those who
dared to work with the opponents and, not against
them are the negotiators. They might have negotiated
for themselves, their own organizations or states or for
someone else. We can also be negotiator provided we
have certain attributes and knowledge. We need to be
more positive and empathetic to be a negotiator. We
become negotiator mainly from one of the following
three ways:
* Mr. Silwal is CA. member of ICAN.
NEGOTIATION
iii. Another type of negotiator is developed through

formal training and education. This happens more
through keen interest and intention of the person
to do negotiation. They start learning to negotiate
through formal training and education and develop
a solid skill and modulate their personality to suit to
be negotiator.
However, those who are born negotiator or negotiator
through socialization also benefit from formal education
and training on negotiation skills. These educations are
available in hundreds of law and management schools
and study and research centers worldwide. Lately,
we in Nepal are also privileged to have some courses
included in university programs and also some training
is available.
There are mainly five kinds of negotiators from
personality point of view. Putting it in other way
negotiators personality according to their attitude is of
five types as follows:
i. Avoider
ii. Accommodator
iii. Competitor
iv. Compromiser and
v. Collaborator
Value of issue
Compromise
Need for Justice
ii. There are some other people whose personality,

originally, was not of the type required to be
a negotiator. However, with time and through
informal learning and socialization they get to learn
to negotiate. They attempt to solve disputes and
strike deals through negotiation. They might also
have some role models.
Collaborate
Complete
Achievement of own intrest
i. Some people are borne negotiator. They have such

personal attributes and attitude that they take up
every issue being faced by them in a positive way
and they attempt to solve them jointly with the
other side. They have that patience.
Accommodate
Avoid
Value of Relationship
Importance palced on mercy
Response to others Interest
The above diagram is developed by Pepperdine

University Institute of Dispute Resolution. Out of the
above mentioned five types of negotiator, collaborator
is the best type suited to negotiate. They value for
relationship. They give utmost importance to the issue
and relationship, justice and mercy, their own interest
and the interest of others. This may look impossible
but creative thinking and positive effort may take a
person to the level where we find collaboration. The
collaborator works with the opposite party to find ways
both parties can achieve their goals. For this one has
to look beyond the issues and the limitations within
which generally every negotiator looks in to. They have
to brainstorm new ways. It requires lot of exercise,
patience, deep insight and creative thinking to solve
the problem.
We can achieve through competition but will not give a
lasting relationship. Various inventories are available to
test our personality type from negotiation point of view.
We can modify our type through learning if we do not
fall under the appropriate one.
Negotiation more useful in business

than other fields
For the following reasons negotiation is more effective
and useful in the field of business- trade, commerce,
industry, finance, joint venture, contract, deals, project
development, multinationals etc.:
i. Business organizations need quicker resolution of
dispute.
NEGOTIATION
ii. Various deals including partnership, joint venture

and contracts can be made through negotiation.
iii. Courts mostly refer business disputes for arbitration
and mediation where negotiation is the means of
resolution.
iv. Disputes resolved though negotiation will help save
relationship which is a basis of success in business.
v. Effect of disputes in business is more prominent and
expensive than any other area.
Few mantras for negotiation

success:
i. Come out of myths
To negotiate successfully we should come out of myths

and mystery of negotiating. One should take a positive
view of negotiating and toss away the myths he/she has
created about the process. It has theories that can be
learnt and be taught.
ii. Have real knowledge and skills

To get success in negotiation a person should:
a. Have good communication skill
b. Be emotionally intelligent
c. Know negotiation process and tactics
d. Have knowledge of the subject
e. Be honest and show it
f. Be empathetic and show it
g. Be able to align with organizational goals
h. Recognize barriers and form coalition
i. Be reliable and trustworthy
j. Be both logical and emotional
k. Be persuasive and accepting of others
l. Be single minded, persistent and present
m. Be positive, patient, placid and prepared.
n. Use powerful words like responsibility, love,
benefit, health, money, safety, result, saving, proof,
invention, comfortable
o. Put people first and separate people from the
problem
iii. Find out the driving factors

To make a successful and result oriented negotiation
parties there to must be able to find out driving factors
of both/all the sides. Factors that drive one party need
not be the same to another. It might differ. Knowing
the driving factor of oneself helps him/her to set a
goal and process and knowing that of others helps him/
her to understand others goal. Through this chances of
settling the deal or dispute with win-win outcome will

be higher.
iv. Interest differs- satisfy both/ all if possible:

Negotiators success objectively lies in satisfying
opponents interest without putting himself /herself in
loss. When a person can make opponent happy without
making himself unhappy or other way round, he/she
is the must successful negotiator. We should be able
to understand the fact that not every one wants same
thing out of every deal. Other side's benefit is not
always our loss. Whole success lies in finding out own
and opponent's core interest and the area where both
can be met.
v. Recognize role players and handle them well

Formally or informally various people play roles
in negotiation process and its success. Some are
members of negotiating team and some others are
outsiders. Many of them are hidden too. All the
stakeholders of a business organization play some role
in negotiators success or failure. A lead negotiators
second, the scribe, number person, hangers on,
agents, constituents, bystanders, audiences etc. are
the ones who play vital roles sometimes or other. A
smart negotiator is the one who rightly understands the
existence of such outsiders and its affect on negotiation
process and also manages them with appropriate use
for the benefit of him and sustainable outcome. Even
a personal secretary of other party might play a vital
role in success or failure of a multi-billion business
negotiation. Do not underestimate them.
vi. Home work and prepare well

Before setting foot in every negotiation or an episode
of it we should prepare well. It must be in writing
and structured. Along with other things it must
include possible concession to offer and expect,
reservation price, walk away situations, ZOPA (zone
of possible agreement), BATNA (best alternative to a
negotiated agreement), WATNA (worst alternative to a
negotiated agreement), interests, alternatives, options,
legitimacy, relationship, commitment etc. Preparation
should address what do we and others want, how far
expectations are realistic and also how to achieve
them. Some people do not prepare just because they
think that it consumes a lot of time or they dont
know how to prepare or they think that just starting
NEGOTIATION
to talk do not need preparation. This is not true, it is

dangerous to do anything with out preparation, more in
case of negotiation. It helps us save our self if not gain
more.
vii. Learn to say no positively

Success in negotiation is not only saying yes to each and
every offer of other side. We need to be very cautious
in saying yes or nodding to any offer. We must evaluate
cause and effect of every proposal put forward by
opponent and its acceptance, if at all we give it. We
must be very particular about execution of a promise
made. It is better to say No than saying Yes and
not fulfilling it. More in case of business, if we sign
a contract but do not execute as promised or breach
them we will be penalized. It is better we say no in
advance. While saying No when it is wiser to do so, we
should do it in a positive way. A positive no is the one
that has appositive purpose and positive way of saying
it. A positive No has great capacity of saving our
valuable relationship.
viii. Use appropriate strategy

There could be various tactics and styles that can be
followed in negotiation. Reciprocity, silence, apology,
praising, good cop/bad cop, third party mandate,
bluffing etc. are some of the tactics. There are certain
styles of negotiation. Win-win and win-lose are two
main styles in use. What style to chose depends up on
our objective. Mainly in a situation where we value
relationship and look for long term benefit like in joint
venture, hydro projects, consortium etc. we should
go for win-win approach where in one time deal kind
of negotiation we can opt for win-lose style also.
Negotiation is about joint gain. Instead of distributing
a certain piece of object it is better to enlarge it and
satisfy all the sides. It is also called co-operative or
collaborative style.
ix. Keep, keep and keep

Many obstacles and hurdles are faced in negotiation
process. Deadlock is quite common in negotiation. We
must prepare our self to tackle and solve all of them.
More in case of negotiating complicated business deals
and disputes we face more challenges. Parties are
already in pressure and severe stress. Hence, they can
not understand what is good for them. Sometimes, they
tend to forget their own position and interest. Instead
of solving the problem they rather worsen the situation

and spoil the deal and relationship. A professional
negotiator, despite these hurdles must keep his/her
aspirations up and keep going. With due process, smart
dealing, awareness and continuous effort one can reach
a destination of solving the dispute or making deal with
win-win outcome.
x. Re-negotiate if failed
Its not that every negotiation gives a desired result.
Some situations are such that negotiations face
deadlock or no deal. Some times for various reasons we
need to pause the deal for certain while. This could be
a matter of strategy or tactics in some cases. This halt
may be a short or long one. It may happen due to us or
other side. Whatever may be the type or reason of halt/
deadlock there is always a scope of re-negotiation. The
party who attempts to re-negotiate should be careful
about maintaining momentum and should not make
other side fell that you are in hurry.
xi. Satisfy yourself with outcome

Every thing has its limit. In negotiation we always carry
high aspirations, in fact we should. At the some time it
should be realistic and sustainable. We dont or should
not agree on same terms of dispute or deal that are
not possible to fulfill. Once we reach a level of win-win
we should strike the deal or conclude the difference.
After exercising all possible strategies, tools and tactics
whatever result comes out we should satisfy our self
with the same. Lack of satisfaction from ones own
deed creates a negative cycle that will negatively affect
future of the deal. To make negotiation a success we
should satisfy our self with the outcome.
xii. Make the promises happen

Negotiation is said to have ended with a desirable
conclusion for both the sides. This is not true. When
a deal is concluded or dispute is resolved through
negotiation parties there to must fulfill the promises
made by them. All the terms and conditions agreed up
on must be fulfilled. The true success of negotiation lies
not only on agreement but on execution of promises
by the parties. If any of the parties doesnt make
promises happen, be it financial or otherwise, there
will be relapse and difference will be more critical
and counterproductive than before. Parties will start
NEGOTIATION
charging each other for the same. Relationship will

more sour than before. They will become prejudiced.
We must be well aware about intention and capacity to
fulfill the promises of our self and also the other side.
Conclusion
Negotiation is an art because there is always a role of
personal soft skills and attitude of negotiator in its
success and is also a science to some extent because
there are certain processes with its cause and effect.
When we face a different situation, be it a deal or
dispute, we may attempt to negotiate. If we think that
we are not capable of doing so we can take professional
or personal support of expert negotiator. While working
with them we can learn to negotiate. Socialization and

formal education and training will make difference.
Businessmen need this skill more than any other
people. By negotiating they can save time, money and
relationship. It will be helpful for them in the areas like
HR, contract, procurement, sales, partnership, joint
venture, dispute resolution etc. This is the skill that
makes a person a better human being otherwise also.
This is so effective for the professionals like doctors,
engineers, lawyers, accountants, IT experts, tutors and
coaches, scientists and researchers mostly to handle
their clients and their associates. Undoubtedly, it helps
every person to live todays complicated life easier.
Nepal standard on auditing 705

Modifications to the opinion in the independent
auditors report
(Effective for audits of financial statements for periods beginning on
or after announcement by ICAN in recommendation of AuSB)
CONTENTS
Introduction
Paragraph
Scope of this NSA
Types of Modified Opinions
Effective Date
Objective
Definitions
Requirements
Circumstances When a Modification to the Auditors Opinion is Required
Determining the Type of Modification to the Auditors Opinion
715
Form and Content of the Auditors Report When the Opinion is Modified
1627
Communication with Those Charged with Governance
28
Application and Other Explanatory Material

A1
Nature of Material Misstatements
A2A7
Nature of an Inability to Obtain Sufficient Appropriate Audit Evidence
A8A12
Consequence of an Inability to Obtain Sufficient Appropriate Audit Evidence Due to a

Management-Imposed Limitation after the Auditor Has Accepted the Engagement
A13A15
Other Considerations Relating to an Adverse Opinion or Disclaimer of Opinion
A16
Form and Content of the Auditors Report When the Opinion is Modified
A17A24
Communication with Those Charged with Governance
A25
Appendix: Illustrations of Auditors Reports with Modifications to the Opinion
Nepal Standard on Auditing (NSA) 705 Modification to The Independent Auditors Report
should be read in conjunction with NSA 200, Objectives and General Principle Governing an
Audit of Financial Statements.
Introduction
financial statements as a whole are free from

material misstatement.
Scope of this NSA
1. This Nepal Standard on Auditing (NSA) deals with

the auditors responsibility to issue an appropriate
report in circumstances when, in forming an opinion
in accordance with NSA 700,1 the auditor concludes
that a modification to the auditors opinion on the
financial statements is necessary.
Definitions
2. This NSA establishes three types of modified

opinions, namely, a qualified opinion, an adverse
opinion, and a disclaimer of opinion. The decision
regarding which type of modified opinion is
appropriate depends upon:
5. For purposes of the NSAs, the following terms have

the meanings attributed below:
a) Pervasive - A term used, in the context of
misstatements, to describe the effects on the
financial statements of misstatements or the
possible effects on the financial statements of
misstatements, if any, that are undetected due
to an inability to obtain sufficient appropriate
audit evidence. Pervasive effects on the
financial statements are those that, in the
auditors judgment:
a) The nature of the matter giving rise to the

modification, that is, whether the financial
statements are materially misstated or, in
the case of an inability to obtain sufficient
appropriate audit evidence, may be materially
misstated; and
i) Are not confined to specific elements,

accounts or items of the financial statements;
ii) If so confined, represent or could represent

a substantial proportion of the financial
statements; or
b) The auditors judgment about the pervasiveness

of the effects or possible effects of the matter
on the financial statements. (Ref: Para. A1)
iii) In relation to disclosures, are fundamental to

users understanding of the financial statements.
Effective Date
3. This NSA is effective for audits of financial
statements for periods beginning on or after
announcement by ICAN in recommendation of AuSB.
Objective
4. The objective of the auditor is to express clearly
an appropriately modified opinion on the financial
statements that is necessary when:

a)The auditor concludes, based on the audit

evidence obtained, that the financial statements
as a whole are not free from material
misstatement; or
b) The auditor is unable to obtain sufficient

appropriate audit evidence to conclude that the
b) Modified opinion A qualified opinion, an adverse

opinion or a disclaimer of opinion.
Requirements
Circumstances When a Modification to the Auditors
Opinion Is Required
6. The auditor shall modify the opinion in the auditors
report when:
a) The auditor concludes that, based on the audit
evidence obtained, the financial statements as a
whole are not free from material misstatement;
or (Ref: Para. A2A7)
appropriate audit evidence to conclude that the
financial statements as a whole are free from
material misstatement. (Ref: Para. A8A12)
1 NSA 700The Independent Auditors Report on a Complete Set of General Purpose Financial Statements.
Determining the Type of

Modification to the Auditors
Opinion
Qualified Opinion
7. The auditor shall express a qualified opinion when:
a) The auditor, having obtained sufficient
appropriate audit evidence, concludes that
misstatements, individually or in the aggregate,
are material, but not pervasive, to the financial
statements; or


appropriate audit evidence on which to base
the opinion, but the auditor concludes that the
possible effects on the financial statements
of undetected misstatements, if any, could be
material but not pervasive.
Adverse Opinion
8. The auditor shall express an adverse opinion when
the auditor, having obtained sufficient appropriate
audit evidence, concludes that misstatements,
individually or in the aggregate, are both material
and pervasive to the financial statements.
Disclaimer of Opinion
9. The auditor shall disclaim an opinion when the
auditor is unable to obtain sufficient appropriate
audit evidence on which to base the opinion,
and the auditor concludes that the possible
effects on the financial statements of undetected
misstatements, if any, could be both material and
pervasive.
10. The auditor shall disclaim an opinion when,
in extremely rare circumstances involving
multiple uncertainties, the auditor concludes
that, notwithstanding having obtained sufficient
appropriate audit evidence regarding each of the
individual uncertainties, it is not possible to form
an opinion on the financial statements due to the
potential interaction of the uncertainties and
their possible cumulative effect on the financial
statements.
Consequence of an Inability to Obtain Sufficient

Appropriate Audit Evidence Due to a ManagementImposed Limitation after the Auditor Has Accepted the
Engagement
11. If, after accepting the engagement, the auditor
becomes aware that management has imposed a
limitation on the scope of the audit that the auditor
considers likely to result in the need to express a
qualified opinion or to disclaim an opinion on the
financial statements, the auditor shall request that
management remove the limitation.
12. If management refuses to remove the limitation
referred to in paragraph 11, the auditor shall
communicate the matter to those charged with
governance, unless all of those charged with
governance are involved in managing the entity,2
and determine whether it is possible to perform
alternative procedures to obtain sufficient
appropriate audit evidence.
13. If the auditor is unable to obtain sufficient
appropriate audit evidence, the auditor shall
determine the implications as follows:

a) If the auditor concludes that the possible effects

on the financial statements of undetected
misstatements, if any, could be material but not
pervasive, the auditor shall qualify the opinion;
or
b) If the auditor concludes that the possible effects

on the financial statements of undetected
misstatements, if any, could be both material
and pervasive so that a qualification of the
opinion would be inadequate to communicate
the gravity of the situation, the auditor shall:
(i) Withdraw from the audit, where practicable and

possible under applicable law or regulation; or
(Ref: Para. A13A14)
(ii) If withdrawal from the audit before issuing the

auditors report is not practicable or possible,
disclaim an opinion on the financial statements.
2 NSA 260, Communication of Audit Matters with Those Charged with Governance, paragraph 13.
14. If the auditor withdraws as contemplated by

paragraph 13(b)(i), before withdrawing, the
auditor shall communicate to those charged with
governance any matters regarding misstatements
identified during the audit that would have given
rise to a modification of the opinion. (Ref: Para.
A15)
Other Considerations Relating to an Adverse Opinion or
15. When the auditor considers it necessary to express
an adverse opinion or disclaim an opinion on the
financial statements as a whole, the auditors
report shall not also include an unmodified opinion
with respect to the same financial reporting
framework on a single financial statement or one
or more specific elements, accounts or items of a
financial statement. To include such an unmodified
opinion in the same report3 in these circumstances
would contradict the auditors adverse opinion or
disclaimer of opinion on the financial statements as
a whole. (Ref: Para. A16)
Form and Content of the Auditors

Report When the Opinion Is Modified
Basis for Modification Paragraph
16. When the auditor modifies the opinion on the
financial statements, the auditor shall, in addition
to the specific elements required by NSA 700,
include a paragraph in the auditors report that
provides a description of the matter giving rise
to the modification. The auditor shall place
this paragraph immediately before the opinion
paragraph in the auditors report and use the
heading Basis for Qualified Opinion, Basis for
Adverse Opinion, or Basis for Disclaimer of
Opinion, as appropriate. (Ref: Para. A17)
17. If there is a material misstatement of the financial
statements that relates to specific amounts in
the financial statements (including quantitative
disclosures), the auditor shall include in the

basis for modification paragraph a description
and quantification of the financial effects of the
misstatement, unless impracticable. If it is not
practicable to quantify the financial effects, the
auditor shall so state in the basis for modification
paragraph. (Ref: Para. A18)
statements that relates to narrative disclosures, the
auditor shall include in the basis for modification
paragraph an explanation of how the disclosures are
misstated.
statements that relates to the non-disclosure of
information required to be disclosed, the auditor
shall:

a) Discuss the non-disclosure with those charged

with governance;
b) Describe in the basis for modification paragraph

the nature of the omitted information; and
c) Unless prohibited by law or regulation,

include the omitted disclosures, provided it
is practicable to do so and the auditor has
obtained sufficient appropriate audit evidence
about the omitted information. (Ref: Para. A19)
20. If the modification results from an inability to

obtain sufficient appropriate audit evidence, the
auditor shall include in the basis for modification
paragraph the reasons for that inability.
21. Even if the auditor has expressed an adverse
opinion or disclaimed an opinion on the financial
statements, the auditor shall describe in the basis
for modification paragraph the reasons for any other
matters of which the auditor is aware that would
have required a modification to the opinion, and
the effects thereof. (Ref: Para. A20)
3 NSA 805- Being Drafted, Special ConsiderationsAudits of Single Financial Statements and Specific Elements, Accounts or Items of a Financial
Statement, deals with circumstances where the auditor is engaged to express a separate opinion on one or more specific elements, accounts
or items of a financial statement.
Opinion Paragraph
22. When the auditor modifies the audit opinion, the
auditor shall use the heading Qualified Opinion,
Adverse Opinion, or Disclaimer of Opinion, as
appropriate, for the opinion paragraph. (Ref: Para.
A21, A23A24)
23. When the auditor expresses a qualified opinion
due to a material misstatement in the financial
statements, the auditor shall state in the opinion
paragraph that, in the auditors opinion, except for
the effects of the matter(s) described in the Basis
for Qualified Opinion paragraph:

a) The financial statements present fairly, in all

material respects (or give a true and fair view)
in accordance with the applicable financial
reporting framework when reporting in
accordance with a fair presentation framework;
or
b) The financial statements have been prepared,
in all material respects, in accordance with the
applicable financial reporting framework when
reporting in accordance with a compliance
framework.
When the modification arises from an inability to obtain

sufficient appropriate audit evidence, the auditor shall
use the corresponding phrase except for the possible
effects of the matter(s) ... for the modified opinion.
(Ref: Para. A22)
24. When the auditor expresses an adverse opinion, the
auditor shall state in the opinion paragraph that, in
the auditors opinion, because of the significance
of the matter(s) described in the Basis for Adverse
Opinion paragraph:

a) The financial statements do not present fairly

(or give a true and fair view) in accordance with
the applicable financial reporting framework
when reporting in accordance with a fair
presentation framework; or
b) The financial statements have not been

prepared, in all material respects, in accordance
with the applicable financial reporting
framework when reporting in accordance with a
compliance framework.
25.
When the auditor disclaims an opinion due to an
inability to obtain sufficient appropriate audit evidence,
the auditor shall state in the opinion paragraph that:
Because of the significance of the matter(s) described
in the Basis for Disclaimer of Opinion paragraph,
the auditor has not been able to obtain sufficient
appropriate audit evidence to provide a basis for an
audit opinion; and, accordingly,
The auditor does not express an opinion on the financial
statements.
Description of Auditors Responsibility When the Auditor
Expresses a Qualified or Adverse Opinion
26.
When the auditor expresses a qualified
or adverse opinion, the auditor shall amend the
description of the auditors responsibility to state that
the auditor believes that the audit evidence the auditor
has obtained is sufficient and appropriate to provide a
basis for the auditors modified audit opinion.
Description of Auditors Responsibility When the Auditor
Disclaims an Opinion
27.
When the auditor disclaims an opinion due to an
inability to obtain sufficient appropriate audit evidence,
the auditor shall amend the introductory paragraph
of the auditors report to state that the auditor was
engaged to audit the financial statements. The auditor
shall also amend the description of the auditors
responsibility and the description of the scope of the
audit to state only the following: Our responsibility
is to express an opinion on the financial statements
based on conducting the audit in accordance with
International Standards on Auditing. Because of the
matter(s) described in the Basis for Disclaimer of
Opinion paragraph, however, we were not able to
obtain sufficient appropriate audit evidence to provide
a basis for an audit opinion.
Communication with Those Charged

with Governance
28. When the auditor expects to modify the opinion in
the auditors report, the auditor shall communicate
with those charged with governance the
circumstances that led to the expected modification
and the proposed wording of the modification. (Ref:
Para. A25)
***
Application and Other Explanatory Material
Types of Modified Opinions (Ref: Para. 2)

A1. The table below illustrates how the auditors
judgment about the nature of the matter giving
rise to the modification, and the pervasiveness
of its effects or possible effects on the financial
statements, affects the type of opinion to be
expressed.
Nature of Matter
Giving
Rise to the
Modification
Auditors Judgment about the

Pervasiveness of the
Effects or Possible Effects on the
Financial
Statements
as a whole are free from material misstatement.4

This conclusion takes into account the auditors
evaluation of uncorrected misstatements, if any,
on the financial statements in accordance with NSA
450.5
A3. NSA 450 defines a misstatement as a difference
between the amount, classification, presentation,
or disclosure of a reported financial statement
item and the amount, classification, presentation,
or disclosure that is required for the item to be in
accordance with the applicable financial reporting
framework. Accordingly, a material misstatement of
the financial statements may arise in relation to:

a) The appropriateness of the selected accounting

policies;
b) The application of the selected accounting

policies; or
c) The appropriateness or adequacy of disclosures

in the financial statements.
Appropriateness of the Selected

Accounting Policies
A4. In relation to the appropriateness of the accounting
policies management has selected, material
misstatements of the financial statements may arise
when:
Material but
Not
Pervasive
Material and
Pervasive
Financial statements are

materially misstated
Qualified opinion
Adverse opinion
Inability to obtain
sufficient appropriate
audit evidence
a) The selected accounting policies are not

consistent with the applicable financial reporting
framework; or
Qualified opinion
Disclaimer of
opinion
b) The financial statements, including the

related notes, do not represent the underlying
transactions and events in a manner that
achieves fair presentation.
Nature of Material Misstatements

(Ref: Para. 6(a))
A2. NSA 700 requires the auditor, in order to form an
opinion on the financial statements, to conclude
as to whether reasonable assurance has been
obtained about whether the financial statements
A5. Financial reporting frameworks often contain

requirements for the accounting for, and disclosure
of, changes in accounting policies. Where the entity
has changed its selection of significant accounting
policies, a material misstatement of the financial
4 NSA 700, paragraph 11.

5 NSA 450-Being Drafted, Evaluation of Misstatements Identified during the Audit,
statements may arise when the entity has not

complied with these requirements.
Application of the Selected

Accounting Policies
A6. In relation to the application of the selected
accounting policies, material misstatements of the
financial statements may arise:

a) When management has not applied the selected

accounting policies consistently with the
financial reporting framework, including when
management has not applied the selected
accounting policies consistently between
periods or to similar transactions and events
(consistency in application); or
b) Due to the method of application of the selected
accounting policies (such as an unintentional
error in application).
Appropriateness or Adequacy
of Disclosures in the Financial
Statements
A7. In relation to the appropriateness or adequacy of
disclosures in the financial statements, material
misstatements of the financial statements may arise
when:

a) The financial statements do not include all

of the disclosures required by the applicable
financial reporting framework;
b) The disclosures in the financial statements are
not presented in accordance with the applicable
financial reporting framework; or
c) The financial statements do not provide
the disclosures necessary to achieve fair
presentation.
Nature of an Inability to Obtain Sufficient Appropriate Audit Evidence

(Ref: Para. 6(b))
A8. The auditors inability to obtain sufficient
appropriate audit evidence (also referred to as
a limitation on the scope of the audit) may arise
from:

a) Circumstances beyond the control of the entity;
b) Circumstances relating to the nature or timing of

the auditors work; or
c) Limitations imposed by management.
A9. An inability to perform a specific procedure does

not constitute a limitation on the scope of the
audit if the auditor is able to obtain sufficient
appropriate audit evidence by performing
alternative procedures. If this is not possible, the
requirements of paragraphs 7(b) and 10 apply as
appropriate. Limitations imposed by management
may have other implications for the audit, such
as for the auditors assessment of fraud risks and
consideration of engagement continuance.
A10. Examples of circumstances beyond the control of
the entity include when:

a) The entitys accounting records have been
destroyed.

b) The accounting records of a significant

component have been seized indefinitely by
governmental authorities.
A11. Examples of circumstances relating to the nature

or timing of the auditors work include when:

a) The entity is required to use the equity method

of accounting for an associated entity, and the
auditor is unable to obtain sufficient appropriate
audit evidence about the latters financial
information to evaluate whether the equity
method has been appropriately applied.
b) The timing of the auditors appointment is

such that the auditor is unable to observe the
counting of the physical inventories.
c) The auditor determines that performing

substantive procedures alone is not sufficient,
but the entitys controls are not effective.
A12. Examples of an inability to obtain sufficient

appropriate audit evidence arising from a limitation
on the scope of the audit imposed by management
include when:

a) Management prevents the auditor from

observing the counting of the physical inventory.
b) Management prevents the auditor from

requesting external confirmation of specific
account balances.
Consequence of an Inability to Obtain Sufficient

Appropriate Audit Evidence Due to a Management-Imposed Limitation after the Auditor Has
Accepted the Engagement (Ref: Para. 13(b)14)
A13. The practicality of withdrawing from the audit
may depend on the stage of completion of the
engagement at the time that management imposes
the scope limitation. If the auditor has substantially
completed the audit, the auditor may decide to
complete the audit to the extent possible, disclaim
an opinion and explain the scope limitation in the
Basis for Disclaimer of Opinion paragraph prior to
withdrawing.
A14. In certain circumstances, withdrawal from
the audit may not be possible if the auditor is
required by law or regulation to continue the audit
engagement. This may be the case for an auditor
that is appointed to audit the financial statements
of public sector entities. It may also be the case
in jurisdictions where the auditor is appointed to

audit the financial statements covering a specific
period, or appointed for a specific period and is
prohibited from withdrawing before the completion
of the audit of those financial statements or before
the end of that period, respectively. The auditor
may also consider it necessary to include an Other
Matter paragraph in the auditors report.6
A15. When the auditor concludes that withdrawal
from the audit is necessary because of a scope
limitation, there may be a professional, legal
or regulatory requirement for the auditor to
communicate matters relating to the withdrawal
from the engagement to regulators or the entitys
owners.
Other Considerations Relating to an Adverse Opinion or
(Ref: Para. 15)
A16. The following are examples of reporting
circumstances that would not contradict the
auditors adverse opinion or disclaimer of opinion:

a) The expression of an unmodified opinion on

financial statements prepared under a given
financial reporting framework and, within the
same report, the expression of an adverse
opinion on the same financial statements under
a different financial reporting framework.
b) The expression of a disclaimer of opinion

regarding the results of operations, and cash
flows, where relevant, and an unmodified
opinion regarding the financial position (see NSA
5107. In this case, the auditor has not expressed
a disclaimer of opinion on the financial
statements as a whole.
6 NSA 706-Being Drafted, Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditors Report,
7 NSA 510, Initial EngagementsOpening Balances,
Form and Content of the Auditors

Report When the Opinion Is Modified
Basis for Modification Paragraph (Ref: Para.
1617, 19, 21)
A17. Consistency in the auditors report helps to

promote users understanding and to identify
unusual circumstances when they occur.
Accordingly, although uniformity in the wording of
a modified opinion and in the description of the
basis for the modification may not be possible,
consistency in both the form and content of the
auditors report is desirable.
A18. An example of the financial effects of material
misstatements that the auditor may describe in the
basis for modification paragraph in the auditors
report is the quantification of the effects on income
tax, income before taxes, net income and equity if
inventory is overstated.
A19. Disclosing the omitted information in the basis for
modification paragraph would not be practicable if:

a) The disclosures have not been prepared by

management or the disclosures are otherwise
not readily available to the auditor; or
b) In the auditors judgment, the disclosures would

be unduly voluminous in relation to the auditors
report.
A20. An adverse opinion or a disclaimer of opinion

relating to a specific matter described in the
basis for qualification paragraph does not justify
the omission of a description of other identified
matters that would have otherwise required a
modification of the auditors opinion. In such cases,
the disclosure of such other matters of which the
auditor is aware may be relevant to users of the
Opinion Paragraph (Ref: Para. 2223)

A21. Inclusion of this paragraph heading makes it clear
to the user that the auditors opinion is modified
and indicates the type of modification.
A22. When the auditor expresses a qualified opinion,

it would not be appropriate to use phrases such as
with the foregoing explanation or subject to in
the opinion paragraph as these are not sufficiently
clear or forceful.
Illustrative Auditors Reports

A23. Illustrations 1 and 2 in the Appendix contain
auditors reports with qualified and adverse
opinions, respectively, as the financial statements
are materially misstated.
A24. Illustration 3 in the Appendix contains an auditors
report with a qualified opinion as the auditor
is unable to obtain sufficient appropriate audit
evidence. Illustration 4 contains a disclaimer of
opinion due to an inability to obtain sufficient
appropriate audit evidence about a single element
of the financial statements. Illustration 5 contains
a disclaimer of opinion due to an inability to
obtain sufficient appropriate audit evidence about
multiple elements of the financial statements. In
each of the latter two cases, the possible effects
on the financial statements of the inability are both
material and pervasive.
Communication with Those Charged

with Governance (Ref: Para. 28)
A25. Communicating with those charged with
governance the circumstances that lead to an
expected modification to the auditors opinion
and the proposed wording of the modification
enables:

a) The auditor to give notice to those charged

with governance of the intended modification(s)
and the reasons (or circumstances) for the
modification(s);
b) The auditor to seek the concurrence of those

charged with governance regarding the facts
of the matter(s) giving rise to the expected
modification(s), or to confirm matters of
disagreement with management as such; and
c) Those charged with governance to have an

opportunity, where appropriate, to provide
the auditor with further information and
explanations in respect of the matter(s) giving
rise to the expected modification(s).
Appendix
(Ref: Para. A2324)

Illustrations of Auditors Reports with Modifications
to the Opinion
Illustration 1: An auditors report containing a
qualified opinion due to a material misstatement of
the financial statements.
Illustration 2: An auditors report containing an
adverse opinion due to a material misstatement of
qualified opinion due to the auditors inability to
obtain sufficient appropriate audit evidence.
disclaimer of opinion due to the auditors inability
to obtain sufficient appropriate audit evidence
about a single element of the financial statements.
Illustration 5: An auditors report containing
a disclaimer of opinion due to the auditors
inability to obtain sufficient appropriate audit

evidence about multiple elements of the financial
statements.
INDEPENDENT AUDITORS REPORT

[Appropriate Addressee]
Report on the Financial Statements8
We have audited the accompanying financial statements

of ABC Company, which comprise the statement of
financial position as at End of Ashad, 20X1, and the
statement of comprehensive income, statement of
changes in equity and statement of cash flows for
the year then ended, and a summary of significant
accounting policies and other explanatory information.
Managements9 Responsibility for the Financial

Statements
Management is responsible for the preparation and
fair presentation of these financial statements in
accordance with Nepal Accounting Standards,10 and
for such internal control as management determines
is necessary to enable the preparation of financial
statements that are free from material misstatement,
whether due to fraud or error.
Auditors Responsibility
Our responsibility is to express an opinion on these
Illustration 1:
Circumstances include the following:
Audit of a complete set of general purpose financial statements prepared by management of the entity in
accordance with Nepal Accounting Standards.
The terms of the audit engagement reflect the description of managements responsibility for the
financial statements in NSA 210.
Inventories are misstated. The misstatement is deemed to be material but not pervasive to the financial
statements.
In addition to the audit of the financial statements, the auditor has other reporting responsibilities
required under local law.
8 The sub-title Report on the Financial Statements is unnecessary in circumstances when the second sub-title Report on Other Legal and
Regulatory Requirements is not applicable.
9 Or other term that is appropriate in the context of the legal framework in the particular jurisdiction.
10 Where managements responsibility is to prepare financial statements that give a true and fair view,
financial statements based on our audit. We conducted

our audit in accordance with Nepal Standards on
Auditing. Those standards require that we comply
with ethical requirements and plan and perform the
audit to obtain reasonable assurance about whether
the financial statements are free from material
misstatement.
An audit involves performing procedures to obtain
audit evidence about the amounts and disclosures in
the financial statements. The procedures selected
depend on the auditors judgment, including the
assessment of the risks of material misstatement of
the financial statements, whether due to fraud or
error. In making those risk assessments, the auditor
considers internal control relevant to the entitys
preparation and fair presentation11 of the financial
statements in order to design audit procedures that
are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness
of the entitys internal control.12 An audit also includes
evaluating the appropriateness of accounting policies
used and the reasonableness of accounting estimates
made by management, as well as evaluating the overall
presentation of the financial statements.
We believe that the audit evidence we have obtained
is sufficient and appropriate to provide a basis for our
qualified audit opinion.
Basis for Qualified Opinion

The companys inventories are carried in the statement
of financial position at xxx. Management has not stated
the inventories at the lower of cost and net realizable
value but has stated them solely at cost, which
constitutes a departure from International Financial
Reporting Standards. The companys records indicate
that had management stated the inventories at the
lower of cost and net realizable value, an amount of Rs.
xxx would have been required to write the inventories
down to their net realizable value. Accordingly, cost
of sales would have been increased by Rs. xxx, and
income tax, net income and shareholders equity
would have been reduced by Rs. xxx, xxx and xxx,
respectively.
Qualified Opinion
In our opinion, except for the effects of the matter
described in the Basis for Qualified Opinion paragraph,
the financial statements present fairly, in all material
respects, (or give a true and fair view of) the financial
position of ABC Company as at End of Ashad, 20X1, and
(of) its financial performance and its cash flows for the
year then ended in accordance with Nepal Accounting
Standards.
11 In the case of footnote 12, this may read: In making those risk assessments, the auditor considers internal control relevant to the
entitys preparation of financial statements that give a true and fair view in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entitys internal control.
12 In circumstances when the auditor also has responsibility to express an opinion on the effectiveness of internal control in conjunction with
the audit of the financial statements, this sentence would be worded as follows: In making those risk assessments, the auditor considers
internal control relevant to the entitys preparation and fair presentation of the financial statements in order to design audit procedures that
are appropriate in the circumstances. In the case of footnote 12, this may read: In making those risk assessments, the auditor considers
internal control relevant to the entitys preparation of financial statements that give a true and fair view in order to design audit procedures
that are appropriate in the circumstances.
13 Company Act, 2063; Bank and Financial Institutional Act, 2063; Insurance Act, 2049; Education Regulation, 2058; Co-Operative Act, 2048 etc.
Report on Other Legal and

Regulatory Requirement 13
[Form and content of this section of the auditors report
will vary depending on the nature of the auditors other
reporting responsibilities.]
[Auditors signature]
[Date of the auditors report]
[Auditors address]
Illustration 2:
Audit of consolidated general purpose
financial statements prepared by
management of the parent in accordance
with Nepal Accounting Standards.
The terms of the audit engagement
reflect the description of managements
responsibility for the financial statements in
NSA 210.
The financial statements are materially
misstated due to the non-consolidation of
a subsidiary. The material misstatement
is deemed to be pervasive to the financial
statements. The effects of the misstatement
on the financial statements have not been
determined because it was not practicable to
do so.
In addition to the audit of the consolidated
financial statements, the auditor has other
reporting responsibilities required under local
law.

Report on the Consolidated Financial Statements14

We have audited the accompanying consolidated
financial statements of ABC Company and its
subsidiaries, which comprise the consolidated
statement of financial position as at End of Ashad 20X1,
and the consolidated statement of comprehensive
income, statement of changes in equity and statement
of cash flows for the year then ended, and a summary
of significant accounting policies and other explanatory
information.
Managements15 Responsibility for the Consolidated Financial Statements

Management is responsible for the preparation and fair
presentation of these consolidated financial statements
in accordance with Nepal Accounting Standards,16 and
is necessary to enable the preparation of consolidated
financial statements that are free from material
misstatement, whether due to fraud or error.
consolidated financial statements based on our audit.
We conducted our audit in accordance with Nepal
Standards on Auditing. Those standards require that we
comply with ethical requirements and plan and perform
the audit to obtain reasonable assurance about whether
the consolidated financial statements are free from
material misstatement.
An audit involves performing procedures to obtain
audit evidence about the amounts and disclosures in
the consolidated financial statements. The procedures
selected depend on the auditors judgment, including
the assessment of the risks of material misstatement
of the consolidated financial statements, whether due
14 The sub-title Report on the Consolidated Financial Statements is unnecessary in circumstances when the second sub-title Report on Other
Legal and Regulatory Requirements is not applicable.
16 Where managements responsibility is to prepare consolidated financial statements that give a true and fair view, this may read:
Management is responsible for the preparation of consolidated financial statements that give a true and fair view in accordance with
International Financial Reporting Standards, and for such ...
to fraud or error. In making those risk assessments,

the auditor considers internal control relevant to
the entitys preparation and fair presentation17 of
the consolidated financial statements in order to
design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing
an opinion on the effectiveness of the entitys
internal control.18 An audit also includes evaluating
the appropriateness of accounting policies used and
the reasonableness of accounting estimates made
by management, as well as evaluating the overall
presentation of the consolidated financial statements.
adverse audit opinion.
Basis for Adverse Opinion

As explained in Note X, the company has not
consolidated the financial statements of subsidiary XYZ
Company it acquired during 20X1 because it has not
yet been able to ascertain the fair values of certain
of the subsidiarys material assets and liabilities at
the acquisition date. This investment is therefore
accounted for on a cost basis. Under Nepal Accounting
Standards, the subsidiary should have been consolidated
because it is controlled by the company. Had XYZ been
consolidated, many elements in the accompanying
financial statements would have been materially
affected. The effects on the consolidated financial
statements of the failure to consolidate have not been
determined.
Adverse Opinion
In our opinion, because of the significance of the matter
discussed in the Basis for Adverse Opinion paragraph,
the consolidated financial statements do not present
fairly (or do not give a true and fair view of) the
financial position of ABC Company and its subsidiaries
as at End of Ashad, 20X1, and (of) their financial
performance and their cash flows for the year then
ended in accordance with Nepal Accounting Standards.

Regulatory Requirements
[Form and content of this section of the auditors report will vary depending on the nature of
the auditors other reporting responsibilities.]
[Auditors address]
Illustration 3:
Audit of a complete set of general
purpose financial statements prepared by
management of the entity in accordance
with Nepal Accounting Standards.
The terms of the audit engagement
reflect the description of managements
responsibility for the financial statements in
NSA 210.
The auditor was unable to obtain sufficient
appropriate audit evidence regarding
an investment in a foreign affiliate. The
possible effects of the inability to obtain
sufficient appropriate audit evidence are
deemed to be material but not pervasive to
In addition to the audit of the financial
statements, the auditor has other reporting
responsibilities required under local law.
17 In the case of footnote 17, this may read: In making those risk assessments, the auditor considers internal control relevant to the entitys
preparation of consolidated financial statements that give a true and fair view in order to design audit procedures that are appropriate in the
the audit of the consolidated financial statements, this sentence would be worded as follows: In making those risk assessments, the auditor
considers internal control relevant to the entitys preparation and fair presentation of the consolidated financial statements in order to design
audit procedures that are appropriate in the circumstances. In the case of footnote 17, this may read: In making those risk assessments,
the auditor considers internal control relevant to the entitys preparation of consolidated financial statements that give a true and fair view
in order to design audit procedures that are appropriate in the circumstances.


We have audited the accompanying financial statements
of ABC Company, which comprise the statement of
financial position as at End of Ashad, 20XX, and the
statement of comprehensive income, statement of
changes in equity and statement of cash flows for

Statements
financial statements based on our audit. We conducted
our audit in accordance with International Standards
on Auditing. Those standards require that we comply
with ethical requirements and plan and perform the
audit to obtain reasonable assurance about whether
the financial statements are free from material
misstatement.
An audit involves performing procedures to obtain audit
evidence about the amounts and disclosures in the
financial statements. The procedures selected depend
on the auditors judgment, including the assessment
of the risks of material misstatement of the financial

statements, whether due to fraud or error. In making
those risk assessments, the auditor considers internal
control relevant to the entitys preparation and fair
presentation22 of the financial statements in order to
design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the
entitys internal control.23 An audit also includes
evaluating the appropriateness of accounting policies
used and the reasonableness of accounting estimates
made by management, as well as evaluating the overall
presentation of the financial statements.
qualified audit opinion.
Basis for Qualified Opinion

ABC Companys investment in XYZ Company, a foreign
associate acquired during the year and accounted for
by the equity method, is carried at Rs. xxx on the
statement of financial position as at End of Ashad,
20XX, and ABCs share of XYZs net income of Rs. xxx
is included in ABCs income for the year then ended.
We were unable to obtain sufficient appropriate
audit evidence about the carrying amount of ABCs
investment in XYZ as at End of Ashad, 20XX and ABCs
share of XYZs net income for the year because we
were denied access to the financial information,
management, and the auditors of XYZ. Consequently,
we were unable to determine whether any adjustments
to these amounts were necessary.
Qualified Opinion
In our opinion, except for the possible effects of the
matter described in the Basis for Qualified Opinion
19The sub-title Report on the Financial Statements is unnecessary in circumstances when the second sub-title Report on Other Legal and
22 In the case of footnote 22, this may read: In making those risk assessments, the auditor considers internal control relevant to the
entitys preparation of financial statements that give a true and fair view in order to design audit procedures that are appropriate in the
the audit of the financial statements, this sentence would be worded as follows: In making those risk assessments, the auditor considers
internal control relevant to the entitys preparation and fair presentation of the financial statements in order to design audit procedures that
are appropriate in the circumstances. In the case of footnote 22, this may read: In making those risk assessments, the auditor considers
internal control relevant to the entitys preparation of financial statements that give a true and fair view in order to design audit procedures
that are appropriate in the circumstances.
paragraph, the financial statements present fairly, in all

material respects, (or give a true and fair view of) the
financial position of ABC Company as at End of Ashad,
20XX, and (of) its financial performance and its cash
flows for the year then ended in accordance with Nepal
Accounting Standards.
Report on Other Legal and Regulatory Requirements

will vary depending on thenature of the auditors other
[Auditors address]
Illustration 4:
Audit of a complete set of general purpose
financial statements prepared by management of
the entity in accordance with Nepal Accounting
Standards.
The terms of the audit engagement reflect the
description of managements responsibility for
the financial statements in NSA 210.
The auditor was unable to obtain sufficient
appropriate audit evidence about a single
element of the financial statements. That is, the
auditor was also unable to obtain audit evidence
about the financial information of a joint
venture investment that represents over 90% of
the companys net assets. The possible effects
of this inability to obtain sufficient appropriate
audit evidence are deemed to be both material
and pervasive to the financial statements.
In addition to the audit of the financial
statements, the auditor has other reporting
responsibilities required under local law.


We were engaged to audit the accompanying financial
statements of ABC Company, which comprise the
statement of financial position as at End of Ashad, 20XX,
and the statement of comprehensive income, statement
of changes in equity and statement of cash flows for

Statements
financial statements based on conducting the audit in
accordance with Nepal Standards on Auditing. Because
of the matter described in the Basis for Disclaimer
of Opinion paragraph, however, we were not able to
Basis for Disclaimer of Opinion

The companys investment in its joint venture XYZ
(Country X) Company is carried at xxx on the companys
statement of financial position, which represents over
90% of the companys net assets as at End of Ashad,
20XX. We were not allowed access to the management
and the auditors of XYZ, including XYZs auditors
audit documentation. As a result, we were unable to
determine whether any adjustments were necessary in
respect of the companys proportional share of XYZs
assets that it controls jointly, its proportional share of

XYZs liabilities for which it is jointly responsible, its
proportional share of XYZs income and expenses for
the year, and the elements making up the statement of
changes in equity and cash flow statement.
Because of the significance of the matter described
in the Basis for Disclaimer of Opinion paragraph, we
have not been able to obtain sufficient appropriate
audit evidence to provide a basis for an audit opinion.
Accordingly, we do not express an opinion on the

will vary depending on the nature of the auditors other
[Auditors address]


We were engaged to audit the accompanying financial
statements of ABC Company, which comprise the
statement of financial position as at End of Ashad, 20XX,
and the statement of comprehensive income, statement
of changes in equity and statement of cash flows for

Statements
financial statements based on conducting the audit in
accordance with Nepal Standards on Auditing. Because
of the matters described in the Basis for Disclaimer
Illustration 5:
Audit of a complete set of general purpose financial statements prepared by management of the entity
in accordance with Nepal Accounting Standards.
The terms of the audit engagement reflect the description of managements responsibility for the
financial statements in NSA 210.
The auditor was unable to obtain sufficient appropriate audit evidence about multiple elements
of the financial statements. That is, the auditor was unable to obtain audit evidence about the
entitys inventories and accounts receivable. The possible effects of this inability to obtain sufficient
appropriate audit evidence are deemed to be both material and pervasive to the financial statements.
In addition to the audit of the financial statements, the auditor has other reporting responsibilities
required under local law.
29 Where managements responsibility is to prepare financial statements that give a true and fair view
of Opinion paragraph, however, we were not able to

Basis for Disclaimer of Opinion

We were not appointed as auditors of the company until
after End of Ashad, 20XX and thus did not observe the
counting of physical inventories at the beginning and
end of the year. We were unable to satisfy ourselves by
alternative means concerning the inventory quantities
held at End of Ashad, 20X0 and 20X1 which are stated
in the statement of financial position at Rs. xxx and
xxx, respectively. In addition, the introduction of
a new computerized accounts receivable system
in September 20X1 resulted in numerous errors in
accounts receivable. As of the date of our audit report,
management was still in the process of rectifying
the system deficiencies and correcting the errors.
We were unable to confirm or verify by alternative
means accounts receivable included in the statement
of financial position at a total amount of Rs. xxx as at
End of Ashad, 20XX. As a result of these matters, we
were unable to determine whether any adjustments
might have been found necessary in respect of recorded
or unrecorded inventories and accounts receivable,
and the elements making up the statement of
comprehensive income, statement of changes in equity
and statement of cash flows.
Because of the significance of the matters described
in the Basis for Disclaimer of Opinion paragraph, we
have not been able to obtain sufficient appropriate
audit evidence to provide a basis for an audit opinion.
Accordingly, we do not express an opinion on the

[Form and content of this section of the auditors
report will vary depending on the nature of the
auditors other reporting responsibilities.]
[Auditors address]
NEWS
International Financial
Reporting Standards
(IFRS) Certification
Course
ICAN organized IFRS Certification
course which was held from 3rd to
14th June, 2011 with the Technical
Assistance from ICAI. This training
focused the high level officials
from different organizations
along with members of ICAN. This
course was designed to provide
in depth knowledge of IFRS as
Nepal is schedule to converge
to IFRS effective mid July 2012.
The designated resource persons
from India shared not only the
technical aspects but also the
practical experiences relating to
the various IFRS and IAS. The main
objectives of the Training was to
enhance the confidence among the
investors, bankers and the general
public towards capital market
by pronouncing the standards of
disclosure in financial reporting
practices. 47 participants were
present in the seven day training.
On the first day of the program
CA. Amarjit Chopara, ICAI, Chair
person of IFRS Implementation
Committee were present CA. Sunir
Kumar Dhungel, President of ICAN,
and CA. Sudarshan Raj Pandey, Vice
President of ICAN were also present
on the occasion.
CA. Sudarshan Raj Pandey, Vice
President of ICAN welcome all
participants and delegates with
Group photo of IFRS Certification Course resource person and the participants.
welcome speech. on the last day of the program Mr. Pandey concluded the
program with vote of thanks and distributed certificate to the participants.
Training on Members Capacity Building

Training on members capacity building were held in Dhangadi, Chitwan,
Nepalgunj and Pokhara on chaitra 25 and 26, 2067 and Baishakh 23 and
24, Ashad 9, 10 and11 and Ashad 18 and 19 respectively to enhance the
members capacity. During the training session 41, 47, 34 and 38 members
were participated respectively. Those training were focused on subject
matter on the preparation of working file before auditing.
Interaction Program
CA. Pushpendra Singh, Technical Joint Director, ICAN participated in an
interaction program entitled Trade in Services under WTO and SAFTA
organized by the Ministry of Commerce and Supplies at the WTO Reference
Center, Babarmahal, Kathmandu on Chaitra 17, 2067. The program was held
to discuss on the changes and amendments necessary in the Nepalese Acts
and Regulations relating to the professional services to comply with the
various provisions set forth under WTO and SAFTA. During the program, CA.
Pushpendra Singh, expressed his remarks on the scenario of Accountancy
and Auditing Profession in Nepal and commented on the status of current
provisions of the ICAN Act that is to be amended so

as to accommodate the spirit of WTO and SAFTA. The
program was participated by government officials and
professionals from various fields.
CA. Pushpendra Singh, Technical Joint Director, ICAN
participated in a Focus Group Discussion organized
by the Public Procurement Monitoring Office at the
Office of the Auditor General, Babar Mahal, Kathmandu
on March 10, 2011. The discussion was intended to
carry out an assessment of public procurement process
on the basis of Baseline Indicators of OECD- DAC and
was participated by the representatives from various
Government Offices, Corporation, Entities receiving
Government Grant, Auditor General and AUDAN. In the
program, CA. Singh discussed and evaluated various
sub-indicators under Indicator 9:The Country has
Effective Control and Audit Systems so as to facilitate
the assessment process.
Different interaction programs were organized with the
members of the Institute in different places outside
the valley. Interaction program were conducted in
Narayanghat, Nepalgunj and Pokhara on 23rd Baishakh,
11th Ashad and 19th Ashad, 2068 respectively. On the
program CA. Sunir Kumar Dhungel, President of ICAN
declared the present status and the future plans of
the Institute. In the same program CA. Sunir Kumar
Dhungel, president of ICAN answered the question
raised by the members.
In the similar way, another interaction programs were
organized with the industrial Professionals separately
in Narayanghat, Nepalgunj and Pokhara respectively.
On the program CA. Sunir Kumar Dhungel, President of
ICAN lightened the role of the Institute and relationship
and co-ordination between the Auditors and the
industrial professionals. On the same program industrial
professionals raised the issues of scarcity of professional
Accountants and the role of the Institute for the
capacity building.
Similarly, on 26th Ashad, 2068 another interaction
program was organized with the Beema Samiti. This
program emphasized on the challenges and role of the
Auditors while auditing Insurance Companies.
Preview of Interaction Programe with Beema Samiti.
During the program discussed were made on the existing

Act and Regulations, problem facing during auditing and
professional standard. This program was chaired by CA.
Sunir Kumar Dhungel. Mr. Fatta Bahadur K.C, Chairman
of Beema Samiti was also present on the program. Mr.
Prakash Khanal, Deputy Director of Beema Samati had
presented the working paper on the program regarding
the challenges on auditing of insurance companies.
ISA (Information System Audit) Training and eligibility
test
To enhance the Information system Auditing Capacity of
Chartered Accountant members, the Institute organized
ISA Course with technical assistance from ICAI. The
training was facilitated by the experts from ICAI,
India. Twenty Seven Chartered Accountant members
participated in this program. The training program was
run for twelve days from 3rd April to 14th April, 2011.
ISA eligibility test was held on 31st may, 2011in the
Institute premises. On this eligibility test 23 chartered
accountants took test among which 15 were declared as
ISA.
Member Department and Professional Development
Department
About Membership
29 examinees participated in the membership exam
held on May 15-18, 2011, from various other recognized
institutions as per the provisions and rules laid by ICAN.
Among the examinee 13 were declared as members of
ICAN.
Membership Status and Renewal Status of ICAN Member
The following is the Membership status and the renewal
status of members till June 30, 2011
Member Service Department and Professional Development

Department
About Membership
29 examinees participated in the membership
exam held on May 15-18, 2011, from various
other recognized institutions as per the
provisions and rules laid by ICAN. Among the
examinee 13 were declared as members of
ICAN.
Membership Status and

Renewal Status of ICAN
Member
Following is the Membership status and the
renewal status of members till June 30, 2011
Category/
Status
Total
Member
Total
Renewed
Number
Total
COP
Total
Renewed
Number
FCA
215
167
186
133
CA
323
266
311
199
Total
Firms
Total
Renewed
Number
406
260
RAB
3364
2311
3110
1772
869
667
RAC
1576
1006
1436
843
301
205
RAD
2343
1551
2144
1398
193
147
About CPE Training

To enhance the capacity of the members, CPE has been conducted according to the schedule. AUDAN, CAI and INCA
have cooperated for training in various places according to the code of conduct. During the Training session around
4330 were participated in the CPE training for renewal of Certificate of Practice (COP). Further few training were
held for those members those who were not able to take previous trainings.
Education Department
Scholarship Distribution
A program was organized to announce the full and
partial scholarship to the CA students for fiscal year
2066/67 studying at different levels of chartered
Accountancy Course. Altogether, 27 students studying
at different levels were granted different types of
scholarship. The scholarship was distributed by CA.
Sunir Kumar Dhungel, President of ICAN. During the
program, CA. Paramananda Adhikari, Technical Director,
briefed about the scholarship scheme and objectives
of scholarship and lastly, CA. Binay Prakash Shrestha,
Executive Director of ICAN thanked all the students for
their hard work
CA. Sunir K. Dhungel handing over the scholorship amount to the
student. CA. Paramananda Adhikari, Technical Director looks on.
S.N.
CAP III
CAP II
CAP I
Total
Full Scholarship
Partial
Scholarship
14
23
Total
16
27
Crash Course
Crash course was organized from 12th April, 2011 to
8th may, 2011 targeting the students of CAP II level for
students appearing for the June 2011 CA examination.
The course had been aimed to providing technical
details and short guidance with a special focus on
clarifying the students queries on the course matter.
The course covered six subjects namely Accounting,
Auditing, Cost, finance, corporate law and income
tax. Total of 114 students of CAP II level attended the
classes and altogether 27 classes were organized.
Revision Test Paper (RTP) and

Suggested
Revision Test papers for CAP II level were produced with
aimed to provide adequate practice for the students
to enhance their performance in the final examination.
In the similar way suggested question answer were
published for all levels.
Eligible certificate
Following is the data of different levels eligible
students for June 2011, final examination.
S.N.
Level
Both
Group
First
group
Second
Group
Total
CAP I
313
21
20
354
CAP II
197
30
36
263
CAP III
13
20
40
Institute has been organizing Career Counseling program

in different places. To provide sufficient knowledge
about Chartered Accountancy Course Branch Office of
ICAN had visited different colleges in Butwal. And also
Branch Office Butwal had conducted career counseling
program which was held on 21st May 2011. In the similar
way, ICAN had participated in Career fair to raise
awareness about CA and Accounting Technician (AT)
course, which was organized on 27th April to 1st May,
2011 by Global Exposition and Management Service Pvt.
Ltd in Vrikuti Mandap, Kathmandu. Large no of students
and parents visited the ICAN install to get information
about institute and CA and AT education.
The participants had shown keen interest on programs
such as Chartered Accountancy (CA) and Accounting
Technician (AT) education and expressed their interest
to join CA and AT course. Generally, counseling and
fair had deliberated positive message to the interested
people and was focused on information about the
Institute, criteria of enrollment, future prospectus,
international recognition and membership criteria of
the Institute.
Like wise, to generate the awareness about CA and AT
course, CA. Paramananda Adhikari, Technical Director
of the Institute had given different relevant information
about CA and AT education through Television and
Radio.
Additional Study Materials

156 books for different levels were added for library
purpose among them 60 books are Nepalese editions
and 96 books are Indian Editions. Approximately 5000
books and other study materials are available in the
Institute library according to the library source.
CAP II Study material Published

The study materials for CAP II level have been published
by the Institute. These books are freely distributed to
the students who have registered at the Institute in CAP
II level. Those books are also made available for sale at
the cash counter of the Institute. The study materials of
CAP III level is coming soon.
Career Counseling
With the view to raise awareness about Chartered
Accountancy Education, Education Department of the
Examination Department
About board Exam, June 2011
Examination Department has successfully completed
JUNE 2011 final Exam. That exam is conducted from 1st
June to 9th June, 2011 at Brilliant College, Chabahil.
Following are the numbers of applicants and appeared
students.
Level wise Applicants and examinee for June Examination, 2011

S.N.
Level
Description
Both Group
First Group
Second Group
Total
Foundation
Applicants
15
Appeared
15
Intermediate
Applicants
16
31
Appeared
15
29
3
4
5
6
Final
CAP I
CAP II
CAP III
Applicants
16
20
15
51
Appeared
16
17
13
46
Applicants
510
77
73
660
Appeared
492
73
71
636
Applicants
531
126
118
775
Appeared
522
119
102
743
Applicants
45
17
15
77
Appeared
43
16
13
72
Upgrading News
Following is the number of members applied and taken upgrading exam which was held on June 2011.
S.N.
Description
Both Group
Applicant
12
Examinee
Applicant
Examinee
First Group
Second Group
Total
16
10
Total Number of Members applied for C to B
Total Number of Members applied for D to C

2
International News
CAPA and IPSAS Meeting
CA. Sunir Kumar Dhungel, President of ICAN had
participated CAPA board meeting and IPSAS meeting
held in Korea, along with other delegates from ICAN on
May, 2011. The other delegates were CA. Sudarshan Raj
Pandey, CA. Sujan Kumar Kafle RA. Mohan Raj Regmi.
SAFA board Meeting and Committee

Meeting
ICMA Pakistan had organized 16th SAFA board meeting,
Seminar and Committee meeting in 9 April to 10 April,
2011 in Karachi, Pakistan. Nepalese delegates CA. Sunir
Kumar Dhungel, Prisident of ICAN and CA. Suvod Kumar
Karn, Past President of ICAN were participated the
same. International Seminar was held on 9th of April
and 8 committee meetings and 16th SAFA board meeting
were organized in 10th of April.
IFAC Update
IAASB issues enhanced overarching
assurance standard for comment
IAASB has released for public comment propose revised
International Standard on Assurance Engagement (ISAE)
3000, Assurance Engagements other than Audits or
Reviews of Historical Financial Information. To Access
the exposure draft or submit a comment, visit the
IAASBs website at: www.iaasb.org/ExposureDrafts.php.
Comments are to be sent before 1st September, 2011.
IAESB proposes clarified standards

on assessment of Professional
competence
IAESB has released for public exposure a proposed
revision of International Education Standard (IES) 6,
Assessment of professional competence. The revised
education standard will assist IFAC member bodies
and other professional accountancy organizations in
understanding both the learning and development
requirements for areas of assessment of professional
competence, and their obligations in upholding the
standards. To Access the exposure draft or submit a
comment, visit the IAASBs website at: www.ifac.org/
Education/ExposureDrafts.php. Comments are to be
sent before 1st September, 2011.
IPSASB Publishes 2011 Handbook of

Pronouncements
IPSASB has published its 2011 handbook of International
Public Sector Accounting Pronouncements. The
handbook contains all Current IPSASB pronouncements,
including 31 accrual-based standards and the IPSASBs
cash basis standard. The handbook can be downloaded
from the IFAC Website.
IAESB Proposes Revised Standard

on Professional Values, Ethics and
Attitudes
IAESB has released for public exposure a proposed
revision of International Education Standard (IES) 4,
Professional Values, Ethics and Attitudes. The revised
standard, part of the IAESBs project to improve the
clarity of its standards, proposes that the development
of professional values, ethics and attitudes be
addressed by learning and development activities
that occur through out the career of the professional
accountant. To Access the exposure draft or submit a

comment, visit the IAASBs website at: www.ifac.org/
Education/ExposureDrafts.php. Comments are to be
sent before July 15, 2011.
IPSASB Publishes Exposure Draft

relating to Conceptual Framework
for Public Sector Entities.
IPSASB has released for comment an exposure draft,
key characteristics of the public sector with potential
implication for financial reporting. The paper provides
background on issues affecting the development of a
conceptual framework for public sector entities and
standard setting. To Access the exposure draft or submit
a comment, visit the IFAC website at: www.ifac.org/
Guidance/EXD-Outstanding.php. Comments are to be
sent before August 31, 2011.
Draft Q&A on the IFRS for SMEs

The SME implementation group, responsible for assisting
the IASB on matters related to the implementation of
the IFRS for SMEs, has published three more questions
and answer document on the IFRS for SMEs for public
comment. The new Q&As cover the following topics:
Captive insurance subsidiaries
Interpretation of traded in public market
Investment funds with only a few participants
The Q&As are intended to be non mandatory guidance
that will help those who use the IFRS for SMEs to
think about specific accounting questions. To view
new Q&As, visit: http://www.ifrs.org/IFRS+for+SMEs/
Q+and+A+IFRS+for+SMEs.htm
National Best Presented

Accounts Award 2010
Heartly congratulations !
Category-wise Awardees
Category 1
Winner
First runner-up
Second runner-up
Banking Sector (Subject
to
Prudential Supervision)
Nabil Bank Limited

Standard Chartered Bank Nepal Limited
Nepal Industrial & Commercial Bank Limited
Category 2 Non - Banking Sector (Subject

Supervision)
Winner
First runner-up
Second runner-up
to
ACE Development Bank Limited

Sanima Bikas Bank Limited
Siddhartha Development Bank Limited
Category 3 Non- Banking Financial Sector

Prudential Sepervision
Winner
First runner-up
Second runner-up
Category 4
Winner
First runner-up
Category 5
Winner
Category 7
Winner
not
Subject
to
Prime Life Insurance Company Limited

Prudential Insurance Company Limited
Life Insurance Corporation (Nepal) Limited
Manufacturing Sector
Butwal Power Company Limited
Unilever Company Limited
Communication
and Information
Technology Sector
Nepal Telecom Limited
Category 6 Hospitality, Health, Transport

Winner
Prudential
and
Shipping
Oriental Hotels Limited
Public Sector Entities

Karja Suchana Kendra Limited

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Chartered

Journal of the Institute of Chartered Accountants of Nepal

   

(Quarterly Journal of The Institute of Chartered Accountants of Nepal)

CA. Sunir Kumar Dhungel

Auditing Profession In Question

Revenue Recognition Customer Loyalty Program

Risk Management in Banks and Financial

Nepalese Banking Crisis Explained

Design, Layout & Printed by:

Market Risks for the Banks and Financial

An Overview of Privatization in Nepal

The Institute of Chartered Accountants of Nepal,

(including courier charges)

Opinions expressed by the contributors in this journal are their own

Trade Finance: Factoring & Forfaiting

Preparing for 2012: A Journey to ifrs

Information System Audit- An Introduction 42

International Financial Reporting

Member Service Department and

Understanding Asian Perspectives on

Successful Business Negotiation

Nepal Standard on Auditing 705

from ICAI who were experts in their deliveries. We want to thank on

Sunir Kumar Dhungel

Auditing Profession In Question:

Need Redefinition or Explanation or Acting Ethically

system to prevent and detect error and fraud and

* Mr. Sharma is a Chairman of Nepal Auditing Standard Board.

to one cross check on the correctness (and not really

government officials and even some of the auditors,

These are applied in the audit of historical financial statements

The Nepal Chartered Accountant | March 2011

High, but not

confidence of the intended users other than the

Need for redefining

c) A high level government official expressing his

The Nepal Chartered Accountant | March 2011

There is lack of clarity of the meaning and purpose of

4410) in Primary Schools and VDCs, Review Engagement

10 The Nepal Chartered Accountant | March 2011

award credits or points as marketing expenses. For any

The Nepal Chartered Accountant | March 2011 11

the amount for which the award credits could be sold

recognizes this net amount as revenue when the third

Fair value of award credits

To be recognized during the year (5000/8000*10,000)

"Risk Management in Banks and Financial

Recent failures of Nepal Share

All the financial institutions face different types of

* Ms. Pandey is a CA member of ICAN.

The Nepal Chartered Accountant | March 2011 13

are illustrative list of causes. They need to be taken as

i. High expectation of investors, managers

ii. Stiff competition leading the business mal

iii. Poor Corporate Governance.

iv. Assets and Liabilities maturities mismatch

14 The Nepal Chartered Accountant | March 2011

need money for business ventures, projects etc. The

vi. Illiquid Market

institution becomes very difficult. Liquidity problem

We have also experienced constructive inspections

Risk Management is actually

The Nepal Chartered Accountant | March 2011 15