This report was prepared by the World Bank, on the basis of a diagnostic review carried out between April and November 2009, including three field missions.
The report was prepared by a team led by Akram El-Shorbagi (MNAFM) and included Henri Fortin (PRMPS), Suhair Musa (MNAFM), and consultants Ana Cristina Hirata Barros and Samir Sahhar, under the guidance and supervision of Patricia McKenzie (Manager, MNAFM). Héctor Alfonso provided assistance with regard to the financial statements review. The task team also received the support of Samia Msadek (Manager, EAPFM), Behdad Nowroozi (MNAFM), and the World Bank Country Management Unit (MNC04) in Jerusalem and Washington.
The review was conducted through a participatory process involving many West Bank & Gaza institutions, including the Palestinian Ministry of Finance, Monetary Authority, Capital Market Authority, Stock Exchange and Association of Certified Public Accountants, as well as representatives of the private sector and the donor community. In addition, comments on the draft report were received from Douglas Pearce (MNAFP), Zubaidur Rahman (OPCFM) and Thomas Zimmerman (IFAC).
The task team gratefully acknowledges the support and comments received.
The publication of the report was authorized on August 19, 2010.
20. There is some uncertainty with regard to the legal framework currently in force in WB&G. The Legislative Council has not convened since June 2007, when Hamas came to power in Gaza. Since no laws have been able to be passed during this period, presidential decrees have been issued instead. However, such decrees are not considered final from a constitutional point of view, and as a result, may be subject to revision once the political situation is resolved. Specifically, recent amendments made to the Jordanian Companies Law may be contested in the future.
21. The basic pieces of legislation setting forth the legal forms private companies may take are Companies Law no. 12 of the Hashemite Kingdom of Jordan (1964) as amended in the West Bank, and Egyptian Companies Act no. 18 (1929) in Gaza. The types of companies are broadly similar to the ones found in other jurisdictions (public corporation, closely-held corporation, general partnership, and limited partnership).6 In the West Bank, corporations represent 32 percent of all companies, and partnerships, 67 percent.7 All corporations are required to have at least 20 shareholders. Private corporations are restricted to a maximum of 50 shareholders and may not be listed. Public corporations must be listed;8 41currently are.
22. No specific accounting standards are required by statute except in regulated sectors. The company laws also set forth the minimum accounting, auditing and publication requirements for companies. The two laws are generally in alignment, and the financial reporting requirements of WB&G companies are broadly similar. All limited liability companies are required to prepare financial statements; however, the laws do not specify the form and content of the financial statements that must be prepared (e.g., balance sheet, income statement, etc.). In addition, all companies are required to abide by the Income Tax Law of 1995, as amended. The tax authority sets forth tax accounting rules; however, they are rarely applied in practice. In practice, IFRS are the standards of reference in WB&G, and many public interest entities (PIEs) apply IFRS (see below and Section III).
23. The WB&G statutes do not provide for a differentiated reporting framework allowing SMEs to apply a simpler set of standards, which poses the risk of an excessive regulatory burden on these SMEs. Full IFRS are designed for PIEs, i.e. companies in which the public has a significant interest, such as listed companies. Full IFRS are considered too burdensome for smaller companies. In this regard, since WB&G has adopted IFRS (de jure for PIEs and de facto for other companies), it should consider adopting the IFRS for SMEs, a simplified and abridged version of full IFRS.
24. All companies are required to file annual financial statements with the Companies Registrar within four months of the year-end. As per the PCMA Disclosure Regulations Article 20, unlisted companies are required to disclose annually their audited financial statements and other material information to the PCMA.9 Additional rules apply to regulated entities (listed companies, financial institutions, etc.). The application of corporate financial reporting and auditing requirements to different enterprises is summarized in Table 1. A detailed table of requirements is provided in Annex 1.
30. Listed companies, banks, insurance companies, and MFIs are required by PCMA and PMA regulations to be audited by a certified public accountant (CPA) registered with PACPA. The PSE must be informed of listed companies’ auditor appointments and terminations within one day of their occurrence.27 In the case of banks, external auditors must be approved by the PMA. Prospective auditors and firms must submit an application to PMA demonstrating that they are licensed with PACPA and have adequate experience auditing financial institutions. For the insurance sector, PCMA must be notified of auditor appointment and terminations within three days.28 Further, a statutory auditor may not audit more than one insurance company at a time.29 This rule, however, is not strictly enforced. There is no such limitation for listed companies, banks, or MFIs. There is currently no regulation requiring MFIs to inform PMA or PCMA on the appointment and termination of auditors.
31. All limited liability companies—regardless of size—are required to undergo a statutory audit on an annual basis.30 As mentioned previously, all limited companies are required to submit audited annual financial statements to the Companies Registrar as well as to the Tax Authority. The external audit must be performed by a licensed member of the PACPA, who must sign the financial statements. In practice, however, non-CPAs are signing the financial statements that are submitted to both the Companies Registrar and Tax Authority. The wholesale requirement for a financial statement audit for all limited companies is somewhat unusual. In many other countries, closely-held companies are not subject to such requirement. In others, statutory audits are only applicable to large non-listed entities. Given the large number of small and medium-sized enterprises in WB&G, the general audit requirements seems excessive, and raises the cost of doing business, or may even result in habitual non-compliance.
32. PACPA has adopted ISA in its bylaws. Since all statutory audits are required to be carried out by PACPA-licensed auditors, they should be carried out in conformity with ISA.
33. Listed companies are required to undergo statutory auditor rotation every five years, similar to banks and MFIs. The PCMA requires that listed companies undergo a statutory audit partner or staff rotation at least every five years,31 whereas banks and MFIs are required to rotate the audit partner every five years, per PMA rules.32 PCMA is currently in the process of developing an auditor rotation requirement for the insurance sector.
34. Banks are required to form an audit committee.33 The members of the audit committee are appointed by the board of directors, and the majority of its membership must be independent (i.e., not officers or employees of the bank). Among other things, the audit committee is responsible for reviewing the financial statements of the bank, reviewing the recommendations made by the external and internal auditors, and recommending an external auditor to the board and shareholders. The law does not require that audit committee members have specific skills or experience in accounting, finance, or related areas. Communications with the external auditors are governed by the rules specified in Code of Corporate Governance.34
35. The PMA and PCMA have both recently adopted a code of good corporate governance. The PMA’s code, which applies to the banking sector, contains mandatory requirements (for which sanctions apply in cases of non-compliance) as well as additional guidelines (actions that represent good practices and are encouraged, but not required). The code, which is based on the OECD Corporate Governance Principles (2004), as well as on the Basel Committee’s paper on corporate governance for banks, covers a broad range of issues, including composition, structure, and role of the board of directors; compliance, internal and external audit; disclosure and transparency; and risk management. Similarly, PCMA issued a separate code of corporate governance applicable to public entities in November 2009 that contains mandatory requirements as along with additional guidelines representing good practices that are encouraged, but not required.
38. Under the Audit Law, the principal requirements for obtaining a license to practice as an auditor, in addition to passing the examination set by the BPA, include obtaining a university degree in accounting or related discipline, and at least five years of practical experience in audit.37 In addition, prospective CPAs must be Palestinian nationals. According to article 9 of the Audit Law, the Ministry of Education and Higher Education is the competent authority to accredit and assess academic qualifications stipulated in the Law. Currently, there are no examinations given to CPA candidates. However, offering such an exam is being studied under new licensing regulations, which are currently under development by the BPA. There are no clear arrangements for monitoring practical experience gained by candidates to ensure it is acceptable. Also the 2004 Audit Law is not clear on whether the monitoring of practical training experience should be the responsibility of the BPA or the PACPA membership committee.
39. No licenses have been issued since 2004, and regulations have yet to be issued regarding entry requirements for licensing. Regulations are expected to be issued by the BPA in 2010. In the meantime, the licensing process is on hold and over 120 applications for licenses are pending, but cannot be approved until matters relating to professional examinations, qualifications, and professional experience are regulated. This blockage has become a major hindrance to the development of the profession. The regulatory vacuum for licensing and regulations in Gaza is further exacerbated by the BPA’s decision to accept West Bank applications only. The BPA indicated that its decision is contingent on the resolution of the conflict between WB&G.
40. The market for the provision of audit services is fairly broad. Demand for services is enhanced by the requirement that all companies publish audited financial statements annually. Intense donor activity in WB&G also generates a significant demand for audit and assurance services. The profession is diverse and includes three of the large audit firms that audit almost all banks, insurance companies, listed companies and other large corporate entities (e.g., PIF, PADICO). There is limited competition for the audits of public interest entities. Mid-sized firms and sole practitioners are mainly geared toward tax return preparation and certification.
41. The legally sanctioned professional association, PACPA, is still a nascent body; it maintains two full-time and one part-time paid staff. All licensed auditors are required to become members of PACPA. Every three years, elections are conducted for the 13 members of its Board of Directors, which must include at least four members from West Bank and four from Gaza, to ensure fair representation.38 PACPA has nine committees, one each for examinations, professional conduct, continuing professional education, discipline, membership, research,39 public relations and magazine, external relations, and retirement.40 However, most of the committees are not active.
42. PACPA’s revenues are insufficient to operate effectively. PACPA collects revenue from application fees, annual subscription fees for members, annual licensing fees, courses, seminars and workshops, and other sources, such as donations, which are minimal.
43. PACPA began the IFAC application process in June of 2008 but is not yet a member. It does not yet meet most of the IFAC’s SMOs (see Table 2).
45. A sizable number of practitioners offering tax and accounting services did not have a background in audit when they were initially licensed, due to the fact that they were already practicing during the Israeli Civil Administration of the WB&G. An attempt by the BPA to grade auditors into categories was widely opposed within the profession, and the issue is still under deliberation.
47. The teaching materials used in universities are focused on US GAAP and US GAAS, with little coverage of IFRS and ISA. Universities use the latest editions of accountancy and auditing textbooks, mainly from American publishers. The textbooks are selected by the professor and the staff based on their knowledge of available textbooks. Selections are made every two years. There are no specific courses on international standards in most universities, and no courses are tailored specifically to cover the code of professional ethics, a topic only touched on in other audit classes. As a result, there is a gap between what is taught and what must be applied, as IFRS are required for regulated sectors.
48. There is a shortage of qualified professors to teach IFRS. University professors often lack knowledge of international standards, as most were educated in the United States. They are more familiar with US GAAP than with international standards.
49. An internship is required by most universities for undergraduate students. The internship is supervised by a professor, who receives weekly reports. At the end of the internship, a comprehensive report should be submitted by the student. Internships are mainly in audit firms, private sector companies, government bodies, and banks. The internship is required to be in the field of the student’s major. However, students have limited options when it comes to internships, and universities do not assess potential internship providers in order to ensure that proper and adequate training is offered to students.
50. Currently, there is no continuing professional education (CPE) requirement. New BPA bylaws currently being drafted would require 30 hours of CPE every year. However, there are no institutions accredited by PACPA to provide CPE, and PACPA's education committee is currently not active. These issues must be addressed in order for the forthcoming CPE requirement to be properly applied in practice.
52. Within the PCMA, the Issuance and Disclosure Department performs several reviews, including (a) an analysis of changes between preliminary and final versions; (b) a review of unusual items such as "abnormal changes" in amounts compared to the previous years, changes in accounting policies, and subsequent events; and (c) a review of specific elements of the financial statements such as investments. When a material issue is uncovered, the PCMA sends a note to the company’s general manager requesting clarification or corrective action. The note can take the form of a written reprimand. The process for conducting reviews is not documented and does not follow a formal, approved procedure. It should be noted that the PCMA’s supervisory framework is currently being reassessed with the support of WB technical assistance in order to revamp the securities market regulatory framework.
53. The PSE has recently started conducting its own enforcement actions on recurring financial reporting by listed companies, besides the usual reviews of the financial information contained in the offering documents at the time of the issues. The Securities Market Law of 2004 did not set clear boundaries between PCMA’s and PSE’s roles regarding enforcement of financial reporting requirements. The PSE’s vision is that it should leave the role of setting rules to the PCMA and focus on enhancing PSE monitoring and enforcement of issuers’ financial reporting. Starting June 30, 2009, for the first time PSE personnel began reviewing financial statements filed by issuers. In the near future, PSE plans to retain a professional firm or hire specialized staff to carry out more thorough reviews on its behalf.
54. For the banking sector, the PMA performs a broad range of on-site and off-site monitoring and enforcement actions, including specific actions regarding financial reporting. Off-site supervision is based on the CAMELS rating system and monthly ratio analyses, using an offsite, in-house banking supervision system. In order to foster adherence to its standards the PMA has issued specimen financial statements including minimum disclosures. The PMA’s banking supervision department has 59 employees and 16 in Gaza including some Arab Certified Public Accountants (ACPA). Coordination takes place with PCMA regarding listed banks’ disclosures. Before banks may release their financial statements to the public, they must be approved by the PMA.
55. Regarding insurance companies, the regulatory framework for financial reporting and enforcement is still being developed. The PCMA supervises the insurance sector through an ad hoc department with a staff whose professional experience averages five years. In addition, a three-member committee (two members from the PCMA and one from the Insurance Federation) oversees the results of inspections and other monitoring actions. The outcome of inspections is communicated verbally to the inspected entities. The procedures for reviewing insurance financial statements under IFRS and the related information and documentation need to be formalized.
56. The registry of companies conducts basic enforcement actions regarding non-listed companies. One of these is a notice issued in the press to remind all companies that they are required by law to file their financial statements. For public limited companies, if the Registrar does not receive the financial statements, it normally issues a reminder letter to the general manager. For closely-held companies that do not file their financial statements, no follow-up action is taken.
57. Monitoring of the audit practice is currently very limited and there is no Quality Assurance review system in place. PACPA does not conduct practice reviews or inspection of its membership. It has recently set up an Office Committee to carry out visits to registered practitioners in order to ensure that they actually practice accounting and auditing and do not conduct business activities that are deemed incompatible with PACPA membership or detrimental to the profession’s image.
58. PACPA’s Ethics Committee reviews cases of complaints against members but there have been very few such complaints. According to PACPA, for 2008, approximately seven meetings were held to review six cases, most of which related to complaints from PACPA members, and no sanctions have been published recently.44
60. For the banking sector, even though IAS (understood as meaning IFRS) is mandated by the banking law, in effect some differences with the international standard do exist. Areas of difference relate to (a) the valuation of loan-loss provisions, (b) loan-loss provision disclosures and (c) the accounting treatment of certain types of transactions pertaining to Islamic banking. The PMA-required method to measure provisions follows a matrix-based approach, that is, it requires fixed percentages of provisions to be applied to the principal amount based on the number of past-due days for different categories of loans. This differs from the approach of IAS 39, Financial Instruments: Recognition and Measurement, which requires assessing loss provisions on the basis of estimated future cash flows by loan or group of loans. Significantly different amounts are likely to result from applying these different approaches.
61. No legally-mandated accounting standards exist for non-regulated sectors. The Companies Law is silent on the question of which accounting standards should be applied and on the source of accounting standards. No local standards have been developed and standards from other countries are not used.
67. A number of audit clients lack financial reporting expertise and therefore expect the auditors to prepare IFRS-based financial statements; as previously noted, there are clear indications that audit firms are involved extensively in the preparation of those financial statements. Clients emphasize that audit firms gradually transfer knowledge to company staff, who then can take over drafting financial statements. This practice has implications for ownership by preparers of the financial statements and raises issues of audit independence.
68. Some audit firm representatives consider that management attitudes tend to keep audit fees low, which can have a detrimental effect on audit quality. The degree of compliance with applicable auditing standards varies between large and small audit firms. In general, the larger audit firms are better equipped to provide quality audit services, but even in those firms compliance with standards is not always ensured. When management in some companies does not place a high value on the required independent audit, allocating only a small budget to hire a very small audit firm, the low priority assigned to the audit is reflected in the quality of the audit performed.
69. Big-4 network affiliates and other large internationally affiliated firms are required to apply ISA and they are normally subject to intra-networks quality reviews. Based on discussion with firm leadership, random samples of engagements that are classified as high risk are subject to such a review. The audit firms are notified two weeks in advance on engagements to be reviewed, which casts doubt on the actual benefit of this exercise. In addition, a regional review partner is mandatory for those engagements. These quality review procedures are not considered a substitute for an independent professional oversight and quality assurance mechanism under the new framework developed in the wake of the accounting failures of Enron and other large corporations in the late 1990s.
70. While audit reports are generally in line with ISA in terms of content and wording, a significant degree of non-compliance was found. Instances of non-compliance related to (a) the acceptance of obvious transgressions in the application of IFRS accounting and disclosure requirements, (b) the inclusion of additional paragraphs not contemplated by IFAC rules and, (c) in one case, departures from the text of ISA 700, The Independent Auditor’s Report on a Complete Set of General-Purpose Financial Statements, which made the relevant report difficult to understand. Except in one case, the audit reports are silent on the uncertainties arising from the current political situation in WB&G, despite the associated business risks for the companies whose financial statements are audited.
71. Auditors are requested by the PMA to conduct additional compliance testing for companies under their purview. The auditors are asked to issue an opinion on the effectiveness of internal controls and compliance with regulations. However, because checking for compliance with PMA regulations beyond the financial audit is not a compensated activity, in the absence of independent monitoring, compliance is uncertain.
73. As in most countries, perceptions surrounding the accounting and audit profession are also mixed. Users and stakeholders tend to distinguish three groups within the profession:
77. Implementation of these policy recommendations will be beneficial to private and financial sector growth, insofar as they will:
3. Adopt IFRS for SMEs as the standard of reference for preparing financial statements outside the regulated sectors (i.e., banks, listed companies and insurance undertakings). This would be consistent with the fact that full IFRS has been adopted de jure in the regulated sectors and de facto by large enterprises operating in WB&G.
4. For small companies required to file annual financial statements under the Company Laws, an even simpler system should be adopted. The example of the United Kingdom which has developed a set of Financial Reporting Standards for Small Entities (FRSSE), could be drawn upon in that regard.
C. Audit Profession
5. Finalize and promulgate the draft Regulations of the Audit law, most urgently and importantly those relating to entry into the auditing profession (professional examinations, qualifications, and professional experience requirements).
6. The BPA should assume its role as an oversight board and monitor application of auditing and ethical standards to ensure that auditors have established a system of quality control and effectively apply ISA, ISQC 1 and the IFAC Ethics Code.
7. Adopt the International Standards on Quality Control (ISQC) 1 and assist PACPA members with their implementation.
D. Education and Training
8. Promote a CPE program consistent with IAESB’s Education Standards. This should be one of the first priorities for PACPA's education committee.
9. Update training and related materials to take into account new and amended IFRS and ISAs and assist professionals with the implementation of the standards. The IFRS Foundation has developed training material for IFRS-for-SMEs which is available for free and could be used to that effect.
10. Engage in a dialogue with universities in WB&G with a view to:
ii. providing practice-oriented teaching with stronger focus on business administration and case studies to best prepare professional accountants.
12. Develop BPA’s institutional and technical capacity to ensure it can meet its responsibilities.
13. In view of the long-term goal of achieving IFAC membership, PACPA should also develop its capacity in key areas that are essential for the profession to achieve high quality of practice, especially education, ethics and professional conduct, and contribution to quality assurance.