Accounting Theory and Practice

Special Issues in Financial Accounting &

Reporting: Islamic Accounting

(References: Sulaiman, M., Mohd Ariffin, N., and Mohd Shariff , R.A. (2017)Accounting for
Islamic Banks )
Outline
• Objective of Islamic Accounting
• Differences between conventional and Islamic Accounting
• Islamic Accounting Framework
• Development of Islamic Accounting in Malaysia
What is Accounting?
✓ General definition:
The process of identifying, measuring and
communicating economic information to
permit informed judgements and decisions
by the users of information

✓ Language of business
What is Accounting?
Objectives of Financial Accounting &
Reporting
▧ Provide information that is useful to the present and potential investors and
creditors and other users in making economic decisions.

▧ Primary users : shareholders, investors and creditors

▧ Secondary users : employees, customers and the public.

▧ Accountability framework - the objective is to provide a fair system of

information flow between the accountor (agent) and the accountee (principal)
 Conventional Accounting Concepts –
Financial Accounting deals with …
Recognition
✓ To test whether Recording
the critical event ✓ Procedure of double-entry
concerning an bookkeeping system.
element or Measurement
financial ✓ Determination of
transaction has the amount at
taken place. which the
element is to be
✓ Deals with timing recorded Presentation
as to when the ✓ How the event / transaction
event has taken is disclosed in the financial
place. statements
Conventional Accounting Concepts –
Underlying Assumptions
Going Concern
Financial statements are
prepared on the
assumption that the
Accruals business will continue for Accounting Entity
Transactions and events foreseeable future The company is regarded
are recognised in the as a separate entity, thus
financial statements in separating the company’s
the period to which they liability from that of its
occur irrespective of owners.
whether cash was Periodicity
received or paid. Economic activities of a
business are divided into
time periods, normally
yearly.
 Qualitative Characteristics of Accounting
Information
Relevance Faithful Timeliness
Able to influence the representation Information should be made
economic decision of users Represent faithfully the available in time to
by evaluating past, presence transactions and events that influence decision-making.
and future events. 3 have occurred.3 qualities:
qualities: Predictive value, complete, neutral and free
Feedback value, and from error
Materiality

Understandability Comparability Consistency

Aware of the abilities and Able to make comparison of the Consistent in applying
limitations of those for bank’s performance and position accounting measurement,
over time and with other banks,
whom accounting valuation and disclosure
consistency in applying
information is provided accounting measurement, methods from one period to
valuation and disclosure methods another
from one period to another
 What is Islamic
Accounting?
The ‘accounting process’ which provides appropriate
information (not necessarily limited to financial data) to
stakeholders of an entity which will enable them to ensure
that
o the entity is continuously operating within the bounds of the
Islamic Shariah and
o delivering on its socio-economic objectives.
 Basis of Islamic accounting
Islam as a religion (way of life)
From the Islamic point of view – economics, politics,
religion and social affairs fall under Shariah (Islamic law).
o Islamic economics is built on the Shariah paradigm
Basic objectives of Islamic economics is:
o Provision of basic human needs
o Fair and equitable provision of economic resources
o Non-exploitation of individuals
In an Islamic society, the muslim man/woman is the
representative agent of the Islamic economic system, not
the economic man or woman as perceived by capitalism
Ultimate objective of Islamic economics is the economic
well being of the ummah through
 equitable equitable distribution of material resources and
subsequently attaining social justice
 Objectives of Islamic Accounting
The growth of Islamic financial markets and institutions
reiterates the need for different accounting requirements.

▧ Islamic accounting is needed to serve different principles of

financial instruments that are found on the Shariah
requirements.
• Prohibition of paying and receiving riba (interest) based on
arguments of social justice, equality
• Profit symbolises successful entrepreneurship but interest is
accrued irrespective of outcome of business
• Social justice demands that borrowers and lenders share rewards
as well as losses in an equitable fashion

▧ To facilitate the needs of users of accounting information of

Islamic financial institutions who, in theory, demand different
sets of information.
• Stakeholders expect the operation to be Shariah-compliant
Features of Islamic Accounting

No difference Different
in terms of information
recording needs by the
(double entry users
system) Clear (legitimate and
distinction of equitable
accounting transactions
objectives and wealth Vs.
(religious vs. wealth
commercial maximisation
obligation)
Features of Islamic Accounting

Different Islamic
Shariah
contractual relationships
compliance
(e.g. mudarabah)

Determination of Zakat
Distinct accountability
-requirement that
relationships (to Allah Muslims pay a portion of
S.W.R and ummah their wealth on annual
basis to help those who
are less fortunate
Users of Accounting Information of
IFIs
▧ Equity holders

▧ Investment Account holders

▧ Other depositors

▧ Creditors

▧ Shariah Committee & Shariah Advisory Council

▧ Regulatory agencies

▧ Zakat agencies
Accounting Concepts/assumptions –
Islamic Perspective
The conventional accounting concepts have been scrutinised
to ensure that they are in line with Islamic principles and
Shariah :

▧ Accounting/economic entity concept

The IFI is regarded as a separate entity, thus separating the
IFI’s liability from that of its owners.

Muslim jurisprudence (Fiqh) is familiar with the idea of an

entity or nominal personality
• It resembles the widely practised of waqf (trust foundation) in
Muslims traditions.
• It shows that the concept of an institution as a distinct entity is
acceptable in Islamic thought
 Accounting Concepts – Islamic
Perspective
▧ Going concern concept

Many Islamic financial contracts such as mudarabah are

for a number of specific periods.

Contracts are assumed to continue until there is evidence

to the contrary
 Accounting Concepts – Islamic
Perspective
▧ Periodicity concept

Implies that a company can divide its economic activities into

artificial time periods.

Accepted in Islam on the basis that even in the case of zakat, it is

being paid once a year as a period of measurement.

o The concept of haul determined that the wealth must be owned at least
one year to qualify for the payment of zakat obligation.
 Accounting Concepts – Islamic
Perspective

▧ Monetary unit

• Money is the common denominator of economic activity and

provides an appropriate basis for measurement

• Money as a unit of measure can be accepted in Islam under a

monetary system where the stability in the value of money is
maintained
• However, in an inflationary environment, the role of money as a
unit of measure becomes questionable
• It fails to serve as a just and honest unit of account
• It makes money an unfair standard of deferred payments
 Accounting principles – Islamic
Perspective

• Major Islamic principles which govern financial dealings and

contracts which are mentioned in the Al- Quran:

1. Realisation of fairness and justice

2. Preservation of rights and dues of all parties
3. Paying zakat (One of the five pillar of Islam) –necessitates having
accurate and just financial statements

• Eltegani(1994) argues that accounting principles which maintain

fairness and justice are accepted in accounting for Islamic banks
 Conventional Vs Islamic Accounting

Conventional Islamic Accounting:

Accounting: • Based upon law originating
• Based upon modern in the Qur’an (Islamic law,
commercial law-permissive As-Sunnah)
rather than ethical • Full disclosure (to satisfy
• Limited disclosure any reasonable demand for
(provision of information information in accordance
subject to public interest) with the Shari’a)
• Personal accountability • Public accountability (focus
(focus on individuals who on the community)
control resources)
 Difference between conventional and Islamic
reporting perspective
ISSUE CONVENTIONAL ISLAMIC

Objectives • Determine if organizations

Assist users in their abide by the principles of
economic decision the Shariah
making
• Determine if the socio-
economic objectives are
achieved

Measurement Historical cost, lower • Historical cost

of cost and NRV • Cash equivalent value-
monetary units that would be
realized if an asset was sold(or
purchased) for cash in the
normal course of business at a
particular date
Continue…
ISSUE CONVENTIONAL ISLAMIC
Reports • Statement of Financial Position • Statement of Financial
• Statement of Profit and Loss Position
• Cash Flow Statement • Statement of Profit and
• Statement of Changes in Loss
Owners’ Equity • Cash Flow Statement
• Environmental and Social • Statement of Changes in
Report Owners’ Equity
• Environmental and Social
Report
• Statement of sources and
uses of zakat funds
• Statement of sources and
uses of Qard Funds(loans
that do not attract any
returns, a means to
achieve social objectives)
Continue…
ISSUE CONVENTIONAL ISLAMIC

Disclosure • Limited disclosure Full disclosure

• Economic • Economic issues
• Environmental • Environment
• Social such as • Social issues-
employee-related, monopoly practices
products, community -interest/riba
development -corrupt practice
-non-fulfillment
of contract
-amount of zakat paid
-computation of zakat
 2.
Islamic Accounting
Standards
• Standards setting bodies
• Financial Reporting environment
Islamic Accounting Standard Setting
Bodies

Malaysia Accountin Islamic

n g and Financi
Accounti Auditing al
ng Organisati Service
Standard ons of IFI s Board
Board (AAOIFI)
(IFSB)
(MASB)
Malaysian Accounting Standards Board (MASB)

▧ Established under the Financial Reporting Act 1997

▧ An independent authority to develop and issue accounting

and financial reporting standards in Malaysia.

▧ On 1 August 2008, the Financial Reporting Foundation,

which oversees the operations of MASB, and MASB issued
a statement on their plan for full convergence of the MFRSs
with IFRSs as issued by IASB by 1 January 2012
Malaysian Accounting Standards Board (MASB)
▧ On 17 November 2011, the MASB issued a new MASB approved
accounting framework, the Malaysian Financial Reporting Standards
(MFRS Framework), which is a fully IFRS-compliant framework and
equivalent to IFRSs.

▧ The MFRS Framework comprises Standards as issued by the

International Accounting Standards Board (IASB) that are effective on
1 January 2012.

▧ It also comprises new and revised Standards recently issued by the

IASB that will be effective after 1 January 2012

▧ The adoption of the MFRS Framework allows Malaysian entities to be

able to assert that their financial statements are in full compliance with
IFRSs
MASB – Financial Reporting from Islamic Perspective
▧ In 1997, the initial sentiment was that a separate, stand-alone set of
Islamic standards was necessary to satisfactorily report Islamic
transactions and events.
▧ In 2001, standard MASB i-1 (later re-numbered FRS i-1), Presentation
of Financial Statements of Islamic Financial Institutions, was issued.
▧ However, it was found that much of the conventional accounting
concepts and generally accepted accounting principles could be
applied to Islamic financial transactions and events, with additional
disclosures to explain the use of Islamic contracts.
▧ Indeed, even MASB i-1 (FRS i-1) was largely a reiteration of
requirements already found in FRS 101, Presentation of Financial
Statements, and FRS 108, Accounting Policies, Changes in Accounting
Estimates and Errors.
MASB – Financial Reporting from Islamic Perspective
▧ MASB ceased its policy of issuing Islamic accounting standards.

▧ It may instead issue other documents that discuss the application of MASB
approved accounting standards to Islamic transactions. These documents,
however, are neither standards nor interpretations to standards.

▧ On 15 September 2009, the MASB issued Statement of Principles i-1 (SOP i-

1), Financial Reporting from an Islamic Perspective to affirm that MASB
approved accounting standards shall apply to Shariah compliant financial
transactions and events, unless there is a Shariah prohibition.

▧ Since then the MASB would no longer be issuing Islamic accounting standards,
it accordingly withdrew FRS i-1.
▧ Any additional guidance on accounting for Islamic financial transactions and
events will take the form of other pronouncements, usually Technical Releases,
which supplement MASB approved accounting standards.
MASB – Islamic Technical Pronouncements
Accounting and Auditing Organisations of IFI
(AAOIFI)

▧ Established in 1991 and based in Bahrain

▧ An international not-for-profit organization primarily

responsible for development and issuance of standards for
the global Islamic finance industry.

▧ Primary purpose:
To enhance the confidence of users of the financial statements
of the IFIs and ultimately to promote IFIs
Accounting and Auditing Organisations of IFI
(AAOIFI)
▧ Objectives :

➢ Develop accounting and auditing thought relevant to IFIs

➢ Disseminate accounting and auditing thought relevant to IFIs
➢ Prepare, promulgate and interpret accounting and auditing standards
for IFIs
➢ Review and amend accounting and auditing standards for IFIs

▧ Supported by many institutional members, including central

banks and regulatory authorities, financial institutions,
accounting and auditing firms, and legal firms, from over 45
countries.
Accounting and Auditing Organisations of IFI
(AAOIFI)

▧ Its standards are currently followed by the leading Islamic

financial institutions across the world and have introduced a
progressive degree of harmonisation of international
Islamic finance practices.

▧ Issued a total of 94 standards – consisting of 54 Shariah

standards, 26 accounting standards, 5 auditing standards, 2
codes of ethics and 7 governance standards.
 Example of AAOIFI standards
FAS 1 – General Presentation and Disclosure in the Financial Statements of
Islamic Banks and Financial Institutions.

FAS 2 – Murabaha and Murabaha to the Purchase Orderer

FAS 3 – Mudaraba Financing

FAS 4 – Musharaka Financing

FAS 7 – Salam and Parallel Salam

FAS 8 – Ijarah and Ijarah Munthia Bittanleek

FAS 9 – Zakah

FAS 10 – Istisna’ and Parallel Istisna’

 Islamic Financial Services Board (IFSB)
▧ Started operations on 10th March 2003, based in Kuala Lumpur.

▧ An international standard setting body of regulatory and supervisory agencies.

▧ Ensuring the soundness and stability of the Islamic financial services industry,
which is defined broadly to include banking, capital market and insurance.

▧ Introducing new, or adapting existing international standards consistent with Shariah

principles, and recommend them for adoption.

▧ Issued 30 Standards, Guiding Principles and Technical Note.

• Risk Management( IFSB-1), Capital Adequacy (IFSB-2), Governance for Islamic Assurance (IFSB-8)
Accounting Standards for IFI
International Financial Reporting Standards (IFRS)
➢ Issued by International Accounting Standards Board (IASB).
➢ Used in more than 120 countries.
➢ Adopted as Malaysian Financial Reporting Standards (MFRS).

AAOIFI Financial Accounting Standards (FAS)

➢ Issued by the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI).
➢ Used for IFIs in Bahrain, Sudan, Syria, Lebanon, Qatar, Oman.

Other standards
➢ Local conventional standards, e.g. US GAAP
➢ Local Islamic standards, e.g. Pakistan & Indonesia- Institute of Chartered
Accountants of Pakistan and Indonesian Accounting Institute
Financial Reporting Environment
➢ Islamic banking financial reporting practices are subjected to the central
banks’ regulation in the respective countries

➢ In Malaysia, for example, it is under the purview of BNM (GP8), Companies

Act 2016, applicable MASB accounting standard and International Financial
Reporting Standard (IFRS)

➢ Lack of Shariah consistency as each bank relied on Shariah advisors of

respective banks even with the supervision of the central banks
 Financial Reporting Environment

➢ Lack of comparability and consistency on the accounting treatment on recognition,

measurement and disclosure of Islamic-based transactions
➢ hinder the measurement and comparison financial performance of the Islamic banks
internationally

➢ Lack of sound regulation on accounting hinders the development of Islamic

banking

➢ In Malaysia, efforts by MASB with the guidance of AAOIFI’s standards to develop

guidelines or Technical Releases for Islamic financial institutions
Discussion on selected
standards
1) 3AAOIFI FAS 1
2) MASB TRi-3
AAOIFI FINANCIAL ACCOUNTING STANDARD 1
General Presentation and Disclosure in the Financial Statements of Islamic
Banks and Financial Institutions (FAS 1)
▧ Issued in January 1996

▧ In addition to other conventional disclosures, the IFIs should

disclose two very important aspects of their unique
functions:

1. The role of the Shariah advisor or Shariah board in

supervising the bank’s activities and the nature of advisor’s
or board’s authority in accordance with the bank’s by-laws
and in actual practice

2. The bank’s responsibility towards zakat

AAOIFI FINANCIAL ACCOUNTING STANDARD 1
General Presentation and Disclosure in the Financial Statements of
Islamic Banks and Financial Institutions
(FAS 1)

▧ Disclosure of significant accounting policies :

o Accounting policies adopted which are not consistent

with the concepts of financial accounting for IFIs

o On valuation, the standards require that the policies, bases,

and methods adopted for revaluation of assets, liabilities and
restricted investments to their cash equivalent value over the
historical value.
AAOIFI FINANCIAL ACCOUNTING STANDARD 1
General Presentation and Disclosure in the Financial Statements of
Islamic Banks and Financial Institutions
(FAS 1)
▧ Disclosure of earnings or expenditures prohibited by
the shariah:

o Financial statements should disclose the amount and nature

of earnings and expenditures that have been realized or
incurred from sources or by means which are not permitted
by shariah.

o Disclose how it intends to dispose of the assets generated by

the prohibited earnings or acquired through prohibited
expenditures
AAOIFI FINANCIAL ACCOUNTING STANDARD 1
General Presentation and Disclosure in the Financial Statements of
Islamic Banks and Financial Institutions
(FAS 1)
▧ Disclosure of earnings or expenditures prohibited by the shariah:

o Crucial in order to enhance the confidence of the stakeholders on the

integrity of IFIs

o Any shariah non-compliant activities are expected to be disclosed and

efforts to cleanse the account from non-shariah compliant incomes or
expenses must be made transparent.
MASB TRi – 3
Presentation of Financial Statements of IFI
• Although IFRS provide a structural framework for reporting,
they have not accommodated Shariah precepts which form
the basis of all Islamic transactions
• MASB have issued four technical release to facilitate the
application of IFRS to Islamic Financial transactions
• MASB Tri-3-Adopted in Malaysia, effective date : 1
January 2010

• Objective: Basis for presentation and disclosure of financial

statements of IFIs that conduct Islamic banking activities.

▧ To ensure comparability of these statements with those in previous

periods and with those of other IFIs
MASB TRi – 3
Presentation of Financial Statements of IFI
▧ In addition, this Technical Release provides guidelines for
the structure, and basis of the content of financial statements
to ensure conformity with Shariah requirements.

▧ It also prescribes minimum disclosure requirements.

▧ The recognition, measurement, and disclosure of specific

Islamic-based transactions and events will be dealt with in
other MASB Islamic accounting pronouncements.
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ MASB MFRS 101 requires a complete set of financial
statements including the following components:

(a) Statement of financial position,

(b) Statement of comprehensive income,
(c) Statement of changes in equity,
(d) Statement of cash flows; and
(e) Notes to the accounts.

▧ In addition to the above statements, TR i-3 requires an

Islamic Financial Institution to present, outside its financial
statements, any other statements useful to users, for
example, Zakat Fund and Qard Fund.
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ Recommends voluntary additional statements that include a
financial review by management describing and explaining the
main features of the IFIs financial performance and financial
position, mentioning principal uncertainties such as:

(a) Factors determining performance (e.g. changes in the

environment, response to those changes, investment policies aimed at
maintaining and enhancing performance, etc.)

(b) Sources of funding, policy on gearing, and its risk management

policies

(c) The IFI’s strengths and resources whose value is not reflected in
the balance sheet.
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ In any circumstance when management concludes that compliance with a
requirement in a standard would be misleading, and therefore that departure
from a requirement is necessary to achieve a fair presentation, an IFI should
disclose:
1. Management’s conclusion that the financial statements fairly present the IFI’s
financial position, financial performance and cashflows;

2. Complied in all material respects with applicable MASB standards except that they
have so departed in order to achieve fair presentation;

3. Nature of departure, including the treatment that the standard would require, the
reason why that treatment would be misleading in the circumstances and the
treatment adopted;

4. Final impact of the departure on the profit/loss, assets, liabilities, equity and cash
flows.
 MASB TRi – 3
Presentation of Financial Statements of IFI

▧ Requires disclosure of Shariah advisor and zakat

obligations.

▧ IFI should disclose the role and authority of Shariah

advisor or board in monitoring the IFI’s activities
pertaining to the shariah matters.

▧ Disclose, where applicable, its responsibility towards

payment of zakat on behalf of depositors, shareholders
and others.
 MASB TRi – 3
Presentation of Financial Statements of IFI

▧ With regards to shariah compliant activities, an IFI is

encouraged to disclose (if there is any):

o The amount and nature of earnings realised from

sources or means which are not permitted by shariah
o The amount and nature of expenses not permitted by
shariah;
o The manner of disposal of prohibited earnings

→ To ensure transparency in the institutions’ activities

and transactions.
BNM Guidelines on Financial Reporting
▧ The Guidelines on the Specimen Reports and Financial Statements for
Licensed Islamic Bank or GP8-i was issued to the Islamic banks in
August 2015 by Bank Negara Malaysia.
▧ GP8-i is aimed at :
○ ensuring consistency and comparability of the reports and financial
statements amongst the Islamic banks
○ Compliance with the Companies Act , approved accounting
standards and Shariah requirements, Bursa Malaysia requirements

▧ The GP8-i is to be adopted by the Islamic banks for annual accounts

commencing 2016.

▧ The objective of the issuance of the GP8-i is to provide the basis for
presentation and disclosure of reports and financial statements of Islamic
banks.
▧ It sets out the minimum requirements for the presentation and
disclosure of reports and financial statements of Islamic banks.
 CONCLUSION
ISLAMIC ACCOUNTING FRAMEWOR AIMS FOR:

1. Shariah compliance and achievement of Islamic goals on

financial activities

2. Equitable and fair recognition, measurement, valuation and

disclosure of financial information

3. Achievement of both economic and spiritual well being of the

society
Group Discussion
1. Discuss the differences between conventional and Islamic
accounting. (Tuesday class)
2. Discuss the revenue recognition and materiality principle
from an Islamic perspective. (Tuesday class)
3. Discuss disclosure principle and consistency from an Islamic
perspective. (Wednesday class)
4. Outline the development of Islamic Accounting standards in
Malaysia. (Wednesday class)

Tuesday slot students may opt for Ques 1 or 2 (choose either 1)

Tuesday slot students may opt for Ques 3 or 4 (choose either 1)
or 2
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