Accounting of Islamic Banks
Introduction
(Week 1 & 2)
Part 1
Development of Islamic
Banking System
Definition of a Bank
Banking business means:
(a) The business of;
(i)
Receiving deposits on current account,
deposit account, savings account or other
similar account;
(ii)
Paying and collecting cheques drawn by
or paid in by customers; and,
(iii) Provision of finance; or
(b) Such other business as the bank (BNM),
with the approval of the Minister may
prescribe
Banking and Financial Institutions Act 1989
(BAFIA)
Definition of an Islamic Bank
“Banking business whose aims and
operations do not involve any
element which is not approve by the
religion of Islam”
Islamic Banking Act (1983)
Need for Islamic Banking System
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Shariah Islamiyyah compliance
Meet financing and investment needs
of the Muslims
Meet modern requirement of
individual and commercial needs
Encourages financial innovations but
in line with Shariah
In Malaysia, growing regulatory and
social support
Historical Development of Islamic
Banking
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The 1st. Islamic Bank – Mit-Ghamr Nasser
Social Bank, Egypt (1963)
Dalla Al-Baraka Group, Saudi (1969)
Islamic Development Bank, Jeddah, Saudi
(1975)
Dar al-Maal al-Islami, Saudi (1981)
BIMB (1983)
Jordan Islamic Bank, Dubai Islamic Bank
etc…
Factors Affecting the Development
of Islamic Banking System
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Legal, political and economic changes
internationally
Islamization and Institutional Reform (e.g.
Pakistan, Iran, Sudan, Malaysia)
International Muslim organizations (OIC –
IDB – etc)
International response to capture
capital/fund of oil rich Islamic countries
(e.g. Citibank, Dresdner Kleinworth
Benson, ANZ group, etc.
Malaysian Dual Banking System
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In 1963, the Pilgrims and Fund Management
Board provides a savings mechanism for Muslims
to perform Hajj
In 1983, the Islamic Banking Act (IBA) was
approved and defined Islamic Banking as
“banking business whose aims and operations do
not involve any element which is not approve by
the religion of Islam”.
Government Investment Act (Act 275) 1983
empowers the government to issue Government
Investment Certificates (GIC) with returns in the
form of discretionary gift (Hibah) rather than
interest
In 1993, Conventional banks can operate Islamic
baking and financial products known as Skim
Perbankan Tanpa Faedah (SPTF)
PART 2
Traditional western (secular)
accounting objectives
Definition and Purpose of
Accounting
In 1966 the American Accounting Association
defined accounting as:
“…the process of identifying, measuring and
communicating economic information to
permit informed judgements and decisions by
users of that information”
In 1975 they added that the purpose of the
process was:
“…to provide information which is potentially
useful for making economic decisions and
which, if provided, will enhance social welfare”
ACCOUNTING
A PROCESS OF
Recognising,
recording,
classifying
and summarising
business
transaction
Documents
Vouchers
Ledger
Trial Balance
Report (Mgmt)
Measuring,
Analyzing,
Interpreting Result
of Operation
Reporting &
Presenting
Financial Position
Profitability
= Income - Expenses
Financial Statement
Growth
Liquidity
Productivity
• Balance Sheet
• Income Statement
• Stmt of Changes
In Equity
• Cash Flow Statement
• Notes to Accounts
STAKEHOLDERS
1. Management
2. Board of Directors
3. Shareholders
4. Investors
5. Creditors
6. Authorities – BNM, Inland
Revenue, Baitulmal
7. Staff
8. Public
Traditional Model of Accounting
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Accounting entity (Owners (principals)
are different from managers (agents)
Economic events (identifiable and
measurable in monetary terms)
Financial description
Decision usefulness to a very restricted
set of users (esp. those with financial
involvement with the entity)
Neo-Classical Economics and
maximization of wealth of stakeholders
Objectives of Financial
Accounting and Reporting
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Provide information that is useful to
present and potential investors and creditors
and other users in making rational decisions
Information should be comprehensible to
those who have reasonable
understanding of economic activities and
are willing to study the information
Primary user groups are shareholders,
investors and creditors
Secondary user groups are 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)
PART 3
Accounting from an Islamic
perspective
Accounting and Islam
Al-Baqarah 282: “O you who believe! When
you deal with each other, in transactions
involving future obligations in a fixed period
of time, reduce them to writing, let a scribe
write down faithfully as between the parties:
let not the scribe refuse to write: as God has
taught him, so let him write. Let him who
incurs the liability (debtor) dictate, but let
him fear his Lord God, and not diminish
aught of what he owes. If the party liable
(debtor) is mentally deficient, or weak, or
unable himself to dictate, let his guardian
dictate faithfully, and get two witnesses, out
of your own men, and if they are not two
men, then a man and two women, so that if
one of them errs, the other can remind
him….”
Accounting and Islam
“…The witnesses should not refuse when they
are called on (for evidence). Disdain not to
reduce to writing (your contract) for a future
period, whether it be small or big: it is more
just in the sight of God, more suitable as
evidence, and more convenient to prevent
doubts among yourselves. But if you carry
out the transactions on the spot there is no
blame if you reduce it not to writing. But
take witness whenever you make a
commercial contract, and let neither the
scribe nor witness suffer harm. If you do
(such harm), it would be wickedness in you.
So fear God; for it is God that teaches you.
And God is well acquainted with all things”
Definition of Accounting from an
Islamic Perspective
“The process of identifying, measuring, and
communicating economic and other
relevant information inspired by Islamic
Worldview and complied with Syari’ah
Islamiyyah to permit informed
judgements and decisions by potential
and expected users information to
enhance social welfare”
Islamic Accountability
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Transcendental accountability to Allah
SWT (Hablumminallah)
Social accountability to the society
(Hablumminan-nass)
Individuals as trustees or khalifah
Success in this world and in the hereafter
(al-falah)
Economic goals beyond purely wealth but
include tazkiyah (purification of self and
wealth)
Objectives of Financial Statements
Traditional
Islamic
Income
Statement
Balance
Sheet
Economic
Performance
Financial
Position
Fulfilment of
Amanah
Financial Trust
and
Obligation
Cash Flow
Cash Position
Equity
Statement
Wealth
Ownership
Cash
Entrusted
Wealth
Entrusted
Features of Islamic Accounting
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No different in terms of recording (double entry
system)
Clear distinction of Accounting Objectives i.e.
religious obligation vs. commercial obligation
(different significance of financial statements)
Different users information need (legitimate and
equitable transactions and wealth vs. maximization
of wealth and economic consequences)
Compliance with the principles and rules of Syari’ah
Different Islamic contractual relationships
(mudarabah instrument; murabahah etc.)
Distinct accountability relationships (to Allah SWT
and Ummah)
Determination of zakat
User Groups of Accounting
Information for Islamic Banks
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Investors (potential and existing) (lawful
and equitable investment)
Creditors (potential and existing) (lawful
trade assets)
Regulators (e.g. Bank Negara)
Syari’ah Supervisory Board & Advisory
Council (syari’ah compliance)
Customers (lawful goods and services)
Others who may be effected by the
disclosure or non-disclosure of information
PART 4
Introduction to AAOIFI
Accounting Standards and
Objectives of Financial
Accounting and Reporting
Accounting and Auditing
Organizations of Islamic Financial
Institutions (AAOIFI)
Primary Purpose
 To enhance the confidence of users of the
financial statements of the IFIs and
ultimately to promote IFIs
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
Accounting and Auditing Organizations of Islamic
Financial Institutions (AAOIFI)
http://www.aaoifi.com/
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History: established in 1991 –
agreement of association by IFIs
worldwide supported by IDB
Head office is in Bahrain
Organizational Structure – Supervisory
Committee; Financial Accounting Standard
Board; Executive Committee; Shari’ah
Committee
Funded by founding members of IFIs,
establishment of waqf etc.
AAOIFI: Accounting, Auditing and
Governance Standards
Financial Accounting
Statements of
Standards
Financial
 Musharaka Financing
Accounting
 Profit Allocation Basis
 Objectives
 Investment Account
 Concepts
Holders
Financial Accounting
 Salam Financing
Standards
 Ijarah Financing
 Presentation and
 Zakah
Disclosure of Financial
Statements of Islamic  Istisna’ Financing
 Provisions and Reserves
Banks
 Presentation and Disclosure
 Murabaha Financing
of Financial Statements of
 Mudaraba Financing
Islamic Insurance
Companies
AAOIFI: Accounting, Auditing and
Governance Standards
Auditing Standards
 Objectives and
Principles of Auditing
 The Auditor’s Report
 Terms of Audit
Engagement
Governance
Standards
 Syariah Supervisory
Board
 Syariah Review
 Internal Syariah
Review
Code of Ethics
 Code of Ethics for
Accountants and Auditors
of IFI
New Financial
Accounting Standards
 Investment Fund
 Disclosure Bases for
Determining and
Allocating Insurance
Surplus (and deficit)
New Auditing Standards
 Audit Tests for Syariah
Compliance
Objectives of Islamic Financial
Accounting and Reporting (AAOIFI)
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To determine rights and obligations of
interested parties
To safeguard entity assets and rights of
others
To contribute to enhancement of
managerial productive capacities
To provide useful information to make
legitimate decisions
Syari’ah compliance
Distinguish prohibited earnings and
expenditure
Objectives of Islamic Financial
Accounting and Reporting (AAOIFI)
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Present entity’s economic resources,
obligations and related risks
Determine Zakat obligations
Estimate cash flow and related risk
Ensuring reasonable (or equitable) rates
of returns to investors
Disclose Islamic Bank’s discharge of social
responsibility (not as a constraint but as a
goal)
PART 5
Accounting concepts from an
Islamic perspective
Impact of Syari’ah Contractual
Conditions Accounting concepts
Existence (Recognition of revenue and
expense)
Lawful (Recognition of revenue and
expense)
Measurable (Measurement of assets and
liabilities)
Deliverable (Recognition & Measurement)
Equitable (Profit determination and
distribution)
Accountability (Disclosure & Presentation)
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Accounting Concepts: An Islamic
Perspective
Accounting unit
 Separate legal entity; limited liability;
owners are different from managers
 Similar to the concept of “juridical person”
in the case Waqf & Baitulmal
 Almost similar to Mudarabah as far as the
purpose and principles
 Liabilities limited to the capital
contribution & may be injurious to the
creditors in the case of liquidation
 To be constrained by the syari’ah as to the
rights and obligations
Accounting Concepts: An Islamic
Perspective
Periodicity
 periodic reports of financial positions as of
a given date and divided into reporting
periods (normally annual)
 Accounting for zakat based on “haul” (one
year complete ownership)
Going concern
 contracts assumed to continue until there
is evidence to the contrary
 Para 21 MASBi-1 when material
uncertainties, those uncertainties should
be disclosed
Accounting Concepts: An Islamic
Perspective
Monetary and stability of unit
measurement
 currency as common denominator
 Impact of inflation & purchasing power on
reporting?
Prudence & Conservatism
 Generally, not to overstate assets and
incomes, and not to understate liabilities
and expenses
 As long as can be determined with
certainty (objectivity)
Accounting Recognition and
Measurement Concepts
Recognition
 Define the basic principles that determine
the timing of revenue, expense, gain and
loss
Measurement
 Define the broad principles that
determine the amount at which assets,
liabilities, owners equity etc. are
recognized
Islamic Perspective of Accounting
Recognition
Revenue Recognition
 Recognized when realized
 The right to receive not necessarily when the
payment is received (i.e. accrual basis –
MASBi-1 para 22; AAOIFI) e.g. when a bank
delivers the service
 Syariah Requirement: the amount of revenue
should be known and collectible
Expense Recognition
 Realization either because the expense relates
to the earning of revenue (e.g. transportation
cost for services), or because it relates to the
period of income statement (e.g. bonus)
Islamic Perspective of Accounting
Measurement
Matching Concept
 Matching of revenues and gains with
expenses and losses that relate to that
period
 Measurement Attributes: acquisition cost
(HC), cash equivalent value, asset’s
replacement cost etc.
 In the case of Zakat measurement,
preference is current market value
(AAOIFI FAS 9: Cash Equivalent Value)
Islamic Perspective of Accounting
Measurement
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Historical Value vs. Current Value
Cash Equivalent Value (most preferred
if the following are available):
availability of objective indicator;
relevant information;
logical and relevant valuation
consistency of valuation methods
experts valuation
conservatism in the valuation process
Definition of Assets
“Capable of generating positive cash flows
or other economic benefits in the future
either by itself or in combination with other
assets which the bank has acquired the right
to hold (rightful ownership of maal), use
of dispose (rights on manfaat) as a result
of past transactions or events” (AAOIFI)
Desirable Characteristics of
Accounting Information
1. Relevance
 Predictive Value (ability to predict
potential outcome)
 Feedback Value (ability to verify the
accuracy of prior prediction)
 Timeliness (available as soon as after the
reported events)
Desirable Characteristics of
Accounting Information
2. Reliability
 Representational faithfulness
(information reflect what it purports to
present)
 Objectivity (measurement and disclosure
appropriately used and if replicated by
independent person gives the same result)
 Neutrality (accounting information
directed towards common needs of users
and not needs of particular group of
users)
Desirable Characteristics of
Accounting Information
3. Comparability
 Able to make comparison of the bank’s
performance and position over time and
with other banks
4. Consistency
 Consistent in applying accounting
measurement, valuation and disclosure
methods from one period to another
Desirable Characteristics of
Accounting Information
5. Understandability
 Aware of the abilities and limitations of
those for whom accounting information is
provided
6. Materiality
 Accounting information is regarded
material if its omission, non-disclosure or
misstatement results in distortion of the
financial statements
Conclusions
Islamic accounting framework
(objectives and concepts):
1.
Compliance with syari’ah and,
achievement of Islamic goals, on financial
activities (financing schemes and financial
instruments)
2.
Equitable and fair recognition,
measurement, valuation and disclosure of
financial information
3.
Achievement of both economic and
spiritual well being of the society