IRTI 15th DL Course :9th lecture
8 Rajab1433H,
29th May 2012,
O ye who believe!, If a wicked person comes to you with any
news, ascertain the truth, lest ye harm people unwittingly and
afterwards become full of repentance for what ye have done”
REINVENTING
AUDITING AND
ACCOUNTING FOR
ISLAMIC FINANCE:
THE IDEAL,
REALITIES AND
CHALLENGES
Assoc. Professor Dr Shahul Hameed bin Mohamed Ibrahim
Head, CIFP
International Centre for Education in Islamic Finance
Kuala Lumpur, Malaysia
CONTENTS
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WHY THE NEED FOR REINVENTING
• The purpose of developing Islamic socio-economic
organizations such as IFIs are to:
• Achieve the socio-economic objectives of the islamic
economic system especially social justice.
• Need fullfillment
• Equitable earnings
• Dignity of the khalifa
• Less concentration of wealth
• While operating with the bounds of the Shariah
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WHY THE NEED FOR REINVENTING
• Accounting and auditing are both tools to provide
information and to measure performance.
• Conventional accounting and auditing have been
developed in a environment with materialistic values
where financial objectives are emphasized for finance
providers
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CONTEMPORARY DEFINITIONS OF ACCOUNTING
identifying
Financial
Statements
classifying
Economic
Events and
Transactions
measuring
Finance
Providers
recording
summarizing
Reporting and Interpreting
Buy ,Sell
and Hold
shares
The process of identifying, classifying, measuring, recording, summarizing and
reporting economic events to interested shareholders and creditors for them to
make informed decisions (i.e to buy, hold or sell their shares) as to the amount,
timing and certainty of future cash flows, the which is said to allocate scarce
resources to the most efficient uses and which is said to achieve social welfare.
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RESULT OF INCONGRUENCY BETWEEN ECONOMIC SYSTEM AND ACCOUNTING SYSTEM
SSYSTEMSYSTEMSYSTEM(SOURCE; SHAHUL, 2001)
4 .THE SOCIO -ECONOMIC
OBJECTIVES OF THE
SHARI’A
5A. THE SOCIO-ECONOMIC OBJECTIVES OF THE
SECULAR CAPITALIST ECONOMIC SYSTEM
4A. CAPITALIST
ECONOMIC
INSTITUTIONS
5. THE ISLAMIC
ECONOMIC SYSTEM &
FINANCIAL SYSTEM
1. ESTABLISHMENT OF
ISLAMIC SOCIOECONOMIC
INSTITUTIONS
2A. USE OF CONVENTIONAL
ACCOUNTING
BASED
ON
SECULAR
PHILOSOPHICAL
VALUES INCONSISTENT WITH
ISLAMIC VALUES
3A. INCONSISTENT OR DEVIANT
DECISION MAKING OF MUSLIM
USERS (HOMEO ECONOMICUS)
2. USE OF ISLAMIC
ACCOUNTING CONSISTENT
WITH ISLAMIC VALUES
3. CONSISTENT DECISION MAKING IN
LINE WITH ISLAMIC NORMS (HOMEO
ISLAMICUS)
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PROPOSED DEFINITIONS
Islamic accounting can be defined as 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 the entity is continuously operating within the
bounds of the Islamic Shari’a and delivering on its socioeconomic
objectives. Islamic accounting is also a tool, which enables
Muslims to evaluate their own accountabilities to God (in respect
of inter-human/environmental transactions).
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INFORMATION FOR IFIS ACCORDING TO AAOIFI
AAOIFI has thus identified the common “minimum “information needs as follows:
Information which can assist in evaluating the bank’s compliance with the principles of
Shari’a in all of its financial and other dealings.
Information which can assist in evaluating the bank’s ability in:
 Using the economic resources available to it in a manner that safeguards these
resources while increasing their value, at reasonable rates.
 Carrying out its social responsibilities and in particular those that have been specified by
Islam, including the good use of available resources, the protection of the rights of others
and the prevention of corruption on earth.
 Providing for the economic needs of those who deal with the bank.
 Maintaining liquidity at appropriate levels.
Information which can assist those employed by the bank in evaluating their relationship
and future with the Islamic bank, including the bank’s ability to safeguard and develop
their rights and develop their managerial and productive skills and capabilities.
(para2 8)
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TYPES OF REPORTS REQUIRED BY AAOIFI
(a) Analytical financial reports about sources of funds for Zakah and their uses.
Although the financial statements of Islamic banks will disclose the liability for Zakah
and the amount that has been disbursed, users of financial statements might be
interested in additional analysis of sources of funds for Zakah, methods of its
collection including controls to safeguard these funds and their uses.
(b) Analytical financial reports about earnings or expenditures prohibited by the Shari’a
It is our intent for the financial statements to disclose income earned by the Islamic
bank from prohibited transactions or sources and expenditures prohibited by the
Shari’a and how those earnings were disposed of. However, users of the financial
statements may be interested in detailed financial reports. Such reports may include
information about the causes of such earnings, their sources, how they were disposed
of and procedures established to prevent entering into transactions prohibited by the
Shari’a.
(c) Reports concerning the Islamic bank’s fulfillment of its social responsibilities
(d) Reports about the development of the Islamic bank’s human resources
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OBJECTIVES OF ISLAMIC FINANCIAL
ACCOUNTING
To determine the rights and obligations of all interested parties, including those rights
and obligations resulting from incomplete transactions and other events, in
accordance with the principles of Islamic Shari’a and its concepts of fairness,
charity and compliance with Islamic business values.
To contribute to the safeguarding of the Islamic bank’s assets, its rights and the
rights of others in an adequate manner.
To contribute to the enhancement of the managerial and productive capabilities of
the Islamic bank and encourage compliance with its established goals and
policies and, above all, compliance with Islamic Shari’a in all transactions and
events.
To provide, through financial reports, useful information to users of these reports, to
enable them to make legitimate decisions in their dealings with Islamic banks.
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INFORMATION REQUIRED BY IFI’S USERS
(a)
Information about the Islamic bank’s compliance with the Islamic Shari’a and its objectives and to establish such compliance;
(b)
Information establishing the separation of prohibited earnings and expenditures, if any, which occurred, and of the manner in
which these were disposed of . (para 37)
(b)
Information about the Islamic bank’s economic resources and related obligations (the obligations of the Islamic bank to transfer
economic resources to satisfy the rights of its owners or the rights of others), and the effect of transactions, other events and
circumstances on the entity’s economic resources and related obligations.
(b) This information should be directed principally at assisting the user evaluating the adequacy of the Islamic bank’s capital to
absorb losses and business risks; assessing the risk inherent in its investments and; evaluating the degree of liquidity of its
assets and the liquidity requirements for meeting its other obligations. (para 38)
(c)
Information to assist the concerned party in the determination of Zakah on the Islamic bank’s funds and the purpose for which it
will be disbursed().
(d)
Information to assist in estimating cash flows that might be realized from dealing with the Islamic bank, the timing of those flows
and the risk associated with their realization. This information should be directed principally at assisting the user in eval uating the
Islamic bank’s ability to generate income and to convert it into cash flows and the adequacy of those cash flows for distributing
profits to equity and investment account holders.
(e)
Information to assist in evaluating the Islamic bank’s discharge of its fiduciary responsibility to safeguard funds and to invest
them at reasonable rates of return, and information about investment rates of returns on the bank ’s investments and the rate of
return accruing to equity and investment account holders.
(f)
Information about the Islamic bank’s discharge of its social responsibilities
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AAOIFI’s Recommended
Set of Financial Statements
Unique to
Similar to conventional to
Financial Statements
Statement of Financial
Position
(Balance Sheet)
Cash Flow Statement
Income Statement
(Profit and Loss Account)
Statement of Retained
Earnings (Statement of
Changes in Owners’
Equity)
Islamic Financial
Institutions
Statement of Changes
In
Restricted Investments
Statement of Sources and
Uses of Funds in the
Zakah and Charity Fund
Statement of Sources and
Uses of Funds in the Qard
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EXAMPLES OF ANNUAL REPORTS
CONVENTIONAL BANKS
ISLAMIC BANKS NOT FOLLOWING AAOIFI
ISLAMIC BANKS FOLLOWING AAOIFI
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17
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ISSUES IN USING IASB STANDARDS , IFRS
the prohibition on partaking in interest-based • transactions and whether this should
affect the use of discount rates for measuring financial instruments.
• the prohibition on partaking in interest-based • transactions and whether this should
affect the use of discount rates for measuring financial instruments.
•
whether concepts such as ‘control’, ‘risks and • rewards’ or ‘rights and obligations’,
essential in determining the accounting treatment under IFRS,, are readily translatable
to Islamic finance, where the sanctity of contractual form is so important the unique
structures in Islamic finance that can • confer rights and obligations on institutions,
which are quite distinct from apparently similar conventional products (eg profitsharing investment accounts based on murabaha)
• whether potential changes to IFRS, such as in the • areas of lease accounting,
financial instruments, insurance accounting and consolidation may have an impact on
institutions applying IFRS, in the future.
Source: ACCA report:Harmonising financial reporting of islamic finance
•
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CONTEMPORARY DEFINITIONS OF AUDITING
“The objective of an audit of financial statements is to enable the
auditor to express an opinion whether the financial statements are
prepared, in all material respects, in accordance with an
applicable financial reporting framework”.
International Standards on Auditing (ISA) 200, Objective and General Principles Governing an
Audit of Financial Statemen
Auditing is “a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence
between those assertions and established criteria and communicating the results to interested
users” (Committee on Basic Auditing Concepts [COBAC], 1972: 2)
,
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AN EXAMPLE OF CONFLICT BETWEEN IFRS AND
AAOIFI
Example: Ijara and presentation of leases off balance sheet
One of the most common structures used in Islamic finance is the Ijara – a form of leasing
arrangement. The pure Ijara is essentially an operating lease and there would appear
to be little conflict in accounting for this (either for the lessor or the lessee) under the
requirements of IAS17.
Increasingly used forms of leasing by IFIs are the ijara muntahia bittamleek (ijara MB) or
ijara wa iqtina, which are similar to a hire purchase agreement popular in conventional
finance. This is essentially a form of financing which, under IFRS, is treated as a
finance lease because, as with a hire purchase agreement, the risks and rewards
associated with owning the asset are in substance transferred to the lessee. Thus
under IAS17 the asset would be booked as such by the lessee, while the lessor (the
financer) would book a receivable for the rent and related interest receivable. (ACCA
2010)
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AUDITING PROCESS
Systematic
process
Collection of
evidence
Reliable and
sufficient
About subject
matter
Comparison with
criteria
Communication
of findings
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Comparison between conventional and islamic auditing
Element
Conventional Audit
Islamic Auditing
3 party relationship
Entity, auditor, user
Appropriate
subject matter
Financial statement
assertions
Suitable criteria
IFRS
Sufficient
appropriate
evidence
Observation, inquiry,
physical examination,
vouching of documents
and minutes of directors
meetings
Standard audit report
prepared by auditor
Entity, auditor and
broader range of users
Processes, contracts,
personnel, systems,
performance, financial
statements
Shari’a principles and
rules, aaoifi standards
and appropriate parts
of IFRS
Same techniques on
relevant documents
and events.
Written assurance
report
A more detailed report
prepared by a shari’a
auditor
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Evolution of Auditing
Financial Audit
Financial
statement
s
Late
1800s/1900s
Performance Audit
Economy,
effectiveness and
efficiency of resource
utilization, programs
& activities
1960s/1970
s
Social &
Environmental Audit
Social contribution &
environmental
compliance
1970s
Shari’ah Audit
Every aspect of
organization’s
activities as required
by Islamic religiious
teaching
2000s
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ISSUES IN SHARIAH AUDITING
REVIEW VS AUDIT
AUDIT SCOPE
QUALIFICATIONS, EXPERIENCE AND COMPETENCY OF AUDITORS
AUDIT STANDARDS
ESTABLISHED CRITERIA
AUDIT REPORTS
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SHARIAH AUDITING DEFINITION
According to GSIFI 2 of AAOIFI,
Shari’a review is an examination of the extent of an IFI’s compliance, in all its
activities, with the Shari’a. This examination includes contracts, agreements,
policies, products, transactions, memorandum and articles of association,
financial statements, reports (especially internal audit and central bank
inspection), circulars, etc. The objective of a Shari’a review is to ensure that the
activities carried out by an IFI do not contravene the Shari’a.
While the SSB is responsible for forming and expressing an opinion on the extent
of an IFI’s compliance with the Shari’a, the responsibility for compliance
therewith rests with the management of an IFI
• The AAOIFI definition is broad “in all its activities”
• It uses the word “review” instead of the word audit
• Review =negative assurance, lower level of assurance than audit
• Perhaps in the beginning this is better than a full scale audit, however, the
scope in AAOIFI is quite broad
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INDEPENDENCE AND QUALIFICATIONS OF
SHARIAH AUDITORS (SSB)
A unique corporate governance mechanism of Islamic financial Institutions is the
shari’a supervisory board (SSB) which is theoretically an independent external
body akin to external auditors.
Consisting of at least 3 scholars in fiqh muamalat, who may be supported by
experts in Islamic banking with knowledge of fiqh muamalat- problem may not
have accounting or auditing expertise
The board is supposed to direct, supervise and review the activities of the Islamic
Financial Institution to ensure shari’a compliance in all its activitiesproblemSelf interest threat to independence.
The SSB is known under various names
 In Malaysia, Bank Negara calls it shari’a committee, although Bank Islam Malaysia Bhd., uses the term
Shariah Supervisory Council,
 whereas Meezan Bank of Pakistan has both a Shari’a Advisor (who issued the Shari’a Report) and a SSB,
 Shamil Bank of Bahrain uses Religious Supervisory Board,
 and al Baraka Bank uses the term Shari’a Board.
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Confusion in SSB Nomenclature?
Bank Islam Malaysia
Bank Negara
Malaysia
Shariah supervisory
Council
Shari’a
Committee
Meezan Bank
Pakistan
Shari’a Advisor
Al Baraka
Bank Bahrain
Shamil Bank Bahrain
Shari’a Board
Religious Supervisory
Board
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DUTIES OF THE SSB – A MALAYSIAN VIEW
GPS1 (Shariah Guideline 1 of the Central Bank of Malaysia gives what i believe
is a more thought out role of the SSB then the AAOIFI standard i.e.
participate and actively engage in deliberating Shariah issues put before them.
advise the BOD on Shariah matters in its business operation.
 Endorse Shari’a Compliance Manuals which specify the manner in which a
submission or request for advice is to be made to the SC, the conduct of SC meetings,
and the manner of compliance with any shari’a decision.
 endorse and validate relevant documentations such as contracts, agreemnts,
product manual, marketing, advertisements, sales illustrations and brochures
used to describe the product. for shari’a compliance.
To assist related parties such as the IFI’s legal counsel, auditor, or consultant, on
shari’a matters for advice upon request.
To advise on matters which have not been endorsed or resolved to the Shariah
Advisory Concil of BNM.
To provide written shari’a opinions where the IFI requests advice and on applications
for product approvales to the BNM and to assist the SAC on reference for advice e.g by
explaining shari’a issues involved and references to jurisprudential literature. And
established sources.
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THE MEANING OF “SHARIA’” IN SHARIA
AUDITING
 Shariah compliance according to AAOIFI means “compliance with
Islamic Shari’a Rules and Principles as reflected in the fatwas,
rulings and guidelines issued by them (hereinafter, the Shari’a)
 This seems contradictory. Unless fatwas, rulings and guidelines
covers all activities, then the “extent of shariah compliance in all its
activities cannot be reviewed.”
 In practice, as our research confirms, the SSB is mainly issuing
fatwa's related to financing products and not other activities, hence
aaofi’s definition is a bit contradictory.
 Auditing by persons based on criteria issued by the auditor
themselves poses a “self review” threat to independence.
 It does not bode well for the use of audit judgment making the
review a mechanistic procedure.
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Shariah auditing standards
In the conventional accounting world, the IAASB develops International
standards on auditing and assurance services and these are pretty
established and accepted globally
In the case of shariah auditing, the Accounting and Auditing Association
for Islamic Financial Institutions (AAOIFI ) has a set of standards both
for conventional and shariah auditing of IFIs.
The shariah auditing standards were reclassified as Governance
standards. These are :
Shari’a Supervisory Board: Appointment, Composition and Report
Shari’a Review
Internal Shari’a Review
Audit and Governance Committee for Islamic Financial Institutions
 Independence of Shari’a Supervisory Board (new)
 Statement on Governance Principles for Islamic Financial Institutions (new)
 Corporate Social Responsibility




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AAOIFI’s Auditing, Governance and Ethics Standards
Auditing Standards
Objective and principles of
auditing
1
2
The Auditor’s Report
2
Shari’a Review
3
Terms of Audit Engagement
3
Internal Shari’a Review
Testing for Compliance with
Shari’a Rules and Principles by
an External Auditor
4
Audit and Governance
The Auditor’s
Responsibility to Consider
Fraud and Error in an Audit
of Financial Statements
Ethics standards:
5
Independence of Shari’a
Supervisory Board
6
1.
Code of ethics for accountants
and auditors of IFIs.
7
Statement on Governance
Principles for IFIs
Corporate Social
Responsibility
2.
Code of ethics for employees of
IFIs
1
4
5
Governance Standards
Shari’a Supervisory Board:
Appointment, Composition and
Report
Committee for IFIs
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DUTIES OF THE SSB – A MALAYSIAN VIEW
GPS1 (Shariah Guideline 1 of the Central Bank of Malaysia gives what i believe
is a more thought out role of the SSB then the AAOIFI standard i.e.
participate and actively engage in deliberating Shariah issues put before them.
advise the BOD on Shariah matters in its business operation.
 Endorse Shari’a Compliance Manuals which specify the manner in which a
submission or request for advice is to be made to the SC, the conduct of SC meetings,
and the manner of compliance with any shari’a decision.
 endorse and validate relevant documentations such as contracts, agreemnts,
product manual, marketing, advertisements, sales illustrations and brochures
used to describe the product. for shari’a compliance.
To assist related parties such as the IFI’s legal counsel, auditor, or consultant, on
shari’a matters for advice upon request.
To advise on matters which have not been endorsed or resolved to the Shariah
Advisory Concil of BNM.
To provide written shari’a opinions where the IFI requests advice and on applications
for product approvales to the BNM and to assist the SAC on reference for advice e.g by
explaining shari’a issues involved and references to jurisprudential literature. And
established sources.
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SHARIAH AUDIT PROCEDURES
(3)
Documenting
Conclusions
& Reporting
to
shareholders
(1) Planning
Review
Procedures
SHARI’A REVIEW
CYCLE
(2) Executing
Review
Procedures &
preparing
working
papers
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PLANNING REVIEW PROCEDURES
The Shari’a review procedures shall be planned so that it is completed in an
effective and efficient manner. The plan shall be adequately developed to
include a complete understanding about the IFI’s operations in terms of
products, size of operation, locations, branches, subsidiaries and divisions.
The planning shall include obtaining a list of all fatwas, rulings and
guidelines issued by the SSB.
Understanding the activities, products and management’s awareness and
attitude towards compliance with the Shari’a is essential. This will have a
direct effect on the nature, extent and timing of the Shari’a review
procedures.
The plan shall be properly documented including the sample selection criteria
and sizes, taking into consideration complexity, and frequency of
transactions.
The review procedures shall be designed based on the above input. The review
procedures shall cover all activities, products and locations. These
procedures shall ascertain whether the SSB approved transactions and
products have been undertaken and all related conditions have been met.
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EXECUTING REVIEW PROCEDURES
& PREPARING WORKING PAPERS
At this stage all the planned review procedures are executed. The
SSB review procedures shall normally include:
 obtaining an understanding of the management’s awareness, commitment and
compliance control procedures for adherence to the Shari’a;
 reviewing of contracts, agreements, etc.;
 ascertaining whether transactions entered into during the year were for products
authorised by the SSB;
 reviewing other information and reports such as circulars, minutes, operating and
financial reports, policies and procedures, etc.;
 consultation/co-ordination with advisors such as external auditors; and
 discussing findings with an IFI’s management.
The execution of the above review procedures shall be documented in
work papers which shall be complete, neat and cross referenced to
review procedures.
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SHARIAH AUDIT PROCEDURES
(3)
Documenting
Conclusions
& Reporting
to
shareholders
(1) Planning
Review
Procedures
SHARI’A REVIEW
CYCLE
(2) Executing
Review
Procedures &
preparing
working
papers
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PLANNING REVIEW PROCEDURES
The Shari’a review procedures shall be planned so that it is completed in an
effective and efficient manner. The plan shall be adequately developed to
include a complete understanding about the IFI’s operations in terms of
products, size of operation, locations, branches, subsidiaries and divisions.
The planning shall include obtaining a list of all fatwas, rulings and
guidelines issued by the SSB.
Understanding the activities, products and management’s awareness and
attitude towards compliance with the Shari’a is essential. This will have a
direct effect on the nature, extent and timing of the Shari’a review
procedures.
The plan shall be properly documented including the sample selection criteria
and sizes, taking into consideration complexity, and frequency of
transactions.
The review procedures shall be designed based on the above input. The review
procedures shall cover all activities, products and locations. These
procedures shall ascertain whether the SSB approved transactions and
products have been undertaken and all related conditions have been met.
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EXECUTING REVIEW PROCEDURES
& PREPARING WORKING PAPERS
At this stage all the planned review procedures are executed. The
SSB review procedures shall normally include:
 obtaining an understanding of the management’s awareness, commitment and
compliance control procedures for adherence to the Shari’a;
 reviewing of contracts, agreements, etc.;
 ascertaining whether transactions entered into during the year were for products
authorised by the SSB;
 reviewing other information and reports such as circulars, minutes, operating and
financial reports, policies and procedures, etc.;
 consultation/co-ordination with advisors such as external auditors; and
 discussing findings with an IFI’s management.
The execution of the above review procedures shall be documented in
work papers which shall be complete, neat and cross referenced to
review procedures.
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DOCUMENTING CONCLUSIONS
& REPORTING TO SHAREHOLDERS
The SSB shall document their conclusions and prepare their report to
the shareholders based on the work done and discussions held.
The SSB report shall be read at the annual general meeting of the
IFI. A detailed report, when warranted, shall also be issued to an
IFI’s management.
Quality assurance
 The SSB shall implement adequate quality control policies and procedures to ensure
that the review is conducted in accordance with this standard.
 Quality control procedures may include review of all work papers to ensure that review
procedures were properly understood and executed. Additional discussions may be
held with the IFI’s management, if required, to ensure that all significant matters were
covered during the review.
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INTERNAL SHARIAH REVIEW
In addition to the shari’a review, the IFI is also required to conduct an
internal shari’a review by a special shari’a compliance unit or department
or a branch of the internal audit department depending on the size of the
bank. This is just like the internal audit and external audit which
complement each other. It is plainly impossible for the SSB to carry out a
vouching audit to verify the shari’ah compliance of an IFI. Therefore, it
has to rely on its internal control systems, part of which is the internal
shari’a review.
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SHARIAH AUDIT REPORTS
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AAOIFI’S SHARIAH AUDIT REPORT
In the name of Allah, The Beneficent, The Merciful
To the Shareholders of The Example Islamic Financial Institution
Assalam Alaikum Wa Rahmat Allah Wa Barakatuh
In compliance with the letter of appointment, we are required to submit the following report:
We have reviewed the principles and the contracts relating to the transactions and applications introduced by the
Example Islamic Financial Institution during the period ended. We have also conducted our review to form an opinion
as to whether the Example Islamic Financial Institution has complied with Shari’a Rules and Principles and also with
the specific fatwas, rulings and guidelines issued by us.
The Example Islamic Financial Institution’s management is responsible for ensuring that the financial institution
conducts its business in accordance with Islamic Shari’a Rules and Principles. It is our responsibility to form an
independent opinion, based on our review of the operations of the Example Islamic Financial Institution, and to report
to you.
We conducted our review which included examining, on a test basis of each type of transaction, the relevant
documentation and procedures adopted by the Example Islamic Financial Institution
We planned and performed our review so as to obtain all the information and explanations which we considered
necessary in order to provide us with sufficient evidence to give reasonable assurance that the Example Islamic
Financial Institution has not violated Islamic Shari’a Rules and Principles.
In our opinion:
a) the contracts, transactions and dealings entered into by the Example Islamic Financial Institution during the year
ended ... that we have reviewed are in compliance with the Islamic Shari’a Rules and Principles;
b) the allocation of profit and charging of losses relating to investment accounts conform to the basis that had been
approved by us in accordance with Islamic Shari’a Rules and Principles;
(where appropriate, the opinion paragraph shall also include the following matters:)
c) all earnings that have been realized from sources or by means prohibited by Islamic Shari’a Rules and Principles
have been disposed of to charitable causes; and
d) the calculation of Zakah is in compliance with Islamic Shari’a Rules and Principles.
We beg Allah the Almighty to grant us all the success and straight-forwardness.
Wassalam Alaikum Wa Rahmat Allah Wa Barakatuh
(Names and signature of the members of the Shari’a supervisory board)
Place and Date
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EXTREMES IN PRACTICE - TOO BRIEF (THE MALAYSIAN CASE)
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EXTREMES IN PRACTICE – THE GOLD STANDARD – MEEZAN BANK OF
PAKISTAN
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EXTREMES IN PRACTICE – THE GOLD STANDARD – MEEZAN BANK OF PAKISTAN
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WHO SHOULD CONDUCT SHARI’AH
AUDIT?
New
Professionals
called
Shari’ah
auditors??
Islamic Jurists
(Ulama)?
External
Financial
auditors??
Shari’ah
Supervisory
Board??
Internal
auditors
under
supervision
of SSB??
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QUALIFICATION & COMPETENCE
REQUIREMENTS
Degree/Professional
qualification in accounting
and specialized certification
in Shari’ah audit??
?
Degree/Professional
qualification in
accounting & Fiqh
(Islamic Law)??
Trax Associates, Sept 2003
Degree/Professional
qualification in
accounting??
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Scope of Shari’ah Audit
Human
resource
Management??
Business
Policies??
Processes &
Procedures??
Scope of
Shari’ah Audit
Marketing &
advertising??
Zakat calculation
& payment??
Contracts &
agreements??
Social
contribution??
Environmental
impact of
operation??
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TO WHAT EXTENT & WHEN SHOULD
SHARI’AH AUDIT BE PERFORMED?
To what extent?
When?
Every single activity?
Throughout financial year?
To the extent deemed
satisfactory by the auditors?
During new product
application?
Using sampling method?
At the end of financial year?
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THE MALAYSIAN PRACTICE
The following is the result of interviews conducted by my student Sister
Nawal Kassim who is undertaking a PhD in Accounting under my
supervision.
 22 respondents comprising external auditors, Sharia supervisory board
members and staff of shariah compliance units/internal auditors of 9 IFIs
and 6 Islamic branches of conventional banks in Malaysia.
Interviews covered:
definition and responsibility,
 organization of the shariah compliance function
Reporting structures of shariah compliance units
 scope of audit,
audit procedures,
 independence, qualifications and authority of SSBs.
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MALAYSIAN PRACTICE- DEFINITION
Preference for shariah review as opposed to audit (in line with aaoifi
definition.)
One respondent (head of Islamic bank audit dept of local Islamic
branch) consider no need for separate audit unit as “procedures
and processess are the same as conventional auditing” – minority
view
Another respondent (shariah compliance unit) said that the
responsibility for the shariah audit is the responsibility of the
Shariah supervsory board or in Malaysia known as the Shariah
Committee
Another respondent (external auditor) is of the view that shariah
compliance audit is an internal matter nothing to do with external
auditor because:
 Not required by law
 Lack of expertise
 Will increase audit cost
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PRACTICE- ORGANIZATION OF THE
SHARIAH COMPLIANCE FUNCTION
Many different structures as illustrated below:
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REPORTING STRUCTURES OF SHARIAH
COMPLIANCE UNITS
The shariah departments or units reports to various
persons in different IFIs. This includes
 Reporting to CEO/MD (3/22 )
 Reporting to SSB (10/22)
 Reporting to Risk manager (4/22)
 Product development manager (3/22)
Problems of independence can be seen. Perhaps should
report to audit committee of the BOD
All products/findings are endorsed by SSB
No direct contact with Scompliance personnel but through
shariah division head or shariah co-ordinator who
attends the SSB meetings.
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MALAYSIAN PRACTICE- AUDIT SCOPE
Most IFIs audit compliance of products only.
 Cost consideration of extending scope
 Newcomers and therefore need to compete by developing new products
 (discuss Implication on audit report on activities and operations)
 Education of staff needed before scope expansion
 Perceived to be difficult
Other scope under research stage
Extension of scope in agenda
Discussion on going on staff compliance with sharia dress codes and
marketing of products
Not in favour of social and environmental or performance audit as
considered not within scope and lack of public awareness
 Fear workload increase without adequate resources
 Capitalist mentality- shariah audit is a business unit to make profits.
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MALAYSIAN PRACTICE- AUDIT PROCEDURES
Begins at proposal stage
Use of checklist with non-compliance parameters
development by shariah division and endorsed by SSB
Key Risk indicators
Use shariah policy, guidelines, circulars and fatwas.
Non compliance reported to SSB on a monthly basis
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EX POST AUDIT
Documents reviewed include
 Concept papers, structure and terms sheet
 Documentation examined include agreements, letters of offer, policies
and procedures, corporate advertisements/brochures and pamphlets
The above documents are compared with
 Fatwas
 Central bank regulations
 Company’s shariah compliance audit manual
Non compliance are noted as comments and queries and post
audit monitoring is carried out.
Observation: lack of audit judgment, very mechanical process is
evidence.
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