1 Islamic Accounting and Auditing
Abstract
The report is based on Islamic auditing and accounting contains, introduction, history,
comparison, and details regarding to different aspects associated to them and effects of Islamic
Accounting on Auditing.
Glance at conventional Accounting and Auditing
Conventional Accounting
A book-keeping of financial transactions of a business on daily, weekly, fortnight, and monthly
basis or according to fiscal year. Its like record of funds paid and received of a business or any
firm including, expenses, revenues, shares, stake-holders shares, and retained earning.
Conventional Auditing
Evaluating and monitoring of business transactions record to ensure about the effectiveness of
implementation. Auditing is done on periodic basis; it could be after six months, or at the end of
a business fiscal year.
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Introduction
Islamic finance is flourishing around the globe, grasping the attention due to the services being
provided according to Islamic law and shariah. The interesting factor of Islamic finance is the
explicit link between financial decision and values, in other words estimation of profit, loss, and
risks are discussed and shared. As conventional banks have several activities and field same as
Islamic finance also have them.
Islamic Auditing and Accounting are main topics of proposal, and aim is to discuss and explain
their working along with rules and laws of Islam- Shariah in them.
Islamic accounting is purity of transactions for long and short run, which enhances the
performance of auditing.
Following are the key points of Islamic Accounting.
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To report accurate income determination.
To promote efficiency and leadership.
To comply with the shariah (Islamic principles).
Commitment to justice.
To report a good things.
To adapt to positive social change.
Based upon ethical law originating in the Qur’an (Islamic law, As-Sunnah).
Full disclosure.
Public Accountability (focus on the community who participate in exploiting resources).
Islamic auditing- evaluating, and it needs to be realized that the jurists sitting on the Board or
working as Shariah Advisors possess little knowledge about the accounting and auditing, and
more importantly, the operations of the financial institutions. Islamic auditor must express an
opinion as to whether the financial statements are prepared, in accordance with Shariah’s rules
and principles and the accounting standards of the Accounting and Auditing Organization for
Islamic Financial Institutions.
By analyzing and evaluating Islamic Accounting, Auditing monitors and locates the fraud, errors
in financial services of institution, organization or bank. As Islam- shariah provides the details of
the rules and laws describes by Allah-Quran, prophet (PBUH) hadiths. These rules and laws are
modernized were introduced in different businesses and banks where any one can easily adopt
them, not limited to Muslims. The theme of Islamic accounting and auditing is purity and free of
those things which are prohibited by Islam-Shariah.
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History
In Holy Quran, the word Hesab has been used for Accouting, which is for the individuals, and
Allah will take it through Accounting –record. Islam has also provided the guidelines and
approvals for Accounting and Auditing of individuals and businesses.
Title
“ACCOUNTING PROCEDURES AND RECORDING PROCEDURES IN THE EARLY ISLAMIC STATE
OMAR ABDULLAH ZAID, UNIVERSITY OF BAHRAIN, ACCOUNTING HISTORIANS JOURNAL
VOL 31, NO 2 Review”
“Islamic Accounting has playing important role in Islamic society since, 642 A.D. The
Accounting system been practiced in past Near and middle east were advanced. Islam has the
potential to influence the structure and concepts of accounting in the Islamic world. The exact
location and development of Accounting not limited to one nation or area, it has been practiced
and developments in different civilizations and nations till now. The accounting practiced was
done in ancient time to keep the financial record of business.
From Muslim world the concepts of accounting has been transferred into different civilizations
and nations and developments were made according to locations. The development of
Accounting and other sciences was done according to Islam and analysis of Holy Quran. As
Holy Quran provide complete guidance on social and commercial issues, which was further
explained by Prophet Mohammad (PBUH). In Islamic accounting, the role and importance of
Zakat was introduced in 624A.D by, during the time of the second Caliph, Omar bin Al-
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Kattab. The Zakat was important for individuals and entrepreneurs who are associated with
business, till now Zakat is practiced. Individual Muslims generally, and entrepreneurs
specifically, were concerned with the development and implementation of accounting books,
systems and recording procedures.
“O ye who believe! When you contract a debt for a fixed period, write it down. Let a scribe
write it down in justice between you. Let no scribe refuse to write as Allah has taught him, so
let him write. Let him (the debtor) who incurs the liability dictate, and he must fear Allah, his
Lord, and diminish not anything of what he owes. But if the debtor is of poor understanding,
or weak, or is unable to dictate for himself, then let his guardian dictate in justice. And get two
witnesses out of your own men. And if there are not two men (available), then a man and two
women, such as you agree for witness, so that if one of them (two women) errs, the other can
remind her. And the witnesses should not refuse when they are called (for evidence). You
should not become weary to write it (your contract), whether it be small or big, for its fixed
term, that is more just with Allah; more solid evidence, and more convenient to prevent doubts
among yourselves, save when it is a present trade which you carry out on the spot among
yourselves, then there is no sin on you if you do not write it down. But take witnesses
whenever you make a commercial contract. Let neither scribe nor witness suffer any harm,
but if you do (such harm), it would be wickedness in you. So be afraid of Allah; and Allah
teaches you. And Allah is the All-Knower of each and everything .And if you are on a journey
and cannot find a scribe, then let there be a pledge taken (mortgaging); then if one of you
entrust the other, let the one who is entrusted discharge his trust (faithfully), and let him be
afraid of Allah, his Lord. And conceal not the evidence for he, who hides it, surely his heart is
sinful. And Allah is All-Knower of what you do".
The practice of Accounting in Islam reflected as comprehensive code of spiritual and material
life. The implementation of Zakat along with large revenues with expenses established a
procedure based on controlling activities (Auditing) in 622 A.D. The purpose of controlling
procedure is to locate deficit and surplus in state’s treasury or of any business.
Two discoveries were made related to auditing:
First one was deficit.
Second was unrecorded deficit of expense which causes a loss, due to not recording of
transactions. This omitted expense was subsequently uncovered when the book balance was
compared with corresponding schedules and other balances in the main Dewan at the end of the
financial year.The 12 month period is known as Al-Hawl.
Examples of recording procedures developed and applied by government authorities and
individual entrepreneurs in the Islamic state are as follows:
1. Transactions were to be recorded immediately when they occurred.
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2. Transactions were to be classified according to their nature. This required similar and
homogeneous transactions to be classified under one account and recorded as such.
3. Receipts were to be recorded on the right hand side of the page and sources of receipts were to
be identified and disclosed.
4. Payments were to be recorded and sufficiently explained on the left hand side of the page.
5. Recorded transactions were to be carefully explained.
6. No space was to be left between transactions. If a space was left for any reason, a line had to
be drawn across the space. This line was called Attarkeen.
7. Corrections to recorded transactions by overwriting or deletion were prohibited. If Al-Kateb
(the accountant/bookkeeper) had mistakenly overstated the amount, he was obliged to pay the
difference to the Dewan. If an expense was omitted, Al-Kateb was required to pay the shortfall in
cash even if it could subsequently be proven that the expense did occur.
8. When the account was closed, a specific sign was to be placed in the books to reflect the
closure of the account.
This indicates that procedures 3 and 4 were not only applicable to the treasury accounting system
but were of a general nature and applied to all accounting systems employed in the Muslim
society. Furthermore, this was in compliance with the Arabic method as explained earlier in the
"treasury accounting system.
9. All similar transactions recorded in the preliminary book were to be posted to the specialized
books maintained for that type transaction.
10. The posting of similar transactions was to be performed by persons independent from those
who recorded the transactions in the daily and other books.
11. The balance, called Al-Hasel (the difference between two amounts), had to be extracted.
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12. A monthly and/or yearly report was to be prepared. This report had to be detailed and
provide sufficient information to determine, for example, incoming crops, where they came from
and how they were distributed.
13. At the end of each financial year, a report was to be prepared by Al-Kateb detailing all goods
and funds under his custody and management.
14. Annual reports prepared by Al-Kateb were to be reviewed (audited) and compared with prior
year reports and with records maintained in the main Dewan.
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Effects of Islamic Accounting on Auditing
By analyzing the history, this is quite clear that Islamic accounting recording procedures
examples enables the auditing to examine the frauds and errors. Islamic auditing not only limited
to monitoring system, but it also helps to correct the errors and also provide guidance for
improvements.
The opinion of auditor matters a lot, based on truth and fairness. The auditor must be sure about
the accounting transactions are according to Islam-shariah and financial report won’t have deficit
or surplus error during specific period.
According to Islam rules for Auditor as follows:
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Honesty.
Fairness.
Integrity.
Righteousness.
Independence.
Need to be focus on an issue.
Confident.
Careful.
Professional attitude.
Should follow the standards of Islamic Auditing.
About AAOIFI
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is
an Islamic international autonomous non-for-profit corporate body that prepares accounting,
auditing, governance, ethics and Shari'a standards for Islamic financial institutions and the
industry.
AAOIFI was established in accordance with the Agreement of Association which was signed by
Islamic financial institutions on 1 Safar, 1410H corresponding to 26 February, 1990 in Algiers.
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Then, it was registered on 11 Ramadan 1411 corresponding to 27 March, 1991 in the State of
Bahrain.
AAOIFI has gained assuring support for the implementation of its standards, which are now
adopted in the Kingdom of Bahrain, Dubai International Financial Centre, Jordan, Lebanon,
Qatar, Sudan and Syria. The relevant authorities in Australia, Indonesia, Malaysia, Pakistan,
Kingdom of Saudi Arabia, and South Africa have issued guidelines that are based on AAOIFI’s
standards and pronouncements.
ROLE OF AAOIFI
The AAOIFI sets the standards for Islamic accounting and auditing, nowadays Islamic
accountants and auditors follows the rules by AAOIFI.
The scope of an auditor is to judge the procedures and working of a business.
Reasonable assurance must be provided that financial statements, reports are free from mistakes
and according to Islam- AAOIFI standards. There are some limitations in auditing for instance
gathering data for evidence, analyzing the samples, drawing conclusion on limited attained data.
In Islamic finance accountants who have to follow the rules of Islam –AAOIFI, auditor also
followed these rules in order to examine and establish a report on certain financial statements.
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AAOIFI Structure
Shari’a Standards
Review Committee
Accounting Standards
Committee
Auditing & Governance
Standards Committee
Shari'a Standards
Committee (1)
Shari'a Standards
Committee (2)
Shari'a Standards
Committee (3)
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Objectives of Islamic Accounting
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Provide information through periodic reports about entity’s financial position, cash flows,
and other events during accounting periods.
Information should facilitate the management, in planning, directing and supervising the
entity’s activities.
The accounting process should be according to Islam-shariah-AAOIFI (shows the
modern rule of Islamic financing activities according to Islam).
It also facilitates the government in collecting taxes and guiding national economy.
To contribute in providing safe guards, to Islamic Bank’s assets, its rights and rights of
the others.
Objectives of Islamic Auditing
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Based on Fairness.
Auditing report should be clear.
Auditing must ensure the financial report future viability.
The auditor should follow the “Code of Ethics for Professional Accountants”
issued by the AAOIFI, and the International Federation of Accountants which do
not contravene Islamic Rules and Principles.
Auditor should plan and perform professional competence and due care
recognizing that circumstances may exist which cause the financial statements to
be materially misstated.
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Comparison of Islamic And Conventional Accounting and Auditing
Conventional Accounting
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Based on modern-commercial law.
Limited disclosure.
Personal Accountability.
Profit maximization.
Survival of fittest.
Absolute Owner-ship.
Islamic Accounting
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Based on ethical law, originated by Holy Quran.
Full disclosure.
Public accountability.
Religious.
Shared profit.
Reasonable profit.
Equity.
Environment.
Relative Owner-ship.
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Conventional Auditing
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Presence of truth and justified.
Unbaised examiner and evaluator follow the GAAS (Generally Accepted
Auditing Standards).
Divided into three sections:
General standards, standards of field work, reporting standards.
Rules are according to commercial laws .
Sarbanes-Oxley Act Of 2002 - SOX
The rules and enforcement policies outlined by the SOX Act amend or
supplement existing legislation dealing with security regulations. The two
key provisions of the Sarbanes-Oxley Act are:
1. Section 302: A mandate that requires senior management to certify the
accuracy of the reported financial statement.
2. Section 404: A requirement that management and auditors establish
internal controls and reporting methods on the adequacy of those controls.
Section 404 had very costly implications for publicly traded companies as it
is expensive to establish and maintain the required internal controls.
Islamic Auditing
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Presence of truth and justified.
Follows the rules of Islam-AAOIFI.
Unique rules and restrictions.
Totally based on Islamic ethics.
It has following features:
Fairness, clear, concerned about Islamic rules implementation
in financial statements.
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Report of Islamic Auditing of A Business Organization or Bank based On
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Objective.
Introduction.
Scope and Purpose.
Executive Summary.
Document Review Activities.
Procurement of Goods and Services Documentation.
Design Documentation.
Project Team Effectiveness.
Quality Control Documentation.
Quality Assurance Documentation.
Evaluation of Onsite Activities.
Personnel Qualifications and Staffing Levels
Materials handling procedures.
Employee dealing.
Internal Auditing report review and comparison.
Following the Islamic laws.
Determine Zakat obligations of both depositors and shareholders.
Equitable allocation of profit and loss.
 Recommendations Summary and General Conclusions.
Impact of Shari’ah Contractual Conditions of Transactions on Reporting Process
Shari’ah Conditions
Reporting Process
Impact
Existence
Recognition
Valid contracts
Lawful
Recognition
Lawful Activities
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Performance
Measurement
Provision for uncertainty
Deliverable
Recognition
Provision for uncertainty
Equitable
Distribution
Reasonable rates of return
Accountable
Presentation/ Disclosure
True and fair view
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Conclusion
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References
 http://www.iiu.edu.my/iaw/Articles/ia%20history/ACCOUNTING%20PROCEDUR
ES-ISLAMIC%20STATE.htm
 http://www.aaoifi.com.
 http://www.aaoifi.com/objectives-acc.html.
 http://www.investopedia.com/terms/g/gaas.asp.
 http://www.ifsb.org/