MUSTAFFA BUKHARI UMCCED KL

UDE 2010-
ISLAMIC FINANCIAL AND ACCOUNTING
CONCEPTS

04 - ACCOUNTING OBJECTIVES AND CONCEPTS FOR IFIS

 Developing a theory of Islamic Accounting
methodologies.
• Before developing accounting rules and standard for
IFIs, it is important to understand conceptual
framework to create consistency.
• In developing conceptual framework, theory
development come as part and parcel in the process
and come in several approach.
• There are two (2) approach to accounting theory
construction:
– Empirical inductive approach
– Deductive approach
 Developing a theory of Islamic Accounting
methodologies.
• The Empirical Inductive Approach:Specific to
general
– The empirical inductive approach is an attempt to
develop a theory based on generalising from empirical
phenomenon.
– The inductive approach in accounting begin with
observation of organization’s financial information and
proceed to draw generalization and principle of
accounting.
– Financial information leads to formulation of principles.
 Developing a theory of Islamic Accounting
methodologies.
• The Deductive Approach:
– General to specific
– In this approach, theoretical accounting principles are
logically derived by deduction from assumptions
– Step used to derived the deductive accounting approach
in accounting
1. Specifying objective of financial statement
2. Selecting the “assumption”- basic accounting proportions –
of accounting
3. Deriving the principle of accounting
4. Developing the technique of accounting.
 Developing a theory of Islamic Accounting
methodologies.
• However the development for Islamic accounting need to be
done carefully as it need to follow the sharia requirement.
• There are two methods whereby Islamic accounting
concepts could be arrived at:
1. Establish objectives (and concepts) based on the principles of
Islam and its teachings and consider these objectives in relation
to contemporary accounting thought.
2. Start with the objectives established in contemporary
accounting thought, test them against the Islamic Sharia, accept
those that are consistent with Sharia and reject those that are
not, and develop those that are unique.
Deriving the Islamic Accounting objectives
from Islamic economic objectives.
• The ultimate objective of Islamic Economics (and thus
Islamic accounting) is to lead man to falah, i.e. well
being or success in this world and the hereafter
• Islamic accounting should similarly provide information
to facilitate this socioeconomic process which will
facilitate the working of the Islamic economic system
• Falah is said to have three components:
1. survival (Baqa)
2. Freedom from want (ghana)
3. Honour and power (‘Izz)
Deriving the Islamic Accounting objectives
from Islamic economic objectives.
• Falah component:
– Survival (Baqa)
• Referring back to maqasid sharia.
Deriving the Islamic Accounting objectives
from Islamic economic objectives.
• Falah component:
– Freedom from want (ghana)
• no one should live in abject poverty but also assumes
self-reliance and work rather than parasitic idleness.
– ghana encompasses biological (health), economic
(i.e. means of livelihood), social (brotherhood and
harmonious interrelationships) and political
survival (freedom and participation in affairs of
the state)
Deriving the Islamic Accounting objectives
from Islamic economic objectives.
• Falah component:
– Honour and power (‘Izz)
• concept of ‘Izz means self respect, civil liberties,
protection of honour and life for the individual; and
economic power, freedom from debts and military
power to safeguard freedom and to enforce justice, for
the community.
 Deriving the Islamic Accounting objectives
from Islamic economic objectives.
• The economic conditions are said to lead to falah:
– Infaq which is to spend in the way of God on the poor, needy, relations,
neighbours and for the socio-economic good of the community
– Prohibition of riba (interest) as riba is considered a subtle institution which
is exploitative and iniquitous.
– Fulfillment of Covenants (Contracts) and Trusts. Honouring commitments
and fulfilling contracts is a condition for the achievement of falah
– Avoiding Zulm (injustice, exploitation and usurpation of others’ rights)
– Seeking God’s bounty: The believer is expected to show enterprise and
effort to achieve falah. A parasitic existence, idleness and beggary are
prohibited in Islam unless due to physical or mental disability
– Avoidance of Niggardliness. Withholding resources from society even from
spending on oneself and one’s family deprives the community of God’s
bounty
 Accountability and Islamic Accountability: the
objective and premise of Islamic accounting
• Since the objective of Muslims and the Islamic
economic system is to achieve falah, the
principles of profit and wealth maximisation
and the incessant concern with shareholder
value, on which capitalist businesses are
based, are questionable from an Islamic
framework.
• Basically in Islamic accounting, one are
accountable to God and to man.
 Accountability and Islamic Accountability: the
objective and premise of Islamic accounting
• The accountability to God and man in accounting can be seen on the
Islamic accountability model:
– This primary accountability is transcendent, as it cannot be perceived through the senses and is
therefore represented by a dotted arrow (1)
– However, this transcendent accountability is made visible (through the revelation of the Qur’an
and Hadith) to both investors and managers, in the form of Islamic teachings. This is represented
by the two dashed arrows (2)
– The secondary accountability is established by contract between the owner/investor and
manager (3)
– As the company performs its activities the Islamic accounting system identifies, records,
measures and reports these socioeconomic activities (similar to the conventional accounting
system) to the investor thus discharging the secondary accountability (4)
– The Islamic accounting system also identifies, measures and reports the socioeconomic activities
pertaining to Islamic/social/economic/environmental and other issues to both the
owner/investor and the manager (5 & 6)
– The Angels of course record these actions and account this to Allah according to Islamic belief
(7)
 Benefits of establishing objectives of
financial accounting for Islamic banks.
• (SFA1) (para 19) , five reasons are given for establishing
objectives which are:
– To be used as a guide by AAOIFI when developing financial accounting
standards to ensure consistency in developing standards.
– To assist Islamic banks, in the absence of accepted accounting standards, in
making choices among alternative accounting treatments.
– To act as a guide and a regulator of subjective judgment made by
management when preparing the financial statements and other financial
reports.
– The objectives, when properly defined, should increase users’ confidence and
understanding of accounting information and, in turn, their confidence in
Islamic banks.
– Establishing objectives should lead to the development of accounting
standards which are likely to be consistent with each other. This should
increase users’ confidence in the financial reports of Islamic banks
Differences in objectives of financial accounting
from those of conventional banks.
• Although the objective of financial accounting is
to provide information to make decisions
• the user and the type of information is different as
the objectives of the users of information of IFIs
are different based on their worldview
• Those who deal with Islamic banks are concerned,
in the first place, with obeying and satisfying Allah
in their financial and other dealings
 Identifying users, their information
requirements and the financial reports required
The major users of financial reports of Islamic
Financial Institutions

HOLDER OF
ZAKAT INVESTMENT
AGENCY ACCOUNT.
 Common Information Needs of users of
financial reports
• AAOIFI has identified the common “minimum “information needs as
follows
– Information which can assist in evaluating the bank’s compliance with the
principles of Sharia 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.
 Common Information Needs of users of
financial reports
• Understanding the minimum requirement of
information needed help to understand which
report to be prepared.
• We can categorise the above information needs
into two groups:
1. Normal financial information i.e. financial position,
liquidity, profitability
2. Specific additional financial and non financial
information i.e. sharia compliance, discharge of social
responsibilities and information for employees
 Common Information Needs of users of
financial reports
• The first group in is taken care of by those that are currently
produced by financial accounting in the form of financial statements
and related notes. These include the balance sheet, income
statement and cash flow statement
• The second group requires new types of reports which could be
both financial and non financial, which are not currently being
produced such as:
– Analytical financial reports about earnings or expenditures prohibited by
the Sharia
– Reports concerning the Islamic bank’s fulfilment of its social responsibilities
– Reports about the development of the Islamic bank’s human resources
– Analytical financial reports about sources of funds for Zakah and their uses.
 Objectives of financial accounting and
reports for Islamic banking and financial
Institutions.
• Four objectives of financial accounting for IFI’s as
follows:
– To determine the rights and obligations of all interested
parties
– 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
– To provide, through financial reports, useful information to
users of these reports
 Objectives of financial accounting and
reports for Islamic banking and financial
Institutions.
• Objectives of financial reports
– Financial reports, which are directed mainly to external users, should provide
the following types of information:
• Information about the Islamic bank’s compliance with the Islamic Sharia and its
objectives and to establish such compliance
• Information about the Islamic bank’s economic resources and related obligations 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
• 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
• 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
• 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
• Information about the Islamic bank’s discharge of its social responsibilities.