Humanomics

Relationship between internal Shariah audit characteristics and its effectiveness

AZAM ABDELHAKEEM KHALID Hasnah Haj Haron Tajul Ariffin Masron
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To cite this document:
AZAM ABDELHAKEEM KHALID Hasnah Haj Haron Tajul Ariffin Masron , (2017)," Relationship between internal Shariah
audit characteristics and its effectiveness ", Humanomics, Vol. 33 Iss 2 pp. -
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 Relationship between internal Shariah audit characteristics and its effectiveness

1. INTRODUCTION
The concept of effectiveness has received increasing attention in the literature in
recent times. Internal auditors assist management in ensuring that there is a proper
internal control system in place and that the operations of the company are carried
out efficiently, economically and effectively (Haron, Chambers, Ramsi, & Ismail,
2004). Internal Shariah audit effectiveness helps develop the work of Islamic
financial institutions (IFIs) because the financial reports reflect the quality of internal
Shariah audit department’s. The internal Shariah audit department is very important
inside IFI that the internal Shariah audit is regarded as the key element in the
application of accounting systems, which in turn, helps in evaluating the work of the
department. The internal Shariah audit is considered as the backbone of the business
accounting as it is the section that records all businesses related to the sector. It is
concerned with advising entities how to achieve their objectives through managing
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risks and improving internal control. Even though internal Shariah audit is useful in
all types of IFIs, much of it is required in the public sector where objectives are
usually broad, complex and not easy to measure. In IFIs and their relation to
practices of Shariah auditing in Islamic banks; an increase in efficiency and
effectiveness, of the internal Shariah auditors are needed.

Many professionals have not had enough time to gain required experience to enable
them to competently advise on or manage IFI transactions. Internal Shariah auditors’
effectiveness is still so relatively scarce in some IFIs. Consequently, the lack of
measurement to audit the performance of IFIs in relation to realization of Maqasid
al-Shariah as well as the absence of internal Shariah audit characteristics will lead to
ineffectiveness of internal Shariah auditors in IFIs. These phenomenons will affect
the effectiveness of internal Shariah auditors in IFIs. Failures of large corporate such
as Enron and WorldCom have called for emphasis on internal auditors, resulting in
increased need for internal Shariah auditor to monitoring role. This neccesitates IFIs
to invest in internal auditing and improve the characteristics of internal Shariah
auditor to ensure the achievement of organization objective (Rahman, 2011).

Given the background information above, the aim of this research paper is to
examine: 1) the current practices of internal Shariah audit among difference IFIs in
Bahrain; 2) to examine the relationship between characteristics and effectiveness of
internal Shariah audit in IFIs in Bahrain. The remaining part are organized as
follows: the next section briefly reviews the relevant literature related characteristics
and effectiveness of internal Shariah audit followed by research hypotheses and
explain linkages to previous studies, the third section presents the research
methodology while the last section presents findings, results and conclusion.

2. LITERATURE REVIEW
2.1 Shariah Auditing in IFIs
The establishment of IFIs has resulted in great changes; especially in the way the
institutions do their business (Karim, 2001) and objectives (Harahap, 2002), which in
turn has affected the audit of these institutions (Karim, 2001). Currently, auditing
practice of IFIs in various countries are under their respective local jurisdiction with
some adopted fully and others partially the Accounting and auditing organization for

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 Islamic financial institutions (AAOFI) standards. AAOIFI’s guidelines on Shariah
audit can be considered as the most relevant guideline available for Shariah audit
practice. Besides internal Shariah auditors, there are external auditors who are
responsible for financial audit; and all IFIs have Shariah supervisory board (SSB) in-
house whose main duty is to certify the adherence of the banks to Shariah principles.

Organization that has effective internal audit function will be much better than those
organizational that has not such a function especially in related to fraud, detection
and prevention (Corama, 2006; Maria, 2012; Omar & Bakar, 2012). The internal
Shariah audit is concerned with sound and effective internal control system for
Shariah compliance through continuous periodical assessment (Rahman, 2011). The
internal auditor not act only as a player to ensure corporate governance as well as
providing internal consultancy (Stewart & Subramaniam, 2010), but the role has
been extended to practice Shariah audit in order to ensure that the operations of IFIs
are Shariah compliant. The internal Shariah auditor should satisfy himself and
formulate accurate judgment that the transactions and controls he examined during
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his audit process comply with Islamic Shariah rules and principles (Yahya &
Mahzan, 2012).

2.2 An Overview of IFIs in Bahrain

The International Association of Islamic Banks (IAIB) outlined that, the Islamic
banking system involves a social implication which is necessarily connected with the
Islamic order itself, and represents a special characteristic that distinguishes Islamic
banks from other banks based on their philosophies. In exercising all its banking or
development activities, the Islamic bank takes into prime consideration the social
implications that may be brought about any decision or action taken by the bank.
Since the 1970s, Islamic banking has emerged as a new reality in the international
financial scene. Its philosophies and principles are however, not new, having been
outlined in the Holy Qur'an and the Sunnah of Prophet Muhammad (p.b.u.h.) more
than 1,400 years ago. The emergence of Islamic banking is often related to the
revival of Islam and the desire of Muslims to live all aspects of their life in
accordance with the teachings of Islam. One of the countries which have a significant
role towards the development of Islamic banking and finance is Bahrain which has
started Islamic banking industry since 1979. Bahrain is notably considered as the
most developed country in term of Islamic finance infrastructure within the Gulf
Cooperation Council (GCC) (Wilson, 2009).

The kingdom of Bahrain actively promotes itself as an international hub for Islamic
finance. In order to achieve this goal, the central bank of Bahrain (CBB), through its
comprehensive regulatory framework, opens its gate to local and international IFIs to
operate within the country, Bahrain is also the host to several organizations central to
the development of Islamic finance i.e. the AAOIFI, Liquidity Management Centre
(LMC), the International Islamic Financial Market (IIFM), the general council for
Islamic banks and financial institutions (CIBAFI) and the Islamic International
Rating Agency (IIRA). Most bank financings in Bahrain are in personal, trade,
manufacturing and construction sector. The Bahraini Islamic bank (BisB) was the
first Islamic bank in Bahrain established in 1979 and since then, the industry has
been growing rapidly. Bahrain has become a country with the highest number of
Islamic banks not only in the Middle East but also in the world (Iqbal & Molyneux,

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 2005). Since 1992, all Bahraini banks are required to adopt International Accounting
Standards (IAS) and starting from 1997, they are expected to comply with AAOIFI
and need to be published in addition to the audited financial statements. On the other
hand, foreign banks are required to either comply with the United Kingdom (UK) or
USA Generally Accepted Accounting Principles (GAAP) or to comply with (IAS)
(Islam, 2003). In 2000, the CBB has set a comprehensive prudential set of
regulations, which includes capital adequacy, asset quality, and management of
investment accounts, corporate governance and liquidity management in ensuring
IFIs have comparable standards to conventional banks. This regulatory framework
has attracted confidence among the investors and customers of Islamic banking in
Bahrain, hence the industry enjoys sustainable growth, product innovation and an
expanding market (Iqbal & Molyneux, 2005).

2.3 Effictiveness of internal Shariah audit

According to IIA (2010), effectiveness can be defined as degree including quality to
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which established objectives are achieved. Bank Negara Malaysia BNM (2010)
defines effectiveness as objective to ensure a sound and effective internal control
system for Shariah compliance. According to AAOIFI (2010) effectiveness is the
performance of internal Shariah audit work such as ability to plan, implementation,
document information and Shariah audit findings, ability to make recommendation,
numbers of repeated reports, follow up and evaluation of extent of Shariah
compliance with Islamic Shariah rules and principles, Fatwas, guidelines and
instructions by the IFI’s SSB (AAOIFI, 2010). Badara & Saidin (2013), in their
research highlighted a few definitions of the effectiveness term. It means that internal
audit effectiveness can be define as the degree to which established objectives are
achieved (Badara & Saidin, 2013). Most of the researchers agree that a program can
be seen as effective if its outcome goes along with its objective (Ahmad, Othman, &
Jusoff, 2009; Ussahawanitchakit, 2012).Therefore, from the above definition, this
study defined Shariah audit effectiveness or internal Shariah audit effectiveness as
the ability of internal Shariah auditors to achieve established objective within IFIs.

Previous studies in Shariah audit have looked into the needs and challenges
(Rahman, 2008), perceptions of academicians and practitioners towards Shariah
audit (Mulany, 2008), professionalization of Shariah auditor (Shahul, 2013),
conceptualizing the duties and rules of Shariah auditors (Othman, et al., 2015) and
audit framework for Shariah compliance (Shafii et al., 2010). As well as a few
studies done on Shariah audit practices in IFIs focused on the scope, competency,
and working practices and current framework used to perform Shariah audit (Kasim
et al., 2009; Nik Suliman, 2012; Yahya & Mahzan, 2012). However, internal Shariah
audit effectiveness has not been studied compared to studies in external audits and
also internal audit in conventional bank. Currently, the Shariah audit and Shariah
review process is done internally. The literature review related to internal Shariah
audit effectiveness will be adapted from previous literature. Prior research related to
internal audit effectiveness are conducted by Ahmad (2009); Arena & Azzone (2009;
Badara & Saidin (2014); Endaya & Hanefah (2013); Mihret & Yismaw (2007).

Ahmed et al. (2012) identified lack of training and support from management, lack
of employees, and negative perception of management towards the recommended
solutions given by the internal auditors as factors that affect the effectiveness of

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 internal audit in Malaysian public sector. In addition, the study found that internal
audit effectiveness relates to understanding the stakeholders’ expectations towards
the performance of an organization. It is found that the internal audit function could
deliver an effective performance of internal audit when the internal auditors
understand the expectations of board of directors, CEO, and operating management
in the institutions (Feizizadeh, 2012). Effective internal Shariah auditor professionals
have the following characteristics: the ability to align the structure of internal Shariah
audit with the dynamics of the Islamic banks operations; there should be strong
relationship between management skills for maintaining appropriate and SSB needs
and expectations. Beside the above, the level of training, education, experience as
well as professional qualifications of the internal auditors influenced the
effectiveness of internal audit (Al-Twaijry, Brierley, & Gwilliam, 2003).

IFIs especially Islamic banks are showing concerned to their internal Shariah audit in
order to ensure the effectiveness of Shariah compliance in which in turn can
contribute positively to the Ummah (society) at large (ISRA & Finance, 2013).
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Therefore, Islamic banks with effective and efficient internal Shariah audit function
are more than those that have not such a function to detect fraud within their
organizations. Hence, an effective internal Shariah auditor is the one who assist IFIs
in meeting their objectives; therefore, IFIs should ensure that their internal Shariah
audit is effective to create value and effectiveness in such organization. From the
author’s review of literature, there is no study that has been conducted to examine
the factors that contribute to the effectiveness of internal Shariah auditors in IFIs
especifically Islamic banks. Interpersonal skills, internal auditor’s commitment and
support from audit committee and BOD, audit performance and integrity, audit
department efficiency, auditing competencies, internal auditor’s knowledge on
company’s business operation and industry and auditor independence are found to be
important attributes contributing towards internal audit function effectiveness
(Nasibah, Othman, Othman, & Jusoff, 2009). An effective internal Shariah auditor
assists in adding value and improves the performance of IFIs. Based on the
approaches of previous research (e.g., Al-Twaijry, Brierley & Gwilliam 2003;
Arena & Azzone 2009; Cohen & Sayag 2010; Mihret, James & Mula 2010; Mihret
& Yismaw 2007).

2.4 Internal Shariah Audit Characteristics

This research paper formulates the internal Shariah audit characteristics base on the
AAOIFI and previous studies. The literature reviewed for internal Shariah audit
characteristic reveals that their effectiveness is influenced by independence of
internal Shariah audit; competency of internal Shariah audit and work performance
in engagement planning, performing engagement and communicating results of
internal Shariah audit. Internal Shariah audit characteristic program in IFIs are shared
with the conventional audit program, which in some extent this audit program will
involve certain modifications to be adopted when it applies to Islamic banking
products and operations (Yahya & Mahzan, 2012). The overall aim of this research is
to shed further light on the effectiveness of internal Shariah audit in IFIs in the
context of Bahrain and to elicit the level of understanding for those who are involved
in internal Shariah auditing. The internal Shariah audit characteristic can be divided
into mainly three factors (independence; competence and work performance in

4
 engagement planning, performing engagement and communicating results of internal
Shariah audit).

AAOIFI (2010) emphasized that the objectives of the internal Shariah audit is to
ensure that the management of an IFI discharge their responsibilities in relation to
the implementation of the Shariah rules and principles as determined by the IFI’s
SSB. There are several standards that have been established by AAOIFI for
institutions that conducted business following the Shariah rules and principles.
Among the standards are independence and objectivity, professional proficiency and
scope of work. Besides that, performance of internal Shariah audit, quality assurance
and elements of an effective internal Shariah audit control system are also counted as
the standards that need to be followed.

2.5 Measurement of Internal Shariah Audit Effectiveness

Internal Shariah audit needs to demonstrate its own effectiveness by using
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performance measurement system that ties to the expectations of its key

stakeholders. The most commonly employed measures of effectiveness consists of
completion of planned audit and timely completion of the work plan as well as
measures of acceptance and adoption of internal audit function recommendations
(Soh & Martinov-Bennie, 2011). This research defined internal Shariah audit
effectiveness as the outcome of internal Shariah audit. The internal Shariah audit
performance is measured by the number of major Shariah audit findings reported,
internal Shariah audit plan accomplished, acceptance of Shariah audit’s
recommendations and Shariah audit’s implementation of improvements. Internal
audit is effective if it meets the intended outcome it is supposed to bring about in an
organization (Getie Mihret & Wondim Yismaw, 2007). The effectiveness of internal
audit greatly contributes to the effectiveness of each auditee in particular and the
organization at large (Dittenhofer, 2001). The dependent variable in this study is
internal Shariah audit effectiveness. As the head of internal Shariah audit work
closely with SSB and responsible for the entire Shariah audit activities therefore, it is
appropriate to use head of internal Shariah audit assessment of internal Shariah audit
effectiveness. To be effective, internal Shariah audit must ensure that the
management of IFIs discharges their responsibilities in relation to the
implementation of Shariah rules and principles as determined by SSB of IFIs.

3. HYPOTHESES DEVELOPMENT
3.1 Internal Shariah Audit independence
Internal Shariah auditors usually housed an independent internal audit department,
and their main task is to examine and evaluate the extent of the Bank’s compliance
with the Islamic Shariah rules and principles, Fatwas, guidelines, and instructions
issued by the IFI’s SSB. The primary objective of the Internal Shariah audit (is to
ensure that the management of an IFI discharges their responsibilities in relation to
the implementation of the Shariah rules and principles as determined by the IFI’s
SSB (AAOIFI, 2010). Shariah audit function is handled by internal audit department
of IFIs, to be independent an auditor should be able to demonstrate that there is no
threat to his independence such that an outsider would not doubt the auditor’s
objectivity (Arens, 2008; Messier, 2002). Thus, it is suggested that there is a need to
have regular independence Shariah auditor in IFIs (Kasim, Ibrahim, Hameed, &

5
 Sulaiman, 2009). To ensure effectiveness, the internal Shariah audit reports should
be presented, reviewed and endorsed by Audit and governance committee and these
reports should also be escalated to the attention of SSB’s of IFIs. The internal
Shariah auditors should have an independent mental attitude. Internal Shariah
auditors must strive to maintain a high level of independence to retain the confidence
of the users relying on their reports (Rahman, 2011).

Al-Twaijry et al. (2003), affirm that unrestricted access to documentation and

unfettered powers of enquiry are important aspects of independence and internal
audit effectiveness. In addition, Getie Mihret and Wondim Yismaw (2007) indicate
that, to achieve effective audit work, auditors are required to have full and
unrestricted access to all activities and records and properties, and be provided with
cooperation from the auditee. Thus, internal Shariah audit should be sufficiently
independent from the auditee to be able to conduct their work objectively and
without interference. Therefore, a key characteristic of an effective internal Shariah
audit is the independence with which it operates. As such, it is hypothesized that the
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emphasis on independence of internal Shariah audit will positively affect the internal
Shariah audit effectiveness. As such, based on the above discussion, the following
hypotheses are formulated:
H1: Independence of internal Shariah audit positively affects internal Shariah audit
effectiveness.

3.2. Internal Shariah Audit competency

Shafii et al. (2013) argued that, Shariah auditor should have the knowledge and
experience to audit IFIs. Shariah qualification is recommended to all internal Shariah
auditors; according to AAOIFI (2010) standards No. 3 Para 12 stated that, the
internal Shariah auditors shall possess the disciplines, knowledge and skill essential
to the performance of internal Shariah audits. Proficiency in Islamic Shariah rules
and principles in general, and Fiqh al-Muamalat in particular, is required in
performing internal Shariah audits. Thus, the internal auditors who are attached to
the IFI must not only have the auditing skills but also would need an additional
qualification which is Shariah knowledge specifically in Fiqh Muamalat. Ratna and
Hameed (2009) emphasise the importance for Shariah auditors to establish and
standardize the qualifications and competence requirement of a Shariah auditor.

Ali (2007), examined the significance of internal auditing in the Malaysian public
sector and found that a lack of qualified staff in terms of training, experience, and
knowledge about internal auditing will negatively affect the performance of the
internal auditor. He suggested training as an important requirement to improve the
work of the internal audit. Base on previous literature, knowledge and qualifications
of Shariah auditor will influence internal Shariah audit’s effectiveness. As such, it is
hypothesized that the emphasis on competence of internal Shariah auditors will
positively affect the internal Shariah auditor’s effectiveness.The following
hypotheses are formulated:
H2: Competence of internal Shariah auditor positively affects internal Shariah audit
effectiveness.

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 3.3 Internal Shariah Audit work Performance
Internal Shariah auditors should also perform their work in accordance to the
auditing standards. They should properly plan their audit work, perform their work
well and also communicate the results of their audit work to the appropriate parties.
Banaga et al (1994) feels that internal Shariah auditors should also comment on
management’s performance of the resources under his control. The scope of Shariah
audit would be limited if the internal Shariah auditor were not in a position to
comment on all areas of the affairs of the audit entity (Siddiqui & Podder, 2002).

According to Khan (1982), the scope of Shariah auditing of Islamic framework is

much larger than traditional auditing; from the traditional auditing concept of attest
and authority, to reporting on various social and economic aspects of business
organizations. In addition to financial statements the Shariah audit must cover a
broader dimension; some users of financial statements obviously feel that auditors
should comment on management’s performance (Goodwin-Stewart & Kent, 2006).
One of the objectives of Islamic law and IFIs is to expand the scope of Shariah audit
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to a broader which is the challenges that facing the IFIs from the well-established
conventional financial system. A wide challenge from the policy makers and top
management may face Shariah auditors who are progressive thinkers and various
believe and practices. The scope of Shariah audit should be wider encompassing
‘social behaviour’ and performance of organizations which including their
relationship with all the stakeholders (Hisham and Nor Khadijah, 2012).
Furthermore, Hisham and Nor Khadijah (2012) stated that Zakah calculation and
payment need to be covered by the scope of the Shariah audit as it is broader than
conventional audit this supported also by ( Hood and Bucheery, 1999; Ratana and
Hameed, 2009).

The work performance of Shariah audit depending on Shariah advisor and the SSB
who supervise the Shariah review or Shariah audit. This stance has been supported
by Rahman, (2008) where he stated that “the Islamic financial services industry
currently has not fully hand systematically undertaken Shariah audit i.e. no
systematic review has been comprehensively undertaken to ensure proper Shariah
compliance. Therefore, Shariah audit should involve a systematic review of the
operational aspect of IFIs; these also include the examination of policies and
procedures of IFIs, such as product manuals, operational processes and contracts. It
also needs to review the organizational structure to ensure it is feasible to undertake a
Shariah compliance activity.

Furthermore, Zakah calculation and payment, agreement, contracts, processes and

procedures, financial system and reporting and business policies are the areas of
business activities that the scope of Shariah audit should be considered strongly.
However, marketing and advertising, human resources management and social and
environmental contributions, are the other extended scope work of Shariah audit,
Shariah embraces every aspect of human life (Ratna and Hameed, 2009). Thus, work
performance is still an important factor for maintaining effective and high quality of
internal Shariah audit department. This is because performance measurement was
more supported towards efficiency and effectiveness of internal audit (Rupšys &
Boguslauskas, 2007). As such, based on the arguement above emphasis on the work
performance of Internal Shariah audit will positively affects internal Shariah audit
effectiveness. This leads to the next hypothesis:

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 H3: Work performance of internal Shariah audit (in engagement planning,
performing engagement and communicating results) positively affects internal
Shariah audit effectiveness.

4. RESEARCH METHODOLOGY
The main objective of this research paper is to examine the influence of internal
Shariah audit characteristics on internal shariah audit effectiveness in IFIs in
Bahrain. The empirical data presented in this paper was collected by questionnaire
survey sent to 52 IFI. A survey of 181 participants consisting internal Shariah
auditors, Shariah supervisory board and Audit and governance committee who are
engaged with the process of Shariah auditing in IFIs was conducted. The
questionnaires were mailed to respondents and collected back, only 126 responded to
this survey. There were eleven questionnaires excluded from the sample due to
incompleteness, the final sample were 115 respondents (response rate of 64%). All
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data are based on a 5 point-Likert- scale which considered as interval data. The scale
ranges from (1) strongly disagree to (5) strongly agree. The findings of this research
were achieved through the analysis of the responded surveys using SPSS Version 22,
descriptive statistic was used to examine the perception of different participant on
internal Shariah audit effectiveness. SmartPLS 2.0 was used to evaluate the
relationship among the constructs by conducting partial least square (PLS) analysis.

5. RESULTS AND DISCUSSIONS

5.1 Profile of the Respondents
With reference to the demographic information on the type of IFIs (Table 1.1) out of
the 115 respondents, most of them are from Islamic banks 62 (53.9%). This is
followed by Islamic insurance and Islamic window each 17 (14.8%), Islamic
investment 13 (11.3%), and Islamic finance 6 (5.2%), with regard to position of the
respondents, the descriptive statistics revealed that 76 (66.1%) of the respondents
were internal Shariah auditors, 23 (20.0%) were SSB and 16 (13.9%) were AGC.
This shows that the majority of the respondents were internal Shariah auditors. For
educational qualifications of the respondents, the study shows that 42 (36.5%) of the
respondents have Diploma; while 19 (16%) of the respondents have PhD. However,
the majority of the respondents are within the education level of Diploma.

With regard to professional qualifications of the respondents, descriptive statistics

revealed that majority of the respondents are having CIA and CSAA with the highest
percentage of 25 (21.7%) each while only 17 (14.8%) having CIPA. With respect to
work experience, descriptive statistical analysis showed that 34 (29.6%) of the
respondents having working experience from less than 3 years while 10 (8.7%) of the
respondents having working experience of the range of 12-15 years. Therefore, it
could be said that the respondents are lack of working experience in IFIs in Bahrain.
Finally, the mean descriptive statistics revealed that there are about 4 staff in internal
Shariah audit department this is due to small size of IFIs in Bahrain, whereas there
are 3 members of SSB are attached to others IFIs this is due to the less members of
SSB in IFIs in Bahrain, so that most of the SSB members are cross members of
different IFIs. Table 1.1 provides the summaries of demographic data of the
respondents in IFIs.

8
 Table 1.1
Profile of Respondent
Demographic Category Frequency Percentage
(%)
Type of IFI Islamic bank 62 53.9
Islamic Insurance 17 14.8
Islamic Investment 13 11.3
Islamic Finance 6 5.2
Islamic Window 17 14.8
Total 115 100
Audit Firm KPMG 33 28.7
Deloitte & Touche 19 16.5
Ernst & Young 34 29.6
PriceWaterhouseCoopers 17 14.8
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Non-big four 12 10.4

Total 115 100
Position AGC 16 13.9
SSB 23 20.0
ISA 76 66.1
Total 115 100

PhD 19 16.5
Educational Qualifications
Master 15 13.0
Degree 39 33.9
Diploma 42 36.5
Total 115 100
Professional Qualifications CPA 24 20.9
ACCA 24 20.9
CIA 25 21.7
CIPA 17 14.8
CSAA 25 21.7
Total 115 100
Working Experience Less than 3 years 34 29.6
3-6 years 21 18.3
6-9 years 20 17.4
9-12 years 19 16.5
12-15 years 10 8.7
Above 15 11 9.6
Total 115 100

5.2 Measurement Model

The measurement model was evaluated to determine the validity and reliability of the
measurement items. The individual loadings, internal composite reliability, and
discriminant validity were examined and discussed in detail in the next subsection.
The constructs validity have defined as the extent to which a set of measured
variables actually measure what they have supposed to measure, based on a

9
 grounded theoretical measure (Hair et al., 2011). The reliability of a measurement
refers to its consistency, construct validity was measured through convergent and
discriminant validity (Hair et al., 2010).

Convergent validity is the extent to which a measure correlates positively with

alternative measures of the same construct. In an effort to confirm the construct
validity for this respective research work, a common measure to establish convergent
validity on the construct level is the Average Variance Extracted (AVE) as suggested
by Hair et al., (2011). In order to prove that the latent variable explain more than half
of its indicators variance, Hair et al., (2011) suggested that AVE value of 0.5 and
higher should be achieved. In this study, all the AVE value of constructs is greater
than the acceptable value. Items loadings of all reflective measurement should be
above value of 0.708.

According to Hair et al., (2013) indicators which outer loadings between 0.4 and 0.7
should be considered for removal only if the deletion leads to an increase in average
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variance extracted (AVE) and composite reliability (CR) above the suggested
threshold value. CR for all constructs where confirmed satisfactory with value above
0.7. So convergent validity is confirmed (Nunnally & Bernstein, 1994). Tables 1.2
show the summary of the measurement model.

Table 1.2
Measurement Model
construct Items Loadings AVE CR
Independence ISAI2 0.993 0.756 0.902
ISAI4 0.804
ISAI6 0.797
Competency IASC6 0.936 0.681 0.913
ISAC1 0.776
ISAC2 0.771
ISAC3 0.911
ISAC5 0.709
Engagement ENG1 0.784 0.747 0.922
ENG2 0.945
ENG3 0.855
ENG4 0.866
Performance PER2 0.834 0.655 0.850
PER3 0.857
PER3 0.730
Communicating COMM2 0.849 0.701 0.875
COMM3 0.847
COMM5 0.814
Effectiveness ISAE2 0.880 0.814 0.929
ISAE3 0.869
ISAE6 0.955

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 Discriminant validity is the extent to which a construct is truly and entirely distinct
from other constructs by empirical standard (Hair et al., 2013). Similarly, a high
level of discriminant validity implied that a construct is unique and captures
phenomena not presented by other constructs in the model. There are various ways to
compute discriminant validity; the more precise method is to compares the square
root of the AVE values with the latent variable’s correlations. Specifically, the
square root of each construct’s AVE should be greater than its highest correlation
with any other construct in order to establish discriminant validity (Fornell &
Larcker, 1981). Therefore, the result indicates that dicriminant validity is well
established as shown in table 1.3
Table Error! No text of specified style in document..3
Discriminant Validity
COMMRE ENGP ISAC ISAE ISAI PERENG
COMMRE 0.837
ENGP 0.276 0.864
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ISAC 0.027 -0.025 0.825

ISAE 0.248 0.210 0.233 0.902
ISAI 0.029 0.125 0.066 -0.190 0.869
PERENG 0.356 0.170 0.147 0.188 0.064 0.809

Diagonals in (bold) represent the squared root of AVE while the other entire
represent the correlation

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Downloaded by Fudan University At 17:51 27 March 2017 (PT)

Figur 1.1 Measurement model

ISAI: Internal Shariah Audit Independence
ISAC: Internal Shariah Audit Competency
ISAWP: Internal Shariah Audit Work Performance
ISAE: Internal Shariah Audit Effectiveness
ENG: Engagement Planning
PER: Performing Engagement
COMM: Communicating Results

5.3 Assessment of Structural Model

The assessment of structural model was conducted after the measurement model with
the purpose of analyzing the relationships between latent variables hypothesized in

12
 the research model (Duarte & Raposo, 2010). The paths of the relationship between
variables were computed in structural model, followed by bootstrapping analysis to
assess the statistical significance of the path coefficients. The bootstrapping can be
defined as non-parametric to statistical inference that does not make any
distributional assumptions (Sharma & Kin, 2013). This study used the procedure of
5000 re-sampling to test significance of regression coefficient and this was the usual
recommendation when using bootstrapping to estimate parameters (Chin, Marcolin,
& Newsted, 2003).

Figure 1.2 and Table 1.4 present the results of direct effect hypothesized in this
study. The R2 of ISAE was 0.197, suggested that 19.7% of the variance in internal
Shariah audit effectiveness was explained by internal Shariah audit independence,
internal Shariah audit competency, internal Shariah audit work performance with
dimension engagement planning, performing engagement and communicating
results. The results shows that all the constructs were positively related to internal
Shariah audit effectiveness: internal Shariah audit competency (ISAC) with (β =
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0.237, p<0.01), internal Shariah audit work performance (ISAWP) with (β = 0.318,
p<0.01). Conversely, internal Shariah audit independence work (ISAI) was
negatively related to internal Shariah audit effectiveness (ISAE) not supported. Thus,
hypotheses H2, and H3 were supported, whereas H1 was not.

13
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Figure1.2 Structural Model Frameworks

ISAI: Internal Shariah Audit Independence

ISAC: Internal Shariah Audit Competency
ISAE: Internal Shariah Audit Effectiveness
ENG: Engagement Planning
PER: Performing Engagement
COMM: Communicating Results

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 Table 1.4
Hypothesis testing for directs effect
Hypotheses Relationship Std. Beta Std. Error t-value Decision
1 ISAI -> ISAE -0.242 0.163 1.480 Not Support
2 ISAC -> ISAE 0.237 0.089 2.648** Support
3 ISAWP -> ISAE 0.318 0.081 3.897** Support
** p<0.01, * p<0.05
ISAI: Internal Shariah Audit Independence
ISAC: Internal Shariah Audit Competency
ISAE: Internal Shariah Audit Effectiveness
ISAWP: Internal Shariah Audit Work Performance

6. Conclusion
6.1 Relationship between internal Shariah audit independence and its
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effectiveness
According to Maqasid al Shariah theory, internal Shariah audit independence should
have a positive relationship with internal Shariah audit effectiveness. The internal
Shariah auditors should be independent to protect the interest of the Muslim Ummah.
Moreover, the internal Shariah audit department of an IFI must be given sufficiently
high status in IFIs structure to enable it to have a better communication with
management and ensure the independence of internal Shariah audit from the
auditees. However, results show that independence of internal Shariah audit does not
affected significantly to the internal Shariah audit effectiveness. Thus H1 is not
supported.

Independence of internal Shariah audit was found not to have a positive and
significant relationship with the effectiveness of the internal Shariah audit. This may
be occurring due to the IFIs support to the internal Shariah audit effectiveness.
Accordingly, the level of independence, reporting level, direct contact with the board
and senior management, conflict of interest, the interference, the unrestricted access
to all departments and employees, appointment and removal of the head of internal
Shariah audit, and performing non-audit activity may not be equally perceived. But,
without the relevant senior management support simply the independence of the
internal Shariah audit to the internal Shariah auditors may not be enough to add value
and to identify the non-Shariah compliant activities performed in their department.
Therefore, the existence of adequate and competent internal Shariah audit staff and
the availability of approval internal Shariah audit charter in their department in line
with the appropriate management support for internal Shariah auditor’s activity are
strong enough to make effective, the internal Shariah audit function in the IFIs. And
this in turn leads to make the result of internal Shariah audit independence for the
internal Shariah audit effectiveness, insignificant contribution and not support the
proposed hypothesis (H1). The insignificant relationship indicates that the reporting
levels of Head of internal Shariah audit, which is used as a proxy for internal Shariah
audit independence does not affect internal audit effectiveness. This finding is
consistent with Mihret and Yismaw (2007) who found that, the independence of
internal auditors was not being statistically significant with internal audit
effectiveness in the public sector and higher educational institution in Ethiopia. The
insignificant relationship is also consistent with Wood and Prawitt (2007) who stated

15
 that independence of internal audit does not significantly determine the external audit
fees in their multivariate analyses.
Whereas this study is inconsistent with study conducted by (Cohen & Sayag, 2010;
Vinten & Van Peursem, 2005). They found that, the greater the independence of the
internal auditor, the greater is the internal audit effectiveness. An independent
internal auditor has free access to important documents, data and information about
the organization for audit work which can provide audit findings and report freely
and directly to the management. These characteristics may only occur if there is
support of the organization to ensure the internal audit effectiveness. However,
without the relevant management support, the merely independence of IFI to the
internal Shariah audit may not be enough to add value and identify the non-
compliance Shariah activities performed by their department.
The internal Shariah audit effectiveness is very much influenced by internal Shariah
audit’s independence. However, if the internal Shariah audit is not independent, the
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report issued will be biased, which in turn will amount to lack of accountability and
transparency of IFIs. The insignificant relationship is consistent with Amanuddin
Shamsuddin, Manijegar;, and Kirupanangtan (2014) who stated that the
independence of internal audit in public sectors has many weaknesses which include
staff shortages, lack of competency and operating in less than an advanced audit
mode in a significant number of the audit units. The research also highlighted an
inadequate number of staff and skills and training shortages to premeditated
hindrances by audits, amongst others, of the auditors in their attempts to perform
their duties At present, in Bahrain, there are variations of Shariah audit practices in
the IFIs. For example, some have an internal Shariah audit unit; some outsources
their internal Shariah audit to external Shariah auditors and others conduct Shariah
review. According to BNM (2010) Shariah audit is one of the functions to be
performed by the internal auditors. By implication, Shariah audit should be attached
to internal audit department of an IFI.

6.2 Relatinship between internal Shariah audit competency and its effectiveness
According to Maqasid Al-Shariah theory, this study predicts a positive relationship
between competency of internal Shariah audit and effectiveness of the internal
Shariah audit. The results from the direct relationship between competency of
internal Shariah audits and effectiveness of the internal Shariah audit is in line with
expectation. Competency of internal Shariah audit positively affects the internal
Shariah audit effectiveness. H2 is supported that is, the higher the competence of the
internal Shariah audit, the higher the effectiveness of internal Shariah audits, was
supported. The higher the level of education and more training given to employees
the higher the internal Shariah audit competency and therefore, they are able to be
more effective in IFI. This result is consistent with the findings of Alzeban and
David (2014) who measured competency of internal audit by educational
qualification, professional qualifications, work experience in the field of internal
auditing and continuous development (average annual training hours). Their study
suggested that higher internal audit effectiveness is associated with greater
competency of the staff within the internal audit department. This result is also in
agreement with studies by Ahmad et al., (2009); Mihret and Yismaw (2007) and
Alzeban & Gwilliam (2014), Mihret and Yismaw (2007) stated that internal audit

16
 requires experience, knowledge, training and skills on a large range of system and
operations.

But, this result was inconsistence with some previous auditing researches (Arena and
Azzone, 2009; Cohen and Sayag, 2010). They argued that, there was no correlation
between professional proficiency and adequacy with the internal audit effectiveness.
However, the previous research was conducted in terms of the number of internal
auditors, professional certification and level of education, whereas this research was
conducted, the effects of internal Shariah audit by considering the overall abilities of
the internal auditor staff and the availability of adequate and certified internal
auditors in terms of their performance to proceed the required Shariah auditing
activities by matching with the AAOIFI standards and organizational objectives by
using modern technologies when compared to those previous studies. however, the
existence of adequate and competent internal Shariah audit staff in the IFIs results
with positively relationship with internal Shariah audit effectiveness and with high
contribution to the internal Shariah audit effectiveness by performing their activities
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on time, cover the planned scope of Shariah auditing activities by using the
computerized data tools and specific internal Shariah audit software. These results
with the overall contribution of internal Shariah audit effectiveness and its positive
relationship with internal Shariah audit effectiveness leads to highly support of
hypothesis (H2).
Therefore, it is essential to deploy auditor with comprehensive professional skills and
upgrade these skills through continuing due professional care and development.
Moreover, the study indicates that criteria of internal Shariah audit competency can
be determined by IFIs at the institutional level, such as skills to perform Shariah
audit, maintaining technical competence through continuing their educations and
participating in training their IFI’s employees. Therefore, the presence of adequate
and competency of internal Shariah audit in IFIs results in positive relationship with
internal Shariah audit effectiveness and leads to higher contribution to internal
Shariah audit effectiveness by performing Shariah audit activities on time.

6.3 Relationship between work performance of internal Shariah audit and its
effectiveness
This study hypothesized a positive relationship between internal Shariah audit work
performances and internal Shariah audit effectiveness. The results support the
positive relationship between internal Shariah audit work performance in
engagement planning, performing engagement and communicating results and
internal Shariah audit effectiveness. Therefore, these three factors of work
performance are important criteria to achieve higher internal Shariah audit
effectiveness as such all the relationships are positive and significant. The findings
shows that each of these dimensions is important and found to be interrelated to each
other as shown by positive correlation among them.

According to AAOIFI (2010) planning documentation shall include obtaining

background information about the activities to be reviewed, such as locations,
products/services, branches, divisions, etc. Planning is also considered a vital audit
activity as it ensures the appropriateness of resources by projecting requirements in a

17
 timely sequence (Mihret and Yismaw, 2007). Performing engagement by
establishing internal Shariah audit objectives and scope of work, obtaining SSB
Fatwas, guidelines, instructions, prior year internal and external Shariah review
results, relevant correspondence including supervisory and regulatory agencies.
Communicating results with all individuals in the IFI who need to know about the
internal Shariah audit. Written audit reports shall be discussed with the appropriate
level of management before issuing the final report. On completion of internal
Shariah audit, at least a quarterly written report shall be prepared which must be
signed by the head of internal Shariah audit department, addressed to the board of
directors and copied to the SSB and management. This report shall be objective,
clear, constructive and timely. The report shall present the purpose, scope and results
of the internal Shariah audit and it shall contain expression of the internal Shariah
audit opinion. All disputes between management and internal Shariah auditors on
matters relating to Shariah interpretation shall be referred to the SSB for ruling. The
internal Shariah auditors shall follow up to ascertain that appropriate action is taken
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on their reported internal Shariah audit findings. Recommendations related to

Shariah matters made by the SSB, external auditors and regulatory agencies shall
also be followed up. The management is responsible for rectification of non-
compliance, prevention of non-recurrence of non-compliances, and ensuring that the
agreed upon actions were carried out including their timing and extend of follow up
(AAOIFI, 2010).
Findings are consistent with Cohen and Sayag (2010) who found the greater quality
of the auditing work is positively related to greater internal auditing effectiveness.
The positive and significant relationship between work performance and
effectiveness of internal Shariah audit support the AAOIFI standards. AAOIFI
standards emphasize the importance of performance of internal Shariah audit work as
proper planning of documentation to establish internal Shariah audit work objectives,
scope of work and obtaining SSB Fatwas, guidelines and instructions. Moreover, it is
good to determine the resources necessary to perform the internal Shariah audit,
communicate the internal Shariah audit program (timely manner) and determine how
and when the internal Shariah audit results should be communicated in writing to all
IFIs. The work performance of internal Shariah audit in engagement planning,
performing engagement and communicating results will not only increase their
effectiveness and efficiency but can also improve their credibility. This implied that,
work performance of the internal Shariah auditor will enhance the internal Shariah
auditor’s effectiveness. Thus, the above result displayed the significant positive
effect of internal Shariah audit characteristics on the internal Shariah audit
effectiveness, thereby supporting Maqasid al- Shariah theory prediction of the
research framework.

6.4 Research Contributions

The provides various implications to practitioners and academicians. Moreover, this
contribution serves as recommendations to IFIs and a contribution to the body of
knowledge. The internal Shariah audit effectiveness and its characteristics are very
important to IFIs in Bahrain. However, the implications of the study can be classified
into theoretical and practical implications. In furtherance to the above, the study has
contributed to Maqasid al-Shariah theory in examining the relationship of
characteristics of internal Shariah audit (independence, competency and work

18
 performance of internal Shariah audit) and the effectiveness of internal Shariah audit.
This study has adapted questionnaire from the instrument by AAOIFI (2010) and
developed it based on literature review. On the other hand, the internal Shariah audit
is accountable to the shareholders and to Allah S.W.T therefore, the internal Shariah
audit will be more effective when is getting support from SSB and sources from
board of directors of IFIs. Subsequently, this research study found a strong support
for internal Shariah audit competency and work performance in engagement
planning, performing engagement and communicating results of internal Shariah
audit on effectiveness of internal Shariah audit, whereas internal Shariah audit
independence does not support. The overall results from this study confirmed that
internal Shariah audit characteristics (independence, competency and work
performance of internal Shariah audit in engagement planning, performing
engagement and communicating results) are the key determinants on internal Shariah
audit effectiveness in IFIs in Bahrain.

6.5 Limitations and Suggestions for Further Study

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This research study is exploratory in nature and despite the contribution made with
regards to internal Shariah audit effectiveness there are some limitations and
opportunities for future research to be considered when evaluating the study
implications. Firstly, due to small sample size available for this study, the result may
not be generalizable beyond the 52 IFIs from which respondents were drawn. Future
study can extend the sample to Gulf countries council (GCC) by making comparative
study on internal Shariah audit effectiveness. Secondly, due to limited availability of
literature review in this field specifically in internal Shariah audit effectiveness.
Therefore, more research is required to be conducted on internal Shariah audit
effectiveness particularly in Islamic banks because the majority of IFIs are Islamic
banks. Lastly, due to limited availability of previous research, the current study only
examine the impact of internal Shariah audit characteristics on internal Shariah audit
effectiveness. Future researches can consider other factors such as size of internal
audit department, cooperative between internal and external auditor and management
support for internal audit. The moderator variables could be introduced such as SSB
or AGC. Finally, Supports from shareholders and management of IFIs are essential
for higher effectiveness of internal Shariah audit as indicated by this study.

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