BWFS 3023 ISLAMIC ACCOUNTING

TOPIC 1 INTRODUCTION TO ISLAMIC ACCOUNTING

TOPIC OUTLINES
Background of Islamic accounting

Objectives of Islamic accounting

The basis for Islamic accounting The differences between Islamic & conventional

accounting

LEARNING OBJECTIVES
Explain the concept of Islamic accounting

Explain the need for reporting framework

particularly for Islamic financial framework Differentiate between Islamic accounting and conventional accounting

Its a Financial Intermediary !

Savings & Investment Financing

Surplus Units
Individuals Businesses Government Financial Intermediary (e.g. bank)

Deficit Units Individuals Businesses Government

Return on investment & savings

Return on financing

Banks Liabilities

Banks Assets

Types of banks
Those classified as financial institutions in

Malaysia constitute commercial banks, Islamic banks, merchant banks, foreign banks representative offices, finance companies and discount houses

Why Do We Need Islamic Banking System?

 Shariah Islamiyyah compliance Meet financing and investment needs of the

Muslims Meet modern requirement of individual and commercial needs Encourages financial innovations but in line with Shariah In Malaysia, growing regulatory and social support

Historical Development of Islamic Banking

The 1st. Islamic Bank Mit-Ghamr Local Savings Bank (1963) -

Nasser Social Bank, Egypt (1971) Dalla Al-Baraka Group, Saudi (1969) Islamic Development Bank, Jeddah, Saudi (1975) Dubai Islamic Bank (1975) Faisal Islamic Bank - Egypt and Sudan, Kuwait Finance House (1977) Jordan Islamic Bank (1978) Bahrain Islamic Bank (1979) Dar al-Maal al-Islami (1981) BIMB (1983) Bank Muamalat (1999) Kuwait Finance House (Malaysia) (2006) Al Rajhi (Malaysia)(2006) Islamic Banks Subsidiaries

ISLAMIC BANKING IN MALAYSIA

In Malaysia: dual banking system regime - Islamic Banking runs parallel with conventional banking (nonIslamic Bank) Islamic Banking System in Malaysia is governed and regulated by Central Bank of Malaysia (Bank Negara) Regulatory Framework: - Banking And Financial Institution Act (BAFIA) 1989- govern conventional bank - Islamic Banking Act 1983- govern Islamic Bank - Companies Act 1965 - Central Bank of Malaysia Act 1958 - Garis Panduan 8 (GP8-i)- relevant to reporting of financial statement for Islamic Bank

NEW ACT FSA & IFSA

30 June 2013 - The regulatory and supervisory

framework of Malaysia enters a new stage of its development as the Financial Services Act 2013 (FSA) and Islamic Financial Services Act 2013 (IFSA) come into force.
The Act substitute the few separate laws to

govern the financial sector under a single legislative framework for the conventional and Islamic financial sectors respectively, namely, the Banking and Financial Institutions Act 1989 (BAFIA), Islamic Banking Act 1983, Insurance Act 1996 (IA), Takaful Act 1984, Payment Systems

Full-fledged Islamic banks:

Bank Islam Malaysia Berhad (1983)

Bank Muamalat Malaysia Berhad (1999)

Bank Kerjasama Rakyat (2002) Future:
Agrobank probably the first full-fledged Islamic

Agriculture bank by 2015

Table 1: The Islamic Banking Subsidiaries in Malaysia No. 1 2 3 4 5 6 7 8 9 Local Islamic Banking Subsidiaries Affin Islamic Bank Berhad Alliance Islamic Bank Berhad AmIslamic Bank Berhad (AmIslamic) CIMB Islamic Bank Berhad EONCAP Islamic Bank Berhad (EIBB) Hong Leong Islamic Bank Berhad Maybank Islamic Berhad (MIB) Public Islamic Berhad RHB Islamic Bank Berhad Commencement date 6 June 2006 April 2008 18 May 2006 2 June 2003 1 April 2006 28 March 2005 1 January 2008 3 March 2009 1 March 2005

 The foreign commercial banks that have started their

Islamic subsidiaries in Malaysia are:

HSBC Amanah Malaysia Berhad ( Launched on 25

November 2008) Standard Chartered Saadiq Berhad (Launched on 12 November 2008) OCBC Al Amin Bank Berhad ( Launched on 11 November 2008)
Three foreign Islamic banks:
Al Rajhi Banking and Investment Corporation Berhad

(Al Rajhi) Kuwait Finance House Berhad (KFHMB) Asian Finance Bank Berhad (AFB),

Islamic Bank: Financial Claims & Assets

SHAREHOLDERS EQUITY & RESERVES
UNRESTRICTED INVESTMENT ACCOUNT HOLDERS/ GENERAL INVESTMENT ACCOUNTS

FIXED ASSETS

Uses of Islamic Funds

Sources of Islamic Funds

INVENTORY

DEPOSITORS

INVESTMENTS

PAYABLES
FINANCING
RESTRICTED INVESTMENT ACCOUNT HOLDERS/ SPECIAL INVESTMENT ACCOUNTS

CASH & CASH EQUIVALENT ASSETS

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What Does it Mean By Shariah Compliance?

Validity and Permissibility

Valid is the contract that meets its requirements and conditions. Permissible (Halal) is the contract that is used to obtain Halal

(Permissible) ends.
A valid contract is not necessarily Halal (permissible).

Initiating a marriage contract with a woman whereby all conditions

are fulfilled but with the intention to divorce her the other day (just to obtain the sexual pleasure) is a valid contract, but is not Halal. Selling guns to criminals is valid, but it is not Halal. Validity is based on the form of the contract while permissibility is based on the substance of the contract and the intention of the contractors/party.

What is Riba?

Juridical Meaning of Riba

Literally means excess, increase, expansion, growth. In Shariah: (Refer to Wahba Al-Zuhaily, Fiqh Al-Islami Wa

Adillatuh) Hanafis School: A surplus of commodity or an excess in return without counter value Riba is a predetermined excess or surplus over and above the loan received by the creditor conditionally in relation to a specified time period
Riba was made forbidden in the 8th or 9th year

after the Hijrah (flight from Makkah)

Quranic Prohibitions
Those who devour riba will not stand except as

stands one whom Syaitan by his touch has driven to madness (Al-Baqarah: 275) But Allah has permitted Trade and forbidden riba (Al-Baqarah:275) O you who believe! Fear Allah and give up what remains of your demand for riba, if you indeed believers. If you do it not, take notice of a war from Allah and His Messenger; but if you turn back, you shall have your capital sums; deal not unjustly and you shall not be dealt with unjustly (Al-Baqarah:278-279)
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Hadith Justification
Avoid the seven grievous sins They asked: What are

they. O Messenger of Allah? He (p.b.u.h.)replied, Associating anything with Allah, magic, killing a soul which Allah has declared inviolate without a just cause, devouring the property of an orphan, dealing with riba, fleeing on the day of fighting, and culminating the chaste, innocent, believing woman. (Muslim) Riba is of seventy three kinds, the lightest in seriousness of which is as bad as ones marrying his own mother; for the Muslim who practices riba goes mad. (Al-Hakim) The Messenger of Allah (p.b.u.h.) cursed the devourer of riba, his constituent, the one who acts as a witness to it, and one who acts as a notary to it.

Categories of Riba
1.

Riba al-Duyun

2.

Riba al-Buyu

Applies to loan or to any debt regardless of the cause of that debt be it because of a loan contract or because of any transaction like a price that has not been paid yet by the buyer in a sale contract

1.

2.

Applies to sale transactions in certain commodities It has two types: Riba al Nasiah (delay in paying or delivery of one or the two sold items); and Riba al Fadl (exchanging one ribawi commodity for the same commodity but unequal in amount

Riba Al Duyun (Loan)

The basis for the prohibition of riba in loan

transactions as a result of delay in time is the Quranic verses, eg. 2:275 In loan transactions, riba will occur if the three conditions below are fulfilled:
There is excess or surplus over and above the loan

capital Determination of this surplus in relation to time Stipulation of this surplus in the loan agreement

Riba Al Buyu (exchange)

The basis for the prohibition of riba in the

exchange of ribawi commodities is the famous saying (hadith) of the Prophet s.a.w. on six commodities:
Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt like for like, equal for equal, and hand-to-hand (spot); if the commodities differ, then you may sell as you wish, provided that the exchange is handto-hand or a spot transaction

What is Gharar?

Meaning
Deceit, fraud, uncertainty, danger, peril, or hazard that might lead to destruction or loss Technically: uncertainty and/or ignorance of one/both parties in a contract over the substance or attributes of the object of sale, or doubt over its existence and availability at the time of contract
Literally:

Prohibition of Gharar
All jurists agree that gharar should be avoided in commercial

exchange contracts Prohibition of gharar Indirect references made in the Quran Conclusively prohibited by the Sunnah of the Prophet s.a.w. Classical examples of gharar sale Sale of fish still in the sea Sale of birds in the air Sale of unborn animals Types of gharar Gharar yasir (minor or slight) Tolerated and will not invalidate a contract Gharar fahish (major or excessive) Not tolerated and may result in contract voidability

Contd
The conditions of Gharar can change according to the

environment, custom and technology. Venues of Gharar Type, shape, quantity, weight and sum Due to delivery time Due to price value and payment method. Due to ambiguity in ownership and the capacity of asset owner

Rationale for Gharar Prohibition

To ensure full consent and satisfaction of the

parties in a contract Without full consent, a contract may not be valid Full consent can only be achieved through certainty, full knowledge, full disclosure and transparency Gharar in commercial contracts may lead to injustice, exploitation and/or enmity among contracting parties
More info.:
http://www.zaharuddin.net/senarai-lengkap-

artikel/38/733-gharar-a-gambling-in-daily-

What is Accounting?

Definition and Purpose of Accounting

In 1966 the American Accounting Association defined accounting as: the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of that information In 1975 they added that the purpose of the process was: to provide information which is potentially useful for making economic decisions and which, if provided, will enhance social welfare

Islam and Accounting

Al-Baqarah 282: O you who believe! When you deal with each other, in transactions involving future obligations in a fixed period of time, reduce them to writing, let a scribe write down faithfully as between the parties: let not the scribe refuse to write: as God has taught him, so let him write. Let him who incurs the liability (debtor) dictate, but let him fear his Lord God, and not diminish aught of what he owes. If the party liable (debtor) is mentally deficient, or weak, or unable himself to dictate, let his guardian dictate faithfully, and get two witnesses, out of your own men, and if they are not two men, then a man and two women, so that if one of them errs, the other can remind him.

Islam and accounting (cont.)

The witnesses should not refuse when they are called on (for evidence). Disdain not to reduce to writing (your contract) for a future period, whether it be small or big: it is more just in the sight of God, more suitable as evidence, and more convenient to prevent doubts among yourselves. But if you carry out the transactions on the spot there is no blame if you reduce it not to writing. But take witness whenever you make a commercial contract, and let neither the scribe nor witness suffer harm. If you do (such harm), it would be wickedness in you. So fear God; for it is God that teaches you. And God is well acquainted with all things

Lessons learned from verse 282, Surah Al Baqarah

Proper, complete and transparent recording of financial

and business transactions. Trustworthy and responsible accountants. Written contract for all significant financial and business transactions. Truthful witnesses (at least 2) to ensure proper accountability, and check and balance. Materiality accounting concept to the smallest denomination. Fear God (Taqwa/Peity) for all contractual parties: borrower, lender, buyer, seller, accountant, auditor etc. The purpose of accounting to facilitate muamalat transactions in equitable, fair and just transactions.

What is the definition of Islamic Accounting?

 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 Shariah 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).

Islamic Accountability
Transcendental accountability to Allah SWT

(Hablumminallah) Social accountability to the society (Hablumminan-nass) Individuals as trustees or khalifah Success in this world and in the hereafter (alfalah) Economic goals beyond purely wealth but include tazkiyah (purification of self and wealth)

Understanding Roles and Responsibilities

Allah 1
Concept of Khilafah

Self 2

Other s

Shariah

The Basic Features and Objectives of Islamic Accounting

the transformation from profit maximization to

Zakat maximization (as an emphasis of the welfare of the society, not only individual interest)
Any activity (accounting) policy must comply with

the Islamic Shariah (as Muslims are bound to do this),

it would inherently incorporate a balance between

individual character and social character (Muslims are the most generous community who look after the welfare of others),

 the enterprise would be encouraged to participate

in releasing humans from the oppression of economic, social and intellectual factors and releasing the environment from human exploitation (providing accurate and appropriate information for making decision, setting appropriate prices of the products, through equitable distribution of wealth, and retaining the environment favorable through green reporting), it provides a bridge between the world and the hereafter (every Muslim has a final goal is to enter into Jannah achieving the satisfaction of Allah through performing good deeds in this world).

Objectives of Financial Statements

Traditional
Income Statement Statement of Financial Position Cash Flow Economic Performance Financial Position

Islamic
Fulfilment of Amanah Financial Trust and Obligation Cash Entrusted

Cash Position

Equity statement

Wealth Ownership

Wealth Entrusted

The Basis of Islamic Accounting

The basis of Islamic Accounting is acceptance of Tawhid (Oneness and Unity of God-As Islam is a code/way of life given by Allah SWT), Adl (Maintenance of Justice for all), Ihsan (Goodness/ Kindness to all concerned parties), Amanah (Maintenance of Honesty in all aspects), Tawakkal (Trust in God in doing all activities), Infaq (Spending to meet social obligations/ responsibilities),

Istislah (Maintenance of Public Interest), and avoidance of the Riba (Avoidance of Interest), Ihtikaar (Avoidance of Hoarding), Zulm (Avoidance of Tyranny), Hirs (Avoidance of Greed), Israf (Avoidance of Extravagance) [Lewis, 2006]

What is the Similarities of Islamic Accounting with Conventional Accounting?

Both Islamic and conventional accounting is to provide information

Differences between Islamic Accounting and Conventional Accounting?

The objectives of providing the information

Islamic Accounting enable users to ensure that Islamic organisations (whether business, government) abide by the principles of the Shariah or Islamic Law in its dealings and enables the assessment of whether the objectives of the organisation are being met.

 The type of information which Islamic accounting

identifies, measures is different. Conventional accounting concentrates on identifying economic events and transactions, while Islamic accounting must identify socioeconomic and religious events and transactions. Islamic Accounting is more holistic in its approach as both financial and non-financial measures regarding the economic, social, environmental and religious events and transactions are measured and reported.
Islamic accounting may require a different statement

altogether to deemphasize the focus on profits by the income statement provided by conventional accounting.
Islamic Accounting recognizes that all including the

society are the users of the reports. The reason being that society as a whole can make corporations accountable for their actions and ensure they comply with Shariah principles and do not harm others while making money ethically and achieve a equitable allocation and distribution of wealth among members of society especially

Components of Islamic accounting

Features of Islamic Accounting

No different in terms of recording (double entry system) Clear distinction of Accounting Objectives i.e. religious

obligation vs. commercial obligation (different significance of financial statements) Different users information need (legitimate and equitable transactions and wealth vs. maximization of wealth and economic consequences) Compliance with the principles and rules of Shariah Different Islamic contractual relationships (mudarabah instrument; murabahah etc.) Distinct accountability relationships (to Allah SWT and Ummah) Determination of zakat

User Groups of Accounting Information for Islamic Banks

Investors (potential and existing) (lawful and equitable

investment) Creditors (potential and existing) (lawful trade assets) Regulators (e.g. Bank Negara) Shariah Supervisory Board & Advisory Council (Shariah compliance) Customers (lawful goods and services) Others who may be effected by the disclosure or nondisclosure of information

Users Group - AAOIFI

Equity holders

Holders of investment accounts

Other depositors Current and saving account holders Other who transact business with the Islamic

financial institutions, who are not equity or account holders. Zakat agencies Regulatory agencies

FINANCIAL REPORTING, AUDITING & GOVERNANCE FRAMEWORK

AUDIT COMMITTEE

SHAREHOLDERS

AAOIFI

IFSB/MASB

INVESTMENT ACCOUNT HOLDERS

ISLAMIC FINANCIAL INSTITUTION

SHARIAH SUPERVISORY BOARD

OTHER STAKEHOLDERS

REGULATORY AUTHORITIES

GOVERNANCE COMITTEE

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COMPARISON OF FINANCIAL STATEMENTS

BANK ISLAM MALAYSIA BERHAD, BAHRAIN ISLAMIC BANK AND PUBLIC BANK

END OF TOPIC 1 ALLAH KNOWS BEST