Introduction

(Week 1 & 2)

Development of Islamic
Banking System

Banking business means:

(a) The business of;
(i) Receiving deposits on current account,
deposit account, savings account or other
similar account;
(ii) Paying and collecting cheques drawn by
or paid in by customers; and,
(iii) Provision of finance; or
(b) Such other business as the bank (BNM),
with the approval of the Minister may
prescribe
Banking and Financial Institutions Act 1989
(BAFIA)

Banking business whose aims and

operations do not involve any element
which is not approve by the religion of
Islam
Islamic Banking Act (1983)

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

The 1st. Islamic Bank Mit-Ghamr Nasser

Social Bank, Egypt (1963)
Dalla Al-Baraka Group, Saudi (1969)
Islamic Development Bank, Jeddah, Saudi
(1975)
Dar al-Maal al-Islami, Saudi (1981)
BIMB (1983)
Jordan Islamic Bank, Dubai Islamic Bank
etc

Legal, political and economic changes

internationally
Islamization and Institutional Reform (e.g.
Pakistan, Iran, Sudan, Malaysia)
International Muslim organizations (OIC
IDB etc)
International response to capture
capital/fund of oil rich Islamic countries
(e.g. Citibank, Dresdner Kleinworth
Benson, ANZ group, etc.

In 1963, the Pilgrims and Fund Management

Board provides a savings mechanism for Muslims
to perform Hajj
In 1983, the Islamic Banking Act (IBA) was
approved and defined Islamic Banking as
banking business whose aims and operations do
not involve any element which is not approve by
the religion of Islam.
Government Investment Act (Act 275) 1983
empowers the government to issue Government
Investment Certificates (GIC) with returns in the
form of discretionary gift (Hibah) rather than
interest
In 1993, Conventional banks can operate Islamic
baking and financial products known as Skim
Perbankan Tanpa Faedah (SPTF)

Traditional western (secular)

accounting objectives

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

ACCOUNTING
A PROCESS OF
Recognising,
recording,
classifying
and summarising
business
transaction
Documents
Vouchers
Ledger
Trial Balance
Report (Mgmt)

Measuring,
Analyzing,
Interpreting Result
of Operation

Reporting &
Presenting
Financial Position

Profitability
= Income - Expenses

Financial Statement

Growth
Liquidity
Productivity

Balance Sheet
Income Statement
Stmt of Changes
In Equity
Cash Flow Statement
Notes to Accounts

STAKEHOLDERS
1. Management
2. Board of Directors

3. Shareholders
4. Investors
5. Creditors

6. Authorities BNM, Inland

Revenue, Baitulmal
7. Staff
8. Public

Accounting entity (Owners (principals)

are different from managers (agents)
Economic events (identifiable and
measurable in monetary terms)
Financial description
Decision usefulness to a very restricted
set of users (esp. those with financial
involvement with the entity)
Neo-Classical Economics and
maximization of wealth of stakeholders

Provide information that is useful to present

and potential investors and creditors and other
users in making rational decisions
Information should be comprehensible to
those who have reasonable understanding
of economic activities and are willing to study
the information
Primary user groups are shareholders,
investors and creditors
Secondary user groups are employees,
customers, and the public
Accountability framework - the objective is
to provide a fair system of information flow
between the accountor (agent) and the
accountee (principal)

Accounting from an Islamic

perspective

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.

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

The process of identifying, measuring, and

communicating economic and other
relevant information inspired by Islamic
Worldview and complied with Syariah
Islamiyyah to permit informed
judgements and decisions by potential
and expected users information to
enhance social welfare

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
(al-falah)
Economic goals beyond purely wealth but
include tazkiyah (purification of self and
wealth)

Traditional

Islamic

Comprehensive Economic
income
Performance

Fulfilment of
Amanah

Financial
Position

Financial
Position

Financial Trust
and Obligation

Cash Flow

Cash Position

Cash Entrusted

Equity
Statement

Wealth
Ownership

Wealth
Entrusted

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 Syariah
Different Islamic contractual relationships
(mudarabah instrument; murabahah etc.)
Distinct accountability relationships (to Allah SWT
and Ummah)
Determination of zakat

Investors (potential and existing) (lawful

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

Introduction to AAOIFI
Accounting Standards and
Objectives of Financial
Accounting and Reporting

Primary Purpose
To enhance the confidence of users of the
financial statements of the IFIs and
ultimately to promote IFIs
Objectives
Develop accounting and auditing thought
relevant to IFIs
Disseminate accounting and auditing
thought relevant to IFIs
Prepare, promulgate and interpret
accounting and auditing standards for IFIs
Review and amend accounting and auditing
standards for IFIs

History: established in 1991

agreement of association by IFIs
worldwide supported by IDB
Head office is in Bahrain
Organizational Structure Supervisory
Committee; Financial Accounting Standard
Board; Executive Committee; Shariah
Committee
Funded by founding members of IFIs,
establishment of waqf etc.

Financial Accounting
Statements of
Standards
Financial
Musharaka Financing
Accounting
Profit Allocation Basis
Objectives
Investment Account
Concepts
Holders
Financial Accounting Salam Financing
Standards
Ijarah Financing
Presentation and
Zakah
Disclosure of Financial Istisna Financing
Statements of Islamic Provisions and Reserves
Banks
Presentation and Disclosure
Murabaha Financing
of Financial Statements of
Islamic Insurance
Mudaraba Financing
Companies

Auditing Standards
Objectives and
Principles of Auditing
The Auditors Report
Terms of Audit
Engagement
Governance Standards
Syariah Supervisory
Board
Syariah Review
Internal Syariah
Review

Code of Ethics
Code of Ethics for
Accountants and
Auditors of IFI
New Financial
Accounting Standards
Investment Fund
Disclosure Bases for
Determining and
Allocating Insurance
Surplus (and deficit)
New Auditing Standards
Audit Tests for Syariah
Compliance

To determine rights and obligations of

interested parties
To safeguard entity assets and rights of
others
To contribute to enhancement of managerial
productive capacities
To provide useful information to make
legitimate decisions
Syariah compliance
Distinguish prohibited earnings & expenditure

Present entitys economic resources,

obligations and related risks
Determine Zakat obligations
Estimate cash flow and related risk
Ensuring reasonable (or equitable) rates
of returns to investors
Disclose Islamic Banks discharge of social
responsibility (not as a constraint but as a
goal)

Accounting concepts from an

Islamic perspective

Accounting unit
Separate legal entity; limited liability; owners
are different from managers
Similar to the concept of juridical person in
the case Waqf & Baitulmal
Almost similar to Mudarabah as far as the
purpose and principles
Liabilities limited to the capital contribution &
may be injurious to the creditors in the case
of liquidation
To be constrained by the syariah as to the
rights and obligations

Periodicity
periodic reports of financial positions as of
a given date and divided into reporting
periods (normally annual)
Accounting for zakat based on haul (one
year complete ownership)
Going concern
contracts assumed to continue until there
is evidence to the contrary
Para 21 MASBi-1 when material
uncertainties, those uncertainties should
be disclosed

Monetary and stability of unit

measurement
currency as common denominator
Impact of inflation & purchasing power on
reporting?
Prudence & Conservatism
Generally, not to overstate assets and
incomes, and not to understate liabilities
and expenses
As long as can be determined with
certainty (objectivity)

Recognition
Define the basic principles that determine
the timing of revenue, expense, gain and
loss
Measurement
Define the broad principles that
determine the amount at which assets,
liabilities, owners equity etc. are
recognized

Revenue Recognition
Recognized when realized, when one of 3 condition
is met:

The right to receive not necessarily when the payment is

received (i.e. accrual basis MASBi-1 para 22; AAOIFISFA2) e.g. when a bank delivers the service
Syariah Requirement: the amount of revenue should be
known and collectible with reasonable degree of
certainty
There is an obligation on the part of another party to
remit.

****Accrual Basis concept

Expense Recognition
Realization either because the expense relates to
the earning of revenue (e.g. transportation cost
for services), or because it relates to the period
of income statement (e.g. bonus)

Subject of discussion among syariah jurists

Fiqh expert (Fuqaha) deterimned cash basis
of acctg to be the mode of practice to
account Islamic transaction in the past.
Syariah council of Msian bank permitted the
use of modified cash basis .
Conventional banks & other financial
institution offer IBS used accrual basis
Cash basis failed to address separate legal
entity, going concern concept but exist in
IBS .

NSAC recognised that IFI can adopt cash basis

in recognizing income.
Mudharabah contracts recognised cash basis
Fuqaha allowed the use of accrual basis to
recognised income.
NSAC recognised fuqaha approach base on
following argument:
MASB-harmonization & standardization of practice
MASB-to provide guidance & acct principles

comparable for decision making

MASB obj to provide info to interested parties about
IFI compliance with syariah

Matching Concept
Matching of revenues and gains with
expenses and losses that relate to that
period
Measurement Attributes: acquisition cost
(HC), cash equivalent value, assets
replacement cost etc.
In the case of Zakat measurement,
preference is current market value (AAOIFI
FAS 9: Cash Equivalent Value)

Historical Value vs. Current Value

Cash Equivalent Value (most preferred
if the following are available):

availability of objective indicator;

relevant information;
logical and relevant valuation
consistency of valuation methods
experts valuation
conservatism in the valuation process

4 obj acct disclosure:

Avoid riba & pay zakat
Social accountability
Full disclosure

AAOIFI (SFA2)-adequate disclosure

means FS should contain all material
info to make them useful to users.

Capable of generating positive cash flows

or other economic benefits in the future
either by itself or in combination with other
assets which the bank has acquired the
right
to hold (rightful ownership of maal), use
or dispose (rights on manfaat) as a result
of past transactions or events (AAOIFI)

1. Relevance
Predictive Value (ability to predict
potential outcome)
Feedback Value (ability to verify the
accuracy of prior prediction)
Timeliness (available as soon as after
the reported events)

2. Reliability
Representational faithfulness
(information reflect what it purports to
present)
Objectivity (measurement and disclosure
appropriately used and if replicated by
independent person gives the same
result)
Neutrality (accounting information
directed towards common needs of users
and not needs of particular group of
users)

3. Comparability
Able to make comparison of the banks
performance and position over time and
with other banks
4. Consistency
Consistent in applying accounting
measurement, valuation and disclosure
methods from one period to another

5. Understandability
Aware of the abilities and limitations of
those for whom accounting information is
provided
6. Materiality
Accounting information is regarded
material if its omission, non-disclosure or
misstatement results in distortion of the
financial statements

Islamic accounting framework

(objectives and concepts):
1. Compliance with syariah and,
achievement of Islamic goals, on financial
activities (financing schemes and financial
instruments)
2. Equitable and fair recognition,
measurement, valuation and disclosure of
financial information
3. Achievement of both economic and
spiritual well being of the society