BWFS 3023

CHAPTER 5:ACCOUNTING STANDARDS

IN ISLAMIC BANKING

Established in accordance with the Agreement of Association which was signed by Islamic financial institutions on 1 Safar, 1410H corresponding to 26 February, 1990 in Algiers Registered on 11 Ramadan 1411 corresponding to 27 March, 1991 in the State of Bahrain. An Islamic international autonomous non-for-profit corporate body Prepares accounting, auditing, governance, ethics and Shari'ah standards for Islamic financial institutions and the industry Responsible for formulation, issuance of finance standards and developing new standards and also reviewing existing standards

ACCOUNTING AND AUDITING ORGANIZATION FOR ISLAMIC FINANCIAL INSTITUTIONS ( AAOIFI )

supported by institutional members including central banks, Islamic financial institutions, and other participants from the international Islamic banking and finance industry, worldwide. gained assuring support for the implementation of its standards, which are now adopted in the Kingdom of Bahrain, Dubai International Financial Centre, Jordan, Lebanon, Qatar, Sudan and Syria

The relevant authorities in Australia, Indonesia, Malaysia, Pakistan, Kingdom of Saudi Arabia, and South Africa have issued guidelines that are based on AAOIFI’s standards and pronouncements. to support technical application of standards,

AAOIFI offers the following professional qualifications programs.

Certified Islamic Professional Accountants (CIPA)

Certified Sharia’a Adviser and Auditor (CSAA)

MISSIONStandardization and harmonization of international Islamic finance practices and financial reporting in accordance to Shari’ah VISIONTo guide Islamic financial markets operation and financial reporting on Shari’ah principle and rules.To provide Islamic financial markets with a standard that can support growth of the industry.

Of AAOIFI

To develop accounting and auditing thoughts relevant to Islamic Financial InstitutionsTo disseminate accounting and auditing thoughts relevant to Islamic Financial Institutions and its applications through training, seminar, publication of periodical newsletters, carrying out and commissioning of research and other meansTo prepare, promulgate and interpret accounting and auditing standards for Islamic Financial InstitutionsTo review and amend accounting and auditing standards for Islamic Financial Institutions

AAOIFI PRIMARY OBJECTIVE

Introduction to MASB

• The Malaysian Accounting Standards Board (MASB) is established under the Financial Reporting Act 1997 (the Act)

• Act as independent authority to develop and issue accounting and financial reporting standards in Malaysia.

• Make up the frameworks for financial reporting in Malaysia together with the Financial Reporting Foundation (FRF).

• These frameworks comprises an independent standard-setting structure with representation from all relevant parties in the standard-setting process, including preparers, users, regulators and the accountancy profession

Develop and promote high quality accounting and reporting standards that are consistent with international best practices for the benefit of users, preparers, auditors and the public in Malaysia. In a wider context, the MASB seeks to contribute directly to the international development of financial reporting for the benefit of users, preparers and auditors of financial reports.

- Develop high quality, clear and enforceable national accounting standards for financial reporting that benefit users.- Bring about harmonisation of national accounting standards with international accounting standards- Promote the use and application of those standards by way of communication with and education of users, preparers, auditors and the public-Activelly contribute to the development of accounting standards internationally, including, Islamic-based accounting standards- Promote and support research in the area of financial reporting, in particular, for emerging markets and Islamic markets.

Of MASB

FUNCTION AND POWER OF MASB

• Issue new accounting standards as approved accounting standards and to review, revise or adopt existing accounting standards as approved accounting standards;

• Issue statements of principles for financial reporting;• Sponsor or undertake development of possible accounting standards;• Conduct public consultation as necessary;• Develop a conceptual framework for the purpose of evaluating proposed

accounting standards;• Make such changes to proposed accounting standards as considered

necessary;• Seek the view of the FRF in relation to new and existing standards, statement

of principles, and changes to proposed standards;• Determine scope and application of accounting standards; and• Perform such other function as the Minister of Finance may prescribe

- Lack of Shar’iah consistency as each bank relied on shari’ah advisors of respective banks.

- This lack of comparability and consistency on the accounting treatment on recognition, measurement and disclosure of Islamic-based transactions.

- Causing the measurement and comparison of financial performance of the banks are difficult to make.

- So, MASB aim to develop Malaysian accounting standard or technical releases for Islamic financial institutions.

- Section known as MASB FRSi-1 (from 2003- 2010) then only serve as Technical Realese or TRi-3 (from 2010 onward).

Problem arise in MASB

MASB TRi-3

Applies to all financial institutions that undertake Islamic Banking Activities and participate in Islamic Banking Scheme

Specify a complete set of financial statements which is include (like requirements for a complete set of financial statement for conventional institutions)

• 1)balance sheet • 2) income statement • 3) cash flow statement • 4) accounting policies, explanatory notes & appendices • 5)and statement that showing about owners equity # Recommends voluntary additional statements that include a financial review by

management DESCRIBING and EXPLAINING the main features of the Islamic financial institutions financial performance and financial position, mentioning principal uncertainties such as sources of funding and factors determining performance

- MASB Tri-3 also recommended an environmental report and value added statements and any other statements useful to users, such as Zakat Fund and Qard Fund

- Prescribe guidelines on going concern principles whereby the management should make an IFI’s ability to continue as a going concern

- MASB Tri-3 prescribed that the financial statements of IFIs should be clearly identified and distinguished from other information in the same published documents

- Recommended a number of additional disclosures unique in the case of IFIs, such as disclosures associated with risks of Islamic contract like wadi’ah contract guarantee safe custody of deposits

- Prescribed required disclosure of Shari’ah advisor and zakat obligations. It is required that an IFI should disclosure the role and authority of shariah or board in monitoring the IFIs activities pertaining to the shariah matters

General Presentation and Disclosure Requirements

( AAOIFI )

General presentation and disclosure in the financial statements of Islamic banks and

financial institutions

This is the financial accounting standard no. 1 (FAS 1) that issued by AAOIFI on January 1996.

The standard is applicable to the financial statement published by Islamic banks to meet the common information needs of the main users of

such statements.

Disclosure Requirements In Accounting Disclosure

i. Firm need to avoid any riba transaction

• Firm are required pay zakat on saving, share and etc.

Full disclosure of account information to users for purposes of serving God.

AAOIFI FAS 1 are complete set of financial statements consist of conventional statement

Balance sheet

Income statement

Cash flows statement

Statement of changes in

owner’s equity or statement of

retained earnings

Notes to the financial

statements

There are 3 additional statements

I. Statement of changed in restricted investment.II. Statement of sources and uses of funds in the

Zakah and charity funds.III. Statement of sources and uses of funds in the

Qard fund.

I. Statement of changed in restricted investment.

II. Statement of sources and uses of funds in the Zakah and charity funds.

III. Statement of sources and uses of funds in the Qard fund.

The role of the Shariah

advisor / Shariah board’s

supervising the bank’s activities and the

nature of adviser’s /

board’s authority

(bank’s by-laws and

actual practice.

The bank’s responsibility toward Zakah

The importa

nt aspect

of unique

function

The disclosure of significant accounting policies:

1) Accounting policies adopted by the management of the Islamic bank but which are not consistent with the concepts of financial accounting for Islamic banks-Revaluation of asset, liabilities and restricted investment to their cash equivalent value

2) Disclosure of earnings or expenditure prohibited by the Shariah.

- The amount and nature of earnings or expenditures that have been realized or incurred from sources or by means which are not permitted by the Shariah.- Dispose of the assets generated by the

prohibited earnings or acquired through prohibited expenditures. (To enhance the confidence of the stakeholders on the integrity of Islamic financial institutions).

The disclosure of significant accounting policies:

1) Accounting policies adopted by the management of the Islamic bank but which are not consistent with the concepts of financial accounting for Islamic banks-Revaluation of asset, liabilities and restricted investment to their cash equivalent value

2) Disclosure of earnings or expenditure prohibited by the Shariah.

- The amount and nature of earnings or expenditures that have been realized or incurred from sources or by means which are not permitted by the Shariah.- Dispose of the assets generated by the

prohibited earnings or acquired through prohibited expenditures. (To enhance the confidence of the stakeholders on the integrity of Islamic financial institutions).

3) Requires disclosures related to unrestricted and restricted investment accounts.

- Disclosures are required on the magnitude of balances of all unrestricted investment accounts and their equivalent- Disclosure should be made on the distribution of unrestricted investment accounts in accordance with maturity. 4) The disclosures of the method used by the Islamic bank in allocating investment profits / losses between unrestricted investment account holders or their equivalent.

- Disclosure should be made of the returns of each type of investment accounts and their rate of return. 

Disclosure Requirements On Balance Sheet Investment Accounts

• Disclosure should be made, in the notes to the financial statements on the accounting policies and of the bases applied by the IFI in the allocation of profits between owners‟ equity and investment account holders. (Para 23)

• Disclosure should be made in the notes to the financial statements on significant accounting policies, of the bases applied by the IFI for charging provisions, and the parties to whom they revert once they are no longer required. (Para 24)

• Comparison on structural objectives

COMPARISON BETWEEN AAOIFI STANDARD & IASB STANDARD

• Categories of accounting standards for Islamic financial institutions

• Examples of main differences between AAOIFI Standards and IFRS

A. Differences on COVERAGE of standards

IFRS AAOIFI

• For entire economic and social activities.

• Generic, mostly not industry-specific.

• Specific for Islamic finance industry.

• Based on requirement of Islamic finance practices.

Comparison on structural objectives

B. Differences on TYPES of standards

IFRS AAOIFI

• Type-specific.• Accounting.

• All-encompassing.• Accounting,• Shari’ah,• Auditing, Ethics, and

Governance.

Categories of accounting

standards for IFIs

AAOIFI standards issued because IFRS / IASB standards cannot be adopted in whole by

Islamic financial institutions (IFIs).

AAOIFI standards issued for specific Islamic

banking and finance practices not covered

by IFRS / IASB standards.

IFRS / IASB standards that can be adopted by IFIs (therefore AAOIFI does not issue similar

ones and allows adoption of those standards).

1. AAOIFI standards issued because IFRS / IASB standards cannot be adopted in whole by IFIs

• Due to Shari’ah compliance issues or because IFRS / IASB standards do not fully cover characteristics of Islamic banking and finance.

• In these cases, AAOIFI standards are issued to apply to topics covered by the IFRS / IASB standards.

• Eg.: AAOIFI’s FAS 1 (General Presentation and Disclosure in Financial Statements of IFIs) covers IAS 1 (Presentation), 7 (Cash Flow), 18 (Revenue), etc.

Categories of accounting standards for IFIs

2. AAOIFI standards issued for specific Islamic banking and finance practices not covered by IFRS / IASB standards

• For financial transactions and practices unique to Islamic banking and finance.

• In these cases, AAOIFI standards are issued to apply to topics not covered by IFRS / IASB standards.

• Eg.: AAOIFI’s FAS 2 (Murabaha & Murabaha to the Purchase Orderer), FAS 7 (Salam & Parallel Salam).

3. IFRS / IASB standards that can be adopted by IFIs

• These standards do not give rise to Shari’ah compliance issues and are adequate to cover practices of IFIs. In these cases, AAOIFI does not issue equivalent standards

• IFIs adopting AAOIFI standards are allowed to also follow other standards if there are no equivalent AAOIFI standards.

• Eg.: IAS 10 (Events after Balance Sheet Dates), IAS 24 (Related Party Disclosures).

Examples of main differences between AAOIFI and IFRS

A. Investment account funds in IFIs

• An IFI’s major source of funds is ‘unrestricted’ investment account funds from its customers.

• These funds are generally managed by IFI based on Mudarabah investment management profit-sharing agreement.

• Under Mudaraba investment management, IFI is not liable for loss arising from investments (except due to IFI’s misconduct, negligence, etc) – Shari’ah standard.

• AAOIFI standards require ‘unrestricted’ investment account funds to be presented in statement of financial position as a separate item between liabilities and owners’ equity.

• In contrast, based on IFRS these would be presented as liabilities (along with other deposits).

B. Ijarah (leasing)• An IFIs major financing mechanisms are Operating Ijarah and Ijarah

Muntahia Bittamleek.• For both, asset ownership rests with IFI throughout the lease term.• In Ijarah Muntahia Bittemleek, there must be independent contract

for transfer of asset ownership.• AAOIFI standards require both Operating Ijarah and Ijarah Muntahia

Bittamleek to be treated similar to Operating Lease.• In contrast, based on IFRS, both Operating Ijarah and Ijarah

Muntahia Bittamleek would normally be classified and treated as Finance Lease.

IAS vs IFRS

• IAS stands for International Accounting Standards, while IFRS refers to International Financial Reporting Standards.

• IAS standards were published between 1973 and 2001, while IFRS standards were published from 2001 onwards.

• IAS standards were issued by the IASC, while the IFRS are issued by the IASB, which succeeded the IASC.

• Principles of the IFRS take precedence if there’s contradiction with those of the IAS, and this results in the IAS principles being dropped.