Auditing Islamic Funds and Investment

Portfolio – Challenges and Practicalities

PRESENTED BY:
TAJUDEEN ADETOKUNBO ONI
B.Sc., MBA, FCA, CIPA
PARTNER – AHMED ZAKARI & Co (Chartered Accountants)
OBJECTIVES

• To define Islamic banking and finance;

• To describe audit issues regarding Islamic investment portfolio
management
• To explain the auditing guidelines for Islamic banking audit
• To identify key areas to focus on while auditing Islamic financial
instruments 
• To define the performance indicators of a typical Islamic banking
product
CONTENT
1. Introduction
2. Overview of Islamic Banking Audit
3. Introduction to Islamic Portfolio Investments
4. Auditing Guidelines for Islamic Banking
5. Key Audit Areas for Islamic Financial Instruments
6. Performance Auditing for Islamic Banking Products
7. Differences between Islamic Financial Institutions and Conventional Financial institutions
8. Challenges and Practicalities
9. Conclusion
10. Case Study
11. References
12. Glossary
INTRODUCTION
• Islamic finance is a non-interest financial structure that is based on real
assets or business activities in compliance with the tenets of Shariah.
• It has experienced rapid growth in the past four decades.
• The assets managed by the Islamic Financial Institutions (IFIs) are
forecasted to exceed $3.8tn by 2022 up from $2.2tn at the end of 2016.
• There are now more than six hundred (600) Islamic financial institutions in
more than seventy-five countries.
• The world Islamic financial services industry stood at US$2.293tn at the end
of December 2016 with average growth rate of 13.89% per annum (Global
Islamic Finance Report, 2017).
INTRODUCTION – CONT’D

• Recent accounting scandals, where companies prepared fraudulent

accounting records, have given rise to the question of the audit quality as
well as audit independence.
• Despite the evolving issues in the audit independence and audit quality,
auditors nowadays face yet another challenging issue, which is the audit of
IFIs.
• The scope of conventional statutory financial audit is inadequate to fulfil the
needs of the stakeholders of IFIs.
INTRODUCTION – CONT’D

• Because IFIs need to adhere to shariah principles in all their business

transactions and operations, a new dimension in auditing, as well as
auditing standards which can cope with such principles, is needed.
• Recognizing the limitations of the International Standards on Auditing
(ISA) in addressing issues related to religious compliance, the
Accounting and Auditing Organization for IFIs (AAOIFI) has taken steps
in producing a number of auditing standards and audit methodologies
specifically for IFIs.
 OVERVIEW OF ISLAMIC BANKING AUDIT

• Conventional company audit and IFIs audit share similar functions but the
latter focuses more on the compliance of the IFIs to the Shari’ah principles
and requirements. – 1
• The conventional financial audit is insufficient to cater for the needs of the
stakeholders of IFIs as the International Standards on Auditing (ISAs) do
not cover the Shari’ah aspects. – 2
 OVERVIEW OF ISLAMIC BANKING AUDIT – CONT’D

Auditing IFIs covers a wider scope than statutory financial statement

auditing, which includes:
• Conduct financial audits.
• Conduct tests on the Shariah compliance of IFIs, according to fatawa
(religious rulings) Conduct tests on guidelines set by the Shariah
Supervisory Board (SSB) or (Advisory Committee of Experts-ACE).
 INTRODUCTION TO ISLAMIC PORTFOLIO INVESTMENTS

• Asset Management is the provision of liquidity needed to ensure the

functioning of the economy through a process of capital allocation that
makes individuals financial objectives to match with the capital
requirements of sovereign, companies and other individuals.
• Islamic Asset Management enables investors to achieve their
individual financial objectives matching the capital requirements of
any sovereign, companies and other individuals through the use of
instruments that ensure the respect of the highest sharia principles
of investment.
INTRODUCTION TO ISLAMIC PORTFOLIO INVESTMENTS
– CONT’D

Islamic Asset Management Instruments

• Equities (compliant) : The following should be less than 33%
• Total debt/ 12 months trailing market capitalization
• Interest bearing securities/ 12 month trailing market capitalization
• Murabaha
• Commodities
• Sukuk
• Takaful
• Money Market Instruments
• Islamic Real Estate Investment Trusts (I-REITs)
 INTRODUCTION TO ISLAMIC PORTFOLIO INVESTMENTS
– CONT’D
Non Permissible Sectors
• Alcohol
• Weapons
• Tobacco
• Pork
• Financial Services (Non Compliant)
• Gambling
• Pornography
• Leisure/ Media (Non Compliant)
INTRODUCTION TO ISLAMIC PORTFOLIO INVESTMENTS
– CONT’D

• Islamic Mutual Funds

The funds are (Sharia compliant) investment vehicles pooling individual,
corporate and sovereign funds for the purpose of investing in a common
portfolio of (Sharia compliant) securities such as equities, bonds (Sukuk),
money market instruments and other assets.
INTRODUCTION TO ISLAMIC PORTFOLIO INVESTMENTS
– CONT’D

Islamic Fund Management specifically comprises of the following:

• Unit trust funds
• Wholesale funds
• Private retirement scheme
• Hajj Scheme
• Exchange traded funds
• Real Estate Investment Trusts (REITs).
 AUDITING GUIDELINES FOR ISLAMIC BANKING

• Accounting and Auditing Organisation for Islamic Financial

Institutions (AAOIFI) is responsible for developing and issuing
standards for international Islamic finance industry.
• Supported by over 200 institutional members from over 40 countries. •
Members are central banks, regulatory authorities, financial institutions,
accounting & auditing firms, legal firms, etc.
 AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

A total of 88 standards have been issued by AAOIFI, with the composition of:
• 48 Shari’ah standards.
• 26 accounting standards.
• 5 auditing standards.
• 7 governance standards.
• 2 codes of ethics.
In addition, new standards are being developed and existing standards
reviewed.
 AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Auditing Standards - Guidelines on external auditing of Islamic financial

institutions.
• Objective and Principles of Auditing.
• The Auditor’s Report.
• Terms of Audit Engagement.
• Testing for Compliance with Shari’ah Rules and Principles by an
External Audit.
• The Auditor’s Responsibility to Consider Fraud and Error in an Audit of
Financial Statements.
AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Objective of Audit
• To enable auditor of financial statements to express an opinion as to
whether the financial statements are prepared, in all material respects,
in accordance to Shari’ah rules and principles, AAOIFI accounting
standards, and other relevant accounting standards and practices.
 AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Concept of Reasonable Assurance

• An audit is designed to provide reasonable assurance that financial
statements taken as a whole are free from material misstatement.
• Reasonable assurance also means that the auditor has satisfied
himself or herself that transactions examined during audit comply with
Shari’ah rules and principles as determined by the Islamic financial
institution’s (IFI’s) Shari’ah Supervisory Board (SSB).
AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Responsibility of an external auditor for compliance with Shari’ah

rules and principles:
• While the auditor is responsible for forming and expressing an opinion
on the financial statements, the management of the IFI is responsible
for ensuring that the financial statements and the IFI’s activities comply
with Shari’ah rules and principles as determined by the IFI’s SSB.
• The responsibility to interpret Shari’ah rules and principles lies with the
IFI’s SSB.
 AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Responsibility of an external auditor for compliance with Shari’ah

rules and principles – Cont’d
• The auditor shall be knowledgeable about Shari’ah rules and
principles, but would not possess the same level of knowledge as
that of SSB members, and thus the auditor shall not be expected to
provide interpretation of these rules and principles.
• The fatwas, rulings and guidance issued by the SSB form the basis
on which the auditor considers whether the IFI has complied with
Shari’ah rules and principles.
 AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Scope of auditor’s work:

• The responsibility of the auditor is to form an opinion on whether the
transactions of the IFI are in compliance with the fatwas, rulings and
guidance issued by its SSB.
• The auditor shall have no responsibility for assessing the competence
of the members of the SSB.
• The IFI’s process for introducing new products or modifying existing
products shall include appropriate procedures for ensuring compliance
with Shari’ah rules and principles including reviews by the IFI’s
management, internal audit and the SSB.
 AUDITING GUIDELINES FOR ISLAMIC BANKING – CONT’D

Scope of auditor’s work – Cont’d

• Review available documents to ensure that all types of products
offered by the IFI have been subject to a review by the SSB, and that
the SSB has found these products to be in compliance with Shari’ah
rules and principles.
• Verify that the transactions entered into by the IFI are consistent with
the fatwas, rulings and guidelines of the SSB, and;
• Review the findings of all internal reviews carried out by the IFI
management, the internal audit, and the internal Shari’ah review by or
on behalf of the SSB.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS

Key Aspects of the Audit of IFIs :

• Shari’ah Supervisory Board (SSB)/Advisory Committee of Experts
(ACE)
• Audit and Governance Committee
• External Audit
• External Shari’ah Audit
• Internal Audit/Internal Sharia Audit
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

Shari’ah Supervisory Board (SSB)/Advisory Committee of Experts (ACE)

• The SSB/ACE plays a key role in the overall audit and governance framework, both ex-
ante and ex-post:
• Their role ex-ante is to formulate policy and guidelines to be followed by
management in their activities, including approval of products.
• The ex-post role is to conduct Shari’ah review, which is an examination to ensure
that the activities carried out by an IFI do not contravene the principles of shariah.

The shariah review is a comprehensive review of not only the financial statements but
also of contracts, agreements, and transactions, to ensure shariah compliance and to add
credibility to management’s activities.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

Audit and Governance Committee (AGC)

• The AGC, comprising nonexecutive directors is responsible for checking
the structure and internal control processes and ensuring that the
activities of the IFI are Shari’ah-compliant. – 3
• The duties of the AGC also include the review of the reports produced by
the internal Shari’ah review, the External auditors and the SSB/ACE to
ensure that appropriate actions have been taken.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D
External Audit
• Financial statement audit is to enable the auditor to express an opinion as to
whether the financial statements are prepared, in all material aspects, in
accordance with an identified financial reporting framework. The financial
statement audit involves obtaining and evaluating evidence about an entity’s
financial affairs so as to establish the degree of correspondence between
the management’s assertions and the established criteria, such as legal
requirements and accounting standard.
• External auditors must also attest that management has complied with the
shariah precepts with the wider objective of shariah (maqasid al-shariah),
which is to protect and improve the condition of human life in all dimensions .
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

External Audit – Cont’d

• When testing for compliance to Shari’ah principles, sufficient and
appropriate audit evidence must be gathered by the auditor to give
assurance that the financial report of IFIs are Shari’ah compliant.
• When conducting the audit, the auditor will include procedures in his or
her examination to ensure that all new fatawa, rulings, and guidance, and
modifications to existing fatawa, rulings, and guidance, are identified and
reviewed for each period under examination.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

External Audit – Cont’d

• The auditor will review the reports issued by the ACE to the IFI
concerning shariah compliance as well as the ACE’s minutes of meetings
to ensure that all types of products offered by the IFI have been subjected
to a review by the ACE.
• The auditor must also examine the findings of all internal reviews carried
out by the IFI’s management, the internal audit, and the report of the
internal shariah review.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

External Shariah Audit

• The primary objective of the shari’ah review (carried out by
independent division or part of internal audit department) is to
ensure that the management of an IFI discharge their
responsibilities in relation to the implementation of the shari’ah rules
and principles as determined by the IFI’s ACE.
• Shari’ah audit involves a systematic review of the operational
aspects of the IFIs.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

External Shariah Audit – Cont’d

• These operational aspects of IFIs include an examination of the policies and
procedures of the IFIs such as product manuals, operational processes,
contracts, among others.
• Shari’ah audit also reviews the organizational structure to ensure it is feasible to
undertake a Shari'ah compliant activity. This will include the availability of
qualified staff with a sufficient knowledge of shari’ah to support the operations of
the IFIs.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

Internal Audit/ Internal Shariah Audit

• The Shari’ah audit function can be performed by the internal auditors who
have adequate Shari'ah related knowledge and skills in order to achieve the
ultimate goals.
• The internal auditors are required to play their part in ensuring a sound and
effective internal controls system have been put in place in line with the
Shari’ah practices strictly.
KEY AUDIT AREAS FOR ISLAMIC FINANCIAL INSTITUTIONS
– CONT’D

Internal Audit/ Internal Shariah Audit – Cont’d

• Whenever they encounter challenges or difficulties while performing the
audit, the matter can be solved by obtaining assistance from the experts in
the Islamic finance so long the audit objectives are preserved.
• Shari’ah audit tasks should be split between auditors and management, in
that, the audit engagement may be performed by internal auditors in order
to maintain integrity, whereas the review for the Shari’ah report shall be
perused through by the management.
PERFORMANCE AUDITING FOR ISLAMIC BANKING
PRODUCTS

• Performance auditing is an assessment of the activities of an

organization to see if the resources are being managed in terms of
economy, efficiency and effectiveness and accountability requirements
are being met reasonably.
• The hard core of performance auditing is the framework of economy,
efficiency and effectiveness.
 PERFORMANCE AUDITING FOR ISLAMIC BANKING
PRODUCTS - CONT’D
• Economy refers to acquisition of resources at the lowest cost keeping in
view the objectives of the organization. It implies that the resources
should be acquired at the right cost, at right time, at right place in right
quantity and of right quality.
• Efficiency means optimum utilization of resources keeping in view the
objectives of the organization. It implies maximizing output from giving
resources or minimizing input for given outputs.
• Effectiveness refers to the achievement of objectives. It involves
assessment of outcomes of programs and projects, which are usually
external to the organization.
 PERFORMANCE AUDITING FOR ISLAMIC BANKING
PRODUCTS - CONT’D
Performance Audit Approach
• Reasonable manager - What would a reasonable manager do in a given circumstance?
• External evidence - Reach out to the clients for ascertaining the quality of service being
provided
• Normative - Identify instances of waste, inefficiency and ineffective operations, systems
and procedures
• Audit of Policies - Point out if the results of certain policies lead to uneconomical or
inefficient operations or if they defeat the very purpose for which the policy was made in
the first instance
• Balance - A balanced view of the auditee operations. It reports on the successes of the
management with equal emphasis as it points out its failures
PERFORMANCE AUDITING FOR ISLAMIC BANKING
PRODUCTS - CONT’D
Application of Performance Auditing to Islamic Banking Products
The Islamic banks have two avowed objectives:
• Eliminating Ribah (interest) from financial transactions;
• Promoting ethical economic values in the society.

• How do we operationalize the Islamic economic values to make them

useful for performance auditing?
• Is the provision of finance to a client promoting competition and
discouraging monopolies?
PERFORMANCE AUDITING FOR ISLAMIC BANKING
PRODUCTS - CONT’D
• Examine the purpose of funding and see that they are not used for any
objective prohibited by the Shari'ah.
• The Islamic banks should see that the business, which they have financed,
has been instrumental in promoting environmental protection.
• Observation of commitments with the society by the client by:
• Promoting human resource development
• Fulfilling their commitments and contracts
• Honest advertising
• Maintaining quality standards
• Avoiding dealings in interest
• Treating their employees fairly
• Promoting equitable distribution of wealth through proper pay scales
• Benevolence through charitable deeds.
 DIFFERENCES BETWEEN ISLAMIC FINANCIAL
INSTITUTIONS AND CONVENTIONAL FINANCIAL
INSTITUTIONS
• The differences between conventional banks and Islamic banks are
important factors that affect or determine the auditing process of each of
the types of the financial institutions.
These factors are as follows:
• Products
• Standards/guidelines
• Reporting/Accounting
• Risk management features
 DIFFERENCES BETWEEN ISLAMIC FINANCIAL
INSTITUTIONS AND CONVENTIONAL FINANCIAL
INSTITUTIONS – CONT’D

Products
• Products and services offered by conventional and Islamic banks are
mostly homogeneous except for the element of profit sharing and
interest, with the aim of profiting the business. Thus, when auditing the
Islamic financial institution, it is important for the auditors to note the
different types of products that are offered and their effect on the
revenue recognition.
 DIFFERENCES BETWEEN ISLAMIC FINANCIAL
INSTITUTIONS AND CONVENTIONAL FINANCIAL
INSTITUTIONS – CONT’D

Standards/guidelines
• Conventional banks operations are guided by the Banks and Other Financial Institution
Act (BOFIA) , CAP B3, LFN 2004 as amended and issue their reports in compliance
with the Financial Reporting Council of Nigeria Act No. 6, 2011 and in accordance with
the International Financial Reporting Standards and the Companies and Allied Matters
Act, CAP C20, LFN 2004. Whereas Islamic banks are bound to follow the above
guidelines and in addition, follow the the Financial Accounting Standards issued by the
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI).
Auditors need to consider these guidelines when conducting audit so as to see the level
of material misstatement and the relevant audit procedures in auditing the institutions.
 DIFFERENCES BETWEEN ISLAMIC FINANCIAL
INSTITUTIONS AND CONVENTIONAL FINANCIAL
INSTITUTIONS – CONT’D
Reporting
• Conventional banks and IFIs have different reporting guidelines as stipulated by the
Central Bank of Nigeria (CBN). Apart from the standard requirement of filing financial
reports, which includes the auditors report, Audit Governance Committee report etc, to
the CBN latest by the end of March following the December year end, the IFIs are, in
addition to the above, required to disclose their Shari’ah Committee’s Report to board of
the banks. Shari’ah Committee’s Report is a document that discloses attestation
provided by Shari’ah Committee with regards to compliance of Islamic Financial
Institution (IFI). Among other information that are included in it are Shari’ah Committee’s
engagement and their responsibility in expressing opinion over the IFIs compliance with
Shari’ah. Thus when auditing in Islamic Financial Institution, it is crucial for the auditors
to look also at the Shari’ah committee report to ensure that all areas have been looked
into during the examination of the financial statements.
 DIFFERENCES BETWEEN ISLAMIC FINANCIAL
INSTITUTIONS AND CONVENTIONAL FINANCIAL
INSTITUTIONS – CONT’D
Risk management features
• Conventional banks provide financing and long-term lending that are not made on the
basis of existence of capital goods. Moreover, they only comply with conventional
regulatory standards. On the other hand, Islamic banks provide financing that are
assets backed in nature and results in productive economic activities; hence, it does
not result in inflation. Furthermore, the underlying asset collateralizes the finance
transaction provided by Islamic banks. Also, the dual audit, that is, complying with
conventional standards as well as Shari’ah standards. This covers the legal risks as
there is a double check on money laundering and other fraudulent activities.
Therefore, it is important to understand the risk of the industry so that the auditors are
able to determine the level of audit risk and then set the appropriate materiality level.
 CHALLENGES AND PRACTICALITIES
• First, the focus and scope of audit tend to be on financial statements rather than
the broader concept of shariah audit, which involves the audit of all activities of
IFIs based on maqasid al-shariah (Purpose of Shari'ah). Furthermore, the use of
the term “Shari'ah review” rather than “Shari'ah audit” by AAOIFI may implicate a
lower level of assurance in the case of the former.

• Second, based on AAOIFI’s auditing standards, the functions of shariah audit or

review are distributed to different entities, for example, external auditor, SSB/ACE,
internal shariah reviewer, and the Audit and Governance Committee. While
external auditors act as the external mechanism in monitoring compliance, their
lack of competence in shariah makes them rely heavily on the SSB’s fatawa,
whereas in fact they should be making an independent judgment on the issue of
compliance.
CHALLENGES AND PRACTICALITIES – CONT’D

• Third, the independence of the SSB/ACE has been questioned as they

are involved in making fatawa and in setting up the guidelines on shariah
compliance, as well as, in conducting a shariah review or audit of the IFI
concerned.
• Fourth, the challenge to undertake shari’ah audit is to establish audit
evidence, develop a systematic and thorough audit program and carry
out the audit competently and independently. A major decision facing
every shari’ah auditor would be to determine the appropriate types and
amount of evidence to accumulate in order to satisfy that the client has
maintained effective internal control over shari’ah matters
CONCLUSION
• Audit is one of the most important part of corporate governance
machinery in modern organizations.
• It forms important elements in the process of securing corporate
accountability.
• It also enhances stakeholder’s faith in the stewardship of the company.
• Unlike conventional statutory financial audit which requires auditors to
express their view that the financial statements are prepared according to
GAAP and relevant financial reporting standards; the auditing of IFIs
cover a wider range of scope.
• Auditors/shari’ah auditors must attest that the management has complied not
only with relevant standards but also the shari’ah framework in all of the
transactions to achieve the maqasid as shari’ah 
 CONCLUSION - CONT’D

• The absence of shari’ah audit scope has left the industry in the dark. At the
moment, the scope is dependent on the shari’ah advisors and the Shari’ah
Supervisory Board who oversees the shari’ah review or shari’ah audit.
• Generally, there are still a few unresolved issues in shari’ah audit in terms of:
• Scope
• Framework
• Shari’ah auditor’s qualification
• Shari’ah auditor’s independence
• It may give an unhealthy image to the Islamic financial institutions credibility.
• It may also threaten the confidence of the public in Islamic financial institution’s
product and services compliance to shari’ah rules and guidelines.
CASE STUDY
REFERENCES 1 - Sultan (2007)
2 - Haniffa (2010)
3 – AAOIFI GSIFI No.4
4 - Islamic Economic Studies Vol.5, No.1,
December 1997 & No.2, April 1998
GLOSSARY • RIBA – Interest
• SHARIAH – Laws or rules
• MAQASID AL- SHARIAH – Purpose of Shariah
as it relates to Fiqh Muamalat
• FIQH MUAMALAT – Islamic Commercial
Jurisprudence
• FATAWA – Rulings
 • Mr. Oni is a Certified Islamic Professional Accountant (CIPA) who
FACILITATOR’S is highly experienced in various areas of accounting practice. He
PROFILE has in-depth experience in the areas of Auditing and
Investigation, Accounting and Management Control Systems,
Financial Management, Corporate and Personal Tax Consulting,
Banking and Management of SMEs and large corporates.

• Mr. Oni is a Fellow of the Institute of Chartered Accountants of

Nigeria (ICAN), with a Bachelor of Science Degree in Accounting
from Olabisi Onabanjo University and MBA Degree from Bayero
University Kano.

• Mr Oni had a distinguished career with KPMG AUDIT. (Chartered

Accountants), a Member Firm of KPMG International from 1992
to 1998 where he trained and qualified as a Chartered
Accountant and Tax Specialist. He joined Oni Idris and Co.
(Chartered Accountants) in 1998 as a partner, a position he held
before joining Ahmed Zakari and Co. in 2003 as the Partner in
Tajudeen Adetokunbo Oni Charge of Lagos operations.
BSc, MBA, FCA, CIPA