Chapter 03: Financial reporting for

Islamic financial
institutions
International Standards
for Islamic Finance

May 2009
Content
AAOIFI – Introduction
AAOIFI Accounting Standards and IFRS
Adoption of AAOIFI Standards
How AAOIFI Standards Support Islamic
Finance Industry
AAOIFI – Introduction
AAOIFI – Introduction
• AAOIFI is responsible for formulation and issuance of
international Islamic finance standards.
• AAOIFI has issued 80 standards:
- 26 accounting standards,
- 5 auditing standards,
- 7 governance standards (incl. on Shari’a supervision),
- 2 codes of ethics, and
- 40 Shari’a standards (rules for application of Shari’a).

• In addition, AAOIFI is developing a number of

new standards and reviewing existing standards.
AAOIFI – Introduction (continued)
• AAOIFI, based in Bahrain, is supported by over 200
institutional members from over 40 countries.
Members include:
- Central banks and regulatory authorities,
- Islamic and conventional financial institutions,
- Accounting and auditing professions, and
- Islamic financial support services providers.
• So as to support technical application of standards,
AAOIFI offers professional qualification programs:
- Certified Islamic Professional Accountants (CIPA),
- Certified Shari’a Adviser and Auditor (CSAA).
AAOIFI – Introduction (continued)
• AAOIFI has also introduced Contract Certification
Program – to certify that financial contracts between
Islamic financial institutions and their clients are in
compliance with AAOIFI standards and Shari’a
rules and principles.
• The Contract Certification Program is designed to:
- Promote greater harmonisation of international
Islamic finance practices,
- Provide independent endorsement for Islamic
financial institutions, and
- Give further support on application of our
standards.
AAOIFI Accounting Standards and
IFRS

• Comparison on structural objectives

• Categories of accounting standards for

Islamic financial institutions
• Examples of main differences between
AAOIFI Standards and IFRS
Comparison on structural objectives

A. Differences on coverage of standards …

AAOIFI IFRS

• Specific for Islamic • For entire economic and

finance industry. social activities.
• Based on requirement of • Generic, mostly not
Islamic finance practices. industry-specific.
Comparison on structural objectives

B. Differences on types of standards …

AAOIFI IFRS

• All-encompassing. • Type-specific.
• Accounting, • Accounting.
• Shari’a,
• Auditing, Ethics, and
Governance.
Categories of accounting standards for IFIs
1. AAOIFI standards issued because IFRS / IASB
standards cannot be adopted in whole by Islamic
financial institutions (IFIs).

2. AAOIFI standards issued for specific Islamic

banking and finance practices not covered by IFRS /
IASB standards.

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

(therefore AAOIFI does not issue similar ones and
allows adoption of those standards).
Categories of accounting standards for IFIs
1. AAOIFI standards issued because IFRS IASB
/ standards cannot be adopted in whole by IFIs
• Due to Shari’ a 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).
Categories of acct’g standards for IFIs

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

• These standards do not give rise to Shari’a 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’smajorsource of funds is
investment account funds from its customers.
‘unrestricted’
• These funds are generally managed by IFI based
on
Mudaraba 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’a standard.
Examples of main differences between AAOIFI
and IFRS

a. Investment account funds in IFIs (continued)

• 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).
Examples of main differences between AAOIFI
and IFRS
b. Ijarah (leasing)
• An IFI’s major financing mechanisms are Operating
Ijarah and Ijarah Muntahia Bittamleek (leasing that ends
with transfer of asset ownership to lessee).
• For both, asset ownership rests with IFI throughout the
lease term.

• In Ijarah Muntahia Bittamleek , there must be

independent contract for transfer of asset ownership.
Examples of main differences between AAOIFI
and IFRS
b. Ijarah (leasing) (continued)
• AAOIFI require both Ijarah and
standards
Muntahia Bittamleek Operating to similar to
Operating Lease.
Ijarah be treated
• In contrast, based on IFRS, both Operating Ijarah
(especially if lease term is for major part of economic life
of lease asset) and Ijarah Muntahia Bittamleek (due to
the transfer of asset ownership by the end of lease term)
would normally be classified and treated as Finance
Lease.
Adoption of AAOIFI
Standards
Adoption of AAOIFI Standards
• AAOIFI standards are mandatory in 9 jurisdictions (and
supra-national entity):
- Bahrain
- Dubai International Financial Centre,
- Jordan,
- Qatar,
- Qatar Financial Centre,
- Sudan,
- South Africa (for investment management),
- Syria, and
- Islamic Development Bank Group.
Adoption of AAOIFI Standards (continued)
• AAOIFI standards are also adopted as guidelines or
basis for national standards in jurisdictions incl.:
- Brunei,
- Indonesia,
- Kuwait
- Lebanon,
- Malaysia,
- Pakistan,
- Saudi Arabia, and
- United Arab Emirates.
• Overall, AAOIFI standards are used by all IFIs across the
world.
How AAOIFI Standards
Support Islamic
Finance Industry
How AAOIFI Standards Support Islamic Finance
Industry

AAOIFI standards reflect Enhance

concept and essence of confidence of
Islamic finance transactions. users of Islamic
finance products.

And bring about Promote growth

harmonisation of Islamic of demand for
finance practices. Islamic finance.
How AAOIFI Standards Support Islamic Finance
Industry

AAOIFI standards also Promote better

ensure convergence of view of IFIs’
financial reporting by IFIs. financial
performances.

Enhance
And introduce greater
transparency of
clarity to the
IFIs’ financial
financial reports of
reports.
IFIs.
 AAOIFI
AAOIFI has issued the FAS 1 Accounting Standard No. 1 on
Financial
General Presentation and Disclosure in the Financial Statements
of Islamic Banks and Financial Institutions in January 1996.

The standard is applicable to the financial statements published

especially by Islamic banks to meet the common information
needs of the main users of such statements.

The standard makes it clear that if the requirements of the

standard contradict the bank’s charter or the laws and
regulations of the country in which it operates a disclosure
should be made on the contradiction and the impact of
promulgated standards on the relevant elements of the
financial statements.
 AAOIFI
AAOIFI FAS 1 FASthat1 the
specified complete set of financial
statements consist of conventional statements such as a statement
of financial position (balance sheet); income statement, cash flows
statement; statement of changes in owners’ equity, or a statement
of retained earnings; and notes to the financial statements.

However, the standard added three (3) additional statements that

could be useful for users of Islamic banks and financial institutions
(Para 2/1) that are:
(1) Statement of changes in restricted investment.
(2) Statement of sources and uses of funds in the Zakah and charity
fund (if the bank assumes the responsibility for the collection and
distribution of zakah).
(3) Statement of sources and uses of funds in the Qard fund.
 AAOIFI
The standard also FAS
makes1it clear that Islamic banks and
financial institutions, in addition of other conventional
disclosures (Para 3/2), should disclose two (2) very
important aspects of their unique functions:

(1) The role of the Shari’ah adviser or the Shari’ah board

in supervising the bank’s activities and the nature of
adviser’s or board’s authority in accordance with the
bank’s bye-laws and in actual practice.
(2) The bank’s responsibility towards zakah.
 AAOIFI FAS
1
For the disclosure of significant accounting policies, AAOIFI FAS 1 made a
number of disclosure requirements to meet the objectives and functions of
Islamic banks such as the accounting policies adopted by the
management of the Islamic bank but which are not consistent with
the concepts of financial accounting for Islamic banks (Para 3/4).

On valuation, the standards require that the policies, bases and methods
adopted by the bank’s management for revaluation of assets, liabilities and
restricted investments to their cash equivalent value. This indicates the
preference of the AAOIFI on the basis of cash equivalent value over
the historical value.
 AAOIFI
FAS
Another important disclosure 1 by the standard is disclosure of
required
earnings or expenditures prohibited by the shari’ah. The standard requires
that financial statements should disclose the amount and nature of
earnings or expenditures that have been realised or incurred from sources
or by means which are not permitted by the shari’ah (Para 3/6).

The Islamic bank should also disclose how it intends to dispose of the
assets generated by the prohibited earnings or acquired through
prohibited expenditures. Any shari’ah non-compliant activities are
expected to be disclosed and efforts to cleanse the account from non-
shari’ah compliant incomes or expenses must be made transparent.
 AAOIFI
investment accounts.
FAS
AAOIFI FAS 1 requires disclosures 1
related to unrestricted and restricted

Disclosures are required on the magnitude of balances of all unrestricted

investment accounts and their equivalent (Para 3/8).

Disclosure should also be made on the distribution of unrestricted

investment accounts, by type, in accordance with maturity (Para 3/9).

Disclosures of the method used by the Islamic bank in allocating investment

profits (or losses) between unrestricted investment account holders or
their equivalent (Para 3/18).

Disclosure should also be made of the returns of each type of investment

accounts and their rate of return.
Thank You

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