CHAPTER 2

RECORDING
TRANSACTIONS AND
MARKET VALUES IN
ISLAM
Learning Objectives
After studying this chapter, you should be able to:
 Explain the main accounting concepts and their compliance with the Islamic
Sharia.
 Describe the importance of market values to the Islamic accounting system.
 Explain transactions analysis using the accounting equation.
 Record, post, and analyze transactions using an accounting system.
 Prepare a trial balance
 Prepare a chart of accounts.
 Prepare a simple set of Islamic financial statements.
 Use accounting information to make decisions in an Islamic business environment.
 TRANSACTIONS AND THE ACCOUNTING EQUATION
The outcome of the accounting process in any Islamic organisation includes:
 The balance sheet showing the financial position of the organisation,
 The income statement showing the results of its operations in the form of income,
 Cash flow statement.

 These statements are based on the accounting equation, which reflects resources used in the business and
claims against these resources.
 The accounting equation is usually stated in one of the following two equivalent forms:
Assets = Liabilities + Owners' equity
Assets − Liabilities = Owners' Equity
 Assets are economic resources entrusted to organisations by God according to the Quran. Organisations benefit
from these assets, and they should be reflected in Islamic financial statements in accordance with the Islamic
Sharia.
 Liabilities represent an obligation the company will have to pay at a future date.
 Owners’ Equity represents the residual interest for the owners in a business.
KEEPING ACCOUNTING RECORDS IN ISLAMIC BUSINESSES :
 The Quran specifically requires followers to keep records of their indebtedness.

 The following procedures were applied by governments and entrepreneurs during the period of the Islamic
State:
1. The recording of transactions was done immediately upon the occurrence of the economic events having
financial impact on the institution.
2. Classification of recorded transactions was done on the basis of their nature. This resulted in grouping
transactions under headings similar to those used today.
3. Receipts were recorded on the right-hand side and payments on the left-hand side with full explanation given
for each record and transaction.
4. Blank spaces between records were not allowed.
5. Deleting or overwriting records was not allowed. Mistakes were explained in writing.
6. Accounts were signed before being closed.
7. Posting of similar transactions to a specialized book was done by a different person to the one recording the
original transactions.
8. Accounts were balanced and the difference between the totals was referred to as al-Hasel (“the result”).
9. Reports were produced on a monthly or annual basis.
10. Annual reports were audited and kept in the main Dewan.
 Islamic enterprises in today's computerized business environment still account for the financial
implications of economic events taking place within the organization in a similar manner.
 Transactions reflecting economic events are reflected in individual accounts.
 Initial actions are recorded in a journal to reflect the need to record transactions on a daily basis, so that
no transaction with a financial effect is omitted. The grouping of the accounts is done in the ledger.

Double-Entry Accounting
 These practices became the components of what was later referred to and further developed as the
double-entry bookkeeping system. The double-entry bookkeeping system thus evolved to comply with the
recording requirements specified in the Quran.
 Accountants follow a step-by-step approach in recording business transactions in the journal.

Increases and Decreases in the Accounts

 Increases in assets are debits and are recorded on the left side of the T-account, and decreases are credits
and are recorded on the right side of the T-account.
 For liabilities and owners’ equity accounts, increases are credits and are recorded on the right side and
decreases are debits and are recorded on the left side.

The T-Account
 Ledger accounts are therefore affected by the recording of business transactions, either as debits or as
credits.
 To the left side of the ‘T’ we list the debit amounts from the transaction affecting this particular account.
To the right side of the ‘T’ we list all the credit amounts from transactions affecting this particular account.
Posting Entries from the Journal to the Ledger
 Amounts recorded in the journal are posted to their respective accounts in the ledger.
 With the use of computerised accounting systems, It is automatically implemented by the system.
Balancing the Accounts
 The balance for each account is computed by adding the total of the debit side and adding the
total of the credit side; the account balance is the difference between the totals of the debit and
credit sides
The Trial Balance
 The trial balance is a total of all debit and credit balances shown in the ledger accounts at an
accounting date.
 It is used as a check on the accuracy of the accounting system.
 If the total of all credits and debits is unequal, there is something wrong with the recording of the
transactions, described earlier.
 Islamic financial statements
 Islamic financial statements share the same broad classification of traditional accounting.
 An Islamic financial accounting system should facilitate the production of a statement of financial position to
reflect the status of the financial position at a particular point in time.
 It should also facilitate the production of an income statement to identify the results of operation over a
period of time.
 The system should also facilitate the production of a cash flow statement to report the flow of cash in and out
of the firm.
 A value-added statement is an important additional piece of information, especially in an Islamic context,
 It identifies the value the entity brings to the community at large throu2bngh its economic activities.
 The latter is a more significant objective of business organizations in Islam than in non-Islamic
organizations.

Financial Accounting Standard No. 1 (FAS1), issued in January 1996 by AAIOFI

 It requires additional statements of changes in restricted investments, sources and uses of zakat and charity
funds (if the bank assumes the responsibility for the collection and distribution of zakat), and sources and
uses of qard funds. Detailed notes to these financial statements are also mandated.
 The standard lists specify Sharia disclosure requirements for Islamic banks and financial institutions.
Balance Sheet :-
 The balance sheet represents the financial position of the entity at a particular point in time. The balance sheet
contains a summary of the entity's assets, liabilities, and owners' equity.

Profit and Loss Statement:-

 The profit and loss statement presents the results of an entity's operations over a period of time.
 This statement lists the revenues and expenses of an entity for a specific period, such as a month or a year. The
difference between the revenue and expenses indicates the net profit or loss.

Statement of Changes in Owners' Equity :-

 The changes in the entity's owners' equity over a period of time is presented in the statement of owners' equity.
Investments by the owner and from net profit earned during the period increases owners' equity. Drawings and losses
decreases owners' equity.

Statement of Cash Flows :-

 The statement of cash flows represents the movement in cash inflows and outflows of the company during a period
of time. The outcome of the cash flow statement is the net increase or decrease in the cash account shown in the
balance sheet during an accounting period and the cash balance at the end of the period. Some consider the cash flow
statement to be a check on the substance of the profit and loss statement.
Statement of Sources and Uses of Funds in the Zakat and Charity Funds:-
 This statement shows the source and application of zakat funds by a business entity over a period of time.
 Zakat is calculated on the basis of the appreciation of net asset values over an accounting period, excluding
assets acquired for consumption or used in production.

Statement of Sources and Uses of the Qard Fund :-

 This statement represents the amount of money loaned free of interest, referred to in Arabic as qard (benevolent
loan).
 It is part of the social responsibility of companies and individuals towards others in the community.
 Funds that are unused should be loaned free of interest for a specific period of time.
 In Islam, fixed-interest-based credit is illegal.
 Government soft loans and grants to organizations are examples of qard loans.
 In such cases, the providers of loans will use accounting information to assess whether their loans are used in
accordance with the agreements underlying them, as well as to assess the ability of the relevant organization to
pay back their loan on time
 USING ACCOUNTING INFORMATION FOR DECISION MAKING

 Understanding religion is an important component of understanding the way business decisions

are made in religious societies.
 Religious tenets provide much of the foundation for business decisions as well as for the moral
codes that guide individual and group behavior.
 While Islam is not alone among religions in the references it makes to business-related matters, it
is distinctive in the extent to which its percepts address directly and in detail the conduct of
business.
 The Islamic principle of khilafa requires individuals to be personally responsible for what is done
with the resources entrusted to them.
o This principle, together with the principle of shura, which requires them to consult with
those affected by their organisations, places a duty upon individual believers to take a
personal interest in the management of their organisations.
 The interests of those affected by the operation of the organisation and its decisions are also
safeguarded by the Islamic principles of Adalah (justice).