Accounting and

Financial Reporting
Framework for Islamic
Financial Institutions
Prepared by : Assoc. Prof. Dr. Noraini Mohd Ariffin (IIUM)
Prof. DR. Maliah Sulaiman (IIUM)
Dr. Ros Aniza (IIUM)
Accounting? Islamic
Accounting?
Islamic Accounting
Standards
 1.
Accounting ?
Islamic Accounting ?
• Conventional Accounting concepts
• Accounting concepts and Shariah requirements
What is Accounting?
✓ General definition:
The process of identifying, measuring and
communicating economic information to
permit informed judgements and decisions
by the users of information

✓ Language of business – to manage

the financial aspects
What is Accounting?
Objectives of Financial Accounting &
Reporting
▧ Provide information that is useful to the present and potential investors and
creditors and other users in making rational decisions.

▧ Provide information that is comprehensible to those who have reasonable

understanding of economic activities and are willing to study the information.

▧ Primary users : shareholders, investors and creditors

▧ Secondary users : 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)
Conventional Accounting Concepts
– Financial Accounting deals with
…
Recognition
✓ To test whether Recording
the critical event ✓ Procedure of double-entry
concerning an bookkeeping system.
element or Measurement
financial ✓ Determination of
transaction has the amount at
taken place. which the
element is to be
✓ Deals with timing recorded Presentation
as to when the ✓ How the event / transaction
event has taken is disclosed in the financial
place. statements
Conventional Accounting Concepts
– Underlying Assumptions
Going Concern
Financial statements are
prepared on the
assumption that the
Accruals business will continue for Accounting Entity
Transactions and events foreseeable future The company is regarded
are recognised in the as a separate entity, thus
financial statements in separating the company’s
the period to which they liability from that of its
relate irrespective of owners.
whether cash was Periodicity
received or paid. Economic activities of a
business are divided into
time periods, normally
yearly.
Qualitative Characteristics of Accounting
Information
Relevance Reliability Materiality
Able to influence the Information is free from Accounting information is
economic decision of users material error and bias, and regarded material if its
by evaluating past, presence represent faithfully the omission, non-disclosure or
and future events. 3 transactions and events that misstatement results in
qualities: Predictive value, have occurred. distortion of the financial
Feedback value, and statements
Timeliness

Understandability Comparability Consistency

Aware of the abilities and
limitations of those for
whom accounting
information is provided
Able to make comparison of
the bank’s performance and
position over time and with
other banks
Consistent in applying
accounting measurement,
valuation and disclosure
methods from one period to
another
 What is Islamic
Accounting?
The ‘accounting process’ which provides
appropriate information (not necessarily limited to
financial data) to stakeholders of an entity which
will enable them to ensure that the entity is
continuously operating within the bounds of the
Islamic Shariah and delivering on its socio-
economic objectives.
 Objectives of Islamic
Accounting
▧ The growth of Islamic financial markets and
institutions reiterates the need for different accounting
requirements.

▧ Islamic accounting is needed to serve different

principles of financial instruments that are found on
the Shariah requirements.

▧ To facilitate the needs of users of accounting

information of Islamic financial institutions who, in
theory, demand different sets of information.
 Features of Islamic
Accounting

No difference Different
in terms of information
recording needs by the
(double entry users
system) Clear (legitimate and
distinction of equitable
accounting transactions
objectives and wealth Vs.
(religious vs. wealth
commercial maximisation
obligation)
 Features of Islamic
Accounting
Different Islamic
Shariah contractual relationships
compliance (e.g. mudarabah,
murabahah, etc)

Distinct accountability
relationships (to Allah Determination of
S.W.R and ummah Zakat
Users of Accounting Information of
IFIs
▧ Equity holders

▧ Investment Account holders

▧ Other depositors

▧ Creditors

▧ Shariah Committee & Shariah Advisory Council

▧ Regulatory agencies

▧ Zakat agencies
 Accounting Concepts – Islamic
Perspective
The conventional accounting concepts have been
scrutinised to ensure that they are in line with Islamic
principles and Shariah :

▧ Accounting unit concept

The IFI is regarded as a separate entity, thus separating
the IFI’s liability from that of its owners.

It resembles the widely practised of waqf (trust foundation)

and Baitul Mal (Islamic treasury) in Muslims traditions.
 Accounting Concepts – Islamic
Perspective
▧ Going concern concept

Many Islamic financial contracts especially musharakah

and mudarabah are for a number of specific periods.

Contracts are assumed to continue until there is evidence

to the contrary
 Accounting Concepts – Islamic
Perspective
▧ Periodicity concept

Accepted in Islam on the basis that even in the case of

zakat, it is being paid once a year as a period of
measurement.

The concept of haul determined that the wealth must be

owned at least one year to qualify for the payment of zakat
obligation.
 Accounting Concepts – Islamic
Perspective
▧ Stability of the purchasing power of the monetary unit

To assist the users to usefully evaluate the financial

performance and position during a specific period.

▧ Prudence & Conservatism

A degree of caution is applied in exercising judgement and

making estimates

Generally, not to overstate assets and incomes, and not to

understate liabilities and expenses
 2.
Islamic Accounting
Standards
• Standards setting bodies
• Financial Reporting environment
• Accounting Standards (MASB FRSi-1, AAOIFI FAS
1)
Islamic Accounting Standard Setting
Bodies

Malaysia Accountin Islamic

n g and Financi
Accounti Auditing al
ng Organisati Service
Standard ons of IFI s Board
Board (AAOIFI)
(IFSB)
(MASB)
Malaysian Accounting Standards Board
(MASB)

▧ Established under the Financial Reporting Act 1997

▧ An independent authority to develop and issue accounting

and financial reporting standards in Malaysia.

▧ On 1 August 2008, the Financial Reporting Foundation,

which oversees the operations of MASB, and MASB issued
a statement on their plan for full convergence of the MFRSs
with IFRSs as issued by IASB by 1 January 2012
Malaysian Accounting Standards Board
(MASB)
▧ On 17 November 2011, the MASB issued a new MASB approved
accounting framework, the Malaysian Financial Reporting Standards
(MFRS Framework), which is a fully IFRS-compliant framework and
equivalent to IFRSs.

▧ The MFRS Framework comprises Standards as issued by the

International Accounting Standards Board (IASB) that are effective on
1 January 2012.

▧ It also comprises new and revised Standards recently issued by the

IASB that will be effective after 1 January 2012

▧ The adoption of the MFRS Framework allows Malaysian entities to be

able to assert that their financial statements are in full compliance with
IFRSs
MASB – Financial Reporting from Islamic
Perspective
▧ In 1997, the initial sentiment was that a separate, stand-alone set of
Islamic standards was necessary to satisfactorily report Islamic
transactions and events.
▧ In 2001, standard MASB i-1 (later re-numbered FRS i-1), Presentation
of Financial Statements of Islamic Financial Institutions, was issued.
▧ However, it was found that much of the conventional accounting
concepts and generally accepted accounting principles could be applied
to Islamic financial transactions and events, with additional disclosures
to explain the use of Islamic contracts.
▧ Indeed, even MASB i-1 (FRS i-1) was largely a reiteration of
requirements already found in FRS 101, Presentation of Financial
Statements, and FRS 108, Accounting Policies, Changes in Accounting
Estimates and Errors.
MASB – Financial Reporting from Islamic
Perspective
▧ MASB ceased its policy of issuing Islamic accounting standards.

▧ It may instead issue other documents that discuss the application of

MASB approved accounting standards to Islamic transactions. These
documents, however, are neither standards nor interpretations to
standards.

▧ On 15 September 2009, the MASB issued Statement of Principles i-1

(SOP i-1), Financial Reporting from an Islamic Perspective to affirm that
MASB approved accounting standards shall apply to Shariah compliant
financial transactions and events, unless there is a Shariah prohibition.

▧ Since the MASB would no longer be issuing Islamic accounting

standards, it accordingly withdrew FRS i-1.
 MASB – Islamic Technical
Pronouncements

▧ Any additional guidance on accounting for Islamic financial

transactions and events will take the form of other
pronouncements, usually Technical Releases, which supplement
MASB approved accounting standards.

▧ MASB may also issue Discussion Papers for public comment in

order to seek confirmation of the Board’s understanding of certain
matters, as well as to solicit views on alternative solutions and
tentative conclusions.
MASB – Islamic Technical
Pronouncements
Accounting and Auditing Organisations of IFI
(AAOIFI)

▧ Established in 1991 and based in Bahrain

▧ An international not-for-profit organization primarily

responsible for development and issuance of standards for
the global Islamic finance industry.

▧ Primary purpose:
To enhance the confidence of users of the financial statements of
the IFIs and ultimately to promote IFIs
Accounting and Auditing Organisations of IFI
(AAOIFI)
▧ 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

▧ Supported by many institutional members, including central

banks and regulatory authorities, financial institutions,
accounting and auditing firms, and legal firms, from over 45
countries.
Accounting and Auditing Organisations of IFI
(AAOIFI)

▧ Its standards are currently followed by the leading Islamic

financial institutions across the world and have introduced a
progressive degree of harmonisation of international Islamic
finance practices.

▧ Issued a total of 94 standards – consisting of 54 Shariah

standards, 26 accounting standards, 5 auditing standards, 2
codes of ethics and 7 governance standards.
 Example of AAOIFI standards
FAS 1 – General Presentation and Disclosure in the Financial Statements of
Islamic Banks and Financial Institutions.

FAS 2 – Murabaha and Murabaha to the Purchase Orderer

FAS 3 – Mudaraba Financing

FAS 4 – Musharaka Financing

FAS 7 – Salam and Parallel Salam

FAS 8 – Ijarah and Ijarah Munthia Bittanleek

FAS 9 – Zakah

FAS 10 – Istisna’ and Parallel Istisna’

Islamic Financial Services Board (IFSB)
▧ Started operations on 10th March 2003, based in Kuala Lumpur.

▧ An international standard setting body of regulatory and supervisory

agencies.

▧ Ensuring the soundness and stability of the Islamic financial

services industry, which is defined broadly to include banking,
capital market and insurance.

▧ Introducing new, or adapting existing international standards

consistent with Shariah principles, and recommend them for
adoption.

▧ Issued 26 Standards, Guiding Principles and Technical Note.

Accounting Standards for IFI
International Financial Reporting Standards (IFRS)
➢ Issued by International Accounting Standards Board (IASB).
➢ Used in more than 120 countries.
➢ Adopted as Malaysian Financial Reporting Standards (MFRS).

AAOIFI Financial Accounting Standards (FAS)

➢ Issued by the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI).
➢ Used for IFIs in Bahrain, Sudan, Syria, Lebanon, Qatar, Oman.

Other standards
➢ Local conventional standards, e.g. US GAAP
➢ Local Islamic standards, e.g. Pakistan & Indonesia- Institute of Chartered
Accountants of Pakistan and Indonesian Accounting Institute
Financial Reporting Environment
➢ Islamic banking financial reporting practices are subjected to the central
banks’ regulation in the respective countries

➢ In Malaysia, for example, it is under the purview of BNM (GP8),

Companies Act 2016, applicable MASB accounting standard and
International Financial Reporting Standard (IFRS)

➢ Lack of Shariah consistency as each bank relied on Shariah advisors of

respective banks even with the supervision of the central banks

➢ Lack of comparability and consistency on the accounting treatment on

recognition, measurement and disclosure of Islamic-based transactions
Financial Reporting Environment
➢ Lack of consistency and comparability of accounting practices hinder
the measurement and comparison financial performance of the Islamic
banks internationally.

➢ Lack of sound regulation on accounting hinders the development of

Islamic banking

➢ In Malaysia, efforts by MASB with the guidance of AAOIFI’s

standards to develop guidelines or Technical Releases for Islamic
financial institutions
 “
… the transparency in the conduct of banking
institutions, facilitated by the proper accounting
standards that reflect the true and fair value of
banking operations would lead to greater
accountability and responsibility of the part of the
bank’s management.
- Tan Sri Dato’ Dr. Zeti Akhtar Aziz
Discussion on selected
standards
1) AAOIFI SFA 1
2) AAOIFI SFA 2
3) AAOIFI FAS 1
4) MASB TRi-3
 AAOIFI STATEMENT OF FINANCIAL
ACCOUNTING 1
Objectives of Financial Accounting for Islamic Banks
and Financial Institutions (SFA 1)

▧ Financial accounting processes

▧ General objectives
▧ Limitations of Financial Accounting
▧ Limitations resulting from nature of FA processes
▧ Importance of establishing objectives
▧ Differences between reports of Islamic Banks and Conventional
Banks
▧ Functions of Islamic Banks
▧ The 2 Approaches to establish objectives
▧ Major users of information
▧ Common information needs of users
 AAOIFI STATEMENT OF FINANCIAL
ACCOUNTING 2
Concepts of Financial Accounting for Islamic Banks
and Financial Institutions (SFA 2)

▧ Basic elements of Financial Statements

▧ Basic accounting assumptions

▧ Qualitative criteria for financial accounting information

▧ Preparation and presentation criteria

 1
General Presentation and Disclosure in the Financial
Statements of Islamic Banks and Financial Institutions

(FAS 1)
▧ Issued in January 1996

▧ In addition to other conventional disclosures, the IFIs should

disclose two very important aspects of their unique
functions:

1. The role of the Shariah advisor or Shariah board in

supervising the bank’s activities and the nature of advisor’s
or board’s authority in accordance with the bank’s by-laws
and in actual practice

2. The bank’s responsibility towards zakat

 1
General Presentation and Disclosure in the Financial
Statements of Islamic Banks and Financial Institutions

(FAS 1)

▧ Disclosure of significant accounting policies :

o Accounting policies adopted which are not consistent with

the concepts of financial accounting for IFIs

o On valuation, the standards require that the policies, bases,

and methods adopted for revaluation of assets, liabilities and
restricted investments to their cash equivalent value over the
historical value.
 1
General Presentation and Disclosure in the Financial
Statements of Islamic Banks and Financial Institutions

(FAS 1)
▧ Disclosure of earnings or expenditures prohibited by
the shariah:

o Financial statements should disclose the amount and nature

of earnings and expenditures that have been realized or
incurred from sources or by means which are not permitted
by shariah.

o Disclose how it intends to dispose of the assets generated by

the prohibited earnings or acquired through prohibited
expenditures
 1
General Presentation and Disclosure in the Financial
Statements of Islamic Banks and Financial Institutions

(FAS 1)
▧ Disclosure of earnings or expenditures prohibited by the shariah:

o Crucial in order to enhance the confidence of the stakeholders on the

integrity of IFIs

o Any shariah non-compliant activities are expected to be disclosed and efforts

to cleanse the account from non-shariah compliant incomes or expenses
must be made transparent.
 1
General Presentation and Disclosure in the Financial
Statements of Islamic Banks and Financial Institutions

(FAS 1)
▧ Disclosures related to unrestricted and restricted investment
accounts :

o Magnitude of balances of all unrestricted investment accounts and their

equivalents

o Distribution of unrestricted investment accounts, by type, in accordance with

maturity

o Disclosures of the method used in allocating investment profits (or losses)

between unrestricted investment account holders or their equivalent

o Disclosure of the returns of each type of investment accounts and their rate
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ Adopted in Malaysia, effective date : 1 January 2010

▧ Objective: Basis for presentation and disclosure of financial

statements of IFIs that conduct Islamic banking activities.

▧ To ensure comparability of these statements with those in

previous periods and with those of other IFIs
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ In addition, this Technical Release provides guidelines for
the structure, and basis of the content of financial statements
to ensure conformity with Shariah requirements.

▧ It also prescribes minimum disclosure requirements.

▧ The recognition, measurement, and disclosure of specific

Islamic-based transactions and events will be dealt with in
other MASB Islamic accounting pronouncements.
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ MASB MFRS 101 requires a complete set of financial
statements including the following components:

(a) Statement of financial position,

(b) Statement of comprehensive income,
(c) Statement of changes in equity,
(d) Statement of cash flows; and
(e) Notes to the accounts.

▧ In addition to the above statements, TR i-3 requires an

Islamic Financial Institution to present, outside its financial
statements, any other statements useful to users, for
example, Zakat Fund and Qard Fund.
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ Recommends voluntary additional statements that include a
financial review by management describing and explaining the
main features of the IFIs financial performance and financial
position, mentioning principal uncertainties such as:

(a) Factors determining performance (e.g. changes in the

environment, response to those changes, investment policies aimed at
maintaining and enhancing performance, etc.)

(b) Sources of funding, policy on gearing, and its risk management

policies

(c) The IFI’s strengths and resources whose value is not reflected in
the balance sheet.
 MASB TRi – 3
Presentation of Financial Statements of IFI
▧ In any circumstance when management concludes that compliance with a
requirement in a standard would be misleading, and therefore that departure from a
requirement is necessary to achieve a fair presentation, an IFI should disclose:

1. Management’s conclusion that the financial statements fairly present the IFI’s
financial position, financial performance and cashflows;

2. Complied in all material respects with applicable MASB standards except that they
have so departed in order to achieve fair presentation;

3. Nature of departure, including the treatment that the standard would require, the
reason why that treatment would be misleading in the circumstances and the
treatment adopted;

4. Final impact of the departure on the profit/loss, assets, liabilities, equity and cash
flows.
 MASB TRi – 3
Presentation of Financial Statements of IFI

▧ Requires disclosure of Shariah advisor and zakat

obligations.

▧ IFI should disclose the role and authority of Shariah

advisor or board in monitoring the IFI’s activities
pertaining to the shariah matters.

▧ Disclose, where applicable, its responsibility towards

payment of zakat on behalf of depositors, shareholders
and others.
 MASB TRi – 3
Presentation of Financial Statements of IFI

▧ With regards to shariah compliant activities, an IFI is

encouraged to disclose (if there is any):

o The amount and nature of earnings realised from

sources or means which are not permitted by shariah
o The amount and nature of expenses not permitted by
shariah;
o The manner of disposal of prohibited earnings

→ To ensure transparency in the institutions’ activities

and transactions.
BNM Guidelines on Financial Reporting
▧ The Guidelines on the Specimen Reports and Financial Statements for
Licensed Islamic Bank or GP8-i was issued to the Islamic banks in
August 2015 by Bank Negara Malaysia.

▧ It sets out the minimum requirements for the presentation and disclosure
of reports and financial statements of Islamic banks.

▧ The GP8-i is to be adopted by the Islamic banks for annual accounts

commencing 2016.

▧ The objective of the issuance of the GP8-i is to provide the basis for
presentation and disclosure of reports and financial statements of Islamic
banks.

▧ GP8-i is also aimed at ensuring consistency and comparability of the

reports and financial statements amongst the Islamic banks
 CONCLUS
ION
ISLAMIC ACCOUNTING FRAMEWOR AIMS FOR:

1. Shariah compliance and achievement of Islamic goals on

financial activities

2. Equitable and fair recognition, measurement, valuation and

disclosure of financial information

3. Achievement of both economic and spiritual well being of the

society
 Discussion
▧ Read the following article (uploaded):
Mervyn K Lewis, “Islam and Accounting” (Accounting Forum, Volume
25, Issue 2, June 2001)
El-Tegani Abdul Gader Ahmed , “ Accounting Postulates and Principles
from An Islamic Perspective” (Review of Islamic Economics, 1994)
Prepare the following questions:
1. What are the differences between conventional accounting and Islamic
accounting?
2. What are the basis of Islamic accounting?
▧3. The importance of the following concept :
▧ - Realization of fairness and justice
▧ - Preservation of the rights and due of all parties
▧ - Paying zakat (that necessitates having accurate and just financial
statements which represent accurately and truly financial position of the
entity)