ISLAMIC ACCOUNTING FRAMEWORK (1)

1. ISLAMIC ACCOUNTINGFRAMEWORK (1)

2. INTRODUCTION • Islam- Ad din: way of life • Islam-provide a broad framework for all aspect of life, including how business should be conducted. • Past 25 yrs -A paradigm shift from conventional utilitarian economics to Islamic economics • Growth of Islamic Bank in the world, Middle East and Asia.

3. Islamic Framework

5. Need for Islamic Accounting • One of the reasons is that conventional accounting is unsuitable to an Islamic society because of conflicting values. • Accounting system should be consistent with Islamic norms and objectives. • There is a growing importance of Islamic banking industry and resulting in more business operation in line with shariah. • Accounting is a product of environment, thus need to meet this objective in Islamic environment.

6. Need for Islamic Accounting • The establishment of BIMB- reinforce the need for Islamic accounting. • IB Financial reporting- regulated by Bank Negara Malaysia, Banking and Financial institutions Act, Islamic Banking Act 1983, Co. Act 1965 and applicable MASB standards. • MASB (2000)- concerns on lack of comparability of financial performance among banks/ F.I. and lack of comparability of financial performance of individual banks/ F.I. over a period of time.

7. Need for Islamic Accounting • Shahul Hameed (2001)- Islamic accounting needs to be broad based covering all Islamic business, government and voluntary organizations. • Conventional accounting is inconsistent with specific Islamic objectives. • Development of Islamic accounting theoretical framework must be derived from Islamic philosophy, principles and values.

8. Need for Islamic Accounting • Thinker,(1984);Hines,(1988), Gray et al. (1996)- the need of Islamic accounting is due to increasing dissatisfaction with conventional accounting. • Conventional accounting has been criticized for contributing wealth appropriation and conflicts between various classes in society ( Tinker, 1984). E.g. conflict on the use of budget and accountability issue.

9. What is the Islamic values? What is its implication to the Islamic economics?

10. Islamic Values and Islamic Economics Shariah law prescribes guidelines for Islamic values: • Believe in God- the creator who has absolute sovereignity to make laws to human etc. • The Quran- contain principles and code of life to follow until the day of judgment when all human beings have to render accounts of their actions before his Lord.

11. Islamic Values and Islamic Economics (contd.) • 3. The sunnah – sayings and actions of the prophet which is practical application of al Quran. • 4. Man as the Vicegerent –as a trustee of the earth and environment. Man has to strive for life and follow certain law (haram & halal) and avoid being cruel and unjust to other. • E.g. The prohibition of interest, payment of zakat, fulfillment of contracts, complete disclosure of relevant information for economic or social contract.

12. Islamic Values and Islamic Economics (contd.) • Islam governs the conducts of business and commerce through Islamic economics. • Theoretical precepts of Islamic economics has been implemented in Islamic banks, takaful, zakat centre, etc. • There is a need for Islamic accounting in order to emphasize the equitable distributions of wealth and to achieve the objective of social solidarity and socio-economic justice among Muslim society. • Need for positive values- iqtisad (moderate),justice, ihsan (kindness), honesty, patience and public interest. • Avoid the negative values- tyranny (zulm), miserliness, greed, hoarding of wealth, extravagance (israf).

13. Islamic Instruments • 1. Abolition of interest or riba – interest from loan (riba an nasi’ah) and interest from trade( riba al-fadl). See Quran chapter 2: 38, 274-5, 277. • Riba An-Nasi’ah – This is riba when time is allowed for the borrower to repay the loan after its due date. In return, the borrower must pay the additional or premium for the extension in duration. i.e. Interest on lent money or capital. • Riba Al-Fadl – This is riba as a result of trade or sale transactions. Taking a superior thing of the same kind of goods by giving more of the same kind of goods of inferior quality, e.g., dates of better quality for dates of inferior quality in greater amount.

14. Islamic Instruments • 2. Avoid Illegal or haram money in business transaction. • 3. Avoid speculation and uncertainty (gharar). • 4. Profit sharing – economic cooperation between labor and capital e.g, mudharabah ( one capital provider, one entrepreneur who supply expertise or work) • 5. Joint ventures – musharakah contract-share profit and loss • 6. Zakat insititutions – purify the wealth and help the poor and the needy. • 7. Avoid wasteful use of resources

15. Conventional Accounting v.s. Mainstream Economics • EMH- influenced the direction of financial accounting and reporting. • Accounting principles is based on rational economic purposes of business and decision models. • Conventional Accounting and mainstream economics principles are intertwined ( see neoclassical economics).

16. Islamic Economics Based on the Al –Quran Islamic ethics focus on social consequences of collective action. Islam institutionalized public accountability. Islam views directly into the quality and sustainability of community life (intrinsic value) Shariah views private interest as secondary and subsidiary to community. Must conform with shariah principles and ethics. Mainstream Economics Influenced by Christian and western view Christian ethics focus on the consequences of individual action on individuals. Focus on individual, preferences and economic utility. View on Self interest and free-market economy. Excludes the individual’s relationships with God. More on secular views. Islamic Economics v.s. Mainstream Economics

17. Islamic Economics and Islamic Accounting • Economics, politics, social etc. must conform with shariah. • Islamic ethics- governs how business should be run, how accounting ought to be undertaken, and how banking and finance to be arranged. • Accountants must perform their duties in accordance with rules and regulations of Islam and its ethical principles (truthful, fairness and justice)

18. Islamic ethical principles • 1. Business and managerial ethics- • Business person must be honest, fair dealing, high moral values and do not exploit others. • Islam prohibits monopolies, price fixing, sale of stolen goods, hoarding of good to raise the price and other prohibited elements such as gambling, alcohol, pornography and harmful products . • The market should be free and not subject to manipulation. • Manager – is a custodian on God’s trust give to him/her to manage.

19. Islamic ethical principles • 2. Social accountability • “Hisab” or account is the root of accounting. • To account relate to one’s obligation to’ account’ to God on all matters pertaining to human endeavor for which every Muslim is accountable. • All resources are given by God as a trust. Man are trustees for what the have been given ( goods, property, assets). The success of individuals hereafter, depends upon their performance in this world. • Management and capital provider are accountable (also to society) for their actions, both within and outside the firm.

20. Islamic ethical principles • 3. Full disclosure • Quran 2:71: “..one have brought the truth..”-relevance referred to disclosure of all facts – fair and accurate. • Full disclosure – to predict future obligations and assess investment risk. • 4. Periodicity • Requirement to pay zakat one a year (fulfill haul and nisab) • Use Islamic calendar-hijrah @lunar system, conventional uses gregorian calendar

21. Islamic ethical principles • 5. Records • Quran 2: 282: .When you contract a debt for a fixed period, put in writing… • All trading activities need to be fully documented for verification especially on credit loans and transaction. • 6. Materiality • Need to disclose all necessary information and materiality of financial affairs which is related to shariah requirement.

22. Islamic ethical principles • 7.Reliability • Quran 4:58: .They must produce true and complete, reliable financial disclosure for them. • 8. Financial Accounting Reports • Value added statement with emphasis on accountability to society. • Share of the various group.

23. Islamic ethical principles • 9.Asset and liabilities • Islamic asset –all property resulting from previous asset belonging to owner and obtained in a lawful way. • Liability- a faithful obligation or any debt to other persons without interest. • Issues: • -Income measurement and capital maintenance- profit is recognized after capital is returned.( see chapter 10) • -Zakat and measurement issue- current /market value or net realizable value? • -Asset Valuation and Prohibition of interest- any discounting method?

24. Implication for Islamic Accounting Theory • A duty of Muslim to perform accounting in accordance with shariah and apply Islamic ethics. • The need to sustain ethical investments for IB (equity financing) which is not suitable in conventional banking ( i.e. debt based financing); • Lack of investor protection in Islamic financial institutions. • Greater responsibility on the adequacy of Islamic accounting procedures.