Ethics and Social Accounting vs. Islamic Accounting

 by  : Hanan Gabil, Wed Al-Nafie and Wejdan Al-Harbi

In early history of accounting, the first name to describe the system of debits and credits in journals and ledger which in fact still the basics of today’s accounting is called Luca Pacioli, year 1494.


Accounting is defined as a valuable knowledge to be performed and it is considered to be the main index for all countries’ economy. Accounting is also an essential part in processing information of business and economy activity into financial statements. In other words, accounting is the universal language of business and economics as well as finance. However, unfortunately, there is still fraudulent and dishonest practices in business and economic activities. Accounting can be divided into 6 categories as follows:

  1. Finance Accounting
  2. Management Accounting

iii.  Auditing Accounting

  1. Taxation
  2. Funds
  3. Forensic Accounting.


There is no certain activity that could be possible done without relying on accounting, because accounting deals with information that consists of financial status and profitability of economic enterprises.


Islamic accounting has existed since the 1500s and has its own principle that not only can decrease the degree of unexpected activities pertaining to accounting process but also increase the welfare of both internal and external parties of the business. That’s because Islamic accounting has an aspect that has more meaning and value which is a similar aspect of conventional accounting too. It comprises of all values required to the most preferable accounting process. This essay details the differences between Social accounting and Islamic accounting.



Ethics in accounting has been posed after scandals that had the greatest impact of the recent century such as examining collapse hiding, law breaking, fraud and violating moral standards. This setback drove companies towards a common strategic goal – principles of accounting. Thus, the following four elements of principle are essential in ethics:

  1. Honesty and trustworthiness

This rule requires a complete and honest presentation of relevant financial and non-financial information. Information presented should be adequately transparency and must not be used for an ethical advantage. A high degree of integrity and discretion is essential.



  1. Objectivity

Objectivity requires all professionals and information to be fair and unbiased. Professional judgment must be free from conflict of interest such as hospitality and family relationship. It is strongly recommended to refrain from personal relationships and accepting gifts on duty.


  1. Confidentiality of information

Unless absolutely necessary and required by the relevant accounting and auditing standards, confidential information should not be disclosed or be used to gain any unethical advantage.


  1. Professional competence and conduct

Professionals are required to have an appropriate level of academic and work competence, preferably related to their field. Any offers of professional duty for which one does not possess sufficient skills to execute the task effectively should be declined. Professionals must always comply with relevant accounting and auditing standards and perform their duties diligently.


According to the ethical code of conduct, having a code does not eliminate fraudulent activities. In fact, it is a guide to accountants which needs to be fully accepted by professionals before it can be effectively adopted into practice. Therefore, there are two additional codes that are incorporated into Islamic accounting:


  1. Faith-driven conduct

Under Islamic accounting, self-monitoring is fundamental. Self-monitoring may be defined as being constantly conscious of one’s actions and their accountability before Allah on the day of judgment. It is also important to seek Allah’s satisfaction instead of pleasing people while performing professional duties which are consistent with Islamic values and the Shariah. One must always be diligent and sincere in his work and actions. This also stresses on keeping promises and honouring agreements.


  1. Legitimacy

Legitimacy requires all professional duties to be according to the Shariah. Accountability to Allah is given priority over accountability to the management. Professionals must have competent knowledge of the Shariah rules and principles through education and formal training. All business activities and transactions must be Shariah compliant and should be verified for religious legitimacy by professionals who are responsible for executing them.


Social Accounting

Social accounting is also coined as Social Responsibility Accounting because of its responsibility to measure and inform the public about the social activities undertaken by the enterprise and their impact on the society. It is the vision of  which a business seeks to make a valuable impact on social operations. In simpler words, social accounting can facilitate the identification and management of social risks.


Business is a socio-economic activity and its objective is the welfare of the society. It requires full responsibility for providing solutions for social issues. Therefore, the concept of social accounting is to manage huge amounts of funds at their disposal and invest substantial amounts in social activities so as to nullify the adverse effects of industrialization.



The benefit of social economy is to act as an evidence of social commitment, fulfill its obligations, and advise the government and the general public to form correct opinions that are just and ethical. However, it does have its limitations. It can be labor intensive if strategic planning has not been set, or also been not useful for benchmarking.


Islamic Accounting

In an Islamic society, accounting should establish purposes according to Islamic teachings in relation to contemporary accounting thought. Those which are Shariah-compliant are pursued and those that are not are discarded.


Certain Islamic ethical principles have a direct impact on accounting policy and principles.

These principles are derived from the Holy Qur’an and the Sunnah, that stresses on the need for justice, truth, and fairness, and are considered to be a society’s priority and responsibility. This also contains specific standards for accounting practices. In Islamic financing principles, it must follow specific elements which gives it distinctive religious identity. These elements  are:

  • Riba (interest): The payment and taking of interest as occurs in a conventional banking system is explicitly prohibited by the Holy Qur’an.
  • Zakat: The process of repetitive distributions of income and wealth is inherently in Islam to guarantee a fair standard of living for every people especially the poor. Zakat is different from a tax, A tax is an obligation of citizens toward the society, whereas zakat is an obligation of a Muslim not only to society but also to Allah.
  • Haram: Islamic banks cannot finance activities or items forbidden in Islam,

Islamic banks give priority to essential production which caters to the needs of

the majority of the Muslim community.

  • Takaful (joint-guarantee): The only type of insurance that would appear to be lawful according to the Shari’ah insurance.


Muslims ought to conduct their business activities according to the requirements of their religion which are moderation, justice, kindness, honesty, spending to meet social obligations. Unfairness and greed should be avoided at all times.


Applying Islamic accounting principles leaves a beneficial impact directly and indirectly on the internal and external parties of the business; some of which are highlighted below.


  • Less possibilities of unexpected activities by the accountant such as fraud in business and society.
  • The creditor will feel more secure in investing their funds in the business.
  • Financial statement and reporting will facilitate better and more accurate decision making by the users.
  • One of the Islamic accounting purpose is to be concerned about the employees and their families when performing their jobs. It can be useful in reducing poverty and increasing the welfare of the society within the company. This increases the purchasing power of the underprivileged which indirectly contributes to the economic growth.


The company also benefits from increased profits, customers’ loyalty, trust, positive brand attitude, combating negative publicity, and having a rightful place in the business world.



Overall, accounting is the recording of financial transactions and focuses on presenting the information in financial statements, These reports must be prepared according to accounting principles. Accounting also provides essential information to the management to keep the business financially healthy. It places high importance on ethical values. It is of utmost importance for a business to provide accurate evaluation, truth in operations, clear revenues and expenses.


Social accounting differs from Islamic accounting. The general concept of Corporate social responsibility (CSR) is to guarantee sustainability which is forbidden under Islamic accounting Exception is only made if it can be regenerated. CSR activities has a direct impact on the social environment. Therefore, it is required by law for CSR activities and information about its operations to be truthfully disclosed to the general public.


Because Islamic accounting obligates businesses to follow the Sharia strictly, it is considered a religious responsibility. Economic responsibility requires financial statements to be viable, profitable and efficient whereas ethical accounting is obliged to respect societal and religious values.


Therefore, Islamic accounting is considered to be much more complex than the social CSR concept in terms of providing the economy with accurateness, justice without taking or giving interest.


Lewis, M. K. (2001). Islam and accounting. Accounting Forum,25(2), 103-127. doi:10.1111/1467-6303.00058


Yarahmadi, H., & Bohloli, A. (2015). Ethics in Accounting. International Journal of Accounting and Financial Reporting,5(1), 356-360. Retrieved April 27, 2017, from


Schneider, B. (2017). Accounting Basics: History Of Accounting. Retrieved April 26, 2017, from


Mishra, S. (2015). Social Accounting: Concept, Definition, Features and Benefits | Financial Analysis. Retrieved April 27, 2017, from


Islam, M. A. (2015). Social Compliance Accounting Managing Legitimacy in Global Supply Chains. Cham: Springer International Publishing.


Asfadillah, C., et al. (2012). The Importance of Islamic Accounting in Modern Era. Cambridge, UK.


Comprative analysis of AAOIFI Vs IFSB

Nahlah Aljudaibi, Adwaa S. Melebari and Hanadi Simbawah


Islamic finance has been rapidly grown recent few years nearly 20 percent annual growth in each year (Zeine Zeidane, 2015), The Islamic Financial Services Industry now has assets of over $175billionwith equity of US$15billion. With more than 300 Islamic banks, finance companies, investment banks (Shahul Hameed bin Mohamed IbrahimStandard,2007 )& Poor’s Ratings declare that over all assets held by Islamic financial institutions estimate around $1.8 trillion with probability to increase for double-digit growth over the coming few years to reach about $3 trillion.

Thus the Islamic finance system must adapting a stander accounting system that compliant with sharia rule and has a sharia objective which cares about Din(faith), nafs (life), maal(wealth), nasel(progeny) and aqal (rational). For following these principles and provide stander accounting system to service Islamic finance institutions and  guide the operations of the industry around the world, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was established since 1991 in Bahrain which was issuing accounting, auditing and Sharia standards for financial reporting at Islamic financial institutions. The another institution that considers as issuing supervisory and regulatory standards and guidelines which are governance standards for Islamic institutions is The Islamic Financial Services Board (IFSB) that established in 2002 in Malaysia.

Before elaborate, the two Islamic accounting stander in details must explain the general principles of Islamic accounting.



General principles of Islamic accounting;

According to the (Muhammad, 2002), there are three general principles in Islamic accounting

  1. Accountability:

The concept of accountability is that everyone is accountable for his actions on the Day of Judgment.  The accounting man is a person who involves in accounting issue which let him responsible with the mandated and also related parties, forming in financial statements.

  1. Justice

Justice in accounting system has a meaning of honest and cares about ethical and moral value regarding the parties are included in the financial transaction.

  1. Truth:

The measurement and reporting of accounting activity must create justice or fairness for all shareholders and this cannot happen without Truth principle


AAIOIFI is based in Bahrain and operates as an independent international organization with support from some200 institutional members coming from about 45 different countries. Consist of central banks and monetary authorities, financial institutions, accounting and auditing firms, and other institutions that support the international Islamic finance industry.

AAIOFI is a stander for sharia, accounting, auditing, and governance exactly is issued of 88 standers including of 48 Sharia standards, 26 accounting standards, 5 auditing standards, 7governance standards and 2 codes of ethics. The standards are implemented globally even in non-member countries as they are applicable to IFIs worldwide.

The objectives of AAOIFI:

  • To develop accounting and auditing thoughts relevant to Islamic financial institutions
  • To disseminate accounting and auditing thoughts relevant to Islamic financial institutions and its applications through training, seminars, publication of periodical newsletters, carrying out and commissioning of research and other means
  • To prepare, promulgate and interpret accounting and auditing standards for Islamic financial institutions
  • To review and amend accounting and auditing standards for Islamic financial institutions

AAOIFI carries out these objectives in accordance with the precepts of Islamic Shari’a which represents a comprehensive system for all aspects of life, in conformity with the environment in which Islamic financial institutions have developed. This activity is intended both to enhance the confidence of users of the financial statements of Islamic financial institutions in the information that is produced about these institutions, and to encourage these users to invest or deposit their funds in Islamic financial institutions and to use their services.

AAOIFI Standards

Shari’ah Standards

Guidance on Shari’a permissibility and rules for specific Islamic finance products and mechanisms. AAOIFI’s Shari’ah standards are typically issued through a professional and meticulous scholarly methodology (known as the due process). The standards development process follows a number of stages, commencing with the commissioning of consultants to conduct a thorough study on a specific topic or issue that greatly impact the Islamic finance industry. The study involves Shari’ah characterization of the topic in question and the compilation of Fiqh academy fatwas and collective fatwas pertaining to the topic, and it accounts for all relevant practical applications. The exposure draft is then submitted to the respective Shari’ah standards subcommittee which discusses and reviews it. If approved, the consultant will be commissioned to prepare an exposure draft on the same topic or issue. The first exposure draft will then be discussed with the subcommittee prior to submission to the Shari’ah Board for further discussion and elaboration.

Accounting Standards

Guidance on accounting treatment for specific Islamic finance products and mechanisms and guidance on presentation of financial statements for Islamic financial institutions. Accounting standards due to the unique characteristics coupled with the growing demand of IFIs’ products and services so as to facilitate and enhance the credibility and reliability of the financial statements and reports. It is argued that the current standards which are based on conventional framework seem insufficient to guide the IFIs. Currently, the various IFIs apply different accounting standards in their preparation of their accounts due to the absence of Islamic accounting standards (Zaini, 2007). The trend towards the AAOIFI standards has become a pressing issue that has generated heated debate among Organization of Islamic Cooperation countries.

AAOIFI accounting standards have been made part of mandatory regulatory requirement in jurisdictions such as Bahrain, Jordan, Oman, Qatar, Qatar Financial Centre, Sudan, and Syria.

AAOIFI accounting standards have also been adopted by Islamic Development Bank Group, a multilateral institution.

In addition, AAOIFI accounting standards have also been used as basis of national accounting standards in jurisdictions such as Indonesia and Pakistan..

Auditing, Governance and Ethics Standards

AAOIFI auditing, governance and ethics standards are not part of mandatory regulatory requirement for Islamic finance.  Instead, these standards are used voluntarily by leading Islamic financial institutions across all major Islamic finance jurisdictions.

AAOIFI’s Auditing Standards broaden the scope of the external auditor so that s/he is satisfied with reasonable assurance that the Islamic bank’s transactions comply with Shari’a rules and principles. Require the external auditor’s report to clearly state in the auditor’s opinion whether or not the financial statements give a true and fair view in accordance with Islamic Shari’a rules and principles and the financial reporting framework.

AAIOFI’s Governance Standards aim to enhance the role of SSB in corporate governance. Provide guidelines to harmonize the SSB’s structure and process, including: l Its appointment, dismissal, and the format of its report and the information it should contain. l Steps that should be followed by the SSB in its review to form an opinion as to whether or not the bank has complied with Shari’a precepts.

AAOIFI’s code of ethical structure conduct consists of three sections; namely the foundations of accounting ethics, the principles of ethics for accountants, and the rules of ethical conduct for accountants. The foundations of accounting ethics delineate seven basic foundations; namely, integrity, vicegerency, sincerity, piety, righteousness, Allah-fearing, and, accountability to Allah. From these seven foundations, AAOIFI developed six basic ethical principles; namely, trustworthiness, legitimacy, objectivity, professional competence and diligence, faith-driven conduct, and professional conduct and technical standards. Finally, for all six ethical principles, they developed guiding rules for accountants in their professional works.


Islamic Financial Services Board, it’s an international organization that issues guiding principles and standards for association to central bank and monetary authorities and other institutions that are responsible for regulation and supervision of Islamic financial services industry. IFSB was founded in Malaysia 2002 and started operation on 2003. It serves as an International standard-sitting body of regulatory and supervisory agencies to ensure soundness and stability of the Islamic financial services industry in banking, capital market, insurance.

IFSB definesShari’ahgovernance system as a set of institutional and organizational arrangement through which an Islamic financial institution ensures that there is effective independent oversight of Shari’ah compliance over each of the following structures and process:

  1. a) Issuance of relevant Shari’ah pronouncement or resolution. This refers to a juristic opinion on any matter pertaining to Shari’ah issues in Islamic finance given by the appropriately mandated Shari’ah board.
  2. b) Dissemination of information on such Shari’ah pronouncement or resolutions to the operative personnel of the IFIs who monitor the day-to-day compliance with the Shari’ahresolutions vis-à-vis every level of operations and each transaction. However, this task would normally be done by the internal Shari’ah compliance department.
  3. c) An internal Shari’ah compliance review or audit reports that if there is any incident of non-compliance, it should be recorded and addressed and rectified. With regard to this, IFSB-3 sets out that Shari’ah resolution issued by the Shari’ah boards should be strictly adhered to. d) An annual Shari’ah compliance review or audit for verifying that internal Shari’ah compliance review or audit has been appropriately carried out and its findings have been duly noted by the Shari’ah boards.

The IFSB members have increased from 9 in 2003 to 188 members in 2016with 3 membership type:

1)      31 as full members.

2)      22 as associate members.

3)      125 as observer members.

The ISFB consists of:

  • The general assembly, which includes all members of the ISFB
  • The council, which acts as the policy making body of the IFSB and includes the senior executive of each full member of the organization
  • The technical committee, which advises the council on issues and consists of up to 15 persons appointed by the council
  • The working group, which drafts standards and guidelines and reports to the technical committee
  • The secretariat, which acts as the permanent administrative body and is headed by a secretary-general appointed by the council



The objectives of the IFSB are:

* To promote the development of a prudent and transparent Islamic financial services industry through introducing new, or adapting existing, international standards consistent with Sharî’ah principles, and recommending these for adoption

* To provide guidance on the effective supervision and regulation of institutions offering Islamic financial products and to develop for the Islamic financial services industry the criteria for identifying, measuring, managing and disclosing risks, taking into account international standards for valuation, income and expense calculation, and disclosure.

* To liaise and cooperate with relevant organizations currently setting standards for the stability and the soundness of the international monetary and financial systems and those of the member countries.

* To enhance and coordinate initiatives to develop instruments and procedures for efficient operations and risk management.

* To encourage cooperation amongst member countries in developing the Islamic financial services industry.

* To facilitate training and personnel development in skills in areas relevant to the effective regulation of the Islamic financial services industry and related markets.

* To undertake research into, and publish studies and surveys on, the Islamic financial services industry.

* To establish a database of Islamic banks, financial institutions and industry experts.

IFSB Standards

the IFSB has issued twenty-seven Standards, Guiding Principles and Technical Note for the Islamic financial services industry. The published documents are on the areas of:

  1. Risk Management (IFSB-1)
  2. Capital Adequacy (IFSB-2)
  3. Corporate Governance (IFSB-3)
  4. Transparency and Market Discipline (IFSB-4)
  5. Supervisory Review Process (IFSB-5)
  6. Governance for Collective Investment Schemes (IFSB-6)
  7. Special Issues in Capital Adequacy (IFSB-7)
  8. Guiding Principles on Governance for Islamic Insurance (Takāful) Operations (IFSB-8)
  9. Conduct of Business for Institutions offering Islamic Financial Services (IIFS) (IFSB-9)
  10. Guiding Principles on Sharī`ah Goverance System (IFSB-10)
  11. Standard on Solvency Requirements for Takāful (Islamic Insurance) Undertakings (IFSB-11)
  12. Guiding Principles on Liquidity Risk Management (IFSB-12)
  13. Guiding Principles on Stress Testing (IFSB-13)
  14. Standard on Risk Management for Takāful (Islamic Insurance) Undertakings (IFSB-14)
  15. Revised Capital Adequacy Standard (IFSB-15)
  16. Revised Guidance on Key Elements in the Supervisory Review Process (IFSB-16)
  17. Core Principles for Islamic Finance Regulations (IFSB-17)
  18. Guiding Principles for Retakāful (Islamic Reinsurance) (IFSB-18)
  19. Recognition of Ratings on Sharī`ah-Compliant Financial Instruments (GN-1)
  20. Guidance Note in Connection with the Risk Management and Capital Adequacy Standards: Commodity Murābahah Transactions (GN-2)
  21. Guidance Note on the Practice of Smoothing the Profits Payout to Investment Account Holders (GN -3)
  22. Guidance Note in Connection with the IFSB Capital Adequacy Standard: The Determination of Alpha in the Capital Adequacy Ratio (GN-4)
  23. Guidance Note on the Recognition of Ratings by External Credit Assessment Institutions (ECAIS) on Takāful and ReTakāful Undertakings (GN-5)
  24. Quantitative Measures for Liquidity Risk Management (GN-6)
  25. Development of Islamic Money Markets (TN-1)
  26. Stress Testing (TN-2)
  27. Guiding Principles on Disclosure Requirements for Islamic Capital Market Products (IFSB 19).


This paper discusses the important role of AAIOFI and IFSB to ensure that the whole activities of financing activities are in line with the Shari’ah. Also the paper including comparison between AAIOFI and IFSB, the country that host it , objectives, members, standards ,rules and regulation.




Lumpur, K. (2015). IFRS vs AAOIFI : The Clash of Standards ?, (March 2007). Trokic, A. (n.d.). Islamic Accounting ; History , Development and Prospects, 1–6. \Lumpur, K. (2015). IFRS vs AAOIFI : The Clash of Standards ?, (March 2007).

Kingdom, U. (2012). AAOIFI – Governance and Auditing Standards, (September).

Nawal Kasim, Sheila Nu NuHtay, S. A. S. (2013). Comparative Analysis on AAOIFI , IFSB and BNM Shari ’ ah Governance Faculty of Accountancy. International Journal of Business and Social Science, 4(15), 220–227. Retrieved from

Business Zakat Accounting: Fiqhi Basis by Dr Mohammed Obaidullah

The available zakat accounting standards as well as laws governing business zakat reflect a sort of consensus that adjusted net working capital of a business may be regarded as the base for computation of zakat liability of a business. The second accepted alternative is the adjusted growth capital which essentially arrives at the same outcome, given the accounting equality between total assets and total liabilities and equity in the balance sheet of a business organization. The apparent consensus follows from fiqhi prescription of imposing zakat on urud al-tijarah or the inventory of goods available for trade.

images (1)
Zakatability of Urud Al-Tijarah

We briefly summarize below the fiqhi basis for zakat liability on urud-al-tijara. The full line of arguments and counterarguments are available in chapter 4 of the text Fiqh Al-Zakat by Dr Yusuf Al-Qaradhawi.

Urud al-tijarah, according to Islamic jurists implies business inventory, which means any commodities obtained for the purpose of resale for profit, except liquid monetary assets. Some jurists define ‘urud al tijarah as anything that one buys in order to sell for profit. We quote here from the work of Dr Qaradhawi the evidence from the Qur’an, the Sunnah and Ijma for zakat obligation on business inventory.

The Quran

“O ye who believe, give of the good things which ye have honorably earned, and of the fruits of the earth which we have produced for you.” (Surah Al-Baqarah No.2, Verse: 267)

Scholars interpret the words ‘that you have earned’ as things earned by means of trade, and the words ‘that we have produced from the earth for you’ as things earned by means of agriculture. This is supported by other verses about zakah that are general and therefore include business assets, such as the verses:

“and on their wealth and possessions there is the right for he who asked and he who is deprived,” (Surah al Dhariyat, 51:19)

“and on those in whose wealth is a recognized right for he who asks and he who is deprived,” (Surah al Ma’arij, 70:24-25)


“Out of their goods take sadaqah so by it thou might purify and sanctify them.” (Surah al Tawbah, 9:103)

The Sunnah

Abu Daud reports from Samurah bin Jundub that ” the Prophet (p) used to order us to pay al sadaqah out of what we have for sale.” (Mukhtasar Al Sunan, Vol. 2, p.175)

Al Daraqutini reports Abu Dharr “I heard the Messenger of God (p) saying ‘Camels are zakated, lambs are zakated, and clothes and housewares are zakated.” (Al Muhalla, Vol. 5, pp. 234-235)

There is no disagreement that clothes and other housewares for personal or household use are exempt, which means that housewares and clothes mentioned in this saying refer to business inventory for resale. This is in addition to the general sayings that obligate zakah on all kinds of wealth without discrimination, such as “give zakah on your wealth.” (Al Tirmidhi, Vol. 3, p. 91)

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Islamic Accounting – An Introduction

“Corporation have emerged as the dominant governance institution on the planet, with the largest among them reaching into virtually every country in the world an exceeding most government in size and power, increasingly, it is the corporate interest more than the human interest that define the policy agendas of state and international body although the reality and its implication have gone largerly unnoticed and unaddressed”(Korten). The western models of accounting have contributed to this situation.

According to Hayashi, “The traditional Western double-entry based accounting technology is well-suited to an orthodox, positivist society of any kind. It is not surprising that it is proving inadequate, as people are returning to more integrated world views, whether Islamic or otherwise”. The main critics of western accounting states that it failed to consider the social interest, promote the exploitation of capitalist over labor and society and Promote the concentration of wealth and power o the hand of the rich.
Accounting is being developed based on religion and culture in many societies. Shinto for example has a potential drive to establish a Shinto based Accounting in Japan as the Japan is society with has strong commitment to traditions and culture. According to the research the culture and accounting are closely related. Different culture, different economic – socio-politico systems demand different accounting system. The researchers in Islamic accounting emphasis that “Islam is different from Occident (Capitalist ideology), so it must have its own accounting system”.

The western accounting is Individuality – oriented, focus on individuality aspect without consider any social aspect and secular. But the Islamic accounting has to be developed to address these issues Society – oriented and should be based on focus on society aspect, basically Al Qur’an & As Sunnah (Shariah),
religious (must responsibility to God at the Judgment Day).

Therefore, It is necessary to develop an accounting system based on Islamic values and guidelines to the will benefit the mankind. Sura Baqara V 282 clearly states about the recording of transactions and give divine guidance to the humanity in all the aspects of business and accounting.

The Islamic accounting practices will be able report accurate income determination, to promote efficiency and leadership, to comply with the shariah (Islamic principles), commitment to justice, to adapt to positive social change. The Islamic accounting should be based Al-Quran and As-Sunnah.
The key success in Islamic accounting practices is the formation of Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). The AAOFI was found to report ethical dimensions in the Islamic financial institutions which was not addressed by the international accounting standards. The formation of AAOFI is the key stone for success in Islamic finance industry.
Islamic finance industry gave the real sprit to Islamic accounting. There are many researches going in this field. Some western educational institutions started to offer courses in Islamic accounting. These developments signify that Islamic accounting will also develop along with Islamic finance industry and will the benefit the humanity.

Dr. Jamaldeen M Faleel DBA
Assistant Professor – Finance and Accounting
Effat University – Jeddah, KSA

The Diploma in Islamic Accounting and Compliance (DIAC)

faa030000399Association of International Accountants (AIA) uk jiontly with BIBF has introduced Diploma In Islamic Accounting And Compliance (DIAC) to cater the islamic finance market.There is an increasing demand for accountancy professionals who demonstrate a thorough understanding of Islamic Accounting and Governance Reporting requirements as set by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI), while preserving compliance with International Financial Reporting Standards (IFRS). To access global markets and maintain the process of Islamic transactions, Islamic Finance professionals need to be familiar with both sets of standards as they apply to Islamic Financial Institutions. The Diploma in Islamic Accounting and Compliance (DIAC) has been designed to address this demand.

The Diploma in Islamic Accounting and Compliance (DIAC) is a professional certification jointly developed and certified by the Bahrain Institute of Banking and Finance (BIBF) and the Association of International Accountants (AIA).AIA, a premier international professional accountancy body, is responsible for setting the syllabi for the course, preparing the independently developed exam papers and appointing leading professional examiners.

The BIBF, as the premier institute for financial education and training in the Gulf, is responsible for compiling the course structure and providing its highly reputed teaching and support services. The DIAC programme seeks to develop the next generation of accounting professionals and leaders in Islamic Finance. It is specifically designed to cater to the needs of global professionals who require a qualification that enhances and certifies their knowledge and practical understanding of the multi-jurisdictional accounting systems that Islamic banks are exposed to.

source : bibf


images40Research Paper by Dr. Shahul Hameed bin Mohamed Ibrahim, PhD, M.A., CA (M), FCCA
Assistant Professor and Head, Department of Accounting, Kulliyah of Economics and Management Sciences, International Islamic University Malaysia

1. Introduction

To professional accountants who have been brought-up on the idea of accounting as an ‘objective’, technical and value-free discipline, the idea of attaching a religious adjective to accounting may seem to be embarrassing, unprofessional and even dangerous.

This is especially true when the adjective is Islam (Christian or Buddhist may at least sound more peaceful), which is media-hyped to be synonymous with terrorism.

On the other hand, the development of Islamic banking and finance now embraced even by ardent capitalist institutions such as Citibank, HSBC and ANZ banks may interest accountants to the possibility of new opportunities for the profession (especially in the wake of lay offs and downsizing by the big four firms).

Perhaps, the Enron affair has rekindled an interest in having a more honest profession who truly care about the public interest in addition to their pockets.

Whatever the interest or curiosity, we hope accountants will find this series of articles interesting, informative, and profitable and yes we hope it may even lead to a bit of soul searching.

In this month’s article, we try to explain what is Islamic accounting (although it will not be the final definition) together with a discussion of the main differences between Islamic and conventional accounting, provide some justifications for the addition of the world ‘Islamic’ to the word accounting, make a prima facie case for Islamic accounting and finally make the important distinction between accounting for Islamic banks and Islamic accounting, which is presently thought of by many people as synonymous.

2. Meaning of Islamic Accounting

Islamic accounting can be defined as 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 Shari’ah and delivering on its socioeconomic objectives.

Islamic accounting is also a tool, which enables Muslims to evaluate their own accountabilities to God (in respect of inter-human/environmental transactions).

The meaning of Islamic accounting would be clearer if we compare this with the definition of “conventional” accounting. (Conventional) accounting as we know it is defined to be the identification, recording, classification, interpreting and communication economic events to permit users to make informed decisions (AAA, 1966).

From this, it can be seen that both Islamic and conventional accounting is in the business of providing information.

The differences lie in the following:

  • The objectives of providing the information
  • What type of information is identified, and how is it measured and valued, recorded and communicated, and
  • To whom is it communicated (the users)

    While conventional accounting aims to permit informed decisions whose ultimate purpose is to efficiently allocate scarce resources available to their most efficient (and profitable) uses by providing information efficiency in the market (FASB, 1978).

    Apparently this is achieved by the user making the appropriate, buy, sell or hold decisions on their investments.

    Islamic Accounting, on the other hand, hopes to enable users to ensure that Islamic organisations (whether business, government or NFP) abide by the principles of the Shari’ah or Islamic Law in its dealings and enables the assessment of whether the objectives of the organisation are being met.

    At the very basic level, it can be said that Islamic organisations (whether business or otherwise) differ from their conventional counterparts by having to adhere to certain Shari’ah principles and rules and also try to achieve certain socio-economic objectives encouraged by Islam.

    Following from the above, the type of information which Islamic accounting identifies, measures is different. Conventional accounting concentrates on identifying economic events and transactions, while Islamic accounting must identify socio-economic and religious events and transactions.

    A few of us, older ones, might still remember when we did our first accounting or book-keeping courses, we had to do final accounts (i.e. balance sheet and trading, profit and loss account.

    However, Americanization of the curriculum has popularised the term financial statements.

    Hence, the concentration of accounting has moved from stewards manorial accounts to accounting for money (accentuated by the monetary measurement concept).

    This is not to say that Islamic accounting is not concerned with money (especially when accounting for businesses).

    On the contrary due to prohibition of interest-based income or expense, profit determination is more important in Islamic accounting than conventional accounting.

    However, Islamic accounting must be holistic in its reporting Hence, both financial and non-financial measures regarding the economic, social, environmental and religious events and transactions are measured and reported.

    Conventional accounting mainly uses historic cost (or lower) to measure and values assets and liabilities.

    The profession is well aware of the limitations of the stable unit of measure assumption of the monetary unit and to its credit has tried in the past in its inflation accounting initiatives.

    However, despite recommendation from its own research efforts (True blood committee?), the idea of using current values was given up due to its complexity and presumed lack of objectivity.

    From an Islamic point of view, at least for the purpose of computation of Zakat, current valuation is obligatory (see for example, Clarke et al, 1996) prompting calls for a current value Balance Sheet (Baydoun and Willet, 2000).

    A further difference is, Islamic accounting may require a different statement altogether to deemphasize the focus on profits by the income statement provided by conventional accounting. Baydoun and Willlet (2000) have suggested a Value Added Statement to replace the Income Statement in Islamic Corporate Reports.

    They argue that this shows and encourages a cooperative environment in business as opposed to a destructive competitive environment.

    The third category of differences is in the users of the information.

    Although the profession has recognised various stakeholders as users of accounting information (see for example, the Corporate Report, 1975), the users which it focuses on are shareholders and creditors (i.e. Financiers – those who provide the funds).

    This is obvious from the fact the FASB’s SFAC 1 dismisses a whole range of stakeholders by the term “and others”.

    From recent developments in finance and financial markets, accounting seems to be serving an elite group of financiers – market players and banks and other financial institutions.

    It has been accused of helping a group of rich people get richer (Gray et al., 1996) – a grave charge since the profession always justifies its monopoly on audit services by virtue of the public interest.

    Islamic accounting serves the whole gamut of stakeholders recognised by the corporate report, not that each group can serve its own interest best, but society as a whole can make corporations accountable for their actions and ensure they comply with Shari’ah principles and do not harm others while making money ethically and achieve a equitable allocation and distribution of wealth among members of society especially the stakeholders of the concerned corporation.

    3. Religion and accounting- an explosive mix?

    Now we come to the question, is it wise to add the adjective “Islamic” to accounting?

    Why not accounting for Islamic organisations or accounting from the Islamic perspective? The worry is that the addition of any religious adjective may compromise the objectivity of the discipline as religion is mostly seen as an unchanging dogma and code not subject to pragmatic or logical considerations.

    We will take this matter in two stages:

    a) Is conventional accounting value free and objective as it portrayed to be or is there a hidden adjective attached to it?

    b) The problem of epistemology- the nature and sources of knowledge

    What are the implicit assumptions behind the theory and practice of conventional accounting, in other words – what is the worldview behind conventional accounting?

    Some years back, European and communist states adopted a different system of accounting. In a centrally planned or a socialist state, there is a lack of profit motive or not too much of it. Hence, the conventional accounting i.e. Profit and loss account, balance sheet did not make much sense in that economic system. This is why the accounting profession never developed in the communist countries.

    It is only after liberalisation i.e. conversion to capitalism that these states are trying to catch up with the West.

    A little more reflection and we come to the conclusion that the conventional accounting system in which we were educated and work in is in fact Capitalist Accounting.

    The adjective ‘capitalist’ is not used before the word accounting, because it would not then appear neutral as capitalism is a philosophy and many ways a religion. Its sacred symbols of private property, the hudud (literal meaning the definitive borders) of the market and its God- wealth for the creation of which, business and finance exists.

    Capitalism is not only the economic system which allows choices and opportunities but a philosophy and religion which forsakes equity for efficiency and the wants of a few for the needs of the many. It can be said to be the dominant ‘religion’ of the world (both in Muslim and Non-Muslim countries).

    Hence, to call a spade, a spade, accounting should be renamed capitalist accounting, economics as capitalist economics and so forth. Hence, faculty of economics in our universities should be renamed faculty of capitalist economics. However, we do not because it is not necessary, it is assumed and implicit. Due to the non-explicitness of this assumption, we sometime forget that accounting is not objective, neutral and value-free as it is portrayed to be.

    Secondly, we discuss the problem of epistemology- the nature and sources of knowledge.

    Ever since the so-called ‘enlightenment’, science has gained the upper hand and has replaced religion as the authority in defining what is knowledge.

    Modern research emphasises positivism i.e. what is. Knowledge is only what is perceptible through our senses through observation and experiment or what appears logical to our mind. Revelation is not considered a source of knowledge as religious truths cannot be verified by our senses.

    Accounting is considered a science (many US and UK universities use MS or MSc not MA for post graduate accounting programmes) and such mixing religion with accounting may be considered unprofessional.

    However, as Chapra (2000) argues science and religion deals with different levels of reality. While sciences deal with the physical universe perceptible by the senses, religion deals with a higher level of reality which is transcendental and beyond the sense of perception.

    The sources of scientific knowledge are reason and its method observation and experiment. It describes and analyse ‘what is’ and tries to predict what will happen in the future (e.g. Forecast earnings from models).

    When dealing with the physical universe, it is exact in its description and analysis and more accurate in its predictive power (e.g. in Physics or Chemistry). However, when it deals with human beings who do not behave in a consistent manner, unlike the revolution of the planets above, its analysis is less precise and its predictions less accurate. The recent move by the SC on insisting on 10% accuracy on profit forecasts reports by accountants has given a headache for accountants as forecasting is not an accurate science as it deals with behaviour of human beings in the marketplace.

    Unlike science, religion depends on Revelation as well as reason for its knowledge. Its objective is to help transform the human condition from ‘what is’ (e.g. Enron, WorldCom) to what should be (perhaps, Johnson & Johnson under Burke). It should bring about individual and social change to conform to its worldview and values and institutions that it provides.

    The ultimate objective of both science and religion is to bring about the well-being of human beings. One addresses the physical and material while the other addresses the social, mental, emotional and the spiritual. Chapra (2000) further argues that if both of these are important, then both science and religion can better serve mankind by greater cooperation and coordination between them.

    Religion can help science by reminding it of its ultimate objectives and limitations, to use the power and mastery over the universe for well-being rather than destruction. Science can help religion by helping it realise ‘what ought to be’ by providing a better description of ‘what is’ , facilitating prediction and providing better technology for a more efficient use of all available resources.

    It can thus be seen that rather then becoming an explosive mix, the mixing of science and religion can be fruitful and in fact serve to stabilise society from the instability of a world dominated either by science or religion alone.

    4. A Prima-facie case for Islamic Accounting

    Accounting is a tool to achieve certain objectives. In order to be useful, it must be relevant to its purpose. The purpose of accounting has been extended by the American Accounting Association in 1975 (presumably concerned to promote the public interest responsibility of the profession) which defined the purpose of accounting “to permit informed decisions which will enable scarce resources to be allocated efficiently thereby achieving social welfare”.

    Hence, like it or not, the accounting profession is entrusted with the responsibility of helping to achieve social welfare by providing its services. It is common sense, that one must use the right tool for the right job. If one were to use a sledgehammer to crack a nut, we would get paste instead of nuts! Hence, Islamic accounting may be more appropriate to achieve the socio-economic and religions objectives of Islamic institutions and Muslim users.

    The diagram below (Shahul, 2001) shows the situation of match and mismatch.


    Briefly, Islamic institutions such as Islamic banks, Tabung Haji in Malaysia etc. are established to meet the socio-economic objectives of the Shariah (Islamic Law) through the implementation of an Islamic economic system.

    Hence, these institutions should logically use Islamic accounting, especially for monitoring these institutions to achieve their objectives which are different from capitalist institutions.

    However, if conventional accounting which developed to meet the needs of a capitalist economy is used instead in these institutions, a mismatch is likely.

    This will lead to the institutions not meeting the Shari’ate socio-economic objectives and even worse may turn these Islamic institutions into capitalist institutions by providing materialist profit-focused information instead of the holistic information provided by Islamic accounting.

    It can thus be seen that it is not at all unscientific or objectionable, to use Islamic accounting and would in fact be more logical to use it as it would result in an ethical based accounting system which measures not only profits but social, environmental and religious performance.

    Finally, it must be borne in mind that accounting for Islamic banks and financial institutions is not Islamic Accounting but only a subset of it. Although the efforts of AAOFI must be appreciated for developing standards for Islamic Banks, the methodology and hence the outcome is questionable. This is discussed elsewhere (see Karim, 1995).

    Islamic accounting is not the just technicalities of accounting for Islamic financial instruments employed by Islamic banks but much more requiring whole new areas of performance measurement including the social, environmental, economic and the Shariate.

    We will explore the reasons why conventional accounting is unsuitable for Islamic institutions as well as more details of what is the content of Islamic articles in later articles.


    AAA(1966), A Statement of Basic Accounting Theory, US: American Accounting Association.

    Baydoun and Willet (2000), “The Islamic Corporate Report”, Abacus, Vol. 36, No. 1, 2000.

    Chapra, U (2000), The Future of Economics, An Islamic Perspective, Leicester, UK: The Islamic Foundation.

    Clarke F., R Craig and S. Hamid (1996), “Physical Asset Valuation and Zakat: Insights and Implications, Advances in International Accounting , vol. 9., 1996.

    Corporate Report (1975), The Corporate Report, London: Accounting Standards Sterring Committee.

    FASB (1978), Statement of Financial Accounting Concept 1:Objectives of Financial Reporting by Business Enterprises, Stamford, Connecticut: Financial Accounting Standards Board.

    Gray, RH, Owens K and Maunders K (1996), Accounting and Accountability: Changes and Challenges in Corporate Social and Environmental Accounting, London: Prentice Hall.

    Karim, RAA (1995), “The Nature and Rationale for a Conceptual Framework for Financial Reporting by Islamic Banks”, Accounting and Business Research, Vol 25, No. 100, pp285-300.

    Shahul Hameed (2001), “Islamic Accounting – Accounting for the New Millenium?”, Paper presented at the Asia Pacific Conference 1, Kota Bahru, Kelantan, October 10-12, 2001.


    Dr. Seif I. Tag El-Din,

    I. Introduction
    The contemporary experience of Islamic banking is hardly more than three decades
    old, though it proved to be groundbreaking with far reaching impacts worldwide.
    Among the major challenges faced by Islamic banking experts and Shariah Scholars
    has been the idea of developing appropriate accounting and auditing standards, to
    achieve financial transparency and enhance the quality of financial service to society.

    Banking success, in general, depends on the extent of public trust placed in the
    financial strength of individual banks, particularly the trust of depositors and
    investors. In addition to the paramount importance of financial strength, trust in
    Islamic banks relates also to the extent of adherence to Shariah, which, after all, is the
    identity card of Islamic banks. One major source of public confidence is the quality
    of information issued to the investing public about banks’ ability to achieve both
    financial and Shariah-related objectives.

    Hence, developing unique accounting and auditing standards for the dissemination of
    such information about Islamic banks becomes a necessity. The need for accounting
    records as means for trust building is emphasized in the Quran : “…Never get bored
    with recording it, however small or large, up to its maturity date, for this is seen by
    Allah as closer to justice, more supportive to testimony, and more resolving to doubt,
    except when it is spot trade carried out amongst yourselves, then you are not to
    blame for not recoding it”, (al-Baqara: 2 82). Even for spot transactions where debt
    is not involved, the Quran allows an open discretion for taking records, and that is all
    what accounting is about.

    The reason why Islamic financial accounting methods and principles have to be
    carefully distinguished from their conventional counterparts is the same reason why
    Islamic banks and financial institutions has existed in the first place. Prohibition of
    interest in financial dealings is the primary reason, but there are various other issues
    and fine details which make up for the case of Islamic financial accounting standards.
    For a better appreciation of accounting issues, it is appropriate to highlight the basic
    financing and investment structure of a typical Islamic bank as adopted by the
    accounting standards.

    1/1 Core concept of Islamic bank
    As a financial intermediary, the basic mechanism of the Islamic bank is to accept
    deposits from surplus persons on the liability side and offer financing on the assets
    side to the deficit persons. The basic idea is to activate this mechanism on acceptable
    Islamic modes which preclude payment or receipt of interest and conform to the jurist
    rules of Shariah. Formal definitions of accounting elements will be provided later, as
    our intention here is only to highlight the basic mechanism.
    Liabilities & Assets. Among other things, liabilities of an Islamic bank consist of
    two main categories: the usual interest-free current accounts and saving accounts, and
    investment accounts based on the profit-and-loss sharing principle (PLS) between the
    bank and depositors. The latter is the Islamic alternative of term deposits in
    conventional banks where the principles of Mudarabah and Musharakah are adopted
    instead of the interest rate. Assets include, among other things, a broad range of
    financings: Murabaha, Ijara, Istisnaa, Salam, Mudarabah and Musharakah. It will be
    assumed in this course that the reader is familiar with these modes of financing.

    Investment structure: For the purpose of accounting standards, two major categories
    of investment activities are defined:

    Unrestricted investment accounts and their equivalents: These are funds
    received by the Islamic bank from investors whereby the Islamic bank is held free
    to invest those funds without prior restrictions, including the mixing of these
    funds with the bank’s own investment. In this case, rules of unrestricted
    Mudarabah are adopted.

    Restricted investments and their equivalents : The bank acts only as manager –
    agent or non-participating Mudarib – not authorized to mix his own funds with
    those of investors without prior permission of the investors.

    Fiduciary service for funds devoted for social purposes: The financial statements
    of Islamic bank must also reflect its functions as possible agent of Zakah payment,
    manager of charitable funds and Qard Fund.

    The above financing, investment and unique religious features have proved to reflect
    far reaching implications as regards the preparation and presentation of financial
    statements of Islamic banks. The accounting treatment of different Islamic modes of
    financing will arouse various issues of recognition, measurement and disclosure.
    Similar issues arise with respect to investments, depending on their type, where
    investors are allowed to subscribe or withdraw their funds totally or partially during
    the period of investment.

    1/2 Common grounds with conventional banks
    Apart from its detailed characteristics, Islamic accounting shares with their
    conventional counterparts the same common process of recognition, measurement and
    recording of transactions and fair presentation of rights and obligations Recognition
    of rights and obligations must apply to a given period of time tracing all changes of
    consummated transactions that may have taken place. Measurement is the
    quantification of financial effects of consummated transactions and the impact of
    other events during the same period of time. The recording process offers a lucid
    classification scheme of financial effects together with other events, in order to show
    the results of the entity’s operations and changes in its financial positions including
    cash flow. Periodic reports are, then, prepared and issued by the entities to disclose
    their financial records during a given period of time.

    Information so reported would then assist investors to take the right decisions with
    respect to their future dealings with the entity in question. It also assists the entity’s
    own management to evaluate its performance and lay future plans for the entity’s
    activities and financial services. Governmental agencies benefit a great deal from
    such reported information in the process of supervising the banking and financial
    sector and evaluating tax policies. Governmental regulatory requirements for
    conventional financial institutions are also shared by Islamic entities, like the basic
    provision of having adequate banking capital to provide safety for depositors’ money.
    Given the provision of adequate capital, success of Islamic banks depends on
    compliance with Shariah as well as the financial competence to realize rates of return
    commensurate to investment risks assumed.

    1/3 Scope of lecture:

    Due to the time constraint, we shall focus in this lecture on the following topics:

    1. Objectives of financial accounting for Islamic financial institutions
    2. Basic assumptions and criteria for Islamic accounting
    3. General lay out of Islamic financial statements.

    Therefore, accounting standards for the various Islamic modes of financing are
    beyond the scope of this brief presentation. The present lecture is based on the
    Accounting and Auditing Standards For Islamic Financial Institutions, 1997,
    published by AAOIFI (the Accounting and Auditing Organization for Islamic
    Financial Institutions). Since its establishment in 1991, the Bahrain-based AAOIFI
    has been catering its advisory services as the professional body responsible to develop
    suitable accounting and auditing standards for Islamic banks. Additional help can be
    obtained from other references Listed at the end.

    II. Objectives of financial accounting
    To achieve the desired success, accounting standards for Islamic banks should be
    developed consistently in relation to the unique objectives of financial accounting for
    Islamic banks and institutions. It is for this reason, as well as the need to ensure
    consistency among all present and future accounting standards, that the Islamic
    objectives have to be clearly specified. The setting of clear objectives for financial
    accounting of Islamic banks and institutions, as opposed to their conventional
    counterparts, will also assist Islamic banks, in the absence of accepted accounting
    standards to make sensible judgements for choice among alternative accounting

    The objectives of financial accounting determine the type and nature of information
    which should be included in the financial reports in order to assist users of these
    reports in making sound decisions. Governments agencies, generally, have the power
    to directly obtain the type of information that best serves their needs. This leaves
    external users of information limited to the common information contained in the
    Islamic banks financial reports, namely: equity holders, holders of investment
    accounts, current and saving account holders, other depositors, other dealers with
    Islamic banks, Zakah agencies and regulatory agencies. On this basis, the objectives
    of financial accounting for Islamic banks and institutions are to achieve the following:

    1. Determine the rights and obligations of all interested parties, including rights
    and obligations resulting from incomplete transactions and other events, in
    accordance with the principles of Shariah and its concepts of fairness, clarity
    and business ethics.

    2. Subscribe to the safeguarding of Islamic banks’ assets, rights of Islamic banks
    and rights of others in an adequate manner.

    3. Subscribe to the enhancement of management and Islamic banks’ productive
    capabilities, and encourage compliance with the established goals and policies,
    and above all Islamic Shariah, in all transactions and events.

    4. Provide through financial reports useful information to report users, and thus
    enable them to make legitimate decisions in their dealings with Islamic banks.

    On the other hand, the objective of financial reports are to provide the following kinds
    of information :

    1. Information about the Islamic bank’s objectives and the extent of its
    compliance with Shariah. And, if the bank is partly engaged in prohibited
    dealings, information about the separation of such dealings and how to
    dispose of them.

    2. Financial information assisting users to evaluate the adequacy of the Islamic
    bank’s capital, risks inherent in investment, and degree of liquidity for
    meeting the outstanding obligations.

    3. Information to assist in the assessment of Zakah on Islamic banks’ funds and
    the targets of its dispersal.

    4. Information about cash flows, their timing, and associated risks. This will help
    users evaluate an Islamic bank’s ability to generate sufficient dividend income
    for equity and profits for investment holders.

    5. Information to assist in evaluating the Islamic banks’ discharge of its fiduciary
    responsibility, to safeguard funds and invest them at reasonable rates of return.
    This includes information about investment rates of returns on the bank’s
    investments and the rates of return accruing to equity and investment holders.

    III. Basic assumptions and criteria for financial accounting :

    3/1 A

    Accounting unit : As per Resolution No. 65/17, 7th Session of the Fiqh
    Academy, Jeddah, 9-14 March, it is possible in Islamic jurisprudence to form
    a limited liability company. This provision allows for the treatment of the
    Islamic bank as a separate accounting unit from its owners.

    On-going concern: In the absence of persuasive evidence to the contrary,
    financial accounting assumes the continuation of an entity as an on-going
    concern. This has an important implication to Islamic banks as there is not
    perceivable time horizon of assets liquidation or investment termination in
    case of equity owners and owners of unrestricted investment accounts or their
    equivalents. In most cases there is no specific time when actual investment
    results would be known. This point will have implications for the issue of

    Periodicity: Life of the Islamic bank should be broken into reporting periods
    to prepare financial reports that provide information to interested parties about
    the performance of the bank.

    Stability of purchasing power: Financial accounting uses monetary units as a
    common denominator to express basic elements of financial statements.
    However, the use of monetary units is subject to inflationary and deflationary
    pressures which may significantly affect its purchasing power. For the
    purpose of accounting standards such effects are completely ignored.

    Qualitative Criteria of accounting information

    Usefulness: Usefulness of accounting information must be evaluated in
    relation to the objectives of presenting financial statements which are focused
    on making their external users make the best out of them. Hence, to be useful
    accounting information must target the interest of external users.

    Relevance: A close relationship must exist between the financial accounting
    information and the purpose for which this information is provided.
    Accounting information is relevant if it helps the main users of financial
    statements to evaluate the potential outcomes of maintaining, or establishing,
    relationships the given Islamic bank, rather than assisting investors to choose
    from alternative options. To be relevant, accounting information must satisfy
    three main qualities.
    Predictive value makes it possible for users to asses the potential
    outcome of a current or a new relationship with the bank.
    Feedback value assists users to check the accuracy of their prior
    predictions, say, about net income.
    Timeliness means information is only useful at the time when it is
    needed. Optimal frequency of reporting and minimal lag between
    successive reports are therefore important criteria for useful accounting

    Reliability: This is the quality which permits users to depend on the reported
    information with confidence, but reliability does not mean absolute accuracy.
    It means that based on all the specific circumstances surrounding a particular
    transaction or event, the method chosen to measure/disclose its effects
    produces information that reflects the substance of the event or transaction.
    The provision of estimates /judgements in accounting applying methods is not
    inconsistent with Shariah. Most particularly, reliability should satisfy the
    following properties of representational faithfulness, objectivity and

    Comparability: Usefulness of accounting information is enhanced by
    comparability of bank’s performance over time. This property requires the
    adoption of similar methods of measurement/ disclosure in relation to similar

    Consistency: Banks should stick as much as possible to the same
    measurement/disclosure methods from one period to another, unless there is
    genuine call for change ( e.g changing depreciation measurement). In this
    case, the new change and its effect should be appropriately disclosed.

    Understandability: Accounting information is targeted to common users not
    to accountants. The nature of information, the way it is presented and the
    technical background of external users are important factors in the preparation
    of understandable information. Use of simple classification tools, clear
    information headings, juxtaposition of data and statement of net results which
    users want to know, would contribute to better understandability.
    3/3 Recognition / measurement & revaluation criteria:
    Accounting recognition : refers to the timely recording of the basic elements of
    financial statements as they take effect, which is the reason why a clear definition of
    accounting elements must precede their recognition. It is worth noting that recognition
    relates to accounting flows rather than stocks since the stocks will, then, be
    automatically recognized. This issue is particularly crucial as regards recognition of
    assets acquired under various Islamic modes of financing , profit/loss investment
    accounts, and funds ((e.g when should Murabaha profit, or Mudarabah capital, be
    recognized ? when should investment profit be recognised, and how is it measured?).
    The rules governing recognition and measurement must be appreciated by reference
    to Shariah rules.

    Accounting measurement: refers to the determination of the amounts at which
    accounting elements should be recognized. Measurement of accounting flows requires
    the matching of incomings with the corresponding outgoings, separately, for each
    independent account during a given period of time, e,g the matching of revenues and
    gains with expenses and losses to get the bank’s net income for a given period of

    Measurable attributes: Measurable attributes of an asset or a liability fall broadly
    into two categories: cash equivalent value and historical cost. The latter stands for
    the cash value expected to be realized as of the current date if an asset is sold for cash
    in the normal course of business. The formers stands for the asset’s fair value at the
    date of its acquisition including amounts incurred to make it usable or ready for
    disposition. These two attributes invoke significant implications as regards
    measurement of assets acquired under various modes of financing. They also relate to
    the issue of revaluation of unrestricted investment accounts and restricted investment

    3/4 Issue of Revaluation
    Measurement attributes, as defined above, provide for the possibility of adopting cash
    equivalent value by the Islamic bank both as a joint investor in the unrestricted
    investment accounts and as a manager as in the restricted investment accounts.

    Justice consideration: In general, the value the holder of an investment account
    expects to realize from his funds is considerably dependent upon the cash equivalent
    value he expects to realize if investments were re-valued, or sold, as of the current
    date. Yet, the results of investments do not occur at a given point of time. Rather, such
    results are earned over the life time of the investments even though the ultimate
    results will become certain only at the time when the investments are liquidated.
    However, if investments were to be measured at historical costs, recognition of
    investment results will only take place at the time of investment liquidation. This

    point arouses a strong consideration of justice between holders of investments
    accounts since they are allowed to subscribe or withdraw their investments at different
    times during the period of the contract. In case of unrestricted investment accounts,
    justice has to be observed, not only between holders of unrestricted investments, but
    also between them as a group and the equity owners of the bank as a group.

    Revaluation of assets/liabilities and restricted investments: Measurement of cash
    equivalents expected to be realized or paid require periodic revaluation of assets
    liabilities and restricted investments. However, the currently adopted standard is that
    “ historical cost shall be the basis used in measuring and recording the assets at the
    time of acquisition thereof”. Nonetheless, it is permissible to do the revaluation for the
    purpose of presenting supplemental information which may relevant for an existing or
    a potential holder of an investment account.

    3/5 Preparation and presentation criteria:

    Materiality: An item is regarded material – qualitatively or quantitatively – if its
    omission non-disclosure or misstatement will result in distortion of the
    information being presented in the financial statements and thereby, misguidance
    of users. In deciding whether an item is material, its nature and amount must be
    taken into account.
    Qualitative materiality refers to the nature of given transactions or events
    whether it is usual/unusual, expected/unexpected, Shariah compliant/non-
    compliant, etc.
    Quantitative materiality refers to the relative amount of an item as for
    compared with normal expectations, or relative to an appropriate base.

    Cost of information: Information is a costly economic resource. Therefore, a
    process of cost/benefit analysis must underlie the decision to choose the relevant
    information for financial reporting.

    Adequate disclosure: Basic information about the bank must be disclosed, as
    well as currency used, and accounting policies adopted. More generally, financial
    statements, notes accompanying them, and any additional presentations should
    contain all material information necessary to make them useful to end users.
    Optimum aggregation and written descriptions/clarifications are two important
    Highly aggregated data conceals useful detail, and highly detailed data can
    be side-tracking and confusing. Optimal aggregation is the middle course
    which must be adopted.
    Heading captions and amounts must be supplemented information just
    enough to clarify their meanings. Supplementary notes to financial
    statement is an example.
    Based on the above assumptions and criteria, the general layout of financial
    statements can now be considered.

    IV. General lay out of Islamic financial statements :

    Islamic financial statements
    Share the same broad classification of conventional financial statements as representations of stocks and flows. The stock concept is typical of the balance sheet which provides a summary of the financial position of an entity at a given point of time. The income statement, on the other hand, provides a summary of the inflow and outflows during a given period of time, as it is measured on accrual basis. The latter is
    particularly relevant for assessing the operating efficiency of the entity, but not the sate of cash liquidity. It is for this reason that a cash-basis statement is needed to complement the flow concept of financial statements as opposed to the stock concept.

    The set of financial statements of an Islamic financial institutions consist of the

    Financial statements reflecting the Islamic Bank’s function as an investor
    and its rights and obligation regardless of the objective of investment
    whether it is profit oriented or socially oriented. Such financial statements
    Statement of financial position
    Statement of income
    Statement of cash flow
    Statement of retained earning or statement of changes in owners’

    A financial statement reflecting changes in restricted investments managed
    by the Islamic bank for the benefit of others, whether based on Mudarabah
    contract or agency contract

    Financial statements reflecting the Islamic bank’s role as a fiduciary of
    funds made available for social purposes when such services are provided
    through separate funds:
    Statement of sources and uses of Zakah and Charity fund
    Statement of sources And uses of funds in the qard fund.
    Statement of financial position:
    Disclosure & Definitions
    The date of the statement must be disclosed. The statement
    should include the Islamic bank’s assets, liabilities, equity of unrestricted
    investment account holders and its equivalents, and its owners’ equity. Assets
    and liabilities should be combined into groupings in accordance of their
    nature, and in order of their relative liquidity, but the conventional division
    into current and fixed groups is not recommended. Assets should not be set-off
    against liabilities unless there is a religious or legal right and an actual
    expectation of set-off (e.g deferred profits in Murabaha shall be set-off against
    Murabaha receivables). Separate totals for assets, liabilities, unrestricted
    investment accounts and their equivalents, and owners’ equity must be
    provided. Other considerations of disclosure will be added to their respective
    items below.

    The following definitions relate to the broad items of the
    statement of financial position.

    Assets: An assert is any measurable thing that is capable to generate cash
    flows or other economic benefits in the future, individually or in combination
    with other assets, of which the Islamic bank has acquired the right to hold, use
    or dispose of, as a result of past transactions or events.
    Disclosure of assets: The following breakdown of assets should be disclosed
    either on the face of the financial statement of financial position or the notes to
    financial statements:

    1. Cash and cash equivalent
    2. Receivables ( Murabaha, Salam, Istisnaa)
    3. Investment securities
    4. Mudarabah investment
    5. Musharakah investment
    6. Investment in other entities
    7. Inventories (including goods purchased for Murabaha prior to
    consummation of Murabaha agreement
    8. Investment in real estate
    9. Assets acquired for leasing
    10. Other investments (disclosure of their types)
    11. Fixed assets (disclosure of depreciation for significant asset types )
    12. Other assets (disclosure of significant types).

    Liabilities: A liability is any measurable present bank’s obligation to another
    party to transfer assets, extend the use of an asset, or provide services to that
    party in the future as a result of past transactions or events. The Islamic
    obligation must not be a reciprocal to an obligation of the other party to the

    Disclosure of liabilities: The statement of financial position or its note should
    disclose the following liabilities:
    1. Current accounts, saving accounts and other accounts with separate
    disclosure of each category
    2. Deposits of other banks
    3. Salam Payable
    4. Istisnaa Payable
    5. Declared but undistributed profits
    6. Zakah and taxes payable
    7. Other accounts payable

    Equity of unrestricted investment account holders and their equivalents:
    At the date of the statement of financial position, equity of unrestricted
    investment account holders (and their equivalents) refers to the amount of
    original funds received minus withdrawals or transfers to other accounts
    plus/minus shares in profits/losses. Because of they are based unrestricted
    Mudarabah, unrestricted investment accounts and their equivalents are treated
    as elements of the financial position. It is noteworthy that equity of
    unrestricted investment account holders and their equivalents is not considered
    a liability since there is no obligation on the bank to guarantee original
    principals except in cases of proven neglect. Likewise, equity of unrestricted
    investment account holders and their equivalents is not considered part of
    ownership equity because they do no enjoy voting right or entitlement to
    profits generated from the use of the bank’s current accounts.

    Disclosure of unrestricted investment accounts/equivalents: The method
    used to allocate investment profit/loss between the bank and the unrestricted
    investment account holders and their equivalents should be disclosed, whether
    the bank acts as Mudarib or agent, should be disclosed. Separate disclosures of
    assets jointly financed by the Islamic bank and unrestricted investment
    account holders and those exclusively financed by the bank should be
    provided in supplementary notes.

    Owners’ equity: It is the amount remaining at the date of the statement of
    financial position, from the Islamic bank’s assets after deducting the bank’s
    liabilities, equity of unrestricted investments and their equivalents and
    prohibited earnings if any.

    Disclosure of owners’ equity: See statement of changes in owners’ equity
    4/2 Income statement :
    Disclosure, definition and recognition :
    The period covered by the income statement should be disclosed .
    To the extent applicable, the following information should be disclosed in income
    statements with separate disclosures of investment revenues, expenses, gains and
    losses jointly financed by the bank and unrestricted investment account holders
    and their equivalents, and those exclusively financed by the bank:

    Revenues and gains from investments

    (-)Expenses and losses from investments

    (=)Income (loss) from investments

    (-)Share of unrestricted investment account holders from income (loss)
    from investments before the bank’s share as Mudarib

    (=)The bank’s share in income (loss) from investments

    (+)The bank’s share in unrestricted investment income as Mudarib

    (+) The bank’s share in restricted investment profit as Mudarib

    (+)The bank’s fixed fee as an investment agent for restricted investment

    (=/-) Other revenues, expenses, gains and losses

    (-) General and administrative expenses

    (=) Net income (loss) before Zakah and taxes

    (-) Zakah and taxes ( separate disclosures)

    (=) Net income (loss)
    Definitions & recognition:
    The following definitions and methods of
    recognition relate to the broad items of the income statement.

    Revenues : Gross increases in assets or decreases in liabilities or a combination
    of both during the period covered by the income statement which result from
    legitimate investment, trading, rendering of services, including investment
    management of restricted investment accounts. This excludes increases in assets
    or decreases in liabilities due to investment by, or distribution to owners, deposits
    or withdrawals by unrestricted account holders or their equivalents, deposits or
    withdrawals by current or non-investment account holders or the acquisition of

    Recognition of revenues: Revenues should be recognized at the time when
    realized. Realization of revenues pre-supposes the fulfilment of three main
    conditions: First, the bank should have earned the right to receive revenue through
    a completely consummated process. Second, an obligation must fall on another
    party to a remit a fixed or a determinable amount to the bank (e.g share in actual
    profit). Third, amount should be known and collectible, if not already collected.
    Expenses : They are the reverse of revenues: gross decreases in assets or
    increases in liabilities or a combination of both resulting from similar activities as
    in revenues. This excludes gross decreases in assets or increases in liabilities
    resulting from the same sources as defined for revenues.
    Recognition of expenses: Expenses are also recognized when realized, either
    because the expense relates directly to the earning of revenues that have been
    realized or because indirect cost relating to a certain period covered by the income
    statement. The latter costs could either be those providing a benefit in the current
    period but are not expected to realize reasonable measurable benefits in the future.
    Examples are management compensation, bonuses and administrative expenses
    which are difficult to allocate directly to specific services performed by others to
    the bank or specific assets acquired by the bank. Or, expenses that represent costs
    that will benefit multiple periods, like depreciation of fixed assets. These has to be
    rationally allocated to to the periods that benefit from the use of such assets.
    Gains and losses: A gain is a net increase in net assets which results from holding
    assets that appreciate in value during the period covered by the income statement
    or from incidental legitimate reciprocal (e.g sale of assets not acquired for sale) or
    no-reciprocal transfers (donations), except for non-reciprocal transfers with equity
    owners or holders of unrestricted investment accounts or their equivalents. A loss
    is a net decease in net assets which results from holding assets that depreciate in
    value during the period covered by the income statement or from incidental
    legitimate reciprocal and non-reciprocal transfers (e.g penalties by Central Bank,
    or involuntary conversion of assets- theft, destruction, etc), except for non-
    reciprocal transfers with equity holders or holders of unrestricted investment
    accounts or their transfers.

    Recognition of gains and losses: Gains/losses are recognized when realized in
    one of two possible situations: completion of a reciprocal or non-reciprocal
    transfer resulting in gain or loss, or sufficient evidence indicating reasonably
    measurable appreciation or depreciation in values of recorded assets or liabilities.
    The latter makes up for estimated unrealized gains and losses resulting from
    revaluation of assets and liabilities.

    Return on unrestricted investment accounts/equivalents: It is the share
    allocated to the holders of these accounts out of investment profits/losses as a
    result of their joint participation with the Islamic bank with the financing of
    investment transactions during the period covered by the income statement – not
    an expense (in case of profit) or revenue (in case of loss).

    Net income (net loss): It is the net increase (decrease) in owners’ equity resulting
    from revenues, expenses, gains, losses, after allocating the return on unrestricted
    investment accounts and their equivalents, for the period. It is the result of all on-
    going profit oriented operations of the bank and other events and circumstances
    affecting the value of assets held by the bank during the period covered by the
    income statement. All legitimate changes in equity are included except those
    resulting from investment by owners and distributions to owners.

    4/3 Statement of changes in owners’ equity
    or statement of retained earnings:
    Disclosure and definitions:

    The period covered by the statement of changes in owners’ equity or
    the statement of retained earnings should be disclosed.

    Statement of changes in owners’ equity: Basic elements are net income(loss),
    investment by and distribution to owners (non-reciprocal transfers). Investment by
    owners is the amount of increase in owners’ equity, while distribution to owners is
    decrease in owners’ equity. The former results from the transfer of assets, or
    performance of service, or the assumption, or payment by owners of an obligation of
    Islamic bank for the purpose of increasing their equity in the bank. The latter results
    from transfer of assets by the Islamic bank to owners , or performance of services, or
    assumption or payment of the owners for the purpose of reducing their equity in the
    bank (e.g dividends).
    Disclosure of changes in owners’ equity: The statement of changes in owners’
    equity should disclose:

    Paid-in capital, legal and discretionary reserves, separately, and retained
    earnings as of the beginning of the period with separate disclosure of the
    amount of estimated earnings resulting from revaluation of assets and
    liabilities to their cash equivalents where applicable.

    Capital contribution by owners during the period

    Net income (loss) during the period

    Distributions to owners during the period

    Increase (decrease) in legal and discretionary reserves during the period

    Paid-in Capital, legal and other discretionary reserves and retained earnings as
    of the end of the period with disclosure of the estimated amount of retained
    earnings resulting from the revaluation of assets and liabilities to their cash
    equivalents where applicable.

    Statement of retained earnings: Basic elements are net income (loss), dividends, and
    transfers to other owners’ equity accounts. The latter is a decrease retained earnings
    resulting from their transfer to legal or other reserves or to the owners’ capital
    Disclosure of changes in retained earnings: The statement of changes in retained
    earnings should disclose:

    Retailed earnings at the beginning of the period with separate disclosure of the
    amount of estimated of retained earnings resulting from the revaluation of
    assets and liabilities where applicable

    Net income (loss) for the period

    Transfer to legal and discretionary reserves during the period

    Distribution of profit to owners during the period

    Retained earnings at the end of the period with separate disclosure of the
    amount of estimated retained earnings resulting from revaluation of assets and
    liabilities to their cash equivalence where applicable.

    4/4 Statement of cash flows: disclosure & definitions
    The period covered by the cash flow statement must be disclosed.
    The statement should disclose the net increase (decrease) in cash and cash
    equivalent during the given period and the balance of cash and cash equivalent at
    the beginning and end of the period. As regards transactions and other transfers
    that do not require payment or receipt of cash and cash equivalent should be
    disclosed (e.g bonus shares, or acquisition of assets in exchange for shares in the
    equity of the bank).

    Cash and cash equivalent: Currency local or foreign which is available
    immediately as means of transacting business (Deposits with central bank, other
    Cash flow from operations: Refers to cash inflows or outflows during the period
    as a result of transactions and other events whose effects are reflected in the
    income statement of the bank (revenues, expenses, gains, losses) except for gains
    or losses resulting from the sale of assets acquired by the bank for its own use.
    Cash flows from investing activities: refer to cash outflows as a result of the
    acquisition of assets for investment including investment for the Islamic bank’s
    own use, and/or cash inflows resulting from sale of assets acquired by the bank for
    investment or for its own use.
    Cash flows from financing activities: refer to cash inflow as a result of
    investment by owners, deposits by holders of unrestricted investment accounts
    and their equivalent and deposits of the usual bank accounts (current, saving) and
    cash outflows resulting from distribution to owners or withdrawals by holders on
    the mentioned accounts.

    Statement of changes in restricted investment
    and their equivalent:

    Definitions & disclosure:

    Restricted investment accounts and their equivalents:
    Because they are
    based on restricted Mudarabah, restricted investments are not assets of the
    Islamic bank and should not be reflected in the bank’s statement of financial
    position. The bank does not have the right to use or dispose of these
    investments except within the conditions of the contract between the bank and
    holders of these accounts. The statement must show deposits and withdrawals
    by holders of restricted investments and their equivalent as of a given date.
    Restricted investment profits/losses before the investment manager share
    in profits (losses): It is the amount of net increase (decrease) in restricted
    investments before the bank’s share as Mudarib or compensation as an
    investment agent, other than the result of deposits/ withdrawals.
    The investment manager share in restricted investment profits: If the
    bank acts as agent, it gets a fixed percentage regardless of investment results,
    but no compensation is given to the bank if it acts as Mudarib.
    Recognition of restricted investment profit/loss: Restricted investments
    profit/ loses are recognized in terms of realized profits/ losses resulting from
    reciprocal and non-reciprocal transfers, or as estimated unrealized
    profits/losses resulting from the revaluation of restricted investments.

    The period covered by the statement of changes in restricted investments/equivalents
    should be disclosed. The statement should segregate restricted investments by source
    of financing ( e.g accounts or portfolio units) and by type. Disclosure should include
    the following:

    Balance of restricted accounts at the beginning of the period, with separate disclosure
    for the part of the balance which results from revaluation of restricted investment
    accounts to their cash equivalents where applicable.

    Number of investment units in each of the investment portfolios and the value per
    unit at the beginning of the period

    Deposits received or investment units issued during the period

    Withdrawals or repurchase of units during the period

    Bank’s share in investment profit as Mudarib or fixed fee as investment agent.

    Allocated overhead expense, if any.

    Restricted investment accounts profits/losses during the period with separate
    disclosure of the part resulting from revaluation to cash equivalents where applicable

    Number of investment units in each of the investment portfolios at the end of the
    period and the value per unit.

    Note to the statement of changes in restricted investments and their equivalents should

    1. Nature of contractual relationship between bank and owners of restricted investments
    – Mudarib or agent
    2. Rights and obligations associated with each type of investment account or investment

    4/6 Statement of sources and uses of funds in the Zakah
    and Charity Fund:

    Disclosure & definitions:

    The period covered by the statement of sources and uses of funds in the Zakah and
    Charity Fund should be disclosed. Disclosure should be made of the bank’s
    responsibility for the payment of Zakah on behalf of owners of unrestricted
    investment accounts and their equivalents. Disclosure should be made of payments
    and uses of funds during the period and available funds at the end of the period.
    Sources of funds in the Zakah and Charity fund: Zakah is a fixed obligation
    calculated by reference to net assets that have appreciated or have the capacity to
    appreciate in value over a specific period of time except for assets acquired for
    consumption or used in production. In the case of a limited liability company, Zakah
    should be based on the company’s net assets, and the total amount be divided between
    owners who should then their Zakah obligations personally. Otherwise, the company
    should pay out Zakah on behalf of its owners, if it is so authorized. The bank may
    also act as an agent of Zakah or other charitable contributions for its various
    accounts’ holders and other parties.
    Uses of funds in the Zakah and charity fund: These are the eight categories stated
    in the Quran ( al-Tawaba: 56)
    Fund balance in Zakah and Charity fund: Refers to outstanding funds which have
    not been distributed as of a given date.

    4/7 Statement of sources and uses of funds in the Qard Fund:

    Qard is a non-interest bearing loan allowing borrower to use the loaned funds for a
    specific period of time such that the same amount of loan should be returned to lender
    at the end of the period – a means of achieving social objectives.
    Sources of funds in the Qard fund: Represent gross increase in funds available from
    both external and internal sources for lending during the period covered by the
    Uses of funds in the Qard fund: Represent the amount of gross decrease in funds
    available for lending during the period covered. It includes new loans granted,
    repayments of funds previously provided to the fund by individuals on a temporary
    basis, and reimbursements of funds made available to the funds by the Islamic bank
    from current accounts or prohibited earnings.
    Fund balance in the Qard fund: The outstanding collectible loans and the other
    funds not loaned or used for other purposes.

    The period covered by the statement of sources and uses of funds in Qard Fund
    should be disclosed. The above define items should all be disclosed.


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