A Comparison Between Reporting of Conventional Leasing and Islamic Leasing

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Transcript of A Comparison Between Reporting of Conventional Leasing and Islamic Leasing


AbstractAll over the world financial institutions are striving to serve their customer in a better way. In this era of competition Islamic finance and banking present new product in front of customers which is according to SHARIAH compliances and capturing a large market of Islamic communities this study focused at Ijarah and conventional lease the two characteristics of conventional and Islamic banks and also looks at how they are accounted and treated under AAOIFI and IAS respectively. The paper discusses similarities and differences between Ijarah and conventional leasing in detail under AAOIFI and IAS.

ObjectiveThe main objective of this study is to provide a better detail overview of difference between Islamic banking and conventional banking for Ijarah and conventional leasing and to find out the differences and similarities between Ijarah and conventional lease and accounting and treatment of both type leases.

MethodologyThe report is compiled after analyzing and studying numerous characteristic of Ijarah and conventional lease contracts from different sources including internet, research papers online journals and websites of different banks and books.

Research limitationsInformation provided in this paper is purely subjective and it is not backed by any statistical analysis and empirical evidence.


There are two types of banking system 1. Islamic banking system 2. Conventional banking system

Islamic banking system:Islamic banking system is a system that is according to principle of Islamic shariah and operates according to guiding principles of Islamic economics. In Islamic law interest is not allowed payment and collection of interest (riba) and usury is also prohibited in Islamic laws. Islamic law also prohibits investments and trading in businesses which considered as unlawful financially risky.

Conventional banking system:Conventional banking system truly based on this principle you can get more if you have more or more you have more you can get and little you have little you get and if you have nothing you get nothing. Conventional banking system suffered a lot in case of delaying in repayment from loan taker conventional banking system charged on loan or debt on monthly installment and penalty is also charged in case of late payment. Islamic banking system vs conventional banking system: Major difference between conventional and Islamic banking system is Islamic law (shariah) does not allowed interest and people are forbidden to take profit or extra amount above principle amount that is being lend without acquiring certain level of risk. To double the amount that is being invested is forbidden and it is been asked to equally share gain between the investor and manger who provide expertise. In Islamic banking system risk and liability is beard by the banks in transactions with customer while in conventional banking system risk is eliminated liability is not taken instead take interest

from customer taking benefit of interest without bearing liability is considered as Haram in Islam. . Principles of Islamic and conventional bank: 1) Interest based transaction is not present. 2) Economic activities like oppression commonly called zulm and speculation called gharar is avoided. 3) Production of goods and services which violate Islamic law is strictly prohibited and considered haraam. 4) Islamic tax called zakat is practiced Islamic banks. Conventional banking system based on the principle of debtor and creditor relationship and interest is charged because it is considered as opportunity cost of money or price of credit. Islamic banks functions, activities and method of operating guided by Islamic shariah and based on Islamic principles. On the other hand conventional bank modes of operating and functions extracted from solely manmade Principles.

Distinguishing features or characteristics of conventional or Islamic banks shown as below that create border line between two banking systems. I. Risk bearer:

In case of conventional banks investor is assured that he will get fixed or previously decided interest rate and no risk is beard by investor. While in Islamic banks risk is shared between investor and manager of funds. II. Profit:

The main purpose of conventional banks is to maximize profit and aims at getting more money that is being invested without any restrictions

Islamic banks are subject to Islamic law and Islamic law restrictions in maximizing profits they have to follow shariah for earning profits. III. Zakat:

Islamic banks provide service of zakat collection and have zakat collection centres for this purpose through which they also pay zakat. Conventional banks have no concerned with zakat and does not provide this service. IV. Basic function:

Islamic banks fully aware of their customer business and understand their customer business because their Basic function is participation in partnership business. The basic function of conventional banks is to lend and get money back including compounding interest. V. Penalty:

In Islamic banks no extra amount is charged for late payment or in case of defaulter customer is asked to pay certain amount for charity. Conventional banks charged compounded interest or extra money for late payment or in case of defaulter. VI. Growth with equity:

The goal of Islamic banks is to make sure growth with equity focused on public benefit or interest. Conventional banks does not make sure growth with equity and Usually focused on their interest. VII. Borrowing money:

It is easier for commercial banks to borrow money from market that is based on interest. For conventional banks it is not easy because they have to carry out transaction that is according to shariah. VIII. Project appraisal:

In Islamic banks lots of importance is given and work is being done on appraisal and development of project because profit and loss are shared equally. An Islamic bank does not give much attention towards project appraisal and developing projects because they have fixed income coming out of loan or advances. IX. Emphasis:

Islamic banks are more interested and care about viability of projects and emphasis greatly on projects. On the other side conventional banks care about credit worthiness of their clients or borrower and much concerned about good borrower. X. Relationship:

Relationship that exists between clients and bank in case of conventional banking system is borrower and lender or debtor and creditor. In case of Islamic banks this relationship takes form of investor and trader or partner or as buyer or seller. XI. Guarantee of deposits:

Islamic banks provide guarantee of repayment of funds to their clients in case of al-wadiah only called deposit account but client have to equally share profit and loss in case of account based on mudarabah. Guarantee is being provided in all deposits by conventional banks.

AAOIFIINTRODUCTION AAOIFI stands for accounting and auditing organization for Islamic financial institutions. it is autonomous nonprofit organization that develop and set shariah standards or accounting, auditing governance and rules and regulations for Islamic industry and institutions. This independent international organization including central banks, Islamic financial institutions, participants

from Islamic banking and finance sector and have 200 members from 45 countries was registered on 27 marches in 1991 in Bahrain and created on 26 February 1990 in Algiers as a result of agreement signed by Islamic financial institutions. Islamic countries supported implementation of AAOIFI and issued guidelines based on standards of AAOIFI including Pakistan and Saudi Arabia and South African countries. From the commencement of AAOIFI it has issued 80 standards including 26 accounting, 5, auditing 40 shariah, 7 governance, 2 codes of ethics. The main difference between IAS and AAOIFI is IAS has not specified industry it is for all economic and social activities. And it is type specific for accounting only. While AAOIFI is not type specific cover 1) accounting 2) shariah 3) auditing 4) governance and ethics based on shariah and industry specific it is for Islamic finance sector only.

Purpose of Establishing AAOIFI:First reason of establishing AAOIFI is AAOIFI established standards specifically for Islamic financial institutions that is not counter by IASB or IFRS and could not be followed by IFI which is set by IFRS and IASB like in the case of investment account funds and ijarah in Islamic financial institutions which is treated differently under IASB and AAOIFI.

Literature Review

We have studied different articles and research papers consult with journals and books regarding Ijarah and conventional lease for literature review. On the basis of which we have concluded this report cracks of these articles and research paper is as follows. Mohamed Ibrahim and Shahul Hameed in their research paper IFRS VS AAOIFI the clash of standards. said that Islamic leasing contract cannot be capitalized in customer books because it is according to shariah compliance and requirements result is asset which is leased depreciated

in bank books which is opposite to IAS 17(Iv) and because of contradicting functions of Islamic banks with these standards Islamic banks could not follow IAS 30. There is huge difference exists between both standards and it will exist in future as well. Differential structural objective is the reason of difference between these two standards AAOIFI purpose is to develop standards while IFRS is not fulfill shariah requirements and there is social, legal and economical difference exists between Islamic and conventional banks functions and standards.

Ros Aniza Moh