Accounting and Control for Islamic Financial Institutions (FIN 6650)

Article Review

Prepared for:

Dr. Noraini Mohd. Ariffin

By:Afifuddin Baharuddin (G 0933213)Sazali Mohd Morshid (G0938039)Rina Izzati Raduan (G0933792)

WOULD THE OBJECTIVES AND CHARACTERISTICS OF ISLAMIC

ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS MEET THE ISLAMIC

SOCIO-ECONOMIC OBJECTIVES?

Jurnal Akuntansi & Auditing Indonesia (Volume 8, No.2, December 2004 )

By Rizal Yaya

(Department of Accounting, Muhammadiyah University of Yogyakarta)

Coverage

OBJECTIVES OF ARTICLE

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIES

INAPPROPRIATENESS OF CONVENTIONAL ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS

APPROACHES IN DEVELOPING ISLAMIC ACCOUNTING

OBJECTIVES OF ISLAMIC ACCOUNTING

CHARACTERISTICS OF ISLAMIC ACCOUNTING

OBJECTIVES OF ARTICLEExplores the objectives and characteristics of

what is perceived as Islamic accounting and try to evaluates its problems in meeting the Islamic socio-economic objectives.

Section one - elaborates on the characteristics of Islamic business activities,

Section two - inappropriateness of conventional accounting for Islamic business organizations.

Section three - approaches to developing Islamic accounting system will be evaluated.

Sections four and five - discuss and evaluate the objectives and characteristics of Islamic accounting respectively.

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIESPromotion of ‘Adala (Justice)

Command from Allah in 6:152 & 5:9"And come not near to the orphan's property, except to improve it, until he (or she) attains the age of full strength; and give full measure and full weight with justice. We burden not any person, but that which he can bear. And whenever you give your word (i.e. judge between men or give evidence, etc.), say the truth even if a near relative is concerned, and fulfill the Covenant of Allah, This He commands you, that you may remember.” (6:152)

“Allah has promised those who believe (in the Oneness of Allah - Islamic Monotheism) and do deeds of righteousness, that for them there is forgiveness and a great reward (i.e. Paradise).”(5:9)

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIES, cont.Promotion of ‘Adala (Justice), cont…

Prophet (pbuh) has also reemphasized the importance of practicing justice and has sternly warned against tolerance to injustice.(Group Note: Unfortunately, no Hadith was quoted on this by the writer)

Be just & truthful while bearing witness Be just & truthful while settling dispute; even

among adversary Not allowed to exploit & be exploitated

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIES, cont.Promotion of ‘Adala (Justice), cont…

Principles to ensure justice in business transactions: Put contract in writing Have witness to the contract Individual responsibility

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIES, cont.Promotion of ‘Adala (Justice), cont…“O you who believe! When you contract a debt for a fixed period, write it down. Let a scribe write it down in justice between you. Let not the scribe refuse to write as Allah has taught him, so let him write. Let him (the debtor) who incurs the liability dictate, and he must fear Allah, his Lord, and diminish not anything of what he owes. But if the debtor is of poor understanding, or weak, or is unable himself to dictate, then let his guardian dictate in justice. And get two witnesses out of your own men. And if there are not two men (available), then a man and two women, such as you agree for witnesses, so that if one of them (two women) errs, the other can remind her. And the witnesses should not refuse when they are called on (for evidence). You should not become weary to write it (your contract), whether it be small or big, for its fixed term, that is more just with Allah; more solid as evidence, and more convenient to prevent doubts among yourselves, save when it is a present trade which you carry out on the spot among yourselves, then there is no sin on you if you do not write it down. But take witnesses whenever you make a commercial contract. Let neither scribe nor witness suffer any harm, but if you do (such harm), it would be wickedness in you. So be afraid of Allah; and Allah teaches you. And Allah is the All-Knower of each and everything” (2:282).

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIES, cont.Promotion of Ihsan (Benevolence)

Good behavior or an act that benefited others without expecting return

Practices in business that result to Ihsan: Leniency; Motives to serve others by considering their needs &

interests, helping others, support good cause Consciousness of Allah & His priorities

CHARACTERISTICS OF ISLAMIC BUSINESS ACTIVITIES, cont.Promotion of Ihsan (Benevolence), cont…

Priorities include: to prefer the great and everlasting rewards of the

Hereafter to the finite benefits of the present world To prefer that which is morally pure to that which is

impure and to prefer what is lawful to that which is not

INAPPROPRIATENESS OF CONVENTIONAL ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS

Contradictions to Islamic Teachings Conventional accounting as scorekeeper of performance &

does not take into account the harm caused by the business

Caused by decision usefulness objectives Focus on informational efficiency from shareholders perspective

which may not be efficient from others such as employees, government and community

Operates under assumed liberal economic society in which increasing gap between rich & poor is not questioned, no room for environment & ethical values, self-interest

Bias to country that developed the capital market & sometimes does not make any socio or economic sense.

INAPPROPRIATENESS OF CONVENTIONAL ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS, cont...Contradictions to Islamic Teachings, cont…

Utilized for enrichment of shareholders & creditors at the expense of damaging society & environment Concept of historical cost & conservatism can be misleading &

cannot guarantee justice & honesty with the information that it carries

Conservatism distorted data & non-disclosure of relevant information

Monetary Unit concept unable to serve as just & honest unit of account money as an inequitable standard of deferred payments an untrustworthy store of value encourage some people to be unfair to others

INAPPROPRIATENESS OF CONVENTIONAL ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS, cont...

Contradictions to Islamic Teachings, cont… Realization Concept

Earning process for revenues should be known & collectible to a certain degree

Unfair to withdrawing depositors who may lose part of future profit if they withdrew prior to full liquidation of the project

Going concern Concept There is something else other than Allah that will live

continuously.

INAPPROPRIATENESS OF CONVENTIONAL ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS, cont...• Irrelevance of Conventional Accounting to Islamic

Accounting Objectives Matching Concept

Preference to revenue-expense approach rather than asset liability approach

Accountability through zakat only works with asset liability approach

Objectivity Concept More relevance to secondary objective to facilitate in

making economic decision to suit own interest Not relevant to Zakat accountability

INAPPROPRIATENESS OF CONVENTIONAL ACCOUNTING FOR ISLAMIC BUSINESS ORGANIZATIONS, cont...• Insufficiency of Conventional Accounting in Achieving Socio-economic

Objectives Main accounting reports are still important to Islamic accounting but

not sufficient Other type of information needed to reflect accountability to Allah &

accountability to Men Reference to overall objective of Shariah & not user’s rights & needs Additional disclosure to obtain socio-economic objective:

True figures of Zakat payable Extend of justice and benevolence Treatment of employees Impact on environment Adherence to Islamic code of ethics

APPROACH IN DEVELOPING ISLAMIC ACCOUNTING

• Deduction from Islamic Teachings Approach Establishing objectives based on principles of

Islam & its teachings Match with contemporary accounting thought as

long as do not breach Shariah precepts and deemed appropriate to Islamic business organization

Minimize influence of secular accounting theory on the objective to be developed

However, from theory to practice may be difficult in today’s reality

APPROACH IN DEVELOPING ISLAMIC ACCOUNTING, cont…

• Contemporary Accounting Based Approach Adopts existing Western objectives that are

appropriate to Islamic business Excludes those violating Shariah Focuses on moral dimensions currently absent Deals with actual functioning institutions & is

practical Concept of Ibaha – permissible until explicitly

prohibited Concentrate only on those not currently available

e.g. treatment of Musharakah

APPROACH IN DEVELOPING ISLAMIC ACCOUNTING, cont…

• Contemporary Accounting Based Approach, cont… Critics:

Not suitable for society that have revealed doctrines that governs all social, economic and politic aspects

Partial approach to Islamization Deceptive as still maintain un-Islamic

assumptions & retain norms & hypotheses of original model albeit modification to accommodate Islamic components

APPROACH IN DEVELOPING ISLAMIC ACCOUNTING, cont…

• Hybrid Approach Combination of the first two approaches & addresses the

shortcomings Steps:

Identify ethical & accounting principles of Shariah in relation to business activities and compare with current practice

Identify primary & secondary objectives according to Islamic ethical principles

Considering development of socially related reporting that cannot be ignored by modern accounting

Identify theoretical foundation Identify user and information that they need

OBJECTIVES OF ISLAMIC ACCOUNTING• Decision Usefulness

Information which is useful to users Current objective may still be compatible but some

modification Examples: AAOIFI SFA No.1 for financial institutions:

Compliance with Shariah requirements Economic resources & obligations & effect of transactions Information on determination of Zakat Estimation of cash flow that can be realized, timing and risk

associated with it Discharge of Fiduciary duty to safeguard fund & investment Discharge of social responsibility

OBJECTIVES OF ISLAMIC ACCOUNTING, cont…

• Stewardship Safeguarding of the assets Enhancement of managerial and productive

capabilities Compliance to established goals and policies Focus for external reporting Discharge of stewardship duty by management to

shareholders for the use of company resources Efficient & profitable use

(remark: no emphasis given on the stewardship to Allah, the ultimate master)

OBJECTIVES OF ISLAMIC ACCOUNTING, cont…

• Accountability Duty to provide an account or reckoning of

those actions for which one is held responsible

Principal –agent relationship Two parts:

Responsibility to undertake certain actions To provide an account of these actions

OBJECTIVES OF ISLAMIC ACCOUNTING, cont…• Accountability, cont…

Accountability through Zakat Ultimate accountability to Allah Zakat maximization vs. profit maximization Achieving social welfare(remark: the writer is not convinced)

Islamic Accountability Trust given by Allah Concept of Khalifah (primary) Secondary accountabilities include:

Duty between manager & institutions Identify, measure & report socio-economic activities Shariah compliance & Zakat Distribution of wealth

CHARACTERISTICS OF ISLAMIC ACCOUNTING

• Financial Measurement Aspects Zakat as measurement tools

Zakat is a concept of asset measurement in Islam Zakat is the pillar of Islam Development of accounting in early Muslim state is closely related to Zakat

Muslim jurists: zakat based on prevailing price necessitate the application of current costing rather than historical costing

Conservatism principle need to be relooked: move to selection of accounting techniques with most favorable impact on society rather than owner (e.g. better to overestimate Zakat)

Current Value + Historical Cost may also be possible (though the writer is not in favor)

CHARACTERISTICS OF ISLAMIC ACCOUNTING, cont…

• Disclosure and Presentations Aspects Fulfillment of duties & obligations in accordance to Shariah

To also disclose prohibited transactions undertaken Zakat obligation need to pay & paid Social responsibility: charity, wages to employees & environment

protection

Social accountability & full disclosure Current value balance sheet Income statement as notes Incorporation of Value Added Statement (VAS) Transparency & avoid manipulation

WRITER’S CONCLUSION

it would also be appropriate to direct an Islamic accounting system towards the achievement of the Islamic socioeconomic objective of falah. Hence, in designing an Islamic accounting system, its objectives and characteristics should be able to direct the enterprise not only to provide a true picture of the enterprise but also to encourage them to be Ihsan (benevolence) and discourage them from being unjust. Based on the previous discussion, it is shown that some of the proposals for the objective and characteristics of Islamic accounting have doubtful ability to achieve the Islamic socio-economic objectives.

GROUP OBSERVATIONS & COMMENTS Since the title ask the question related to socio-

economic objectives, it would be beneficial to the reader if this aspect is firstly defined

The quotes and reference made to other materials formed large portion of this article which limit the view of the writer himself

The group believes that major part of the arguments are referring to goals and objectives of business organization as a whole. Once these are re-aligned to goals and objectives of Shariah, major part of the so called conventional accounting problems can be resolved

The conclusion to this article has not really answered the title of this article