Accounting Issues _Islamic Banks

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Transcript of Accounting Issues _Islamic Banks

ISSUES IN ACCOUNTING STANDRADS:FOR ISLAMIC FINANCIAL INSTITUTIONS Markfield Institute of Higher Education Dr. Seif E. I. Tag El-Din, October, 2004

Introduction Banking success : public trust placed in individual banks (depositors/ investors). Trust in Islamic banks: also relates to the extent of adherence to Shariah ( the identity card of Islamic banks). Source of public confidence: quality of information both financial strength and Shariah adherence.

Imperative need for Accounting Standards Emphasis of the Quran: ...Never get bored with recording it, however small or large, up to its maturity date, for this is seen by Allah closer to justice, more supportive to testimony, and more resolving to doubt..

Imperative need for Accounting Standards An open room for making appropriate accounting judgement: except when it is spot trade carried out amongst yourselves, then you are not to blame for not recoding it, (al-Baqara: 2 82).

General Plan:

1. Key Concept of an Islamic Bank 2. Objectives of Islamic financial accounting 3. Basic Accounting assumptions and criteria 4. General Layout of Islamic Accounting Financial Statements

I. Key concept of Islamic bank 1. 2.

Mechanism: accept deposits and offer financingsplus other banking/ investment services.

Compliance to Shariah: interest rate eliminationplus alternative Islamic modes.

PLS investment alternatives:Unrestricted investments. Restricted investments.

Fiduciary service for funds devoted to social purposes : Zakah, Charitable funds.

Key Concept of Islamic bank: Balance Sheet Assets Side : Physical assets plus interest-freefinancial assets: Murabaha, Ijara, Istisnaa, Salam, Mudarabah, Musharakah etc.

Liability side : 1. Liabilities: interest-free demand deposits, interestfree saving deposits- no fixed return term deposits. 2. Unrestricted investment accounts : The Islamic alternative of term deposits.

3. Net, worth 4. minority interest

Islamic Banks Processing of rights and obligations Recognition timely recording of the basicelements of financial statements as they take effect .

Measurement - quantification of financialeffects

Recording - lucid classification scheme offinancial effects

Presentation - periodic reports to disclosefinancial records during the given period of time.

II. Objectives of financial accounting.Why to identify unique objectives? 1. Ensure consistency with the objectives of Islamic accounting standards. 2. Ensure internal consistency for all present and future standards 3. Provide general guidance for choice among possible alternatives.

Objectives of financial accounting.1. Determine rights and obligations of all interested parties in accordance with the principles of Shariah. 2. Subscribe to the safeguarding of the Islamic banks assets, its rights and the rights of others. 3. Subscribe to the enhancement of managerial and productive capabilities of Islamic banks. 4. Report useful information to users, thus enabling them to make legitimate decisions in their dealings with Islamic banks.

Users of Financial Reports 1. 2. 3. 4. 5. 6. Focus must be placed on non-authoritative common information needs. Appropriate Users of information are Equity holders Investment account holders Current and Saving Account holders Other dealers with Islamic banks Zakah Agencies Regulatory agencies

Objectives of Financial Reports: Information about Islamic banks extent of compliance with Shariah. Information about adequacy of Islamic banks capital, investment risks, and liquidity. Information about cash flows-timing/risks. Information about Banks policy in Zakah assessment and disbursal. Information about Banks fiduciary responsibilities. Information about discharge of other social responsibilities.

II. Basic assumptions and Criteria: The assumptions Accounting unit : treatment of an Islamic bank asa separate accounting entity from its owners

On-going concern: no perceivable time horizonof assets liquidation or equity/ unrestricted investment termination. Consider the far reaching consequences !

Periodicity : breaking life of the Islamic bank intoreporting periods

Stability of purchasing power. Theaccepted standard is to ignore changes in the value of money.

Qualitative Criteria of accounting information Usefulness : in relation to given financial reporting objectives . Relevance: Predictive value, Feedback value and Timeliness Reliability : reflect the substance of the event or transaction. Comparability: similar methods of measurement/ disclosure in relation to similar events. Consistency: same measurement/disclosure methods from one period to another. Understandability : simple classification tools, clear information headings, juxtaposition of data and statement of net results which users want to know,

Preparation and presentation criteria: Materiality: Qualitative as opposed toQuantitative materiality

Cost of information : Information is acostly economic resource.

Adequate disclosure : Optimumaggregation and written descriptions/ clarifications :

Measurement and Revaluation Accounting measurement: the determinationof the amounts at which accounting elements should be recognized matching.

Measurable attributes: fall into two categories:cash equivalent value and historical cost.

Justice consideration: value of an investmentaccount is dependent upon its expected cash equivalent value.

Issue of Revaluation Revaluation of assets/liabilities :Measurement at cash equivalents require periodic revaluation of assets liabilities and restricted investments.

Currently adopted standard:

historical cost shall be the basis used in measuring and recording the assets at the time of acquisition thereof.

General lay out of Islamic financial statements : Basic classification as of conventional statements: stocks and flows. Balance sheet: snap shot of stocks at a givenpoint of time financial position.

Income statement: moving film; summary ofinflow and outflows during a given period of time - accrual basis.

Cash-flow statement : moving film; cashbasis statement of inflows and outflows. .

Main categories of Islamic financial statements :1. Financial statements reflecting the Islamic Banks function as an investor . 2. A financial statement reflecting changes in restricted investments managed by the Islamic bank Mudarib /Agent. 3. Financial statements reflecting the Islamic banks role as a fiduciary of funds for social purposes.

Islamic Banks function as an investor Statement of financial position Statement of income. Statement of cash flow. Statement of retained earning / or statement of changes in owners equity.

Statement of financial position: Disclosure: Date of the statement Grouping of Assets and Liabilities in accordance of their nature, and in order of their relative liquidity. No current/ fixed groupings. Separate totals for Assets, Liabilities, Unrestricted Investment Accounts and their equivalents, and Owners Equity.

Statement of financial position: Definitions: Assets: an asset is a measurable thing capable to generate cash flows or other economic benefits in the future, individually or in combination with other assets. Islamic bank must have acquired the right to hold, use or dispose of, as a result of past transactions or events.

Statement of financial position: Definitions: Liabilities: A liability is a measurable present banks 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. Islamic banks obligation must not be a reciprocal to an obligation of the other party to the bank.

Statement of financial position: Definitions:Unrestricted Investments and their equivalents (Unrest. part. bonds): Treated as elements of financial position, because they are based on unrestricted Mudarabah. Not considered a liability. Why ? not considered part of ownership equity because they do no enjoy ownership rights (e.g voting right)

Statement of financial position: Definitions Owners equity: It is the amount remaining at the date of the statement of financial position, from the Islamic banks assets after deducting the banks liabilities, equity of unrestricted investments and their equivalents Prohibited earnings if any, must also be deducted.

Statement of financial position: Assets Disclosure : Cash and cash equivalent Receivables ( Murabaha, Salam, Istisnaa) Investment securities Mudarabah investment Musharakah investment Investment in other entities

Statement of financial position: Cont. Assets Disclosure: Inventories. Investment in real estate Assets acquired for leasing Other investments (disclosure of their types) Fixed assets (disclosure of depreciation for significant asset types ) Other assets (disclosure of significant types).

Statement of financial position: Liability Side

Liabilities Equity of unrestricted investment account holders and their equivalents. Owners equity:

Statement of financial position: Liability Disclosure Current accounts, saving accounts and other accounts with separate disclosure of each category Deposits of other banks Salam Payable Istisnaa Payable Declared but undistributed profits Zakah and taxes payable Other accounts payable

Statement of financial position:Unrestricted investment accounts: Disclosure

Method used to allocate profit/loss between the bank and unrestricted investment account holders. Assets jointly financed by the Islamic bank and unrestricted investment account holders and those exclusively financed by the bank .

Income statement : Defin