BWFS 3023 ISLAMIC ACCOUNTINGSCHAPTER 7

ACCOUNTING FOR ZAKATAINI NUR HAJJAR BT KHAIROL NIZAM SYAMILA BT MANSOR NORDIYANA BT MANSOR NOORHAFIZA BT ROSLI 207661 207705 207844 207869

INTRODUCTION

MEANING OF ZAKAT: Literal meaning (Arabic word): 1. Growth or increase- by giving Zakat will increase in prosperity in the world and religious merit in hereafter. 2. Cleansing and purification- purifies from sins take from their property to (sadaqah) in order to purify them.verse 9:104

Legally meaning: Zakat means transfer of ownership of specific wealth to specific individual or individuals under specific conditions. General meaning: A compulsory levy on imposed on the Muslims so as to take surplus money or wealth from the comparatively well to do members of the Muslim society and give it to the destitute and needed.

Zakat is one of the five pillars of Islam. Just as Solat is the most important act of worship which have to be perform bodily, Zakat is the main act of worship to be perform monetarily. Those who fulfill his duty have been promised abundant rewards in this world and hereafter and whoever evades Zakat has been sternly warned in the Quran and Hadith of the consequences The payment of zakat means the Muslim has obeyed Allah, and it also functions to check the individuals against unwelcome trait of greed. Zakat is part of a social system of Islam which act as mechanism for distribution of wealth,

ZAKAT VERSUS TAXATIONZAKAT Source of regulations is shariah. TAXATION Source of regulations is determined by the government of the time.

Levy sanctioned by God only on the Muslims.Rates and distribution are specified. Both zakat avoidance and evasion are not in line with the true spirit of zakat. Compliance is voluntary and noncompliance is subjected mainly in the Hereafter.

Levy sanctioned by government on its citizens.Rate and distribution is subject to government fiscal policy and changeable. Tax avoidance is allowed but tax evasion is an offence. Non-compliance is punishable offence according to the tax law.

Integral part of social security Source of public finance and system and part of a broder Islamic tools of states fiscal policy.

ZAKAT VERSUS TAXATIONNo such transfer of zakat burden. If not efficiently handled, tax burden may be shifted to the public, which in turn may adversely affects the economy. Focuses mainly legal and economic implications. A financial responsibility towards state.

Spiritual implications and mode of worship. Religious duty and the payer pays zakat as an act of submission to God.

FIQH OF ZAKATThe sources of obligation to pay Zakat are highlighted in many verses of the Al-Quran. Verse 110 in Surah Al-Baqarah has mentioned,

And establish prayer and give zakah, and whatever good you put forward for yourselves you will find it with Allah. Indeed, Allah of what you do, is Seeing. (2:110)

In Al-Quran, Surah AL-Bayyinah, verse 5,

"And they were commanded not, but that they should worship none but Allah alone and perform the salah and give zakat, and that is the right religion .(98:5)

ZAKAT HAS TO PAY TO SUPPORT SPECIFIC CATEGORIES PEOPLEIn Al-Quran, Surah At-Taubah, verse 60, Allah has explained that: The alms are only for (1) the poor and (2) the needy, and (3) those employed to administer the Zakat, for (4) those whose hearts are to be won over, and for (5) freezing of human beings from bondage, and (6) those who are burdened with debts, and for (7) every struggle in Gods cause, and for (8) the wayfarer: this is the ordinance from Allah and Allah is all knowing and full of wisdom.

8 ASNAF ZAKAT RECIPIENTS

1)FAKIR One who has neither material possession nor means of livelihood. One who suffers and has no means to sustain his/her daily needs. 2) MISKIN One with insufficient means of livelihood to meet his/her basic needs.

3)AMIL One who is appointed to collect Zakat and the expenses incurred in the administration of Zakat.4)MUALLAF One who recently embraced Islam.

5)RIQAB One who wants to free himself from the bondage or shackles of slavery. 6)GHARIMIN One who is in debt but needs assistance to meet his/her basic needs. 7)FISABILILLAH Those who strive in the cause of Allah for betterment of the community. 8)IBNUSSABIL (Musafir) Stranded travelers on a permissible journey.

TYPES OF ZAKAT

Zakat FitrahZakat on each person Where the payment can be made throughout the month of Ramadhan but must be before the start of Aidilfitri prayer.

Zakat on WealthA religious levy on wealth. No stipulated time and depend on the amount of wealth the giver has.

Zakat should only be collected from various types of wealth. The types of wealth mentioned by the Quran were used by the people during the time of Prophet Muhammad to store and create wealth. These traditional wealth are as follows:

1) The Agriculture Produce (dates, wheat and etc.) Surah Al-Anam, verse 141 2) Mineral and marine wealth (gold and silver) Surah Al-Baqarah, verse 267 3) Gold and silver (including jewellery and money) Surah At-Tubah, verse 35 4) Trade wealth Surah Al-Baqarah, verse 267 5) Livestock wealth (camels, sheep, etc.) Surah An-Nahl, verses 5-7

Modern WealthThese wealth derived from secondary sources of Syariah, Ijtihad, Ijma and Qiyas of Contemporary Ulama. These modern wealth may include:

1) Income (salaries and wages) 2) Financial Securities (shares and bond) 3) Islamic Financial Institution ( banks, insurances) 4) Business 5) Savings 6) Gold and Silver 7) Agriculture 8) Livestock

OBLIGATORY CONDITIONS FOR ZAKAT ON WEALTHMuslim 2. Full ownership of assets 3. Completed nisab (The minimum amount of wealth liable to Zakat) 4. Completion of haul (Wealth must be owned for one full year before it liable to Zakat)1.

The Rates of ZakatOnce the properties reach nisab, they will subjected to 4 types of rates: 1) 2.5% from capital income, trade wealth, money, gold etc. 2) 10% agriculture produce / 5% if the produce irrigated by machinery. 3) 20% of treasure trove (harta karun) 4) Zakat for livestock according to detailed code of rates.

FUNDAMENTAL PRINCIPLES OF ZAKAT ACCOUNTING ON WEALTHIn order to pay the Zakat, the wealth must be individually and legally owned. 2) Wealth must be assessed based on its current or market value. 3) In assessing Zakat, method of computation must be agreed upon by both parties (Zakat collection and Zakat payer). 4) Zakat payer must disclose all his/her financial facts.1)

Assets Subjected to Zakato you who believe! give away some of the good things you have earned and some of what the earth produces (chapter 2: verse 267)

assets acquired for trading (marketable securities) financing assets (mudharabah, musyarakah, salam) Gold and silver cash and cash equivalents receivables (net of provision for doubtful debts)

General conditions for all zakatable assets

Ownership The subject matter of Zakat must be in the complete ownership of the payer. If someone possesses an asset but does not own it, Zakat is not liable for him or her. Potential of growth The asset must have the potential of growth as the word Zakat itself means Growth or Increase. Asset must be in excess of basic necessity The subject matter of Zakat should be other than the basic necessities of a person. So the assets included in the basic necessities such as crockery, furniture, car are not the subject matter of Zakat provided that these assets are not purchased with the intention of sale.

Valuation of Assets

The valuation of the assets is based on the selling price prevailing at the time the zakat falls due. On the other hand, it is parallel to the concept of cash equivalent value with provision for bad debts. However, it is subject of much debate in Anglo-American accounting. The rules of zakat are inconsistent with the generally accepted accounting practice (GAAP) of Anglo-American accounting. Problems arise from the valuation of inventories and the valuation of accounts receivable.

Valuation of Inventories

According to GAAP, inventories should be valued at the lower of cost or market value. The market value can be either replacement cost or net realizable value. Although it is usually the latter. In practice, this rule almost always results in cost being the balance sheet valuation. For Zakat purpose, only the selling price is relevant. This means that Muslim firm cannot follow the GAAP valuation for inventories if they want to comply with the rules for Zakat.

Valuation of Accounts Receivable

Zakat is payable only on those receivables expected to be realized.In the case of valuation of account receivables, the AAOIFI FAS 9 does not make specific that zakat needs to be charged on net receivables. unlike Anglo-American practice, there is no overall estimated provision for bad debts. Accounts are assessed one-by-one to determine whether and to what extent they are expected to be collected.

In addition, the anglo-american accounting follows the concept of conservatism as the concepts refers to the need of exercise care when dealing with uncertainties. This is to ensure that assets and revenues are not overstated and liabilities and expenses are not understand. However, it is inconsistent with the concept of zakat as understanding assets would mean less zakat liability.

Method of Assets Valuation for ZakatAAOIFI FAS 9:

zakat base should include the historical cost and any holding gains or losses to reflect the true value of the assets and the current financial position of the entity. however, trade liabilities, long term liabilities, equity and fixed assets are permissible to be valued at the book value. differences in valuation will affect the assessment and adjustment of the differences in the valuation need to be provided.

Accounting Treatment For Zakat AAOIFI

FAS 9 MASB TR i-1

Importance of Accounting Standard for Zakati.

ii.

iii.

Helps Islamic banks and other Islamic business entities to perform zakat obligations; Enable to reduce the differences exist on the methods used by Islamic banks and other business entities in measuring zakat, and valuing assets subjected to zakat and; Help to improve the quality of disclosure on zakat information in the financial statements of the Islamic bank and business entities.

AAOIFI FAS 9

At the international level, the Accounting and Auditing Organization of Islamic Financial Institutions (AAOIFI), a Bahrainbased accounting and auditing standardsetting body, has issued a Financial Accounting Standard for zakat (FAS 9), effective from 1 January 1999 onward. The main focus is on Islamic banks. This document can be said to represent a relatively comprehensive standard that covers various aspects of zakat accounting for Islamic financial institutions.

MASB TR i-1

In the case of Malaysia, it has released the MASB (2006) Technical Release i-1 (TR i-1): Accounting for Zakat on Business, that became effective on July 1, 2006. TR i-1, however, emphasizes that since most business-related zakat issues fall under the SIRCs jurisdiction (and thus are considered outside the MASBs purview), TR i-1 only deals with financial reporting issues related to a corporations zakat (Abu Bakar, 2007).

AAOIFI FAS 9 & MASB TR i-1Definition Classification Recognition Measurement presentation disclosures

Definition

According to the AAOIFI: Zakat means blessing, purification, increase and cultivation of good deeds. In Sharia, it is an obligation in respect of funds paid for a specific type of purpose and for specified categories [. . .] The government may also authorize shareholders to pay it personally if it is satisfied that they will do so, or it may instruct Islamic banks to organize its payment on behalf of Islamic banks shareholders, using the combined basis for nisab as described [above] (AAOIFI, 2001c, p. 322).

Definition

According to MASB zakat is an obligatory contribution assessed based on certain assets owned by a Muslim that satisfy certain conditions and is to be distributed to specified categories of beneficiaries. zakat on business is defined as an obligatory contribution assessed based on business assets owned by an entity that satisfy certain conditions and is to be distributed to specified categories of beneficiaries.

Classification and RecognitionFAS 9 recognize it as a non-operating expense that has to be included in the determination of net income in the income statement. TR i-1 recognizes it as an expense to be included in the income statement for the period in which it is incurred.

Measurement and Zakat determination

AAOIFI

Net Assets (Net Current Assets) Method; The first method considers all cash, receivables net of doubtful debts, assets acquired for trading, and net financing assets (excluding unearned income) to be assets. Fixed assets and long-term investments are excluded. Thus, the zakatable amount is all assets minus the fixed assets, intangibles, current liabilities, and long-term investments. Net Invested Funds Method. Under the second method, the invested funds include paid-up capital, reserves, general provisions (investment risks), retained earnings, net income, and long-term liabilities. Thus, the zakatable amount is all

Measurement and Zakat determination

MASB TR i-1 Adjusted Working Capital (Net Current Assets) Methods; Adjusted Growth Net (Net Owners Equity) Methods.

Presentation

FAS 9 of AAOIFI characterized the presentation of zakat as depending on two circumstances either the Islamic bank which is obliged to pay zakat or not. If the Islamic bank is obliged to pay zakat, it shall be treated as a non-operating expense and shall be included in the determination of net income in the income statement; whereas the unpaid Zakat shall be treated as a liability and presented in the liabilities section of the statement of financial position of the Islamic bank. Section 2/2/3 of FAS 9 : [. . .] the zakat due from the Islamic bank as well as amounts of zakat received from other sources of funds shall be presented in the statement of sources and uses of funds in the Zakat and charity fund (para

PresentationMASB TR i-1presentation of zakat is highlighted in point 15, where it states: The amount of zakat assessed for the current period shall be presented as a line item on the face of the income statement.

Disclosure

AAOIFI1. 2.

3.

4.

the methods of zakat measurement used; the ruling of the Islamic banks Shari`ah supervisory board on zakat-related issues that are not included in this standard; whether the Islamic bank, as a holding company, pays its share of its subsidiaries zakat obligations; the amount of zakat due from each share, in case the Islamic bank does not pay

the amount of zakat due from the equity of its investment account holders; 6. whether the Islamic bank collects and pays zakat on behalf of those of its holders who have investment and other accounts; 7. restrictions imposed by the Islamic banks Shari`ah supervisory board in determining the zakat base; and 8. disclosure requirements listed in Financial Accounting Standard No. 1: General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions shall be observed.5.

DisclosureMASB TR i-1set up in points 16 and 17 for example, the entity shall disclose in the notes accompanying the financial statements: method used in the determination of zakat base; its responsibility towards payment of zakat on business; and major components of zakat. It is further stated that components of Zakat may include: current zakat expense; zakat payment; zakat liability; and any adjustments recognized in the period for zakat of prior periods.

Limitations of AAOIFI FAS 9 in MalaysiaFirst, as the organizations name and therefore the standard implies, the AAOIFI-issued standard is only applicable to Islamic financial institutions (IFIs); it does not cover such other business entities as limited companies and partnerships. Second, the standards other limitation is attributed to the fact that it has not taken into account (which its formulators were not obliged to do) the unique features of Malaysias society and legal framework. This means that FAS 9 is not totally applicable to Malaysia due to the required compliance with the respective countrys central bank guidelines (BNM) and by-laws, as well as other regulatory requirements and settings.

Limitations of MASB TR i-1

Although the MASB highlights in the introduction of TR i-1 (paragraph IN3) that the purpose of having a TR i-1 is to standardize the recognition, measurement, presentation, and disclosure of a corporations zakat, this ideal objective is apparently far from feasible unless a corporation issues a comprehensive and authoritative ZAS based on a mutual agreement with the relevant SIRC, zakat center, and other parties, particularly the regulatory bodies.

Accounting IllustrationNet Asset Method Trade Assets: Cash Deposits and placements Held-for-trading securities Available-for-sale securities Financing of customers Tax recoverable Bills receivable (RM) 155000 2010500 1420500 90200 3800300 9200 114570 7600270 Net Invested Fund Sources of Funds: Share capital Reserves (RM) 500000 647500 1147500 Less (Non-Current/ Trade Assets): Fixed Assets Statutory deposits Adjustment: Available-for-sale securities Adjustment: Bad debts written off 350000 250500 400000 12730

Less : Trade Liabilities (1013230) Deposits from customers Deposits from banks and Other financial institution Bills payable 7350000 50500 65500 7466000 Zakatable amount Zakat payable = (2.5% on zakatable amount) 134270 3356.75 134270

Zakat Calculation based on Working Capital ModelCurrent Assets Cash Balance Bank Balance Closing stocks Trade debtors Prepayments Other Current Assets Less Current Liabilities Trade Creditors Financial loans Short-term payable / Dividends payable Overdraft Financial/Capital Lease Net Current Assets $ xx xx xx xx xx xx $

xxx

xx xx xx xx xx

xxx xxx

+/- Adjustments Minus Current Assets $

Non-halal factorsLiquor, non-halal product Deposit for expenses Loan receivable Items that have been paid Zakat

xxxx xx xx xx

Bad debts, obsolete stocks, any substantialdevalued items Staff fund in Current Assets Staff loan Raw stocks/work-in-progress stocks Add Current Assets Donations Add Current Liabilities Non operating financial loans Dividends payable Overdraft Financial/ Capital Lease Total Net Assets due for Zakat Zakat Rate

xxxx xx xx xx xx xx xx xx xx xxx 2.5%

Muslim Ownership share

CONCLUSIONZakat for wealth is alms that purifies the wealth, increases the multiplicity of wealth and benefits in fulfilling socio-economic needs of the recipients of Zakat. The principle of Zakat clearly differ from conventional taxation system both in terms of philosophy and operations. The valuation of wealth subjected to Zakat are truly and fairly value assets based on Shariah compliant where the mix between Shariah and accounting proves to be useful in developing proper, objective and transparent accounting for Zakat purposes.

References

Books: Abdul Rahim Abdul Rahman, (2010), An Introduction to Islamic Accounting Theory And Practice. Kuala Lumpur: Cert Publications Sdn Bhd. Ayub, M. (2007). Understanding Islamic Finance. England: John Wiley & Sons Ltd.

Journals: Muhammad Akhyar Adnan, Nur Barizah Abu Bakar, (2009),"Accounting treatment for corporate zakat: a critical review", International Journal of Islamic and Middle Eastern Finance and Management, Vol. 2 Iss: 1 pp. 32 45 Nur Barizah Abu Bakar (2007). A Zakat Accounting Standard (ZAS) for Malaysian Companies. American Journal of Islamic Social Sciences, Vol. 24 No.4 (Fall