1.0 Introduction

Over the last decade, Malaysia has aggressively progressed by striding to advance as a major

Islamic Financial Hub. The development of Islamic finance in Malaysia received firm support by

firmly established financial institutions and further supported by robust regulatory framework.

Currently, in Malaysia the increase in the awareness for Islamic products encourages the need to

have a robust Islamic financial institution (IFI) in order to support the rise for Islamic banks in

Malaysia. Whilst conventional banking institution have gained trust from the general public, the

popularity and widespread use of Islamic banks (IB) can still be expanded.

However, as an IFI, an Islamic bank is envisaged to emulate Islamic values in all aspect

especially to the eye of its stakeholders as the users of its services or banking products. Any

Islamic corporation specifically Islamic financial institution needs to have a reliable governance

model and proper strategies that will encourage the implementation of robust and effective

corporate governance (CG) within the Islamic context.

Base on BNM Governance Framework 2010, Shariah audit refers to the periodical assessment

conducted from time to time. This is to provide an independent assessment and objective

assurance designed to add and improve the degree of compliance in relation to the Islamic

financial institution IFI’S business operation, with the main objective of ensuring a sound and

effective internal control system for Shariah compliance.

The function of Shariah Audit shall be performed by internal auditors, who have acquired

adequate Shariah-related knowledge and training. In addition, the internal auditors may engage

the expertise of the Islamic financial institution IFI’s Shariah officers in performing the audit, as

long as the objectivity of the audit is not compromised.

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The development of audit shariah in Malaysia can have many kind of benefit. Good development

on the shariah audit providing guidance on Islamic capital Market (ICM) transactions and

activities with the aim to standardizing and harmonizing application. The audit shariah serve two

main Islamic perspective of disclosure which is full disclosure and social accountability. They

tend to server the disclosure of information with the public interest. It demonstrating their

accountability to the decision maker, and the most pertinent information items from an Islamic

perspective is often lacking.

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1.1 History of Shariah Accounting and Shariah Auditng development in Malaysia

1983

Islamic Banking Act (IBA) 1983 was enacted in Malaysia. The first full-fledged Islamic Bank

was established in Malaysia.

1984

Takaful Act 1984 was enacted to provide regulation for takaful business in Malaysia.

1996

Amendment to section 124 of banking and Financial Institution Act(BIFA) allowing

conventional banks in Malaysia to offer Islamic banking products through Islamic window.

1998

Interest free Banking Scheme (SPTF) was upgraded to Islamic Banking Scheme allowing

convention banks to open full-fledged Islamic banking subsidies.

2001

Malaysia’s Financial Sector master plan sets target for Islamic Finance to make up 20% of the

finance sector by 2010.

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2002

Islamic Financial Services Board (IFSB) was established in Malaysia.

2003

Bank Negara Malaysia (BNM) guidelines or outsourcing of Islamic banking operating (23rd June

2003)

2004

BNM provides guidelines on directorship for Takaful Operators. (8th November 2004)

2005

BNM provides guidelines on the Government of Shariah Committee for Islamic Financial

Institutions (1st April 2005).

BNM issues guidelines on Financial Report for Licensed Islamic Banks (1st July 2005).

2007

BNM provides guidelines on Corporate Governance for Licensed Islamic Banks (24 th January

2007).

2008

BNM guidelines on outsourcing for Takaful operators (22nd July 2008)

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2009

Amendment of section 51 of Central Bank Act(CBA) to position the Shariah Advisory Council

of BNM as the open authority for the determination of Islamic laws for the purpose of Islamic

Financial business.

BNM provides guidelines on Introduction of New Products (18th May 2009).

BNM issues guidelines on Introduction of New Products for Insurance Companies and Takaful

Operators (1st July 2009)

2010

Launch of the new Shariah Governance Framework by BNM (effective 1st January 2011)

BNM guidelines on Internal Audit Function Of Licensed Institutions (1st July 2010)

BNM guidelines on Financial on Financial Report for Takaful Operators (23rd December 2010)

2011

By 30th July 2011, IFL’s are to company with Shariah Governance Framework.

Currently: Launch of phase 2 of the Financial Services Masterplan (FSMP).

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2.0 Currents issues and Problem statement

Malaysia is the model that representing a modern Islamic country due to it islamization process

to infuse Islamic values throughout the country at all the level from individual to institutional

organisation. The development on the audit Shariah in Islamic bank believes to disclose the

information in transparency and accountability.

It is believed that good development on the shariah audit providing guidance on Islamic capital

Market (ICM) transactions and activities with the aim to standardising and harmonising

application. The ICM transaction leads the ways that do not conflict with the principle of Islam.

Such application would be implementing in the each of the market as well as the corporate social

reporting. It demonstrating their accountability to the decision maker, and the most pertinent

information items from an Islamic perspective is often lacking.

From the prior study, the audit shariah serve two main Islamic perspective of disclosure which is

full disclosure and social accountability. They tend to server the disclosure of information with

the public interest. The transparency of the information is provided to the user to make sure fulfil

their desired on the information. In Islamic context it defined that the ummah (public) had the

right to know the operational effects of an organization weather its well-being together with the

Shariah requirement being achieved.

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The finding by Haniffa (2002) Islamic Social Reporting is also an extension to development of

the Audit Shariah. It focus on social justice goes beyond reporting on the environment, minority

interests and employees. It also concern with the issues related to the well-being of the society on

the unfair trading practices such as zakat. However, there are few factors that affect the

development of audit shariah toward the future, such as profitability, board composition, and

industry type. This result show few studies in influencing social reporting while failed to provide

evidence on these factors influence social reporting.

From our studies, we found out that even though the auditors are responsible in auditing the

financial statement and give reasonable assurance that the financial statement is free from

material misstatement, but the external auditor does not access or audit the transaction made by

the shariah listed company. It does not have the proper framework in the development of the

Audit shariah. Furthermore, in the market there might impose the internal department level such

as internal audit department, but there are no independent party being appoint to audit the

financial report of the Islamic Financial Institutions. It had been a challenge for the audit shariah

to be undertaken.

Nowadays, the development of the audit shariah required an independent and qualified shariah

person. The person who audits the report must know all the information regarding the shariah

requirement as well as have the qualification on the chartered accountant. If the person who carry

on the shariah work without the competent in shariah, he or she will not considered carry on their

duties.

Next issue is professionalizing the role of Shari'ah auditors: How Malaysia can generate

economic benefits. Malaysian can generate economic benefit by implementing Shariah Audit in

the country; it can prevent instances of Shari'ah non-compliance which is a peculiar risk to all

institutions operating under an Islamic worldview domain. The previous paper state that Islamic

law must be developed as guide for those who conduct the financial audit for Islamic Institution

or Islamic enterprise because the accounting principle compatible with Islamic Law.

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Previous study state that relationship between corporate governance and external auditing in

Islamic banks observed that in theory it is argued that the role of a Shari'ah auditor in an(Islamic

Financial Institution ) IFI is different and wider than a conventional auditor due to checks for

Shari'ah compliance. But in practice, they observed that there is a vacuum in Shari'ah auditing as

external auditors fail to check for Shari'ah compliance issues due to their lack of knowledge in

this area.

Shariah compliance also faces challenge in Islamic bond markets. The challenges of

implementing shariah which are there is high cost associated with Shariah compliance makes

non-compliance an inherent risk in a system involving profit maximizing issuing firms. The

problems become conflict with the possibility of fatwa shopping, where the issuing firm can

move away from the ethical advisor enabling them to issue less Shariah compliance but more

profitable or low risk structure. The problem is much more severe in the bond market where the

Shariah standards are lax and the Shariah advisors can be hired on a one-off basis.

Another prevailing circumstance in terms of shariah auditing is Shariah screening process in

Malaysia. Screening process is design to identify the elements that violate the rules and

guidelines of Shariah law, which rooted from al-Quran, and the teaching of Prophet Muhammad.

Shariah law prohibits elements such as usury (riba or interest), gambling (maysir) and

uncertainty (gharar). These elements are present in many conventional financial activities.

For a Muslim, this means getting involved indirectly in prohibited practices, which is considered

as grave sin.(Adam, 2012). Shariah screening is conducted to eliminate stocks believed to be

unacceptable for investments, which involve in prohibited element including liquor, gambling

and riba.

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Besides, another issue highlighted would be in terms the auditors need to have the analytical

thinking competency as they need to perform procedures using certain professional skill and

techniques to verify the truth and fairness of their client’s financial statement this is because the

conventional audit on the financial statement has long been associated to independent

verification on whether the institutions’ financial statement has been presented with true and fair

view.

The function of audit from the Islamic view is much more important and mandatory as it

manifests the accountability of the auditors not only to the stakeholders, but ultimately to the

Creator, Allah s.w.t as the Muslims believe that one’s action and thoughts are always being

watched by Allah (the concept of Muraqabah).

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3.0 Literature Review

Shariah Advisory Council in Malaysia was established in 1996 to serve the purpose of advising

the Securities Commission on Shariah related matters. Among the notable services or advisory

provided by this institution are providing guidance on Islamic Capital Market (ICM) transactions

and activities. ICM’s nature is such that it does not conflict with the fundamental principles of

Islam.

(Haniffa, 2002) quoted that, ICM has led to ISR stating that the Muslim business leaders and

critical decision makers have expectations that relevant information’s disclosed by companies

may assist them in fulfilling their spiritual needs. This is because when a company fully discloses

its information by adopting corporate social reporting, it directly reflects the company’s

accountability to the decision makers.

Other studies conducted in the sector of shariah auditing are by; Zurina, Shafii, Nor Aishah,

Mohd Ali & Nawal Kasim, (2014) which indicates that there is a serious need for a strong

Islamic Financial Institution (IFI) as the awareness on Islamic products has increased and also

support the continuous development of Islamic banks in Malaysia. Even though, conventional

Banks have managed to garner more trust from the people, Islamic banks still have their potential

to be expanded.

Besides that, Ernst and Young World Competitive report (2013-2014) estimated that Malaysia’s

International Islamic banking assets has anticipated to raise about RM 1.27 trillion by 2018 from

current RM 410 billion (2012) (Bernama, 2014). Global Financial review found that, over past

30 years, the Islamic sector has grown from 0 to RM 1.6 trillion in assets. Despite the financial

crisis, the industry has still grown from 19%-21% in 2011 and 2012, (Popper, 2013).

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Other than that, another development highlighted by Zurina Shafii, Suppiah Salleh &

Syanidawati Hj Shahwan (March 2010), in their study is that, shariah compliance audit is

necessary to ensure that shariah committee are able to confirm that the IFI’s conduct their

operations in accordance with the guidelines and standard’s issued by Shariah Supervisory Board

of IFI’s, Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI).

Mainly their objective is that all the activities carried out are shariah compliant. In Malaysia

itself, there are Shariah Advisors who help to prepare a written shariah opinion, similar to the

audit opinion provided by the conventional auditors. The concept is that, the audit procedures

conducted in means of Shariah are more towards the fundamental principles of Islam and is very

strict compared to normal conventional audit. Moreover, it is based on Islamic teaching that

obeys certain rules and mandate by the Almighty.

In another study, Shahul and Yaya, 2005, believe that shariah auditing plays an important part in

stirring awareness among islamic institutions to contribute in achieving the desired objectives of

the Islamic law Maq’asid Ash-Shariah. The main suggestion on it this matter is that regular

independent shariah audit should be conducted in IFI’s as the society currently requires are

thorough audit in everything as the credibility of information are continuously decreasing in

current times.

Syed Alwi, 2007, mentioned that shariah audit should be conducted in a timely manner and

extended to all activities such as activities relating each other. For instance, chain of activities

interrelated to each other like the system, the products, the employees, the environment and the

society. It is important to develop a proper shariah audit framework in achieving the main goals

of shariah compliance in IFI’s so that a proper contribution can be made to the overall society

(ummah).

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However, in the study made by Nawal, Shahul & Maliah, 2005, they found that there is a gap

between what actually desired and what ought to be desired. This means that, there is a gap

between what is actually practiced and what is desired from shariah auditing.

A deeper study in terms of development is on the formation Shariah Supervisory Board (SSB)

which is one of the most important governance mechanisms of an Islamic Financial Institution

(IFI) to ensure compliance with Shariah. In addition, one clear approach which were taken by the

IFIs is to introduce Islamic financial products which are parallel to the Shariah law. In brief, the

purpose of these products should not be to maximize profit by complying with the mechanism of

these products with the Shariah law, but instead, the objective of these financial products have to

be in line with the Shariah as well, which is to help the public to avoid from riba and poverty (i.e.

maslahah).

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4.0 Limitations and criticisms

The realization of Shariah Auditing is an uphill task. International Accounting Standards Board

(IASB) states that the current framework of shariah accounting does not cover the adequate need

of the accounting transaction as specific as they are covered in the IFRS. Besides that, there have

been very less support by the Islamic countries in the development of shariah auditing because

they are currently using conventional accounting standards. This in return may have caused a

resistance to change by the members of the OIC

In Malaysia; MASB had plans to adopt AAOFI standards for the purpose of use of Islamic

institutions and businesses. However, due to certain differences the implementation and

adaptation have been stalled. AAOFI on the other hand, has failed to play its purpose in

governing and developing Islamic accounting and auditing standards. This is because,

statistically, out of 56 countries who are the members of OIC, only 6 countries chose to apply

AAOFI standard and the others still have not opt to adopt to this standards. Therefore, it became

difficult to practice shariah accounting and auditing in Malaysia.

Another limitation would be in where numerous questions have been arising mostly among the

Islamic practitioners themselves who cast doubt on the need of Islamic Accounting. This is a

major setback as the ones who need to support and develop shariah system are questioning it.

Recently, in Malaysia, it has been told that the top notch in CIMB have publicly rejected the

need of Islamic accounting and shariah auditing by stating that it is better to use conventional

aspect as they cover a wider aspect.

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Other issues include:

The effect of dual operating frameworks in most of the OIC countries

The government in these countries will face a huge difficulty as they need to introduce

amendments to local laws and legislations to allow these IFIs and non-IFIs to implement Shariah

principles in the financial reporting structures of their statements.

The development of conventional accounting principles and auditing method for a period

more than 100 years

Since conventional accounting is being heavily developed, backdated to almost a hundred years,

it will cause a lot of parties to resist on the shariah accounting and auditing. This is because;

there will be resistance to change among the practitioners who have practiced the conventional

way for a long time.

Lack of expertise and skills

Another serious limitation for shariah auditing will be in terms of skills and expertise. This is

because, in the current modern world, the scope for shariah auditing and Islamic accounting

offered to study is very low and most of the western powers have limited the scope for this sector

in their respective institution. Since, the scope is limited; Malaysia is also facing difficulties in

producing expert on shariah accounting and auditing matters.

Cost

Cost is also another contributing factor for institutions and businesses in Malaysia to adapt to

shariah accounting and auditing. This is because; it will definitely cost these companies a lot to

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convert from conventional accounting to Islamic accounting as the service of an expert is very

scarce.

Only IFI’s are practicing Shariah accounting and auditing in Malaysia

This indicates that the demand for other businesses are very low when it comes to Islamic

accounting. Hence, since there are limitations in terms of number of businesses wanting to

convert to shariah based accounting, the development of shariah auditing and accounting are

limited and cannot be widely achieved here.

Convergence

Currently, the world is moving towards convergence. Convergence here is in the context of

standardization of accounting principle across the globe. Hence, Islamic finance and shariah

auditing might be considered as a disintegrator. It is also due to the worldviews of conventional

economic and financial systems that are different from the Islamic economic and financial

systems.

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5.0 Recommendations

Shariah Audit Framework & Training

A body should be formed to provide shariah Audit Framework for entity’s requiring it. Besides,

the body should also provide training for all the personnel involved. This body should be an

independent body and should be recognized by Bank Negara Malaysia and Malaysian

Accounting Standard’s Board (MASB)

Provide a specific Shariah Auditing Framework for all other entities including SME’s and

other businesses.

Currently, in Malaysia, only financial institutions are applying shariah accounting. Hence, the

scope of shariah auditing is limited to these institutions. Hence, if Shariah Accounting is

introduced to SME’s and other businesses, the scope of shariah auditing can be expanded.

Increase the demand for shariah accounting and auditing

There should several measures taken on the effort to increase the demand of shariah auditing and

accounting in Malaysia. Notably, this effort can be taken by the government by providing

incentives to companies that practice shariah auditing. The incentives can be in any means. For

example, tax incentives and so on.

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Shariah Risk Management Framework

Shariah risk considerations should be embedded into the risk management framework to help the

management and address shariah non-complaint risk effectively. With shariah risk management

framework, the institutions will be able to better manage their financial risks.

Another contribution of this framework is that it will increase the transparency of the shariah

audit. It is done through several methods, such as:

i.) Categorizing each product in accordance with shariah requirements

ii.) Conduct shariah audit instead of conventional audit using the framework

iii.) Do a regular check up with Shariah Supervisory Board (SSB) to maintain the

credibility of shariah audit

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6.0 Conclusion

As a conclusion, it can be deduced that the development of shariah auditing in Malaysia is still at

its infant stage. This is because; only IFI’s are applying shariah auditing. Other than that, the

frameworks and guidelines are still not as clear as the conventional audit framework and

guidelines. Next, it terms of acceptance, it can be said that there are still a lot of argument among

the Muslim countries on the implementation of shariah auditing as most prefer to adopt the

standards of IASB compared to AAOFI. Besides that, the lobby group such as IASB, MASB

and other bodies governing the accounting principles would resist in accepting the underlying

principles as the western world dominates the accounting policies throughout the globe.

Hence, in Malaysia itself, MASB faces some conflict in accepting shariah accounting principles

and stalls the discussion paper on this issue. In a nutshell, if the recommendations are

implemented and the limitations are resolved, there will be a vital improvement in the

development of shariah auditing in Malaysia.

7.0 References

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Zurina Shafii, Nor Aishah Mohd Ali and Nawal Kasim 2014, Shariah audit in Islamic

banks: an insight to the future shariah auditor labour market in Malaysia retrieved on 10

January 2015 from http://www.sciencedirect.com

Hisham Yaacob ,2012 Issues and challenges of shariah audit in islamic financial

institutions: A Contemporary View retrieved on 10 January 2015 from

http://www.googlescholar.com

Rohana Othman, Azlan Md Thani, Erlane K Ghani (October 2009), Determinants of

Islamic Social Reporting Among Top Shariah-Approved Companies in Bursa Malaysia,

retrieved on 10 January 2015 from http://www.googlescholar.com

Zurina Shafii, Supiah Salleh, Syahidawati Hj Shahwan, March 2010, Management of

Shariah Non-Compliance Audit Risk in the Islamic Financial Institutions via the

Development of Shariah Compliance Audit Framework and Shariah Audit Programme

retrieved on 10 January 2015 from http://www.sciencedirect.com

Nawal binti Kasim, Assoc. Prof. Dr Shahul Hameed Mohamad Ibrahim, Prof. Dr Maliah

Sulaiman, 2008, Shariah Auditing in Islamic financial institutions: Exploring the gap

between the “desired” and the “actual” retrieved on 10 January 2015 from

http://www.sciencedirect.com

Mohd Hairul Azrin Haji Besar, Mohd Edil Abd Sukor, Nuraishah Abdul Muthalib and

Alwin Yogaswara Gunawa, The Practice of Shariah Review as Undertaken by Islamic

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Banking Sector in Malaysia International Review of Business Research Papers Vol.5 No. 1

January 2009 Pp. 294-306 retrieved from http://www.googlescholar.com

Khatkhatay, M.H. and Nisar, S. (2007). Investment in Stocks: A Critical Review of Dow

Jones Shariah Screening Norms. Paper presented at the International Conference on

Islamic Capital Markets. Retrieved on 10 January 2015 from http://www.kantakji.com

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