TOPIC 3: ISLAMIC ACCOUNTING AND REGULATORY FRAMEWORK

LESSON LEARNING OUTCOMES

1. Introduction to Islamic Accounting    - Examine the conceptual framework of Islamic accounting from an Islamic perspective.    - Examine the regulatory and governance framework.    - Examine the accounting and reporting resolution based on Shariah Resolution Second Edition by Bank Negara Malaysia.

DEFINITION OF ISLAMIC ACCOUNTING

• Islamic Accounting: Defined as an accounting process that provides relevant information (not limited to financial data) to stakeholders. It aids in ensuring that an entity:   - Operates in line with Islamic Shari’ah principles.   - Achieves its socioeconomic objectives.
• Function: Acts as a tool for Muslims to evaluate their accountability to Allah, particularly concerning human relationships and environmental stewardship.

DEFINITION OF CONVENTIONAL ACCOUNTING

• Conventional Accounting:"Accounting is the identification, recording, classification, interpreting, and communication of economic events to permit users to make informed decisions (AAA, 1996)."
• Main Objective: To assist users in making informed decisions about the allocation of scarce resources efficiently (FASB, 1978).
• Focus: Primarily to provide information that helps investors decide whether to buy, sell, or hold their investments.

DIFFERENCES BETWEEN ISLAMIC ACCOUNTING AND CONVENTIONAL ACCOUNTING

1. Objective in Providing Information

   - Islamic Accounting: Aims to ensure compliance with Shari’ah principles and achieve socio-economic justice while reflecting accountability to Allah and society.    - Conventional Accounting: Focuses on providing useful financial information to support decision-making regarding profitability and efficient allocation of resources.

2. Type of Information (Identification, Measurement, Recording, Communication)

   - Islamic Accounting: Covers both financial and non-financial data (social, environmental, ethical) measured in line with Islamic values and recorded to show compliance with Shari’ah.    - Conventional Accounting: Primarily focuses on quantitative, financial information measured in monetary terms, recorded using GAAP/IFRS, to assist investment decisions.

3. Users of the Information

   - Islamic Accounting: Used by Allah (ultimate accountability), management, investors, zakat authorities, regulators, community, environmental stakeholders.    - Conventional Accounting: Primarily used by investors, creditors, managers, and government agencies, focusing on economic/financial stakeholders.

4. Antecedent and Legislations for Reporting

   - Islamic Accounting: Derived from Al-Qur’an, Sunnah, Ijma’ Ulamak (scholars’ opinions), Qiyas, and standards issued by AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions).    - Conventional Accounting: Derived from secular laws, company acts, and standards specified by organizations such as FASB (Financial Accounting Standards Board) or IASB (International Accounting Standards Board).

5. Accountability

   - Islamic Accounting: Pursues accountability to Allah, society, environment, and stakeholders, emphasizing ethical and social responsibility (amanah).    - Conventional Accounting: Focuses on accountability to shareholders, investors, and creditors, prioritizing wealth maximization and profit.

6. Foundation

   - Islamic Accounting: Built on an Islamic worldview encompassing Tawhid, Shari’ah compliance, socio-economic justice, and accountability to Allah and mankind.    - Conventional Accounting: Based on a secular economic worldview emphasizing efficiency, profitability, and capital market needs.

THE OBJECTIVE AND NEEDS OF ISLAMIC ACCOUNTING

1. To show the financial position of the company and how management fulfills its responsibility to shareholders.
2. To ensure Shari’ah compliance by providing disclosures on how wealth is earned, spent, and distributed.
3. To offer useful information for decision-making to investors, creditors, and other stakeholders.
4. To make information understandable for users with basic knowledge of economic activities.

Additional Aspects:

• The importance of proper recording transactions, instilling fear of Allah while recording transactions in order to maintain an Islamic true and fair view.
• Justice in financial transactions ensuring both the debtor's and creditor's rights are respected.
• The Islamic materiality concept, which requires financial transactions to have trustworthy witnesses, who must be independent and protected by law.
• Proper accounting practices are essential to prevent doubts and disputes among individuals.

Development Approach to Islamic Accounting Concepts

• Accept: Conventional accounting concepts that are consistent with Shari’ah.
• Reject: Concepts inconsistent with Shari’ah.
• Develop: Concepts unique to Islamic banking and finance.

THE USER AND USES OF ISLAMIC ACCOUNTING

• Investors/Shareholders: Assess halal returns, ensure profit-sharing is fair, and confirm Shariah compliance.
• Financers: Evaluate the business’s ability to repay financing facilities in a halal and fair manner.
• Employees: Assess job security, fair wages, halal sources of income, and organizational financial stability.
• Suppliers: Ensure timely payments and that transactions are based on halal activities and assess creditworthiness.
• Customers/Depositors: Verify that funds are invested in halal activities and ensure fair profit distribution.
• Government and Agencies: Utilize accounting information to design economic policies, tax regulations, and oversee business activities.
• Society/Public: Use accounting information as necessary based on their various needs.
• Shariah Committee: Verify compliance with Islamic law (Shari’ah) in transactions and reports.
• Auditors: Evaluate transparency, accountability, and adherence to Islamic accounting standards.
• Regulators (e.g., Bank Negara Malaysia): Monitor compliance with Islamic financial regulations and Shari’ah governance.

THE REGULATORY AND GOVERNANCE FRAMEWORK

• Islamic Financial Services Board (IFSB): An international standard-setting body that promotes soundness and stability in Islamic financial services. Focuses on risk management, corporate governance, and capital adequacy aligned with Shari’ah.
• Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI): Issues Shari’ah-compliant standards for accounting, auditing, governance, and ethics, enhancing transparency across institutions.
• International Accounting Standards Board (IASB): Develops IFRS to ensure consistency and comparability globally.
• Malaysian Accounting Standards Board (MASB): Issues accounting standards reflective of local needs and international standards while ensuring relevance to Islamic finance.
• Central Bank of Malaysia (BNM): Regulates and supervises Islamic financial institutions, issues guidelines on Shari’ah governance, and houses the highest authority for Islamic finance rulings.

The Regulatory Body Role in Islamic Accounting

• IFSB: Sets global prudential standards for Islamic financial institutions, focusing on risk management, capital adequacy, and Shari’ah alignment.
• AAOIFI: Issues Shari’ah-compliant standards, promoting transparency and uniformity in reporting.
• IASB: Provides IFRS framework applicable to Islamic institutions for global comparability.
• MASB: Develops Malaysian standards in collaboration with BNM and Shari’ah Advisory Council to ensure compliance with Islamic principles.
• BNM: Supervises Islamic financial institutions and oversees Shari’ah governance frameworks, reporting guidelines, and regulations.

CONCEPTUAL FRAMEWORK OF ISLAMIC ACCOUNTING FROM AN ISLAMIC PERSPECTIVE

1. Generally Accepted Accounting Principles (GAAP): A uniform set of accounting standards used to compile financial statements ensuring consistency and comparability for investors.
2. Underlying Accounting Assumptions: Accounting relies on assumptions that need to align with Shari’ah principles, such as:    - Accounting Unit Concept: Identifying economic activities of institutions distinctly from owners.    - Going Concern Concept: Assuming continuity of contracts until termination.    - Periodicity Concept: Dividing the institution's life into regular reporting periods.
3. Qualitative Characteristics of Financial Statements: Characteristics ensuring that financial information is accurate, fair, and Shariah-compliant:    - Relevance    - Reliability    - Comparability    - Consistency    - Understandability    - Materiality    - Adequate Disclosure    - Timeliness
4. Accounting Recognition Principles: Timing for revenue and expense recognition must align with Shari’ah, including:    - Revenue Recognition: Recognizing revenue when control is transferred and performance obligations are met.    - Matching Concept: Recording expenses in the same period as the revenues they generate.
5. Accounting Measurement: Process of assigning monetary values to the elements of financial statements, with methods that comply with Shari’ah such as:    - Historical cost measurement    - Current values    - Realizable value    - Present value

Accounting Measurements: Definitions and Shari’ah Points