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Wednesday, January 6, 2010



It is widely accepted that the primary objective of financial reporting and accounting is to provide useful information to assist users in making economic decisions. Thus, it can be argued that financial reporting and accounting is therefore, a religious obligation. Hence, if accounting is a religious obligation, then the rules of accountability must be purely divine. In order to do so, appropriate accounting framework based on Shariah principles must be in place. The concern of this project paper is to explore the reasons of why the Malaysia Accounting Standards Board (MASB) has only producing one Islamic accounting standard (FRSi-1)together with two Technical Releases that do not carry any legal capacity and mandatory for Islamic banks to apply yet except the FRSi-1. As comparison, the Accounting and Auditing of Islamic Financial Institutions (AAOIFI) has already come out with more than 15 Islamic accounting standards. This paper will also will analyse the future options of the development of Islamic accounting standards to cater the growth of Islamic financial instruments in the market.

1.0              Introduction

The contemporary experience of Islamic banking is hardly for more than three decades old but has proved to be groundbreaking with far reaching impacts worldwide. Banking success depends on the extent of public trust placed in the financial strength of individual banks, particularly the trust of depositors and investors. In addition to the paramount importance of financial strength, trust in Islamic banking is also relates to the extent of adherence to Shariah, the identity of the Islamic banks. Thus, to enhance the trusts and confidence of public especially the Muslim society towards Islamic banks is the quality of information issued to the investors and depositors about bank’s ability to achieve both financial and Shariah-related objectives. Hence, developing and having a unique accounting and financial reporting standards for the dissemination of such information about financial performances of Islamic banks becomes a necessity. The nature of financial intermediation, including the function of banking, is different to the case of Islamic bank. The Islamic precepts influence the structure and activities of Islamic financial institutions (IFIs) in several ways with the most important principle being the prohibition against the payment and receipt of interest whilst advocating into partnership and equity participation of both side of balance sheet. Only by understanding the nature of Islamic financial intermediation theoretical framework, then, we can come to appreciate on why IFIs have different set of risks that applied onto them. These have leads to the needs for specific standards that adhere to the Islamic principles for auditing and corporate governance too.

It is widely accepted that the primary objective of accounting is to provide useful information to assist users in making economic decisions. Thus, it can be argued that accounting is therefore, a religious obligation. Hence, if accounting is a religious obligation, then the rules of accountability must be purely divine. In order to do so, appropriate accounting framework based on Shariah principles must be in place. The motivation for the development of Islamic accounting comes together with the emergence Islamic economic and Islamic resurgence for the last two to three decades. The Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) was formed to promulgate a set of accounting standards specifically for recording of Islamic financial transactions. To this date, AAOIFI has produced a set of accounting standards that could represent a benchmark framework that draws rationales from the Shariah. However, currently, AAOIFI has no legal backing. Only few countries such as Bahrain and Sudan have made AAOIFI standards mandatory to their IFIs. In the absence of legal provisions, compliance with its standards is on voluntary basis to the extent that IFIs do not comply. In so doing, how IFIs’ financial statements are to be made comparable? When accountants encounter difficulties to understanding complex Islamic financial transactions, they will eventually resort to the conventional accounting treatment.

For Malaysian case, as the Islamic banking and Islamic financial system develops, the Malaysian Accounting Standards Board (MASB) recognises the need for a set of comprehensive guidelines and accounting standards, particularly to cater for the growth in Islamic-based transactions as well as to meet the objectives of promoting investment in Islamic banking and capital market in Malaysia. The FRSi-1: Presentation of Financial Statements of Islamic Financial Institutions (previously known as MASBi-1) issued by MASB provides a basis for the presentation and disclosure of financial statements of institutions that undertake Islamic banking activities. Furthermore, Bank Negara Malaysia (BNM) or the Central Bank of Malaysia, governing body for financial institutions in Malaysia, has also issued its own guidelines for disclosures and financial presentations for these institutions: Revised Guidelines on Financial Reporting for Licensed Institutions (BNM/GP8) and Guidelines on Financial Reporting for Licensed Islamic Banks (BNM/GP8-i). Subsequent to the introduction of FRSi-1 (formerly known as MASBi-1), MASB to the date has also issued 2 Technical Release known as; (i) TRi-1: Accounting for Zakat[1] on Business, and (ii) TRi-2: Ijarah[2]. Recently, MASB has come out with the new Exposure Draft (ED) known as the MASB Exposure Draft ED i-3: Presentation of Financial Statements of Islamic Financial Institutions to abrogate the previous FRSi-1.

This paper endeavors to analyze the rationales for the lack luster performance of MASB to come up with sets of accounting standards that cater for Islamic financial transactions. This is because AAOIFI has already come out with more than 15 standards covering all sets of Islamic financial transactions whereas MASB only with one standard whilst 2 other standards are still in the capacity of Technical Release which is not mandatory for use yet. The second section of this paper will give a general overview of what is exactly is Islamic accounting promoted by AAOIFI and a comparison between the General Accepted Accounting Principles (GAAP) with the building blocks of AAOIFI’s Islamic accounting. Subsequently, the third section will highlight the salient points of FRSi-1: Presentation of Financial Statements of Islamic Financial Institutions and Guidelines on Financial Reporting for Licensed Islamic Banks (BNM/GP8-i). The fourth section will analyse on why MASB has lacking in performing and generating as much Islamic accounting standards as expected (if it is to be compared to the AAOIFI’s standards).

 2.0       Principles of Islamic accounting versus General Accepted Accounting Principles (GAAP)

Islamic accounting can be initially defined as the “accounting process” which provides appropriate information (not necessarily limited to financial data) to stakeholders of an entity which will enable them to ensure that the entity is continuously operating within the bounds of the Islamic Shariah and delivering its socioeconomic objectives. The meaning of Islamic accounting would be clearer if we compare this with the definition of ‘conventional accounting’. The conventional accounting as we know it is defined to be the identification, recording, classification, interpreting and communication of economic events to permit users to make informed decisions (AAA, 1966). It can be seen that both accounting systems set out similar objective of reporting. Not only that, Islamic accounting shares with their conventional counterparts the same common process of recognition, measurement and recording of transactions and fair presentation of rights and obligations. However, the differences lie in the following;

  • The objectives of providing the information;
  • The type of  information is identified;
  • How the information is it  measured, valued, recorded and communicated; and
  • To whom will the information be communicated (the users).

Having appreciated the basic concepts of Islamic accounting in comparison with the conventional accounting, the following sub-sections will discuss the objectives of Islamic accounting with subsequently the discussion between principles of accounting i.e. Generally Accepted Accounting Principles (GAAPs) with the Islamic worldview requirements that has lead to the development of Islamic accounting in order to appreciate the rationale for the introduction and implementation behind it. Only by appreciating the distinctions, then we can appreciate the important and rationales behind the needs to apply Islamic accounting for IFIs.

2.1       Objectives of Islamic accounting

The objectives of financial accounting determine the type and nature of information which should be included in the financial reports in order to assist users of these reports in making sound decisions. On this basis, the objectives of financial accounting for IFIs are to achieve the following;

o   Determine the rights and obligations of all interested parties, including rights and obligations resulting from incomplete transactions and other events, in accordance with the principles of Shariah and its concepts of fairness, clarity and business ethics.
o   To promote and ensure only Islamically permitted economic activities are carried out.
o   Subscribe to the safeguarding of Islamic banks’ assets, rights of Islamic banks and rights of others in an adequate manner.
o   Subscribe to the enhancement of management and Islamic banks’ productive capabilities, and encourage compliance with the established goals and policies, and above all Islamic Shariah, in all transactions and events.
o   To avoid disputes among society members through providing a fair basis of sharing profits, wealth transfers and full disclosure of activities and values.
o   Provide through financial reports useful information to report users, and thus enable them to make legitimate decisions in their dealings with Islamic banks.
o   To provide a fair basis for the calculation of zakat (Islamic Taxation).

2.2              The principles of accounting concepts and Islamic worldview

Conventional accounting structure in its current structure follows what are known as Generally Accepted Accounting Principles (GAAP) or the fundamental accounting concepts. This takes into account among others historical cost, conservatism, accrual and matching, substance over form, going concern monetary measurement, materiality and consistency and others. In this section, the paper shall discuss this in comparative perspective with the values of the Islamic worldview that has led to the development of Islamic accounting and the rationales behind it.

2.2.1                                Going concern and accruals

These two concepts are considered part of the bedrock of accounting. Going concern is particularly important with regard to measurement. As result, the conventional accounting standards requires that financial statements be prepared on going concern and requires that the directors assess whether there are significant doubts about the entity’s ability to continue as a going concern. The accruals concept lies at the heart of the definitions of assets, liabilities, gains, losses and changes to shareholders funds. Accruals basis of accounting requires the non-cash effects of transactions to be reflected in the financial statements for the period in which they occur. This concept is closely related to the ‘realisation’ concept whereby the firms can only allow profits that are ‘realised’ by the balance sheet date to be included in the Income Statements.

Basically, the going concern concept embedded in conventional accounting is not in conflict with the requirements of Islamic accounting whereby the directors should making assessment on the firms’ ability to continue as a going concern. Consequently, the financial statements must also be prepared on the basis of going concern basis unless the directors want to liquidate the firms or to cease trading or has no realistic alternative but to do so.

Basically, the principle of accruals concept does not in conflict to the requirements of Shariah. It is allowable under the purview of Shariah. This is evidenced from the treatments of murabahah[3] or bay’ bithaman-ajil (BBA)[4] financing transactions conducted by Islamic banks. If the banks treat a murabahah or BBA transaction as a financing transaction or purely as a sales transaction, it has the same effect on profit. However, Islamic banks may differ in terms of the timing of recognition of the margin: at time of sale, as cash received or as payment becomes due. If the cash basis is adopted, the profit will be recognised as and when the instalments are received. On the other hand, the accrual basis method recognises profit based on a proportionate allocation of profits whether cash is received or otherwise. However, AAOIFI rejects the first method, except where the credit period does not exceed the current financial period. Thus the preferred method would be the accrual basis. In this case, the banks have to set-up ‘Profit-In-Suspense account’ or ‘Unearned Income account’ whereby the deferred profits (unearned income) shall be offset against Murabahah receivables. Consequently, for each payment made by the debtor, the profit related to the payment would realise and recorded in the Income Statement of the banks. The followings are the sets of journal entries to record Murabahah financing schemes:

Journal entries:
*      Purchase of asset by Bank;
Dr       Equipment (at cost)
Cr       Cash / Creditors

*      Recognition of murabahah financing assets;
Dr       Murabahah financing (cost + profit)
Cr       Equipment (at cost)
Cr       Unearned income (Profit) / Deferred profit

*      Repayment received from customers;
Dr       Cash
Cr       Murabahah financing

*      Income recognition at the end of each period;
Dr       Unearned income (Profit) / Deferred profit
Cr       Profit and loss a/c

2.2.2                                Prudence and consistency

These two concepts are considered desirable qualities of financial statements rather than part of bedrock of accounting. The prudence concept was closely linked to that of ‘realisation’. The concept of prudence implies that IFIs should take a very pessimistic outlook in estimating income, expenses, assets and liabilities and promotes the need to be cautious in overstating assets or profits especially in the face of inevitable uncertainties in the business world. Circumstances that lead too uncertainties such as collectability of doubtful receivables, the probable useful life of assets and other contingencies are recognised by the disclosure of their nature and extent with a reasonable dose of prudence in the preparation of financial statements. The concept of consistency implies that a company should rarely if ever change the way in which financial information is prepared and presented. However, the comparability is regard to be more fundamental objective than consistency. In particular, any IFIs should not use consistency to justify an accounting policy that is no longer the most appropriate to its particular circumstances.

Apparently AAOIFI Standards are silent on the prudence principle in financial reporting. If IFIs understate the potential income or assets value, the financial report would be ‘unfair’ to the stakeholders and the users of financial statements (because if the report do not show the potential income/ assets, it is in conflict to the very idea of financial reporting in Islam which focus on ‘fair reporting’ of an entity’s financial position). However, if IFIs take a route to ensure in exact detail the value of each element of financial statement, this will increase the costs in the effort of ensuring the full and exact disclosure in the financial statements and this will burden the shareholders. Therefore, AAOIFI Standards are silent with regards to the concept of prudence and leaves it to the best discretion of the preparers of financial statements to comply with their local regulatory requirements or management or to any other regulations that would shape the decision in so far as employing prudence in the reporting process.

The requirement for consistency is also not in conflict with the Islamic accounting requirement whereby the presentation and classification of items in the financial statements should be retained from one period to the next unless circumstances require it to change. This is because comparability is regarded to be more fundamental objective than consistency. Should there is unexpected events occurred that require the reporting entity to change its accounting policy, the comparability would prevail.

2.2.3                                Definition of asset and the concept of ‘substance over form’

A major difference between conventional accounting and Islamic accounting lies in the definition of assets. AAOIFI defines asset as that which the enterprise has acquired rights to hold, use or dispose and does not recognise asset based on ability to control through other than legal ownership. An asset, in the conventional sense, is regarded as an asset when there is any future economic benefit embodied in the asset regardless of whether there is legal control by the reporting firm. From Islamic perspectives, to qualify as an asset, IFIs should have acquired the right to hold, use or dispose of the asset. Thus, AAOIFI does not particularly endorse the concept of ‘substance over form’. In view of the primacy of contract in transactions in Islam, the emerging reality must be constructed or appear to be as the form. This is evident in the treatment of leased assets (ijarah[5]) and murabahah transactions. For murabahah contracts, the essence of the transaction is in fact a sales transaction. Thus, the ownership title will be passed to the purchaser upon acquisition. But, IFIs can require the purchaser to pledge the assets acquired as collateral to the financing amount. The financier or the bank is prohibited to buy back the assets from the purchaser.

Under ijarah contract, AAOIFI recognised ijarah asset as fixed asset (incidental to legal ownership). Thus, repair and maintenance costs are the expense of the lessor (i.e. the financier or the banks) but the conventional practice, it is borne by the lessee. The examples of journal entries are shown as follows:

Journal entries:
*      Cash purchase of equipment for ijarah financing;
Dr       Equipment
Cr       Cash

*      Provides ijarah financing to lessee;
Dr       Investment in Ijarah asset
Cr       Equipment

*      Maintenance cost of ijarah financing asset;
Dr       Profit and loss a/cIjarah expenses
Cr       Cash

*      Depreciation cost of ijarah financing asset;
Dr       Profit and loss a/cDepreciation expenses
Cr       Accumulated depreciation

*      Ijarah rental received from lessee & income recognition;
Dr       Cash
Cr       Profit and loss a/c – Revenue

2.2.4    Historical cost and conservatism versus current value

Conventional accounting uses monetary units as a common denominator to express basic elements of financial statements. However, the use of monetary units is subject to inflationary and deflationary pressures which may significantly affect its purchasing power. Thus, historical cost concept only provides input to the ‘satisficing’ notion. Some decision makers do not seek to optimize but ‘satisfice’.

The current convention of historic cost and conservatism is deemed arose from the needs of bankers and shareholders. This concept is believed has been developed from the requirements of interest-based bankers who are interested not in seeing whether a proposed venture is profitable, but whether capital and interest are repaid. Thus there is needed to be conservative in the valuation of assets by using historical cost but anticipating all liabilities in conservatism concepts (Shahul Hameed, 2005). It is also favourable because the cost of publishing historical cost financial statements are negligible compared with those prepared under current cost accounting. However, these concepts could be contrary to the idea of fairness and justice. For example under valuation of historical cost, zakat or Islamic tax based on historical cost valuation would yield lower receipts and consequently lower transfer payments to the beneficiaries in times of inflation or rising costs. Zakat is basically an income tax and its payment is a religious obligation. Since zakat is based on wealth, current values would satisfy Islam’s concept of justice more adequately than would historical cost. Many writers have called for the provision of a fair zakat with proper valuation base is the most important objective of Islamic accounting. As quoted by Baydoun and Willet (1997), mention that zakat is so central to the Islamic faith that it has to be given a prominent place in the system of Islamic accounting. This may be strange to conventional accountants whereby many of them make their living by giving advice on how to avoid tax.

AAOIFI has also supports the use of current value and very specific on the method of current valuation to be used in the case of Islamic banking environment. The rationale for this position is that present and potential investment account holders (e.g. Mudarabah[6] investment account holders) need information to evaluate the bank’s ability to achieve its investment objectives. Thus if investments are measured using historical costs, inequities would occur in the distribution of investment results between the holders of investment accounts. Therefore, the current values appear to be consistent with the principles of socio-economic justice advocated in Islam. However, due to practical difficulties in the implementation, AAOIFI has put its recommendation on this issue on hold. For time being, AAOIFI accepted the historical cost concept. Its alternative measurement recommended is the “current cash equivalent”. Although the acceptance of the cost concept was not endorsed by all members, the majority of them were of the opinion that ‘it is not evident that adequate means are currently available to apply this (current value equivalent) concept in a manner that is likely to produce reliable information’ (para 135, Statement of Financial Accounting No. 2, AAOIFI).

Karim (1996) mentions that most IFIs tend to adhere to historical costing in the valuation of their assets. According to him, some banks, (e.g. Kuwait Finance House) use the “lower of cost or market value” for valuation of inventories whilst the others (e.g. Bank Islam Malaysia Berhad) use only the historical cost. There is no unanimous agreement among Islamic scholars with regard to this issue. This may be because this area is subject to Ijtihad (continuous exertion), as the Shariah only provides a general rule with regard to valuation and measurement. As mentioned in the Quran:

“Give measure and weight with (full) justice;... whenever you speak, speak justly...” (6:52)

“And O mankind! Give just measure and weight, not withhold from the people the things that are their due...” (11:85)

“And cover not Truth with falsehood, nor conceal the Truth when ye know (what it is)” (Surah Al-Baqarah: 42)

“But verily it is Truth of assured certainty” (Surah Al-Haqqah: 51)

                        2.2.5    Accounting unit

As per resolution No. 65/17, 7th Session of the Fiqh Academy, Jeddah, (-14 March, it is possible in Islamic jurisprudence to form a limited liability company. This provision allows for the treatment of the Islamic bank as a separate accounting unit from its owners.

                        2.2.6    Periodicity

Life of the IFIs should be broken into reporting periods to prepare financial reports that provide information to interested parties about their performances.

3.0      3.0    MASB FRSi-1, Bank Negara Malaysia’s BNM/GP-8i and rationales behind the needs for Islamic financial reporting standards

Western orientation of financial reporting and accounting was primarily based on the ‘stewardship theory’ and later, on ‘decision usefulness’. These are the factors that gave rise to the development of modern accounting and financial reporting practices by connecting the responsibility value between the “accountor” with specific target audience such as investors, creditors and lenders. According to conventional accounting theory, the “stewardship function of managers” must be the focus of attention of accountants in reporting to external parties. Because of these factors, historical cost concept was designed to satisfy the needs of those specific audiences, without making any provision for changes in purchasing power. According to Kohler (1963); “accounting is what it is today not so much because of the desire of accountants, but because of the influence of businessmen”.

The debacles of world giant conglomerates e.g. Enron, WorldCom, Global Crossing, Adelphia and Parmalat due to financial scandals, have evidence us how critical the issue is. Public begin to criticize openly on how accountants perform their professional duties in providing the true and fair view of the financial position of their client’s company. There have been suggestions that there should be a shift in the focus of financial reporting from ‘decision usefulness’ to ‘accountability’. The ‘decision usefulness’ paradigm is anathema to Islamic society since the primary aim is to serve the needs of stakeholders who are more directly involved with an enterprise such as investors, creditors and lenders. One of the objectives of accounting is to provide a fair information flow between “accountor” and “accountee”. From an accountant point of view, the accountability is a consequence of responsibility. By using the ‘accountability-based’ framework, the financial reporting would be more responsibility driven and the paradigm is aligning to the Islamic precepts. It is governed by divine injunctions and does not separate the secular and religion and holistic in its reporting. The objective of accounting and financial reporting for the fair information flow to the “accountee” or to the stakeholders and society at large will be achieved, as compared to the ‘decision usefulness’ paradigm endorsed by the West. Its principles do not serve the interest of any particular group, but to the society as a whole which can make corporations accountable for their actions and ensure they comply with Shariah principles.

The ‘accountability-based’ framework of financial reporting within the Islamic precepts is broader than what is generally understood in the West. According to Islam, man has covenant with God. To some extent, the covenant that exists between man and God is similar to the contract existing between the principal and agent as espoused by Gray et al (1987) in the principal-agent accountability framework. Accordingly, this covenant requires the man discharges his accountability in accordance with the responsibilities laid down by Shariah. From this point of view, one would thus expect the scope of Islamic financial reporting cover to be wider than that which is currently practised in the West, give the Islamic ethics and accountability. Accountability, as mentioned in the Quran:

“Then he that will be given his Record in his right hand will say: “Ah here! Read ye my Record!”, “I did really understand that my Account would (one Day) reach me!” (Surah Al-Haqqah: 19-20)

The ‘accountability-based’ framework of financial reporting ‘qualities’ are indeed reflected in the AAOIFI standards; SFA No.1: Objectives of Financial Accounting for Islamic Banks and Financial Institutions and FAS No.1: General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions, The FRSi-1 (previously known as MASBi-1) issued by Malaysian Accounting Standards Board recognises (MASB) and the Guidelines on Financial Reporting for Licensed Islamic Banks (BNM/GP8-i) issued by Bank Negara Malaysia (BNM). These will be analysed on the following sections.

3.1       Regulations for presentation and disclosures in financial reports

The International Accounting Standards committee (IASC), currently known as the International Accounting Standards Board (IASB) has issued standards on accounting disclosure for business enterprises including banking and financial institutions. The International Accounting Standards (IAS 30) is among the standards that specifies the disclosure in financial statements of banks and other financial institutions. However, this standard does not distinguish between Islamic and non-Islamic banks.

On the other hand, for Islamic banks, AAOIFI has introduced the framework and set the standards for reporting, auditing and governance purposes. Amongst the standards are the objectives, concepts and general presentation and disclosures in financial statements of IFIs.

For Malaysian case, as the banking and financial system develops, the MASB recognises the need for a set of comprehensive guidelines and accounting standards, particularly to cater for the growth in Islamic-based transactions as well as to meet the objectives of promoting investment in Islamic banking and capital market in Malaysia. The FRSi-1 (previously known as MASBi-1) issued by MASB provides a basis for the presentation and disclosure of financial statements of institutions that undertake Islamic banking activities. Previously, MASB1 (currently known as FRS 1) and other MASB standards adopted by companies in Malaysia were the conventions accepted. Furthermore, BNM or the Central Bank of Malaysia, governing body for financial institutions in Malaysia, has also issued its own guidelines for disclosures and financial presentations for these institutions: Revised Guidelines on Financial Reporting for Licensed Institutions (BNM/GP8) and Guidelines on Financial Reporting for Licensed Islamic Banks (BNM/GP8-i).

3.2       BNM/GP8-i by Bank Negara Malaysia

The GP8-i is the first guideline pertaining to IFIs’ financial reports presentations and disclosures, was introduced in August 2003. For commercial banks that practicing Islamic Banking Scheme (IBS) or “Skim Perbankan Tanpa Faedah” (SPTF), GP8-1996 is used, so as to cater to the need for specialized reporting and disclosure requirements for commercial banks participating in the interest free scheme. The minimum components of the specimen under the GP8-i comprise the following;

  • Performance Overview
  • Statement of Corporate Governance
  • Directors’ Report
  • Statement by Directors
  • Statutory Declaration by Directors
  • Reports of the Auditors
  • Report of the Shariah Advisory Board
  • Balance Sheet
  • Income Statement
  • Statement of Changes in Equity
  • Cash Flow Statement
  • Notes to the Accounts

The obvious differences between GP8 and GP8-i are the additional components to GP8-i: (i) the Statement of Corporate Governance, and (ii) Report of the Shariah Advisory Board. BNM has taken into consideration the requirement of AAOIFI and also the Bursa Malaysia Berhad in its Revamped Listing Requirements in 2001 for the issuance of the Statement of Corporate Governance. As prescribed in the guideline, it is to enhance the disclosure practices and presentation of reports and financial statements of IFIs. A requirement of the GP8-i for the presentation of Report by the Shariah Advisory Board is also a requirement by AAOIFI, adopted into GP8-i.

            3.3       Rationales behind the needs for Islamic financial reporting standards

In summary, we can conclude that the needs for Islamic financial reporting standards for IFIs is because of the nature of the IFIs itself that require the information regarding business to be disbursed to the users must be Shariah compliant, or else, it will not represent the true colours of the business operations. Moreover, by using Islamic financial reporting standards, it is governed by divine injunctions and does not separate the secular and religion and holistic in its reporting, and thus, the objective of accounting and financial reporting for the fair information flow to the “accountee” or to the stakeholders and society at large will be achieved. It will also be the basis to provide guidance for preparers in preparing a complete set of financial statements. It will also ensure comparability of operational and financial performance of all IFIs.

4.0       MASB and its Islamic accounting standards

As mentioned above, to this date MASB has only come out with FRSi-1 with 2 Technical Release known as; (i) TRi-1: Accounting for Zakat on Business, and (ii) TRi-2: Ijarah. Just recently, MASB has issued an Exposure Draft (ED) known as Exposure Draft i-3: Presentation of Financial Statements of Islamic Financial Institutions. Basically, the new MASB ED i-3 presents proposed amendments to FRSi-1. The Board has proposed to revise FRSi-1 to mirror proposed amendments to FRS 101, as set out in MASB ED 61: Presentation of Financial Statements. This is to maintain consistency between the two standards. The proposals in the two EDs would also bring the eventual Standards closer in alignment to IASB’s IAS 1 (revised 2007) which is largely in line with the equivalent standard issued by the US-based Financial Accounting Standards Board (FASB). The proposed changes also include a requirement on capital disclosures, to incorporate consequential changes due to IASB’s revision to IFRS 7.

            4.1       Process of developing Islamic accounting standards by MASB.

The process of developing Islamic accounting standards has led MASB engaged in elaborate and rigorous ‘due process’ and elicit views of practitioners, accountants, auditors, regulators and users of financial statements of Islamic financial institutions. MASB has also takes cognisance of the fact that all its standards are legally binding and has to ensure that the accounting standards it issues are enforceable without hindering the growth of Islamic banking.

4.2       The review of MASB’s Islamic accounting standard and the Technical Releases (TRs)

In this particular sub-section will highlight the probable causes of why MASB’s efforts in developing Islamic accounting standards are viewed not at par to the efforts of AAOIFI. In this section also I will give my semi-professional judgements to the probable causes for performance of MASB. This is based to my practical experiences as an accountant. Not only that, I have directly interviewed several prominent figures from the society of accountants in Malaysia with regards to the development of Islamic accounting and what are the futures will look like pertaining to the developments of Islamic accounting. However, the names of the interviewee are not disclosed for reasons that only I would know.

FRSi-1: Presentation of Financial Statements of Islamic Financial Institutions
FRSi-1 is the first accounting standard specially created for IFIs that is in harmony with the International Accounting Standards (IASs). In its development, MASB had also taken into consideration the substance of AAOIFI Standards, requirements of the Malaysia’s Companies Act 1965, Basle requirements and the requirements by the Revised Guidelines on Financial Reporting for Licensed Institutions (BNM/GP8). MASB also recognises the fundamental importance of Shariah requirement in developing this Standard and has established a formal structure that allows for issues relating to Shariah to be referred to the National Shariah Advisory Council (NSAC) of BNM. The NSAC focuses its attention specifically to the following aspects of the Islamic Banking operations;

  • Cash and accrual accounting basis for income recognition.
  • Allocation and distribution of profits to depositors.

With regards to the issue of selection between the concept of cash and accrual accounting basis for income recognition, the first experts (fuqaha) have determined that cash basis of accounting to be a mode of practice to account for Islamic transactions in the past. As economies develop and new transactions emerge to cater for new ways of doing business, the nature of contracts and its underlying transactions have compelled examination of the cash accounting to ensure that accounting and financial reporting of these transactions reflect the true nature of the business and its underlying transactions. Co-mingling of funds in Mudarabah contracts, separate legal entity, going concern are concepts that cash accounting has failed to address completely but they exist in the Islamic banking business today. However, some fuqaha have allowed the use of accrual basis in income recognition on a concept that assumes that profit can be estimated and distributed prior to completion of a contract and prior to realisation of cash. The NSAC recognises that where fuqaha differ in their opinion. To ensure consistency, fairness and transparency, the NSAC has recommended the MASB to adopt a harmonisation approach along with strategy to achieving standardisation in financial reporting. In this regard, the NSAC recommended an accrual basis of accounting as a benchmark treatment. An alternative to the benchmark treatment is the cash basis of accounting. An IFI that opts for the alternative treatment will have to disclose that fact in the notes to the financial statement, and to disclose a reconciliation to reflect the financial position had accrual basis been used.

With regards to the issue of allocation and distribution of profits to various categories of depositors, most fuqaha are of the opinion that distribution of profit should be made at gross level. This ruling was made after examining the underlying terms and conditions of Mudarabah principles. As a result of this decision, expenditures relating to Mudarabah funds are deductible only to the extent that they are directly attributable to the investment of those funds. Indirect overhead expenses should not be deducted from Mudarabah fund. The NSAC takes note that if the net method is used, the management of the IFIs will be at liberty to declare discretionary expenses such as bonuses, salary increases at the expense of the Mudarabah depositors, and this may be seen to be unjustifiable to the Mudarabah depositors, unless sanction is first obtained from the depositors.

TRi-1: Accounting for Zakat on Business
MASB recognised that there is a need to issue an accounting pronouncement for zakat on business because, as mentioned above, the zakat is so centre to the religion of Islam. Hence, the issuance of accounting pronouncement on it may lead more entities to pay zakat. In addition, as at the date of issuance of this Technical Release, there is no accounting pronouncement issued by IASB on this matter. Thus, TRi-1: Accounting for Zakat on Business issued by MASB would be timely. TRi-1 sets out the overall considerations as well as requirements pertaining to the recognition and assessment of zakat, determination of zakat base used in zakat assessment, presentation, measurement and disclosure of zakat information in the financial statements. TRi-1 has stated that eventhough MASB has followed the standards issued by AAOIFI as an instrumental in developing new standards (e.g. accounting standard for zakat issued by AAOIFI entitled Financial Accounting Standard 9: Zakah or FAS 9), The Board has considered AAOIFI’s FAS 9 is inappropriate in the Malaysia context because: (i) the accounting treatment prescribed are specific for application by IFIs that also act as collectors and distributors of zakat; and, (ii) the accounting treatments prescribed might run contrary to state or federal legislation in Malaysia. This has evidenced that eventhough MASB has the option to assimilate the FAS 9 as one of its standards, but MASB gives cognisance that the disparity between Malaysia and Bahrain legal jurisdictions resulted in different treatment of zakat paying/ payable. Therefore, lots of research and discussions are to be made by MASB especially between 14 zakat authorities in Malaysia.

TRi-2: Ijarah
The proposed accounting treatment for Ijarah spelled out in TRi-2: Ijarah share some of the treatment FAS 8: Ijarah whereby Ijarah gives rise to two items – the underlying Ijarah item owned by the lessor[7] and the usufruct obtained by lessee. However, from Shariah point of view (where AAOIFI’s silence to the treatment of the substance over form), there is no such thing as finance lease. Thus, Ijarah must only be in the form of operating lease. On the other hand, respondents for TRi-2 questioned the necessary for MASB to come out with separate accounting standard. Some respondents believed that the treatment of Ijarah as an operating lease in MASB ED i-2 oversimplified the matter. Another significant comment raised was that Ijarah in MASB ED i-2 was that Ijarah is not classified as ‘operating’ or ‘finance’ lease. Another comment was that the treatment of Ijarah as an operating lease ignored the lessee’s right to the benefit of Ijarah item, which should be recognised as an asset (‘substance over form’ principle). The conclusion derived from the respondents on MASB ED i-2 is that Ijarah is a concept that can be used in conjunction with other arrangements to yield many different products. The operating lease equivalent is only one of these products.

From conventional banking perspectives, the treatment of finance lease is most preferred because the banks normally do not want to concentrate on the operational complexities of leasing. Hence, the banks transfer substantially all risks and rewards of ownership of the leased assets to the customers. This treatment is in line to the conventional accounting treatments with regards to the principle of the ‘substance over form’ on the contrary side is not particularly endorsed by the AAOIFI. Hence, the asset is booked in the customer’s book whilst the banks treat the financing as receivable.

On the other hand, AAOIFI treatment on Ijarah is only in the form of operating lease where all the expenses in maintaining the assets are borne by the Islamic banks, not to transfer to the customers, unless agreed by the customers. As mentioned above, AAOIFI’s accounting treatments advocating to the principles of ‘form over substance’. This is because, from a Shariah point of view, there is no such thing as a finance lease. This is because anything which separates the physical transaction from its financial aspect making the transaction a loan and thus, is prohibited. Hence, the leased asset is to be recognised and depreciated by Islamic bank and the rental receivable is treated as income.

The accounting treatment of AAOIFI for Ijarah is totally contrary to MASB’s TRi-2. TRi-2 has suggested 2 treatments; (i) finance lease, and (ii) operating lease. Where Ijarah transfers substantially all the usufruct of tangible item, therefore, an entity shall account for Ijarah as finance lease in accordance with MASB approved accounting standards on leases. In the financial statements of a lessee, accounting for Ijarah as a finance lease would confer the lessee rights over an asset similar to ownership of the particular asset. On the other hand, where Ijarah does not transfer substantially all the usufruct of a tangible item and that item is within the scope of MASB approved accounting standards on leases, an entity shall account for Ijarah as an operating lease in accordance with MASB approved accounting standards on leases. In the financial statements of a lessee, accounting for Ijarah as an operating lease would not recognise the lessee’s right to the benefit of the Ijarah item as an asset. Therefore, the lessee’s obligation to settle Ijarah payments is not recognised as a liability. In the financial statements of a lessor, accounting for Ijarah as an operating lease would assign the ‘full value’ of the lessor’s net investment to the Ijarah item without taking into consideration the usufruct transferred to the lessee. This treatment is, in line to the AAOIFI’s accounting treatment.

We can draw conclusion from the accounting treatments for Ijarah available made by MASB is that not only it endorses the principle of ‘form over substance’ but also the ‘substance over form’.

4.3       Why MASB’s efforts in developing Islamic accounting standards is not at par with AAOIFI and the future options.

From my study and assessment to the impact in developments of Islamic accounting standards with interview to prominent figures in the society of accountants in Malaysia, the Malaysian Institute of Accountants (MIA) itself do not endorse to the products of AAOIFI standards. Generally, most of the Islamic products can be accounted according to the existing International Financial Reporting Standards (IFRSs). They viewed the AAOIFI’s standards is panacea of the ‘fire-fighting’ approach. The standards produced based on products, without resorting to firm conceptual framework as compared to IFRSs.

Impliedly, we can conclude that is not that MASB do not want to produce strings of Islamic accounting standards, but it is due to general overview that the accounting itself is already seen as Islamic. When only the principle of ‘form over substance’ endorsed by AAOIFI, one particular argument that needs to be reviewed is; what is wrong with the principle of the ‘substance over form’? The argument is that since when Islam refuse to take the ‘intention’ or ‘niyah’ into considerations? Most of sunni schools such as Maliki school of law uphold that the ‘intention’ will be the determination in deriving to the ahkam or rules due to certain acts.

These are some probable causes of why MASB is not so aggressive in developing the Islamic accounting standards. Another probable cause because the involvement of Shariah experts when promulgating the standards. This is because, to have fuqaha who is also an expert or exposed to the rigorous detail of accounting treatment especially in Islamic financial transactions is hard to find. On the contrary, to have experts of both worlds may speedy up the development of Islamic accounting standards.

After interview with some of the local prominent figures, the accounting experts, there are possibilities that the development of Islamic accounting standards would be embedded in the conventional accounting standards. The FRS accounting standards would come with specific notes or treatments for any deviation from the conventional accounting standards in order to cater for accounting of Islamic-based transactions. It is a kind of FRSIC-like treatments towards existing accounting standards. FRISC or the Financial Reporting Standards Implementation Committee is a task force group within the MIA that will analyse the suitability of the FRSs in the current Malaysia’s financial environment. If the FRSs to be implemented or that has already been implemented, but its application may not meet the objectives of fairness for example, the FRISC may issue consensuses that may be deviated from the original application of FRSs but will be legally binding. The future options of Islamic accounting would also follow this model. Only if the application of certain FRSs will result not to show a true and fair view of the transactions or when the application of certain FRSs directly violating the principle of Shariah, then consensuses by the FRISC which will allow deviation from the original standards will be uphold in the accounting process. The consensus is the body of the Islamic accounting but embedded together with the FRSs. Only if there are totally no existing accounting standards that can fully cater the accounting of Islamic financial transactions (for example; accounting for zakat), then only, a new specific set of Islamic accounting standard will be produced. It is believed that, by having it this way, the development of Islamic accounting which is directly impact to the development of Islamic banking and finance will rose hand in hand internationally.

5.0       Conclusion

AAOIFI was established on the premise that set of specific standards, methods and principles for financial reporting and accounting standards for Islamic financial transactions for IFIs to be developed, and carefully distinguished from their conventional counterparts.  The same reason why Islamic financial institutions (IFIs) have existed in the first place. Prohibition of interest in financial dealings is the primary reason, but there are various other issues and fine details which make up for the case of Islamic accounting and financial reporting. In fact, it is a must for every accounting practitioner to get to know the relevancy and the rationale of these standards. As for my personal opinion, MASB do not have to follow the path taken by AAOIFI in promulgating a new set of standards for Islamic financial transactions. This is because the FRS requirements have already cater the needs for accounting for such instruments. Thus, the need for new set of standards should not come into the picture at all. In fact, it may lead to the state of confusions for accounting practitioners. The fact that the AAOIFI standards are so backwards, the applications of such standards may lead un-Islamic picture for both Income Statements and Balance Sheets. However, MASB should consider to maintain the accounting for zakat as the needs to account for such instrument is real. More so, MASB might want to consider to consider the probability of coming with variation of FRS 139 standard that may cater the needs to accounting perfectly of Mudharabah instruments because it poses the hybrid nature of Debt and Equity (DEQUITY) which is not cater by FRS 139 standard yet.

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[1] Zakat: The literal meaning of the word means “blessing, purification, growth and increase”. The technical definition of zakat is a specified amount on specified wealth/ income which is collected from muslims who are liable and to be distributed to eight categories (asnaf) of people mentioned in the Qur’an.
[2] Ijarah : Contract of hiring/ leasing.
[3] Murabahah : The sale of goods at cost plus an agreed profit mark-up. Murabahah receivables are measured at the end of the financial period at their cash equivalent value (i.e. the amount of debt due from the customers at the end of the financial period less any provision for doubtful debts).
[4] Bay’ Bithaman-Ajil or BBA : Price-deferred sale. A variation of Murabahah but the payment for sale is deferred, may be by instalments.
[5] Ijarah : Contract of hiring/ leasing.
[6] Mudarabah : A profit and loss sharing contract in which one party provides the financial capital (account holder) and the other (banker) manages the enterprise. While profit is shared, loss is borne by the financier.
[7] Usufruct: the legal right to use and enjoy the advantages or profits of another person’s property.


  1. thank you for the information...
    really help me in complete ny assignments...

  2. Salam..thank you for the information.really useful for my research. may i know whther this articles has been published to any journals? thanks and regards