IIAM Shariah Audit Masterclass

Assalamualaikum warahmatullah wabarakatuh

Thanks Dr. Rizwan Bakar (IIUM Accounting Alumni) for commenting on previous posting. We should discuss further the issues through email soon.

Last week on the 14th of October, I was invited to share my thought on Shariah Audit at the National Internal Audit Conference. This event was organised by the Institute of Internal Auditors Malaysia (IIAM) and was held at the KL Convention Centre. It was well attended by internal auditors from many different types of industries.

The interest on Shariah Audit is emerging very fast but many are not sure how to go about. Those internal auditors working in Islamic Banks, Takaful firms and other Islamic institutions have conducted some forms of Shariah Audit. They faced many challenges from the planning stage to properly develop Shariah Audit Programs to how to effectively handle Shariah non-compliance risks.

I shared my views on the issues facing Islamic financial industry especially on properly offering and managing Islamic financial services. The challenges such as linking Shariah risk management, Shariah internal control, and Shariah compliance review with Shariah Audit. I can't share the issues fully here. I also deliberated on the role of Shariah Committee, the Board and the Management to properly facilitate the development of Shariah audit. Otherwise, many Shariah non-compliance issues will not be properly addressed. Ultimately, it may affect the integrity and the credibility of the Islamic institutions.

I also provoked the participants of the fact that IIA's Code of Ethics and COSO's Framework are insufficient to address the ethical issues and internal control issues in Islamic institutions. I also shared the AAOIFI's Code of Ethics that to a certain extent contribute towards a different paradigm of Islamic value system in shaping the internal auditors.

As usual, moving forward, I hope more of the emerging issues of Shariah Audit will be addressed by the regulatory authority such as BNM. However, from the academic view point, there is a lot of potential to close the knowledge gap on Shariah Audit.  

Islamic Accounting Symposium (Jakarta, 27-28 August, 2014)

On 28th August, 2 weeks ago, I was invited as a speaker in Islamic Accounting Symposium organised by Universiti Islam Negeri (UIN) Shariff Hidayatullah, Jakarta, Indonesia. The topic given to me was Development of Islamic Accounting Theory. It is an interesting topic considering the emerging interest in the development of Islamic accounting especially in Islamic financial industry.

I started my presentation by explaining the movement of Islamization of knowledge. I defined the term "Islamization" from the perspective of Syed Muhamad Naquib Al-Attas. I also explained the systematic process of undertaking the Islamization from the well structured suggestion made by Almarhum Al-Faruqi. I argued that the challenges now is how to interact with the Islamic sources of knowledge and the ability of our Muslim scholars to be able to articulate the modern disciplines. Our Islamic accounting scholars have no choice but they must be able to deal with the Qur'an and the Sunnah. They also have to dig the Islamic heritage especially on the Islamic history of accounting.

I presented a table on the development of Islamic accounting from 1980s to now. I started with the overview of literature by Abdel Magid (1981). At this early stage, Abdel Magid presented the accounting implications of Islamic banking theory and practice. I also provided an overview of Gambling and Karem (1986) when they examined the theory of social accounting from the Islamic cultural and societal perspective. It is interesting to note that at the beginning of the Islamic accounting literature were mostly normative and theoretical. It is well understood as at the beginning, we have to contend with developing the skeletal theoretical framework.

By 2000s, I presented the list of emerging literature published in international refereed journals. I summarized the development in terms of methodology and I argued that more dynamic and pragmatic studies that used empirical quantitative and qualitative methods in developing their research framework. In terms of theory, there were many studies that adopted variety of theoretical stands such as Islamic accountability, Muslim culture and traditions, Islamic banking theory etc to frame their research.

Going forward, let us hope Islamic accounting theory will emerge as a new discipline that are sound theoretically and grounded in practice. With the emerging Islamic financial industry, the relevance of Islamic accounting practice is more obvious. Let us hope that there are more able Muslim scholars to come forward to further develop Islamic accounting theory.....  

My Presentations

Last week, I made 2 presentations. On Tuesday at USIM, I presented a topic on "Islamization of Accounting Knowledge: Challenges and Hopes". It was attended by academic staff of the Faculty of Economics and Muamalat. On Thursday, I presented at my previous university, IIUM, on the topic "Emerging Issues on Zakat Management and Accounting". It was attended by academic staff and postgraduate students of the Faculty of Economics and Management Sciences. Both topics are inter-related and reflect my academic concerns for many years.

As I am settling down at USIM, it is important for the next generation of academics to be aware of the development of Islamic accounting. Islamization of accounting is a challenging task as we need to master conventional accounting theory and practice before we can embark on Islamizing accounting. Our ability to deal with our heritage i.e. the Qur'an and the Sunnah together with critical understanding of past literature will determine how far we can move forward.

On the topic of Zakat, I have presented 4 emerging issues. First, on the need to measure performance of Zakat institutions by focusing on the outcome of Zakat collection and distribution rather than focusing only on inputs and outputs of activities. Secondly, I also shared my views and past research on the efficiency of Zakat institutions in Malaysia. Past research findings indicated that `decentralization' of decision making process and providing good facilities in terms of Zakat payment systems influenced efficiency. Thirdly, I shared my concerns on the shortcomings of the present measurement method for Zakat on business wealth and the present accounting valuation method of fair value in assessing Zakat. Fourthly, the conventional accounting system, I argued, is not `friendly' for Zakat accounting and reporting purposes.

Finally, as I reflect on the new field of Islamic accounting, there is a need for more intensive and high quality research. May Allah SWT provides us strength and patience in exploring and contributing towards Islamic accounting knowledge. As we are at the end of the month of Ramadhan, I pray for the blessings from Allah (Barakah and Rahmah) and, Eid Mubarak to all Muslim readers and friends.

Now, I am with USIM

Assalamualaikum...

Ramadhan Kareem. May Allah SWT bless us and hopefully Ramadhan this year will make us a better person insha Allah.

From 1st July, I will be working with the Islamic Science University of Malaysia (USIM) based in Nilai, Malaysia. I have been appointed as a Professor and attached with the Faculty of Economics and Muamalat. This journey is part of my Hijrah towards the betterment of myself and possibly the Ummah as well. I hope I can contribute to USIM especially when they will be offering new postgraduate programmes in Islamic banking and finance, and Islamic accounting soon.

Beside full-time at USIM, I am also attached with the International Shari'ah Research Academy in Islamic Finance (ISRA) based in Petaling Jaya, Malaysia, as a Research Fellow. This position is on a part-time basis and I will spend at least 1 day per week at ISRA. I will mainly to contribute in conducting research and enhancing their research activities.

Wassallam. Thank you.



  

The Potential of Qualitative Social Research in Islamic FInance

Last Thursday, I conducted a Research Workshop on Qualitative Research for the researchers of ISRA. If we examine the past literature on Islamic finance, there are many quantitative theoretical and empirical research such as on performance and efficiency, consumer behaviour, managerial aspects of Islamic financial institutions etc. have been undertaken and published. There are also many `Qualitative Textual Research' in Islamic finance especially on Shariah and legal issues. However, there are very few research that have been done using `Qualitative Social Research' in Islamic finance.

The nature of Qualitative Social Research' can be summed up as follows:

“Data consist of descriptions and accounts provided by participants in the research site, together with the researcher’s observations on activities and interactions and the context in which they take place. Data must be collected over an extended period of time so that processes can be recorded…The researcher, in general, does not seek to test prior hypothesis. Rather he, or she seeks to theorize through the data in an inductive manner. Analysis of the data is itself an emergent process. The researcher seeks gradually to develop empathy with the data, to understand what they tell of participants’ realities and the process through which they unfold. The researcher must constantly construct alternative interpretations until he or she is satisfied that the representation is a faithful account. Interpretations must be grounded  in context and consistent with the chronological ordering of events and interactions. Finally, the results must be represented in such a way that the reader can independently judge their credibility." (Dent, J, 1991. “Accounting and Organizational Culture”, Journal of Accounting Organizations and Society)

The usefulness of Qualitative Social Research is normally to assist researchers in discovering personal experiences and values such as religious conviction, behavior, culture etc. It is also useful to uncover and understand what lies behind the complex human, organizational or societal phenomenon. Qualitative data can give intricate details of the phenomenon and help to develop new research hypotheses/propositions. Another strength of this type of research is the richness and in-depth research findings.

The Qualitative Social Research can be utilised in Islamic finance in a variety of ways such as:

• Understanding the Shari’ah, the managerial, marketing or/and accounting issues and practices in IFIs
• Corporate and organizational culture in IFIs
• Culture of Shari’ah compliance in different types of IFIs
• Shari’ah compliance from the different views of stakeholders
• Corporate and Shari’ah governance in IFIs

ISRA Research Fellow & New Research Initiative

From 15th May 2014, I have been appointed as Research Fellow by the International Shari'ah Research Academy on Islamic Finance (ISRA). The position is on a part-time basis and I will spend at least 1 working day in ISRA. I will be involved as principal researcher in at least 1 research project and I will also be involved in other activities to enhance research function including conducting research workshops in relevant areas.

Here, I provide a synopsis of the research project that I will be heading at ISRA:

Research Title: "The Application of Intangible Assets in Islamic Financial Industry: An Islamic Accounting Perspective"

 Recent study by ISRA (i.e. Bouheraoua et. al., 2013) on the “Shariah Issues in Intangible Assets and their Application in Islamic Finance Institutions” has raised a number of pertinent issues. The study has critically discussed the emerging issues on intangible assets especially recognition and measurement; financing and trading; and zakat. The study has found that (i) there is an issue of gharar in the identification and determination of intangible assets; (ii) it is generally permissible to finance and trade intangible assets except in the trading and exchange of receivables, options and futures; (iii) zakat is obligatory on intangible assets if the intention is to trade them. However, the study has not really delved into accounting issues on intangible assets from an Islamic perspective. The study has reviewed only briefly the issues of accounting recognition. However, there are many other pertinent issues such as accounting measurement and financial reporting which have not been properly dealt with. As the Islamic financial industry is evolving with many related issues on intangible assets, there is an urgent need to extend the above study. This proposed study will examine the accounting issues of intangible assets from the Islamic (Shari’ah) perspective. Three pertinent accounting areas of concern to be examined are namely accounting recognition; accounting measurement; and financial reporting. This study aims to contribute towards a better understanding of accounting for intangible assets from an Islamic perspective. The study will also enhance the application of intangible assets in the Islamic financial industry and ensure that all the requirements are properly governed by the Shari’ah precepts.       

My Article Published in the Edge

SHARI’AH AUDIT: FROM COMPLIANCE TO ASSURANCE

From 2012, all Islamic financial institutions (IFIs) in Malaysia are required by Bank Negara Malaysia (BNM) to observe and comply with the Shari’ah Governance Framework (SGF). The SGF is a set of organisational arrangements through which IFIs ensure effective oversight, responsibility and accountability of the board of directors, the management and the Shari’ah Committee. Ultimately, the SGF serves as a guide towards ensuring an operating environment that is compliant with Shari’ah principles.

The SGF, to a certain extent, has successfully reinforced the Shari’ah compliance functions, internal Shari’ah review and audit requirements, supported by an appropriate risk management process and research capability. The implementation of the SGF so far has contributed towards Shari’ah compliance process. However, currently, the Islamic financial industry lacks a robust Shari’ah assurance process.

Shari’ah audit is essentially an assurance process as it should be conducted by independent auditors. Shari’ah audit is needed to fill the gap of Shari'ah compliant activities and services of the IFIs. The stakeholders need to be assured that the institutions that offer Islamic financial services have sufficient levels of Shari’ah assurance processes and controls. Today, mere claims by the IFIs that they are fully Shari’ah compliant may no longer be sufficient. Independent assurance through Shari’ah audit is essential to enhance the integrity and the accountability of the IFIs.

Pitfalls of the SGF

The SGF requires all IFIs to establish Shari’ah audit function that performs annual audits in order to provide an independent assessment of the adequacy and compliance with established policies and procedures, and the adequacy of the Shari'ah governance process. Closer scrutiny of the SGF indicates that the Framework did not sufficiently explain the requirements and the functions of Shari’ah audit. The best example would be the crucial relationship between the Shari’ah audit and the Shari’ah risk management which was not clearly spelled out.

There is also a lack of guidance as to the level of appropriateness of Shari’ah risk management framework. Instead the SGF expects the IFIs to develop their own risk management framework. Realising the uniqueness and complexities of Shari’ah non-compliance risks, Shari’ah risk management function should be properly developed before the IFIs can effectively undertake Shari’ah audit. Shari’ah non-compliance risk indicators and measurement should be clearly identified. In addition, the line of reporting and responsibility on Shari’ah risk management should also be clearly expounded.

On another note, the SGF specifies that the Shari’ah audit shall be performed by the internal auditors, whom are trained and have adequate knowledge of Shari’ah. However, the SGF did not specify the level of Shari’ah knowledge and the specific areas of Shari’ah that they need to equip themselves. The nature of their work requires specialised knowledge of Shari’ah essential for them to carry out their work effectively. The IFIs should also be required to create special positions of Shari’ah auditors within their internal audit division.

The SGF has also purposely excluded the function of external Shari’ah audit. External audit, in contrast to internal audit, represents the third party role to provide check and balance of the Shari’ah assurance requirements. Similar to external financial audit, the absence of external and independent audit reports by qualified Shari’ah auditors will certainly affect the credibility of IFIs in the eyes of stakeholders.

One important governance concern is on the line of authority of Shari’ah audit function. As per the SGF, Shari’ah audit is directly answerable to the audit committee. Unfortunately, the audit committee’s present scope of work is already very demanding. To expect them to plan and to scrutinise the Shari’ah audit would be an additional burden and responsibility that may affect the overall efficiency of audit committee.

Another taken for granted issue is on the role of Shari’ah committee with regards to Shari’ah audit function. There is a dire need for a comprehensive guideline in the case where there is a dispute or different of opinion between the management and the Shari’ah auditors on matters relating to Shari’ah interpretation. By right, all disputes or differences shall be referred to the Shari’ah committee of the IFIs.

In theory, the Shari’ah committee and the Shari’ah auditors should be responsible to jointly plan the Shari’ah audit. Once the Shari’ah audit function is performed by the auditors then it must be reported directly to the Shari’ah committee and the audit committee for deliberations and remedial actions. The final report must then be tabled to the board of directors for their attention and further action.  

The Urgent Need for Shari’ah Audit Framework

The above arguments indicate an urgent need for the Shari’ah Audit Framework that should complement the SGF. The primary objective of this elusive Framework is to provide guidelines for the management to properly discharge their responsibilities according to Shari’ah rules and principles. In addition, the purpose of the Framework is to ensure that the system of internal control for Shari’ah compliance is conceptually sound and effective in its implementation.

The Shari’ah Audit Framework is needed to clearly specify the roles and functions of both the internal and the external Shari’ah auditors. Shari’ah auditors should have direct and regular communications with all levels of management and the Shari’ah committee. Knowing the sensitivity of some Shari’ah issues, there should not be any scope limitation and restriction of access to evidences, documents, reports etc. in order for the Shari’ah auditors to undertake their work. This is to ensure the efficiency and the effectiveness of Shari’ah audit function.

The need for a more robust Shari’ah assurance function – not just Shari’ah compliance - should be considered seriously by BNM. The need for a comprehensive Shari’ah Audit Framework to guide the industry is long overdue. The issues raised above are only `tips on the iceberg’ and certainly there are many other outstanding issues facing the Islamic financial industry. The imperative next step is the need for a comprehensive guideline on Shari’ah audit to ensure that all activities and operations of the IFIs truly in compliance with Shari’ah.

Shariah Audit Conference 2014

This article has argued for the need of a more robust Shari’ah audit function and guidelines. Realising the increasing demand for greater integrity and transparency of IFIs, the Institute of Internal Auditors Malaysia (IIAM) will organise a Shariah Audit Conference 2014 after a successful inaugural event organised by the industry’s association in 2011. IIAM in collaboration with the Islamic Banking and Finance Institute Malaysia (IBFIM) will organise this important event on 20^th and 21^st May 2014 at Hotel Istana, Kuala Lumpur. This event will hopefully be able to discuss the pertinent issues of Shari’ah audit and to explore future direction of this nascent industry. The shift of focus from Shari’ah compliance to Shari’ah assurance is indeed crucial to enhance the public confidence of the IFis which in turn contributes toward sustainable growth of the Islamic financial industry.

Accountability: An Islamic Theory?

The word accountability is derived from the root word "account". In Arabic, "account" means Hisab. That is why accounting in Arabic can be translated as Muhasabah i.e. the process of Hisab. How about the Arabic meaning of accountability? The process of Muhasabah is ensure accountability.

There is another Arabic word Taklif which refers to that "personal accountability". In Islam, once we reach the age of puberty we are Mukallaf i.e. we are personally accountable to Allah for our deeds and misdeeds.

In Islam, there is a concept Habluminallah or our relationship with God. As human beings we have "covenant" with our creator. It means we rely on God for our existence. We are not omnipotent like God. Our "covenant" with God means we have to be accountable to God. Otherwise, the "covenant" has no purpose. On one hand we have to rely on God but on another hand we are also accountable to God.

Hablumminallah as a concept that distinguish Islamic accountability process from the Western counterpart that is purely agent-principal relationships. Islamic accountability process to God is our multidimensional and transcendental relationship to God (Hablumminallah).

On the other hand, Hablumminannass is our social relationship to other human beings. Our covenant with other human beings requires us to respect, work together, and cooperate on the basis of mutual respect and justice. Hence, we are also accountable to other human beings to ensure our covenant to other human beings is fulfilled. The relationship, in the conventional sense, is a horizontal relationship instead of a transcendental relationship.

Why are discussing all the above concepts? To me, it could help us to conceptualise the nature of Islamic accountability concepts (Muhasabah or Taklif) and relationships (Habluminallah wa Hablumminannass). Hence, it should guide us to develop "what should be" the Islamic accounting objectives that consequently guide the Islamic accounting theory to be developed.    

Is accounting a purely technical and value free discipline?

Accounting is not a science like physics as accounting rules are man-made and not the results of natural phenomena. Accounting is also not purely technical and value free discipline like computing as accountants used judgements in their works. Accounting is not merely bookkeeping and only recording of financial transactions as accountants also measures and values assets and liabilities. Accounting process also communicates financial information and interpreted by users of information, who are also human beings.

So what really is accounting?

Accounting, most likely, is a social science. The accounting rules are determined by accountants and regulators. Accountants and regulators are human beings and need to be understood. Accountants used judgements in measuring and valuing assets and liabilities. As human being, accountants are not value free. Accountants will be influenced by their background, education and some time culture. How about the religion or belief of the accountants. Will religion or belief influenced accountants' rules and judgements?

Many past studies have proved that accountants' works and judgements are being influenced by their beliefs, values or/and religion. If you are keen to know this fact you can google some of the past studies including my PhD thesis and my other papers on this subject matter. However, some studies have proven that beliefs, values and religion did not influence accountants. Could it be that human beings including accountants now are more secularised? Could it be that accountants have been trained to follow rules and used less judgements? Are accounting policies today are highly regulated and less opportunities for accountants to reflect?

On another note, in developing Islamic accounting theory, we need to explore many possibilities. One of my PhD student is trying to prove that the religiosity of Muslim accountants influence accountants' judgements. She examined the religiosity using questionnaire survey and examined the intention of accountants in potential fraudulent financial reporting. Let us wait for her findings soon.

Who said Islamic accounting theory development is purely qualitative? We can study using quantitative method on many potential accounting problems to develop Islamic accounting theory. As I mentioned in my earlier posting Islamic accounting theory can be "what it should be" (normative and qualitative) or "what it is" (quantitative and positivist). The study on the impact of religious values and culture can be done qualitatively and as well quantitatively. Methodologies do not matter. What really matter is to find the truth in whatever way possible. Are we ready?




  

Misconceptions About Islamic Banking (Part 1)

1. "Islamic banking encourages people to take Islamic financing and encourage people to be in debt".

Islamic banks offer Islamic alternative to people who are in need financially. Rather than they take loan with interest, which is prohibited in Islam, Islamic banking provides Halal alternative. Islamic banking is not supposed to "sell" Islamic financing like the conventional banks. Islamic way of marketing plan should be different as we provide solution and assistance to those who are in need rather than promoting customers to take debt.

2. "Islamic banking creates debt similar to conventional bank, hence they are the same"

In substance, Islamic banking creates economic outcome very similar to debt. However, the contract of rights and obligations are based on Bai' i.e. buying and selling at transparent mark-up. Hence, the legal form is markedly different. The profit is not riba. The perception that Islamic financing leads to the same outcome as the conventional bank may not hold truth. Islamic banking provides an arrangement that is more ethical as it is based on mutual need and benefit.

3. "Islamic banking treated debtors similar like conventional bank including harassing customers who are not able pay back on time or failure to pay"

Islamic banking is expected to treat customers and debtors differently. If they are unable to pay, they are normally given opportunity to restructure their financing and debt. The Islamic bank may give them more time or reduce the installment to assist the customers. However, if the customers are hardcore debtors then the Islamic bank has the right to repossess the asset as the customers have  mutually agreed when they signed the agreement to take the Islamic financing. Islamic debt collection policy should enable both the customers and the banks to be protected according to Shari'ah. In Islam, the role of debtors and creditors is to make sure that both parties fulfill their rights and obligations according to the agreed contracts.

Shari'ah Audit: The Way Forward

Shari'ah audit for Islamic financial institutions (IFIs) is an emerging practice. Shari'ah audit is important to provide Shari'ah assurance rather than just Shari'ah compliance. It is crucial to ensure credibility and enhance integrity of IFIs. Shari'ah Governance Framework (SGF 2011) has charted the path for Shariah audit in Malaysia. Many IFIs have started embarking on Shari'ah audit. Some are still struggling to practice as Shari'ah audit needs the understanding and the expertise of both the financial services and the Shari'ah.

The shift of focus from internal compliance to independence assurance is a requirement and no longer an option. It is not enough to claim that they are Shari'ah compliance without a robust practice of Shari'ah assurance through internal or/and external audit. More importantly now is the importance to link Shariah assurance and Shari'ah risk management. The SGF 2011 does not address this critical link sufficiently. I believed the next step of development is to develop a robust methodology for risk identification, risk measurement, risk mitigation etc. for Shari'ah non-compliance risk.

At the end of next month, there will be a conference to be organised by Institute of Internal Auditors Malaysia on Shari'ah Audit. They have requested me to write an article to promote the conference in the Edge. Hopefully, I will be able to write a piece of my thought soon. I intend to write on the importance of linking Shari'ah audit and Shari'ah risk management. The link is to ensure proper management and reporting of Shari'ah risk management (pre event) and Shari'ah audit (post event).    

Attributes of Good Research and Good Researcher

Last week, I shared with my PhD students at IIUM Institute of Islamic Banking and Finance (IIiBF) a topic on Attributes of Good Research and Good Researcher. Here, I summarized the main points of my presentations.

Attributes of good research:
1. Undertake a comprehensive and critical literature review
2. Well conceived research objectives
3. Theoretically sound research hypotheses or propositions
4. Well developed research design and theoretical framework
5. Valid and reliable research method and analysis
6. Useful and well written research findings

Attributes of good researcher:
1. Clear and sincere intention
2. Love of knowledge
3. Disciplined and good time manager
4.Good aptitude and creative minds
5. Equip with necessary research skills
6. Ambitious

I discussed the above attributes in a proper context with the following quotations:

"And Allah has brought you forth from your mother’s womb knowing nothing – but He has endowed you with hearing, and sight, and minds, so that you might cause to be grateful”(Al-Qur’an, An-Nahl, verse 78)

“Seek knowledge from the cradle to the grave” (Prophet Muhammad SAW)

“Longing for knowledge is eternal” (Einstein)

It is important to appreciate research and knowledge in our short time in this temporary world. Let us contribute to mankind and the Ummah to the best of our ability and effort. 

  

Is there a theory of Islamic accounting? (Part 2)

In the previous posting, I argued that a theory of accounting can be of two possibilities i.e. what it should be and what it is. "What it should be" in a conventional methodological approach is a normative theory. We need to develop Islamic accounting theory from the sources of Islamic knowledge i.e. the Qur'an, the Sunnah, and other sources of Shari'ah. Hence, it will be hypothethical but founded on the Islamic belief system. The way to develop it might be in qualitative and persuasive way.

Islamic accounting theory needs to be founded on Islamic accountability theory. We need to distinguish Islamic accountability from the conventional counterpart which mainly centred upon the agency theory. It does not mean that the agency theory with the theorisation of agency cost and moral hazard will not be relevant, however, the conventional agency theory is argued as insufficient to explain the accountability relationship. It is superficial to only view i the context of principal and agent only. In Islamic accountability theory, we need to theorise the Islamic concept of Hamblumminallah rather than just Hablumminannass. We also need to bring in the Islamic concept of Khalifah (vicegerency), Amanah (trust) and Taklif (individual responsibility) and theorise the relationship of accountability in the Islamic way.

With the richness and very distinguished Islamic accountability theory, we should be able to theorise the role of accounting as a mechanism to ensure financial, managerial and public accountability. Modern corporations and institutions need a much more comprehensive and equitable accountability theory. Islamic accounting then will function as "what it should be" in the context of Islamic accountability relationships. We can even link the theory with the functions of Islamic financial institutions such as Islamic banks. These institutions, in theory, should be founded on Islamic accountability theory rather that the western's principal-agent relationships in the conventional sense. Hence, the Islamic accountability of Islamic institutions should in turn shape (or may be create) Islamic accounting theory.

In the next few months, my intention is to write and develop a normative theory of "what Islamic accounting should be" in the form of an academic paper. I need to spend more time to theorize the Islamic accountability from the rich heritage of Islamic concepts. I hope many aspirants PhD candidates willing to work in this area. It is dry and challenging by certainly thought provoking. May Allah SWT guide us.


      

Is there a theory of Islamic accounting? (Part 1)

Accounting theory is a difficult subject even for accounting professors. Practitioners normally avoid theory as they are too concerned with practices. For accounting students, accounting theory is a boring and dry subject. Many accounting degree programmes and professional accounting qualifications are not really teaching accounting theory. However, accounting theory is important as theory provides the foundation for practice. Sometime practices change the theory. Conventional accounting has been in search of accounting theory for more than 50 years and yet the theory of accounting (even if there is) is still debatable and developing.

In a simple term, accounting theory is an explanation and a justification of "what accounting is" and what "accounting should be". It provides a framework of thinking and principles to guide practice. Hence, Islamic accounting is an explanation and justification of what "Islamic accounting is" and what "Islamic accounting should be".

For what "Islamic accounting is", my suggestion is we need to examine the practice of accounting especially in the contemporary Islamic institutions such as Islamic banks and Zakat institutions. In theory, these institutions are guided by the Islamic worldview and the Shariah. From the study of these institutions we need to be able to derive a theory of Islamic accounting.

For what "Islamic accounting should be", my suggestion is we need to study the main source of guidance for the Muslims i.e. the Qur'an to derive some broad principles that can guide accounting practice. For example, the implications of verse 282 Surah Al-Baqarah on the accounting theory development should be studied and explained thoroughly. We also need to study the body of knowledge of Shari'ah, Usul Fiqh and Fiqh Muamalat to draw some guidances as well.

Finally, who need to initiate, study and spend their life time to undertake the above important tasks?  

My latest papers from 2011

 In case anyone is interested and needs a softcopy, please email me at abdulrahim.iium@gmail.com. Make sure you introduce yourself. Sharing knowledge is so important to enhance the Islamic accounting and finance theory and practice.

1.   “A Framework to Analyse Efficiency and Governance of Zakat Institutions”, Journal of Islamic Accounting and Business Research, Vol.2 No.1, Emerald: UK, 2011 (with Norazlina Abdul Wahab).

2.      “Determinants of Customers’ Intention to Use Islamic Personal Financing: The Case of Malaysian Islamic Banks”, Journal of Islamic Accounting and Business Research, Vol.2 No.1, Emerald: UK, 2011 (with Hanudin Amin, Stephen Laison Sondoh & Ang Magdalene Chooi).

3.   “Enhancing Integrity of Islamic Financial Institutions in Malaysia: The Case of Shariah Audit Framework”, ISRA Journal, Vol.3 No.1, 2011.

4.     Management Accounting Systems in Islamic and Conventional Financial Institutions in Malaysia”, Journal of Islamic Accounting and Business Research, Vol. 2 No. 2, Emerald: UK, 2011 (with Siti Zaleha Abdul Rasid & Wan Khairuzzaman Wan Ismail).

5.    “Management Accounting and Risk Management in Malaysian Financial Institutions” (with Siti Zaleha Abdul Rasid), Managerial Auditing Journal, Vol.26 No.7, Emerald: UK, 2011. [SCOPUS]

6.      “Efficiency of Zakat Institutions in Malaysia: An Application of Data Envelopment Analysis” (with Norazlina Abdul Wahab), Journal of Economic Cooperation & Development, Vol. 33, No.1, Statistical Economic and Social Research and Training Centre for Islamic Countries (SESRIC), Turkey, 2012.

7.   “Productivity Growth of Zakat Institutions in Malaysia: An Application of Data Envelopment Analysis” (with Norazlina Abdul Wahab), Studies in Economics and Finance. Vol. 29 No. 3, 197 – 210, 2012. [SCOPUS]

8.   “The Efficiency of Islamic and Conventional Commercial Banks in Malaysia” (with Suraya Ahmad), International Journal of Islamic and Middle Eastern Finance and Management. Vol. 5 No. 3, 241 – 263, 2012.

9.    “Theory of Islamic Consumer Bahaviour: An Empirical Study of Consumer Behaviour of Islamic Mortgage in Malaysia” (with Hanudin Amin & Dzuljastri Abdul Razak), Journal of Islamic Marketing, Emerald UK, 2013.

10.  “Determinants of Efficiency of Zakat Institutions in Malaysia: A Non-Parametric Approach” (with Norazlina Abdul Wahab), Asian Journal of Business and Accounting, Vol. 6, No.2, 2013. [SCOPUS]

Substance Over Form (Part 2)

Should Islamic financial transactions reflect the legal form or the economic substance? My honest opinion both are importance. However, for Islamic financial transactions the legal form determine the Shariah compliant of the transactions. Economic substance may seem similar to conventional but the legal form is markedly different. The previous example on Islamic investment in Islamic banks indicates just that.

Another classic example is in the case of Islamic financing. Islamic financing instruments normally revolved around the concept of buying and selling such as bai muajal, bai bithaman ajil or bai at-tawarruq. Economic substance of Islamic financing is very similar to conventional loan. The profit on loan is interest but in the case of Islamic financing it is purely profit. However, Islamic financing involved buying and selling of asset at transparent mark-up. There are contracts of purchasing and selling of assets involved. The relationship is buyer and trader as compared to conventional loan borrower and lender. Conventional loan is simply money lending with interest.

This leads to a question whether Islamic financing is like a conventional loan. From the economic substance it may appear to be similar as the flow of funds has almost the same impacts but from the legal form it is obviously not. This leads to my argument that Substance Over Form as an accounting principle cannot be adopted for Islamic financial transactions. The concept that should be used is Form Over Substance. I have discussed 2 examples already, should we discuss more....?

Substance Over Form (Part 1)

One of the most important fundamental principles of modern accounting and financial reporting is the impact of the economic substance should be reflected rather than the legal form. The economic substance reflect the purpose of the financial transaction or the economic consequences truly and fairly. The legal form is secondary important because it only accounted the legal or the technical aspect of the transaction.

The best example is when a motor vehicle company purchase motor vehicle for business purposes i.e. for sale. The substance that should be reflected is purchase of stock of goods for sale. However, if the company purchase a motor vehicle to be used by the company or by the management then the economic substance is fixed asset purchase. Even though the legal form is the same, the economic substance should be different due to different purposes of the purchases.

In the case of Islamic financial transaction, when an investor put their money in the Islamic bank let say based on a Mudarabah contract,  the economic substance is the same like conventional deposit. However, the legal form is different. Conventional deposit is a lending transaction and the bank pays the depositor interest. In the case of Islamic and Mudarabah investment, it is a relationship between the investor (Rabbul Mal) and the bank (Mudarib). The profit earned by the Islamic bank is then shared with the investor and it is not an interest payment.

From the above example, if Islamic financial transactions used Substance Over Form principle then we missed out the legal form that make up the transaction. Legal form must be reflected to distinguish the accounting treatment of Islamic investment from interest-based lending. The profit must also be distinguished from interest income that reflect the different underlying principle of Islamic financial transactions.

To be continued...      

Toward a Theory of Equitable Islamic Accounting and Finance

Welcome to my dormant blog. I will try my best from now on to write and contribute my thought using this blog. Now, I should have more time to write and hopefully expand the interest on Islamic accounting and finance theory and practice.

Is there a theory of Islamic accounting? Is there a theory of Islamic finance? I will try to answer these 2 questions in the next posts. There are many writings on Islamic accounting and finance. Unfortunately, after many years of exploration, there is yet a convincing underlying theory to explain Islamic accounting and finance. I will try to write and argue my thoughts in the next postings. Please stay tuned.

Abdul Rahim Abdul Rahman