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  

Exposure Draft Shari'ah Audit Framework

Alhamdulillah, after extensive works, research and meetings for 8 months i.e. from September 2010 to May 2011, the exposure draft of the Shari'ah Audit Framework finally completed. This 9th. June, we will have the fourth feedback sessions from the industry players and working group members. We hope in July ISRA will organise a Thematic Workshop to get wider feedbacks from industry and stakeholders. I pray hard that the final output later to be presented to BNM will be a success. A small contribution towards a integrity of IFIs in Malaysia, inshaallah.

What will be the impacts of IFRS adoption on Islamic financial institutions?

To the 2 followers of my almost `dormant blog', thank you very much. My apology as I could not update my blog as I wish to.

The above question is well anticipated in the wake of globalised international accounting standards. What are the impacts of IFRS on Islamic financial institutions? Will the adoption lead to Shari'ah non-compliant on accounting issues? To what extent our IFIs can accomodate IFRS? To what extent IFRS can accomodate IFIs accounting needs? I don't have the answers to all these questions. However, these questions needs to be asked by all of us who are concern with the development of IFIs.

For the next few months, I will be involved in a colloborative research project of MASB and ISRA on the issues IFRS and accounting from Shari'ah perspective. Definitely some of the above questions and issues will be addressed. There are a number of specific Shari'ah issues that need to be addressed such as:

1. Substance over form or form over substance
2. Time value of money
3. Fair value accounting measurement
etc.

The list is long and we need to prioritise. Crucial issue is we need Shari'ah scholars who can understand accounting and that is my challenge for this project. I will update as we go along. Hopefully, we will issue some research findings and recommendations by October 2011. Please make dua'.