Islamic Accounting - SBF270 PDF

ISLAMIC BANKING AND FINANCE ISLAMIC ACCOUNTING By: Dr. Dana AlZayani Department of Islamic Banking University of Bahrain 2021 What is Islamic Accounting?  Islamic accounting is the accounting process which...

ISLAMIC BANKING AND FINANCE ISLAMIC ACCOUNTING By: Dr. Dana AlZayani Department of Islamic Banking University of Bahrain 2021 What is Islamic Accounting?  Islamic accounting is the accounting process which provides appropriate information (not necessarily limited to financial data) to stakeholders of an entity which enable Islamic Accounting them to ensure that the entity is continuously operating within the bounds of Shariah and delivering on its socio- economic objectives. Islamic Accounting differ from conventional accounting in the way accounting information is reported, but some also relate to the way transactions are measured  Shariah is based on two primary sources, the Quran and the Sunnah. The Quran is specific about certain basic aspects of business Islamic Accounting life and accounting. the Quran specifically requires followers to keep proper records of their indebtedness and the payment of zakat, which is analogous to a form of religious taxation. " ‫إنَما الَّصَدقاُت ِللُفَقراِء َوالَمساكيِن َوالعاِمليَن َعَليها َوالُمَؤَّلَفِة ُقلوُبُهم‬ ۗ‫َوِفي الِّر قاِب َوالغاِرميَن َوفي َس بيِل الَّلِه َوابِن الَّس بيل َفريَضًة ِمَن الَّلِه‬ ‫َّل‬  Surah Taubah Ayat 60 with English Translation The alms are only for the poor and the needy, and those who collect them, and those whose hearts are to be reconciled, and to free the captives and the debtors, and for the cause of Allah, and (for) the wayfarer; a duty imposed by Allah. Allah is Knower, Wise. ﴾60﴿  Quran also prohibits riba and all activities under the heading of ‘unfair trading’. Islamic Accounting One of purposes that firms prepare financial statements is to enable zakat to be calculated and paid. The assessment of zakat is a primary function of Islamic accounting. What are the main accounting standards bodies?  Accounting Standard: IFRS Founded: April, 2001 Founder: The IFRS Foundation Membership: 14 Highly experienced International Accounting Objectives: Standards Board o To develop in public interest single set of accounting (IASB) standards (A/Ss) that is high quality, understandable and enforceable. o To develop and issue IFRS and Exposure Drafts. o To co-operate with National A/Ss to achieve convergence with IFRSs Key responsibilities: Develop New, review existing and reduce differences between National A/Ss and IFRS.  Accounting Standard: US GAAP Founded: 1973 Founders: the Securities and Exchange Commission (SEC). Financial Accounting Used by US public firms. Standards Board Objectives: To establish and improve financial accounting (FASB) and reporting standards to provide useful information to investors and other users of financial reports and educate stakeholders on how to most effectively understand and implement those standards.  Established in 1990, and registered in Bahrain in 1991. In addition to issuing accounting standards, AAOIFI also AAOIFI issue standards on auditing, governance, ethics, and Shari'ah. AAOIFI establishment - the existing international standards were inadequate to cater for the Islamic finance industry's needs. AAOIFI wanted to address the lack of standardisation of Shari'ah accounting and auditing standards for IFIs in the GCC countries. Do all Islamic financial institutions adopt AAOIFI accounting standards?  AAOIFI standards: Bahrain, Jordan, Lebanon, Qatar, Sudan and Syria. IFRS: Saudi Arabia and UAE. Local accounting standards based on AAOIFI: Indonesia and Pakistan Local accounting standards based on IFRS: Malaysia  Financial statements are fundamental documents through which an institution discloses information regarding its Financial financial performance and financial position. statements Understanding of various statements in a set of financial statements is important for users of such statements as they are able to make an assessment of the institution’s financial standing.  A complete set of financial statements addresses the needs of various users of financial statements. The set consists of the following: a. Statement of Financial Position Financial statements b. Statement of Income c. Statement of Cash Flows d. Statement of Changes in Owners' Equity e. Statement of Changes in Restricted Investments f. Statement of Sources and Uses of Funds in the Zakah and Charity Fund g. Statement of Sources and Uses of Funds in the Qard Fund h. Notes to the Financial Statements What are the components of the balance sheet in IFIs that follows Islamic accounting standards?  The Statement of Financial Position provides the financial position of a financial institution at a specific point in time. Statement of The basic elements of a statement of financial position are financial position as follows: 1. Assets 2. Liabilities 3. Equity of unrestricted investment account holders and their equivalents 4. Owner’s equity.  Statement of financial position  Assets are resources controlled by an IFI as a result of a past transaction, event or condition which provides the IFI an enforceable right over the resource and gives it an economic benefit. Example: Asset Murabaha financing Ijarah financing Istisna’a financing Ijarah recievables Investment securities Trading securities  Liabilities are present economic obligation that is enforceable against the IFI. Liabilities result from past Liabilities transactions or other past events. Example: Customers’ current accounts Borrowings from financial institutions  Equity of unrestricted investment account are Funds received for the purpose of investment on a profit sharing Equity of unrestricted or participation basis under Mudaraba arrangements. investment account The investment accountholders provide economic resources, usually cash, to the IFI for investment purposes with the expectation of receiving attributable profits after paying the IFI a share of the profit and a fee where relevant.  Owners’ equity is the residual interest in the assets of the IFI after deducting all its liabilities and amounts shown in the balance sheet as equity of investment accountholders. Owners’ equity Example: Share capital (issued shares) Treasury shares Reserves  The income statement reflects the financial performance of an IFI over a certain period. Basic elements found in an The income income statement are as follows: statement 1. Revenue (Return on unrestricted investment accounts and their equivalent) 2. expenses 3. Net income (net loss) The income statement  Revenue is the value of all sales of goods and services recognized by a company in a period. Revenues Example: Income from Murabaha financing Income from Musharaka financing Income from Ijarah Muntahia Bittamleek (net of depreciation) Fees and commission income  An expense is the cost of operations that a company incurs Expenses to generate revenue. Example: Staff costs Depreciation  A statement of changes in owners' equity represents the Statement of changes in the equity accounts during the period. changes in owners' equity Elements of statement of changes in owners’ equity: o Net income (loss) o Investment by owners and adjustments o Distributions to owners  The statement of cash flows shows the sources and uses of cash for the period. Statement of cash flows The basic elements of this statement are: o Cash flows from operations: These include cash inflows and outflows as a result of transactions and other events during the normal course of business whose effects are reflected in the statement of income. They do not include gains and losses resulting from the sale of assets acquired by an IFI for its own use.  o Cash flows from investing activities: These represent cash inflows and outflows as a result of the acquisition or disposal of assets for investment or cash flows resulting from the sale of assets previously acquired by an IFI for Statement of cash investment or for its own use. flows o Cash flows from financing activities: These include cash inflows or outflows as a result of investments made by owners (share issue) or distribution to owners (dividends), deposits or withdrawals by holders of unrestricted investment accounts and their equivalent and deposits or withdrawals by current, savings and other similar accounts.  A statement of changes in restricted investments represents the changes in these equity accounts during the period. Statement of Restricted investments are assets acquired by funds changes in provided by holders of restricted investment accounts and restricted their equivalent and managed by the IFI (as Mudarib). investments Restricted investments should be disclosed in a separate statement or disclosed as off- balance sheet item at the bottom of the balance sheet BECAUSE the bank does not have the right to use or dispose of those investments except within the conditions of the contract between the IFI and holders of restricted investment accounts. (the bank cannot mix its fund with restricted investment funds). Statement of changes in restricted investments Statement of changes in restricted investments  Funds provided by Rab al-maal are mixed with banks own funds to be invested as per banks discretion. Unrestricted Investment Account Unrestricted Bank own Investment Mixed fund Authorization funds Accounts Invested in any project chosen by the bank  Funds provided by Rab al-maal cannot be mixed with Restricted banks own funds. Investment Account The bank invests the Restricted fund in a specific project Investment determined by the Accounts account holders.  The sources and uses of the Zakat funds statement is prepared by companies authorised to collect Zakat and distribute these funds as per the Sharia requirements. Statement of The basic elements of this are as follows: sources and uses of funds in the Zakah and charity Sources of funds in the Zakah and charity fund fund o Zakah is to be paid by all Muslims whose accumulated wealth meets the criteria for the payment of Zakah. Companies are also required to pay Zakah determined on the basis of their net assets. o Charity funds are funds donated directly by customers, or funds that arise from certain transactions, including those that a company cannot recognise as income, such as penalties on loan default payment.  Statement of sources and uses Uses of the Zakah and charity fund of funds in the Zakah and charity The Zakah and charity fund is used for the financial fund assistance and social uplifting of society, especially those in need as per the teachings of the Holy Quran and is a cornerstone objective of Islamic finance.  Statement of sources and uses of funds in the Zakah and charity fund  The Fiqh definition of Qard is that it is a non-interest bearing loan intended to allow the borrower to use the loaned funds for a period of time with the understanding that the same Statement of sources and uses amount of loaned funds would be repaid at the end of the of Qard fund period. An IFI may organize a fund for Qard as a means of achieving social objectives. The statement shows the sources and uses of a Qard fund during the period. Sources can be internal or external.  Statement of sources and uses of Qard fund  Notes are an integral part of financial statements and usually comprise of: Notes to the financial a IFIs business overview statements accounting policies used for preparation of financial statements explanations and breakup of amounts disclosed in the financial statements certain additional specialized disclosures (which are not part of other statements but are necessary to understand the financial performance) Why do we need special accounting standards?  Profit and loss distribution amongst the investment account holders (IAHs) in IFI is different as compared to The Need for Islamic Accounting dividend distribution under conventional system. Standards In conventional financial institutions, the profits are distributed to the depositors and losses are borne by the conventional financial institution because profits are guaranteed by the institution, whereas, IFIs share the profit in pre-agreed ratio and losses are shared in capital contribution ratio.  Investment accounts in IFI with further classification of The Need for unristricted and restricted investment account, are Islamic Accounting Standards treated as quasi equity and presented separately from liabilities and owners’ equity in financial statement or off- balance sheet, whereas under traditional system they are treated as financial liability.  Elements of balance sheet in : The Need for Islamic Accounting Conventional banks: Assets, Liabilities and Owners Equity Standards Islamic Banks: Assets, Liabilities, Equity of Investment Account Holders (unrestricted) and Owners Equity. (add: off-balance sheet items)  Any reserve created from the profit attributable to The Need for investment account holders (IAH) is disclosed by an Islamic Accounting IFI. Standards On the other hand, there is no requirement for conventional financial institutions to provide any such disclosure.  An IFI required discloses the areas / sectors where investment is made, whereas, a conventional financial institution does not do the same. The reason for this disclosure is to provide transparency to the users of the The Need for financial statement. Islamic Accounting Standards According to IFRS 815, only public listed companies are required to present and publish information in financial statements, contrary to this, as per AAOIFI FAS 2216 “Segment Reporting”, all IFI whether listed or unlisted need to present and publish information in their financial statements.  The classification of Zakah in the IFIs’ financial The Need for statement is of non-operating expense. On the other Islamic Accounting hand, conventional financial institution classifies Zakah Standards as an operating expense. The set of statements are different under AAOIFI and IFRS (you need to explain)