Download ISSUES IN ACCOUNTING STANDRADS: FOR ISLAMIC FINANCIAL

ISSUES IN ACCOUNTING
STANDRADS:
FOR ISLAMIC FINANCIAL INSTITUTIONS
Markfield Institute of Higher
Education
Dr. Seif E. I. Tag El-Din,
October, 2004
Introduction
• Banking success : public trust placed in
individual banks (depositors/ investors).
• Trust in Islamic banks: also relates to
the extent of adherence to Shariah ( the
identity card of Islamic banks).
• Source of public confidence: quality of
information – both financial strength and
Shariah adherence.
Imperative need for Accounting
Standards
• Emphasis of the Quran:
• “...Never get bored with recording it,
however small or large, up to its maturity
date, for this is seen by Allah closer to
justice, more supportive to testimony, and
more resolving to doubt..”
Imperative need for Accounting
Standards
• An open room for making appropriate
accounting judgement:
• “ … except when it is spot trade carried
out amongst yourselves, then you are not
to blame for not recoding it”, (al-Baqara: 2
82).
General Plan:
1. Key Concept of an Islamic Bank
2. Objectives of Islamic financial accounting
3. Basic Accounting assumptions and
criteria
4. General Layout of Islamic Accounting
Financial Statements
I. Key concept of Islamic bank
•
Mechanism: accept ‘deposits’ and offer ‘financings’
plus other banking/ investment services.
•
Compliance to Shariah: interest rate elimination
plus alternative Islamic modes.
•
PLS investment alternatives:
1.
2.
Unrestricted investments.
Restricted investments.
•
Fiduciary service for funds devoted to
social purposes : Zakah, Charitable funds.
Key Concept of Islamic bank:
‘Balance Sheet’
•
Assets Side : Physical assets plus interest-free
financial assets: Murabaha, Ijara, Istisnaa, Salam,
Mudarabah, Musharakah etc.
• Liability side :
1. Liabilities: interest-free demand deposits, interestfree saving deposits- no fixed return term deposits.
2. Unrestricted investment accounts : The
Islamic alternative of term deposits.
3. Net, worth
4. minority interest
Islamic Banks’ Processing of rights
and obligations
• Recognition – timely recording of the basic
elements of financial statements as they take
effect .
• Measurement - quantification of financial
effects
• Recording - lucid classification scheme of
financial effects
• Presentation - periodic reports to disclose
financial records during the given period of time.
II. Objectives of financial
accounting.
Why to identify unique objectives?
1. Ensure consistency with the objectives of
Islamic accounting standards.
2. Ensure internal consistency for all
present and future standards
3. Provide general guidance for choice
among possible alternatives.
Objectives of financial
accounting.
1. Determine rights and obligations of all
interested parties in accordance with the
principles of Shariah.
2. Subscribe to the safeguarding of the Islamic
bank’s assets, its rights and the rights of
others.
3. Subscribe to the enhancement of managerial
and productive capabilities of Islamic banks.
4. Report useful information to users, thus
enabling them to make legitimate decisions in
their dealings with Islamic banks.
Users of Financial Reports
•
•
1.
2.
3.
4.
5.
6.
Focus must be placed on non-authoritative
common information needs.
Appropriate Users of information are
Equity holders
Investment account holders
Current and Saving Account holders
Other dealers with Islamic banks
Zakah Agencies
Regulatory agencies
Objectives of Financial Reports:
•
•
•
•
•
•
Information about Islamic bank’s extent of
compliance with Shariah.
Information about adequacy of Islamic bank’s
capital, investment risks, and liquidity.
Information about cash flows-timing/risks.
Information about Bank’s policy in Zakah
assessment and disbursal.
Information about Bank’s fiduciary
responsibilities.
Information about discharge of other social
responsibilities.
II. Basic assumptions and
Criteria: The assumptions
• Accounting unit : treatment of an Islamic bank as
a separate accounting entity from its owners
• On-going concern: no perceivable time horizon
of assets liquidation or equity/ unrestricted investment
termination. Consider the far reaching consequences !
• Periodicity : breaking life of the Islamic bank into
reporting periods
• Stability of purchasing power. The
accepted standard is to ignore changes in the value of
money.
Qualitative Criteria of accounting
information
• Usefulness : in relation to given financial reporting
objectives .
• Relevance: Predictive value, Feedback value and
Timeliness
• Reliability : reflect the substance of the event or
transaction.
• Comparability: similar methods of measurement/
disclosure in relation to similar events.
• Consistency: same measurement/disclosure methods
from one period to another.
• Understandability : simple classification tools, clear
information headings, juxtaposition of data and
statement of net results which users want to know,
Preparation and presentation
criteria:
• Materiality: Qualitative as opposed to
Quantitative materiality
• Cost of information : Information is a
costly economic resource.
• Adequate disclosure : Optimum
aggregation and written descriptions/
clarifications :
Measurement and Revaluation
• Accounting measurement: the determination
of the amounts at which accounting elements should be
recognized – matching.
• Measurable attributes: fall into two categories:
cash equivalent value and historical cost.
• Justice consideration: value of an investment
account is dependent upon its expected cash equivalent
value.
Issue of Revaluation
• Revaluation of assets/liabilities :
Measurement at cash equivalents require periodic
revaluation of assets liabilities and restricted
investments.
• Currently adopted standard:
“ historical cost
shall be the basis used in measuring and recording the
assets at the time of acquisition thereof”.
General lay out of Islamic
financial statements :
• Basic classification as of conventional
statements: stocks and flows.
• Balance sheet: snap shot of stocks at a given
point of time – financial position.
• Income statement: moving film; summary of
inflow and outflows during a given period of time
- accrual basis.
• Cash-flow statement : moving film; cashbasis statement of inflows and outflows. .
Main categories of Islamic
financial statements :
1. Financial statements reflecting the
Islamic Bank’s function as an investor .
2. A financial statement reflecting changes
in restricted investments managed by the
Islamic bank – Mudarib /Agent.
3. Financial statements reflecting the
Islamic bank’s role as a fiduciary of funds
for social purposes.
Islamic Bank’s function as an
investor
– Statement of financial position
– Statement of income.
– Statement of cash flow.
– Statement of retained earning / or statement
of changes in owners’ equity.
Statement of financial position:
Disclosure:
• Date of the statement
• Grouping of Assets and Liabilities in
accordance of their nature, and in order of
their relative liquidity.
• No ‘current/ fixed’ groupings.
• Separate totals for Assets, Liabilities,
Unrestricted Investment Accounts and
their equivalents, and Owners’ Equity.
Statement of financial position:
Definitions:
• Assets:
• an asset is a measurable thing capable to
generate cash flows or other economic
benefits in the future, individually or in
combination with other assets.
• Islamic bank must have acquired the right
to hold, use or dispose of, as a result of
past transactions or events.
Statement of financial position:
Definitions:
• Liabilities:
• A liability is a measurable present bank’s
obligation to another party to transfer
assets, extend the use of an asset, or
provide services to that party in the future
as a result of past transactions or events.
• Islamic bank’s obligation must not be a
reciprocal to an obligation of the other
party to the bank.
Statement of financial position:
Definitions:
Unrestricted Investments and their
equivalents (Unrest. part. bonds):
• Treated as elements of financial position,
because they are based on unrestricted
Mudarabah.
• Not considered a liability. Why ?
• not considered part of ownership equity
because they do no enjoy ownership rights
(e.g voting right)
Statement of financial position:
Definitions
• Owners’ equity:
• It is the amount remaining at the date of
the statement of financial position, from
the Islamic bank’s assets after deducting
the bank’s liabilities, equity of unrestricted
investments and their equivalents
• Prohibited earnings if any, must also be
deducted.
Statement of financial position:
Assets Disclosure :
•
•
•
•
•
•
Cash and cash equivalent
Receivables ( Murabaha, Salam,
Istisnaa)
Investment securities
Mudarabah investment
Musharakah investment
Investment in other entities
Statement of financial position:
Cont. Assets Disclosure:
•
•
•
•
•
•
Inventories.
Investment in real estate
Assets acquired for leasing
Other investments (disclosure of their
types)
Fixed assets (disclosure of depreciation
for significant asset types )
Other assets (disclosure of significant
types).
Statement of financial position:
‘Liability Side’
• Liabilities
• Equity of unrestricted investment
account holders and their equivalents.
• Owners’ equity:
Statement of financial position:
Liability Disclosure
•
•
•
•
•
•
•
Current accounts, saving accounts and other
accounts with separate disclosure of each
category
Deposits of other banks
Salam Payable
Istisnaa Payable
Declared but undistributed profits
Zakah and taxes payable
Other accounts payable
Statement of financial position:
Unrestricted investment accounts: Disclosure
• Method used to allocate profit/loss
between the bank and unrestricted
investment account holders.
• Assets jointly financed by the Islamic bank
and unrestricted investment account
holders and those exclusively financed by
the bank .
Income statement :
Definitions/Recognition
• Revenues: Gross increases in assets or decreases in
•
•
•
•
liabilities, or a combination of both, resulting from
legitimate investment, trading, rendering of services,
including investment management of restricted
investment accounts. (exclusions !).
Recognition:
Bank should have earned the right to receive revenue
through a completely consummated process.
An obligation must fall on another party to a remit a fixed
or a determinable amount to the bank .
Amount should be known and collectible, if not already
collected
Income statement :
Definitions/Recognition
• Expenses : The simple reverse of revenues.
• Recognition: Also recognized when realized, either
• because the expense relates directly to the earning of
revenues that have been realized, or
• indirect costs relating to a certain period covered by the
income statement.
Income statement :
Definitions/Recognition
•
Gains (losses ): A gain is a net increase
in net assets resulting from:
1. Holding assets that appreciate in value during
the period covered by the income statement
2. Or from incidental legitimate reciprocal (e.g
sale of assets not acquired for sale)
3. Or non-reciprocal transfers (donations) –
(exceptions !)
Income statement :
Definitions/Recognition
•
Gains/losses are recognized when
realized in one of two possible situations:
1.
completion of a reciprocal or non-reciprocal transfer
resulting in gain or loss,
1.
or sufficient evidence indicating reasonably
measurable appreciation or depreciation in values of
recorded assets or liabilities.
Income statement :
Definitions/Recognition
• Net income (net loss):
• The net increase (decrease) in owners’ equity
• Results from revenues, expenses, gains, losses,
after allocating the return on unrestricted
investment accounts and their equivalents, for
the period.
• It is the result of all on-going profit oriented
operations of the bank and other events and
circumstances.
Income statement :
Disclosure:
•
•
•
•
•
Period covered by the income statement.
Revenues and gains from investments
(-)Expenses and losses from investments
(=) Income (loss) from investments
(-) Share of unrestricted investment account
holders in income (loss) from investments before
the bank’s share as Mudarib
• (=)The bank’s share in income (loss) from
investments
Income statement :
con. Disclosure:
• (+)The bank’s share in unrestricted investment income
as Mudarib
• (+) The bank’s share in restricted investment profit as
Mudarib
• (+)The bank’s fixed fee as an investment agent for
restricted investment
• (=/-) Other revenues, expenses, gains and losses
• (-) General and administrative expenses
• (=) Net income (loss) before Zakah and taxes
• (-) Zakah and taxes ( separate disclosures)
• (=) Net income (loss)
Financial statement for changes
in restricted investments
• Restricted investments are not assets of the
Islamic bank and should not be reflected in the
bank’s statement of financial position.
• The bank does not have the right to use or
dispose of these investments except within the
conditions of the contract between the bank and
holders of these accounts.
• The statement must show deposits and
withdrawals by holders of restricted investments
and their equivalent as of a given date.
Financial statement for changes
in restricted investments
•
•
•
•
•
Disclosure:
The period covered by the statement should be
disclosed.
The statement should segregate restricted investments
by source of financing ( e.g accounts or portfolio units)
and by type.
Nature of contractual relationship between bank and
owners of restricted investments – Mudarib / agent
Rights and obligations associated with each type of
investment account or investment portfolio.
Statement of sources and uses of funds in the Zakah
and Charity Fund:
• Zakah: A fixed obligation calculated by
reference to net assets that have appreciated or
have the capacity to appreciate over a specific
period of time except for assets acquired for
consumption or used in production.
• For Limited liability Company: Zakah should
be based on the company’s net assets, and the
total amount be divided between owners.
• Bank as an agent of Zakah
Statement of sources and uses of funds in the Zakah
and Charity Fund:
• Disclosure
• The period covered by the statement
• Bank’s responsibility for the payment of
Zakah on behalf of owners of unrestricted
investment accounts and their equivalents.
• Payments and uses of funds during the
period and available funds at the end of
the period.
CONCLUSIONS
THANK YOU