FIN 6650

ACCOUNTING AND CONTROL OF

ISLAMIC INSTITUTIONS
ASSOC. PROF. DR. NORAINI MOHD ARIFFIN
DR. ROS ANIZA MOHD SHARIFF
DEPARTMENT OF ACCOUNTING
KULLIYYAH OF ECONOMICS AND MANAGEMENT SCIENCES
IIUM

Evaluation
Group project
25%
Mid-term examination 15%
Article Review
10%
Participation
10%
Final examination
40%
Total
100%
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GET TO KNOW EACH OTHER SESSION

TOPIC 1
OVERVIEW OF SHARIAH AND ACCOUNTING

What is Bank?

Its a Financial Intermediary !

Savings &
Investment

Financing

Surplus Units
Individuals
Businesses
Government

Return on investment
& savings

Banks Liabilities

Deficit Units
Financial
Intermediary
(e.g. bank)

Individuals
Businesses
Government

Return on
financing

Banks Assets
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Why Do
We Need
Islamic Banking System?

 Compliance with Shariah

Meet financing and investment needs of

the Muslims
Meet modern requirement of individual and
commercial needs
Encourages financial innovations but in line
with Shariah
In Malaysia, growing regulatory and social
support

Historical Development of
Islamic Banking
The 1st. Islamic Bank Mit-Ghamr Local Savings Bank

(1963) - Nasser Social Bank, Egypt (1971)

Dalla Al-Baraka Group, Saudi (1969)
Islamic Development Bank, Jeddah, Saudi (1975)
Dubai Islamic Bank (1975)
Faisal Islamic Bank - Egypt and Sudan, Kuwait Finance
House (1977)
Jordan Islamic Bank (1978)
Bahrain Islamic Bank (1979)
Dar al-Maal al-Islami (1981)
BIMB (1983)
Bank Muamalat (1999)
Kuwait Finance House (Malaysia) (2006)
Al Rajhi (Malaysia)(2006)
Islamic Banks Subsidiaries

Malaysian Dual Banking System

In 1963, the Pilgrims and Fund Management Board

provides a savings mechanism for Muslims to

perform Hajj
In 1983, the Islamic Banking Act (IBA) was approved
and defined Islamic Banking as banking business
whose aims and operations do not involve any
element which is not approved by the religion of
Islam.
Government Investment Act (Act 275) 1983
empowers the government to issue Government
Investment Certificates (GIC) with returns in the
form of discretionary gift (Hibah) rather than interest
In 1993, Conventional banks can operate Islamic
banking and financial products known as Skim
Perbankan Tanpa Faedah (SPTF)
10

ISLAMIC BANKING IN MALAYSIA

In Malaysia: dual banking system regime
- Islamic Banking runs parallel with conventional
banking (non- Islamic Bank)
Islamic Banking System in Malaysia is
governed and regulated by Central Bank of
Malaysia (Bank Negara)
Regulatory Framework:
- Banking And Financial Institution Act (BAFIA)
1989- govern conventional bank
- Islamic Banking Act 1983- govern Islamic
Bank
-Takaful Act 1984
-Islamic Financial Services Act 2013
- Companies Act 1965
- Central Bank of Malaysia Act 1958
- Garis Panduan 8 (GP8-i)- relevant to reporting of

2 Full-fledged Islamic banks:

Bank Islam Malaysia Berhad (1983)
Bank Muamalat Malaysia Berhad (1999)

The foreign commercial banks that have

started their Islamic subsidiaries in Malaysia

are:
HSBC Amanah Malaysia Berhad ( Launched on

25 November 2008)
Standard Chartered Saadiq Berhad (Launched
on 12 November 2008)
OCBC Al Amin Bank Berhad ( Launched on 11
November 2008)
Three foreign Islamic banks:
Al Rajhi Banking and Investment Corporation

Berhad (Al Rajhi)

Kuwait Finance House Berhad (KFHMB)
Asian Finance Bank Berhad (AFB)

Interest Based Financial Intermediation

Process
Current
Deposits
(Demand
)
Savings
Deposits
(Demand
)

Shareholder
s Funds

Financial Institution

Loans &
Advances

Investmen
ts

Fixed
Deposits
(Time)
Deposit interest rate
(expense)

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Interest Rate Spread

Interest rate Spread

Lending interest rate

(income)

Profit Sharing Ratio

Financial Intermediation Process
Current
Deposits
(Demand
)
Savings
Deposits
(Demand
)
Investme
nt
Accounts
(Time)
Dividend rate
(Gift or Profit)
(distribution)
16

Shareholder
s Funds

Financial Institution

Equity
Based
Financing
Sales
Based
Financing
Lease
Based
Financing
Investmen
ts

Profit Rate Distribution

(Profit Sharing Ratio)

Profit rate
(income)

What Does it Mean By

Shariah Compliance?

17

Validity and Permissibility

Valid

is the contract that meets its

requirements and conditions.
Permissible (Halal) is the contract that is
used to obtain Halal (Permissible) ends.
A valid contract is not necessarily Halal
(permissible).
Selling guns to criminals is valid, but it is
not Halal.
Validity is based on the form of the contract
while permissibility is based on the
substance of the contract and the intention
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of the contractors.

What is Riba?

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Juridical Meaning of
Riba
Literally means excess, increase, expansion,

growth.
In Shariah: (Refer to Wahba Al-Zuhaily, Fiqh AlIslami Wa Adillatuh)
Hanafis School: A surplus of commodity or an
excess in return without counter value
Riba is a predetermined excess or surplus over
and above the loan received by the creditor
conditionally in relation to a specified time
period
Riba was made forbidden in the 8th or 9th
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year after the Hijrah (flight from Makkah)

Quranic Prohibitions
Those who devour riba will not stand

except as stands one whom Syaitan by his

touch has driven to madness (Al-Baqarah:
275)
But Allah has permitted Trade and
forbidden riba (Al-Baqarah:275)
O you who believe! Fear Allah and give up
what remains of your demand for riba, if
you indeed believers. If you do it not, take
notice of a war from Allah and His
Messenger; but if you turn back, you shall
have your capital sums; deal not unjustly
and you shall not be dealt with unjustly
(Al-Baqarah:278-279)
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Hadith Justification
Avoid the seven grievous sins They asked:

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What are they. O Messenger of Allah? He

(p.b.u.h.)replied, Associating anything with Allah,
magic, killing a soul which Allah has declared
inviolate without a just cause, devouring the
property of an orphan, dealing with riba, fleeing
on the day of fighting, and culminating the chaste,
innocent, believing woman. (Muslim)
Riba is of seventy three kinds, the lightest in
seriousness of which is as bad as ones marrying
his own mother; for the Muslim who practices riba
goes mad. (Al-Hakim)
The Messenger of Allah (p.b.u.h.) cursed the
devourer of riba, his constituent, the one who acts
as a witness to it, and one who acts as a notary to
it.

Categories of Riba
1. Riba al-Duyun

2.

Riba al-Buyu

- Applies to sale

- Applies to loan or to

any debt regardless

of the cause of that
debt be it because of
a loan contract or
because of any
transaction like a
price that has not
been paid yet by the
buyer in a sale
contract

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transactions in certain
commodities
- It has two types:
1. Riba al Nasiah (delay
in paying or delivery of
one or the two sold
items); and
2. Riba al Fadl
(exchanging one ribawi
commodity for the
same commodity but
unequal in amount

Riba Al Duyun (Loan)

The basis for the prohibition of riba in

loan transactions as a result of delay in

time is the Quranic verses, eg. 2:275
In loan transactions, riba will occur if the
three conditions below are fulfilled:
There is excess or surplus over and above

the loan capital

Determination of this surplus in relation to
time
Stipulation of this surplus in the loan
agreement
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Riba Al Buyu (exchange)

The basis for the prohibition of riba in the

exchange of ribawi commodities is the

famous saying (hadith) of the Prophet
s.a.w. on six commodities:
Gold for gold, silver for silver, wheat for wheat, barley
for barley, dates for dates, salt for salt like for like,
equal for equal, and hand-to-hand (spot); if the
commodities differ, then you may sell as you wish,
provided that the exchange is hand-to-hand or a spot
transaction

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Summary of rules under the

hadith
Exchange

Condition

Money1 + Money1

Equality
Hand-to-hand (spot)

Food1 + Food1

Equality
Hand-to-hand (spot)

Money1 + Money2

Hand-to-hand

Food1 + Food2

Hand-to-hand

Money + Food

No conditions free trading

Money + Others

No conditions free trading

Food + Others

No conditions free trading

Others + Others

No conditions free trading

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What is Gharar?

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Meaning
Deceit, fraud, uncertainty,
danger, peril, or hazard that might lead
to destruction or loss
Technically: uncertainty and/or
ignorance of one/both parties in a
contract over the substance or
attributes of the object of sale, or doubt
over its existence and availability at the
time of contract
Literally:

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Prohibition of Gharar
All jurists agree that gharar should be avoided in commercial

exchange contracts
Prohibition of gharar
Indirect references made in the Quran
Conclusively prohibited by the Sunnah of the Prophet
s.a.w.
Classical examples of gharar sale
Sale of fish still in the sea
Sale of birds in the air
Sale of unborn animals
Types of gharar
Gharar yasir (minor or slight)
Tolerated and will not invalidate a contract
Gharar fahish (major or excessive)
Not tolerated and may result in contract voidability
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Rationale for Gharar Prohibition

To ensure full consent and satisfaction of

the parties in a contract

Without full consent, a contract may not
be valid
Full consent can only be achieved
through certainty, full knowledge, full
disclosure and transparency
Gharar in commercial contracts may
lead to injustice, exploitation and/or
enmity among contracting parties
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What is Accounting?

31

Definition and Purpose of

Accounting
In 1966 the American Accounting Association
defined accounting as:
the process of identifying, measuring and
communicating economic information to
permit informed judgements and decisions
by users of that information
In 1975 they added that the purpose of the
process was:
to provide information which is potentially
useful for making economic decisions and
which, if provided, will enhance social
welfare
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FINANCIAL ACCOUNTING EQUATION

AND ISLAMIC FINANCE
ASSETS

= LIABILITIES + EQUITIES

USES OF FUNDS

SOURCES OF FUNDS

PRICING

DISTRIBUTION AMONG CLAIM HOLDERS

EFFICIENCY

EQUITY

Islamic Bank:
Financial Claims & Assets

UNRESTRICTED
INVESTMENT ACCOUNT
HOLDERS/ GENERAL
INVESTMENT
ACCOUNTS

DEPOSITORS

FIXED ASSETS

Uses of Islamic Funds

Sources of Islamic Funds

SHAREHOLDERS
EQUITY & RESERVES

INVENTORY

INVESTMENTS

PAYABLES
FINANCING
RESTRICTED
INVESTMENT ACCOUNT
HOLDERS/ SPECIAL
INVESTMENT
ACCOUNTS

CASH & CASH

EQUIVALENT
ASSETS
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Importance of Recording Credit

Transactions

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Al-Baqarah 282: O you who believe!

When you deal with each other, in
transactions involving future
obligations in a fixed period of time,
reduce them to writing, let a scribe
write down faithfully as between the
parties: let not the scribe refuse to
write: as God has taught him, so let
him write. Let him who incurs the
liability (debtor) dictate, but let him
fear his Lord God, and not diminish
aught of what he owes. If the party
liable (debtor) is mentally deficient, or
weak, or unable himself to dictate, let
his guardian dictate faithfully, and get
two witnesses, out of your own men,
and if they are not two men, then a
man and two women, so that if one of
them errs, the other can remind
him.

Importance of 3rd party

independent witnesses
The witnesses should not refuse
when they are called on (for
evidence). Disdain not to reduce to
writing (your contract) for a future
period, whether it be small or big:
it is more just in the sight of God,
more suitable as evidence, and
more convenient to prevent doubts
among yourselves. But if you carry
out the transactions on the spot
there is no blame if you reduce it
not to writing. But take witness
whenever you make a commercial
contract, and let neither the scribe
nor witness suffer harm. If you do
(such harm), it would be
wickedness in you. So fear God; for
it is God that teaches you. And God
is well acquainted with all things
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Lessons learned from verse 282,

Surah Al Baqarah
Proper, complete and transparent recording of financial

and business transactions.

Trustworthy and responsible accountants.
Written contract for all significant financial and business
transactions.
Truthful witnesses (at least 2) to ensure proper
accountability, and check and balance.
Materiality accounting concept to the smallest
denomination.
Fear God (Taqwa/Peity) for all contractual parties:
borrower, lender, buyer, seller, accountant, auditor etc.
The purpose of accounting to facilitate muamalat
transactions in equitable, fair and just transactions.

Definition Islamic accounting

(Abdul Rahim (2010))
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 Shariah and
delivering on its socioeconomic objectives
Islamic accounting is also a tool, which
enables Muslims to evaluate their own
accountabilities to God (in respect of interhuman/environmental transactions)

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Islamic Accountability
Transcendental accountability to Allah

SWT (Hablumminallah)
Social accountability to the society
(Hablumminan-nass)
Individuals as trustees or khalifah
Success in this world and in the
hereafter (al-falah)
Economic goals beyond purely wealth
but include tazkiyah (purification of self
and wealth)
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Understanding Roles and Responsibilities

Allah
1

3
Concept
of
Khilafah

Self
2
40

Shariah

Othe
rs

Objectives of Financial Statements

Traditional

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Islamic

Statement of
Income

Economic
Performance

Fulfilment of
Amanah

Statement of
Financial Position

Financial Position

Financial Trust and

Obligation

Statement of
Cash Flows

Cash Position

Cash Entrusted

Statement of
Equity

Wealth Ownership

Wealth Entrusted

Differences between Islamic accounting

and conventional accounting
The objectives of providing the information

(Islamic accountability vs decision usefulness)

What type of events and transactions is identified
(monetary and nonmonetary, social, religious and
Economic)
How is it classified (zakatable/non zakatable,
halal/haram), measured and valued (current
values vs historic cost),
To whom is it communicated (the users) (zakat
beneficiaries, mudharaba depositors etc)
How it is communicated (income statement vs
vas, etc.)

Components of Islamic
accounting
Accounting
For
Islamic
Business
Organizations

Accounting
For
Islamic
Societies & Unions

Accounting
For
Zakat Collection &
Distribution

ISLAMIC
ACCOUNTING

Accounting for
Islamic
Banks

Accounting for
Waqfs

Accounting
For
Islamic
Government Agencies

Accounting for Takaful

Features of Islamic
Accounting
No different in terms of recording (double entry

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system)
Clear distinction of Accounting Objectives i.e.
religious obligation vs. commercial obligation
(different significance of financial statements)
Different users information need (legitimate and
equitable transactions and wealth vs.
maximization of wealth and economic
consequences)
Compliance with the principles and rules of
Shariah
Different Islamic contractual relationships
(mudarabah instrument; murabahah etc.)
Distinct accountability relationships (to Allah
SWT and Ummah)
Determination of zakat

User Groups of Accounting

Information for Islamic Banks
Investors (potential and existing) (lawful and

equitable investment)
Creditors (potential and existing) (lawful trade
assets)
Regulators (e.g. Bank Negara)
Shariah Supervisory Board & Advisory Council
(Shariah compliance)
Customers (lawful goods and services)
Others who may be effected by the disclosure
or non-disclosure of information

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END OF TOPIC 1