Islamic Accounting and Financial Reporting - Case Study Example

Islamic Accounting and Financial Reporting Standardization and Harmonization of accounting treatment In the year 1904, the International Congress of Accountants event took place in St. Louis in the United States. This event till date is accepted as a beginning of initiatives that were directed towards harmonization of accounting rules. Following the event Congress, was appointed as a working group. The primary responsibility of the group was to perform international research regarding comparing the accounting principles and rules followed in particular countries. The underlying objective behind this comparability research was to determine the difference that existed between these accounting rules and principles followed in each countries and make possible recommendations in order to reduce the level of these differences. Actions to harmonize the accounting treatments in materialized in the year 1973, when the International Accounting Standards committee, (IASC) was established. This organization later came to be known as the International Accounting Standard Board (IASB) in the year and was introduced in the year 2001. The regulatory board was assigned with the responsibility as well as exclusive rights to develop international accounting standards. The new constitution introduced new name for the already existing International Accounting Standard till 2001. Since 2001 all new standards of accounting set by the International Accounting Standard Board came to be known as the International Financial Accounting Standard (Wystocka, 2008). . With the introduction of the new constitution, the IASB was mainly responsible for expansion in agreement with the interest of the public of a set of superior quality, possible to enforce and understandable accounting standard that could be universally accepted. Other objectives include the promotion of implementation and thorough compliance with the set standard and activities towards the fusion of International Financial Reporting Standards and local accounting standards followed in individual countries. The underlying reason behind such a rigorous application of a unified accounting standard is to make financial reporting congruent which will largely be based on high quality solutions. Works to converge the IFRS and the US Generally Accepted Accounting Principles (US GAAP) is also in progress. This cooperation although is in full congruence with every major leader in the United States is difficult to reach. However, if the complete convergence between the two accounting principles can be attained that will bring a robust set of standards that may prevent misunderstanding and misinterpretation of financial statements (Wystocka, 2008). The harmonization and standardization of accounting treatments will enable accountants to follow a universal rule while preparing financial reports. This will make their task comparatively easier and will also enable them to ensure the reliability, verifiability, comparability and understand ability of the financial statements. In addition a unified international accounting standard will also enable the users of the financial information to understand and interpret the data with utmost prudence. Alongside that, the standardization of accounting statement besides allowing corporations to follow a common accounting standard will also enable them to reduce any probability of occurrence of corporate financial fraud. International Accounting Standards Board (IASB) The IASB has been consistently following the conceptual framework in order to improve the standards of financial reporting (IFRS, 2013a). However, it has to be noted that the conceptual framework in no way symbolizes the IFRS. The framework does not state any accounting requirements regarding a particular disclosure measurement or issue (IFRS, 2013c). According to BDO international (2010), in certain cases conflicts between the Conceptual Framework and IFRS may be witnessed and in those cases IFRS supplants conceptual framework. IASB is an autonomous private sector authority that develops as well as approves the International Financial Reporting Standards (IFRS). The body works under the strict supervision of IFRS. Established in the year 2001, it is mainly responsible for development and pursuance of technical agendas, preparation and issuance of IFRSs and exposure drafts, approval and issuance of interpretations done by the IFRS interpretation committee (Deloitte Global Services Limited, 2014). The fundamental role of the board is to set a universal standard of accounting that can be followed by accountants and auditors working in different countries while preparing financial statements. Given the fact that the board endeavours to create a common accounting standard, it will enable the users of the financial information to interpret the results carefully (Institute of Chartered Accountants Australia, 2013). The IASB aims to create a robust unified accounting standard which facilitates the drafting and presentation of superior quality reports thereby satisfying the users’ needs (Working Group on Fundamental Concepts, 2004). The IASB is majorly responsible for: Developing future IASs and reviewing the existing accounting standards. Synchronizing the accounting standards, procedures and regulations that is associated with the drafting and presentation of financial reports. Assisting officials responsible for the drafting and presentation of financial reports. Assisting auditors in order to enable them to ensure that financial reports are in complete compliance with the set standards. Assisting users to understand and interpret financial information appropriately. The accounting standards set by the board were initially termed as the International Accounting Standard. However that was till 2001 and since then it has been replaced by the International Financial Reporting Standard (IFRS). IFRS has stated proper norms related to the incorporation of pertinent details while drafting financial statements so as to represent the company’s performance faithfully (IFRS, 2013d). The IFRS has incorporated the unit of account maintenance and capital in its cluster of regulations that should be explained in financial reports in order to enable accounting officials to enhance the understand ability of financial information. The accounting standards have been set in a way that they ensure the comparability, verifiability and timeliness of the financial information which will help the users of the information to make informed choices regarding whether or not to invest in a particular company. The IFRS has incorporated the definition of liabilities, assets, expenses and income. The standards also characterize liabilities of a company as its obligations and assets as resources. Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) The AAOIFI was set up by the Islamic financial institutions in the year 1991. The organization is based in Bahrain. The underlying reason behind the establishment of this organization was to set up international accounting and auditing standards on the basis of Shari’ah principles for the Islamic financial institutions. The pronouncements made by AAOIFI are mainly directed towards serving the Islamic financial institutions based in different countries. Two financial accounting statements have been issued by the AAOIFI still date. These statements are related to the concepts and objectives of financial accounting that should be followed by the Islamic financial institutions. The statements include five auditing standard, ten accounting standard as well as ethical codes for auditors and accountants working in Islamic financial institutions. Thus the total number of pronouncements made by the AAOIFI till date is eighteen. Currently the AAOIFI is working on new standards. This is a highly impressive achievement that should be encouraged and supported by the interested parties. The organization has also taken a vital issue into consideration regarding the Islamic financial industry. AAOIFI had published a memo regarding the computation of the capital adequacy ratio for Islamic banks. The committee received good responses from the concerned parties and thus issued an exposure draft statement regarding the issue. AAOIFI follows a robust set of processes that supervises the production of its auditing as well as accounting standards. The processes include the selection of juristic appropriateness of the projected standards by Shari’ah committee of AAOIFI’s. The organization is also responsible for providing opportunity to the interested parties in order to enable them to give their views and opinions regarding the standards that have been set prior to the approval given by the board. Views are exchanged through public hearings where the exposure draft is discussed. The public hearing is held in order to increase the awareness of the standards set up by the AAOIFI amongst the financial community. The organization is attempting to formulate superior quality accounting standards and keep them absolutely updated in order to satisfy the requirements of the users of financial information published by the Islamic financial institutions. The application of the standards set by the AAOIFI is indeed imperative in the Islamic financial industry. The organization endeavours to ensure that the standards are being properly applied by organizing seminars and conferences. Presently, AAOIFI does not possess the power to enforce implementation of the promulgated standards to the Islamic financial institutions. To ensure that the industry follows the standards, the organization has implemented certain strategies by collaborating with the concerned governmental and regulatory bodies mainly responsible for applying the standards of. Out of the eighteen pronouncements made by the AAOIFI, ten of them are associated to the financial accounting standard (Abdel-Karim, 1999). FAS1 is associated with the general presentation as well as disclosure of the financial reports of Islamic Banks and Financial Institutions. FAS2 is related to Murabaha and Murabaha to the Purchase Orderer. FAS3 involves Mudaraba Financing. FAS4 involves Musharaka Financing. FAS5 is associated with revelation of bases for proceeds allocation between investment account holders and owners’ equity. FAS6 involves equity of investment account holders. FAS7 involves Salam and Parallel Salam. FAS8 involves Ijara and Ijara Muntahia Bittamleek. FAS9 concerns Zakat. FAS10 concerns Istisna’ and Parallel Istisna’ (AAOIFI, 2014). Islamic Financial Services Board The Islamic Financial Services Board (IFSB) is a international standard setting organization whose primary responsibility is to promote and augment the stability and soundness of the Islamic financial services industry. The board fulfils its responsibility by issuing international standards and guidance rules for the financial services industry which are broadly explained to comprise capital markets, insurance and the banking sectors. The IFSB is also responsible for conducting research as well as coordinate initiatives regarding issues related to the financial services industry. Alongside that the board organizes seminars, roundtables and conferences for industry stakeholders as well as the regulators (IFSB, 2010). The board is based in Malaysia and was officially established in 2002 and started operating since 2003. The primary objectives of the IFSB are: To set accounting and promote its implementation. Provide guidance regarding effective regulation and supervision alongside developing disclosure and risk management criteria. Establish cooperation with international standard setting authorities and the member countries. Develop human capital and facilitate capacity building. Conduct research in the field of accounting (Haron, n.d.). Challenges for Islamic Financial Institutions while adopting AAOIFI and IFRS standards The auditing and accounting standards adopted by the Islamic financial institutions are obvious reflections of different financial instruments such as insurance and interest laws, contracts and codes of ethics used by them. These standards differ slightly from the standards set by the International Accounting Standards Board (IASB) usually referred to as the International Financial Reporting Standards. The difference mainly lies in the regulations regarding restricted contracts, leases and specialty investment account. These differences may make it difficult for the users of financial information to interpret the data. IASB requires every organization to obey the IFRS completely. This is where the barrier lies. It is a real challenge for Islamic financial institutions to fully comply with each IFRS at the present moment. Firstly, meet the terms of IFRS would mean that the Islamic financial institutions would have to be ready to discard all their particularities, modify/replace the culture of business reporting, loss of process of controlling the standard setting and thereafter adopt the one stated by the IASB. The second issues escalates because of the absence of well qualified IFRS accounting staffs and auditors in countries that follow Islamic financial law in the same level as they are available in the Western countries. Lastly, the IFRS has not yet been proven to be workable FOR the Islamic financial institutions and the standards that they follow and that are why it has not been adopted in many countries. These are particularly the major difficulties that Islamic financial institutions may face while adopting both AAOIFI and the IFRS (El Razik, n.d.). Reference List AAOIFI, 2014. Accounting standards. [online] Available at: [Accessed 12 April 2014]. Abdel-Karim, R. A., 2011. Accounting and Auditing Standards for Islamic Financial Institutions. [pdf] The President and Fellows of Harvard College Available at: http://ifp.law.harvard.edu/login/view_pdf/?file=Accounting%20and%20Auditing%20Standards%20for%20Islamic%20Financial%20Institution.pdf&type=Project_Publication [Accessed 12 April 2014]. BDO International., 2010. Conceptual framework for financial reporting 2010. [pdf] BDO International Available at: http://www.bdointernational.com/Services/Audit/IFRS/IFR-Bulletins-2011/IFRB%20 2010 /IF RB-2010-24.pdf [Accessed 12 April 2014]. Deloitte Global Services Limited, 2014. International Accounting Standards Board (IASB). [online] Available at: [Accessed 12 April 2014]. El Razik, A. A., no date. Challenges of international financial reporting standards (IFRS) in the Islamic accounting world, case of Middle Eastern countries. Scientific Bulletin – Economic Sciences, 8(14), pp. 1-6. Haron, A., no date. The Role of Islamic Financial Services Board. [odf] Oicexchanges Available at: [Accessed Accessed 12 April 2014]. IFRS, 2013a. Conceptual framework. [online] Available at: http://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual-Framework/Pages/Conceptual-Framework-Summary.aspx# [Accessed 12 April 2014]. IFRS, 2013b. Staff paper. [online] Available at: http://www.ifrs.org/Meetings/MeetingDocs/IASB/2013/May/10-Conceptual%20Framework.pdf [Accessed 12 April 2014]. IFRS, 2013c. Conceptual framework (paused). [online] Available at: http://www.ifrs.org/Current-Projects/IASB-Projects/Conceptual-Framework/Pages/Conceptual-Framework.aspx [Accessed 12 April 2014]. IFRS., 2013d. About the IFRS Foundation and the IASB. [online] Available at: http://www.ifrs.org/The-organisation/Pages/IFRS-Foundation-and-the-IASB.aspx [Accessed 23 October 2013]. IFSB, 2010. Defining New Standards in Islamic Finance. [online] Available at: [Accessed 12 April 2014]. Institute of Chartered Accountants Australia, 2013. Conceptual framework. [online] Available at: http://www.charteredaccountants.com.au/Industry-Topics/Reporting/Current-issues/Concept ual-framework.aspx [Accessed 12 April 2014]. Working Group on Fundamental Concepts, 2004. Conceptual Framework of Financial Accounting. [pdf] Working Group on Fundamental Concepts Available at: https://www.asb.or.jp/asb/asb_e/asbj/begriff/ConceptualFramework.pdf [Accessed Accessed 12 April 2014]. Wystocka, E., 2008. Harmonization and standardization of the accounting and its functions. [pdf] oeconomica Available at: [Accessed 11 April 2014]. Read More