Some important theoretical questions from: July 2011, May2011, Sep2010,
Jan2010, May 2009, August 2009 Exams:
Unit 1: Islamic Perspective of Accounting
Unit 3: The financial Reporting Enviroment
Unit 4: Comparative Financial Reporting of Islamic and Conventional Banks
1) Is Islamic accounting and Accounting for Islamic banks the same? Explain. [4 marks]
Islamic Accounting can be defined as 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
Islamic Shari’a and delivering on its socioeconomics objectives. Islamic accounting is also a
tool, which enables Muslims to evaluate their own accountabilities to Allah (in respect of inter
human/environmental transactions).
Accounting for Islamic banks is not Islamic accounting but only a subset of Islamic accounting
where accounting for Islamic banks covers the Islamic accounting attributable to Islamic
banking transactions.
Islamic accounting is also broader covering non financial institution such as waqf, zakat,
Islamic business organization, Islamic government accounting, takaful and Islamic societies &
unions
Islamic accounting is not just technicalities of accounting for Islamic financial instruments
employed by Islamic banks but much more requiring whole new areas of performance
measurement including the social, environmental, economic and the Shari’a.
2) State 4 objectives of Accounting for Islamic Banks, according to AAOIFI. [4 marks]
1. To determine the rights and obligations of all interested parties, including those rights
and obligations resulting from incomplete transactions and other events, in accordance
with the principles of Islamic Shari’a and its concepts of fairness, charity and compliance
with Islamic business values.
2. To contribute to the safeguarding of the Islamic bank’s assets, its rights and the rights of
others in an adequate manner.
3. To contribute to the enhancement of the managerial and productive capabilities of the
Islamic bank and encourage compliance with its established goals and policies, and
above all, compliance with Islamic Shari’a in all transactions and events.
To provide through financial reports, useful information to users of these reports, to enable them
to make legitimate decisions in their dealings with Islamic banks.
3-a) AAOIFI (Financial Accounting Standard 1) recommends a complete set of seven
financial statements for islamic banks. These can be classified into those that are unique
to IFI's and those that are common to other
the table below. (7 Marks)
common
1 Statement of Financial Position (Balance
Sheet)
2 Income Statement (Profit and Loss
Account)
3 Cash Flow Statement
4
business organizations. State 7 of these in
5
6
7
unique
Statement of Changes in Restricted
Investments and their Equivalent
Statement of Sources and Uses of Funds
in the Zakah and Charity Fund
Statement of Sources and Uses of Funds
in the Qard Fund
Statement
of
Retained
Earnings
(Statement of Changes in Owners’ Equity)
3-b) After considering the information needs of the users and the objectives of financial
reports, AAOIFI recommended that in addition to the above reports, financial and non
financial reports in line with the unique functions of Islamic banks. State example of
reports. (3 Marks)
1. Analytical financial reports about earnings or expenditures prohibited by the Shari’a.
2. Reports concerning the Islamic bank’s fulfillment of its social responsibilities
3. Reports about the development of the Islamic bank’s human resource.
4)
AAOIFI (Financial Accounting Standard 1) recommends a complete set of seven
financial statements for Islamic banks. These can be classified into those that are unique to IFI's
and those that are common to other business organizations. State
5)
After considering the information needs of the users and the objectives of financial
reports, AAOIFI recommended that in addition to the above reports, financial and non financial
reports in line with the unique functions of Islamic banks. State example of reports
A123-
Common financial statements for all organizations:
Balance sheet,
income statement and
cash flow statement
B1234-
Unique reports to IFIs set by AAOIFI?
Zakat report: Analytical financial reports about sources of funds for Zakah and their uses.
Analytical financial reports about earnings or expenditures prohibited by the Shariah
Reports concerning the Islamic bank’s fulfillment of its social responsibilities
Reports about the development of the Islamic bank’s human resources
6) LIST the FOUR (4) reports given as examples recommended by AAOIFI that can
provide information “which can assist the Islamic bank in carrying out its social
responsibilities and in particular those that have been specified by Islam”. (4 marks)
7) IDENTIFY THREE (3) unique financial statements and ONE (1) other voluntary
statement which AAOIFI has prescribed for Islamic banks. (4 marks)
8) Islamic Banks face unique accounting problems both from a technical and
philosophical point of view. Describe ANY FOUR (4) of these. (4 marks)
9) Explain the accounting principles enunciated in the Qur'anic verses 2: 282
(ALBAQARAH) and verses 11: 85-86(Hud), reproduced below in relation to the primary
financial statements i. e. the Balance Sheet and Income Statement.
2: 282 0 ye who believe! When ye 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 Allah Has taught
him, so let him write. Let him who incurs the liability dictate, but let him fear His Lord
Allah, and not diminish aught of what he owes. If they party liable 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 there are not
two men, then a man and two women, such as ye choose, for witnesses, so that if one of
them errs, the other can remind her. 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 juster in the sight of Allah, More suitable as
evidence, and more convenient to prevent doubts among yourselves but if it be a
transaction which ye carry out on the spot among
yourselves, there is no blame on you if ye reduce it not to writing. But take witness
whenever ye make a commercial contract; and let neither scribe nor witness suffer harm.
If ye do (such harm), it would be wickedness in you. So fear Allah. For it is God that
teaches you. And Allah is well acquainted with all things.
Hence, 0 my people, [always] give full measure and weight, with equity, and do not
deprive people of what is rightfully theirs, 1118a) and do not act wickedly on earth by
spreading corruption. That which rests with God [1191is best for you, if you but believe
[in Him]! However, I am not your keeper. " (Hud, 11: 85-86) [20 Marks]
Quranic verse 2:282
 The above Quranic verse is the basis of Islamic Accounting where accounting in Islam
deals with among other things, recognition, measurement & recording of transactions,
the fair presentation of rights and obligations.

This verse on debt contracts (2:282) fits the balance sheet and accounting equation.
Asset=Liabilities + Owner’s Equity. In a corporation’s balance sheet, loans from banks sit
in the liability section whereas shareholders funds in the owners equity section. On the
other hand, equity is also a special form of liability to the business entity in essence a
debt repayable with profits or after deducting losses. The debt contract is the
management contract with the directors to manage the money of the owners with the
fiduciary responsibilities of the directors.

The substance over form is an obvious violation of Shariah places paramount
importance on contractual agreement which is the foundation of determining rights and
obligations of the parties to the contract.

An owner of an asset should bear the risks of ownership such as ensuring the usability
of the asset and thus these risks can only be identified if reported to the effect to reflect
the ownership status. Failure to report as such will result in ambiguity and hence trigger
off a potential for gharar element to set in, which is a violation of Shariah.

The verse 2:282 on debt contracts is applicable to accounting. This verse ask believers
to put in writing justly, contracts which involve exchange of monies with future
obligations, drafted by professional writers (who can be interpreted as lawyers or
accountants) duly witnessed. The writers (or accountant) must write the contract
according to what Allah taught him. The objective of writing the contract is given as a
better form of evidence in case of disputes later on and also to avoid doubts and
conflicts. The verse, which is the longest in the Qur’an ends with Fear Allah and Allah
teaches the right way and has full knowledge of everything.
Quranic verse 11:85-86
 This surah Hud mentioning about the bottom line or balance of profit and loss (P&L)
account. This verse tells us what type of bottom line Allah expects i.e what Islamic
accounting should aim for.

P&L account presented the turnover or sales followed by the cost of sales. Then it will
expense mainly salary and wages and other expenses and overheads. Finally, taxes
and zakat (the latter in case of Islamic organizations) before come to the shareholder’s
bottom line.

Each line of the P&L account represents different stakeholders. If in the process of
arriving at the bottom line, any short changing occurs to any of the parties above the
line, there will be economic, social and spiritual consequences. Foremost, customers or
in case of Islamic banks the people who are given financing should be given fair terms,
a fair price and transparency. Do not hide conditions under footers in unreadable small
fonts. These include the transparency of fatwas for the contract, any penalties for late
payment and early redemption and the rights and responsibilities of either party.

In the case of cost of sales, in the bank’s case it is the deposit holders’ return. In
accounting terms we should disclose the profit allocation method, priority accorded to
allocation of funds in case in inadequate investment opportunities, what item of revenues
are shared with the various type of deposits etc. as stipulated in FAS 5 of AAOIFI.

In the case of salaries and wages of employees, the Islamic bank must ensure fair
wages - not always what the market will bear, fair working conditions, quick payment of
salaries. It should also ensure that there is no terribly wide gap in salary levels between
various grades of employees. The latter in the form of millionaire salaries and benefits
paid out to CEO’s and top directors, even though the company is making losses is
already a cause for concern in corporate governance circles.
In case of payment for services, the Islamic bank should ensure fair terms for the appropriate
quality of service. It is often the case, in the retail and manufacturing industry for example, that
suppliers are squeezed out of decent profits by insisting on such low prices or long credit term
that lead to poor quality supplies and service and even bankruptcy of firms in the long run.
10) AAOIFI goes on to list four objectives of financial accounting. What are they?
1- Rights and obligations: To determine the rights and obligations of all interested parties,
including those rights and obligations resulting from incomplete transactions and other
events, in accordance with the principles of Islamic Shariah and its concepts of fairness,
charity and compliance with Islamic business values.
2- Safeguarding: To contribute to the safeguarding of the Islamic bank’s assets, its rights
and the rights of others in an adequate manner.
3- Enhancement: To contribute to the enhancement of the managerial and productive
capabilities of the Islamic bank and encourage compliance with its established goals and
policies and, above all, compliance with Islamic Shariah in all transactions and events.
4- Useful information: To provide, through financial reports, useful information to users of
these reports, to enable them to make legitimate decisions in their dealings with Islamic
banks.
11)
According to SFA1, in order to meet the objectives of financial accounting for Islamic
banks, certain types of information should be provided by financial reports. State two of these?
We can categorize information needs into two groups:
a) Normal financial information i.e. financial position, liquidity, profitability
b) Specific additional financial and non financial information i.e. Shariah compliance,
discharge of social responsibilities and information for employees.
In detail:
1- Information which can assist in evaluating the bank’s compliance with the principles of
Shariah in all of its financial and other dealings.
2- Information which can assist in evaluating the bank’s ability in:
A- Using the economic resources available to it in a manner that safeguards these resources
while increasing their value, at reasonable rates.
B- Carrying out its social responsibilities and in particular those that have been specified by
Islam, including the good use of available resources, the protection of the rights of others
and the prevention of corruption on earth.
C- Providing for the economic needs of those who deal with the bank.
D- Maintaining liquidity at appropriate levels.
3- Information which can assist those employed by the bank in evaluating their relationship
and future with the Islamic bank, including the bank’s ability to safeguard and develop
their rights and develops their managerial and productive skills and capabilities.
12)
Who are the users of IFIs reports?
The user includ
12345-
equity holders,
current and savings account holders,
regulatory agencies such as the Central Bank,
Other depositors and other who transact business with the bank.
However, a special class of users of Islamic banks are
a- investment account holders and
b- zakat agencies.
13)
Question: Find Three Accounting Issues and Three Possible Approaches to the issues?
(Harmonization) “Harmonising financial reporting of Islamic finance”
A review of leading international Islamic Financial Institutions shows that a number of reporting
frameworks are used across the industry, although many use IFRS, some use partly converged
IFRS-based standards, some use IFRS with additional requirements, and some use specific
standards for the Islamic Finance.
Points for Considération



Identify the users, and the objectives of financial reporting & whether it is different from
the conventional financial institutions.
The use of specific Islamic Accounting principles that represent a faithful Islamic
Finance Transactions
Non-Financial Institutions that consume Islamic Finance Products have different
Accounting issue to Financial Institutions.
Major of using a common globally accepted set of accounting standards is the comparability it
offers for the users of different institutions, financial statements, and can enhance the ability of
investing opportunities across the border
IFRS is the only global recognized set of financial reporting standards that provide IFIs a
consistency framework and comparability with conventional institutions.
Possible Approaches to the Issues:
IFRS could be used as the default reporting framework, though the guidance of existing Islamic
Financial reporting models will need to be used to supplement the standards that do not fit into
the framework. Guidance will be presentation & disclosure related. Even in the existing IFRS
standards, there are standards dealing with specific industries and so it is possible for aiming a
specific standard for Islamic Finance Transactions.
Alternatively, a set of globally recognized Islamic Finance Accounting Standards could be used
by the IFIs, where possible it can be based on IFRS, but will include the Recognition,
Measurement, Presentation and Disclosure requirements relevant to Islamic Finance products
and transactions, in order to assist IFIs and the users of their financial reports.
Malaysian Accounting Standards Board (MASB) are in the opinion of using IFRS, unless it has
been proven and shown that there is a clear prohibition in the Shariah, then it can be amended
accordingly, and until that time it can be used.
NB: we quoted this information from article only, so if there is anything extra that you may see it
important, then you may include it.
State four issues in harmonizing accounting for Islamic financial institutions with International
Financial Reporting Standards ( 4 marks )
14)
Unit 2: Islamic Financial Transactions
Units 5,6,7,8,9,10: Accounting Framework and Enviroment:
15) What is the difference between restricted and unrestricted investment accounts. How
are they treated on the Balance Sheet respectively? [4 marks ]
Restricted Investment
Unrestricted Investment
Difference
Accounts
Accounts
Definitions
The investment account holder The investment account holder
imposes certain restrictions authorizes the Islamic bank to
as to where, how and for what invest the account holder’s
purpose his funds are to be fund in a manner which the
invested. Islamic bank may be Islamic
bank
deems
restricted from commingling its appropriate without laying
own funds with the restricted down any restrictions as to
investment account fund for where, how and for what
purposes of investment. In purpose the funds should be
Under
this
addition, there may be other invested.
restrictions which investment arrangement the Islamic bank
account holders may impose. can commingle the investment
For
example,
investment account holder’s funds with its
account holders may require the own funds or with other funds
Islamic bank not to invest their the Islamic bank has the right to
funds in installment sales use (e.g. current accounts). The
transactions
or
without investment account holders and
guarantor or collateral or require the Islamic bank generally
that the Islamic bank itself participate in the returns on the
should carry out the investment invested funds.
itself rather than through a third
party.
Balance sheet treatment
Assets and liabilities relating to In
the
balance
sheet
equity of restricted investment components,
it
is
been
as
equity
of
account holders and their presented
equivalent is treated off unrestricted
investment
balance sheet, separately from account holders, independent
the Islamic bank’s assets and category in the statement of
liabilities.
financial position of the Islamic
bank between liabilities and
Restricted investments are not owners’ equity.
assets of the Islamic bank
and should not be reflected However, in case the Islamic
on the bank’s statement of bank makes it a condition that
financial position since the the funds will not be invested
bank does not have the right before a certain date, and then
to use or dispose of those the funds received shall be
investments except within the recorded in a current account
conditions of the contract until their date of investment
between the Islamic bank and due.
holders of restricted investment
accounts and their equivalent.
16) Explain the differences between Murabaha and, murabaha to the purchase orderer,
illustrated by diagrams (6 marks)
A Murabaha is defined by Fuqaha (jurists) as the sale of goods at cost plus an agreed profit
mark up, As a mode of Islamic financing product, we can redefine murabaha as a sale in which
the Islamic bank informs the customer of its own cost and the profit it is taking on the transaction
and where the sale price is paid in installments over an agreed period of time.
(3)
vendor
customer
Islamic Bank
(1)
(2)
(1)The banks buys the goods for murabaha sale from the vendor and pays for it.
(2) The Bank enters into a murabaha contract with a customer and delivers the good.
(3) The customers pays the bank in installments over the contract period.
Most Islamic banks do not want to do this, as it involves trading and it is risky in the sense that
the bank is an owner of the bought goods, and is thus liable for risk of loss, damage and decline
in value until the time it manages to sell it to a customer.
Murabaha to the Purchase Orderer is a sale in which two parties or more negotiate and
promise each other to execute an agreement according to which the orderer asks the purchaser
to purchase an asset of which the latter will take legal possession. The orderer promises the
purchaser to purchase the asset from him and give the ordered a profit thereon. The two parties
would conclude a sale after the possession of the ordered to the asset.
vendor
(2)
Islamic Bank
(1)
(3)
customer
(4)
(1) The customer orders the bank to purchase goods, which it promises (this may be binding or
non binding) to buy from the bank giving it some profit.
(2) The bank buys and pays for the goods from the vendor.
(3) The banks execute a murabaha contract of sale to the customer and deliver the goods.
(4) The customer pays for the goods on an installment basis to the bank.
17) Explain the differences between murabaha and bai bithaman ajil illustrated by diagrams.
You need not draw the diagram for murabaha again after (a) (3 marks)
(3)
Islamic Bank
customer
(4)
(2)
vendor
(1)
Bai Bithaman Ajil
(1) Customer identifies asset to be purchased and pays deposit to owner and signs sale and
purchase agreement with owner
(2) Bank buys the asset through a property purchase agreement and pays cash to owner on
behalf of customer
(3) Bank sells assets to customer using property sales agreement at BBA price
(4) Customer repays bank in installment.
18) What are the shariah controversies arising out of the Malaysian practice in (10)
above?
19) Identify and explain an alternative Islamic contract which can be used to finance
houses which has yet to be been constructed. (6 marks)
20) Explain the problems for the customer when BBA is used to finance incomplete properties.
(3marks)
 The bank never takes delivery of the goods nor assumes liability for it before it is handed
over to the customer.
 If the developer fails to complete the project, the bank’s customer is left with the mark up
price to pay for an undelivered house.
 In the current BBA home financing, the customer is forced to face the financial burden
of paying for the house even before it is completed, as he has engaged in a ‘debt
contract’ with the bank at the outset. By ignoring the concept of iwad, the BBA
contract is not seen as conforming to the maqasid al-Shari’ah that removes hardship
(raf’ al-haraj) and preventing harm (daf’ al-darar) in the economic sphere, thereby
leaving the welfare of people unprotected – a possible crime when the transaction is
done under an Islamic label.
21)
Illustrate by means of a diagram, how organized Tawarruq can be used for
personal finance. (4 marks)
22)
How does the bank protect itself, if the orderer refuses to take delivery of the goods in a
transaction involving murabaha to the purchase orderer;
a. In case the promise is binding? (4 marks)
In the case of binding, the bank can demand Hamish Jiddiyah (security deposit). If the
customer declines, the bank can deduct any losses and expenses it incurs on transaction
from the security deposit and return the excess. If the loss is greater than the deposit, the
customer becomes liable for the balance.
b. In case the promise is not binding (4 marks)
In the case of non binding, the bank can demand for urboun deposit (down payment). This is
deducted from the purchase price if the customer proceeds with the sale. If not, the
customer loses his deposit, even if the deposit is more than the loss incurred by the bank.
Deposit from the client can be in the form of hamish jiddiyah or urboun. Hamish Jiddiyah is
payment by purchase orderer as deposit at the date of request while urboun is paid by orderer
at the date of transaction.
If the murabahah contract is binding, the bank can deduct the expense from Hamish jiddiyah,
while if it is non-binding, bank should return the Hamish jiddiyah in full amount to the
purchase orderer.
From the case, since the contract is non-binding, the bank should return 10,000 dinar to the
client.
To prevent failure of clients to take delivery, the bank should make the contract binding
promise and then require Hamish jiddiyah or urboun.
23) Explain the difference between Urboun and Hamish jiddiyah
Hamish jiddiyyah: It is the amount paid by the purchase orderer upon request of the
purchaser to make sure that the orderer is serious in his order of the asset. However, if the
promise is binding and the purchase orderer declines to purchase the asset, the actual loss
incurred to the purchaser shall be made good from this amount
Urboun : It is the amount paid by the client (orderer) to the seller (i.e., the original
purchaser) when the former purchases an asset from the seller. If the customer proceeds with
the sale and takes the asset, then the urboun will be part of the price; otherwise, the urboun
will be for the seller.
Hamish Jiddiyayah is problematic, because, in case of a non-binding promise, the bank will
have to return the deposit in full to the potential customer, even if it subsequently incurs a
loss in selling the goods, which the original orderer had refused to take delivery. In case, the
promise is binding and the customer declines, the bank can deduct any losses and expenses it
incurs on transaction from the deposit and return the excess. If the loss is greater than the
deposit, the customer becomes liable for the balance.
In case of urboun deposit, this is deducted from the purchase price if the customer proceeds
with the sale. If not, the customer loses his deposit, even if the deposit is more than the loss
incurred by the bank.
24) Describe the FOUR (4) categories of Musharaka or Shirka (4 marks)
25) Complete the table to compare and contrast pertinent features of Mudaraba and Musharakah
contracts
Subject
Description
Loss Sharing
Profit Sharing Ratio
Mudaraba
Partnership in which one or
more parties who provide
capital contract with another
parties who provide labour
Is borned by rab al mal other
than those incurred due to
negligence.
Mudarib loss his labour as he
is not paid any salaries
Agreed between the rab al mal
and mudarib before they enter
into the contract
Musharaka
All partners contribute the
capital and must
participate in the running
of the business
Losses are shared on the
capital ratio, not in the
profit sharing ratio
Agreed in advanced in
term of percentage of the
profit
26-a) Distinguish Islamic financing mechanism using Ijarah and Ijarah Muntahia bittamleek. 3
marks
Ijarah: contracts that do not end up with the transfer of ownership of leased assets to the
lessee.
Ijarah Muntahia Bittamleek: contract that end up with the transfer of ownership of leased
assets to the lessee.
26-b) State the possible modes of ownership transfer to the lessee under Ijarah Muntahia
Bittamleek? [5 marks]





27)
Gift at the end of the period
Token sales consideration at the end of the period
Sale at specified amount
Sale during the lease period for the remaining installments
Gradual transfer during lease period
Salam & Parallel Salam
Salam is a purchase of commodity at a deferred delivery in exchange for immediate payment.
Parallel Salam A salam contract where by Al-Muslam Ileihi depends for executing his obligation
on receiving what is due to him in his capacity as Al-Muslam. Without executing the second
salam contract, the first one cannot be fulfilled.
“A contract to sell, what a bank as a buyer will get into another salam contract”



Al-Musalam Fihi: the commodity to be delivered
Al-Muslam Ileihi: the Seller
Al-Muslam: the Purchaser
Agent
2.
5.
3.
4.
Ultimate Buyer
Al-Muslam
Ileihi (Seller)
Islamic Bank
1.
Fig1. Salam financing using Agent
3.
Al-Muslam
Ileihi
1.
4.
Islamic Bank
Al-Muslam in the
Parallel Salam
2.
Fig 2. Salam with Parallel Salam Financing
1- The Islamic bank pays the al muslam ileihi in the salam contract.
2- The Islamic bank receives a payment from the buyer in a parallel salam contract with
the bank’s customer.
3- The muslam ileihi in the salam contract delivers the goods to the bank at the agreed
time.
4- The bank delivers the commodity to the al muslam in the parallel salam contract.
28)
Singapore Islamic bank charged ta’wid (compensation) of S$1000 for late
payment by the customer who had entered into a salam contract with the bank for
delivery of durians (by the bank) in six months time. Explain why this is an impossible
situation.
Because in Salam contract the payment should be in cash.
29)
ILLUSTRATE by means of a diagram how an Islamic bank can use the Salam
contract for financing a fruit grower and help a fruit juice manufacturer. (4 marks)
Reproduce and complete the following table:
Subject
Salam contract
Seller in Arabic
Buyer in Arabic
Subject matter in Arabic
When is the price paid?
30)
Istisna’a’ Contract
PER , IRR
(a) EXPLAIN what are Profit equalization reserves and Investment risk reserves as well as
their purposes
(b) Explain the difference between Profit Equalization Reserve and Investment Risk
Reserve. [4 marks ]
Features
Definition of reserve
Measurement of reserve
Profit Equalization Reserve
The amount appropriated by
the Islamic bank out of the
mudaraba income, before
allocating
the
mudarib
share, in order to maintain a
certain level of
return on
investment for investment
account holders and increase
owners’ equity.
Shall be measured as the
amount deemed prudent by
the management of the
Islamic bank in order to
maintain a certain level of
return on investment for
investment account holders
and
increase
owners’
equity.
Investment Risk Reserve
The amount appropriated by
the Islamic bank out of the
income of investment account
holders, after allocating the
mudarib share, in order to
cater against future losses for
investment account holders.
At the end of the financial
period, the amount needed to
bring the balance of the
reserve to the required level
shall be treated as an
appropriation of income
before
allocating
the
mudarib share.
At the end of the financial
period, the amount needed to
bring the balance of the
reserve to the required level
shall be treated as an
appropriation of income
after allocating the mudarib
share.
Shall be measured as the
amount deemed prudent by
the management of the
Islamic bank in order to cater
against future losses for
investment
account
holders.
If the balance exceeds the
amount considered prudent
then the excess amount
shall be credited as a
release from reserve to the
relevant party’s share of
income for that financial
period before allocating the
mudarib share.
If the balance exceeds the
amount considered prudent
then the excess amount
shall be credited as a
release from reserve to
unrestricted
investment
account holders share of
income for that financial
period after allocating the
mudarib share.
PER is a provision shared by both the depositors and the Islamic bank and hence is deducted
from the total gross income. PER is reflected under other liabilities of the bank.
The purpose of introducing a PER is to enable the Islamic banks to mitigate the undesirable
fluctuations of income and to maintain competitive, particularly in terms of deposit rates.
30-c) Why do we have PER and IRR?
1- PER is for income smoothing. If profits from investments dip during a certain period, then
the bank can ‘top up’ the profits using the PER to ensure that investors do not experience volatile
fluctuations in their income stream.
2-IRR is for capital protection, and since capital (i.e. deposits) belongs to the IAH, the IRR is
only taken AFTER the distribution of profits between the IAH and the bank.
3- In situations where investments make losses, the IRR is used to help ‘protect’ the capital (i.e.
deposits).
30-d) Are these reserves acceptable under the IFRS requiring?
The accounting for these reserves under IFRS would depend on whether the IFI is deemed to
have an obligation (either contractual or constructive) to pay depositors from the reserve.
For the case of PER in particular, the IFI’s share of the profits is included, thereby effectively
creating an expected loss provision, currently not permitted under IAS39.
30-E) How are the reserves presented in the financial statement?
There is inconsistency in how IFIs around the world account for the PER:Country
accounting regime
Malaysia
Malaysian GAAP
Bahrain
AAOIFI
classification of PER
Liability
netted of against URIA
(Separate from equity and liability)
UK
IFRS
Equity
UAE
IFRS
Liability
31) Discuss the financial reporting problems of accounting for ijarah muntahia bittamleek,
where the transaction in substance is a financial lease, due to the clash between
International Financial Reporting Standards and AAOIFI accounting standards (6 marks)
 AAOIFI accounting standards require both Operating Ijarah and Ijarah Muntahia Bittamleek to
be treated similar to Operating Lease. In contrast, based on IFRS, both Operating Ijarah
(especially if lease term is for major part of economic life of lease asset) and Ijarah Muntahia
Bittamleek (due to the transfer of asset ownership by end of lease term) would normally be
classified and treated as Finance Lease.
 In conventional accounting, the lessee records the assets in their books because they
consume a significant portion of the economic benefits of the asset. However, in Islamic
Finance, substance over form is not recognized.
 Valuation of asset – Asset acquired for Ijarah shall be recognized upon acquisition at
historical cost.
 Recognition of income – Ijarah revenue shall be allocated proportionately to the financial
period in the lease term
 Repair of leased assets – if immaterial, recognized in the financial periods in which they
occur, if the repairs are material and differ in amount from year to year over the lease term, a
provision for repairs have to be established by regular charges against income.
 Initial direct cost – if material, be allocated to periods in the lease term in a pattern consistent
with that used for allocating ijarah expenses. If immaterial, it shall be charged directly as an
expense to the financial period in which the lease agreement is made.
Unit 11: Takaful:
32) Illustrate with the aid of diagrams and explain:
i.
The pure and modified mudharaba models of takaful. (5 marks)
ii.
The wakalah –jualah model with upfront wakalah fee and mudharabah
profit sharing on the underwiting surplus. (4 marks)
iii.
why did the pure mudharaba model of takaful fail in Malaysia? (2 marks)
iv.
what shariah controversy arises in model (c) above? (2 marks)
33) How does Takaful differ from conventional insurance from the accounting
perspective? (5 marks)
34) Illustrate by means of a diagram the business model of takaful practiced by Al Misr
Takaful Ltd as can be gleaned from the data and notes presented in part (c) below. (5
marks)
35) Explain the difference between facultative and treaty retakaful. (3 marks)
Unit 11: Auditing and Shariah Governance
36) Shariah audit vs. Shariah review
Shariah auditing:
Shariah auditing or Islamic auditing can be defined as ‘a systematic process of obtaining
sufficient and appropriate evidence to form an opinion as to whether the subject matter
(processes, personnel, financial and non-financial performance, financial position, systems,
marketing, products, transaction, contracts etc.) corresponds with the criteria (the Shariah rules
and principles) which is broadly accepted by the Islamic community and to report to stakeholders
thereon.
Some of the things to note from the above definition:
1) Shariah auditing is a process i.e. a series of steps or work.
2) Sufficient and appropriate (reliable and good quality) evidence needs to be collected.
3) The subject matter of the Shariah audit should be wider than a financial statement audit.
In line with the broad ambit to the Shariah including akhlaq, not only should the financial
statements but the banks internal processes, personnel, financial and non- financial
performance, financial position, information and IT systems, marketing of the bank’s
product and of course, the financial contracts employed by the bank. This has
implications for cost and time.
4) The criteria normally are the Shariah principles and rules developed by the Shariah
supervisory board.
The importance of Shariah audit:
First of all, carrying out an audit is essential because for public listed companies it is important
that an audit is carried out to ensure that the companies are using fair policies prescribed by law
and the public’s money is in safe hands. The basic advantage of an audit is that it makes it easier
to compare different companies as the auditors express their opinions about the fairness of
procedures. Of a company is given a good opinion then it means that it is following the law. It
also helps in following certain standards. An audit will keep the managers from trying to indulge
in fraudulent practices as it is a means of accountability. It testifies to reliability and integrity of
the results. The only disadvantage of an audit can be the costs involved because you have to pay
the auditors and also ensure that you maintain detailed records of all the transactions which
involve a lot of costs.
Secondly, what's the function of financial statements? This is a common knowledge for the users
of financial statements. Actually, investors and creditors can make use of financial statements to
make their decision. However, these financial statements were made by companies. How can the
users trust these financial statements? Are these financial statements faithful? If they are not,
how can the users depend on this information to make their decision? This is why auditing exists.
Objective of the Audit of the Financial Statements:
The objective of an audit of financial statements is to enable the auditor to express an opinion
as to whether the financial statements are prepared, in all material respects, in accordance with
the fatwas, rulings and guidelines issued by the Shariah supervisory board of the Islamic
financial institution, the accounting standards of the Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI), national accounting standards and practices, and
relevant legislation and regulations applied in the country in which the Islamic financial
institution operates. The phrase used to express the auditor’s opinion is whether the financial
statements “give a true and fair view” in accordance with the above.
Essentials principles governing the auditor
In order to attain the audit objective, the auditor is expected to comply with the “code of Ethics
for Professional Accountants” issues by both AAOIFI and IFAC, which does not contravene
Shariah rules and principles. This is to ensure that accountants conduct themselves in a manner
that is approved by Shariah. Moreover, the auditor should also conduct the audit in accordance to
ASIF. That is the auditor should plan and perform the audit with professional competence and
due care recognizing the circumstances that may exist which cause the financial statements to be
materially misstated.
Scope of Audit
In paragraph 7 of ASIFI No.1 is stated as follows: The “scope of audit” refers to audit procedures
deemed necessary to achieve the audit objective. “The procedures required to conduct an audit
having regard to the requirements of appropriate Islamic rules and Principles, ASIFIs, relevant
professional bodies, legislation, regulations which do not contravene Islamic rules and
Principles, and where appropriate, the terms of audit engagement and reporting requirements.
International Standards of Auditing (ISA) shall apply in respect of matters not covered in detail
by ASIFI provided that these do not contravene with Islamic Principles”.
Shariah review: According to GSIFI 2 of AAOIFI,
Shariah review is an examination of the extent of an IFI’s compliance, in all its activities, with
the Shariah. This examination includes contracts, agreements, policies, products, transactions,
memorandum and articles of association, financial statements, reports (especially internal audit
and central bank inspection), circulars, etc. The objective of a Shariah review is to ensure that the
activities carried out by an IFI do not contravene the Shariah.
Shariah audit vs. Shariah review:
Scope
Shariah audit:
Shariah review:
Expression
Positive: ‘we found that all of the
Negative: ‘There is no non Shariah
transactions are fully complied with
compliance in this IFI’
Shariah’
Level
High level/ strong
Low level/ weak
Area cover
Narrow
Broad
Execution
A Shariah audit should be done by an
external audit.
Qualification
Auditors specialize in gathering
evidence and using the evidence to
test compliance to certain principles,
in this case it is Shariah principles.
Auditors need to learn the rules
around Shariah contracts and
prohibitions
Malaysian Bank Negar requires a
Shariah Audit for IFI in Malaysia
The review is under the responsibility
of the Shariah Supervisory Board or
it’s designee
The SSB has expertise in Shariah but
need to be trained in auditing
techniques
Sponsorship
AAOIFI recommends a Shariah review,
but does not mention Shariah audit
37) The Association of Chartered Islamic Finance Professionals (ACIFP) would like
develop the shariah auditing profession under its wing, and has hired you as a
consultant to advise them in developing shariah auditing as a profession. As an
initial assignment, you are required to prepare a brief report to the council of ACIFP
on the issues in developing shariah auditing as a profession. (12 marks)
38) Discuss some of the pertinent issues relating to the development of Shariah
Auditing (10 marks)
39) Explain TWO (2) differences between conventional and shari’ah auditing. (4 marks)
40) Using a diagram, Illustrate the three phases of the Shariah review cycle (4 marks)
41) Highlight the deficiencies of the Shariah Supervisory Council report below, as per
AAOIFI’s GSIFI No 1 standard. [10 marks)
REPORT OF THE SHARIAH SUPERVISORY COUNCIL
We, Dato’ Awang Buntut and Ismail Khan, being two of the members of Shariah
Supervisory Council of Bank Islam Surakarta, do hereby confirm on behalf of the
members of the Council, that in our opinion, the operations of the Bank for the year
ended 30 June 2004 have been conducted in conformity with the Shariah principles.
On behalf of the Council
………………………………
…
-----------------------------------Dato’ Awang Buntut
Ismail Khan
Kuala Lumpur,
Date: 27 September 2009
According to GSIFI No.1, the basic Elements which must be contained in the Shari’a
Supervisory Board’s Report are as follows:
a) title
The above report already has a title.
b) addressee
The Shari’a supervisory board’s report above does not shown to whom the report was
prepared. The SSB report should be appropriately addressed as required by the
circumstances of the engagement and local laws and regulations.
c) opening or introductory paragraph
The above report does not have this opening or introductory paragraph. The Shari’a
supervisory board’s report should identify the purpose of the engagement. Illustrative
wording for an opening (introductory) paragraph is shown below:
“In compliance with the letter of appointment, we are required to submit the following
report:
d) scope paragraph describing the nature of the work performed
Illustrative wording for a scope paragraph is shown below:
“We have reviewed the principles and the contracts relating to the transactions and
applications introduced by the Example Islamic Financial Institution during the period
ended. We have also conducted our review to form an opinion as to whether the Example
Islamic Financial Institution has complied with Shari’a Rules and Principles and also
with the specific fatwas, rulings and guidelines issued by us.”
e) opinion paragraph containing an expression of opinion on the compliance of the Islamic
financial institution with Islamic Shari’a Rules and Principles
The Shari’a supervisory board’s report should state whether the Islamic Financial
Institution’s contracts and related documentation are in compliance with the Islamic Shari’a
Rules and Principles.
An illustration of these matters in the opinion paragraph is shown below:
In our opinion,:
 the contracts, transactions and dealings entered into by the Example Islamic Financial
Institution during the year ended ... that we have reviewed are in compliance with the
Islamic Shari’a Rules and Principles;
 the allocation of profit and charging of losses relating to investment accounts conform to
the basis that had been approved by us in accordance with Islamic Shari’a Rules and
Principles;
(where appropriate, the opinion paragraph shall also include the following matters:)
 all earnings that have been realized from sources or by means prohibited by Islamic
Shari’a Rules and Principles have been disposed of to charitable causes; and
 the calculation of Zakah is in compliance with Islamic Shari’a Rules and Principles.
If the Shari’a supervisory board has ascertained that the management of the Islamic
financial institution has violated Islamic Shari’a Rules and Principles or the fatwas, ruling
and guidelines issued by its Shari’a supervisory board, then the Shari’a supervisory board
has to report the violations in the opinion paragraph of its report.
f) date of report
The Shari’a supervisory board should state the period covered by its report and date the
report as of the completion date of the review.
The Shari’a supervisory board should not date the report earlier than the date on which
the financial statements are signed or approved by management
g) Signature of the members of Shari’a supervisory board.
The Shari’a supervisory board’s report should be signed by all members of the Board
42) The shariah report given below does not follow AAOIFI standard on shariah reports.
Redraft the report in accordance with AAOIFI standard GSIFI No. 1. (10 marks)
Report of the Shariah Supervisory Council
We, Dr. Yusof bin Ramli and Mohd Bakir bin Mansor, being two of the members of Shariah Supervisory of Bank Islam Malaysia
Berhad, do hereby confirm on behalf of the Council, that in our opinion, the operation of the Bank for the year ended 30 June 2006
have been conducted in conformity with Shariah principles.
On behalf of the Council:
Dr Yusof bin Ramli
Mohd Bakir bin Ramli
Kuala Lumpur,
26 Oktober 2006
In the name of Allah, The Beneficient, The Merciful
REPORT OF THE SHARIAH SUPERVISORY BOARD
To the Shareholders of the Bank Islam Malaysia Berhad
Assalam Alaikum Wa Rahmat Allah Wa Barakatuh
In compliance with the letter of appointment, we are required to submit the following report:
We have reviewed the principles and the contracts relating to the transactions and applications
introduced by the Bank Islam Malaysia Berhad during the period ended. We have also
conducted our review to form an opinion as to whether the Bank Islam Malaysia Berhad has
complied with Shari’a Rules and Principles and also with the specific fatwas, rulings and
guidelines issued by us.
The Bank Islam Malaysia Berhad’s management is responsible for ensuring that the financial
institution conducts its business in accordance with Islamic Shari’a Rules and Principles. It is
our responsibility to form an independent opinion, based on our review of the operations of the
Bank Islam Malaysia Berhad., and to report to you.
We conducted our review which included examining, on a test basis of each type of transaction,
the relevant documentation and procedures adopted by the Bank Islam Malaysia Berhad. We
planned and performed our review so as to obtain all the information and explanations which we
considered necessary in order to provide us with sufficient evidence to give reasonable
assurance that the Bank Islam Malaysia Berhad has not violated Islamic Shari’a Rules and
Principles.
In our opinion:
a) the contracts, transactions and dealings entered into by the Bank Islam Malaysia Berhad
during the year ended 30 June 2006 that we have reviewed are in compliance with the
Islamic Shari’a Rules and Principles;
b) the allocation of profit and charging of losses relating to investment accounts conform to
the basis that had been approved by us in accordance with Islamic Shari’a Rules and
Principles;
c) all earnings that have been realized from sources or by means prohibited by Islamic
Shari’a Rules and Principles have been disposed of to charitable causes; and
d) the calculation of zakah is in compliance with Islamic Shari’a Rules and Principles.
We beg Allah the Almighty to grant us all the success and straight-forwardness.
Wassalam Alaikum Wa Rahmat Allah Wa Barakatuh
Dr Yusof bin Ramli
Mohd Bakir bin Ramli
Kuala Lumpur, 26 Oktober 2006
43) Briefly discuss any FIVE (5) issues that need to be resolved in promoting Shariah auditing
as a profession. [10 marks]
(i) what is the nature of the shari’a audit review in practise? Is it as extensive as a
statutory audit? If so are the SSB members who are fiqh scholars have the competence
to do an audit or even a review.
(ii) Following the IFAC code of ethics, an auditor should watch out for threats to
independence including self review and advocacy threats. Now we know that the SSB
also advices on the product compliance with the shari’a. They are also supposed to
direct and supervise the IFI to ensure shari’a compliance. This is an uncomfortable
position. The SSB is both judge and jury. Their evaluation and advisory roles should be
separated.
(iii) What is the responsibility of external auditors for shari’a compliance. The standard
is rather vague. It puts the burden mostly on the SSB who may not be in a position to
verify shari’a compliance, and yet they are expected to report on the Further are the
responsibilities in this area include activities not relating to or impinging on the
financial statements?
(iv) Who monitors the shari’a supervisory board. They do not belong to any
professional organization or registered government body who have their code of
professional ethics or standards of practice.
(v)AAOIFI has also issued a code of ethics for employees of IFI’s. How is this
implemented? In case of accountants who work for IFI’s they can be controlled through
their professional accounting organizations (excluding the islamic part) but employees
do not normally belong to professional bodies. Perhaps, all IFI employees should be
given the code as an attachement to their employment contracts and given trainining on
ethics during in their induction in the IFI.
(vi) The audit procedures and evidence need to be worked out in more depth for
different type of events. Compared to the IAASB which has more than 12 standards on
audit evidence alone and 10 international audit practice statements and given the
broader range of shari’a issues, standard setting for islamic auditing has a long way to
go.
(vii) The IAASB has issued 1006 Auditing of the financial statements of banks, which
is a 78 page document which covers a myriad of issues such as internal control in
banks, risks and issues in respect of fraud and illegal acts, ratio analysis, risk and issues
in securities underwriting and brokerage and risks and issues in private banking and
asset management, which are not considered adequately from the perspective of the
shari’a. The industry and regulators will have to face this issues especially risk
management and derivative instruments used in hedging their disclosure and valuation
and their shari’a acceptability.