"
Office of Deputy Dean (Research and Postgraduate)
Kulliyyah of Economics and Management Sciences
International Islamic University Malaysia
MEMORANDUM
To
All KENMS Academic Staff and Postgraduate Students
From
Dc Hafiz Majdi Ab, Rashid
Deputy Dean (Research and Postgraduate)
Date
6th December 2005
SUbject
PRESENTATION OF MASTERS DISSERTATION I RESEARCH PAPER
Dear Prof I Assoc. Prof I Dr. I Br./ Sc
The presentation ofthe following student has been scheduled as follows:
Date I Dayl
Time I Venue
Presenter I
Students no I
programme
Supervisor(s)
15 th December
2005
(Thursday)
03:30 pm
Seminar Room 3,
Levell, KENMS
Ani Salwani Che ' Assoc. Prof. Abdul
Rahim Abd. Rahman
Pa
G03l9092
MSCFIN
All are invited to attend the presentation. Thank you. I"~\.J
Title
AN EXPLORATORY STUDY ON
THE UNDERSTANDING AND
ACCOUNTING FOR ISLAMIC
BONDS: PERSPECTNE OF
MALAYSIAN BANK MANAGERS
AN EXPLORATORY STUDY
ON THE UNDERSTANDING AND
ACCOUNTING FOR ISLAMIC BONDS:
PERSPECTIVES OF MALAYSIAN
BANK MANAGERS
BY
ANI SALWANI CHE PA
A DISSERTATION SUBMITTED IN PARTIAL
FULFILLMENT OF THE REQUIREMENTS
FOR THE DEGREE OF MASTER OF
SCIENCES IN FINANCE
KULLIYAH OF ECONOMICS AND
MANAGEMENT SCIENCES
INTERNATIONAL ISLAMIC UNIVERSITY
MALAYSIA
DECEMBER 2005
ABSTRACT
Malaysia has made commendable progress in developing the Islamic bonds market.
Despite this development, Malaysian Islamic bonds have been criticized as they allow the
trading of receivables based on true trade transactions as opposed to the lending of
money. In contrast, in other Middle Eastern countries, Islamic bonds are the trading of
real asset which subject to profit as well as loss. However, the extent to which Malaysian
practitioners have proper understanding on Islamic bonds is yet to be explored.
The development of Islamic bonds also gives rise to a number of accounting and
reporting issues in the current accounting practice. The introduction of Financial
Accounting Standard No.17 on investment (AAOIFI FAS 17, 2003) is a proactive effort
in providing a codified Islamic accounting standard. However, the extent to which
AAOIFI FAS 17 is relevant and acceptable in Malaysia is yet to be examined.
As Islamic bonds are new in the market, there are only a few research studies have been
undertaken on the topic. In view of this limitation, this study aims to explore the level of
understanding on the principles of Islamic finance and Islamic bonds among Malaysian
bank managers. Further, the study also explores the nature of current Malaysian
accounting practices on Islamic bonds and the level of acceptability of AAOIFI FAS 17.
Using a self-designed questionnaire, a sample of 84 bank managers working in local
commercial, Islamic and merchant banks registered in Malaysia was selected. Out of total
questionnaires distributed, 38 were returned. The results of analyses indicate that
majority of bank managers who are directly involved in investment in Islamic bonds have
only moderate level of understanding on the principles of Islamic finance as well as
Islamic bonds. These results provide empirical evidence that Malaysian bank managers
have inadequate understanding on what they are involved in. The study also found that
AAOIFI FAS 17 is reasonably well accepted by Malaysian bank managers. In addition,
by using Pearson correlation analysis the study observed that there are positive
relationships between the bank managers' understanding on the principles of Islamic
finance and Islamic bonds and their perceived acceptability of AAOIFI FAS 17.
TABLE OF CONTENTS
Abstract (English)
Approval Page
Declaration Page
Acknowledgements
List of Tables
List of Figures
List of Abbreviations
11
111
IV
VI
IX
xi
XlI
CHAPTER ONE: INTRODUCTION
1.1 Introduction
1.2 Objective of the Study
1.3 Background of the Study
1.4 Motivation of the Study
1.5 Organization of the Chapters
I
3
4
7
9
CHAPTER TWO: ISLAMIC BONDS: AN INTRODUCION
2.1 Introduction
2.2 Basic Principles ofIslamic Financial System
2.3 The Concept of Debt in Islam
2.4 The Development ofIslamic Bonds in Malaysia
2.4.1 Murabahah Bonds
2.4.2 Mudharabah Bonds
2.4.3 Ijarah Bonds
2.4.4 Salam and Istisna' Bonds
2.5 The Structure ofIslamic Bonds in Malaysia
2.5.1 Sale-based Financing Debt Instruments
2.5.2 Lease-based Financing Equity-linked Debt Instruments
2.6 Sukuk and Islamic Bonds vs. Conventional Bonds
2.7 Unresolved Issues on Malaysian Islamic Bonds
II
II
15
17
19
20
20
20
21
21
24
26
29
CHAPTER THREE: ACCOUNTING ON ISLAMIC BONDS
3.1 Introduction
3.2 Accounting in Islam
3.3 International Harmonization of Accounting Practices for Islamic
Financial Instruments
3.4 Overview of Accounting Standards for Financial Instruments
3.4.1 Accounting Standards for Financial Instruments Set by
Conventional Standard-setting Authorities
3.4.2 Accounting Standards for Investment in Sukuk Set by AAOIFI
3.5 Comparative Study between AAOIFI FAS 17, FRS 1392005
& FRS 1322005
34
35
37
40
42
44
3.5.1 Scope and Definition
3.5.2 Classification
45
48
3.5.3 Recognition and Measurement
3.5.4 Presentation and Disclosure
49
53
CHAPTER FOUR: RESEARCH METHODOLOGY
4.1 Introduction
4.2 Research Objectives and Research Questions
4.3 Research Design
4.3.1 Sample Selection
4.3.2 Method Used & Questionnaire Design
4.4 Data Collection Procedure
4.5 Data Analysis
57
57
62
64
66
67
CHAPTER FIVE: ANALYSES AND FINDINGS
5.1 Introduction
5.2 Response Rate
5.3 Demographic Analysis
5.4 Analyses and Findings for Research Objective No.1
5.4.1 Analysis on the Level of Understanding on Principles ofIslamic
Finance among Bank Managers in Malaysia
5.4.2 Analysis on the Level of Understanding on Islamic Bonds among
Bank Managers in Malaysia
5.5 Analyses and Findings for Research Objective No.2
5.5.1 Analysis on the Nature of Current Accounting Practices on Islamic
Bonds in Malaysia
5.5.1.1 Adoption of Accounting Standards for Islamic Bonds by
Malaysian Bank Managers
5.5.2 Analysis on the Level of Acceptability of AAOIFI FAS 17 among
Bank Managers in Malaysia
5.6 Analyses and Findings for Research Objective No.3
69
69
70
73
77
83
86
94
CHAPTER FIVE: CONCLUSION
6.1 Introduction
6.2 Conclusion for Research Results and Findings
6.4 Limitation of the Study
6.5 Future Research
BIBLIOGRAPHY
APPENDIX: Sample Questionnaire
100
100
103
104
105
LIST OF TABLES
Table No.
Title of the Tables
Page
4.1
Summary of research objectives, research questions and
questionnaire
60
4.2
List of Malaysian financial institutions selected for the study
64
5.1
Respondents' background according to department
70
5.2
Respondents' gender, age and working experience
71
5.3
Respondents' education background, area of specialization and
frequency of Islamic banking and finance training attended
73
5.4
Level of understanding on basic principles ofIslamic finance
among Malaysian bank managers
74
5.5
Percentage of agreement on the basic principles of Islamic
finance
74
5.6
Percentage of Respondents who are "not sure" on principles of
Islamic finance
75
5.7
Overall level of understanding on conventional bonds, Islamic
bonds and sukuk among Malaysian bank managers
78
5.8
Percentage of questions correctly answered for each type of
bonds
78
5.9
Level of understanding on each type of bonds
79
5.10
Percentage of question correctly answered according to each
Characteristic of Bonds
80
5.11
Analysis of Accounting standards for Islamic bonds adopted by
Malaysian bank managers
83
5.12
Analysis of reliability on AAOIFI standards among Malaysian
bank mangers
86
5.13
List of AAOIFI F AS 17 and their average (mean) level of
acceptability according to Malaysian bank managers
87
Table No.
Title of the Tables
Page
5.14
AAOIFI FAS 17 and its Level of Acceptability
89
5.15
List of highly acceptable accounting treatment (AAOIFI FAS 17)
according to mean scores
89
5.16
List of moderately acceptable accounting treatment (AAOIFI
FAS 17) according to mean scores
93
5.17
Correlation between the level of acceptability of AAOIFI FAS
17, the level of understanding on the principles of Islamic finance
& the level of understanding on bonds
96
LIST OF FIGURES
Figure No.
Title of the Figures
Page
2.1
Structure of AI-bay' Bithamin Ajil bonds (ABBA) and
Murabahah bonds(MuNIF)
23
2.2
Structure of Sukuk al-ljarah
24
2.3
Comparison between Sukukand conventional bonds
27
LIST OF ABBREVIATIONS
AAOIFI
Accounting and Auditing Organization for Islamic Financial
Institutions
AAOIFI FAS 17
Accounting and Auditing Organization for Islamic Financial
Institutions, Financial Accounting Standard No. I 7 on Investment
AASB
Australian Accounting Standard Board
ABBA/ BBA
At-bay' Bithamin Ajil
ACCA
Association of Chartered Certified Accountants
BAFIA
Banking and Financial Institutions Act
BIMB
Bank Islam Malaysia Berhad
BNM
Bank Negara Malaysia
CIMA
Chartered Institute of Management Accountants
DSU
Deficit Spending Unit
FRS 132
Financial Reporting Standard No. 132 on Financial instruments:
Presentation and Disclosure
FRS 139
Financial Reporting Standard No.1 39 on Financial instruments:
Recognition and Measurement
GP8-i
Guidelines on the Specimen Financial Statements for Licensed
Islamic Banks
lAS
International Accounting Standard
IASC
International Accounting Standard Committee
MARC
Malaysian Rating Corporation Berhad
MASB
Malaysian Accounting Standard Board
MASB ED 35
Malaysian Accounting Standard Board, Exposure Draft No. 35 on
Financial instruments: Recognition and Measurement
MASB ED
Malaysian Accounting Standard Board, Exposure Draft No. 45 on
Financial instruments: Presentation and Disclosure
MASB i
Malaysian Accounting Standard Board for Islamic Accounting
Standard
MuNIF
Murabahah Notes Issuance Facilities
MDS
Mudharabah Debt Securities
OlC
Organization ofIslarnic Countries
SAC
Shari 'ah Advisory Council
SPV
Special Purpose Vehicle
SSU
Surplus Spending Unit
CHAPTER!
INTRODUCTION
Two decades ago Islamic finance was considered a wishful thinking. However, serious
research and development of Islamic financial products have shown that Islamic finance
is not only feasible and viable but it is also efficient and productive way of financial
intermediation. Today, Islamic bond is among the most successful Islamic financial
product in the industry .The successful operation ofIslamic bond market in Malaysia and
other Muslims countries such as Bahrain and Qatar are sufficient to show that Islamic
bonds can be an alternative for commercial financing.
Many Malaysia's Shari 'ah scholars view Islamic bonds as debt certificate that can be
traded freely in the primary as well as in the secondary market. The system allows the
trading of receivables based on true trade transactions as opposed to the lending of
money. This means that bondholders are entitled to a certain amount of return through the
difference of amount they paid during the time they buy the bond and the amount they
receive during the maturity when the debt certificates are redeemed upon the issuer.
Global bond market often refers Islamic bond as sukuk. Sukuk are normally backed by
assets sold to a company that is created by the borrower (issuer). The borrower then rents
back the assets and the rent is paid to investors (bondholders) instead of interest. At
maturity, the borrower buys back the assets at an agreed price and investors are paid their
principal.
Malaysia has certainly made commendable progress in developing the Islamic bond
market. During the first quarter of this year, it was reported that outstanding Islamic
bonds in Malaysia have been more than doubled in the past four years as the nation
competes with Middle East financial centers like Bahrain for business that complies with
Islamic law. Recently, Malaysia is the biggest and fastest-growing market globally for the
The objective of this study is firstly to examine the perceptions and understanding on
Islamic bonds among bank managers in Malaysia. Secondly, the study will also attempt
to examine the perceptions of Malaysian bank managers on the accounting principles and
practices on Islamic bonds as well as acceptability of AAOIFI FAS 17 on investment in
securities in Malaysia. In order to achieve the first two objectives, the study analyzes the
perception of key personnel who are directly deal with trading of bonds in local financial
institutions in Malaysia. A sample of 38 bank managers who are also Islamic bonds
traders and finance officers from treasury departments in seven commercial banks, three
Islamic banks and four merchant banks was selected. A self-designed questionnaire was
distributed among the samples for the purpose of the study.
It is expected that by evaluating the level of understanding of bank managers or traders of
Islamic bonds and other Islamic products, the relevant and regulatory agencies can take
appropriate steps to enhance bank managers' knowledge and proficiency. This is to
I
David Young (2005), Malaysia Leads Way in Islamic Debt Sales, international Herald tribune. Business
Asia, Bloomberg.http://www.iht.com/articles!200SI04!2Slbloolnberglsxasia.php
2
ensure that Islamic products currently on offer not appear to be merely Shari 'ahcompliant versions of their conventional counterparts. By doing so, Malaysian money
market would have a clearer and better target market especially when Islamic bonds are
structured with the prospect of attracting some of the estimated US$250 - US$ I trillion
in assets held by Islamic institutions domestically and globally.
1.1 Objectives ofthe Study
The study aims to explore the understanding among bank managers on the concepts of
Islamic bonds and the nature of accounting practices for Islamic bonds in Malaysia. This
analysis is carried out from two perspectives, namely shari 'ah and accounting
perspectives.
There are three research objectives that have been formulated for the study:
I.
to examine the level of understanding on the principles ofIslamic finance and
Islamic bonds among bank managers in Malaysia.
11.
to examine the nature of current accounting practices on Islamic bonds in
Malaysia and the level of acceptability of AAOIFI FAS 17 on investment
among the Malaysian bank managers
111.
to examine the relationship between the bank managers' understanding on
Islamic finance and Islamic bonds and their perceived acceptability of
AAOIFI FAS 17
3
The study aims to examine the perception of Islamic bonds traders and dealers as well as
finance officers in treasury departments working in local commercial, Islamic and
merchant banks. The individuals were selected mainly due to their experiences and
involvements in the trading ofIslamic bonds as well as conventional. Furthermore, banks
are among the active players in bonds market. Thus, they can be considered to be reliable
and relevance in providing an overall picture of Islamic bonds as well as accounting
practices on Islamic bonds in Malaysia.
1.2 Background of the Study
Islamic finance is tremendously developing in Malaysia. The focus is on structuring deals
that are Shari 'ah 2 compliant with the prospect of attracting some of the estimated
US$250 billion in assets held by Islamic institutions globally3. It is known Islamic
financial institutions are not allowed to deposits the excess balances they have in short
term debt instruments. As a result, most institutions end up having highly liquid balance
sheets with raising liabilities.
Over the past few years, Islamic bonds have created new venues for the short -tenl1
placement not only to solve the above liquidity management problem but also to attract
the Muslims wealth in the region. For example, the government of Malaysia issued a
US$600 million Islamic bond known as Global Sukuk Al-Ijarah in June 2002 to raise
funds from global investors especially those from middle- eastern countries. At the same
Sharia is the Islamic law of human conduct which is derived from the Koran (The Muslim Holy Book)
and the deeds and sayings of Prophet Muhammad (Abdel Karim, 1995)
3 Islamic Debt Appleals; Asiamoney, London; August 2004. pg. 1.
2
4
time, Islamic bonds have become standard for domestic sales, with Islamic bonds issues
exceeding conventional bonds. It was also reported that in 2003, the domestic trading of
Islamic private debt securities (IPDS) increased by 59.7 percent to RM 60.7 billion from
RM 38 billion in 2002.
Malaysian money market trades Islamic bond as debt certificate that can be traded freely
in the primary as well as in the secondary market. The system allows the trading of
receivables based on true trade transactions as opposed to the lending of money. This
means that through Malaysian version of Islamic bonds, bondholders are entitled to a
certain amount of return through the difference of amount they paid during the time they
buy the bond and the amount they receive during the maturity when the debt certificates
are redeemed upon the issuer. In contrast, in other Middle Eastern countries, Islamic
bonds are claimed as real assets which subj ect to profit as well as loss.
Most Islamic bonds issued in Malaysian companies have been heavily structured using
the sale-based Islamic financing instruments. The most connnon sale contracts used in
Malaysia are sale with deferred payment or Bay' Bithamin Ajil (BBA) contracts, mark-up
sale or Murabahah contracts, and recently, some forms of manufacturing contracts or
Istisna'. Some argued that the actual contracts underlie the above-mentioned contracts are
mostly that of 'sale of cash' or bay' al- 'inah (Engku Ali, 2003), which are disallowed by
majority of the classical and contemporary jurists (Rosly, 1999 and Engku Ali, 2003).
This is the main reason for Rosly (1999) to claim that contract of bay' al- 'inah is a hilah
(legal device) that are seen as something which are indifferent to riba' based financing.
5
Another additional Islamic law compliance issue in the structure of Malaysian Islamic
bonds is the practice of bay' al-dayn (sale of debt) to securitize the indebtedness created
in the process of bay' al- 'inah asset creation. Asset was used as the subject matter in the
contract of sale of debt is the 'debt' itself, which is arguable to be a suitable asset for
trading (Engku Ali, 2003).
By looking into the above differences, who are actually Malaysian Islamic bonds target
market? What are the impacts of the differences? Harun (2004) believes that one of the
limitations for a comprehensive growth strategy in Islamic banking and finance market in
Malaysia is lack of understanding among Islamic financiers in what they are involved in.
Harun (2004) further argued that many bank managers in Islamic banking were not
formally trained and it was assumed that the above reason contributes to the fact that
Islamic product currently on offer appear to be merely shari 'ah version of conventional
counterparts.
Islamic bonds are also termed as sukuk in global market. The Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI)4 in its 17'h Shari 'ah Standard
for Investment (AAOIFI FAS 17, 2003) defines investment in sukuk as "certificates of
equal value representing receipt of the value of the certificates and common title to shares
4
AAOIFI is an international autonomous non-profit making corporate body based in Bahrain. AAOIFI
was established in 1991 to develop and disseminate relevant accounting and auditing thought as well as
to prepare, interpret, review and amend accounting and auditing standards for Islamic financial
institutions according to the Islamic Shari'ah. The standards are aimed to increase confidence of the
financial statement's users by providing guidelines to produce useful information.
6
and rights in tangible assets, usufructs and services, or equity of a given project or equity
of a special investment activity". The issue is whether this definition is well understood
by bank managers who are managing investment in Islamic bonds and whether Malaysian
Islamic bonds suit the definition.
The development of Islamic bonds as a non-interest based financial instruments at the
same time give rise to a number of accounting and reporting issues in the current
accounting practices (Hancock, 1999 and Abdul Rahman, 2004). As Islamic bonds were
developed with a different structure as well as developed based on Islamic principles and
shari 'ah as the main basis, it may require different set of accounting and reporting
standard to differentiate them from the conventional bonds. The introduction AAOIFI
FAS 17 was a pro-active effort in providing a codified Islamic accounting standard.
However, the main question is to what extent the AAOIFI FAS 17 can be accepted and
relevant in providing adequate disclosure and treatments on Islamic bonds in Malaysia.
In addition, as Malaysian Islamic bonds are claimed to be similar to conventional bonds
by certain scholars, the question is do bank managers need other accounting standards
beside the national accounting standard which currently in force for better accounting
treatment of Islamic bonds? To answer the above questions, the paper will undertake a
survey to examine the extent of tmderstanding among bank managers' on Islamic bonds
and to test the level of acceptability of AAOIFI FAS 17 among practitioners on the
current accounting practice.
7
1.3 Motivation ofthe Study
A review of literature has revealed that there are only a few studies being undertaken on
Islamic bonds. Most of the prior studies are descriptive, mainly discussing Shari 'ah and
legal issues (Bakar, 1997; Ngadimon, 1998; Abdul Aziz, 1998; Rosly and Sanusi, 1999;
Moustapha, 2001; Muhammad Amine, 2001; Engku Ali 2003 and 2004; Adam and
Thomas, 2004). Thus, the study aimed to empirically explore the Malaysian
understanding on Islamic bonds.
Up to date, there is only one study undertaken by Abdul Rahman (2004) that examined
accounting issues on investment in Islamic bonds. The study provides descriptive
analysis on AAOIFI FAS 17 on investment in securities analyzing issues of
classification, recognition, measurement, presentation and disclosure of Islamic bonds.
Rationally, a well regulated Islamic financial system requires a sound accounting and
reporting standard to reflect the differences from the conventional side. However, a lack
of knowledge and understanding on Islamic bond could be contributing towards lack of
studies in other related areas such as accounting, finance etc. Perhaps the most
fundamental reason could be due to the infancy stage ofIslamic banking and finance.
The above limitation creates a need to undertake a study to explore the current
perspective of key people who are directly deal with trading of bonds about this type of
investment. The aim is to address the lack of awareness and understanding on Islamic
bonds as well as accounting issues on Islamic bonds among practitioners especially bank
managers as one of the major players of this money market instrument in Malaysia.
8
Since Islamic bonds can be considered as new modes of Islamic financing, a good
understanding in Islamic financial contracts as guided by the Qur 'an and Sunnah of the
prophet can facilitate understanding on the principles ofIslamic bonds. Thus, the study is
firstly aims to examine the extent of understanding on Islamic financial contracts among
bank managers (traders, dealers, and financial officers). The findings can be considered
crucial in assisting bank managers to understand Islamic bonds. As good understanding
can indicate relative adequacy in practicing Islamic financial products, perhaps it will
also be useful in determining the acceptance of AAOIFI standards in practice.
Hence, the outcome of this study is hoped to provide some insights for several parties
such as academicians, banking practitioners, accountants as well as regulators and the
public at large in term of enhancing the effectiveness, efficiency as well as credibility of
the Islamic financial industry.
1.4 Organization of the Chapters
The research will be presented in six chapters. The first chapter presents an introductory
part of the research. The second chapter provides review ofliterature on Islamic bonds ..
The literature review will provide overview of the principles oflslamic bonds specifically
from Shari' ah perspective. The chapter also highlights basic principles of Islamic
finance, the nature and development of Islamic bonds in Malaysia. It can be achieved by
reviewing some emerging issues on Islamic bonds.
9
Chapter three introduces the accounting issues for Islamic bonds. The chapter first,
discusses the relationship between accounting and Islam. Then, it analyzes and highlights
the development of accounting standards on financial instruments and the nature of
accounting standards for financial instruments in Malaysia. Finally, the chapter compares
AAOIFI FAS 17 on investment in sukuk with two other relevant accounting standards for
financial instruments in Malaysia, namely; (1) Financial Reporting Standard 1322005 for
financial instruments on presentation and disclosure and (2) Financial Reporting Standard
1392005 for financial instruments on recognition and measurement.
Chapter four discusses research methodology adopted by this study. First, it outlines
research objectives and research questions developed. Then, it presents the research
methodology adopted to examine the research objectives and questions. Finally the
chapter explains the procedures involved in data collection and data analysis.
Chapter five analyzes the data collected and provides findings and statistical test formed.
Finally, Chapter six discusses the findings for each of the research objectives and
underlines few limitations faced in the study. It also highlights contributions made by the
study and offers some suggestions for future research.
10
CHAPTER 2:
ISLAMIC BONDS: AN INTRODUCTION
2.1 Introduction
The purpose of this chapter is generally to provide a brief understanding and introduction
to Islamic bonds. In particular, the chapter attempts to review the underlying principles of
Islamic financial contracts that very much influence the creation and importance of
Islamic bonds in current financial market.
The chapter is organized into five parts. Firstly, the chapter analyses the literature
concerning the basic principles of Islamic financial contracts. Secondly, the chapter
examines the basic concept underlies the Islamic bonds contract especially the concept of
debt in Islam. Thirdly, the chapter briefly explores the development of Islamic bonds in
Malaysia and then it examines the differences between Islamic bonds and conventional
bonds and sukuk. Finally, the chapter examines the emerging and unresolved issue related
to the Islamic bonds structured in Malaysia.
2.2 Basic Principles oflslamic Financial System
Generally, a financial system is a set of rules and regulation that govern and control the
flow of fund from surplus spending units (SSU) in a society to deficit spending units
(DSU). While, Islamic finance is a discipline in Islamic tnu 'amalat (economic
transaction) used as a tool in managing a financial system, which derives its principles
from Qur 'an, the traditions of Prophet Muhammad (peace be upon him), and secondary
11
sources including the ijma', qiyas and maslahah which are based on the former two main
sources of Islamic teaching. Qureshi and Millet (1999) identified that there are three
principles that differentiate between Islamic finance and conventional finance. Those
principles outlined in the three main prohibitions by the Shari'ah in Islamic mu 'amalat.
The three essential prohibitions are prohibitions against riba (usury), gharar (uncertainty)
and maisir (gambling).
Riba' (usury) can be literally defined as excess or increase and technically it is known as
predetermined payment above or unequal to the amount of the principal. Studies
undertaken by Chapra (1982) and M. Ariff (2004) in the literature indicated that riba' is a
basis of distinction between Islamic financial system and conventional system.
Prohibition against riba' is the most important principle in Islamic finance as mentioned
in four different revelations in the Qur 'an 5• There is general consensus among Muslims
that riba' is not limited to usury but it includes interest in this modem economy as argued
III
many previous studies (Iqbal and Mirakhor, 1999; Mohd. Sharif, 2004 and Ariff,
2004).
Riba' is a form of injustice happen in the business environment. It is prohibited because it
is seen as unjustified means of profit and wealth creation. One of the reasons is that the
creditor practically does not provide value-added services to the debtor. There is a
difference between profit on rent and profit on loan as since the benefit enjoyed by the
tenant is certain while the productivity of the loan given is not.
5
Surah ai-Rum (30:39), Surah al-Nisa (39:161), Surah Ali 'Imran (3:1302) and Surah al-Baqarah
(2:27581).See Yusuf Ali's translation of the Qur'an.
12
Gharar is an Arabic word that can be translated as risk, hazard or uncertainty. Gharar
can rise in a contract when the nature of a contract gives rise to the possibility of fraud or
deceit by one of the parties, such as when its terms are vague or ambiguous (Mahmood,
2000 and Adam and Thomas, 2004). Such ambiguity will render most contracts void.
An insurance contract is a good example of a gharar contract as neither the insurer nor
the insured party knows the precise nature and extends of their rights and obligations
until after the occurrence of the insured event. The rational behind the prohibition of this
kind of contract is the possibility of generating unearned profit or an unacceptably huge
loss which depends on the occurrence and nonoccurrence of the insured event.
On the other had, maisir can be defined as the forbidden act of gambling or playing
games of chance with the intention of making an easy money or unearned profit. Making
profit through speculation can be a good example for a practice of maisir. Prohibition
against maisir reflects the Islam's wider prohibition against unearned gains. Gambling
activities mostly depend on luck. Not every people will be very fortunate. However,
attractive rewards offered in gambling activities will always tempt gambler to keep
gambling since that is the easiest way to make money without having to put very much
effort in it.
In addition, Rosly (2005) in his latest book includes two additional shari'ah principles
that govern financial transactions in Islam. They are application of ai-bay' (trade and
commerce) and prohibition from conducting business involving prohibited commodities
such as pork, liquor, illicit sex, and pornography.
13
The above principles depict that profit making in Islam is not as easy as been practicing
in conventional financial system. Islam recognizes capital as a factor of production but it
does not allow the factor to make a prior or predetermined claim on the productive
surplus in a form of interest. However, Islamic financial markets do not deal with Divine
rules alone, as business cannot run without making decent profits. But how? It should be
noted that Allah allows trade (bay') but prohibits riba'. However, it is a mandatory
requirement that every trading should fulfill 'iwad requirement as it will bring along the
sense of equity and justice into a business transaction (Rosly, 2005).
'fwad is defined as an equivalent counter value. According to Ibnu al- 'Arabi, "Every
increase, which is without 'iwad or an equivalent counter value is riba' ". By examining
the previous saying, 'iwad is therefore a basic determinant of a lawful (halal) sale. In
simple words, a price consumer pays for a good must be compensated with an equitable
benefit that he or she enjoys from the purchased good.
Rosly (2005) in his study stated that a trading is said to have 'iwad elements if it consists
the following three components, which are (1) market risk, (2) work and effort, and (3)
liability. In Islamic trading, seller would be liable for a good sold. If a purchaser found
that a good he purchased is defective, it can be return to the seller and deserve to get
replacement or get back his money. In this way, the trader deemed to entitle on the profit
that he make from the trading.
14
On the other hand, fixed-income instruments such as bonds are common instruments
which are not fulfilling 'iwad requirements in generating profit because it is seen as
unjustified means of profit and wealth creation. Besides that, it also involve the exchange
of an equivalent for a higher non-equivalent, the creditor is not required to hold market
and systematic risk as the loans are collateralized and secured by a third-party guarantee
(Rosly, 2005).
2.3 The Concept of Debt in Islam
Most of the fiqh books define the term debt as "any right or wealth that is payable upon
the person either to another person or his Lord based on his commitment towards that
person or his Lord" (Moustapha, 2001). This rights may result from financial and nonfinancial transaction and also rights arising from the service transactions such as direct
loan (qard) and trading based on the deferred payment tenD (al-istisna' and salam). In
Arabic, debt is referred to dayn. By referring to Al-Kasani, Engku Ali (2003) refers dayn
as "a constructive asset in the obligation of the debtor" and she also concluded that debt
is a form of asset, constructive, not real and it can also be a financial right.
One of the most common mechanisms to create a financial right is through loans. In
conventional system, loans constitute a major part of business arrangement in banks or
investment companies as lenders entitled for value-added return by way of interest
charged on loans.
On the other hand, Islamic finance should have carried social
accountability toward a more equitable distribution of income and wealth and increased
equity participation in the economy (Ariff, 2004). Islam encourages partnership where
15
partners will be entitled to profit as well as loss according to the performance of their
investments instead of having a business with creditor and debtor relationship.
Rosly (2004) indicated that the only instrument for loan contract available in Islam is al-
qard (benevolent loan) which is given for non-commercial basis. Furthermore, loan
contract ('aqd qard) in Islam is meant to assist but not to harm or impose burden to the
debtor (Moustapha, 200 I). In other word, the lenders are only entitled to the principal
amount and cannot charge anything extra over the principal amount. Therefore, any
additional amount charged on the debt loaned out is considered hurting our fellow being
regardless of his or her financial status.
However, in order to protect the welfare of the creditor from the risk of inflation,
inflation premium on loan can only be done on ex-post basis in a form of hibah (gift).
The prophet (p.b.u.h) and his companions motivate debtor to pay his creditor better than
loan given to him. Mujahid reported that Abd' Allah b. 'Umar took some dirhams as loan
and paid back better dirhams. He said: "0 Abu 'Abd ai-Rahman, these are better than the
dirhams I loaned out to you." Abd Allah b. 'Umar replied: "Yes, I know, but I paid out of
my own goodwill and pleasure" (Rosly, 2005). This extra amount given to creditor can
reflect debtor's high level of ethical and moral (akhlak) in expressing his gratitude to
creditor's willingness in helping his fellow brother who are in need.
16
2.4 The Development of Islamic Bonds in Malaysia
Malaysia is very serious in its vision to create a comprehensive Islamic banking and
capital market as a competitive alternative that runs parallel to their conventional
counterparts. This vision has clearly stated in Malaysia Capital Market and Financial
Sector Master Plan 2000 that aims to position Malaysia as an Islamic financial & Capital
Market centre in the region by 2010. Throughout this period, the development in both
sectors are very impressive especially Islamic bond markets, which also start to attract
more global investors mainly from cash-rich areas such as the Gulf countries.
Malaysia has by far the most advanced Islamic debt market in the region. The growth of
this sector has been very remarkable as the CFO's and bankers become more comfortable
to the Islamic concepts underlie the contract structure. In 1999, Islamic structured debt
constituted only 7% of corporate bond issued in the country and four years later, in 2003,
40% of the US$ 11.8 billion worth of corporate bond issued was Islamic.
The history of the development of Islamic bonds in contemporary finance in Malaysia
started in Early 1990's when the first RM 125 millions Shell MDS Islamic private debt
securities was issued in 1990. Since the first issuance, a continuous series of Islamic debt
securities issued by government as well as corporate sector such as the RM 300 millions
Petronas Dagangan Berhad's IPDS in 1994 and Mudharabah Cagamas Bonds 6 (Engku
Ali (2004). Those early issuance of Islamic bonds are mostly structured using sale-based
Islamic modes of financing under Murabahah and BBA contracts. Both structures have
6
They were the first Is1amic-mortgage-based securities which were issued in May 1993.
17
been used widely and considered the most preferred type of Islamic financing in
Malaysia. As of March 2002, most of the Islamic private debt securities amounting RM
23.614 billions rated by the Malaysian Rating Corporation Berhad (MARC) are using
both abovementioned Islamic contracts while only RM 522 millions are structured under
Ijarah (leasing) contract.
However, throughout this development period, Malaysian Islamic bonds received a lot of
critiques from most of the Islamic scholars mainly Middle-eastern jurists (Rosly, 1999;
Muhammad aI-Amine, 2001; Engku Ali, 2003 & 2004). The issue of bay' al-'inah and
bay' al-dayn contracts underlie the structure of Islamic bonds are highlighted to be a
doubtful Islamic instruments (These two instruments will be discussed in detailed in the
issues on Islamic bonds section). Due to that, after lengthy discussions and debates,
Malaysia recently starts to provide other alternative for Islamic securitization methods
which may not be strictly debt-based and perhaps less arguable in their mechanism
(Engku Ali, 2004). The most preferred alternative is leased-based Islamic securitization
which is known as sukuk al-ljarah. (The sukuk will be discussed in detail in 2.5.2)
The flexibility and the bright future prospect of Islamic bonds are not only prompted the
rapid development of Islamic bonds in term of diversification of product. In 2002, for
example the Malaysian government allows tax deduction for five years on expense
incurred in the issuance of Islamic bonds, based on the shari 'ah principles of Ijarah,
Mudharabah and Musyarakah. The provision can be a good step taken by the
government to attract the mobilization of fund and liquidity in the market. This would
18
provide an alternative to investors in providing liquidity rather than depending on
traditional banks loan. The positive reaction from the market prompted the authority to
later on revised the policy in which it effect more comprehensive tax treatments for
Islamic securities under Federal Budget 2004 which also promotes the application of
Istisna' bonds in the market.
2.4.0 Types ofIslamic Bonds Traded in Malaysian Debt Market
After undergoing few stages of development, today we have so far many types of Islamic
bonds available in the market namely the Murabahah bonds, the Mudarabah or
Muqaradah bonds, the Ijarah bonds, the Istisna' bonds and the Salam bonds which
respectively offer different type of return. The development process is based on the need
ofIslamic financial instruments in the different nature of business structures (Muhammad
AI-Amine, 2001). In addition, to meet the demand of investors, Islamic bonds and
certificates should also be diversified.
2.4.1 Murabahah Bonds
Murabahah is basically the sale of goods at a price covering the purchase price plus a
margin of profit agreed upon both parties concerned (Haron, 1997). Murabahah bonds
are issued for the purpose of financing the purchase of goods so that the certificate can
represent an evidence of ownership to the Murabaha commodity. Rosly (2005) claimed
that Murabahah bonds are more or less similar to the conventional bonds since they are
able to maintain the unique characteristic of conventional bonds which is fixed income in
nature and guarantees capital protection.
19
2.4.2 Mudharabah or Muqaradah bonds
Muqaradah bonds are contracts structured based on a lawful Mudarahah principle with
the capital provided by one party and managed by another party where profit are shares
based on the predetermined profit-sharing ratio. It is a document of ownership issued in
the name of their holder against fund they pay to the owner of the prescribed project
(Muhammad AI-Amine, 2003). Muqaradah or Mudarahah bonds are among the earliest
types of bonds issued in Malaysia. As compared to Murahahah which is debt in nature,
Muqaradah bonds are like a share with regard to varying returns, which are accrued
according to the performance of a stipulated project. In fact, the above criterion makes
the Muqaradah bonds to playa vital role in the process of development financing.
2.4.3 Ijarah Bonds
Ijarah bonds are securities of equal denomination of each issue, representing the
ownership of well defined physical durable assets that are tied to an Ijarah contract as
defined by the shari'ah.Ijarah is a contract ofleasing of equipment required by the client
for a rental fee. Ijarah bonds can be traded in the market at a price determined by the
market forces. Through such contract, the return generated in Ijarah bonds fulfills the
'iwad condition as the return (rental fee) is subject to the ability of the lessee to pay the
rental installments and liability on asset leased out.
2.4.4 Salam and /s(isna' bonds
These two types of securities represent a sale of a commodity on the basis of deferred
delivery against immediate payment. In other word, bondholders hold rights against the
20
good. to be deliver in the future. The only different between Salam and lstisna' is in term
of mode of payment where payment for lstisna' contract can be defer but not in Salam.
2.5 The Structure of Islamic Bonds in Malaysia
Murabahah bonds which also known as al-Murabahah Notes Issuance Facilities
(MuNIF)
and AI-bay' Bithamin Ajil bond (ABBA) have been used widely and
considered the most preferred types of Islamic financing in Malaysia. Thus, for the
purpose of the study, the paper will only discuss in detail the above main types ofIslamic
bonds traded in Malaysian debt market which are, sale-based financing debt instruments;
MuNIF and ABBA bonds and new alternative lease-based financing equity-linked debt
instruments; sukuk al-ljarah.
2.5.1 Sale-based Financing Debt Instruments
There are two main distinguishing features to differentiate Islamic bonds from the
conventional. First, Islamic bonds require the existence of underlying financial assets
representing the value of the securities issued - thus bonds become financial assets that
can be tradable. Secondly, there must not be any interest rate attached to the notes or
certificates whether it is fixed or floating. Due to the above reasons, all sale-based Islamic
bonds today have been issued with zero coupons or in other words no additional payment
are made on par value of the bonds and they were traded at discount.
In order to reflect the above differences, Islamic bonds have been structured through the
following three steps:
21
I. Securitization - the creation of securitized assets (underlying assets)
2. Bond issuance - issuer issues debt certificate to the financier
3. Trading of debt certificates - buying and selling the debt certificate
III
the
secondary market using the bay' al-dayn principle.
Securitization is the process of transferring an illiquid asset into marketable securities
which represent evidence of debt or indebtedness arising out financing facilities
(Moustapha, 2001). This process is undertaken under the contracts of bay' al-'inah (sale
of cash or sale and buy back) between two parties involving two consecutive sales and
purchases with two prices. This process will create 'indebtedness' which is then be
securitized into equal value of debt certificates to enable the debt to be traded.
The securities are later on issued by issuer (borrower) backed by the future cash flows of
the securitized assets. In both MuNIF and ABBA bonds, two types of debt certificates
will be issued. One represents capital component called primary notes and the other
represents profit portion called s.econdary notes or coupon notes. The sale of this
'indebtedness' has been regarded as sale of debt (bay' al-dayn), which is then be traded at
discount in secondary market. Figure 2.1 explains a simple structure of ABBA and
MuNIF bonds traded in the Malaysian Islamic debt market.
22
It should be noted that the difference between this two Islamic bonds is mainly on their
respective maturities. Long term issues normally apply ai-bay' Bitahamin Aji! contract
while short term issues apply al-Murabahah.
Figure 2.1: Structure of AI-bay' Bithamin Aji/ bond (ABBA) and
Murabahah bonds (MUNIF)
(6) bay' al-dayn redemption of primary and secondary
notes at par value
(2) cash payment of RM 100 m
Issuer
(1-4) executed under bay' al-'inah
instrument
Company A
Investors/
Bondholders
.
(I) sell underlying assets to
investors for RM 100 m
(3) sell back the underlying assets to issuer at RM 124 m for
deferred payment within 3 years
(4) RM 124 m is the "indebtedness" created from the
previous transactions, which later on be securitized into
primary and secondary notes by issuer
(5) the issuance of primary and secondary notes as a prove of
indebtednedd (shahdah al-dayn) at par value
Primary notes: RM 100 m
Secondary notes: RM 24 m
23
2.5.2 Lease-based Financing Equity-linked Debt Instruments - Sukuk al-Ijarah
Due to the controversial issues raised regarding assets suitability in bay' al- 'inah and the
issue bay' al-dayn, the structure of sukuk al-ljarah is agreed to be a better alternative to
sale-based debt securities. The following figure 2.2 explains in detail the structure of this
type of sukuk and how it is traded in the market:
Figure 2.2: Structure of Sukuk al-Ijarah
Day 1
Asset(s) sale agreement
c:J
,
Transfer of
sukuk
Funds
Taker
PO:l
,
Issue sukuk
securities
•
PV
~
us $
Sukuk
Holders
US$
Periodic Payments
Ijarah (lease agreement)
..........................................
,
Lease
rentals
Funds
Taker
Sukuk
Holders
US$
Maturity
.Asset(s)
. . . . . . . . . . buy-back
. . . . . . . . . . . .agreement
. . . . . . . . .!
Transfer of
sukuk pool
'
c:J
~
SPY
Funds
Taker
US$
Redemption of
sukuks
~
US$
•
Sukuk
Holders
Source: Adam, NJ.and Thomas, A., (2004),"Islamic Bonds: Your Guide to Issuing,
Structuring and Investing in Sukuk, p.55.
24
The contract of sukuk al-Ijarah starts with the identification of an underlying asset that
must be capable of both sale and leasing. In term of the contractual flow, the process
normally starts with the originator selling the identified assets to the Special Purpose
Vehicle (SPV). The SPY will then enter into a lease contract with the originator. This
lease contract creates a stream of income in the form of rental payment in favor of the
SPY. The SPY then issues the sukuk that are supposed to represent an undivided
proportionate ownership over leased asset. From the Islamic legal perspective, the buyers
of the sukuk effectively bought a portion of the lease assets, and thus, become co-owner
of the assets. As owners, the sukuk holders are also the lessors to the originator, and are
therefore entitled to the stream of rental payments. Finally at the end of the lease period
(reflecting the maturity of the sukuk), the originator will redeem the sukuk from the
holder, effectively buying back the underlying assets from them. The structure of sukuk
al-Ijarah is clearly explained in the figure 2.2.
Based on the above explanations on sukuk al-ijarah structure, Engku Ali (2004) made a
number ofIslamic legal observations as the following;
(i) The sukuk do .not represent debts whereas it represents undivided proportionate
ownership of the leased assets. In this sense the sukuk are not debt instruments, but
more of participatory certificates (similar to equities).
(ii) As the sukuk are neither debt nor money, the Islamic legal difficulties in the sale of
monetary-debts with discounts not arise.
25
(iii) Sukuk represent the leased property (nonnally real asset) and thus, can be bought and
sold at any price that the parties agree to.
All these factors explain the world-wide endorsement of sukuk al-ljarah as Shari 'ah
compliant securities.
2.6 Sukuk and Islamic Bonds vs. Conventional Bonds
Within the capitalistic financial system, a bond or a loan that one obtained has a price
namely interest. Bonds are also a "security" which gives the holder a financial claim on
the issuer (Faerber, 1993). Upon maturity or upon disposal, bondholders are entitled to
receive a return of interest together with the principal amount loaned out. However,
profiting from debt in this conventional way is fundamentally wrong from an Islamic
perspective. Any profit should be realized from an effort and risk taken to undertake any
fonn of business transaction and this form of contract is seemed to violate the principle of
al-Ghurm bi! Ghunm (no profit without risk).
Meanwhile, as aforementioned, the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) in it's
17th
Shari 'ah Standard for Investment sukuk
defines investment sukuk as "certificates of equal value representing, after closing
subscription, receipt of the value of the certificates and putting it to use as planned,
common title to shares and rights in tangible assets, usufructs and services, or equity of a
given project or equity of a special investment activity". In other word, sukuk is assetbased securities that are linked to ownership of an asset. In this fonn on contract, tangible
26
assets are required to back the issuance of sukuk and they must be a permissible in both
their nature and used. At the same time, sukuk must be issued to finance any purpose
which is not only legal in jurisdiction but permissible according to Shari 'ah.
From the above definitions, it can be summarized that conventional bonds and sukuk
differ in terms of the following criteria as shown in figure 2.3;
Figure 2.3: Comparisons between Sukuk and Conventional Bonds
Sukuk
Conventional Bonds
(i) Nature
It is a certificate of ownership share in
specified assets/ projects/ services
It is a certificate of pure debt
obligation
(ii) Underlying assets
The issuance of certificates are
backed by tangible assets, usufruct or
services
In some cases, the issuance of
certificates are backed by secured
loans
(iii) Claims
Ownership claims on the specified
assets an any income raise from the
investment on the asset
Creditors claims on the borrowing
entity comprising principal and
interest
(iv) Security
Secured by ownership rights in the
underlying assets or projects
Generally unsecured except for
mortgage bonds (which are
backed by secured loans), and
equity trust certificates
(v) Trading of security
Sale of ownership interest
in a
specified asset! projects or services
(vi Principal and return
Not guaranteed by issuer
Guaranteed by issuer
(vii) Prices
Besides,
issuer
creditworthiness,
sukuk
price
depend
on
the
appreciation and depreciation of
underlying assets
Price is solely depend on Issuer
creditworthiness
(viii) Purpose
May be issued to finance any purpose
which is not only legal in jurisdiction
but permissible according to Shari'ah.
May be issued to finance any
purpose which is not only legal in
jurisdiction
. Sale of debt instruments
27
Due to the fact that Malaysia stands in contrast to the widely held juristic views on sukuk,
the study attempts to differentiate between Islamic bonds and sukuk. For the purpose of
the study, the researcher will refer Islamic bonds exclusively to sale-based financing debt
instruments, which are MuNIF and ABBA bonds as been structured and traded in
Malaysian debt market. While, sukuk refers to sukuk al-Ijarah. The rational behind the
reclassification are;
(i)
MuNIF and ABBA bonds are shariah-complaint in a way that they are structured
using Shari 'ah permissible contracts listed by AAOIFI, and
(ii)
The certificates are issued to finance any purpose not only legal in jurisdiction but
permissible according to Shari 'ah.
(iii) However, from the literature, the abovementioned types of bonds seem to be
indifferent to conventional bonds and violate the rules of riba' as the contracts
allow trading of receivables based on true trade transaction. Majority of the scholars
rejected the practice since in a case of a sale with deferred
payment (ABBA
bonds), buying the receivable at variable price is the same as buying or selling cash
which is forbidden in the hadith as it is ribawi item (Engku Ali, 2003 and Adam
and Thomas, 2004). The details on the issue will be discussed in the next section.
(iv) While, sukuk al-Ijarah is the main Malaysian sukuk structure that is well accepted
in global market since it meet the Shari 'ah requirements as agreed by majority of
Muslims scholars.
28
2.6 Unresolved Issues in Malaysian Islamic Bonds
From the first time it was introduced and implemented in the market, Islamic bonds
cannot be isolated from the debate and controversy. The most controversial issues are
related to fiqh issues that seem to be incompliance with the syari 'ah. Rosly (1999),
indicated that the instruments of bay' al- 'inah and bay al-dayn which are extensively
used in designing Malaysian Islamic bonds could be a limitation to attract foreign
portfolio investment into this country. He expected that, Malaysia will be able to attract
supply of capital from Middle-eastern countries when less evidence of bay' al- 'inah is
found in the financial contracts ofIslamic bonds.
Bay' al- 'inah is referred as a sale based on the transaction of Nasi'ah (delay) in which
two contracts executed at one time where a buyer is bound to buy back an asset sold with
different prices (Rosly, 1999). Until today, this instrument is exclusively adopted in
Malaysia. By taking shafi'ie's opinion (unlawful intention is immaterial) as the basis of
ruling, Malaysian scholars has legalized the used of this instrument in many Islamic
products mostly debt instruments in the market.
The advantage of bay al- 'inah (sale of cash or buy back sale) is it guarantees profit to
interested parties (investors) from the difference in prices in two contracts concluded.
Based on the structure, the contract seems to be indifferent to the interest-based loan.
Such kind of contract enables the investor not only to avoid market risk in holding an
asset, but also to entitle for a return without having to put much effort in it.
29
On the other hand, Moustapha (2001) defines bay' al-dayn (sale of debt) as "a contract in
which the creditor sells his payable right upon the debtor either to the debtor or to a third
party. This sale contract may be either on spot or forward basis. It may also be either at a
discount price or at the cost price". This definition is in fact suit the practice of debt
trading in Malaysian Islamic debt Market.
However, it is noteworthy that Muslim jurists are divided in their opinion regarding the
tradability of debt whether debt can be bought and sold. According to a study done by
Engku Ali (2003), majority of the jurists agree on the permissibility on the sale of debt
between creditor and debtor under hiwalah principle (Haron, 1997; Rosly 1999;
Muhammad ai-Amine ,2003). However, their views are divided with regard to the sale of
debt between creditor and third party. The modern scholars tend to tolerate with the sale
of debt provided that the sale contract is free from riba' and gharar as decided by the
orc Islamic Fiqh Academy.
Nevertheless, it is difficult to be certain in a case where debt has receivable in monetary
form because it is considered as similar to money (Engku Ali ,2003 and Rosly, 2005),
while money has no intrinsic value. As such, dealing in money (same currency) cannot
generate profit but a riba ' unless converted into real assets to deal with. This concept is
totally different from the modern banking system which is based on the concept that
money should be treated like any other factor of production and must earn some return
over a period of time (Hairetdinov, 1998).
30
Since most of the Islamic bonds traded in Malaysia today have monetary receivable, the
rules of exchange of money for money would be applied. Therefore, the contract of debt
sale would be subject to the following conditions (Engku Ali, 2003):
a) The price of debt is not in monetary form. However, if the price is in form of
money, the exchange must be (i) at par value and (ii) it must follow the exchange
rate of the trading day. However, if the price is of different denomination with the
debt and the exchange must be on spot basis.
b) The payment of the price should be on spot or cash to avoid the exchange with
another debt (bay' al-kali bi al-kali).
By observing the nature and structure of Islamic bonds in Malaysia especially
Murabahah bonds and BBA bonds, the practice of trading ofIslamic bonds in Malaysia
may not be shari 'ah-compliant due to the following reasons as analyzed by Engku Ali
( 2003):
a) They involve monetary receivables
b) The price paid is in monetary terms
c) Contradict with the rule of parity in the exchange of money for money due to the
practice of discounting.
However, it should be noted that the Shari 'ah Advisory council of the Malaysian
Securities Commision (SAC) legalize bay' al-dayn (sale of debt) to the third parties with
the following explanations:
31
a) Debt would no longer be subject to the rule of currency exchange since it has
been securitized to be an independent asset and capable of being bought and sold
at whatever price agreed by the contracting parties. Therefore, discounting of the
sale of debt is allowed.
b) Discounting in the sale of debt is allowed based on the principle of da 'wa ta 'ajjal.
It should be noted that the
Ole
Islamic Fiqh Academy allowed the
abovementioned principle but only to the extent of the application to creditor and
debtor only.
The above ruling is supported by a case ofBanu Nadir as Ibn 'Abbas says:
"When the Prophet (p.b.u.h) asked Banu Nadir to leave Madinahjor good
some afthem came to the Prophet (p.b.u.h) and told him, you have require
us to leave Madinah but we do have our debt, which are yet to be due
date. The Prophet (p.b.u.h) told them: Discount your debts and they will
pay you on spot. They did so and their debts were settled at discount on
spot basis ".
As a conclusion, it is important to note that the differences of opinions and the
absence of mandatory standard for Islamic financial transaction might raise doubt
among customers in term of making appropriate and right judgments in their
business decision and how to jeopardize stakeholders' interest in the case of the
diversity of fiqh opinion. The diversity of opinions on the permissibility and
prohibition of bay' al- 'inah and bay' al-dayn are based on ijtihad since there is no
32
direct source from the Qur 'an and Sunnah pertaining to these issues. Each of the
opinions is supported by strong arguments and reasons. Thus, it is now a matter of
choice. Muslims have choices to accept or reject the opinions based on the
strength of the arguments and the rational behind the reasons.
33
CHAPTER 3:
ACCOUNTING FOR ISLAMIC BONDS
3.1 Introduction
The development of Islamic bonds as a non-interest based financial instruments give rise
to a number of accounting and reporting issues in the current accounting practice
(Hancock, 1999 ; Abdul Rahman, 2004). As Islamic bonds were developed with a
different structure as well as adopted Islamic principles provided by the shari 'ah as the
main basis, it may requires a different set of accounting and reporting standard to
differentiate them from the conventional bonds. The introduction of Financial
Accounting Standard No.17 on investment in securities (AAOIFI FAS 17,2003) is a
good effort in providing a codified Islamic accounting standard. However, the main
question is to what extent the AAOIFI FAS 17 can be applied to provide adequate
disclosure and treatments on Islamic bonds in Malaysia.
This chapter is structured into five sections including an introduction. The second section
evaluates the relationship and importance of accounting in Islam. Then, the chapter
highlights the need for harmonization of accounting practices for Islamic financial
instruments. The fourth section provides an overview of accounting standards for
financial
instruments
set. by conventional standard-setting authorities
such as
International Accounting Standard (lAS) and Malaysian Accounting Standard Board
(MASB) as well as AAOIFI. Finally, the chapter ends with a comparative study between
AAOIFI FAS 17 on investment in sulatk and two newly revised and approved Malaysian
34
accounting standards on financial instruments which are (i) FRS
1322005
for financial
instruments on presentation and disclosure, and (ii) FRS 1392005 for financial instruments
on recognition and measurement.
3.2 Accounting in Islam
Accounting in the conventional culture is often described as the "language of business"
(Askary and Clarke, 1995) since it is an important mean to communicate financial
information to the users. Precisely accounting can be defined as an art of interpreting,
measuring and describing the financial outcomes of economics activities.
The word accounting can be translated in Arabic as al-muhasabah, which comes from the
word "hisab" (to account). Qur 'an repeated the word "hisab" more than eighty times in
different verses (Askary and Clarke, 1995). The fundamental means of accounting can be
referred to Qur'an (4:86), "Surely Allah takes account to all things.. ". Naturally Islam
consider human to be a vicegerent of Allah. The nature of this relationship has been
spelled out clearly when Allah upon creating men, declared: "1 will create a vicegerent
on earth" (Qur 'an, 2:30). Muslims were .created by Allah not only as His vicegerent but
to serve and obey the shari 'ah, a guideline brought down as a way of life for every
Muslim. Allah is said to have proclaimed that, "1 have only created ... men that they may
serve me" (Qur 'an, 51 :56)
The basic similarity between account in Islam and accounting lies in the responsibility of
every Muslim in doing his or her duties as described in Shari 'ah. Every Muslim is
35
encouraged to promote good deeds and at the same time to avoid bad deeds and these
actions are recorded in an 'account' kept by Allah which will continue until death and
balanced up on their day of judgment. The difference between the good and bad deeds
resulted in the accounts will determine the status of man with Allah. This concept is
basically similar with the concept in business accounting.
Conventional accounting basically encompasses the relevance, understandability,
reliability, materiality and faithful presentation as accounting qualities in its system
(Askary and Clarke, 1995). In contrast, one study (Gambling, 1986) claimed that Islamic
accounting carnes a further quality. The most distinguishable characteristic of an
accounting system
III
the Islamic vIew IS that "it should be utilized for Shari 'ah
purposes." Thus, in business activities Islamic accounting is a control tool used to
provide information to determine that any business activities meet shari 'ah purposes.
A good set of accounting information are essential in different aspect of life. Being a
Muslim, man is responsible to the faithful religious obligations in undertaking trading
such as paying zaka/ in a portion of their income. Truthful information would provide
justice not only to zakat payer but also to the poor which always have certain share in the
wealth of the rich. There is a general need for truth in decision about business and
economic activities. The role of economic activities in Islam should be directed towards
the achievement offalah8 not only in this world but in the hereafter. Falah can only be
7
8
A tax levied on the gross assets of Muslims; its payment amounts to a religious duty (Saleh, 1986: 151)
Falah is a tangible quality towards the achievement of God's pleasure (Abdul Rahman: 2004).
36
achieved if each and every transaction in economic activities portrays truthfulness and it
is morally and ethically transacted.
As an individual Muslim accountant, preparing a proper and adequate accounting and
business information is a form of amanah (trust) that needs to be handled ethically and
morally. Due to that, accountant is required to have a good relationship with his creator.
The strong relationship with his creator will help him to improve and strengthen his faith
and inspired him with the value of truthfulness, fairness, tolerance etc. in his business
dealings. In fact, the relationship with the Master (Bablun Min 'Allah) has a strong
influence in developing the mode of relationship with the fellow servant (Hablun Min'
An-Nas) (Abdul Rahman, 2004). Qur 'an, verse 2:40 indicates that faith without good
work is incomplete. Hence, a good accountant doesn't limit himself to discharge his
amanah in a good and proper way but the information he produce can also help other
parties to make a good decision in achieving their business objectives. Due to that, Abdul
Rahman (2004) indicated that this relationship is a key for attainment of falah, the true
success in this world and hereafter.
3.3 International Harmonization of Accounting Practices for Islamic Financial
Instruments
The Islamic prohibition against riba', gharar and masir has led to the emergence of
Islamic banks and financial institutions. Unlike conventional commercial banks, Islamic
banks are prohibited from charging or paying interest. Instead, Islamic banks have taken
various approaches to invent and develop Islamic banking and financial products and at
37
the same time supervisory bodies have adopted different approaches to regulate Islamic
banking. These variations have led Islamic banks to adopt different accounting treatments
for the same transactions rather than refer directly to international accounting Standard or
national accounting standards based primarily on international accounting standard
(Karim, 200 I). This rendered the financial statements ofIslamic banks noncomparable.
In the absence of an Islamic accounting standard, some information related to the
structure of Islamic principles might not properly been disclosed. Regardless what is the
main reason for the differences, there is a need and in fact a must for Islamic banks to
adopt accounting standards that meet the Shari 'ah requirements. This is in line to the fact
that Islamic banks, like any other Islamic business organizations were established with
the responsibility and mandate to ensure their business transactions are in strict
compliance with Islamic Shari 'ah rules and principles.
The objective of Islamic accounting standard is to facilitate comparisons and thereby
minimize the social and economic cost of assessing the alternatives with which one is
faced in making rational decision (Mohd. Shariff and Abdul Rahman, 2004). A financial
statement will be useful for a comparison of the performance if it provides proper
disclosure with regard to the financial reporting, the underlying Shari 'ah principles and
the accounting method adopted is made (Hamat, 1994). The presentation of such
information is critical to the economic decision making process by parties who deal with
Islamic banks and would also have a significant effect on the distribution of economic
38
resources for the benefit of society. Without proper and adequate disclosure about the
information, the 'Islamicity' oflslamic banks' operations will open to be questioned.
The differences in accounting practices in the Islamic banks seems to have intervened
efforts of the international standard setting bodies in enhancing the harmonization of
accounting and financing reporting by the banks. A previous study undertaken by Hamid,
Graig and Clark (1993) argue that Islam have the potential to extend a profound cultural
influence in the quest for the "harmonization of international accounting standards,,9. The
main reason is that Islamic banking and finance system is subject to the precepts of the
Shari 'ah which is not readily fit in with those of the conventional accounting standards.
The harmonization of accounting and reporting programs have led Islamic banks together
with experts in Islamic Shari 'ah and accounting to establish AAOIFl. Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI), a private standard
setting body was established to prepare and promulgate accounting, auditing and
governance standards based on the Shari 'ah principles for Islamic financial institutions.
In a wider scope, AAOIFI is also responsible for the harmonization of financial reporting
. by Islamic financial institutions.
The establishment of AAOIFI also expected to strengthen the effectiveness of Shari 'ah
committees by facilitating the evaluation of emerging financing instruments and by
9
"Harmonization of international accounting standards" is a process of bringing international accounting
standards into some sort of agreement so that financial statements from different countries are
comparable.
39
aiding in the implementation ofIslamic ethics (Mohd. Shariff and Abdul Rahman, 2003).
However, without power to enforce its standards, the AAOIFI seeks the implementation
of its standards partly by getting support from central banks to adopt them, partly by
trying to persuade Islamic institutions of their usefulness and partly by inculcate
awareness on importance of Islamic accounting standards among accountants and
auditors ofIslamic banks.
Today, lAS's and AAOIFI's standards seem to be complementing to each other. As a
newly established organization, AAOIFI's standards are found insufficient to produce
adequate disclosure of financial reporting. At the same time, lAS's standards do not
consider religious aspects in its accounting standards. Thus, the original idea of
harmonization as movmg towards "uniformity in accounting standards" I0 across
countries may not be achieved as long as the above differences exist across countries.
3.4 Overview of Accounting Standards for Financial Instruments
3.4.1 Accounting Standards for Financial Instruments Set by Conventional Standardsetting A uth orities
The accounting for financial instruments has received a great deal of attention by the
international standard-setting authorities in the middle of 1990s. The original intent of
International Accounting Standard Committee (IASC) was to address all matters of
recognition, measurement, derecognition, presentation and disclosure in a single
10
The elimination of alternatives in accounting for economic transactions, other events, and circumstances.
40
'.,
comprehensive standard proved to be unsuccessful. The first standard, lAS 32, issued in
1995 and first effective in 1996 only address less complex issues of presentation and
disclosure. This similar approach has also being adopted by Australian Accounting
Standard Board (AASB) with the release of AASB 1033 in December 1996. The more
complex issues of recognition, measurement, derecognition etc. have been dealt with the
issuance of lAS 39, which become mandatory only in 2001.
The major force for the development of an accounting standard for financial instruments
is the problems associated with secondary or derivative instruments rather than any major
problem with primary instruments (Hancock, 1999). The above development has also
prompted many other countries to follow suit, either by arriving at individual national
requirements confirming with lAS 39 or using the standard as a basis for their individual
national requirements.
In the case of Malaysia, Malaysian Accounting Standards Board (MAS B) has issued
MASB 24 on Financial Instruments: Disclosure and Presentation in March 2000. Two
years later, MASB issued MASB ED 35 on Financial Instruments: Recognition and
Measurement, which was identical to lAS 39 (revised). Due to revision to lAS 39
(revised 2000), MASB decided to withhold the work on ED 35. In December 2004, the
MASB re-exposed MASB ED 35 (revised), which provides a more complete revision
incorporating the entire latest proposal by IASB. The MASB's ED 35 (revised) is based
on lAS 39 (revised 2003) as limited amendments were made to lAS 39 (revised 2003)
proposed in exposure draft issued by IASB. This ED 35 (revised) is intended to be
41
implemented for the period beginning on or after 1 January 2006 and yet it does not
include proposed amendments in IASB ED for Financial Instruments i.e. on fair value
option. This ED 35 (revised) is named FRS 139 on Financial Instruments: Recognition
and Measurement in line with IASB and MASB new mission of moving closer to world
convergence of accounting standards.
Besides the abovementioned standards, Bank Negara Malaysia has provided a guideline
on Financial Reporting for licensed Islamic Banks (GP8-i) issued in June 2005 as a basis
for presentation and disclosure of reports and financial statements of Islamic banks in
carrying out its banking and finance activities. The details of accounting policy for
securities comprising equity instruments, government securities and debt securities has
been provided in Appendix A of the guidelines. GP8-i is set out to ensure consistency and
comparability of these statements among Islamic banks in complying with the provision
of the Companies Act 1965, approved accounting standard issued by MASB as well as
disclosure requirements of the Bursa Malaysia Securities Berhad.
3.4.2 Accounting Standard/or Investment in Sukuk Set by AAOIFI
Global Islamic debt securities market also recognizes Islamic bonds as sukuk. This term
has extensively use by the AAOIFI in setting an accounting standard as well as Shari 'ah
standard in Islamic bonds. AAOIFI Financial Accounting Standard No.17 on investment
provides accounting rules for recognition, measurement, presentation as well as
disclosure for investments institutions whether the investments are in the form of direct
investments, investment funds or investment portfolio, in sukuk, shares and real estate.
42
The history of the development of AAOIFI FAS 17 starts when Accounting and Auditing
Standards Board decided to give priority to the preparation of a standard on investments
its 16th meeting held in Jeddah on 27 December 2000. As a result, two consultants had
been assigned to respectively prepare a preliminary study on the accounting aspect and
juristic aspect of the standards which were later on discussed for comments in 27'h
meeting held in Jordan in April 2001. An exposure draft on the standard was submitted
for the first time and being discussed for comments in May 2001. After series of
discussions and amendments, the board decided that the revised exposure draft should be
distributed and exposed to specialist and interested parties.
A public hearing was later on held in Bahrain on 4 February 2002. More than twenty
participants representing central banks, Islamic banks, accounting firms, Shari 'ah
scholars, academicians and other interested parties attended the event. The revised
exposure draft was finally adopted and proposed on 30 April 2002 in 23'd meeting held in
Bahrain after being reviewed by the members of Accounting Standard Committee in
respond to the comments in the public hearing. The standard was suggested to be
implemented for the annual period beginning on or after 1 January 2003. In the absence
of authorized Islamic accounting standards, AAOIFI FAS 17 is hoped to provide a proper
guidance for the adequate presentation of economic information for investment in Islamic
bonds which fulfill Shari 'ah requirements as well as comparable within the industry.
43
3.5 Comparative Study between AAOIFI FAS 17, FRS2oos139 & FRS2oos132
This comparative study will focus on accounting standards on investment in sukuk
provided in AAOIFI FAS 17 and accounting standards related to asset-backed and
mortgage-backed debt securities provided in FRS 132 and FRS 139.1t is important to note
that FRS 132 as well as FRS 139 do not specifically provide standards on investment in
sukuk. Instead, the standards provide general accounting standards for financial
instruments. Based on the characteristics possess by sUkuk, the researcher found that the
bonds are quite similar to asset-backed and mortgage-backed debt securities. In addition,
Adam and Thomas (2004) incorporated sukuk to asset-backed and mortgage-backed debt
securities in the manner that they are linked to assets and they may be seen as dispersing
risk by moving the identified assets from one investor's balance sheet to another's. This
type of arrangement is normally done through asset securitization.
Asset securitization can be described as a technology by which certain classes of
contractually homogeneous corporate assets, typical loans, leases, and receivables, are
pooled and legally partition from the firm that originated the assets. This accomplished
by legal transference of the title from the originator firm to a special purpose vehicle
(SPY). SPY is typically an irrevocable trust but can also be a corporation, partnership, or
association. Securities are then issued by the SPY, backed by the future cash flow of the
securitized assets.
Secured type of business contract could be seen as a good and profitable business
arrangement to investors. Generally, in conventional practice of asset-backed bonds,
44
account receivables are normally used as collaterals for debts. The pledge account merely
serve as security to the lender, giving comfort that sufficient assets exist to generate cash
flow adequate in amount and timing to repay the debt. However, the debt is paid by the
borrower whether or not the pledged receivables are collected and whether or not the
pattern of such collection matches the payments due on the debt.
On the other hand, sukuk are not merely backed by assets but they are also structured
among the fourteen Shari'ah permissible contracts (as listed by AAOIFI) and the
certificates themselves represent ownership rights on the pledged assets until the
certificates are redeemed upon the issuer. It might be seen as collateralized loan as the
above arrangement but in fact otherwise. Therefore, the ownership titles secure rights of
certificate holders to any future cash flow generated from the use of the assets or any
other transactions related to the assets such as expenses related to their maintenance.
The following section will discuss these differences as well as similarities of the
instruments from an accounting perspective.
3.5.1 Scope and Definition
In general, the scope of AAOFI FAS 17 is applicable to the three category of investments
namely investments in sukuk, investments in shares and investments in real estate.
AAOIFI F AS 17 refers the term sukuk for Islamic bonds. So far, the abovementioned
types of investments are identical to be the permissible investments for Muslims to
participate as they are free from the riba', gharar, and maisir in nature. In addition, it has
45
been stressed by a number of Shari'ah scholars that legitimized Islamic finance must
involve the funding of trade in, or the production of, real assets (Usmani, 2002).
Appendix (E) of AAOIFI F AS 17 identified five types of sukuk that are legally traded in
the market namely Mudaraba (Muqaradah) sukuk, Musharaka sukuk, ljarah sukuk,
Salam sukuk and Istisna sukuk.
On the other hand, the two FRS2oo5 132 and FRS2oo5 139 specifically provide accounting
standards for investments in financial instruments which includes both primary
instruments and derivatives financial instruments. Primary instruments include trade
receivables and payables, loans and debentures, redeemable preference shares as well as
equity such as ordinary shares. While, derivatives instruments include interest rates or
currency options, futures, forward and swap. The two FRS standards provide
comprehensive guidance in order to match the complexity of financial instrument in the
current financial market especially derivatives market which need the special hedge
accounting.
It should be noted that mortgage bonds fall into the category of primary instruments.
Thus, this comparative study will take into consideration any standards applicable to this
primary instrument to be compared with the accounting standards on investment in sukuk
as provided in AAOIFI F AS 17 throughout the analysis.
In term of definition, Investments sukuk as defined by AAOIFI Shari 'ah Standards No.
17 (2/0), are "certificates of equal value representing undivided shares in ownership of
46
tangible assets, usufruct and services or (in the ownership of) the assets of particular
projects or special investment activity, this is true after receipt of the value of the sukuk,
the closing of subscription and the employment of funds received for the purpose for
which the sukuk were issued". However, the definitions given by FRSs are different as
compared to the definition of sukuk given by AAOIFI FAS 17. Both standards define
bonds as "financial assets representing contractual rights to receive cash in the future and
corresponding financial liabilities representing contractual obligations to deliver cash in
the future" I I •
Both definitions highlight the differences in the nature of sukuk and conventional bonds.
The differences are due to Shari 'ah prohibition against riba' and trading of ribawi items.
Mortgage bonds are certificates of debt in nature representing rights on principal amount
and agreed return namely interest (financial assets). Although they are pledged by
secured account receivables, it only represent securities for the bondholders in case of
issuer's failure. While sukuk in shari'ah are certificates representing ownership on the
asset in kind and claims or future cash flow related to the assets which incorporate a
characteristic of equities. Therefore, in some cases, bondholders' entitle not only to profit
but to loss as well.
It is worth to note that investment in sukuk do not include interest-based debts because
receivables as practiced conventionally cannot be traded since Islam prohibits generating
profit from debt. On the other hand, the aim of conventional bond traders usually to make
" AG4, Application Guidance, Financial Reporting Standards (132), Malaysian Accounting Standard
Board.
47
capital gains as fixed-interest bond prices rise when variable market interest rates fall. In
other words, bond trading are activities mainly deal with the exploiting interest rates
development (which is strictly prohibited in Shari 'ah) and trading in paper that is usually
unrelated to the value of underlying assets e.g. mortgage bonds.
The following discussion will capture the analytical studies between the three standards
in term of classification, recognition, measurement, presentation and disclosure aspects.
3.5.2 Classification
In term of classification, AAOIFI FAS 17 classified investment in sukuk into three types
namely: for trading purposes; available for sale; and held to maturity. The basis of
AAOIFI FAS 17 classification is based on the well-knownshari'ah classification of trade
commodities for the purpose of zakat. In Appendix B, Juristic rules for Investments
indicates that the jurists of Maliki School have classified trading assets into the following:
(a) assets that are meant for buying and selling; (b) assets that are held for sale in the
expectation of making profits through price appreciation in the future; and (c) assets
acquired not for trade, but for personal use.
Conventional classification of non-derivatives financial instruments also classified into
the same categories except for investment held for trading. Under FRS 139, the type of
investment is one of the assets classified under financial assets at fair value through profit
or loss. The use of AAOIFI's and both FRSs' classification of investment in sukuk and
financial instruments seems to be quite similar and the classifications provided reflect the
48
differences in management intentions or purpose of investment l2 . In addition to the above
three categories, FRS 139 provides additional classification for loans and receivables that
are not quoted in an active market. Legally, this definition is not applicable to sukuk as
loans and account receivables are prohibited to be traded in Shari 'ah. Meanwhile, Abdul
Rahman (2004) identified problems in classifying the above investments and the main
problem of classifying the investments is to objectively determine the intention of the
investors and intention may also subject to change overtime due to the changes in
economic climate.
3.5.3 Recognition and Measurement
AAOIFI FAS 17 has recommended that initial recognition for investment in sukuk shall
be recognized on the acquisition date and shall be measured at cost. At the end of
accounting period, investment in sukuk held for trading purposes and available for sale
shall be measured at their fair value while for investments held to maturity, the asset shall
be measured at cost. The rationale of AAOIFI's FAS 17 to recommend historical cost for
investment held for maturity rather than fair value could be because of the inherent
uncertainties in relation to the use fair value for capital market instruments.
Another reason could be because there is no intention to trade in the securities before
maturity, thus, there is no apparent need to measure the securities at the end of the year at
fair value. However, if there is an impairment of value for investment held to maturity,
then the subsequent measurement should be at amortized cost.
12
See Para. 9, Financial Reporting Standards (139), Malaysian Accounting Standard Board for definitions
of categories of financial instruments.
49
The standard as well as FRS 139 also prescribe that unrealized gains or losses as a result
of re-measurement need to be recognized in the income statement and realized profits or
losses resulting from sale of any investments shall be measured at the difference between
book value and the net cash proceeds from the sale of investments 13.
In the case of dividends received from investment in sukuk, both AAOIFI standard and
FRS 139 require dividends to be recognized in the income statement at the declaration
date rather than at the date when the cash proceed is received. This indicates the use of
accrual basis of accounting to ensure that the institution recognizes income when it is
realized based on the contract or the right to receive that income. The use of accrual here
is required in order to reflect the actual or fair income at that point when it is realized.
The new FRS 139 favors fair value accounting in its provision for recognition. The new
standard recommends financial assets shall be initially measured at its fair value plus
transaction cost (cost that directly attributable to the asset acquisition) in a case of
financial asset not at fair value through profit or
IOSSI4.
At the end of accounting period
all type of investment shall be measured at fair values except for investment held to
maturity and loans and receivable which shall be measured at amortized cost using
effective interest rate method l5 .
" Para 3, Financial Accounting Standard (17), AAOIFI and Para. 55, Financial Reporting Standards (139),
Malaysian Accounting Standard Board.
14 Para. 43, Financial Reporting Standards (139), Malaysian Accounting Standard Board.
is See Appe~dix A, Para. AG80-AG81, Financial Reporting Standards (139), Malaysian Accounting
Standard Board.
50
Besides the above comparisons, the researcher has identified a few provisions provided
by FRS 139 that has not made available in AAOIFI FAS 17 and otherwise. The
provisions are as followings;
(i) Derecognition offinancial assets
Besides fair value accounting, FRS 139 provides additional provision for derecognition
of financial assets. Paragraph 15-37 of FRS 139 supported by application guidelines in
AG36-AG32 provides detail guidelines for any financial assets entitled to be recognized
and derecognized in the financial statements based on evaluation on the transfer of risk
and reward of ownership of financial assets. According to the standard, an entity shall
derecognize a financial asset when the contractual rights to the cash flows from the
financial asset expire or it transfers the financial asset together with its risk and rewards.
This provision is crucial as failure to recognize a financial asset will result in
understatement of an entity's assets while failure to derecognize a financial asset will
result in overstatement of an entity's assets and both situations will affect company's
value as well as shareholders' wealth.
(if) Separation between the share income portion related to owners' equity and portion
related to unrestricted equity investment account holders
In order to meet the transparency and proper treatment in financial reporting, AAOIFI
FAS 17 provides additional requirement for separation between the share income portion
related to owners' equity and portion related to unrestricted equity investment account
holders. The provision is significant in such a way that without proper treatment and
51
disclosure on the above matter, it may lead to confusion among the both parties regarding
to the method, ratio and process in distributing profit that have been taken place. At the
same time it fulfils the shari'ah requirement of ensuring fair and just profit sharing and
distribution between shareholders and depositors (investors).
It is also found that the guideline on measuring fair values provided in FRS 139 is more
extensive and comprehensive as compared to AAOIFI FAS 17. The detail of the
guideline is as follows;
Measurement offair value
The new issue of FRS 139 provides guidelines in measuring fair value of a security l6.
Fair value as defined in FRS 139 is a "price agreed by willing buyer and willing seller in
an arm's length transaction". The fair value for actively traded securities in the market
normally can be referred to the published quoted prices which are also known as 'bid
price' and 'ask price'. However, for many financial instruments including Islamic bonds,
quoted market prices may not be available. In the case of unquoted securities, FRS 139
suggests an entity to establish fair value through a few possible valuation techniques. The
techniques are discounted cash flow analysis, or option pricing model, or by using recent
arm's length market transaction between knowledgeable and willing parties, or by
referring to the current fair value of another instruments that is substantially the sale.
However, Abdul Rahman (2004) claimed that these techniques involve uncertainties and
are significantly affected by the assumptions used and judgments made regarding risk
]6
See Appendix A, Para. AG71-AG79, Financial Reporting Standards (139), Malaysian Accounting
Standard Board.
52
characteristics of varIOus financial or capital market instruments. The uncertainties
include the arbitrary used of discount rates, future cash flows, expected loss and other
factors. On the other hand, due to the absence of standard measurement for the Islamic
products, the application of the abovementioned measuring techniques as a benchmark
for measuring and valuing Islamic debt instruments are widely practiced.
3.5.4 Presentation and Disclosure
Paragraphs 20 to 29 of AAOIFI FAS 17 generally provides guidelines on presentation of
investments (the study will refer to investments in sukuk), income realized from all types
of investments and profit or losses resulting from the sale of the investments. These
requirements basically similar to general presentation requirements provided by FRS 132
except that AAOIFI requires separate presentation of income for owners' equity and
investment account holders in the case of presenting income, profits or losses. Islamic
banks offer profit and loss sharing investment account, such that investors' return
depends on the return on the assets financed by the investors' fund. Therefore, if profits
from all types of investment are pooled together, there is a probability that the returns are
not from the portion of assets owned by the investors. In this case, riba' and gharar
elements would exist.
Apart of the requirements for general disclosure on accounting policies I7 , fair value of
investments I8 and restrictions on investments I9 , AAOIFI's FAS 17 has also made special
requirements for investments in sukuk. Among the requirements are those disclosure shall
17
18
Para. 23, Financial Accounting Standard (17), AAOIFI.
Para. 24 and Para. 27, Financial Accounting Standard (17), AAOIFI.
53
.'';
be made by the issuer of sukuk, if material, the face value of sukuk, the percentage of
20
sukuk acquired from each party issuing the sukuk and each type of sukuk .
The standard also recommends disclosures on the party guaranteeing the sukuk and the
nature of the guarantee 21 , contractual relationship between the issuer and/or manager of
sukuk and the holders of such sukuk!2 as well as disclosure on the classification of sukuk
according to their maturities23 .
The current AAOIFI FAS 17 unable to provide sufficient requirements that are relevant
to be disclosed in the financial statement such as provisions for disclosure of risk
management policies and disclosure of collateral.
(i) Disclosure of risk management policies
As far as disclosure of risk management policies is concern, FRS 139 provides detailed
discussion on the requirement, which was not part of AAOIFI FAS 17. Disclosure of the
requirement is important in such a way that it provides financial statement users the
ability to assess on and off-balance sheet risks which prominently include predictions
relating to future cash flow associated with the financial instruments. As such it should be
included as part of AAOIFI FAS 17 standard. However, those predictions that subject to
uncertainties might be a reason for AAOIFI not to include the requirement in its standard.
Predictions would render the existence of gharar and gharar is prohibited in Islam.
19
20
21
22
Para. 28,
Para. 30,
Para. 31,
Para. 32,
Financial
Financial
Financial
Financial
Accounting
Accounting
Accounting
Accounting
Standard (17), AAOIFI.
Standard (17), AAOIFI.
Standard (17), AAOIFI.
Standard (17), AAOIFI.
54
(ii) Disclosure of collateral
In the current practice, the pledged account receivables, which remain assets of the
borrowing entity, continues to be shown as current assets in its financial statement. While
in the bondholders' financial report, sufficient information relating to the collateral
should be disclosed in the notes to the account of investment in securities. Paragraph 94
of FRS 132 recommends that in the absence of default by the owner, the bondholder shall
disclose fair value of the collateral accepted and any material terms and conditions
associated with the use of the collateral while AAOIFI FAS 17 requirements only limited
to the party guaranteeing the sukuk and the nature of guarantee24 .
However, those requirements seem to be insufficient in providing adequate disclosure of
the collateral. Sukuk holder might require information relating to the fair value of
underlying assets as well as the expenses related to the assets in assessing their fair value
and bondholders might worry if the fair value of collateral cannot meet their initial value
of investments in a case of issuer's default.
The above discussion indicates the need for the Islamic institutions to be more
transparent in disclosing financial information pertaining investment
In
securities
especially sukuk. The underlying rationale is to provide useful information for users to
make informed judgment especially about institution's investment in securities. The users
are expected to require sufficient information and disclosure not only with respect to the
23
24
Para. 33, Financial Accounting Standard (17), AAOIFI.
Para. 3 I, Financial Accounting Standard (17), AAOIFI and Para. 64, Financial Reporting Standards
(132), Malaysian Accounting Standard Board
55
risks of investment undertaken and the potential return (full disclosure) but it includes the
contractual relationships of the parties involved that is expected to fulfill the shari'ah
requirements (social accountability) that did not be taken into the consideration by the
conventional standard setters.
As a conclusion, it is found that neither AAOIFI nor FRS standards could provide
comprehensive financial information for investments in sukuk as well as investments in
debt securities. For the time being, the three standards seem to be complement to each
other in the absence of comprehensive standard for Islamic financial securities. Without a
comprehensive accounting standards, the variation in accounting practices in Islamic
banks as well as other institutions are expected and the international harmonization
programs will remain unsuccessful. At the same time, the users of financial statement
would not be provided with comparative financial statements in order to judge the
efficiency and effectiveness of Islamic banks operations and their compliance with the
Shari'ah.
56
CHAPTER 4:
RESEARCH METHODOLOGY
4.1 Introduction
This chapter outlines research objectives and research questions as well as presenting the
methodology adopted for the research. The chapter is organized in the following manner.
First, the chapter explains three research objectives and six research questions based on
the literature reviewed in the previous chapters. Secondly, the chapter discusses the
research design developed for the study. Finally, the chapter explains the procedures
involved in the data collection and data analysis.
4.2 Research Objectives and Research Questions.
Reviews of the literature in the previous two chapters have shown that some studies
attempted to provide some understandings on Islamic bonds (Rosly, 1999; Muhammed
aI-Amine, 2001) or Islamic debt securities. Most studies focused on the prospects and
challenges as well as some understanding on issues arising from the analysis of their
structures includingfiqh and legal issues·on Islamic bonds.
Malaysia is serious in its vision to create a comprehensive Islamic banking and capital
market as an alternative to conventional counterpart. This vision has clearly stated in
Malaysia Capital Market and Financial Sector Master Plan 2000 that aims to position
Malaysia as an Islamic financial and Capital Market centre in the region by 2010.
57
However, some authors such as Haron (2004) argues that the low level of understanding
among bank managers on Islamic bonds in addition to the Malaysian current practice
may hinder the development of Islamic bonds in Malaysia. Throughout this development
period, Malaysian Islamic bonds received a lot of critiques Islamic scholars anmainly
jurist (Rosly, 1999; Muhammad aI-Amine, 2001; Engku Ali, 2003 and 2004). The issue
of bay' al- 'inah and bay' al-dayn contracts underlie the structure of Islamic bonds are
highlighted to be a doubtful Islamic instruments as compared to globally acceptable
sukuk type ofIslamic bonds.
Thus, this exploratory study would like to analyze whether bank managers of Malaysian
Islamic financial institutions who are involve in managing investment in Islamic bonds
have good understanding about the investment especially from the perspective of
Shari'ah.
The following research objectives and research questions are developed and to be tested
to evaluate the general understanding on Islamic bonds from the Shari' ah perspective;
Research Objective No.1:
To examine the level of understanding on the principles of Islamic finance and Islamic
bonds among bank managers in Malaysia.
Research questions emerge from this objective are as follows;
• Research Question No.1:
To what extent are bank managers understand on the principles ofIslamic finance?
58
• Research Question No.2:
To what extent are bank managers understand about Malaysian Islamic bonds?
• Research Question No.3
To what extent are bank managers able to differentiate between Malaysian Islamic
bonds, conventional bonds and sukuk?
The second part
oft~estudx exammesacc()untillgstal1Qill'cI~whlCha[(:n:JeyanL£or
Islamic bonds. The development of investment on Islamic bonds specifically and
financial instruments generally give rise to a number of accounting and reporting issues.
In 2003, the need for an accounting and reporting standard of Islamic financial
instruments that meet both Shari 'ah requirements and relevant to be practiced has
prompted AAOIFI to introduce AAOIFI FAS 17 on investment in securities. However,
the standard has not been adopted by Bank Negara Malaysia as yet, but it becomes as one
of the main source of accounting standard for Islamic finance. After two years of
AAOIFI FAS 17 was made public, it is also of interest to observe the nature of current
accounting treatments for Islamic bonds in Malaysian local financial institutions and to
what extent AAOIFI FAS 17 has been adopted and applied. Therefore, based on the
above concern, the following research objectives and research questions are emerged;
Research Objective No.2:
To examine the nature of current accounting practices on Islamic bonds in Malaysia
and the level of acceptability of AAOIFI FAS 17 on investment among the Malaysian
bank managers
59
Research questions raised to analyze the above objective are;
• Research Question No.4:
What is the accounting standard(s) currently used for accounting treatments on Islamic
bonds in Malaysian local financial institutions?
• Research Question No.5:
Do bank managers or local financial institutions refer the AAOIFI standards as their
guidelines in financial reporting?
• Research Question No.6:
To what extent is AAOIFI FAS 17 relevant and acceptable to be used in Malaysian local
financial institutions?
Since Islamic bonds are new in the Islamic banking and finance, the researcher assumes
that good understanding in Islamic financial contracts as guided by the Qur 'an and
Sunnah of the prophet can be a good basis in understanding Islamic bonds. Thus, the
researcher assumes that a good understanding on principles of Islamic finance can be
considered crucial in assisting bank managers to understand Islamic bonds. Meanwhile,
proper understanding and perceptions can reflect adequacy in positioning Islamic
products and efficiency in business dealings. Perhaps it will also be useful in determining
the acceptance of AAOIFI standards in practice. The above assumption drives the
following final research objective and research question;
Research Objective No.3:
To test the relationship between the bank managers' understanding and their
acceptability ofAAOIFI FAS 17
60
·~
.
• Research Question No.7:
Do good understanding on principles of Islamic finance and Islamic bonds influence the
acceptability ofAAOIFI FAS 17 among bank managers?
Table 4.1: Summary of research objectives, research questions and questionnaires
No.1
To examine the level of
No.1
To what extent do the bank managers understand on the
understanding on the principles of
principles of Islamic finance?
82
Islamic finance and Islamic bonds
among bank managers in
No.2:
Malaysia.
To what extent are bank managers understand on Malaysian
83 (a)
Islamic bonds?
No.3:
To what extent are bank managers able to differentiate
83 (b) & ( c)
between Malaysian Islamic bonds, conventional bonds and
sukuk?
No.2:
No.4:
To examine the nature of current
What is the accounting standard(s) currently used or referred
accounting practices on Islamic
for accounting treatments on Islamic bonds in Malaysian
local financial institutions?
bonds in Malaysia and the level of
acceptability of AAOIFI FAS 17
on investment among the
Malaysian bank managers
Cl
No.5:
Do bank managers or local financial institutions ever rely on
C2
AAOIFI standards as guidelines in their financial reporting?
No.6:
To what extent is AAOIFI FAS 17 relevant and acceptable
to be used in Malaysian local financial institutions?
No.5:
No.7:
To test the relationship between
Does good understanding on Islamic finance and Islamic
the bank managers' understanding
bonds influence the acceptability of AAOIFI FAS 17 among
and their acceptability ofAAOIFI
bank managers?
C3
Analyzed us;ng
Pearson correlaaon
coefjicient measure
FAS17
61
·
4.3 Research Design
4.3.1 Sample Selection and Respondents' Background
Given the main purpose of this study is to analyze the understanding on investment in
Islamic bonds among bank managers, the study will examine the perceptions and
understanding of bank mangers who are specifically responsible in managing, monitoring
and evaluating the investment in Islamic bonds specifically and money market
instruments generally. It is believed that based on their experiences and involvement in
the trading of bonds, the managers may be able to provide relevant feedbacks on Islamic
bonds. For the second objective, the study will examine the managers who have
accounting background and are currently involved with treasury department. This might
be relevant to explore their understanding on Islamic bonds as well as their accounting
practices.
In order to meet these two research main objectives, two groups of respondents were
identified. The first group is managers who are also bonds traders and dealers from
Islamic money market or Islamic fixed income division in treasury front office. The
second group is finance officers from treasury back office who are responsible in
bookkeeping and financial reporting ofIslamic bonds.
Normally, there are two major concerns to survey research namely random sampling and
systematic bias. The study minimizes the concerns by not using random sampling but
instead sample was selected to represent the target population.
62
,
There are several stages involved in identifying the samples. First, the latest list of
financial institutions in Malaysia published by Bank Negara was reviewed. However, for
the purpose of this stndy, the samples were restricted to local commercial banks, Islamic
banks and Merchant banks registered in Malaysia. For more than a decade, Islamic banks
as well as commercial banks which offered Islamic products are earliest institutions
exposed to Islamic Banking and finance. While, merchants bankers are among the most
active financier or bondholders and a major arranger for Islamic bonds and global sukuk
sale to investors in the region. Therefore, the feedbacks from these institutions are crucial
for the stndy.
In the second stage, each bank identified was contacted to obtain the right information
regarding the department that managed investment in Islamic bonds as well as managers
who are directly involved in the investment. Their information was confirmed by calling
them personally and they were briefly informed about the survey and the questionnaire to
be sent to them.
From the telephone survey, it was found that there are only between I to 3 managers who
are managing investment in Islamic bonds in each bank. The small number of targeted
respondents is due to the limited number of managers who are trained and have a good
knowledge in this type of investment. Furthermore, in some of the banks, Islamic bonds
represent only a small portion of their total investment.
63
The following is the final list of 14 Malaysian Financial Institutions which participate in
the survey.
Table 4.2: List of Malaysian Financial Institutions Selected for the Study
4.3.2 Method Used & Questionnaire Design
This study is undertaken to examine the perceptions of bank managers in Malaysia and
their understandings on Islamic bonds and accounting practices. Thus, primary data i.e.
questionnaire survey is being used for the study as a method of data collection to enable
researcher to obtain evidence of perceptions among the respondents.
However, there are two major weaknesses common to survey research, which is random
sampling and systematic bias (Mohd. Sharif, 2004). These weaknesses can be reduced by
not using random sampling. Thus, the sample which represents target population is
64
C;"
selected and contacted. Apart from that, postal questionnaire is also expected to receive
low response rate. It is common to get less than twenty five percent return rates for this
method of data collection. In order in overcome the problem, the researcher took the
initiative to contact, remind and do follow up through phone calls as well as e-mails.
The questionnaire
IS
divided into three sections. Section A is designed to collect
demographic information of respondents such as age, specialization and working
experience. Data obtained from this part can be used to established relationship with the
other part of questionnaire.
Meanwhile, Section B is focused on measunng perception and understanding of
respondents on Islamic bonds. This section comprises three main questions including a
question asking general definition of Islamic bonds to be given by respondents. Question
two seeks to analyze the perception and the extent of understanding of respondents on the
basic principles of Islamic finance. Respondents are given three choices whether they
"agree", "disagree" or "not sure" with each of the statement given. The last question
attempts to examine the ability of respondents to compare between Islamic bonds,
conventional bonds and sukuk. Respondents are ask to tick (,J) in an appropriate box if
agree and (x) if they disagree with the characteristic indicated.
Section C is designed to study the nature of accounting practices for Islamic bonds in
Malaysia and respondents' perception on AAOIFI FAS 17. The first question requires
respondents to indicate the accounting standard(s) that their organization currently used
65
':,:
for accounting treatments on Islamic bonds by placing a (~) in colnmn provided. The
standards could be MASB standard, lAS standard or AAOIFI standard. Question two
attempts to analyze whether the respondents' organization refers to the AAOIFI standards
in their accounting and financial reporting practices. Respondents are provided with two
boxes indicates "yes" if the used to apply AAOIFI standard or "No" if otherwise. Finally,
this section attempts to identify the extent of applicability and relevance of AAOIFI FAS
17 in organizations' accounting treatment for Islamic bonds. The respondents are given
with a list of AAOIFI standards comprising recognition & measurement and presentation
& disclosure. Accordingly, respondents are required to rank the level of applicability of
each standard based on five-point Likert Scale with 1 being "Totally Irrelevant" and 5
being "Totally relevant".
4.4 Data Collection Procedure
During the first week of questionnaires distribution the researcher sent the questionnaires
in person to the respondents' workplace. However, after that the questionnaires were sent
through postal mail. In both methods, questionnaires were sent to respondents with their
name printed on the front envelope and they were supplied with a stamped and selfaddressed. All respondents were given two weeks to complete the questionnaire. After.
that a follow-up procedure was done through phone.
66
"
4.5 Data Analysis
Most of the analysis undertaken by the study involved descriptive statistics. Accordingly,
the researcher decided to use mean rating score in addition to frequency analysis for the
questioned involving accounting treatments for Islamic bonds. The mean score for each
accounting treatment were calculated by averaging integer values chosen by the total
respondents. While, for questions involving principles of Islamic finance and
characteristics of financial securities which are Islamic bonds, conventional bonds and
sukuk, the use of weighted average score is considered sufficient measure for the
comparative analysis. The value of 1 will be given if a respondents answer each of the
questions correctly and 0 if otherwise. The formula to calculate the total score is as
follows;
mj
1] Id=i
i=1
Where di is 1 if item i is correctly answered and 0 otherwise and mj is the maximum
number of questions. This method has been widely used by many researchers such as
Cooke (1989), Raffournier (1995), Maali et aI. (2003) and a few others in their previous
studies. The respondents might achieve the maximum 10 score for the question B I and
17
for each type of bonds in question B2. Then, in order to get the weighted average
.
.
scores, the score given will be divided by the total number of questions and they are
presented in percentage.
Apart from that, the study will also perform an analysis using Pearson Product-moment
correlation coefficient measure to test the relationship between respondents'
67
'-'
understanding on the principles of Islamic finance and understanding on bonds and their
l~vel
of acceptability of AAOIFI FAS 17 among Malaysian bank managers. The further
process of data collection and analysis from the survey will be discussed in detailed in
Chapter five.
•
68
"::'"
CHAPTERS:
ANALYSES AND FINDINGS
5.1 Introduction
This chapter presents data analyses and findings. The chapter is organized as follows.
Firstly, analysis on the data collection including response rates are calculated and
presented. Then, the respondents' profiles are highlighted through demographic analysis.
Finally, statistical analyses are presented for each research objective and research
questions which has been developed in the previous chapter.
5.2 Response Rate
There were 84 questionnaires distributed to two groups of bank managers in 18 local
banks in Malaysia. The first group represents managers who are bonds traders and dealers
from Islamic money market or Islamic fixed income division in treasury front office
while the second group represents finance officers from treasury back office who are
responsible in bookkeeping and financial reporting of Islamic bonds. The targeted sample
was selected to avoid random sampling and systematic bias. As a result, the sample was
restricted to respondents who are experts in giving feedbacks on Islamic bonds £i'om 9
commercial banks, 3 Islamic banks and 6 merchant banks registered in Malaysia25 •
Out of 84 questionnaires distributed, only 38 copies were returned. The respondents
constitute 11 finance officers and 27 bond traders and dealers. Most of the returned
25
Please refer to table 4.2 in Chapter four to see the list of respondents identified for the study.
69
questionnaires were completely answered while a few of the incomplete questionnaires
were still considered reliable as the incompletion in certain parts does not affect the
overall analysis.
Table 5.1: Respondents' Backgrounds according to Department
DEPARTMENT
Finance/ Treasury Back Office
Treasury Front Office
11
27
28.9
71.1
In general, this response rate is considered quite low even after rigorous follow up
procedures were undertaken. This was contributed by the limited number of managers
who are trained and have a good knowledge in this type of investment. Furthermore, in
some of the banks, Islamic bonds represent only a small portion of their total investment.
Due to that, some may not be ready to give their feedbacks.
5.3 Demographic Analysis
The first section of the questionnaire requires respondents to answer basic questions on
gender, age, education background, working experience, job position, specialization and
the name of organization in which they are attached. Analysis of respondents'
background and their characteristics is shown in Table 5.1.
70
Table 5.2: Respondents' Gender, Age and Working Experience
GENDER
Male
Female
AGE
30-40 years
41-50 years
51 years and above
WORKING EXPERIENCE
5 years and below
6-10 years
11-20 years
20 years and more
36
2
38
94.7
5.3
100
20
17
38
52.6
44.8
2.6
100
1
12
15
10
38
2.6
31.6
39.5
26.3
100
I
The results of the demographic analysis depicted in table 5.1 shows that 36 out of 38
respondents are male. The portion represents 94.7 percent of the total samples. It is also
found that all respondents were more than 30 years old where 53 percent were between
30 and 40 years old while the remaining were more than 40. Interestingly, majority ofthe
respondents had working experiences of more than 10 years and 26 percent had been
involved in the industry for more than 20 years. Based on the above information, it can be .
concluded that the feedbacks from these respondents can be considered reliable and
posses a high degree of reliability.
Education background is considered significant for the analysis in obtaining informed
opinion. Table 5.3 shows that 89.5 percent of the respondents hold a bachelor degree and
above with the remaining 10.5 percent having a diploma. It is also interesting to find out
71
that three of the respondents are master holders another three are professional certificates
holders i.e. Association of Chartered Certified Accountants (ACCA) and Chartered
Institute of Management Accountants (CIMA). The result indicates that majority of the
respondents are reasonably educated. This implies that perhaps they are more than able to
understand the questionnaire and provide an objective opinion.
Table 5.3 also provides information on the areas of specialization and frequency of the
respondents attending training and seminars on Islamic Banking and Finance. From the
table, it can be seen that the respondents under the survey posses a wide range of
expertise. The majority of them which represent 26.3 percent of the respondents
specialized in Finance followed by Treasury and Accounting with 23.7 percent and 21.1
percent respectively. This result is expected since the respondents are working in treasury
and finance departments and some ofthem involve in accounting and financial reporting.
The result also shows that more than half of the respondents are not well trained. 24 out
of38 of the managers only attend the seminar on Islamic banking and finance once a year
or less than that. Considering the fact that Islamic bonds are newly development Islamic
financial products, the managers who are involve in managing the investment are not well
exposed to the issues and the development of the products. This would lead to the
misconception and confusion in their practice. The effect of this limitation can be seen in
the next analysis.
72
<,
Table 5.3: Respondents' Education Backgrounds, Area of Specialization and
Frequency of Islamic Banking and Finance Training Attended
EDUCATION BACKGROUND
Diploma
Degree
Master
Others 26
SPECIALIZATION
Accounting
Banking
Business Administration
Economics
Finance
Islamic Banking
Treasury
Others
FREQUENCY OF TRAINING
ON IBF ATTENDED
Very frequent
Frequent
Less frequent
Rare
4
28
3
3
38
10,5
73.7
7.9
8
3
21.1
7.9
2.6
7.9
26.3
2.6
23.7
7.9
100
I
3
10
I
9
3
38
1
13
12
12
7,9
2.6
34.2
31.6
31.6
5.4 ANALYSES AND FINDINGS FOR RESEARCH OBJECTIVES NO.1
5.4.1 Analysis on the Level of Understanding on Principles ofIslamic Finance among
Bank Managers in Malaysia
Throughout the study the researcher has stressed the importance of understanding on the
principles of Islamic finance as it might contribute towards a better understanding on
26 Others represent respondents having professional certificates i.e Association of Chartered Certified
Accountants (ACCA) and Chartered Institute of Management Accountants (CIMA).
73
Islamic bonds. This section will empirically analyze the level of understanding among the
respondents on the subject addressed. The level of understanding was measured based on
the score of correct answers from the 10 questions asked in question B2. The analysis has
produced the following result as depicted in table 5.4 to 5.6.
Out of 38 questionnaires returned, one was incomplete and umeliable for this part of
analysis. As such it was excluded from the sample.
Table 5.4: Level of Understanding on Basic Principles ofIslamic Finance among
Malaysian Bank Managers
51.4
9 to 10
TOTAL RESPONDENTS
37.8
100
14
37
Table 5.5: Percentage of agreement on the Basic Principles of Islamic Finance
2
7
49
or servIces
89
to a true commercial or financial risk and liability where
that one must be
to
as well as a loss
haram activities which businesses and actions are explicitly
5
6
73
real asset oriented
3
4
The
97
92
must be consistent with some elements of property
used in Islamic
loan but without
use
76
78
51
cash) is an Islamic instrument used to create a debt which later on be
val ue of debt certificate
57
74
·.
In general, the study concludes that the majority of Malaysian bank managers have a
moderate level of understanding on the basic principles of Islamic finance. The result
shows that 10.8 percent of the samples fall under the category of those who possess low
understanding while 51.4 percent have moderate understanding. It is quite disappointing
to note that only 37.8 percent representing 14 bank managers who have high level of
understanding on the topic. On average, the study found that there is only one manager
with good understanding on the basic principles of Islamic finance in each of the 14
institutions participating in the study.
Table 5.6: Percentage of Respondents who are "Not Sure" on few Islamic Finance
principles
30%
2
22%
3
4
instrument used in
ic loan)
Hassan
allows borrower to use loan given with guaranteed payment of principal
loan but without predetermined hibah (gift)
Shari 'ah oriented financial business is fundamentally real asset oriented
14%
11%
The unfavorable result was also contributed by respondents who are not sure or
indifferent in understanding of those principles. Most of the confusions were centered
within the issue of bay' al- 'inah, bay' al-Dayn, Qard Hassan and real asset- based
business transaction. The researcher suggest that the reasons behind the confusion may be
due to inadequate training and exposure on the current issues related to the Islamic bonds.
75
This can be proven by the result obtained in demographic analysis that more than half of
the respondents are not well trained. 24 out of 38 of the managers only attended the
seminar on Islamic banking and finance once a year or less than that. Consequently, those
limitations lead to their acceptance on conventional practice of interest which is
contradict to Qard Hassan especially in loan financing and the trading of money which is
not a real asset based transaction.
In depth, the study observed that the most agreeable principle of Islamic finance is the
prohibition of riba " gharar and maisir. It is logical to observe that 100 percent of
respondents agreed on the principle. This is due to the fact that the above prohibitions are
the fundamental principles of Islamic banking and finance.
On the other hand, it was noted that the least agreeable principle among the respondents
is money or monetary commodities are not real assets. This respond was expected since
money or loan has been the main source of income for banking industry. The reason
could be because many of them do not realize that money cannot be traded for money in
Islam as money itself does not have an intrinsic value. This result is related to the
confusion raised on Qard Hassan principle which also indicates that there is lack of
understanding on the subject.
Based on overall analysis, it can be concluded that the level of understanding of Islamic
finance among bank managers in Malaysia is far below the expectation. The knowledge
and expertise of the people who are offering Islamic products are in fact should be
76
,
parallel to the development ofIslamic banking development. This scenario would allow
Islamic bank managers as well as Islamic banking products' credibility be questionable.
5.4.2 Analysis on the Level of Understanding on Islamic Bonds among Bank Managers
in Malaysia
This section is focusing on technical characteristics of three types of bonds traded in
Malaysia namely conventional bonds, Islamic bonds and Sukuk. The study aims to
examine the respondent's level of understanding on each type of the bonds. At the same
time the study also try to examine the extent to which the respondents able to
differentiate between the three.
As mentioned earlier, for the purpose of the study the researcher has reclassified the
Islamic bonds into two namely; (i) Islamic bonds - sale-based financing debt instruments
(Murabahah bonds, ABBA bonds), (ii) and Sukuk - lease-based financing equity-linked
debt instruments (sukuk al-Qarah). This reclassification is due to a unique Malaysian
views on bay' al-dayn and bay' al- 'inah as being discussed in the previous chapter. In
short, the permissibility of cash and debt trading by Malaysian jurist and practitioners has
led to the dismissal of Murabahah bonds (MuNIF) and ai-Bay' Bithamin Aji/ bonds
(ABBA) by majority of Middle Eastern jurist and the difference between these two bonds
from global sukuk. Question B3 has been specifically designed to address this concern.
Similarly, the level of understanding was measured based on the percentage score of
correct answers out of 17 questions asked in question B3. The result from the analysis is
shown in table 5.7 to 5.1 O.
77
Out of 38 total questionnaires returned, four respondents were unable to give their
feedbacks on this part of question. As such this part of analysis involves only 34
observations.
Table 5.7: Overall Level of Understanding on Conventional Bonds, Islamic Bonds
and Sukuk among Malaysian Bank Managers
80-100%
TOTAL RESPONDENTS
31
91.2
none
34
o
100
The result shows that majority of Malaysian bank managers has moderate understanding
on bonds. Out of 34 respondents, 91.2 percent were able to obtain between 51 to 80
percent correct answers while remaining 8.8 percent obtained 50 percent and below. The
result is basically similar with the findings on the Malaysian bank managers'
understanding on the principles of Islamic finance.
Table 5.8 Percentage of Qnestions Correctly Answered for Each Type of Bond
By comparing the characteristics of the three types of bonds, the study observed that most
of the respondents have better understanding on conventional bonds as compared to the
78
other two types of bonds. Detail breakdown of the level of understanding on each type of
bonds are shown in table 5.9.
Table 5.9: Level of Understanding on Each Type of Bonds
Conventional
Bonds
49%
below
50-79%
80-100%
Low
Moderate
TOTAL RESPONDENTS
Sukuk
3
21
10
34
4
29
I
34
Islamic
Bonds
12
22
0
34
The rationale behind the above results might be contributed by the fact that bonds are
originated from the conventional financial system and it has been traded in the market
very much earlier than sukuk and Islamic bonds. Realizing the importance of bonds as
sources of financing while interest and debt trading are prohibited in Islam, sukuk then
came into the picture.
Technically, sukuk and Islamic bonds adopt almost similar
arrangements to conventional i.e. both bonds are traded in the same market, rated using
similar pricing benchmark and etc.
The main criteria that differentiate Islamic type of bonds from conventional bonds are
their structure which eliminates interest and debt trading elements. Sukuk clearly
structured under the Islamic financial principles which are operated under true trade
transactions. It bans debt trading, conditional sale and purchase (buyback sale) or any
legal device (hilah) that allows profit making from the trading of cash.
79
'Ie,
Those who want to understand sukuk need to have a good understanding on Islamic
finance which in reality not many of the practitioners have this knowledge. Without
having a good understanding and knowledge on principles of Islamic finance, they could
not see the differences.
The low understanding on MuNIF and ABBA bonds might be contributed by the
confusion in understanding them. Malaysian jurists' views on both MuNIF and ABBA
bonds are contradicting from other Islamic jurist views especially jurists from Middle
Eastern countries. In Malaysia, both bonds are in fact almost similar to conventional
bonds as they are debt certificates. Few of the scholars claimed (Rosly, 2005;
Mubanlmed AI-Amine, 2001) that debt or receivable trading equates the trading of ribawi
item. However, the bonds are considered Islamic as they are concluded using Shari 'ah
permissible contracts namely Murabahah and Bay' Bithamin Aji/ contracts.
Table 5.10: Percentage of Qnestions Correctly Answered According to Each
Characteristic of Bonds
5
6
Assets that are tangible, usufruct and services are securitized by
them into
shares and
certificates for their value
Securities represent
ownership rights in the underlying assets
or projects in addition to any additional collateral enhancements
structured
Security prices are depend on appreciation and depreciation
asset
market value of the
61
43
80
Table 5.10 - Continned
9
10
11
12
The core relationship is a loan of money, which implies a contract
IS
on
whose
make
gains
in the
market
Securities are monetized financial assets that are liquid, easily
transferred and traded in the fmancial market
The principal and return are fixed and guaranteed regardless of
investment
join the pool
the assets of a
can
and
at par
at discount or at
Debt owed as liability is permissible to be securitized for the purpose
70
54
63
e>"'"Ullll'"
17
63
Based on table 5.10, out of 17 characteristics of bonds asked in the questionnaire, the
most understandable characteristic is related to the nature of bonds where 73 percent of
the answers made by the respondents were correct. In other words, majority of the
respondents understand that Islamic bonds and conventional bonds represent a debt
certificate while sukuk is not. However, it was surprising that many of them unable to
understand and differentiate whether bonds represent debt or equity. There were only 59
percent of the answers given by the respondents were correct
On the other hand, the least understandable characteristic of bonds is related to the
pricing mechanism for bonds. Only price of sukuk depends on appreciation and
depreciation of market value of the underlying assets but not for the price of Islamic
81
bonds and conventional bonds. Both Islamic and conventional bonds prices depend on
creditworthiness of the issuer. There were only 43 percent of answers for this
characteristic was answered correctly.
This result might be contributed by the fact that all prices of the three types of bonds are
determined according to the same pricing benchmarks such as Kuala Lumpur inter-bank
offer rate (KLibor), London inter-bank Offer rate (Libor), etc. Those pricing benchmarks
are basically subject to the changes in interest rates. However, it should be noted that
Sukuk are backed by tangible assets. As such, any changes to the market value of these
assets will affect changes in the value of Sukuk. On the other hand, the prices of
conventional and Islamic bonds are determined merely by the changes in interest rates. In
relation to this, it is suggested that a good understanding on the real asset-oriented
financial transaction as required by the Shari'ah and riba'-free financial transactions will
provide a better understanding on this pricing issue.
5.5 ANALYSES AND FINDINGS FOR RESEARCH OBJECTIVES NO.2
S.S.! ANALYSIS ON THE NATURE OF CURRENT ACCOUNTING PRACTICES
ON ISLAMIC BONDS IN MALAYSIA
It is worth to be noted that this part of analyses involve only 20 observations. Out of 38
questionnaires collected, only 20 bank managers responded the questions on accounting
for Islamic bonds in Section C. The following will discuss the analyses performed in
detailed.
82
"
5.5.1.1 Adoption of Accounting Standards for Islamic Bonds by Malaysian Bank
Managers
First part of this section examines the current accounting standards for Islamic bonds as
adopted by bank managers in their practices. The results are depicted in the table 5.11
below.
Table 5.11: Analysis of Accounting Standards for Islamic Bonds Adopted by
Malaysian Bank Managers
4 All three standards
5 MASB and lAS
6 MASB and AAOIFI
TOTAL
2
6
2
20
It is a fact that most of bank managers specifically finance officers adopted MASB rather
than the lAS and AAOIFI standards for the accounting treatments on Islamic bonds. The
analysis shows that out of 20 bank managers being surveyed, 17 of them adopted MASB
standards, 9 adopted lAS and 6 adopted AAOIFI standards in their practice. The results
from this study are quite similar to the study on {jarah undertaken by Mohd Shariff
(2004). Apart from that, the study also agrees that the rationale behind the findings might
be contributed by the fact that MASB standard is the only accepted accounting standard
in Malaysia as suggested by Mohd. Shariff (2004). Thus, every institution in Malaysia is
bound to conform to the requirement of the standard. In addition, the newly endorsed
FRS 132 and FRS 139 have reflected MASB's efforts in undertaking few stages of
83
research and development to ensure that the new standards issued are comprehensive in
providing adequate financial reporting. This positive step might enhance MASB's
credibility as a good accounting standards setter in the eyes of bank managers and
accounting practitioners as a whole.
Other than that, GP8-i issued by Bank Negara Malaysia that are required to be followed
by every banking and financial institution in Malaysia is in fact was stmctured parallel to
the MASB standards. Therefore, it is not surprising if most of bank managers are inclined
to adopt MASB standard as compared to other standards.
Before the introduction of MASB as a body to promulgated accounting standards in
Malaysia, most of the financial institutions followed lAS standards and requirements. As
such, the lAS may be acceptable as compared to the AAOIFI standard. AAOIFI is a
newly established standard setter to promulgate accounting standards for Islamic
financial institutions. The conventional financial institutions may not be well exposed to
the AAOIFI standards. Among all the three standards, the AAOIFI gained the least
adoptions among the financial institutions. Out of20 bank managers being surveyed, only
6 of them adopted and familiar with the AAOIFI standards.
The prevIOus comparative study has revealed that, MASB, lAS and even AAOIFI
standards still have shortcomings that need to be complemented by other standards.
MASB and AIS standards are standards that fulfill the need of conventional institutions.
Some of the requirements of the standards may not conform to the Shari 'ah requirements.
84
On the other hand, some of the AAOIFI standards requirements may not relevant to the
current conventional businesses practices. Those factors might be the best reasons for the
bank managers to adopt more than one standard in their current practices. The statements
are proven as results of the analysis shows that 50% of the respondents used more than
one standard as guidelines in accounting treatments for Islamic bonds. Out of 20 bank
managers being surveyed, two of them use all three standards namely, MASB, lAS and
AAOIFI standards, two of them adopted MASB and AAOIFI and six of them adopted
MASB and lAS.
There were also I and 2 of the respondents who surprisingly adopted only lAS and
AAOIFI respectively. This is not really acceptable as MASB is the main and important
standards which its compliance is compulsory. Perhaps the respondents who selected
only lAS or AAOIFI as their reference are not aware of the standards adopted by their
institutions as all of them are not directly involved in financial reporting.
Second part of this section examines the history of application of AAOIFI standards by
bank managers in their practices. The analysis suggests that less than half of the
respondents as shown in table 5.2 refer to AAOIFI standards in their practices. Most of
the managers are from Bank Islam Malaysia Berhad (BIMB). It is logical since BIMB
was established prior to the issuance of MASB-i standard. AAOIFI FAS 17 perceived to
be the most comprehensive guidelines to be adopted and referred at that time in
producing adequate and Shari 'ah-compliant financial reporting for Islamic bonds and
85
sukuk. As one of the pIOneer Islamic banking institutions in Malaysia, BIMB is
responsible to provide adequate, transparent and Shari 'ah-compliant financial reporting.
Table 5.12: Analysis of Reliability on AAOIFI standards among Malaysian Bank
Managers
I Refer to AAOIFI standards
2 Never refer to AAOIFI standards
TOTAL
9
11
20
5.5.2 Analysis on the Level of Acceptability of AAOIFI FAS 17 among Bank Managers
in Malaysia
This study provides evidence of the level of acceptability and applicability of the
AAOIFI FAS 17 on sukuk (Islamic bonds) in the current Malaysian accounting practices.
AAOIFI FAS 17 was issued for investment in sukuk type of Islamic bonds, which are less
traded in Malaysia. However, due to the absence of accounting standards for Islamic
bonds, AAOIFI FAS 17 can be used as a complementary accounting standard in
Malaysia. Since AAOIFI is the only standard setter for Islamic financial products, this
study aims to evaluate its level of acceptability in Malaysia.
86
Table 5.13: List of AAOIFI FAS 17 and their average (mean) level of acceptability
according to Malaysian Bank Managers
are recognized on the acquisition date and are measured at cost
b.
At the end
c.
period, the unrealized gains and losses resulting
the re-measurement at fair value of held for trading investment in Islamic bonds
are recognized in the income statement under "unrealized re-measurement gains
or losses on investment"
At the end of financial
and losses resulting from the
re-measurement at fair value of available for sale investment in Islamic bonds are
recognized in the statement of financial position under "investment fair value
reserve"
d.
available for
4.35
4.0
3.9
e.
At
end ofthe financial period, the Islamic bonds held to maturity are
measured at historical cost, except that if there is impairment in value, they shall
be measured at fair value. The difference should be recognized in the income
statement
3.75
f.
Realized profits or losses from the sale of investment are measured at the
difference between book value and the net cash proceeds
4.4
g.
There is a split between the portion of income (from sale of investment, dividend
received & reclassification) related to owners' equity and portion related to the
equity of unrestricted investment account holders
3.8
h.
Di vidends are recognized in the income statement at the declaration date
b.
Income from all type of investment is presented under "income
Income from each component is disclosed in the notes
4.25
87
Table 5.13 - Continued
c.
Profits or losses from the sale of investment are presented under "profits or losses
from sale of investment". The information for each component is disclosed in the
notes
4.05
Provides disclosure on the issuer of Islamic bonds, the face value, the percentage
of Islamic bonds acquired from each issuing party and each type of bonds
Provides disclosure on party guaranteeing the bonds and the nature of guarantee
f.
Provides disclosure on the
manager of the bonds and the holder
g.
Provides U1~"1U'~UJI" on
maturities
the issuer
2.95
or
mvestments in 1>H>111JI\" OI:mCLS according to
3.95
In this analysis, the researcher used mean scores to measure the level of acceptability of
the AAOIFI FAS 17. The method is considered sufficient as the research is only an
exploratory study. Table 5.l3 shows the list of accounting treatments as suggested by
AAOIFI FAS 17 and its mean of acceptability among Malaysian bank managers. A
survey method is chosen to measure the level of acceptability of the standard.
Respondents are required to rank the level of applicability of each standard based on fivepoint Likert Scale with 1 being "totally Irrelevant" and 5 being "totally relevant" to be
implemented in their organization. The points 2 to 4 were used to indicate varying
'" degrees of intermediate applicability. The mean points for each accounting treatment
were calculated by averaging integer values chosen by the respondents.
88
Generally the results from the analysis show positive responses from the bank managers.
Out of 16 accounting treatments being analyzed, 75% were ranked as highly applicable to
their organization. For the purpose of the analysis, the researcher has categorized mean
scores ranging from 3.5 to 5 as highly applicable accounting treatments, 2.5 to 3.49 as
moderately applicable and mean scores below than 2.5 were categorized as least
applicable. It is good to find out that all the items being tested scored more than 2.6 as
shown in table 5.14 below.
Table 5.14: AAOIFI FAS 17 and its Level of Acceptability
Low
TOTAL
o
2.49 and below
100%
a) High Applicable Accounting Treatments
Table 5.15: List of Highly Acceptable Accounting Treatments (AAOIFI FAS 17)
According to Mean Scores
No
Mean Score
Accounting Treatments
4.55
1
Investments Islamic bonds are shown
classification
2
Realized profits or leisses from the sale of investment are measured at the
difference between book value and the net cash proceeds
4.4
3
Islamic bonds are recognized on the acquisition
cost
4.4
4
At the end of accounting period, Islamic bonds held for trading and
available for sale are measured at their fair value
4.35
to
89
Table 5.15 - Continued
Income from
type
is
under "income from
investment". Income from each component is disclosed in the notes
Profits or
from
investment are presented
or
losses from sale of investment". The information for each component is
disclosed in the notes
4.05
7
Dividends are recognized in the
4.05
8
At the end of the financial period, the unrealized gains and losses resulting
from the re-measurement at fair value of held for trading investment in
Islamic bonds are recognized in the income statement under "unrealized remeasurement gains or losses on investment"
4.00
9
Provides disclosure on classification of investments in Islamic bonds
according to maturities
3.95
10
At the end of financial period, the unrealized gains and losses resulting from
the re-measurement at fair value of available for sale investment in Islamic
bonds are recognized in the statement of financial position under
"investment fair value reserve"
3.9
11
There is a split between the portion of income (from sale
dividend received & reclassification) related to owners' equity and
portion related to the equity of unrestricted investment account holders
3.8
12
At the end
Islamic bonds
to maturity are
measured at historical cost, except that if there is impairment in value, they
shall be measured at fair value. The difference should be recognized in the
income statement
3.75
declaration date
Out of 16 AAOIFI FAS 17 accounting treatments being tested, 12 have a mean score of
3.5 and above. The highest mean score is 4.55 representing the statement in paragraph 20
of the standard which indicates that investments in sukuk shall be shown separately in the
statement of financial position according to their classification. The statement is quite
similar to paragraph 15 of FRS 132. The standard classifies bonds (financial assets) in
90
o·
accordance with the substance of the contractual arrangement and definition. That
requirement agrees to the requirement made by AAOIFI standard as AAOIFI standard
classifies sukuk in accordance with the same criteria.Hence, this treatment is common to
Malaysian practice and thus, it is expected to be highly accepted by most of the bank
managers.
In general, most of accounting treatments fall under this category have similarities and
conform to MASB standards on financial asset. The following comparisons explain the
similarities;
Paragraph 3 in the AAOIFI FAS 17 indicates that sukuk are recognized on the acquisition
date and are measured at cost which is also fair value of any consideration. The
treatments can be compared with Paragraph 43 in the FRS 139 which provides that
financial assets shall be treated with same measurement at trade date or settlement date.
Paragraph 4 in the AAOIFI FAS 17 provides that subsequent measurement for sukuk held
for trading and available for sale are measured at fair value. On the other hand, sukuk
held to maturity shall be subsequently measured at historical cost as stated in Paragraph 8
of the standard. However, if there is impairment in value, they shall be also measured at
fair value. Paragraph 46 of FRS 139 indicates the similar provision.
Paragraph 7 and 12 of AA OIFI FAS 17 provide accounting treatments on gains and
losses resulting from re-measurement at fair value of available for sale and held for
91
'.
trading investments. The gams and losses for available for sale investment shaII be
recognized in the statement of financial position, while gains and losses for held for
trading investment shall be recognized in the income statement. Paragraph 6 of the same
standard states that dividends are recognized at declaration date. All these three
provisions are mentioned and explained similarly in paragraph 55 of the FRS 139.
However, two out of twelve accounting treatments that fall under this category are not
provided in MASB standards. These accounting treatments, as shown in item 9 and 11 in
the above table, are related to disclosure on classification of investment in sukuk
according to majorities and the split between portions of income related to owner's equity
and portion related to unrestricted investment account holder.
Even though MASB standards do not specifically provide provision for the above
mentioned accounting treatments, they were fairly accepted by most of the respondents.
This result was not expected as most of the respondents never adopt or refer to any
AAOIFI standards in their accounting practice.
92
b) Moderate Acceptable Accounting Treatments
Table 5.16: List of Moderately Acceptable Accounting Treatments
·
!
(AAOIFI FAS 17) According to Mean Scores
No
Accounting Treatments
In the case
the intention of HU.IUlll~, the
reclassification from one category to the other is measured at fair value
2
Provides disclosure on party guaranteeing the bonds and the nature of
guarantee
2.95
3
Provides disclosure on the issuer ofIslamic bonds, the face value, the
percentage of Islamic bonds acquired from each issuing party and each type
of bonds
2.95
4
on
contractual relationship between
or manager of the bonds and the holder
2.6
Mean Score
3.35
Table 5.16 shows the list of accounting treatments of AAOIFI FAS 17 that were less
acceptable among the Malaysian bank managers. Out of twelve accounting treatments
being tested, four of them fall under this category.
In general, most of the accounting treatments that listed under this category are related to
disclosure issues. It is expected that these accounting treatments would be less accepted
since the requirements shown in item 2 to 4 are not provided by either MASB standards
or lAS standards. These AAOIFI requirements stated in paragraph 30 to 32 of the
standard are to ensure adequate disclosure on Islamic principles that underlie the contract
of sukuk such as ljarah, Mudharabah and lstisna', the relationship between sukuk
93
holders and sukuk Issuer, the nature of underlying assets that backed the sukuk
certificates and etc.
However, the result for item 1 as shown in table 5.16 is beyond expectation. Provisions
on reclassification of sukuk are clearly provided in detail by MASB in its FRS 139.
Therefore this accounting treatment should be highly acceptable by Malaysian bank
managers. The result may be due to the following rationale; reclassification of bonds
from one category to another is not encouraged by most of conventional accOlmting
standards. As for example, reclassifications of investment in debt instruments are
permissible under lAS, but these are not expected to occur often. This restriction is due to
complex adjustments of fair value of investments. Therefore, prior to any purchase of
debt security, an institution should determine their firm intention in acquiring the
security. Since this event is rarely happened, barik managers may not familiar to the
treatments. It renders the low acceptability and applicability of the accounting treatment
among the barik managers.
5.6 ANALYSES AND FINDINGS FOR RESEARCH OBJECTIVES NO.3
AAOIFI FAS 17 was developed to provide a set of alternative accounting standard for
investments that cater the objectives of Shari 'ah. The objectives of Shari 'ah on Islamic
mu 'amalat are clearly explained in a set of discipline called Islamic finance. The main
element that clearly differentiates between conventional and Islamic finance is the
prohibition of paying as well as receiving interest which has been the main source of
94
~i
.
income for financial institutions. This prohibition has led to the emergence of Islamic
bonds in the industry.
Based on analysis undertaken in the previous sections, the researcher suggests that the
there is a probability that level of acceptability of AAOIFI FAS 17 among practitioners
are related to their level of understanding on the principles ofIslamic finance and Islamic
bonds. Managers who have strong understanding on the basic principles of Islamic
finance especially on the five prohibitions discussed in chapter two will be able to
understand Islamic bonds better and at the same time he or she will realize the
importance of AAOIFI FAS 17 which cater those Shari 'ah requirements.
Based on the above assumption, the study suggests that it is useful to know whether the
level of understanding on the principles of Islamic finance as well as the level of
understanding on Islamic bonds has significant influence in determining the level of
acceptability of AAOIFI FAS 17. Therefore, as the study deals with sample data the
researcher decided to adopt a widely used sample coefficient of correlation measure
called Pearson product-moment correlation coefficient measure in order to determine the
degree of relatedness of those. variables. A positive sign of the coefficients signifies a
perfect positive relationship between variables while a negative sign denotes a perfect
negative correlation, which indicates and inverse relationship between two variables. For
example, two variables show a positive relationship if one variable increase, the other
variable will also increase.
95
Table 5.17:
Correlations between the Level of Acceptability of AAOIFI FAS 17, the Level of
Understanding on Principles ofIslamic Finance and & the Level of Understanding
on Bonds
V'-cceptability of
AAOIFI
Pearson Correlation
Sig. (2-tailed)
N
Ulstanding on U/standing on U/standing on Ulstanding on Ulstanding on Acceptabil ity
Islamic
Bonds
Conventional
Sukuk
Islamic bonds of AAOIFI
Finance
bonds
.484'
.554'
.424
.522'
.085
I
.062
20
.031
20
.018
20
.011
20
.720
20
20
, Correlation is significant at the 0.05 level (2-tailed).
" Correlation is significant at the 0.01 level (2-tailed).
Table 5.17 summarizes the correlation between level of acceptability of AOIFI FAS 17
and the items that are assumed to have significant influences in determining it. In general,
the result shows that both level of understanding on the principles of Islamic finance and
level of understanding on bonds have positive relationships with the level of acceptability
of AOIFI FAS 17. It is also observed that only level of understanding on bonds has
significant influence on the level of acceptability of AAOIFI FAS 17. The detailed
discussion on the findings will be discussed below;
(i) The relationship between level of acceptability of AAOIFI FAS 17 and the
level of understanding on the principles of Islamic finance
AAOIFI FAS 17 was developed based on the Shari 'ah teachings. It is known that
Shari 'ah prohibits interest and promotes true trading of real assets instead of making
money from loan. Based on that understanding, AAOIFI FAS 17 was developed to reflect
the differences in accounting treatments for sukuk that cannot be clearly explained by
conventional accounting standards.
96
Based on the test conducted, it indicates that the understanding on the principles of
Islamic finance influenced the level of acceptability of AAOIFI FAS 17 among the
sample with positive correlation. However, the result indicates that there is no significant
association between the understanding on the principles of Islamic finance on the
acceptability of AAOIFI standard. It can also be summarized that the higher the levels of
understanding on the principles of Islamic finance might not significantly contribute to
the higher level of acceptability of AAOIFI FAS 17 among bank managers. Hence, this
result might not meet the expectation and assumption made regarding the relationship of
the three variables.
In relation to that, the research provides some rationale to justify the above insignificant
relationship as the following; the majority of accounting treatments for sukuk provided by
AAOIFI FAS 17 are similar to the accounting treatments that are relevant for sukuk in
FRS 132 and FRS 139. Most of the similarities are related to recognition and
measurement issues. This renders bank managers to agree with AAOIFI standard.
However, the lack of provisions on disclosure of the nature of contracts, collateral or
guarantee, as well as on Islamic principles in conventional standards might lead to the
divergence on the applicability of AAOIFI FAS 17 among bank managers who are not
familiar with the provisions.
(ii) The relationship between level of acceptability of AAOIFI FAS 17 and the level
of understanding on bonds
97
It is also observed that there is a positive relationship between the level of understanding
on bonds and the level of acceptability of AAOIFI FAS 17. This signifies that the level of
understanding on bonds influenced the level of acceptability of AAOIFI FAS 17. The
correlation is only significant at 95% confidence interval and insignificant at 99%. The
finding indicates that the more bank managers understand on these three types of bonds,
the more bank managers will accept and apply AAOIFI FAS 17 in their accounting
practices. In other words, bank managers with better understanding on bonds will accept
AAOIFI more that those who understand less. Individually, the result also summarized
that the more bank managers understand about sukuk and conventional bonds the higher
possibility they would accept AAOIFI FAS 17.
The difference between Sukuk and conventional bonds is mainly on the Islamic principles
that underlie the contract of sukuk as well as the nature of the sukuk certificates. It is
clear that AAOIFI is the only accounting standard that can cater the Islamic contracts
while lAS and MASB standards are insufficient on these issues. Therefore, the more they
understand about the differences the more they would realize the importance of AAOlFI
standards in accounting practices.
It is also important to note that the level understanding on Islamic bonds (MuNIF and
ABBA) does not affect the choice of bank managers on AAOIFI standards. The
correlation table (Table 5.17) shows that understanding on those two bonds have no
significant correlation at any significant level. MuNif and ABBA are claimed to be
similar to conventional in many aspect except for the Islamic principles adopted. The
98
elements that differentiate between the two are the underlying principles and contracts
used in the beginning of the contract whereas technically the trading transactions are
remain the same. Therefore, the existing national standards and lAS would be sufficient
to be referred for the accounting on both types of bonds.
99
CHAPTER SEVEN:
CONCLUSION
7.IIntroduction
This chapter will provide a conclusion for the research results and findings. The
conclusion will be discussed in section 7.2. Section 7.3 outlines limitations of this
research. It is important to note that the findings of this research should be interpreted
within these limitations. Finally, several recommendations for future research will be
discuss in section 7.4.
7.2 Conclusion for Research Results and Findings
The findings suggest that the majority of Malaysian bank managers who are directly
involved in the investment in Islamic bonds have only moderate level of understanding
on the principles of Islamic finance. In general, most of the respondents agree on the
prohibition against riba " gharar and maisir in the Islamic financial transactions.
However, many of the respondents do not understand about the concepts such as Qard
Hassan, Bay' al-Dayn and Bay' al- 'inah.
The findings for the second part of the question showed a similar pattern of result. In
general, majority of the respondents have moderate level of understanding on bonds.
However, it is expected that the respondents have better understanding on conventional
bonds as compared to Sukuk and Islamic bonds. The rationale may be due to the
familiarity with conventional financial system and it has been traded in the market very
100
,."
.
much earlier than sukuk and Islamic bonds. The result also indicates that almost half of
the respondents do not have sufficient understanding on MUNIF and ABBA bonds.
The results provide an empirical evidence and support to some pnor claims that
Malaysian bank managers have inadequate understanding on what they are involved in.
There are some possible reasons that might contribute to the findings. Firstly, most
treasury departments in banks lack of managers who are well educated in Islamic banking
and finance. Secondly, majority of bank managers are also not well trained where most of
them only attended seminar on Islamic banking and finance once a year or less than that.
Finally, the exclusive jiqh view on bay' al-dayn and bay' al- 'inah adopted by Malaysian
jurist may cause confusion among Malaysian bank managers. Many Middle Eastern
scholars and jurist claim that both Shari 'ah instruments are seen to be similar to interest
and they are contradicting to Shari' ah teachings.
As far as level of acceptability of AAOIFI FAS 17 is concern, the result also shows that
all AAOIFI FAS 17 accounting treatments were rated within the range of 2.6 and 4.55.
The overall result suggest that AAOIFI FAS 17 is reasonably well accepted by Malaysian
bank managers and may be considered applicable in Malaysia even though mqiority of
Malaysian bank managers observed never refer to any AAOIFI standards. This may be
contributed by the fact that most of the accounting treatments on sukuk provided by
AAOIFI FAS 17 are similar to those which are provided in MASB standards on financial
instruments. However, MASB standards are quite comprehensive as they have gone
through many stages of research and development.
101
· ",
On the other hand, most of the AAOIFI FAS 17 accounting treatments that less
acceptable among Malaysian bank managers are related to disclosure issues. Those
provisions are provided to ensure adequate disclosure on Islamic principles that underlie
the contract of sukuk such as Ijarah, Mudharabah and Istisna', the relationship between
sukuk holders and sukuk issuer, the nature of underlying assets that backed the sukuk
certificates and etc. which are not cater by conventional standard setting bodies. It was
found that those provisions are not cater by either by lAS or MASB.
The third objective of the study is to examine the relationship between the bank
managers' understanding on Islamic finance and Islamic bonds and their perceived
acceptability of AAOIFI FAS 17. Therefore, Pearson product-moment correlation
coefficient measure was used in order to detennine the degree of relatedness of those
variables. Based on the test conducted, it is observed that there is a positive relationship
between the level of understanding on bonds and the level of acceptability of AAOIFI
FAS 17. This signifies that the level of understanding on bonds have significant influence
in determining the level of acceptability of AAOIFI FAS 17. The findings also indicate
that the understanding on the principles of Islamic finance, which is expected to
detennine the level of acceptability of AAOIFI FAS 17 among the sample, shows the
positive sign to the correlation. However, it does not have significant influence in
detennining bank managers' acceptability of AAOIFI FAS 17.
102
7.3 Limitations of the Research
There were few limitations encountered by the researcher throughout the completion of
the study. The limitations can be described as follows;
(i) Discussion Coverage
The limitation is due to the fact that Islamic bonds are still new and it is yet to receive
much interest among scholars. Due to lack of literature, this study is only concem with
sale-based debt security i.e. MuNIF and ABBA bonds and sukuk type of bonds such as
equity linked lease-based debt security which is sukuk al-Ijarah. Hence, to certain extent
to study cannot generalize the findings to other Islamic bonds such as Mudharabah bonds
and Musyarakah bonds. In addition, the comparative study is also limited to comparisons
between the above mentioned bonds with mortgage and asset backed debt securities. At
the same time, FRS 132 and FRS 139 on financial instruments do not specify accounting
treatments for mortgage bonds. Furthermore, FRS standards do not cater for accounting
treatments for Islamic financial instruments in the case of sukuk.
(ii) Sample
Second limitation is related to the sample of the study. A small sample size of 38
respondents would be considered insufficient to generalize the findings to total
population of Malaysian bank managers. The exclusion of financial institutions other than
local commercial banks, Islamic banks and merchants banks are due to time constraint. In
addition, the low response rate of 45% from the total number of questionnaire distributed
indicates lack of cooperation among banks managers.
103
· ""
(iii) Data Analysis
Third limitation is on data analysis. The study adopted descriptive statistics namely,
frequency analysis and average score or mean instead of mode or median since the
former methodology is more suitable in assigning the degree of acceptability of each
accounting treatment. This was done to avoid the case of too many ties in the ranking of
acceptability if mode or median is used.
7.4 Future Research
Based on the above limitations, future research should involve deeper and thorough study
of the accounting issues on Islamic bonds. This research can be a significant contribution
for the literature. In additional, a concentration on certain issues enable researcher to
provide comprehensive analysis on understanding of Islamic principles related to the
issues and Islamic bonds structured.
Future research may involve a bigger and wider number of samples. The study might be
extended to local and foreign financial institutions comprising investment companies,
finance companies, development banks and other. Hence, the findings would include the
impact global policies, shari 'ah views and regulation on the findings.
Considering the fact that FRS 132 and FRS 139 are newly endorsed accounting standard,
the standards are yet to be familiar among the practitioners. Future studies may adopt
longitudinal study in which time series of data on accounting practices for Islamic bonds
can be collected. The advantage of a longitudinal study is that it can track changes over
104
time. The study could be for five years period. This would allow readers to look at the
level of compliance of FRS 132 and FRS 139 among practitioners over the five years
period.
105
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III
Importance,
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109
APPENDIX
SAMPLE QUESTIONNAIRE
APPENDIIX
~,
'.
KULLIYYAH OF ECONOMICS AND MANAGEMENT SCIENCES
PERCEPTIONS OF BANK MANAGERS ON THE CONCEPTS OF &
ACCOUNTING FOR ISLAMIC BONDS
Objective of study:The objective of this study IS mainly to examine the perceptions and
understandings on Islamic bonds among bank managers in Malaysia. In addition,
the study will also examine the perceptions on the accounting principles and
practices on Islamic bonds.
Confidentiality:The details of your responses will be treated III the STRICTEST OF
CONFIDENCE. Any result disclosed will be presented in aggregate form and
individual organization will not be identified.
Instructions:-
l.
2.
3.
4.
This survey consists of 3 main sections.
Finance officers are requested to respond all three sections.
Fund managers/ asset managers are requested to respond at least section A &
section B.
Please feel free to give your sincere response to each question.
For enquiries, please contact:
Name
Telephone Number
Ani Salwani binti Che Pa
0
Q)
019-9155944
E-mail address
ell [email protected]
You are encouraged to retain a copy of the completed survey for your
reference.
0 Please submit the complete questionnaire to the following address:
Associate Prof. Dr. Abdul Rahim bin Abdul Rahman
HUM Institute ofIslamic Banking and Finance (IIiBF)
International Islamic University Malaysia
Jalan Gombak
53100 Kuala Lumpur
Perceptions of Bank Managers on the Concepts of & Accounting for Islamic Bonds
SECTION A: General Information
":;i
1. Personal Information:
Name of Respondent
Gender
DMaie
D
Fem~le
Age
Degree
Specialization
Positionl Title
Total experience in the company: _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __
Total working experience
E-mail
Name of Organization
2. How frequent do you attend seminars or workshops on Islamic banking and finance in a year?
D
D
D
D
Rare (less than once a year)
Less frequent (once a year)
Frequent (two times a year)
Very frequent (three times and more in a year)
3. Does your institution have your own Shari'ah Advisory Committee or Shari'ah advisors (s)?
DYes
D
No
>',
Perceptions of Bank Managers on the Concepts of& Accounting/or Islamic Bonds
SECTION B: Perception and Understanding on Islamic Bonds
I. From your understanding, how could you define Islamic bonds?
2. Please indicate your perceptions on the following principles ofIslamic finance. Place a tick ( .y) in an appropriate box to indicate your perceptions.
Principles ofIslamic Finance
D
D
D
D
D
D
D
D
D
D
D
D
D
The transfer of rights and obligations must be consistent with some elements of property ownership being exchanged D
Qard Hassan (benevolent loan - the only instrument used in Islamic loan) allows borrower to use loan given with
D
guaranteed payment of principal loan but without predetermined hibah (gift)
0
D
D
0
D
D
D
D
D
D
D
D
D
0
D
1.
Islamic financial transactions must free from riba (usury), gharar (ambiguities) and maisir (gambling)
ii.
Shari'ah oriented financial business is fundamentally real asset oriented
iii. Either product or a serivice must be delivered, but money or monetary commoditiies do not constitute the
product or services
iv. For a party to profit, it must commit to a true commercial or financial risk and liability where there must be
a true transaction that one must be prepared to accept a profit as well as a loss
v.
vi.
vii.
The profit must not be from haram activities which businesses and actions are explicitly forbidden in Islam
viii. In Islam, debt = principal loan amount BUT in conventional system, debt> principal loan amount
ix. Bay' al-dayn (debt trading) is allowed only at par valueor discount under the purview of hiwalah (transfer)
to a third party or to a debtor
x.
Agree Disagree Not Sure
Bay' al- 'inah (sale of cash) is an Islamic instrument used to create a debt which later on be securitized into
equal value of debt certificate
2
Perceptions of Bank Managers on the Concepts of & Accountingfor Islamic Bonds
3. Each of the following mayor may NOT represent the characteristics of sukuk, Islamic bonds, and conventional bonds. Please tick ( .y) in an appropriate box if
you agree and ( X ) if you disagree with each ofthe following characteristics.
Characteristics of Financial Securities
Sukuk
Islamic
Bonds
Conventional
Bonds
D
D
D
D
D
D
D
D
D
D
D
D
I.
A sale of security represents a sale of a debt certificate
ii.
A sale of security represents a sale of equity certificate
iii.
Tangible assets are required to back issuance of certificate
iv.
Assets that are tangible, usurfruct and services are securitized by dividing them into equal shares and
issuing certificates for their value
v.
Securities represent secured ownership rights in the underlying assets or projects in addition to any additional
collateral enhancements structured
D
D
D
vi.
D
D
The core relationship is a loan of money, which implies a contract whose subject is purely earning money on money D
Traders/ securityholders usually make capital gains through the changes in the variable market interest rates
D
Securities are monetized financial assets that are liquid, easily transferred and traded in the financial market
D
The principal and return are fixed and guaranteed regardless of investment output
D
In the case of issuer's failure, unsecured securityholders join the pool of general creditors seeking the assets of a
D
bankrupt company
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
D
vii.
viii.
ix.
x.
xi.
xii.
Security prices are depend on appreciation and depreciation of the market value of the underlying asset
Security prices depend on the creditworthiness of the issuer
xiii. Issued to finance almost any purpose which legal in its jurisdiction
xiv. Securities offer fixed income options
xv.
Securities offer variable income options
xvi. Securities can be traded in primary and secondary market either at par value, at discount or at premium
xvii. Debt owed as liability is permissible to securitized them for the purpose of trading
,. Islamic bonds represent Murabahah bonds (MuNIF) and AI-Bay , Bithamin Aji/bonds (ABBA) in Malaysian debt market and Sukuk represent Sukuk al-ljarah.
3
6·
...;.
Perceptions of Bank Managers on the Concepts of & Accounting for Islamic Bonds
i(;"
SECTION C: Accounting for Islamic Bonds (For financial officers only)
1. Please indicate the Accounting Standard(s) that your organization used for accounting treatments on
Islamic bonds.
Tick the
relevant
NO
STANDARD
1
Malaysian Accounting Standard Board
(MASB)
International Accounting Standard
(lAS)
Accounting and Auditing Organization for
Islamic Financial Institutions (AAOIFI)
2
3
NO. OF STANDARD
(Please state the relevant standard.
e.g. MASB 24 or lAS .. .)
Other(s): Please state: _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __
2. Do you ever rely on Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI)
standards as guidelines in your financial reporting?
DYes
D
No
4
Perceptions ofBank Managers on the Concepts of & Accountingfor Islamic Bonds
. Please indicate the extent to which each ofthe following accounting treatments relevant to your organization.
Please circle the appropriate number based on a scale from 1 to 5 where 1 indicates totally irrelevant and 5 is totally relevant.
Totally
Irrelevant
Accounting Treatments
Totally
Relevant
Recognition & Measurement
a. Islamic bonds are recognized on the acquisition date and are measured at cost
1
2
3
4
5
b. At the end of accounting period, Islamic bonds held for trading and available for sale are measured at their fair value
1
2
3
4
5
c. At the end of the financial period, the unrealized gains and losses resulting from the re-measurement at fair value of
held for trading investment ih Islamic bonds are recognized in the income statement under "unrealized remeasurement gains or losses on investment"
1
2
3
4
5
d. At the end of financial period, the unrealized gains and losses resulting from the re-measurement at fair value of
available for sale investment in Islamic bonds are recognized in the statement of financial position under
"investment fair value reserve"
1
2
3
4
5
e. At the end of the financial period, the Islamic bonds held to maturity are measured at historical cost, except that if
there is impairment in value, they shall be measured at fair value. The difference should be recognized in the income
statement
1
2
3
4
5
f. Realized profits or losses from the sale of investment are measured at the difference between book value and the net
cash proceeds
1
2
3
4
5
g. There is a split between the portion of income (from sale of investment, dividend received & reclassification) related
to owners' equity and portion related to the equity of unrestricted investment account holders
1
2
3
4
5
h. Dividends are recognized in the income statement at the declaration date
2
3
4
5
i. In the case where the institution change the intention of holding, the reclassification from one category to the other is
measured at fair value
2
3
4
5
-...-:"
,:,/
Perceptions 0/ Bank Managers on the Concepts of & Accounting/or Islamic Bonds
[---~--- .-.~-
Presentation & Disciosure-- . -
a. Investments in Islamic bonds are shown separately according to their classification
2
3
4
5
b. Income from all type of investment is presented under "income from investment". Income from each component is
disclosed in the notes
2
3
4
5
c. Profits or losses from the sale of investment are presented under "profits or losses from sale of investment". The
information for each component is disclosed in the notes
1
2
3
4
5
d. Provides disclosure on the issuer ofIslamic bonds, the face value, the percentage ofIslamic bonds acquired from
each issuing party and each type of bonds
1
2
3
4
5
e. Provides disclosure on party guaranteeing the bonds and the nature of guarantee
1
2
3
4
5
f. Provides disclosure on the contractual relationship between the issuer and! or manager of the bonds and the holder
1
2
3
4
5
g. Provides disclosure on classification of investments in Islamic bonds according to maturities
1
2
3
4
5
Q THANK YOU FOR YOUR COOPERATION Q