Acconting and Audit for Islamic Banks

Conventional accounting provides information related to financial position, operations, and cash flows about an entity to allow interested parties to make informed decisions about the entity. In contrast, Islamic accounting provides financial information as well as assurance to stakeholders that the entity is observing Shari’ah principles in all its operations. Both systems of accounting provide information; however, they vary in their objectives, type of information, and the ultimate recipients of this information. The motivation for the users of conventional accounting is to direct the normally scarce financial resources towards the most rewarding and profitable ventures. In contrast, users of Islamic Accounting want to establish that the organization in question is abiding by the Shari’ah principles besides meeting their other socio-economic objectives. Where conventional accounting is mainly concerned with economic events and transactions, the Islamic Accounting goes beyond and identifies socio-economic and religious events and transactions.

Another difference is in the users of accounting information. Islamic Accounting serves the interest of the society as a whole instead of a limited number of investors who are only interested in their narrow interests of profit maximization. The users of Islamic Accounting can make businesses accountable and assure that they operate in compliance with Shari’ah principles and do not harm other segments of the society solely for the sake of profit. This could help achieve a more balanced allocation and distribution of wealth in the society.

Since Islam promotes socio-economic justice in the society, there are several larger objective of Islamic Accounting. Similar to conventional accounting, Islamic Accounting is also concerned with money when it relates to businesses. Since Islam prohibits interest dealings and encourages trade, profit and loss in trade based transactions is somewhat more important in Islamic Accounting. Nevertheless, maintaining all-inclusive nature, Islamic Accounting reports both financial and non-financial information in relation to economic, social, environmental and religious events and transactions.

One of the problems with conventional accounting is the use of historic value for reporting assets and liabilities. This problem with conventional accounting has been well recognized within the accounting discipline but no concrete measures have been taken to rectify the situation. The problem of asset valuation is too complex and it has been difficult to arrive at an objective methodology. This does not work for Islamic Accounting. Muslims have to pay Zakat on their accumulated wealth and it has to be valued the current price level, not the historic value.

Further, it has been recommended that the Income Statement of Islamic Corporate Reports be replaced by a Value Added Statement. This statement would replace the inherent and destructive competitive objective of the income statements of the conventional accounting with a cooperative objective to promote socio-economic growth.

Islamic banks distinguish themselves from conventional banks by their compliance to Shari’ah. So the Shari’ah audit is an important element of their operations. Violation of Shari’ah rules could invite lawsuits from customers, investors, or other stakeholders who might have dealings with Islamic banks for religious reasons. Shari’ah Boards need to work in close cooperation with the bank auditors to ensure compliance with Shari’ah requirements and performance of their fiduciary duties and obligations. Many Islamic banks acquire the services of external auditors to guarantee independence of audit and avoid conflicts of interest. The external auditors, though, should be competent in Shari’ah and fiduciary issues in order to be effective.

Alternatively, Shari’ah Board members could also perform the Shari’ah audit if their independence can be assured. But this requires the Board members to be conversant with accounting practices and possess the required skills to handle any resultant accounting issues. Some of the Islamic banks maintain internal Shari’ah auditors who also sit on the Shari’ah Boards. They are tasked with continuously monitoring Shari’ahand fiduciary compliance and reporting their findings to the Shari’ah Board.

In either case, the auditors and Shari’ah Supervisory Board should work closely to ensure that all potential Shari’ah and fiduciary compliance issues are resolved as they arise in order to safeguard against future problems. The guidelines and practices for Shari’ah audits should be well established to ensure that the bank is abiding by the Shari’ah rulings in all its operations.

The rules must also be established for complying with fiduciary duties to the account holders in terms of disclosure of general and additional requirements of financial statements. The financial statement of Islamic banks should include conventional reports as well as some additional reports. These include statements of Qard al-Hasan fund, of sources and uses of zakat funds, prohibited transactions, disposal of non-Shari’ah compliant earnings, investment for safeguarding the environment, investment for propagation of Islamic values, compliance with contracts, and commitments and contingencies. The disclosure requirements for Islamic banks also include Shari’ah Advisors and profit distribution policies.