Islamic Accounting, Reporting and International Financial Reporting Standards - Literature review Example

Islamic Accounting, Reporting And IFRS Introduction Islamic accounting is a term that can be explicated as the accounting procedures, which endow stakeholders of an organization with appropriate information to make it possible them to make sure that the organization is incessantly being run on the premise of the Islamic Shariah laws. According to Adnan and Gaffikin (2011), Islamic accounting is the process of categorizing, evaluating and communicating financial and other pertinent information, based on an Islamic Shariah stance and principles In the field of accounting, there are two fundamental issues that form the premise for accounting standards. These two fundamental issues that form the premise for accounting standards include “substance over form” and “time value of money” (International Accounting Standard Board, 2011). The ‘substance over form’ principle is usually the major problem for many financial firms. The precision and global comparability of financial reporting in Islamic accounting is usually developed by means of the general framework set by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). Besides the AAOIFI, the International Financial Reporting Standards (IFRS) has also given a very appropriate accounting framework for multinational conglomerates that deal with Islamic accounting. As a corollary, Islamic financial institutions (IFIs) are usually stuck between the choice between the standards set the IFRS and AAOIFI especially because of the apparent differences that exists between the IFRS and AAOIFI This paper consequently seeks to explicate ‘substance over form’ and ‘time value of money’ in the aspect both the IFRS and AAOIFI. This will include pointing out the variations in handling ‘substance over form’ and ‘time value of money’ in the IFRS and AAOIFI. The ‘substance over form’ concept in accounting ‘Substance over form’ can be explained as an accounting concept that is used to make sure that financial statements present a complete, pertinent, and precise depiction of dealings and proceedings in a given entity (International Accounting Standard Board 2011). An entity that claims to abide to the concept of ‘substance over form’ should have financial statements that illustrate the overall financial authenticity of the entity (i.e the entity’s economic substance), instead of the legal form of the entity’s dealings. Substance over form is imperative for consistent financial reporting processes, especially on issues pertaining to revenue recognition, sale, and procurement accords The substance over form concept involves the utilization of intensive and regimented judgment in the preparation of the financial statements so as to come up with a business sense from the dealings and proceedings in a manner that excellently replicates their exact epitome. Albeit legal aspects of dealings and proceedings are of immense significance, they may have the aspect that enables them to be looked upon as sources of constructive and pertinent information on the financial statements, hence the momentous importance of the substance over form in the accounting endeavors of an entity. The ‘time value of money’ concept in accounting The time value of money can be explained as an accounting concept responsible for the assertion of the statement that the power of money as a procurement tool differ as time progresses. This means that money purchasing power of money changes as time advances. According to Hovey (2005), the value of money at a prospective instance, can be computed by incorporation of interest accumulated or inflation ensued in the calculations. As a corollary, the rationalization of time value of money as an accounting concept is typically based on the effect of interest and inflation ion the value of money According to Gallager and Andrew (1996), the time value of money concept takes into consideration the valuation of a possible stream of income in the future, in a process where the yearly incomes are marked down then counted up while considering any relevant elements that might affect the value of the money. One of the most imperative premises of the time value of money concept is the assertion that a particular sum of money or a succession of identical sums promised at a forthcoming date can be translated into a corresponding value in the present day. When this assertion is put into perspective, it is also possible to establish the value to which a particular sum of money or a succession of identical sums of money will grow to at some prospective date. Accounting from Islamic Point of View Islamic doctrines are usually drawn from the Quran, which is the principal source of sharia, and hadith, which are composed of the unique teachings of Prophet Mohammed. The paramount fundamental precept in Islam is tawhid or which can be construed as God /Allah’s unity. According to the tawhid, God, or Allah, is the ultimate proprietor and human beings are simply trustees (khalifa) of the earth and its possessions. Jointly, the concepts of Tawhid and Khalifa, as well as the adalah (principle of impartiality or equality) have become the basic philosophies of Islamic teachings. Sharia laws aim at enhancing the success for human beings in the world and in the afterlife. Consequently, the social and personal well-being of a human being as well as the quality of life is not simply calculated in terms of only material possessions but both spiritual and material possessions. Sharia laws allow Muslims to engage in business an amass profit, but it has to be legitimately obtained and utilized in accordance with sharia, which forbids concentration of affluence in the hands of a small number of individuals. El-Ashker (1987) established that Islamic businesses are considered as profit oriented enterprises, but rather than employing the concept of profit maximization in their business activities, they espouse the concept of “adequate” or “sensible” profit by taking into consideration the condition of the market. In view of the fact that accounting from Islamic perspective should make sure that the business is geared towards the fulfillment of sharia, “Islamic accounting is regarded as a tool which facilitates Muslims to assess their own responsibilities to Allah with respect to inter-human and ecological relationships” (Shanmugam & Perumal, 2005, p. 11). The stipulated objectives of Islamic accounting consequently put the aptitude to realize God’s will as the guiding principle of all the accounting dealings and proceedings (Napier, 2009). Since the issue of social justice is fundamental in Islam, Muslims are accountable for the welfare of their fellow Muslims and should therefore stay away from dealings and proceedings that portray selfishness and avarice (Kamla et.al, 2006). As a result, one of the essential considerations in establishing Islamic accounting was to make sure all entities that are instituted on Sharia avoid selfishness and avarice. The holy scripture of Islam austerely stipulates the proscription of riba1 (concentration on the contemporary desires of the world), and commitment to follow the zakat rules2 (giving alms). The proscription of concentration on the contemporary desires of the world refers to the interdiction of dealings and proceedings that exploit the poor. For example, since the institution of a specific interest rate or premium to a loan imposes a burden on the destitute while the bringing more wealth to affluent, it is unlawful according to the Sharia laws. Correspondingly, Islam through the Sharia laws tries to encourage equitable distribution of affluence to every individual in society by imposing zakat, a requirement for all Muslims to reserve a particular fraction of their affluence so that it can be given to the deprived and destitute members of the society. The proscription of imposing interest on loans and the requirement of Muslims to observe zakat is regarded as two major facets of the Sharia law that influence Islamic accounting and financial reporting (Napier, 2009). Consequently, several accounting academics propose that the proscription of imposing interest on loans and the requirement of Muslims to observe zakat are at loggerheads with the conventional accounting principles, which are founded on the concepts of profit maximization and individualism. As a corollary, the AAOIFI hitherto obliges IFIs to present Statements of Sources and Uses of Funds in the Zakat and Charity Funds. The AAOIFI however states that the IFIs should not overtly mention zakat in the goals of their financial accounting. According to AAOIFI (2010), the goal of financial accounting in IFIs and related parties within an Islamic context should be as follows. The first goal should be to establish the rights and responsibilities of all interested stakeholders compliant with sharia and the notion of justice, charity, and fulfillment of the Islamic business principles (p. 17). The second goal is to get involved in the efforts aimed at protecting Islamic banks’ properties, its rights, and the rights of others sufficiently (p. 17). The third goal is to enhance the administrative and prolific abilities of the Islamic bank and promote conformity with its customary objectives and principles and, principally, conformity to the sharia laws (p. 17). The forth goal according to AAOIFI, should be to endow users with constructive information to enable them make lawful decisions in their dealings with IFIs (p. 17). Albeit the AAOIFI has emphasized on the significance of conformity of IFIs in accordance with sharia, Hameed and Osman (2003) reckon that the AAOIFI is discouraged to initiate an overhaul of the contemporary accounting principles and this consequently leads to a strong influence of the convectional accounting practices on the Islamic accounting (Harahap, 2005) Since the conventional accounting practices are not regarded as compliance with the Islamic accounting principles, various designs for Islamic financial statements have been postulated by academics and researchers. For example, Taheri, (2005) brought into perspective the concept of a value added statement for Islamic financial reporting as an alternative for the conventional income statement. Nevertheless, most of these postulated conceptions remain as mere discussions. The Notion of Accounting Harmonization for Islamic Financial Transactions Since Islam is a principled religion with deep-seated concerns on how things should be done rightly, the matters of social fairness, equitability, and justice have been taken into account in all practices, even those concerned with business and accounting. The observance of sharia laws has compelled IFIs to establish their own accounting standards owing to their dissatisfaction with the contemporary accounting standards laid out by the IFRS. Bearing in mind that the growth of IFIs still took the form of Islamic banks in 1987, Islamic Development Bank (IDB) endeavored to come up with accounting standards that observed the Sharia laws. During that period, the majority of Islamic banks used to establish their own individual accounting principles. Karim (1990) observed a major aspect that was influencing the success of the initiative set out by the IDB. As Karim (1990) identified there was the concern of the accounting standards that observed the Sharia laws would obstruct regular accounting practices, particularly because they were looked at as an anomalous element in the accounting field. The establishment of universal accounting standards that observed the Sharia laws was aimed at persuading the regulatory agencies that the IFIs distinctive practices needed accounting standards different from those used in conventional accounting and this led to the establishment of the AAOIFI (Vinnicombe, 2010). Contemporary Accounting Practices for Islamic Financial Transactions According to the Dubai Financial Services Authority (DFSA), the IFIs should follow the IFRS standards when compiling financial statements (DFSA, 2013a, p. 63). In spite of the compulsory compliance with the IFRS, the DFSA further requires IFIs to include particular disclosures when compiling their financial statements (DFSA, 2013b, p. 12). Nevertheless, the pronouncement by DFSA is considered difficult to comply with by some institutions that regard the IFRS standards as appalling in the context of Islamic financial transactions. The clashes between IFRS and Islamic accounting standards, according to AOSSG, (2010) are based on two basic accounting principles, i.e. time value of money and substance over form. Time value of money is the accounting concept responsible for the assertion of the statement that the power of money as a procurement tool differ as time progresses. On the issue of Time value of money, the institution of a specific interest rate or premium to a loan is considered unlawful according to the Sharia laws because it imposes a burden on the destitute while the bringing more wealth to affluent. On the other hand, substance over form is the accounting concept that is used to make sure that the financial statements that illustrate the overall financial authenticity of the entity (i.e the entity’s economic substance), instead of the legal form of the entity’s dealings.. The concept of substance over form is regarded as inappropriate from Islamic point of view. In accordance with the sharia laws, the accounting form is ultimately determined by the Islamic legal form, not an entity’s economic substance. Nevertheless, the deliberations over these issues are still being decided upon by IFIs. This is because as there are different schools of thought brought forward by different sharia scholars. Some accept the time value of money concept in reporting Islamic financial dealings based on the belief that the time value of money financing consequence that is completely different from imposing interest on loans. Others accept the substance over form concept based on the belief that it does not contradict sharia because reporting economic substance is just as imperative as reporting its legal form, provided that the information regarding its legal form are divulged on the financial statements (AOSSG, 2010). The sharia scholars who are reluctant to acknowledge the IFRS standards for Islamic financial transactions argue that some distinctive attributes of Islamic finance are not covered by the IFRS. For example, Mudaraba is one of the most popular kinds of Islamic dealings, which has established a “hybrid” facet between fairness and responsibility. Mudaraba, which is accounted for in the AAOIFI standards as but has no place in the IFRS standards. Ways in which convergence between IFRS and AAOIFI standards can be achieved Paragraph 19 of IAS 1 of the IFRS standards permits financial institutions to depart from the IFRS accounting framework and espouse Syariah principles. As a result, this paper recommends that standard-setters should take advantage of the provisions in Paragraph 19 of IAS 1 of the IFRS standards in coming up with a universal set of standards that harmonizes the views of their Shariah laws with their tactics for convergence. This is because the different opinions in the present day Islamic accounting have only brought about the creation of rifts between various jurisdictions and this trend might persist into the future. So as to stay pertinent in the contemporary and ever changing and cut throat business environment, IFIs must to espouse and acclimatize some of the concepts of the IFRS. This paper suggests that IFIs should follow the propositions of Raman, (2010) regarding the establishment of a four-phased approach to IFRS and AAOIFI standards convergence. This four-phased approach can be very pivotal in the transition process. Phase 1 of the approach proposes that the IFIs should ‘enable top end reporting’. Phase 2 and 3 of the approach should be about ‘recording dealings in GAAPs’. The final phase should be about ‘transforming IFIs to embrace IFRS standards’ Conclusion “Substance over form” and “time value of money” the two fundamental issues that form the premise for accounting standards. The fact that a convergence between IFRS and AAOIFI standards is yet to be reached in terms of these two concepts is detrimental to the fate IFIs in the contemporary and ever changing and cutthroat business environment. Paragraph 19 of IAS 1 of the IFRS provides a very good avenue for the convergence between IFRS and AAOIFI standards. IFIs should as a result take advantage of the provision of the paragraph and adopt a four-phased approach proposed by Raman, (2010) can to help in the transition process. References Accounting and Auditing Organization for islamic Financial Institutions (AAOIFI). (2010), Accounting, auditing and governance standards for Islamic financial institutions. Bahrain. Adnan, M. 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