Project Report On Financial Statement / Accounting of Islamic Banking

23 April 2009
Project Report on
Financial Statement /
Accounting of Islamic Banking
Group Members:
• Mohib Gul Khan (3538)
• Qaisar Khan Khattak (3572)
• Shehbaz Masood (3539)
TABLE OF CONTENTS
• Executive Summary …………………………………………………………………………………
……………………………….03
• Introduction …………………………………………………………………………………
……………………….........04
• Qualitative Characteristics of Financial Statements
....................................................... 06
• Objectives of Financial Accounting for Islamic Banks and IFIs ……………………….…
………………………… 08
• The importance of establishing objectives of financial accounting for Islamic banks
and financial institutions ……………………………………………………………………………
……………….…………………………………….10
• The approach to establishing objectives of financial accounting for Islamic banks
and financial institutions …………………………………………………………………………
………………………………………………………15
• Objectives of financial accounting and financial reports for Islamic banks and
financial institutions ……………………………………………
……………………………………………………………………………………………………………………18
• Corporate AAOIFI ……………………………………………………………………………………………
……………………………….20
• Accrual Method Of Accounting To Islamic Banks ……………………………………………
…............................21
• Islamic modes of financing
.......................................................................................22
• Methods of calculating Zakat
.........................................................................................26
• Accounting for Islamic Banks
.......................................................................................29
• Conventional Banking ( Interest-based) VS Islamic Banking (Non-Interest-based)…
…......................41
• Interview With Adnan Yousuf – Manager FAYSAL BANK LIMITED F-10 Branch……………
………………………63
-2- Financial Statement / Accounting

of Islamic Banks
Executive Summary
There has been large-scale growth in Islamic finance and banking in Muslim countries and
around the world during the last twenty years. This growth is influenced by factors including
the introduction of broad macroeconomic and structural reforms in financial systems, the
liberalization of capital movements, privatization, the global integration of financial markets,
and the introduction of innovative and new Islamic products. Islamic finance is now reaching
new levels of sophistication. However, a complete Islamic financial system with its
identifiable instruments and markets is still very much at an early stage of evolution. Many
problems and challenges relating to Islamic instruments, financial markets, and regulations
must be addressed and resolved.
The emergence of Islamic banks and financial institutions as relatively new organizations
and the great challenge they face to successfully serve the societies in which they operate,
have led them, together with specialists in Islamic Shari’a and in accounting, to seek the
most appropriate means through which accounting standards could be developed and
implemented in order to present adequate, reliable, and relevant information to users of the
financial statements of such organizations. 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 resources for the benefit of
society.
The principles of Islamic Shari’a strike a balance between the interests of the individual and
society. It is known that investment is the foundation of economic activities in any society.
However, not every individual is capable of directly investing his own savings. Accordingly,
Islamic banks play an important role by acting as a vehicle to attract the savings of
individuals and investing those savings for the benefit of the individual and society.
The Objectives of financial accounting of Islamic banks is to determine the rights and
obligations of all interested parties, contribute to the safeguarding of the Islamic bank’s
assets, its rights and the rights of others in an adequate manner, contribute to the
enhancement of the managerial and productive capabilities of the Islamic bank and

of Islamic Banks
encourage compliance with its established goals and policies and, above all, compliance with
Islamic Shari’a in all transactions and events, provide, through financial reports, useful
information to users of these reports, to enable them to make legitimate decisions in their
dealings with Islamic banks.
In this paper, we provide a comprehensive comparative review of the literature on the

Islamic financial system. Specifically, we discuss the basic features of the Islamic finance
and banking. We also introduce Islamic financial instruments in order to compare them to
existing Western financial instruments and discuss the accounting of the Islamic mode of
financing and issues involved in it. The paper also gives a preliminary empirical comparison
of the financial statements of the Islamic Bank with Conventional Bank.
INTRODUCTION
ISLAMIC BANKING:
Efforts have been made in recent years to promote Islamic banking services. In particular,
the State Bank of Pakistan (SBP) exempted Islamic commercial banks from the moratorium
on the establishment of new banks, and the first full-fledged Islamic bank, Meezan Bank, was
licensed in 2002. Several conventional banks have also opened branches that provide only
Islamic financial services. The size of these Islamic banking institutions remains very small.
Although legal ambiguities remain regarding the process of Islamization of the financial
system of Pakistan, the establishment of new Islamic banking institutions is likely to continue
in the coming years.
Financial Standards:
The Accounting Standards Board contributes to the achievement of the Financial Reporting
Council's fundamental aim of supporting investor, market and public confidence in the
financial and governance stewardship of listed and other entities by pursuing its own aims of
establishing and improving standards of financial accounting and reporting, for the benefit of
users, preparers, and auditors of financial information.
Objectives of Financial Statements:
Goals financial statements are supposed to accomplish. The intent of financial statements is
to provide information useful in economic decision making. In particular, the data should be
useful in making investment and credit decisions. Financial statements should provide a

of Islamic Banks
reliable indication of a company's financial position, operating results, and changes in
financial position. Also, statement components and categories should aid in decisions.
Financial statements may provide information in addition to that specified by authoritative
requirements and regulatory groups. Inasmuch as management knows the most about the
business, it is encouraged to identify certain circumstances and explain their financial effects
on the enterprise.
Financial statements provide an overview of a business' financial condition in both short and
long term. All the relevant financial information of a business enterprise presented in a
structured manner and in a form easy to understand, is called the financial statements.
There are four basic financial statements:
Statement Of Financial Position: also referred to as statement of financial position or

condition, reports on a company's assets, liabilities, and net equity as of a given point
in time.
Statement Of Comprehensive Income: also referred to as Profit and Loss statement

(or a "P&L"), reports on a company's income, expenses, and profits over a period of
time. Profit & Loss account provide information on the operation of the enterprise.
These include sale and the various expenses incurred during the processing state.
Statement of retained earnings: explains the changes in a company's retained

earnings over the reporting period.
Statement of cash flows: reports on a company's cash flow activities, particularly its
operating, investing and financing activities.
For large corporations, these statements are often complex and may include an extensive
set of notes to the financial statements and management discussion and analysis. The notes
typically describe each item on the Statement Of Financial Position, Statement Of
Comprehensive Income and cash flow statement in further detail. Notes to financial
statements are considered an integral part of the financial statements.
Purpose of financial statements:
"The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range
of users in making economic decisions."[2] Financial statements should be understandable,
relevant, reliable and comparable. Reported assets, liabilities and equity are directly related
to an organization's financial position. Reported income and expenses are directly related to
an organization's financial performance.
Financial statements are intended to be understandable by readers who have "a reasonable
knowledge of business and economic activities and accounting and who are willing to study
the information diligently."[2]
•Owners and managers require financial statements to make important business

decisions that affect its continued operations. Financial analysis are then performed on
these statements to provide management with a more detailed understanding of the
figures. These statements are also used as part of management's annual report to the
stockholders.

of Islamic Banks
•Employees also need these reports in making collective bargaining agreements (CBA)
with the management, in the case of labor unions or for individuals in discussing their
compensation, promotion and rankings.
2. External Users: are potential investors, banks, government agencies and other parties
who are outside the business but need financial information about the business for a diverse
number of reasons.
•Prospective investors make use of financial statements to assess the viability of

investing in a business. Financial analyses are often used by investors and is prepared by
professionals (financial analysts), thus providing them with the basis in making
investment decisions.
•Financial institutions (banks and other lending companies) use them to decide whether
to grant a company with fresh working capital or extend debt securities (such as a long-
term bank loan or debentures) to finance expansion and other significant expenditures.
•Government entities (tax authorities) need financial statements to ascertain the

propriety and accuracy of taxes and other duties declared and paid by a company.
•Media and the general public are also interested in financial statements for a variety of
reasons
Qualitative Characteristics of Financial Statements:
UNDERSTANDABLE & USEFUL:
•Accounting information should be readily understandable to the intended users of the

information.
•This is a function of both the intended users and the intended uses of the information.
Accounting systems that define either the users or uses narrowly may justify more
complex information requirements and standards. Accounting systems that envision a
broad body of users and/or uses would tend towards less complexity in published
information and standards.
•Typically the belief that, for information to be understandable, information contained in

the various financial disclosures and reporting must be transparent (i.e., clearly disclosed
and readily discernable).

of Islamic Banks
RELEVANT:
The information should be relevant to the decision-making users of the information. It should
make a difference in their decisions. Typically, this means the information must be:
•Timely
•Have predictive value
•Provide useful feedback on past decisions
RELIABLE:
The information should be reliable and dependable. This usually includes the concepts of:
•Representational faithfulness - the information represents what it claims to represent.

For example, if the reported value of a common stock holding purports to be the current
market value, that value should be approximately what the stock could be sold for by the
company holding it.
•Verifiability - another person or entity should be able to recreate the reported value
using the same information that the reporting entity had.
•Completeness - the reported information should not be missing a material fact or

consideration that would make the reported information misleading.
•The concept of neutrality is sometimes incorporated into the concept of reliability.
COMPARABLE AND CONSISTENT:
•For accounting information to be usable, it must allow for comparisons across time and
across competing interests (such as competing companies or industries).
•This leads to a need for some consistency, wherever such comparisons are to be
expected. For example, comparisons of two companies would be very difficult and
potentially misleading if one discounts all its liabilities while the other discounts none of
its liabilities.
UNBIASED:
•Information that is biased can be misleading.
•Biased information is not useful unless the users understand the bias, any bias is
consistently applied across years/firms/industries, and the users can adjust the reported
results to reflect their own desired bias.

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•When faced with uncertainty, there is a need to either require reporting of unbiased
values accompanied with sufficient disclosure, or require the reporting of biased (prudent
or œconservative) values with the bias determined in a predictable, consistent fashion.
COST-BENEFIT EFFECTIVE:
•General understanding that the development of accounting information consumes

resources.
•As such, the cost of producing such information should be reasonable in relation to the
expected benefit.
•Use the materiality accounting rule - may not have to be fully followed for immaterial
items if full compliance would result in unwarranted higher costs.
"Objectives of Financial Accounting for Islamic Banks and IFIs"
Accounting encompasses several areas, generally agreed to include financial accounting,

managerial accounting, cost accounting, and accounting for non-for-profit organizations. We
are concerned here only with financial accounting.
3/1 Financial accounting
Financial accounting has developed over time for many practical considerations relating to
the need of entities to determine their financial rights and obligations, and results of
operations, and to inform present and potential parties concerned with the affairs of the
entity of its financial position, the results of its operations and its cash flows. This
information is intended to assist those parties in making suitable decisions with respect to
the entity. Thus financial accounting plays an important role in directing economic resources
in society to different entities as a result of the decisions made by the parties concerned
of Islamic Banks
with the affairs of those entities. These decisions are based, among other things, on
information available to them through financial accounting which ranks as one of the
important sources of the basic information required for decision making. During the period of
its development, a number of rules and principles have been accumulated which specify the
processes of financial accounting, its general objectives and limitations.
3/2 The financial Accounting Processes:
Financial accounting consists of the following processes:
(a) Accounting recognition of an entity’s financial rights and obligations as of a given date
and changes in those rights and obligations resulting from consummated transactions and
other events during a given period.
(b) Measurement of the financial effect of consummated transactions and the impact of
other events during a given period.
(c) Classifying the financial effect of consummated transactions and other events for the
purpose of determining the entity’s results of operations and other changes in its financial
position including its cash flows.
(d) Preparing periodic reports about the entity’s financial position as of a given date and the
results of its operations and cash flows during a given period.
3/3 The general objectives of financial accounting :
The main objective of financial accounting is to provide information, through periodic

reports, about the entity’s financial position, its results of operations and cash flows, to
assist users of such reports in making decisions. The financial statements (statement of
financial position, Statement Of Comprehensive Income, the statement of cash flows, and
related notes) are the main type of reports provided by financial accounting.
Financial accounting also provides important information which assists the entity’s
management in directing available economic resources. Accordingly, it facilitates
management efforts in planning, directing and supervising the entity’s activities. It also
facilitates the roles of governmental agencies responsible for supervising the national
economy and for collecting tax based on the financial information which it produces.
3/4 Limitations of information provided by financial accounting:
Financial accounting does not provide all the information required by those who need to
make decisions about the entity. This is so because of many reasons, including those related
to the nature of the financial accounting processes, and those related to cost and benefit
considerations. The following are some aspects of the limitations of information produced by
financial accounting and the reasons for such limitations.

of Islamic Banks
3/5 Limitations resulting from the nature of the financial accounting processes:
(a) Financial accounting is concerned mainly with measuring the financial effect of
transactions and other events on the entity’s financial position, results of operations and
cash flows. Accordingly, financial accounting is not usually able to produce information to
assist in the evaluation of the entity’s ability to achieve objectives that are not capable of
financial measurement in an objective manner.
(b) Financial accounting does not differentiate, through its processes, between the entity’s
performance and that of its management. Although, management ability is one of the
important factors that affect the entity’s performance, there are other factors beyond
management control which affect the entity’s performance such as natural disasters and
external political and economic changes. Accordingly, it is not currently possible for financial
accounting to provide information which can assist in evaluating management performance
aside from the entity’s performance.
(c) The information currently provided by financial accounting is historical in nature which
may or may not be indicative of the future. Yet, decisions made by those who need this
information are concerned with the future impact of alternative courses of action.
(d) Financial accounting relies to a very great extent on estimates when measuring the
financial effect of transactions and other events on the entity’s financial position and the
results of operations; for example, depreciation of fixed assets, doubtful receivables, etc.
Such estimates are based on assumptions determined by management which may or may
not turn out to be accurate.
3/6 Limitations resulting from cost and benefit consideration
The information which financial accounting produces has costs associated with its
preparation, presentation and usage. Accordingly, cost considerations affect the information
produced by financial accounting. One of the results of cost considerations is the emphasis
in financial accounting on the production of general purpose financial reports to serve the
common information needs of multiple external users.
4. The importance of establishing objectives of financial accounting for Islamic

banks and financial institutions:
4/1 The importance of establishing objectives:
Human experience proved that any work which does not have clear objectives encounters
limitations, conflicts and blurred vision in its implementation. Financial accounting and
financial reporting are no exception to this precept. Accounting scholars and practitioners
alike have found that the process of developing financial accounting standards without
establishing objectives leads to inconsistent standards which may not be suitable for the
environment in which they are expected to be applied.
- 10 - Financial Statement /
Accounting of Islamic Banks
Agreement on the objectives of financial accounting for Islamic banks would achieve many
benefits:
(a) The objectives will be used as a guide by the Financial Accounting Standards Board for
Islamic Banks and Financial Institutions when developing financial accounting standards.
This should assure consistency in developing standards.
(b) The objectives will assist Islamic banks, in the absence of accepted accounting
standards, in making choices among alternative accounting treatments.
(c) The objectives will be available as a guide and a regulator of subjective judgment made
by management when preparing the financial statements and other financial reports.
(d) The objectives, when properly defined, should increase users’ confidence and
understanding of accounting information and, in turn, their confidence in Islamic banks.
(e) Establishing objectives should lead to the development of accounting standards which
are likely to be consistent with each other. This should increase users’ confidence in the
financial reports of Islamic banks.
4/2 Differences between the objectives of financial accounting and financial

reports for Islamic banks and objectives of financial accounting for other banks:
Financial accounting is mainly concerned with providing information to assist users in

making decisions. Those who deal with Islamic banks are concerned, in the first place, with
obeying and satisfying Allah in their financial and other dealings. Allah says “O ye people!
Eat of what is on earth. Lawful and good; and do not follow the footsteps of the
Evil One, for he is to you an avowed enemy”. (Chapter 2: verse 168).
The objectives of financial accounting for other banks have, for the most part, been
established in non-Islamic countries. It is natural, therefore, that there should be differences
between objectives established for other banks and those to be established for Islamic
banks. Those differences stem mainly from differences in the objectives of those who need
accounting information and, therefore, in the information they need. This does not mean,
however, that we should reject all the results of contemporary accounting thought in non-
Islamic countries. This is so because there are common objectives between Muslim and non-
Muslim users of accounting information.
For example, Muslim and non-Muslim investors share in their desire to increase their wealth
and to realize acceptable returns on their investments. This is a legitimate desire which has
been recognized in Shari’a consistent with Allah’s saying “It is He Who has made the
earth manageable for you, so traverse ye through its tracts and enjoy of the
sustenance which He furnishes” (excerpt from chapter 67:verse 15).
In addition to the above, there are other reasons why different objectives of financial
accounting should be established for Islamic banks. Those are:
(a) Islamic banks must comply with the principles and rules of Shari’a in all their financial
and other dealings.
(b) The functions of Islamic banks are significantly different from those of traditional banks
who have adopted the Western model of banking.
(c) The relationship between Islamic banks and the parties that deal with them differs from
the relationship of those who deal with traditional banks. Unlike traditional banks, Islamic
banks do not use interest in their investment and financing transactions, whereas traditional
banks borrow and lend money on the basis of interest. Islamic banks mobilize funds through
investment accounts on the basis of Mudaraba (i.e. sharing of profit between the investor
who provides the funds and the bank which provides the effort) and invest these funds on
the basis of Mudaraba, profit and loss sharing mechanisms, or deferred payments methods
consistent with the Shari’a.
Hence, accounting standards developed for traditional banks may not be relevant to Islamic
banks. Nevertheless, in developing accounting standards for Islamic banks, the Board may
be guided by clear objectives and concepts which are appropriate for other banks provided
they are in compliance with the Shari’a precepts.
Statement Of Financial Position analysis: Islamic vs. conventional
The goal of financial risk management is to maximize the value of a financial institution as
determined by its level of profitability and risk. Since risk is inherent in banking and
unavoidable, the task of the risk manager is to manage the different types of risk at
acceptable levels to achieve optimal profitability. Doing so requires the continual
identification, quantification, and monitoring of risk exposures, which in turn demands sound
policies, adequate organization, efficient processes, and skilled analysts and elaborates
computerized information systems. In addition, risk management requires the capacity to
anticipate changes and to act in such a way that a bank’s business can be structured and
restructured to profit from the changes or at least to minimize losses. Regulatory authorities
should not prescribe how business is conducted; instead, they should maintain prudent
oversight of a bank by evaluating the risk composition of its assets and by insisting that an
adequate amount of capital and reserves is available to safeguard solvency.
Although the approaches to risk management are diverse, a good starting point is to
undertake a top-down approach starting with the Statement Of Financial Position. One
cannot underestimate the importance of understanding the structure and composition of the
Statement Of Financial Position of a financial institution.
It is critical to assess the ways in which a bank’s risk managers and analysts can analyze the
structure of Statement Of Financial Positions and Statement Of Comprehensive Incomes, as
well as individual Statement Of Financial Position items with specific risk aspects so that the
interaction between various types of risk is understood to ensure that they are not evaluated
in isolation. The relative share of various Statement Of Financial Position components –
assets and liabilities – is a good indication of the levels and types of risk to which a bank is
exposed.
Table 1 below shows stylised Statement Of Financial Position of a conventional commercial

bank. On the liability side, it accepts demand and saving deposits, issues term certificates
such as certificate of deposits (CD), and has capital.
Table 1 Stylised Statement Of Financial Position of a conventional bank – based on

functionality
Assets Liabilities
Loans and advances to customers Customers’ deposits
Cash and cash balances with other Due to banks and other financial
banks institutions
Investments in associates,
Other liabilities
subsidiaries and joint ventures
Financial assets held for trading Sundry creditors
Cash and cash balances with the
Equity and reserves
central bank
On the asset side, there is much more diversity and options in the form of marketable
securities, trading accounts, lending to corporations and to consumers.
From the risk point of view, two observations can be made. First, the deposits create
instantaneous pre-determined liabilities irrespective of the outcome of the usage of the
funds on the asset side, thus creating an asset-liability mismatch. Second, medium- to long-
term assets are financed by the stream of short-term liabilities, exposing the bank to a
maturity mismatch risk and discouraging the bank from investing in long-term non-liquid
projects. An increase in the level of non-retail deposits or funding could expose a
conventional bank to greater volatility in satisfying its funding requirements, requiring
increasingly sophisticated liquidity risk management. Certain funding instruments also
expose a bank to market risk.
For Islamic financial institutions, the nature of financial intermediation, including the function
of banking, is different from that of conventional financial institutions. This is the key to
understanding the difference in the nature of risks in conventional and Islamic banking. For
Islamic banks, the mudarabah contract is the cornerstone of financial intermediation and
thus of banking. The basic concept is that both the mobilisation and (in theory) the use of
funds are based on some form of profit sharing among the depositors, the bank, and the
entrepreneurs (users of funds). The financial intermediation is merely a ‘pass-through’
arrangement similar to funds management, with the difference that there are multiple
portfolios on the asset side.
Table 2 below presents a stylised Statement Of Financial Position of an Islamic bank,

displaying different activities and financial instruments. It serves as a good starting point for
understanding the dynamics of the risks inherent in Islamic banks. This Statement Of
Financial Position classifies the functionality and purpose of different instruments – a
common practice among Islamic banks.
Table 2 Stylised Statement Of Financial Position of an Islamic bank – based on
functionality
Application of funding Sources of funding
Cash balances Demand deposits (amanah)
Financing assets (murabaha,
Investment accounts (mudarabah)
salam, ijara, istisna)
Investment assets (mudarabah, Special investment accounts
musharakah) (mudarabah, musharakah)
Fee-based services (ju’ala, kafala,
Reserves
and so forth)
Non-banking assets (property) Equity capital
The structure of a typical Statement Of Financial Position has demand deposits and
investment accounts from customers on the liability side and Islamic financing and investing
accounts (the equivalent of conventional banks’ loans to customers) on the asset side. This
pattern reflects the nature of banks as intermediaries, with ratios of capital to liabilities at
such a low level that their leverage would be unacceptable to any business outside the
financial services industry. The analyst should be able to assess the risk profile of the bank
simply by analysing the relative share of various asset items and changes in their
proportionate share over time.
While the types of liabilities present in an Islamic bank’s Statement Of Financial Position are
nearly universal, their exact composition varies greatly depending on a particular bank’s
business and market orientation, as well as the prices and supply characteristics of different
types of liabilities at any given point in time. The funding structure of a bank directly affects
its cost of operation and therefore determines a bank’s potential profit and level of risk. The
structure of a bank’s liabilities also reflects its specific asset-liability and risk management
policies.
When compared with conventional banks, Statement Of Financial Position risk profile of
Islamic banks is different. First, the foremost feature of anIslamic bank is the ‘pass-through’
nature of the Statement Of Financial Position. This feature removes the typical asset-liability
mismatch exposure of a conventional bank, as the Islamic bank’s depositors’ return is linked
to the return on the assets of the bank. However, this feature also introduces some
operational issues, such as estimation and accrual of ex-post returns and the treatment of
intra-period withdrawal of deposits.
Second, the nature of assets of two institutions is different. Whereas a conventional bank
tends to stay with fixed income very low credit risk debt securities, an Islamic bank’s assets
are concentrated on the asset-based investments which has credit risk but are also backed
by a real asset. As a result, the lending capacity of the Islamic banking sector (at least for
commercial banks) is bound by the availability of real assets in the economy. Thus, there is
no leveraged credit creation.
Third, the assets of Islamic banks contain financing assets where tangible goods and
commodities are purchased and sold to the customers. This practice creates distinct
exposures. For example, in case of conventional banking, the asset is financed by a loan
from the bank to the customer whereas in case of an Islamic bank, the asset and the
financing are coupled together. The bank is not limited to the exposure as a financier but can
develop additional exposures resulting from dealing with physical assets. Another feature
which distinguishes the risks of an Islamic bank from a conventional bank is the general lack
of liquid securities on the asset side. This feature is not a design issue but is a temporal
phenomenon until a well-functioning securities market for Shari’ah-compliant instruments is
developed.
Finally, due to prohibition of interest, Islamic banks cannot issue debt to finance the assets
which consequently discourages creation of leverage. Due to the lack of leverage, Islamic
banks can be considered less risky during a time of financial crisis. The current financial
crisis was precipitated by excessive leverage and complexity in the financial system, which
had developed multiple layers of intermediaries. Hence, the financing – or the claims on
assets – became remote from the underlying assets. For Islamic banks, the financial
intermediary is closely associated with the asset and is able to perform better monitoring of
the asset as well as the obligor. These features can enhance the stability of the banking
system.
In short, a holistic approach to understanding the risk of Islamic financial institutions should
start with a rigorous analysis of the risk profile of different financial contracts on each side of
the Statement Of Financial Position. Standard analysis techniques such as trend analysis,
impact analysis, bucketing, duration and maturity mismatch, and value-at-risk analysis can
be applied to each financial contract or instrument type but then the results should be
aggregated at the Statement Of Financial Position level to understand a global picture at the
institution level.
5. The approach to establishing objectives of financial accounting for Islamic
banks and financial institutions:
Two approaches to establishing objectives have emerged through the discussion which took
place at different meetings of the committees established by the Board. These are:
(a) Establish objectives based on the principles of Islam and its teachings and then consider
these established objectives in relation to contemporary accounting thought.
(b) Start with objectives established in contemporary accounting thought, test them against
Islamic Shari’a, accept those that are consistent with Shari’a and reject those that are not.
In order to test each approach and select an appropriate one, a Shari’a scholar was
requested to prepare a working paper on the objectives of financial accounting for Islamic
banks consistent with the first approach, and an accounting scholar was requested to
prepare a separate working paper consistent with the second approach. In addition, a joint
working paper was prepared by a Shari’a expert and an accounting expert. Several joint
meetings were held to present and discuss those working papers. It was agreed that one of
the Shari’a scholars, who attended the meetings, prepare a paper summarizing the results of
those discussions and the views presented in the working papers. This last paper was
presented and discussed at a meeting of the Committee attended by several Shari’a and
accounting scholars. Based on the results of those efforts, it was agreed that the second
approach, described above, should be adopted to establish objectives of financial accounting
for Islamic banks and financial institutions.
5/1 The major users of financial reports:
Financial reports include not only financial statements but also other means of
communicating information that relates, directly or indirectly, to the information provided by
financial accounting.
The objectives of financial accounting determine the type and nature of information which
should be included in financial reports, in order to assist users of these reports in making
decisions. Therefore, the objectives of financial accounting should focus on the common
information needs of users of financial reports. In addition, the objectives should focus on
the common information needs of those users who do not have the authority or ability to
directly obtain the information they need, or access to such information. This focus stems
from two reasons, namely the ability of other users to directly obtain from the entity the
information they need to make decisions; and the need for accountants to make a choice
among a variety of contending information needs of different users because of the limited
nature of what could be included in financial reports. This does not mean, however, that
financial reports which are focused on the common information needs of users with limited
access to information will not be useful for others.
The main categories of users of external financial reports for Islamic banks whose
information needs are addressed in this statement include:
a) Equity holders.
b) Holders of investment accounts.
c) Other depositors.
d) Current and saving account holders.
e) Others who transact business with the Islamic bank, who are not equity or account
holders.
f) Zakah agencies (in case there is no legal obligation for its payment).
g) Regulatory agencies.
5/2 Common information needs of users of financial reports who do not have the
authority or ability to obtain additional information from the Islamic bank:
The information needs of users of financial reports increase and vary with the increase in the
categories of users for example investors including equity and investment account holders,
creditors including current depositors, savings depositors, debtors, employees of the Islamic
bank, other financial and banking institutions, and those who deal with the Islamic banks in
any other manner.
Government agencies have the power and authority to directly obtain the types of
information that best serve their needs. On the other hand, other external users are limited
to the information contained in the Islamic bank’s financial reports. Accordingly, it is
essential that the common information needs of these categories of users be the focus of
financial reports. It should be emphasized, however, that financial reports, because of cost
considerations, cannot be expected to provide for every possible information need of these
categories of users, particularly those needs that are not common to all users.
It is possible to summarize the common information needs of users as follows:
(a) Information which can assist in evaluating the bank’s compliance with the principles of
Shari’a in all of its financial and other dealings.
(b) Information which can assist in evaluating the bank’s ability in:
1. Using the economic resources available to it in a manner that safeguards these resources
while increasing their value, at reasonable rates.
2. Carrying out its social responsibilities and in particular those that have been specified by
Islam, including the good use of available resources, the protection of the rights of others
and the prevention of corruption on earth.
3. Providing for the economic needs of those who deal with the bank.
4. Maintaining liquidity at appropriate levels.
(c) Information which can assist those employed by the bank in evaluating their relationship
and future with the Islamic bank, including the bank’s ability to safeguard and develop their
rights and develop their managerial and productive skills and capabilities.
(d) It is assumed that the types of information described above represent the minimum
required to satisfy the common information needs of external users of financial reports.
5/3 Other financial reports:
Financial reports which are intended to provide for the common information needs of
external users have been divided into the following categories:
(a) Those that are currently produced by financial accounting in the form of financial
statements and related notes.
(b) Those that could be produced by financial accounting or other information systems of
Islamic banks in the form of other financial reports, which are not currently being produced.
The distinction between these two categories of reports is essential at this stage of the
Board’s efforts for the following reasons:
1. The first category of reports, i.e. the financial statements and related notes, is the main
output of financial accounting. In addition, they are generally known and are prepared in
accordance with standards that provide reasonable assurance of fairness in the presentation
of the financial position, results of operations and cash flows.
2. The second category of reports lacks a generally accepted definition and there is no
assurance that they would contain reliable and fair presentations of information required by
those who deal with Islamic banks for a variety of reasons, including the limitations of the
financial accounting processes.
Notwithstanding the above, objectives will be established for all financial reports as a group
to guide the development of accounting standards for Islamic banks. The future plans of the
Board will address the specific objective(s) of each report and its concept and develop the
standards for its preparation to assure its accuracy.
Examples of these types of other financial reports for Islamic banks include:
(a) Analytical financial reports about sources of funds for Zakah and their uses.
Although the financial statements of Islamic banks will disclose the liability for Zakah and
the amount that has been disbursed, users of financial statements might be interested in
additional analysis of sources of funds for Zakah, methods of its collection including controls
to safeguard these funds and their uses.
(b) Analytical financial reports about earnings or expenditures prohibited by the Shari’a
It is our intent for the financial statements to disclose income earned by the Islamic bank
from prohibited transactions or sources and expenditures prohibited by the Shari’a and how
those earnings were disposed of. However, users of the financial statements may be
interested in detailed financial reports. Such reports may include information about the
causes of such earnings, their sources, how they were disposed of and procedures
established to prevent entering into transactions prohibited by the Shari’a.
(c) Reports concerning the Islamic bank’s fulfillment of its social responsibilities
Islam has always been concerned with the concept of social responsibility whether that
responsibility be for the welfare of society or the prevention of harm. Indeed, this can be
clearly observed in the Quranic verses, the sayings and deed of the Prophet (may the
blessing and peace of Allah be upon him), and Islamic jurisprudence. For example, Allah said
“But seek with the (wealth) which Allah has bestowed on thee, the Home of the Hereafter,
nor forget thy portion in this world: but do thou good, as Allah has been good to thee and
seek not (occasions for) mischief in the land; for Allah loves not those who do mischief”.
(Chapter 28: verse 77). The Prophet (may the peace and blessings of Allah be upon him) said
“The most loved by Allah among the people are those helpful to others”. The Prophet also
said “There should be neither harming nor reciprocating harm”. Hence, Islam prohibits the
Muslim from causing harm to himself, to others, his environment or society in the pursuit of
material returns. This shows that Islam spearheaded this concept which did not develop in
the West except recently.
(d) Reports about the development of the Islamic bank’s human resources
Those reports may contain information about and the bank’s efforts to develop its human
resources whether with respect to their knowledge of Shari’a or economics. In addition it
would include the bank’s efforts in encouraging its employees to be effective and efficient.
6. Objectives of financial accounting and financial reports for Islamic banks and
financial institutions:
6/1 Objectives of financial accounting:
(a) To determine the rights and obligations of all interested parties, including those rights
and obligations resulting from incomplete transactions and other events, in accordance with
the principles of Islamic Shari’a and its concepts of fairness, charity and compliance with
Islamic business values.
(b) To contribute to the safeguarding of the Islamic bank’s assets, its rights and the rights of
others in an adequate manner.
(c) To contribute to the enhancement of the managerial and productive capabilities of the
Islamic bank and encourage compliance with its established goals and policies and, above
all, compliance with Islamic Shari’a in all transactions and events.
(d) To provide, through financial reports, useful information to users of these reports, to
enable them to make legitimate decisions in their dealings with Islamic banks.
6/2 Objectives of financial reports
Financial reports, which are directed mainly to external users, should provide the following
types of information:
(a) Information about the Islamic bank’s compliance with the Islamic Shari’a and its
objectives and to establish such compliance; and Information establishing the separation of
prohibited earnings and expenditures, if any, which occurred, and of the manner in which
these were disposed of.
(b) Information about the Islamic bank’s economic resources and related obligations (the
obligations of the Islamic bank to transfer economic resources to satisfy the rights of its
owners or the rights of others), and the effect of transactions, other events and
circumstances on the entity’s economic resources and related obligations. This information
should be directed principally at assisting the user evaluating the adequacy of the Islamic
bank’s capital to absorb losses and business risks; assessing the risk inherent in its
investments and; evaluating the degree of liquidity of its assets and the liquidity
requirements for meeting its other obligations.
(c) Information to assist the concerned party in the determination of Zakah on the Islamic
bank’s funds and the purpose for which it will be disbursed.
(d) Information to assist in estimating cash flows that might be realized from dealing with
the Islamic bank, the timing of those flows and the risk associated with their realization. This
information should be directed principally at assisting the user in evaluating the Islamic
bank’s ability to generate income and to convert it into cash flows and the adequacy of
those cash flows for distributing profits to equity and investment account holders.
(e) Information to assist in evaluating the Islamic bank’s discharge of its fiduciary
responsibility to safeguard funds and to invest them at reasonable rates of return, and
information about investment rates of returns on the bank’s investments and the rate of
return accruing to equity and investment account holders.
(f) Information about the Islamic bank’s discharge of its social responsibilities.
Corporate AAOIFI:
The emergence of Islamic banks and financial institutions as relatively new organizations
and the great challenge they face to successfully serve the societies in which they operate,
have led them, together with specialists in Islamic Shari’a and in accounting, to seek the
most appropriate means through which accounting standards could be developed and
implemented in order to present adequate, reliable, and relevant information to users of the
financial statements of such organizations. 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 resources for the benefit of
society.
The principles of Islamic Shari’a strike a balance between the interests of the individual and
society. It is known that investment is the foundation of economic activities in any society.
However, not every individual is capable of directly investing his own savings. Accordingly,
Islamic banks play an important role by acting as a vehicle to attract the savings of
individuals and investing those savings for the benefit of the individual and society.
Islam clearly encourages investment and spending. Indeed, when Islam imposed Zakah, it
required that wealth should be invested, otherwise it would be exhausted by Zakah over a
period of time. It has been reported that the Prophet (may the blessing and peace of Allah
be upon him) said “Trade in orphans wealth (property) lest it would be exhausted by Zakah”.
However, to induce individuals to invest through savings with their Islamic banks, it is
essential that such individuals develop a trust in the ability of Islamic banks to realize their
investment objectives. In the absence of trust in the ability of Islamic banks to invest
efficiently and in full compliance with Islamic Shari’a, many individuals may refrain from
investing through Islamic banks. One of the pre-requisites for the development of such trust
is the availability of information that assures the investing public of the ability of Islamic
banks to achieve their objectives. Among the important sources of such information are the
financial reports of Islamic banks which are prepared in accordance with standards that are
applicable to Islamic banks. However, in order to develop such standards it is essential to
define the objectives and concepts of financial accounting for Islamic banks. In this respect,
it is not harmful to begin where others have ended, if what has been developed by others is
beneficial and does not contradict the Islamic Shari’a.
The interest in developing financial accounting standards for Islamic banks started in 1987.
In this respect, several studies have been prepared. These studies have been compiled in
five volumes and deposited in the Library of the Islamic Research and Training Institute of
the Islamic Development Bank.
The outcome of these studies has been the formation of the Financial Accounting
Organization for Islamic Banks and Financial Institutions (the Organization) which was
registered as a not-for-profit organization in the State of Bahrain in 12/9/1411H
corresponding to 27/3/1991. Since its inception the Organization has continued the efforts to
develop accounting standards. Periodic meetings of the Executive Committee for Planning
and Follow Up (the Committee) have been held with the aim of implementing the plan
approved by both the Supervisory Committee (the supreme authority of the Organization)
and by the Financial Accounting Standards Board for Islamic Banks and Financial Institutions.
In this respect, the Committee has retained the service of several consultants on Shari’a,
experts and practitioners of accounting, and bankers.
8. ACCRUAL METHOD OF ACCOUNTING TO ISLAMIC BANKS:
The difference between the two accounting treatments is meant to reflect the risk to which
the Islamic bank is exposed in executing this type of transaction. In the case of non-obliging
the purchase orderer to fulfil his promise, the bank is exposed to the risk of not being able to
recover the historical cost of the asset if the client decides not to proceed; with the sale. On
the other hand, the bank is exposed to a relatively lower risk if the client is obliged to fulfil
his promise and he refrained from purchasing tha asset after the bank has acquired it. This is
because the Islamic bank usually asks the client to pay an amount up-front - hamish
algedyyah - from which the bank can remedy the damage incurred to it if the client retreats
from purchasing the asset. Moreover, if the amount of hamish algedyyar is not adequate to
cover the loss of the bank, the latter can have recourse to the orderer for the remaining
amount of the loss.
The standard requires the Islamic bank to disclose in the notes accompanying the financial
statements, whether it considers the promise made in the sale oy Murabaha to purchase
orderer, obligatoiy or not.
The standard also prescribes two accounting treatments for profit recognition. In addition to
the accrual method of allocating profit over the period of the contract, the Board decided
after the public hearing to add a cash basis method whereby the Islamic bank can recognise
profit when the instalment is received. However, the standard gives preference to the
accrual method and requires for the implementation of the cash basis method the approval
of either the bank's Shariah supervisory board or the concerned super visory agency in the
country.
The reason for allowing two accounting treatments for asset valuation and profit recognition
is mainly due to the different acceptable Shariah interpretations related to these two issues.
This is in line with the Board's recently adopted policy of pursuing a harmonisation approach
to entertain different Shariah rulings which have accounting implications, but within narrow
bounds. This policy, which the Board implements in close co-ordination with AAOIFI's Shariah
Committee, is meant to enhance the adherence to the full text of the standards by maiy
Islamic banks, particularly as AAOIFI lacks the power of enforcement. On the other hand, the
Board's policy calls for standardising accounting treatments that are not affected by the
Shariah rulings (e.g., issues of disclosure).
The standard also requires the netting of deferred profits off against Murabaha receivables.
The latter should be measured at their cash equivalent value i.e., the amount due from
debtors less provision for doubtful debts. This is meant to give relevant information and a
faithful representation of the financial position of the Islamic bank.
9. ISLAMIC MODES OF FINANCING
Debt creating modes:
•Murabaha
•Salam
•Istesna
•Ijara
Partnership based modes
•Musharaka
•Mudarabah
Murabahah (sale with or without deferred payment):
In this particular kind of sale, the seller clearly mentions the cost of the sold commodity, and
then sells it to the buyer by keeping a profit margin. Thus, Murabaha should not be seen as a
loan given on interest, it is rather a sale of a commodity for cash/deferred price.As regards
Bai Murabaha, the bank purchases a commodity, on a client’s behalf, and then resells it to
the latter, on the basis of plus-profit. Under this kind of agreement, the bank discloses its
cost and profit margins to the client. Thus, unlike Conventional banks (which advance money
to a borrower), the bank will buy the goods from a third party and sell it onwards to a
customer for a pre-agreed price, thus abstaining from interest. The growing use and vitality
of Murabaha agreement is proven by the fact that in Islamic banks world over, 66% of all
investment transactions are through Murabaha. It is argued by critics of Islamic banking that
Murabaha agreements are in reality interest-based contracts, under the garb of a notional
sale and buy back transaction, profit being synonymous to interest in this case. Islamic
scholars have reverted to this argument by stressing that a ‘true’ Murabaha financing
structure is quite different from an overdraft provided by Conventional banks and the former
offers various benefits to the bank and its customers, namely that depositors have a share in
the bank’s profits. Furthermore, the basic difference is the Aqd (contract), which specifies
the Islamic conditions, as against the interest element in Conventional banking transactions.
Basic Rules for a Murabaha transaction:
1. The subject of sale must be in existence at the time of the sale.
2. The seller must have the ownership of the commodity in question.
3. The subject of sale must be in physical or ‘constructive possession’ of the seller while he
is selling it.
4. The sale must be instant and absolute; no provisions for contingencies should be made
part of the contract.
5. The goods/commodity to be sold must reflect a value and must be specified to the buyer,
leaving no room for ambiguities or confusion as between the parties.
6. The sale must be unconditional and the price of the commodity should be certain.
SALAM:
Another contract that is used for financing is the "‘BAI AL SALAM "(in short SALAM).
One of the basic rules for Islamic Contracting is that nothing can be sold that does not
already exist. This contract form was basically intended to finance agricultural exploitations
and is used in this manner to allow farmers to receive financing to assist in the development
of crops.
Therefore, contracting over future goods is allowed, but quantity, quality and time of
delivery have to be specified. The commodity must be composed of units with homogenous
characteristics and which are traded by counting, measuring or weighing according to usage
and customs of trade (excluding precious stones of which quality can differ). Payment must
be immediate and instant buy-back in general is not allowed.
This mode of financing can be used by modern banks and financial institutions, especially in
order to finance the agricultural sector. In Salam, the seller undertakes to supply specific
goods to the buyer at a future date, in exchange of an advanced price fully paid at the spot.
The payment is made in cash, and the supply of purchased goods is deferred.
Purpose of Salam Contracts:
The purpose is to meet the need of farmers, who operate on a small scale, and thus need
the finance for farming purposes, so that they can carry out their day-to-day activities.
Moreover, it is designed to assist the traders, in their export/import transactions. Salam
Proves beneficial to the seller, as he receives the price in advance, and at the same time,
advantageous to the buyer, as the price under the Salam arrangement is normally lower
than the price in spot sales.
ISTISNA:
ISTISNA’ in many regards appears the same as a SALAM, with the difference that ISTISNA’
always relates to commodities that are to be manufactured.
The Manufacturer sells the yet-to-be-made commodity to the Buyer/Financial Institution.
The difference between SALAM and ISTISNA’ is that:
•the payment of the price is not necessarily immediate (deferred payment possible)
•and individualized goods can be envisaged.
If the Manufacturer is acquiring the goods that he will use to make the commodity from the
Buyer / Financial Institution - and therefore his only contribution really is his labor, then an
ISTISNA’-contract in general is not permissible (the IJARAH or rent of labor contract is then
used).
Istisna’ is a sale transaction whereby a commodity is transacted before it comes into
existence. It is an order for a manufacturer to manufacture a certain kind of commodity, to
be used by the purchaser. The manufacturer uses his own material to manufacture the
required goods. The price must be fixed with consent of all the parties involved. All other
vital specifications of the commodity must also be fully settled. Subject to the
acknowledgment or receipt of prior notice, either party can cancel the contract before the
manufacturing party has begun the work. The time of delivery need not be fixed, however a
time limit may be imposed as between the parties.
MUDARABAH:
This is also a kind of partnership, whereby one partner provides finance to the other for
investing in a commercial enterprise. The investment is provided by the first partner called
the ‘Rab-ul-Maal’, while the entire responsibility for the management and work falls upon the
other partner, who is called the ‘Mudarib’. The profits generated, are shared in a
predetermined ratio.There are two kinds of Mudarabah
• Restricted
• Unrestricted
Restricted Mudarabah:
Rab-ul-Maal may specify a particular business for the Mudarib, in which case he shall invest
the money in that specified business only. This is known as ‘
Al-Mudarabah-al-Muqayyadah’
Unrestricted Mudarabah:
But if he leaves it open for the Mudarib to undertake whatever business he wishes, the
Mudarib should be authorized to invest the money in any business he wishes. This type of
Mudarabah is called ‘Al-Mudarabah-al-Mutlaqh’
Roles of Mudarib:
• He is an Ameen (trustee), who is responsible to look after the investment, with an

exception of natural calamities.
• He is a Wakeel (agent), as he makes the purchases from the funds provided.
• He is also a Shareek (partner), thus sharing the profits with Rab-ul-Maal.
• He can also possibly be a Zamin (liable), and thus will have to compensate for any loss
suffered during the course of Mudarabah, due to any erroneous act on his part.
IJARAH:
The IJARA can best be described as the Islamic version of the western style lease: Transfer of
the usufruct only: The risk and liabilities associated with the use of the asset will be borne by
the Client. All the risks and liabilities connected with the ownership (loss, destruction ...) of
the assets rest with the Owner / Financial Institution.
The IJARAH can become a "Ijarah wa Iqtina" (financial lease) when the User/Client has the
right to acquire the commodity at the end of the lease period.In an Islamic leasing (Ijaraha),
the owner of the asset, while retaining the corpus of the asset, transfers its usufruct to
another person for an agreed period, at an agreed consideration. All the liabilities arising
from the ownership must be endured by the lessor. The period of lease must be determined
in clear terms and the asset must be clearly identified as between the partiesSubject leased
should be:
• Valuable
• Identified
• Quantified
Musharakah (ordinary partnership)
This partnership refers to a joint business enterprise in which the partners (two or more
persons) undertake to share all the profit/losses of the venture. The way profit will be shared
must be agreed at the outset and any periodical advance for one or more partners will be
off-set at the settlement of the accounts.
The profit sharing has to be in relationship to the input of capital, but it can be agreed that
one partner gets a bigger share (ex. Provides more labor) provided that a non-working
partner to the MUSHARAKAH (the "silent partner" or capital provider) is always granted a
maximum of the ratio linked to his input in capital.
It is impermissible to establish a fixed and guaranteed return to be allocated to a partner;

since it would suggest the loan of money and/or would mean that a partner does not take his
share in possible losses.
Buy-out clauses (unit per unit) can be built into a contract, preferably at market price or at
historic value. Consequently, one partner will slowly buy out the other partner. This
technique sometimes is used for investment purposes, where the Financial Institution
partners up with a Client, leases the good to the Client (through IJARA) and slowly exits the
project.
Methods Of Calculating Zakat
IN ISLAM, zakat is not a simple charity out of our own sweet will. It has its own mathematics,
just like faraid (Islamic estate distribution law). Therefore, Muslims need to adhere to the
zakat law, and not pay the zakat amount arbitrarily.
The cardinal rate to remember when in computing your zakat is that it is based on a flat rate
of 2.5 % as opposed to the conventional income tax rate that varies according to the amount
taxable. This is the rate for all zakatable wealth that is valued on gold and silver such as
zakat on income, statutory savings, shares, business etc. However, this rate is not applicable
to some types of zakat such as livestock, agricultural output (done in traditional method and
not by business entities) and found treasures.
Zakat assessment also differs from income tax, with the former based on assets while the
latter on income. In zakat jurisprudence, `assets' do not only cover fixed and liquid assets,
but also the inflow of income.
Zakat is obligated only for individuals and entities who have complete or unencumbered
possession on assets. However, for mixed- ownership companies, it is only compulsory upon
the equity held by Muslims. Furthermore, assets that are zakatable must be halal assets or
income.
Businesses whose core operations are non-halal activities, such as liquor-and pork-based
products or delivery services, gambling and interest gaining activities, are not subjected to
zakat. Zakat is an ibadat and does not accept from non-halal sources. If a company runs a
halal product/services as their core business, but is slightly involved in impermissible
revenue/projects, then the revenue from such projects will be excluded in the zakat
calculation.
Nisab valuation:
Another criterion is nisab valuation (threshold of zakat obligation). It is determined based on

the current value of 85gm of gold. When the zakatable assets in a business are equivalent to
or exceed nisab valuation, zakat should be paid at the rate of 2.5%.
Hawl:
Another condition called hawl is based on the asset value calculated from the initial
inception or start of business until the completion of one whole year.
The completion of hawl is not measured on the particular stocks or goods for sale but on the
business operation itself. Originally, the periodic term is based on the lunar calendar but
zakat assessment can also be made using the financial year of the company.
Growth assets:
The quality of assets that are subjected to zakat is that it must have growth (al-nama)
potential. The component of growth assets include cash (in-hand/bank), financial instrument
or securities such as shares, bonds, unit trusts and are classified as a current asset,
inventory of finished goods.
However, raw materials and work in process are exempted because they are not in a form
ready to be sold. Fixed industrial assets like buildings, machines, furniture and office supplies
are also exempted from zakat because they are not business products and only assist in the
business.
Nevertheless, revenue from fixed assets is zakatable.
Calculating business zakat:
This refined approach has been published by Jabatan Kemajuan Islam Malaysia (Jakim) and
adopted by almost all the state zakat authorities.
In the past, zakat authorities were found to be using several approaches to calculating zakat
on business. Nonetheless productive and successful efforts have been made by the
authorities to streamline and `finetune' these approaches.
The original text on business zakat assessment only instructs for zakat payment based on
inventories or goods for sale. However, generations of Muslim jurists have broadened the
scope of business zakat based on their observation of general Islamic jurisprudence.
Conceptually, they have broadened the scope of urud tijarah (literally meaning goods for
trade) to working capital used in business operations. Please take note that in zakat
calculation, all kinds of fixed assets (property, plants and equipment) and long-term
investments will be excluded.
Some of the religious scholars have expressed their opinions concerning the basic
calculations of business zakat. One of the famous opinions is as said by Abu `Ubayd;
`Maimun ibn Mihran clarified: when it comes to you the time to pay zakat (exact time), count
your cash money that you have with you, and also the merchandise you have, value it in the
form of money, and include it in the debts from your customers (with the opinion that it will
be collected) and minus your own debt. Then the balance is the amount for you to calculate
zakat.'
Basically, any organization that is profit-oriented is obliged to pay zakat. There are two
methods that can be used to calculate zakat: Urfiyyah and Syari'yyah.
Urfiyyah is known as the Growth Capital method. It considers equity of ownership of that
particular company and other financial sources. In short, it looks at all resources available,
less the normal (uruf) exemption. Syari'yyah, meanwhile, is called the Working Capital
method. It considers current assets after deducting current liabilities (in short, net current
assets).
Accounting for Islamic Banks
Nexus of Contractual Rights & Obligations in Islamic Financial Activities
ISLAMIC COMMERCIAL
TRANSACTIONS
Gratuitous Trading Investment

Contracts Contracts Contracts
Gift
Leasing Sale
Musharaka
Waqf
Operational Murabaha Mudharaba
Loan Lease
Ijarah
Murabahah
Operating Lease +
Transfer of Salam
Ownership
Ijarah Muntahia Istisna’
Bittamleek etc.
 The major financing instruments used by Islamic banks are Murabaha, Salam,
Istisna's, Ijarah and Ijarah Muntahia Bittamleek, Musharaka, and Mudaraba.
 Murabaha, Salam, and Istisna's are all forms of asset financing based on a sale-
purchase transaction. Salam and Istisna'a are forms of working capital finance, while
Murabaha is normally a credit sale. The return to the financier (profit margin) is
predetermined in advance. Ijarah and Ijarah Muntahia Bittamleek are forms of leasing.
 Musharaka and Mudaraba are forms of profit sharing finance.
Risks Involved to Banks in Islamic Modes of Financing
Financing Type Contract Type Risk Exposure
Murabaha Credit Risk

Sales type Bai Muajjal
Salam Non-delivery &

Isitna’a Credit Risk
Equity Mudaraba Credit/Market risk

Musharaka Equity investment Risk
Leasing Ijarah Market risk

Ijarah MuntahiaCredit risk
Biltamleek
Accounting Issues
 How should Islamic banks account for and present in their Statement Of Financial
Positions the funds in their investment accounts - which are mobilized on profit-
sharing terms via the mudaraba contract where the risk of loss is borne by the
investors.
 How should Islamic banks recognise income generated by the different asset classes
under each of the Islamic instruments, for example, murabaha, istisna 'a, salam,
ijarah, musharaka and mudaraba
 How should Islamic banks measure different asset classes under each of the Islamic
instruments? Asset valuation is needed for many purposes, Statement Of Financial
Position reporting, assessment of Zakah on wealth, and fair appropriation of profits to
investors, on the one hand, and to Islamic banks (as asset managers) on the other.
 How should Islamic banks account for prohibited income, such as interest on accounts
held with correspondent banks which, incidentally, is earned?
 What are the particular disclosures, in financial statements or notes thereto, which
Islamic banks may need to make, given their ethical stance and in particular their
commitment to compliance with Shari'a?
 How should Islamic banks account for the provisions for doubtful debts or decline in
value of impaired assets in case those assets are funded, wholly or party, by
investment accounts?
 To what extent do members of the Shari'a Supervisor}' Boards participate in the

setting of accounting policies and methods which are adopted by Islamic banks?
What is the impact of such participation on financial reporting by Islamic banks?
 Variations within Islamic banks over accounting policies and/or methods can
be clearly seen in the published financial reports:
 Financial Statements
 Asset Valuation
 Income Recognition
 Allocation of Profits
 Provisions
 Zakah
 Reporting contracts
 Statement Of Financial Position

 Off-Statement Of Financial Position
 Value
Treatment in Accounts:
 (FAS No 1) General Presentation and Disclosure in the Financial Statements of Islamic

Banks and Financial Institutions, AAOIFI named and defined the financial statements
that Islamic banks need to prepare and publish. In addition to the ordinary financial
statements - the statement of financial position (Statement Of Financial Position),
Statement Of Comprehensive Income, statement of cash flow and statement of
changes in owners' equity - Islamic banks are required to prepare some specific
financial statements necessitated by their different nature and objectives. The
standard named and defined three financial statements: statement of changes in
restricted investments, statement of sources and uses of Zakah and charity funds,
and statement of sources and uses of qard fund.
 FAS No 1 requires that unrestricted investment accounts be presented on the claims

side of the statement of financial position (liabilities and equity) in a separate section,
not as liabilities but under "equity of unrestricted investment account holders". Thus,
the statement of financial position for an Islamic bank will have two different equity
sections. A possible explanation is that the Islamic bank has the right to commingle its
own funds with the funds of the holders of these accounts. On the other hand, FAS No
1 requires that restricted investment accounts be reported off-Statement Of Financial
Position in the statement of changes in restricted investments.
Assets Valuation:
 AAOIFFs FAS No 2: Murabaha and Murabaha to the Purchase Ordered requires the
bank to measure the asset at historical cost if the customer is obliged to conclude the
contract. On the other hand, if the customer is not obliged to fulfil his promise to
execute the transaction.
 FAS No 2 requires the bank to value the asset on the basis of cash equivalent value.
Furthermore, unlike the treatment of many Islamic banks that presents deferred
profits as liability.
 FAS No 2 requires that these profits be deducted from murabaha receivables.
 In an ijarah. muntahia bittamleek contract, the ownership of the leased asset is

transferred to the lessee at the end of the contract. Some Islamic banks treat ijarah
muntahia bittamleek as a finance lease. However, such a treatment does not give a
faithful representation of the underlying transaction. This is because according to
AAOIFI pronouncements the Shari'a rules relating to the ijarah contract do not allow
the lessor to transfer significant risk and reward to the lessee.
 AAOIFFs FAS No 8 requires leased assets to be booked in an ijarah muntahia

bittamleek assets account and measured at book value. It further requires the
outstanding ijarah rental amounts to be booked in an ijarah instalments receivable
account and measured at their cash equivalent value.
Income Recognition:
 AAOIFI's SFA No 2: Concepts of Financial Accounting for Islamic Banks and Financial
Institutions states that: "revenue should be recognized when realized". This requires
that
 the earning process is complete or virtually complete.

 there is an obligation on the part of another party to remit a fixed or
determinable amount to the bank, and
 the amount of revenue should be known and should be collectible with a
reasonable degree of certainty.
 FAS No 2 states that income generated by murabaha transactions with a contract

period not exceeding the current accounting period should be recognised at the time
of contracting. If the contract period exceeds the current accounting period.
 FAS No 2 proposes two alternative methods: "Proportionate allocation of profit pro

rota tempor is over the period of the credit" or "as and when the instalments are
received" if required by the bank's Shari'a Supervisory Board and/or supervisory
authorities.
 FAS No 3 (and No 4) state: income generated by mudaraba (or musharaka)

transactions shall be recognised at the time of liquidation if the contract commences
and ends during a single financial period. In the case of a transaction that continues
for more than one period, income shall be recognised to the extent that profits are
being distributed.
 The wording in FAS No 3 (and No 4) regarding income recognition tends to be

confusing as it entertains the possibility to mean accrual or cash accounting. The
phrase "time of liquidation" and the clause "to the extent that the profits are being
distributed" may indicate that the standards are advocating the use of cash
accounting. This is so although what is meant is that the bank's share of income from
mudaraba and musharaka transactions is to be recognised on accrual basis. For other
assets generated by salam, ijarah and istisna 'a contracts it is explicitly stated that
income shall be recognised on accrual basis
Allocation of Profits (AAOIFI, FAS No 5)
 bases applied by the bank in the allocation of profits;

 bases applied by the bank for charging expenses to investment accounts;
 bases applied by the bank for charging provisions and to whom they should revert if
no longer required;
 percentages for profit-allocation between investment account holders and the bank;
 any increase by the bank of its percentage profit share;
 if the bank included unrestricted investment accounts in the sharing of earnings
generated by current accounts;
 if the bank included unrestricted investment accounts in the sharing of earnings
generated by banking operations;
 source of funds given priority in case of unutilised idle funds.
Provision
 FAS No 11
 Provisions are defined as amounts charged in the Statement Of Comprehensive
Income and used to revalue assets down to their cash-equivalent values.
 The standard also sets the accounting rules relating to the recognition,
measurement, presentation and disclosure of provisions.
Reserve
 Is a component of equity
 Profit equalization Reserve
 Amount appropriated by the Islamic bank out of the mudaraba income,
before allocating the mudarib share, in order to maintain a certain level
of return on investment for investment account holders and increase
owners’ equity
 Investment Risk reserve
 Amount appropriated by the Islamic bank out of the income of
investment account holders, after allocating the mudarib share, in order
to cater against future losses for investment account holders
Recognition of Reserves
When management of the Islamic bank decides, with approval of investment account
holders, to set up a profit equalization reserve and/or an investment risk reserve
Zakah
 Zakah is a religious alms-giving duty that a Muslim has to pay on his wealth every
lunar year if the wealth exceeds a fixed minimum amount.
 According to AAOIFI's FAS No 9: Zakah, an Islamic bank is obliged to pay Zakah on

behalf of its shareholders when:
 the law requires the Islamic bank to satisfy the Zakah obligation;
 the Islamic bank is required by its charter or by-laws to satisfy the Zakah
obligation;
 the general assembly of shareholders has passed a resolution requiring the
Islamic bank to satisfy the Zakah obligation.
 Zakah should be treated as a (non-operating) expense of the Islamic bank and should
be included in the determination of net Statement Of Comprehensive Income.
 Unpaid Zakah should be treated as a liability and presented in the liabilities section in
the statement of financial position of the Islamic bank
Murabaha:
Murabaha is a cost plus profit sale, i.e. a sale in which the seller informs the customer
about his cost and the amount of profit.
Contemporary Murabaha transaction (referred to as Murabaha to the Purchase Orderer by

AAOIFI Standard) is normally a deferred payment sale.
Ba’y Murabaha, by its very nature, is a purchase-sale / trading transaction. In other words
it is not a “financing” transaction and instead, it is a substitute to financing transactions.
Accordingly, the IFAS - 1 issued by ICAP, as well as, the AAOIFI standard consider it a
trading transaction and suggest the accounting treatment like a trading transactions with
certain exceptions.
On the other hand, the conventional banks, as well as, Islamic banks operating in
Pakistan were accounting for Murabaha as a financing transaction (just like an interest-
bearing loan) and ignoring the purchase and sales of goods.
Payment made to supplier or agent for purchase of asset is accounted for as advance.
Asset is initially measured and recorded at historical cost, including all costs necessary to
bring the asset in its present location and condition.
Perpetual or periodic method of accounting for inventories / purchases may be used.
Valuation of Inventory:
Payment made to supplier or agent for purchase of asset is accounted for as advance.
Asset is initially measured and recorded at historical cost, including all costs necessary to
bring the asset in its present location and condition.
Perpetual or periodic method of accounting for inventories / purchases may be used.
AAOIFI requires that if there is an indication of non-recovery of costs of goods, the asset
shall be measured at cash equivalent value (Net realizable value) through a provision.
According to AAOIFI standard, if a discount is received from the supplier, it shall not be
considered as revenue and instead it should reduce the cost of goods. The discount may
be treated as revenue if this is decided by the Islamic Bank’s Shari’a Supervisory Board.
Murabaha – Sale to the Purchase Orderer shall be recorded at the time of occurrence at
invoiced amount i.e. gross selling price.
Profit shall be recognized at the time of consummation of sales, if the sale is for cash or
on credit but the term does not exceed the current financial period.
The profit on portion of Murabaha receivable not due for payment should be recorded as
“Unearned Murabaha Income” with a corresponding liability on the Statement Of
Financial Position called “Deferred Murabaha Income”.
As per AAOIFI Standard, profits of credit sale whose payment due after the current
financial period shall be recognized using any of the following methods:
Preferred method – Proportionate allocation of profits whether or not cash is

received;
Allowed Alternative method – Profit may be recognized as and when the

amount is received. Accrued amount of profit which is not yet received is disclosed.
Deferred profits shall be offset against (shown as a deduction from) Murabaha

receivables in the statement of financial position / Statement Of Financial Position.
According to most of the jurists in Pakistan, no discount can be allowed in case of early
settlement. Accordingly, in case of early settlement, deferred Murabaha income should
be immediately recognized. However, IFAS – 1 is silent in this respect.
Mudaraba:
Capital Invested
Include in this column total amount of capital invested with corresponding counterparty,
whether related or not. This should include amount before any provisions are made against
the invested capital.
Net Asset Value
The amounts in this column should represent the net value of assets relating to the
corresponding counterparty for Restricted investment accounts after the necessary
provisions are made. Report this amount as net asset value at the reporting date.
Mudarib Fee
Mudarib fee is the amount that the bank (as a Mudarib) is entitled to receive for undertaking
the investment of the funds provided by the restricted investment account holders. The
amount or percentage of the Mudarib fee is agreed between the bank and the investment
account holders before implementing the contract. In case of a loss, the bank is not entitled
to any Mudarib fee and the loss is entirely
shouldered by the restricted investment account holders.
Beginning Balance of Profit Equalization Reserve
Include in this item the beginning balance of the profit equalization reserve that the bank
has set aside in order to maintain a certain level of return on investment for investment
account holders and to increase owners’ equity.
Appropriation during the period
The amount in this item should represent the appropriation made during the period. For
write backs, report here assets written back during the period.
Closing Balance of Profit Equalization Reserve
Include in this item the closing balance of the profit equalization reserve which is
obtained by adding or deducting the inward or outward transfers respectively, to/from the
beginning balance of profit equalization reserve .
Musharaka:
 AAOIFFs FAS No 2: Murabaha and Musharaka to the Purchase Ordered require the
bank to measure the asset at historical cost if the customer is obliged to conclude the
contract. On the other hand, if the customer is not obliged to fulfil his promise to
execute the transaction
 FAS No 2 requires the bank to value the asset on the basis of cash equivalent value.
Furthermore, unlike the treatment of many Islamic banks that present deferred profits
as liability
 FAS No 2 requires that these profits be deducted from murabaha receivables.
Salam & Parallel Salam:
A salam is a purchase agreement for ordered goods (muslam fiih) where the delivery of the
goods is delayed by the seller (muslam ilaihi) and where the buyer immediately pays for the
goods in full before they can be delivered in accordance with specific conditions.
A bank may act as either buyer or seller in a salam transaction. Where it acts as the seller
and then orders a third party to supply goods in the framework of a salam agreement, this is
referred to as a parallel salam.
A parallel salam may be entered into on the condition that:
(a) The second contract between the bank and the supplier be separate from the first
contract between the bank and the final buyer; and
(b) The second contract is entered into only after the first is valid.
The buyer and seller agree on the specifications and price of the ordered goods at the
beginning of the contract. The price of the goods may change over the term of the contract.
Where the bank acts as buyer, a Islamic bank may seek a guarantee from a customer to
avoid the risk of loss to the bank.
The general characteristics of all ordered goods must be made known, including: type,
technical specifications, quality, and quantity. The ordered goods must be the same as those
characterized in the agreement between the buyer and seller. Where goods are incorrect or
damaged, the seller shall be liable for negligence.
The bank as buyer
Salam loans are recognized when the salam operating capital is paid or transferred to the
seller.
Salam operating capital may be in the form of cash and non-cash assets. In the form of cash
it is assessed as the amount paid, while non-cash assets are assessed at fair value (the
value agreed by the bank and the customer).
Ordered goods are recognized and assessed as follows:
(a) Where the goods ordered are in accordance with those stated in the contract they are
valued at the agreed value;
(b) Where the quality of the goods varies:
(i) The goods are assessed based on the terms of the contract if the market value (fair value
if a market value is not available) of the goods is equivalent or higher than the value of the
goods stated in the contract.
(ii) ordered goods already received are assessed at market value (fair value if the market
value is not available) when taken receipt of and any difference is recognized as a loss, if
their market value is lower than the value of the goods as stated in the contract.
(c) if the bank fails entirely or in part to receive the ordered goods on the due date:
(i) if the date for receipt is extended, the recorded value of the salam loan equivalent
to the portion not yet repaid remains at the same value stated in the contract;
(ii) if the salam contract is canceled, whether partially or entirely, the amount of the
salam loan is that portion not yet repaid by the customer.;
(iii) if the salam contract is canceled, whether partially or entirely, and the bank has a
guarantee over the ordered goods and the proceeds from the sale of the guarantee
do not cover the value of the salam loan, the difference between the recorded
value of the salam loan and the sale proceeds is recognized as a receivable due
from the customer. Conversely, if the sale proceeds exceed the recorded value of
the salam loan the customer is entitled to the difference.
(iv) The bank may impose a penalty against a customer but may only do so against
those customers capable of meeting their obligations but who intentionally fail to
do so. This provision shall not apply to customers incapable of meeting their
obligations as a result of force majeure.
(v) Ordered goods already taken receipt of are recognized as stock. At the end of the
financial reporting period, any stock acquired in the framework of a salam
transaction is assessed at the lowest acquisition cost or the net realizable value.
Where the net realizable value is lower than the acquisition cost, the difference is
recognized as a loss.
The bank as the seller:
A salam debt is recognized when the bank receives the salam working capital at an amount
equivalent to the amount of salam working capital received. The salam working capital
received may take the form of cash or non-cash assets. In the form of cash, it is assessed as
the amount received. As non-cash assets are assessed at fair value (being the value agreed
by the bank and the customers).
Where the bank enters into a parallel salam transaction, the difference between the amount
paid by the customer and the acquisition cost of the ordered goods is recognized as a gain
or loss upon delivery by the bank to the customer
Ijara:
The IFAS – 2 issued by ICAP, as well as, the AAOIFI standard suggest the
accounting treatment similar to an operating lease transactions with certain
exceptions.
On the other hand, the conventional banks, as well as, Islamic banks currently
operating in Pakistan are accounting for Ijarah as a financing transaction, just
like finance lease – in accordance with IAS-17. Modarabas, are however, not
following IAS-17.
Accounting by Islamic Bank as Lessor
• Asset is recognized at historical cost and depreciated as per normal

depreciation policy with an expected realizable value at the end.
• According to AAOIFI standard, these are presented as Investments in

Ijarah Assets, while as per IFAS – 2, these are included in property, plant
and equipment with separate disclosure.
• Depreciation has to be calculated in line with the methods allowed by IAS

– 16. Most suitable method is generally the straight line method because,
the rentals are generally also accounted for on a straight line basis.
• Depreciation term shall generally be equal to the lease term, except

where it is expected that the asset will be given on Ijarah again, to same
or some other customer, in which case, the depreciable life shall be equal
to the asset’s useful economic life.
• Lease rentals including other associated charges and Ijarah related

expenses are allocated proportionately in financial periods over the lease
term.
• Initial direct cost is amortized over the lease term. However, IFAS-2
allows that the same may be charged to income as and when incurred.
• Repairs undertaken are recognized as expense.
• According to AAOIFI Standard, a provision for repairs is established if

repairs are material and differ in amount from year to year.
Ijarah Muntahia Bittamleek
IFAS – 2 does not deal with Ijarah Muntahia Bittamleek separately.
Same accounting treatment should be applied as in case of Ijarah, as according

to the substance of transaction, all the risks and rewards remain with the
lessor.
In case of expected selling price is Nil or fixed or equivalent to some pre

agreed amount, the residual value for the purpose of depreciation should be
equivalent to such amount.
Sale and lease back resulting into an Ijarah:
If the sale price is same as that of its fair value any gain or loss shall be
recognized in period in which such transaction occurs; and
If the sale price is different from its fair value any gain or loss shall be
amortized / allocated as an adjustment to Ijarah expenses over the lease
term.
Sale and Lease Back Transaction – Ijarah Muntahia Bittamleek – Lessee’s

Perspective
According to AAOIFI Standard, in case of sale and lease back resulting into
Ijarah Muntahia Bittamleek, gains or losses resulting from sale shall be
allocated as an adjustment to Ijarah expenses over the lease term.
Conventional Banking
(Interest Based)
Versus
Islamic Banking
(Non Interest based)
Financial Statements
This study is based upon the financial statements of two banks that are operating in Pakistan
and that are renowned in their respective sectors. These financial statements were selected
from the annual reports of the said two banks.
Conventional Interest Based Bank

Askari Commercial Bank Was selected as a conventional interest based bank. Askari Bank
Limited (the Bank) was incorporated in Pakistan on October 09, 1991 as a Public Limited
Company and is listed on the Karachi, Lahore and Islamabad Stock Exchanges.
Islamic Non Interest Based Bank

The bank selected for study in this regard is AL Baraka Islamic Bank. The bank operates as a
branch of a foreign bank domiciled and is incorporated in Bahrain on February 21, 1984 and
is a member of AL Baraka Group.
Al Baraka Islamic Bank mainly is engaged in Islamic Banking whereas Askari Bank is
engaged in the business of Corporate Banking. Comparisons were made between the
financial statements of these banks and points were made. Some points were common
between both of the banks and some entirely different those which includes the way of
transacting the banking business. Main Differences between Askari Commercial Banks
Financial Statements and Al Baraka Islamic Banks Financial Statements are summarized
below.
Difference Between Islamic & Conventional Banking.
Askari Commercial Bank Al Baraka Islamic Bank

Askari Commercial Bank prices Al Baraka Islamic Bank prices goods
money. and services such as assets.
Depositors get the fixed rate of Profit is shared between the bank and
interest which does not depends the customer. If bank gets the higher
upon the profitability or loss that is profit then the customer also gets the
made by the bank. The depositor higher profit and if the bank suffers a
does not have any share in the loss then the customer also suffers
business of the Bank so the customer the loss. This implies that the
income is not dependent upon any customer (depositor) is also having
slump in bank’s business. share in the business that bank
undertakes.
Commercial bank deals in money or Islamic bank deals in assets.
paper.
It borrows the funds from the Maharabah partnership arrangement
depositors and pays them interest exists between the customer and the
and the interest is charged in the bank. If the bank gets the profit then
Statement Of Comprehensive Income it shares the profit with the customers
and the amount due to the customer and if they get loss then they share
is showed on the liability side of the the loss between them. The sharing
Statement Of Financial Position. Bank of profits earned depends upon the
borrows the fund at a lower rate and agreement or the amount of
advances the same fund to the investment.
customers at the higher rate of
interest and the difference between
the interest earned from the
customers and interest paid to
customers is the income of the bank
and the amount that is receivable
from the customers is shown in the
Statement Of Financial Position under
the assets side as receivable from the
customers.
The depositor is not informed about Depositor (Investor) is informed by
the source in which the bank is going the bank as to the nature of
to invest the money. He is just investment that the bank is going to
informed about the rate of interest make and the conditions on which the
and other contractual provisions. profit or loss depends.
The interest or rate of return on This is a purely profit and loss sharing
investment is predetermined on the agreement. The depositor gets the
funds that are borrowed by the bank. loss if there is loss to the bank.
The depositor earns the interest in
any case at the rate that is specified.
There is no risk to the investment of Profit earned depends entirely upon
the investor form the conditions that the conditions that are prevalent in
prevail in the market. the market.
Difference in the financial statements Statement Of Financial Position
The format of presentation for The format of presentation for
different categories of assets in different categories of assets in
Financial Statements Statement Islamic Financial Statements
Of Financial Position is Statement Of Financial Position
is
ASSETS
Cash and balances with treasury ASSETS
banks Cash and balances with banks
These represents overnight to Cash in hand
three months placements with Balances with State Bank of
correspondent banks, carrying Pakistan
interest rates determined Current account
with respect to underlying Capital deposit account
currency benchmarks at the Cash reserve account
rates ranging from 2.37% to Balances with Central Bank of
4.69% (2006: 2.34% to 5.23%) Bahrain (CBB)
per annum receivable on Balances with other banks and
maturity. financial institutions
Balances with other banks
Lendings to financial institutions

Call money lendings Sales receivables
Repurchase agreement International commodities
lendings ( Others
Purchase under resale Gross sales receivable
arrangement Deferred profits
Trade related deals Provision for impairment
Others
Particulars of lending
In local currency
In foreign currencies Mudaraba
Securities held as collateral Banks and financial institutions
against lendings to financial There are no non performing as
institutions of 31 December 2007 (2006:
Market Treasury Bills nil).
Pakistan Investment Bonds
Purchase under resale Ijara Muntahia Bittamleek
arrangement Cost:
of listed shares Opening balances
Additions
Disposals
Closing balance
Accumulated depreciation:
Opening balance
Charges during the year
Disposals
Closing balance Net book
value:
At 31 December
Musharaka financing
Musharaka
Provision for impairment (note
24)
Investments
Investments i)Investment in quoted shares
Investments by segments: ii) Held to maturity
Federal Government Unquoted investments
Securities Sukook Leasing (bonds)
Market Treasury Bills Sukook Salam (bonds)
Pakistan Investment Bonds iii) Available for sale
Government of Pakistan Sukuk Quoted investments
Bonds Managed funds
Government of Pakistan Euro Unquoted investments at
Bonds cost
Fully paid up ordinary Private equity
shares Real estate
Listed companies Others
Unlisted companies Less: Provision for impairment
Fully paid preference
shares
Listed companies
Term Finance Certificates Investment properties
(TFCs) These include the investmenst in the
Listed Term Finance properties that are made by the bank.
Certificates
Unlisted Term Finance
Certificates
Foreign Securities
Callable notes
Mena Transformation Fund
Credit Linked Notes
Other Investments
Sukuk Certificates Ijara income receivables
NIT Units Ijara income receivables
Provision for impairment
Ijara income receivables, which
Advances are non-performing as of 31
Loans, cash credits, running December 2007, amounted to
finances, etc. US$ 6.1 million (2006: US$ 6.5
In Pakistan million) out of which US$ 2.5
Outside Pakistan million
(US$ 3.4 million) is not yet past
Ijara Financing – In Pakistan due.
Bills discounted and purchased

(excluding treasury bills)
Payable in Pakistan
Payable outside Pakistan
Advances – gross
Provision against non
performing advances
Specific provision
General provision
General provision against
consumer loans
Particulars of advances
In local currency
In foreign currencies
Short term ( for upto one year)

Long term ( for over one year)
Ijara Financing in Pakistan
Ijara rentals receivable

Residual value
Minimum lease payments
Profit for future periods
Present value of minimum
Ijara payments
Advances have been classified as

under
Category of classification
Special mention
Other Assets Especially
mentioned
Substandard
Doubtful
Loss
Particluars of provision against

non performing advances
Opening balance
Charge / (reversal) for the year
Amounts written off
Other adjustments
Closing balance
Particluars of provision against

non performing advances
In local currency
In foreign currencies
Particulars of write-offs:
Against provisions
Directly charged to profit and
loss account Premises and equipment
These include the land and buildings
Write offs of Rs. 500,000 and and other asstes that comes in the
above bank’s premises.
Write offs of below Rs. 500,000
The land and building represents the
Particulars of loans and head office premises of the Bank that
advances to directors, associated was sold and leased back over a 5
companies etc. year period effective from June 2005.
Debts due by directors,
executives Other assets
of them either severally or
Balance at beginning of Due from Al Tawfeek Company
Loans granted during Advance against financing
Repayments transactions
Balance at end of year Income receivable
Debts due by companies Accounts receivable
Bank are interested as Advance tax (note 25)
directors, Receivables under letters of
companies as members credit
Balance at beginning of Others
Loans granted during
Repayments
Balance at end of year
Debts due by subsidiary
modarabas and other related
Balance at beginning of
Loans granted during
Repayments
Balance at end of year
Operating fixed assets

Capital work–in–progress
Property and equipment
Capital work–in–progress
Civil works
Advances to suppliers and
contractors
Land-freehold
Land-leasehold
Buildings on freehold land
Buildings on leasehold land
Renovation of leased premises
Furniture, fixtures and office
equipment
Carpets
Machine and equipments
Computer equipments
Vehicles
Other assets
Land – freehold
Land – leasehold
Buildings on freehold land
Buildings on leasehold land
Renovation of leased premises
Furniture, fixtures and office
Carpets
Machine and equipments
Computer equipments
Vehicles
Other assets
Deferred tax assets
Other assets
Income / mark–up
Income / mark–up
Advances, deposits,
Advance taxation (
Un–realized gain on
Suspense account
Stationary and stamps
Dividend receivable
Others
The format of presentation for The format of presentation for
different categories of liabilities different categories of liabilities
in Financial Statements in Islamic Financial Statements
Statement Of Financial Position Statement Of Financial Position
is is
LIABILITIES Liabilities
Bills payable Due to banks and other financial
In Pakistan institutions
State Bank of Pakistan
Borrowings Due to other banks and
In Pakistan financial institutions
Outside Pakistan
Particulars of borrowings with Other liabilities

respect to currencies Security deposit against
In local currency Ijara Muntahia Bittamleek
In foreign currencies Bills payable
Margins received
Details of borrowings – secured / Accounts payable
unsecured Deferred tax liability
In Pakistan – local currency Ijara rental received in
Secured advance
Borrowings from the State Unearned profit on sale and
Bank of Pakistan: lease back
Export refinance scheme Provision for staff
Long term financing of export indemnity
oriented projects Charity fund
Repurchase agreement Others
borrowings (repo)
Unsecured
Call borrowings
Unrestricted investment accounts
Deposits and other accounts Unrestricted investment
Customers accounts
Fixed deposits Profit equalization reserve
Savings deposits Investment risk reserve
Current accounts - non-
remunerative
Special exporters' account EQUITY
Margin accounts (i) Share capital
Others Authorised 6,000,000
Financial institutions ordinary shares (2006:
Remunerative deposits 2,000,000) of US$ 100 each
Non-remunerative deposits (ii) Statutory reserve
Particulars of deposits (iii) General reserve
In local currency (iv) Cumulative changes in fair
In foreign currencies value
(v) Foreign exchange reserve
Sub-ordinated loans
Term Finance Certificates –I Retained earnings
Term Finance Certificates –II
Extra Note of CONTINGENCIES &
Liabilities against assets subject COMMITMENTS
to finance lease
Deferred credits/ (debits)
arising due to:
Accelerated tax depreciation
Tax loss for the year
Minimum tax for the year
Surplus on revaluation of
securities
Profit on securities recognized
but not received
Deferred tax liabilities
Other liabilities
Mark-up / return / interest
payable
Mark-up / return / interest
payable
Unearned income / commission
Accrued expenses
Advance payments
Unclaimed dividends
Branch adjustment account
Payable against purchase of
Withholding taxes payable
Federal excise duty payable
Others
Statement Of Comprehensive Income
MARKUP INTEREST INCOME INCOME
Income from Jointly Financed
Mark-up / return / interest earned Investments
On loans and advances to: Income from jointly
i) Customers financed sales
ii) Financial institutions Income from jointly
On investments financed, other financings
i) Available for sale securities and investments
ii) Held to maturity securities Ijara Muntahia
On deposits with financial institutions Bittamleek (note
On securities purchased under Income from
resale agreements investments
Mudaraba
Musharaka
Structuring fees
Mark-up / return / interest expensed Gain on sale of
On deposits investments
On securities sold under Dividends
repurchase Rental income
On sub-ordinated loans Joint investment income
On other short term borrowings Return on unrestricted
investment accounts
(investors share of income
Net mark-up / interest income before Bank's Mudarib
Provision against non- share)
performing loans and advances Bank’s Mudarib share
Provision for impairment in the Return on unrestricted
value of investments investment accounts
Bad debts written off directly Bank’s share of income
Net mark-up / interest income from investment accounts
after provisions (as a mudarib and as fund
owner)
NON MARK-UP/INTEREST INCOME Bank’s income from self
Fee, commission and brokerage financed sales
income Bank’s income from self
Dividend income financed, other financings
Income from dealing in foreign and investments
currencies
Gain on sale of investments - net Revenue from banking services
Federal Government Fees and commissions
Letters of credit
Market Treasury Bills Acceptance fees
Pakistan Investment Guarantees
Term Finance Certificates Others
Shares - Listed
Others
Other revenues
Unrealised gain / (loss) on Foreign exchange gain
Others
revaluation of investments Bank’s Mudarib share in
classified as held for trading - restricted investment profit
net TOTAL INCOME
Other income
Rent of property EXPENSES Include
Net profit on sale of property Operating expenses
and equipment Staff costs
Rent of lockers Administrative expenses
Recovery of expenses from Premises costs
customers Business expenses
Total non-markup / interest General expenses
income Depreciation
NON MARK-UP/INTEREST
EXPENSES
Administrative expenses
Salaries, allowances, etc.
Charge for defined benefit plan
Contribution to defined
contribution plan
Non-executive directors' fees,
allowances and other expenses
Rent, taxes, insurance,
electricity, etc.
Legal and professional charges
Brokerage and commission
Communications
Repairs and maintenance
Finance charges on leased
assets
Stationery and printing
Advertisement and publicity
Auditors' remuneration
Depreciation
Other expenditure (travelling,
security services,
vehicle running expenses, etc.)
Auditors' remuneration
Audit fee
Fee for the audit of provident
and gratuity funds
Special certifications, special
credit review of selected
customers,
half year review and the audit
of consolidated financial
statements
Out-of-pocket expenses
Other provisions / write offs
Other charges
Penalties imposed by the State
Bank of Pakistan
Total non-markup / interest expenses
PROFIT BEFORE TAXATION

Taxation – current year
For the year
Current
Deferred
For prior years
Current
Deferred
PROFIT AFTER TAXATION
Unappropriated profit brought
forward
Profit available for
appropriation
Cash Flow Statement

Cash flow from operating activities Operating Activities
Profit before taxation Provision for impairment -
Less: Dividend income
net
Adjustments: Gain on disposal of
Depreciation premises and equipment
Provision against non-performing advances Gain on disposal of
(net)
Provision for impairment in the value of
investments
investments Gain on disposal of
Net profit on sale of property and equipment investment properties
Finance charges on leased assets Amortisation of income and
(Increase) / decrease in operating assets expenses related
Lendings to financial institutions Unrealised remeasurement
Held for trading securities loss
Advances Depreciation
Other assets (excluding advance
Increase / (decrease) in operating liabilities
Directors' remuneration
Bills payable Share of result of an
Borrowings associate
Deposits Sales receivables
Other liabilities Mudaraba
Cash flow before tax
Income tax paid Ijara Muntahia Bittamleek
Net cash flow from operating activities Musharaka financing
Ijara income receivables
Other assets
Other liabilities
Due to banks and other
financial institutions
Cash flow from investing activities Investing Activities
Net investments in available-for-sale Dividend received from
securities
Net investments in held-to-maturity investments
securities Purchase of investments
Net investments in subsidiary/ Disposal of investments
associate Purchase of investment
Dividend income
Investments in operating fixed assets
properties
- net of adjustment Disposal of investment
Sale proceeds of operating fixed properties
assets-disposed off Purchase of premises and
Net cash flow used in investing equipment
activities
Disposal of premises and
equipment
Cash flow from financing activities Financing Activities
Payments of sub-ordinated loans-net Increase in unrestricted
Payments of lease obligations
Dividends paid investment accounts
Net cash flow used in financing Current accounts
activities Dividend paid
(Decrease)/ increase in cash and cash
equivalents
Cash and cash equivalents at
beginning of the year
Cash and cash equivalents at end of
the year
Askari Commercial Bank
Status And Nature Of Business

Askari Bank Limited (formerly Askari Commercial Bank Limited) (the Bank) was incorporated
in Pakistan on October 09,1991 as a Public Limited Company and is listed on the Karachi,
Lahore and Islamabad Stock Exchanges. The registered office of the Bank is situated at AWT
Plaza, The Mall, Rawalpindi. The Bank obtained its business commencement certificate on
February 26, 1992 and started operations from April 01,1992. Army Welfare Trust directly
and indirectly holds a significant portion of the Bank's share capital at the year end. The
Bank has 150 branches (2006: 122 branches); 149 in Pakistan and Azad Jammu and Kashmir
, including 14 Islamic Banking branches and an Offshore Banking Unit (OBU) in the Kingdom
of Bahrain. The Bank is a scheduled commercial bank and is principally engaged in the
business of banking as defined in the Banking Companies Ordinance, 1962.
Format Of Presentation
Fixed Assets are stated at the top and current assets at the end. This type of format is
mostly used by the companied and is elaborated in the Companies Ordinance and
International Financial Reporting Standards.
Audit Report
This bank has got clean audit report by its auditors A&F Ferguson & Company Chartered
Accountants.
Interest Based Banking

These financial statements are prepared on interest based banking. The bank is engaged in
the operations involving interest.
International Accounting Standards

All applicable International accounting standards are followed.
Islamic Accounting Standards

The financial statements do not state the adoption of any Islamic Accounting standards
except for Islamic banking segment.
Requirements of SBP
Requirements of State Bank Of Pakistan (SBP) are followed. These include the prudential
regulations that are issued by the State Bank Of Pakistan and further amendments and
pronouncements that become effective from time to time.
Basic Operations
Its earnings are based upon interest earned on deposits.
Statement Of Financial Position
Its Statement Of Financial Position totals Rs.12,265,987,000
Profit from Operations

Its Profit from Operations is Rs.7,101,372
Profit Un Remitted
Its profit available for appropriation totals Rs.4,480,991,000
Share Holders Equity

Its share holder equity totals Rs.12,099,645,000
Cash Flow - Cash Position

Its cash and cash equivalents at the end of the year are Rs.18,353,109
Business Segments
The bank carries on its business and generates its income through different geographical as
well as different business segments. The business segments are as under:
1-Corporate Financing
2-Retail Banking
3-Trading & Sales
Standards not yet adopted by the Bank

Standards, amendments and interpretations to existing standards that are not yet effective
and have not been early adopted by the Bank.
The following new standards and amendments to existing standards have been published
and are mandatory for the Bank's accounting periods beginning on or after January 1, 2008,
but the Bank has not early adopted them:
IAS 1 Presentation of financial statements in respect of changes in the names

of certain financial statements,presentation of transactions with owners
in statement of changes in equity and with non-owners in comprehensive
Statement Of Comprehensive Income. Adoption of IAS 1 is not expected
to have an impact on the Bank's financial statements.
IAS 23 Borrowing Cost (Amendment) requires an entity to capitalize borrowing

costs directly attributable to the acquisition, construction or production of
a qualifying asset (one that takes a substantial period of time to get
ready for use or sale) as part of the cost of that asset. The option of
immediately expensing those borrowing costs will be withdrawn.
Adoption of IAS 23 is not expected to have an impact on the Bank's
financial statements.
IFRS 8 Operating segments (effective from January 1, 2009) requires a
'management approach', under which segment information is presented
on the same basis as that used for internal reporting purposes. Adoption
of IFRS 8 is not expected to have an impact on the Bank's financial
statements.
IFRIC 13 Customer loyalty programmes, clarifies that where goods or services are
sold together with a customer loyalty incentive (for example, loyalty
points or free products), the arrangement is a multiple-element
arrangement and the consideration receivable from the customer is
allocated between the components of the arrangement in using fair
values. Adoption of IFRIC 13 is not expected to have an impact on the
Bank's financial statements.
IFRIC 14 The limit on a defined benefit assets, minimum funding requirements and
their interactions', provides guidance on assessing the limit in IAS 19
(Employee benefits) on the amount of the surplus that can be recognised
as an asset. It also explains how the pension asset or liability may be
affected by a statutory or contractual minimum funding requirement.
Adoption of IFRIC 14 is not expected to have an impact on the Bank's
financial statements.
Commercial Interest based banking

Commercial banking segment provides services related to project finance, export finance,
trade finance, leasing, lending, guarantees, bills of exchange and deposits from corporate
customers. Payment and settlement Payment and settlement includes income from
payments and collections, funds transfer, clearing and settlement. Agency service Agency
service includes income from rent of lockers provided to customers. Subordinated loans It
represents subordinated Term Finance Certificates issued by the Bank.
Types of loans granted by Askari commercial bank
Secured loan
A secured loan is a loan in which the borrower pledges some asset (e.g., a car or property)
as collateral (i.e., security) for the loan.
Mortgage loan
A mortgage loan is a very common type of debt instrument, used to purchase real estate.
Under this arrangement, the money is used to purchase the property. Commercial banks,
however, are given security - a lien on the title to the house - until the mortgage is paid off
in full. If the borrower defaults on the loan, the bank would have the legal right to repossess
the house and sell it, to recover sums owing to it.
In the past, commercial banks have not been greatly interested in real estate loans and have
placed only a relatively small percentage of their assets in mortgages. As their name
implies, such financial institutions secured their earning primarily from commercial and
consumer loans and left the major task of home financing to others. However, due to
changes in banking laws and policies, commercial banks are increasingly active in home
financing.
Changes in banking laws now allow commercial banks to make home mortgage loans on a
more liberal basis than ever before. In acquiring mortgages on real estate, these institutions
follow two main practices. First, some of the banks maintain active and well-organized
departments whose primary function is to compete actively for real estate loans. In areas
lacking specialized real estate financial institutions, these banks become the source for
residential and farm mortgage loans. Second, the banks acquire mortgages by simply
purchasing them from mortgage bankers or dealers.
In addition, dealer service companies, which were originally used to obtain car loans for
permanent lenders such as commercial banks, wanted to broaden their activity beyond their
local area. In recent years, however, such companies have concentrated on acquiring mobile
home loans in volume for both commercial banks and savings and loan associations. Service
companies obtain these loans from retail dealers, usually on a nonrecourse basis. Almost all
bank/service company agreements contain a credit insurance policy that protects the lender
if the consumer defaults.
Unsecured loan
Unsecured loans are monetary loans that are not secured against the borrowers assets (i.e.,
no collateral is involved). These may be available from financial institutions under many
different guises or marketing packages:
• credit card debt,
• personal loans,
• bank overdrafts
• credit facilities or lines of credit
• corporate bonds
AL-Baraka Islamic Bank
Incorporation
Incorporated in Bahrain with limited liability. The bank operates as a branch of a foreign bank
domiciled and is incorporated in Bahrain on February 21, 1984 and is a member of AL Baraka
Group.
Branch Banking
This bank is doing business in Pakistan with its branches.
Audit Report
This bank has got clean audit report by its auditors M/S Ford Rhodes Sidat Hyder & Company
Chartered Accountants.
Format Of Presentation
Liquidity based presentation that is most liquid assets at the top and least liquid long term
assets at the bottom.
Shariah Compliance Based Banking

Shariah Compliance Based Banking is practiced in accordance with IFAS Islamic
International Accounting Standards

Some IAS are followed and certain IAS are not followed the IAS that are not followed due to
their not being effectiveness includes
IAS – 1
IAS – 23
IAS – 27
IAS – 3
IFRIC –11
IFRIC –12
IFRIC –13
Requirements of SBP
Requirements of SBP are followed.
Current & Deferred Taxation
The bank also accounts for current and deffered taxation.
Basic Operations
Its earnings are not based upon interest rather these are based upon investments
Statement Of Financial Position

Its Statement Of Financial Position totals Rs.2,444,753,000
Profit from Operations
Its Profit from Operations is Rs.649,998
Profit Un Remitted
Its Un Remitted profit totals Rs.400,348,000
Share Holders Equity
Its share holder equity totals Rs. 2,446,533,000
Cash Flow - Cash Position
Its cash and cash equivalents at the end of the year are Rs.7,600,081
Business Segments
Corporate Financing consisting of income earned by way of SUKUK. Sukuk is the Arabic name
for a financial certificate but can be seen as an Islamic equivalent of bond. However, fixed-
income, interest-bearing bonds are not permissible in Islam. Hence, Sukuk are securities that
comply with the Islamic law (Shariah) and its investment principles, which prohibit the
charging or paying of interest. Financial assets that comply with the Islamic law can be
classified in accordance with their tradability and non-tradability in the secondary markets.
Retail Banking net return on financing to real customers.

Trading & Sales investment held for trading purposes.
Islamic banking is consistent with the principles of Islamic law (Sharia) and its practical
application through the development of Islamic economics. Sharia prohibits the payment of
fees for the renting of money (Riba, usury) for specific terms, as well as investing in
businesses that provide goods or services considered contrary to its principles (Haraam,
forbidden). While these principles were used as the basis for a flourishing economy in earlier
times, it is only in the late 20th century that a number of Islamic banks.
were formed to apply these principles to private or semi-private commercial institutions
within the Muslim community.
Basic Principles Employed (Points of Distinction Between Islamic Versus Interest

based Banking)
Islamic banking has the same purpose as conventional banking except that it operates in
accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on
transactions). The basic principle of Islamic banking is the sharing of profit and loss and the
prohibition of riba (usury). Amongst the common Islamic concepts used in Islamic banking
are profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus
(Murabahah), and leasing (Ijarah).In an Islamic mortgage transaction, instead of loaning the
buyer money to purchase the item, a bank might buy the item itself from the seller, and re-
sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments.
However, the fact that it is profit cannot be made explicit and therefore there are no
additional penalties for late payment. In order to protect itself against default, the bank asks
for strict collateral. The goods or land is registered to the name of the buyer from the start of
the transaction. This arrangement is called Murabaha. Another approach is EIjara wa EIqtina,
which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar
way (selling the vehicle at a higher-than-market price to the debtor and then retaining
ownership of the vehicle until the loan is paid).An innovative approach applied by some
banks for home loans, called Musharaka al-Mutanaqisa, allows for a floating rate in the form
of rental. The bank and borrower forms a partnership entity, both providing capital at an
agreed percentage to purchase the property. The partnership entity then rent out the
property to the borrower and charges rent. The bank and the borrower will then share the
proceed from this rent based on the current equity share of the partnership. At the same
time, the borrower in the partnership entity also buys the bank's share on the property at
agreed installments until the full equity is transferred to the borrower and the partnership is
ended. If default occurs, both the bank and the borrower receives the proceeds from an
auction based on the current equity
Interview With Adnan Yousuf – Manager FAYSAL BANK LIMITED F-10 Branch.
Q: What is Islamic banking?
A: This is a banking activity based on Islamic principles, which do not allow the paying and
receiving of interest (riba’) and promotes profit sharing in the conduct of banking business.
Q: Is Islamic banking meant for Muslims only?
A: No. Islamic banking is for all individuals regardless of their religious belief.
Q: What are the differences between Islamic and conventional banking?
A: The most important difference between Islamic and conventional banking is the
prohibition of interest in Islamic banking. Islamic banking activity must comply with Shariah
principles and avoid prohibited activities such as gharar (excessive uncertainty). For
example, instead of lending with interest, Islamic banks provide financing based on Bai’
Bithaman Ajil whereby it is based on trade.
Q: How do Islamic banks and IBS reward their depositors since payment of
interest is not allowed?
A: Shariah allows the profit sharing arrangement between the bank and the depositor. Profits
from Islamic banking activities will be shared between the bank and the depositor based on
an agreed profit sharing ratio and paid in the form of dividends. The amount of dividend
payout depends on the profits generated from the bank’s operation. Shariah also allows the
bank to give hibah to its depositors based on its discretion.
Q: Where can I obtain Islamic banking products and services?
A: You can obtain Islamic banking products and services at any bank that carry the Islamic
banking logo and which provides Islamic Banking Services.
Q: Does the operations of the Islamic Banks banks fully comply with the
requirements of Shariah?
A: All Islamic banks are required to set up Shariah Committees to advise them and to ensure
that the operations and activities of the bank comply with Shariah principles. All products
and services offered by the Islamic banks and IBS banks must be approved by their
respective Shariah Committees.
Q: Can an IBS bank transfer credit balances of a customer's Islamic account to a

conventional account, or vice versa?
A: Upon a customer's request, an IBS bank may transfer funds from an Islamic account to a
conventional account. On the other hand, only the principal amount can be transferred from
a conventional account to an Islamic account. No element of interest is allowed to be
transferred.
Q: What are the avenues available if I am dissatisfied with the services provided
by Islamic banks or IBS banks?
A: You should contact your bank if you have any complaints. All banks have set up a
dedicated Complaint Unit to deal with customers’ complaints.

Project Report On Financial Statement / Accounting of Islamic Banking

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Project Report On Financial Statement / Accounting of Islamic Banking

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23 April 2009

-2- Financial Statement / Accounting

-3- Financial Statement / Accounting

In this paper, we provide a comprehensive comparative review of the literature on the

Objectives of Financial Statements:

-4- Financial Statement / Accounting

Statement Of Financial Position: also referred to as statement of financial position or

Statement Of Comprehensive Income: also referred to as Profit and Loss statement

Statement of retained earnings: explains the changes in a company's retained

Purpose of financial statements:

•Owners and managers require financial statements to make important business

-5- Financial Statement / Accounting

•Prospective investors make use of financial statements to assess the viability of

•Government entities (tax authorities) need financial statements to ascertain the

Qualitative Characteristics of Financial Statements:

UNDERSTANDABLE & USEFUL:

•Accounting information should be readily understandable to the intended users of the

•Typically the belief that, for information to be understandable, information contained in

-6- Financial Statement / Accounting

•Have predictive value

•Provide useful feedback on past decisions

•Representational faithfulness - the information represents what it claims to represent.

•Completeness - the reported information should not be missing a material fact or

•The concept of neutrality is sometimes incorporated into the concept of reliability.

COMPARABLE AND CONSISTENT:

•Information that is biased can be misleading.

-7- Financial Statement / Accounting

•General understanding that the development of accounting information consumes

"Objectives of Financial Accounting for Islamic Banks and IFIs"

Accounting encompasses several areas, generally agreed to include financial accounting,

3/1 Financial accounting

3/2 The financial Accounting Processes:

Financial accounting consists of the following processes:

3/3 The general objectives of financial accounting :

The main objective of financial accounting is to provide information, through periodic

3/4 Limitations of information provided by financial accounting:

-9- Financial Statement / Accounting

3/6 Limitations resulting from cost and benefit consideration

4. The importance of establishing objectives of financial accounting for Islamic

4/1 The importance of establishing objectives:

4/2 Differences between the objectives of financial accounting and financial

Financial accounting is mainly concerned with providing information to assist users in

Statement Of Financial Position analysis: Islamic vs. conventional

Table 1 below shows stylised Statement Of Financial Position of a conventional commercial

Table 1 Stylised Statement Of Financial Position of a conventional bank – based on

Table 2 below presents a stylised Statement Of Financial Position of an Islamic bank,

5/1 The major users of financial reports:

b) Holders of investment accounts.

d) Current and saving account holders.

It is possible to summarize the common information needs of users as follows:

4. Maintaining liquidity at appropriate levels.

5/3 Other financial reports:

6/1 Objectives of financial accounting:

6/2 Objectives of financial reports

8. ACCRUAL METHOD OF ACCOUNTING TO ISLAMIC BANKS:

9. ISLAMIC MODES OF FINANCING

Debt creating modes:

Partnership based modes

Murabahah (sale with or without deferred payment):

Basic Rules for a Murabaha transaction:

1. The subject of sale must be in existence at the time of the sale.

2. The seller must have the ownership of the commodity in question.

Purpose of Salam Contracts: