1.

0 Introduction
Over the last decade, Malaysia has aggressively progressed by striding to advance as a major
Islamic Financial Hub. The development of Islamic finance in Malaysia received firm support by
firmly established financial institutions and further supported by robust regulatory framework.

Currently, in Malaysia the increase in the awareness for Islamic products encourages the need to
have a robust Islamic financial institution (IFI) in order to support the rise for Islamic banks in
Malaysia. Whilst conventional banking institution have gained trust from the general public, the
popularity and widespread use of Islamic banks (IB) can still be expanded.

However, as an IFI, an Islamic bank is envisaged to emulate Islamic values in all aspect
especially to the eye of its stakeholders as the users of its services or banking products. Any
Islamic corporation specifically Islamic financial institution needs to have a reliable governance
model and proper strategies that will encourage the implementation of robust and effective
corporate governance (CG) within the Islamic context.

Base on BNM Governance Framework 2010, Shariah audit refers to the periodical assessment
conducted from time to time. This is to provide an independent assessment and objective
assurance designed to add and improve the degree of compliance in relation to the Islamic
financial institution IFIS business operation, with the main objective of ensuring a sound and
effective internal control system for Shariah compliance.

The function of Shariah Audit shall be performed by internal auditors, who have acquired
adequate Shariah-related knowledge and training. In addition, the internal auditors may engage
the expertise of the Islamic financial institution IFIs Shariah officers in performing the audit, as
long as the objectivity of the audit is not compromised.
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The development of audit shariah in Malaysia can have many kind of benefit. Good development
on the shariah audit providing guidance on Islamic capital Market (ICM) transactions and
activities with the aim to standardizing and harmonizing application. The audit shariah serve two
main Islamic perspective of disclosure which is full disclosure and social accountability. They
tend to server the disclosure of information with the public interest. It demonstrating their
accountability to the decision maker, and the most pertinent information items from an Islamic
perspective is often lacking.

1.1 History of Shariah Accounting and Shariah Auditng development in Malaysia

1983
Islamic Banking Act (IBA) 1983 was enacted in Malaysia. The first full-fledged Islamic Bank
was established in Malaysia.

1984
Takaful Act 1984 was enacted to provide regulation for takaful business in Malaysia.

1996
Amendment to section 124 of banking and Financial Institution Act(BIFA) allowing
conventional banks in Malaysia to offer Islamic banking products through Islamic window.

1998
Interest free Banking Scheme (SPTF) was upgraded to Islamic Banking Scheme allowing
convention banks to open full-fledged Islamic banking subsidies.

2001
Malaysias Financial Sector master plan sets target for Islamic Finance to make up 20% of the
finance sector by 2010.

2002
Islamic Financial Services Board (IFSB) was established in Malaysia.

2003
Bank Negara Malaysia (BNM) guidelines or outsourcing of Islamic banking operating (23rd June
2003)

2004
BNM provides guidelines on directorship for Takaful Operators. (8th November 2004)

2005
BNM provides guidelines on the Government of Shariah Committee for Islamic Financial
Institutions (1st April 2005).
BNM issues guidelines on Financial Report for Licensed Islamic Banks (1st July 2005).

2007
BNM provides guidelines on Corporate Governance for Licensed Islamic Banks (24 th January
2007).

2008
BNM guidelines on outsourcing for Takaful operators (22nd July 2008)

2009
Amendment of section 51 of Central Bank Act(CBA) to position the Shariah Advisory Council
of BNM as the open authority for the determination of Islamic laws for the purpose of Islamic
Financial business.
BNM provides guidelines on Introduction of New Products (18th May 2009).
BNM issues guidelines on Introduction of New Products for Insurance Companies and Takaful
Operators (1st July 2009)

2010
Launch of the new Shariah Governance Framework by BNM (effective 1st January 2011)
BNM guidelines on Internal Audit Function Of Licensed Institutions (1st July 2010)
BNM guidelines on Financial on Financial Report for Takaful Operators (23rd December 2010)

2011
By 30th July 2011, IFLs are to company with Shariah Governance Framework.
Currently: Launch of phase 2 of the Financial Services Masterplan (FSMP).

2.0 Currents issues and Problem statement

Malaysia is the model that representing a modern Islamic country due to it islamization process
to infuse Islamic values throughout the country at all the level from individual to institutional
organisation. The development on the audit Shariah in Islamic bank believes to disclose the
information in transparency and accountability.

It is believed that good development on the shariah audit providing guidance on Islamic capital
Market (ICM) transactions and activities with the aim to standardising and harmonising
application. The ICM transaction leads the ways that do not conflict with the principle of Islam.
Such application would be implementing in the each of the market as well as the corporate social
reporting. It demonstrating their accountability to the decision maker, and the most pertinent
information items from an Islamic perspective is often lacking.

From the prior study, the audit shariah serve two main Islamic perspective of disclosure which is
full disclosure and social accountability. They tend to server the disclosure of information with
the public interest. The transparency of the information is provided to the user to make sure fulfil
their desired on the information. In Islamic context it defined that the ummah (public) had the
right to know the operational effects of an organization weather its well-being together with the
Shariah requirement being achieved.

The finding by Haniffa (2002) Islamic Social Reporting is also an extension to development of
the Audit Shariah. It focus on social justice goes beyond reporting on the environment, minority
interests and employees. It also concern with the issues related to the well-being of the society on
the unfair trading practices such as zakat. However, there are few factors that affect the
development of audit shariah toward the future, such as profitability, board composition, and
industry type. This result show few studies in influencing social reporting while failed to provide
evidence on these factors influence social reporting.

From our studies, we found out that even though the auditors are responsible in auditing the
financial statement and give reasonable assurance that the financial statement is free from
material misstatement, but the external auditor does not access or audit the transaction made by
the shariah listed company. It does not have the proper framework in the development of the
Audit shariah. Furthermore, in the market there might impose the internal department level such
as internal audit department, but there are no independent party being appoint to audit the
financial report of the Islamic Financial Institutions. It had been a challenge for the audit shariah
to be undertaken.

Nowadays, the development of the audit shariah required an independent and qualified shariah
person. The person who audits the report must know all the information regarding the shariah
requirement as well as have the qualification on the chartered accountant. If the person who carry
on the shariah work without the competent in shariah, he or she will not considered carry on their
duties.

Next issue is professionalizing the role of Shari'ah auditors: How Malaysia can generate
economic benefits. Malaysian can generate economic benefit by implementing Shariah Audit in
the country; it can prevent instances of Shari'ah non-compliance which is a peculiar risk to all
institutions operating under an Islamic worldview domain. The previous paper state that Islamic
law must be developed as guide for those who conduct the financial audit for Islamic Institution
or Islamic enterprise because the accounting principle compatible with Islamic Law.
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Previous study state that relationship between corporate governance and external auditing in
Islamic banks observed that in theory it is argued that the role of a Shari'ah auditor in an(Islamic
Financial Institution ) IFI is different and wider than a conventional auditor due to checks for
Shari'ah compliance. But in practice, they observed that there is a vacuum in Shari'ah auditing as
external auditors fail to check for Shari'ah compliance issues due to their lack of knowledge in
this area.

Shariah compliance also faces challenge in Islamic bond markets. The challenges of
implementing shariah which are there is high cost associated with Shariah compliance makes
non-compliance an inherent risk in a system involving profit maximizing issuing firms. The
problems become conflict with the possibility of fatwa shopping, where the issuing firm can
move away from the ethical advisor enabling them to issue less Shariah compliance but more
profitable or low risk structure. The problem is much more severe in the bond market where the
Shariah standards are lax and the Shariah advisors can be hired on a one-off basis.

Another prevailing circumstance in terms of shariah auditing is Shariah screening process in

Malaysia. Screening process is design to identify the elements that violate the rules and
guidelines of Shariah law, which rooted from al-Quran, and the teaching of Prophet Muhammad.
Shariah law prohibits elements such as usury (riba or interest), gambling (maysir) and
uncertainty (gharar). These elements are present in many conventional financial activities.

For a Muslim, this means getting involved indirectly in prohibited practices, which is considered
as grave sin.(Adam, 2012). Shariah screening is conducted to eliminate stocks believed to be
unacceptable for investments, which involve in prohibited element including liquor, gambling
and riba.

Besides, another issue highlighted would be in terms the auditors need to have the analytical
thinking competency as they need to perform procedures using certain professional skill and
techniques to verify the truth and fairness of their clients financial statement this is because the
conventional audit on the financial statement has long been associated to independent
verification on whether the institutions financial statement has been presented with true and fair
view.

The function of audit from the Islamic view is much more important and mandatory as it
manifests the accountability of the auditors not only to the stakeholders, but ultimately to the
Creator, Allah s.w.t as the Muslims believe that ones action and thoughts are always being
watched by Allah (the concept of Muraqabah).

3.0 Literature Review

Shariah Advisory Council in Malaysia was established in 1996 to serve the purpose of advising
the Securities Commission on Shariah related matters. Among the notable services or advisory
provided by this institution are providing guidance on Islamic Capital Market (ICM) transactions
and activities. ICMs nature is such that it does not conflict with the fundamental principles of
Islam.

(Haniffa, 2002) quoted that, ICM has led to ISR stating that the Muslim business leaders and
critical decision makers have expectations that relevant informations disclosed by companies
may assist them in fulfilling their spiritual needs. This is because when a company fully discloses
its information by adopting corporate social reporting, it directly reflects the companys
accountability to the decision makers.

Other studies conducted in the sector of shariah auditing are by; Zurina, Shafii, Nor Aishah,
Mohd Ali & Nawal Kasim, (2014) which indicates that there is a serious need for a strong
Islamic Financial Institution (IFI) as the awareness on Islamic products has increased and also
support the continuous development of Islamic banks in Malaysia. Even though, conventional
Banks have managed to garner more trust from the people, Islamic banks still have their potential
to be expanded.

Besides that, Ernst and Young World Competitive report (2013-2014) estimated that Malaysias
International Islamic banking assets has anticipated to raise about RM 1.27 trillion by 2018 from
current RM 410 billion (2012) (Bernama, 2014). Global Financial review found that, over past
30 years, the Islamic sector has grown from 0 to RM 1.6 trillion in assets. Despite the financial
crisis, the industry has still grown from 19%-21% in 2011 and 2012, (Popper, 2013).

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Other than that, another development highlighted by Zurina Shafii, Suppiah Salleh &
Syanidawati Hj Shahwan (March 2010), in their study is that, shariah compliance audit is
necessary to ensure that shariah committee are able to confirm that the IFIs conduct their
operations in accordance with the guidelines and standards issued by Shariah Supervisory Board
of IFIs, Accounting and Auditing Organization for Islamic Financial Institution (AAOIFI).

Mainly their objective is that all the activities carried out are shariah compliant. In Malaysia
itself, there are Shariah Advisors who help to prepare a written shariah opinion, similar to the
audit opinion provided by the conventional auditors. The concept is that, the audit procedures
conducted in means of Shariah are more towards the fundamental principles of Islam and is very
strict compared to normal conventional audit. Moreover, it is based on Islamic teaching that
obeys certain rules and mandate by the Almighty.

In another study, Shahul and Yaya, 2005, believe that shariah auditing plays an important part in
stirring awareness among islamic institutions to contribute in achieving the desired objectives of
the Islamic law Maqasid Ash-Shariah. The main suggestion on it this matter is that regular
independent shariah audit should be conducted in IFIs as the society currently requires are
thorough audit in everything as the credibility of information are continuously decreasing in
current times.

Syed Alwi, 2007, mentioned that shariah audit should be conducted in a timely manner and
extended to all activities such as activities relating each other. For instance, chain of activities
interrelated to each other like the system, the products, the employees, the environment and the
society. It is important to develop a proper shariah audit framework in achieving the main goals
of shariah compliance in IFIs so that a proper contribution can be made to the overall society
(ummah).

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However, in the study made by Nawal, Shahul & Maliah, 2005, they found that there is a gap
between what actually desired and what ought to be desired. This means that, there is a gap
between what is actually practiced and what is desired from shariah auditing.

A deeper study in terms of development is on the formation Shariah Supervisory Board (SSB)
which is one of the most important governance mechanisms of an Islamic Financial Institution
(IFI) to ensure compliance with Shariah. In addition, one clear approach which were taken by the
IFIs is to introduce Islamic financial products which are parallel to the Shariah law. In brief, the
purpose of these products should not be to maximize profit by complying with the mechanism of
these products with the Shariah law, but instead, the objective of these financial products have to
be in line with the Shariah as well, which is to help the public to avoid from riba and poverty (i.e.
maslahah).

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4.0 Limitations and criticisms

The realization of Shariah Auditing is an uphill task. International Accounting Standards Board
(IASB) states that the current framework of shariah accounting does not cover the adequate need
of the accounting transaction as specific as they are covered in the IFRS. Besides that, there have
been very less support by the Islamic countries in the development of shariah auditing because
they are currently using conventional accounting standards. This in return may have caused a
resistance to change by the members of the OIC
In Malaysia; MASB had plans to adopt AAOFI standards for the purpose of use of Islamic
institutions and businesses. However, due to certain differences the implementation and
adaptation have been stalled. AAOFI on the other hand, has failed to play its purpose in
governing and developing Islamic accounting and auditing standards. This is because,
statistically, out of 56 countries who are the members of OIC, only 6 countries chose to apply
AAOFI standard and the others still have not opt to adopt to this standards. Therefore, it became
difficult to practice shariah accounting and auditing in Malaysia.

Another limitation would be in where numerous questions have been arising mostly among the
Islamic practitioners themselves who cast doubt on the need of Islamic Accounting. This is a
major setback as the ones who need to support and develop shariah system are questioning it.
Recently, in Malaysia, it has been told that the top notch in CIMB have publicly rejected the
need of Islamic accounting and shariah auditing by stating that it is better to use conventional
aspect as they cover a wider aspect.

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Other issues include:

The effect of dual operating frameworks in most of the OIC countries
The government in these countries will face a huge difficulty as they need to introduce
amendments to local laws and legislations to allow these IFIs and non-IFIs to implement Shariah
principles in the financial reporting structures of their statements.

The development of conventional accounting principles and auditing method for a period
more than 100 years
Since conventional accounting is being heavily developed, backdated to almost a hundred years,
it will cause a lot of parties to resist on the shariah accounting and auditing. This is because;
there will be resistance to change among the practitioners who have practiced the conventional
way for a long time.

Lack of expertise and skills

Another serious limitation for shariah auditing will be in terms of skills and expertise. This is
because, in the current modern world, the scope for shariah auditing and Islamic accounting
offered to study is very low and most of the western powers have limited the scope for this sector
in their respective institution. Since, the scope is limited; Malaysia is also facing difficulties in
producing expert on shariah accounting and auditing matters.

Cost
Cost is also another contributing factor for institutions and businesses in Malaysia to adapt to
shariah accounting and auditing. This is because; it will definitely cost these companies a lot to

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convert from conventional accounting to Islamic accounting as the service of an expert is very
scarce.
Only IFIs are practicing Shariah accounting and auditing in Malaysia
This indicates that the demand for other businesses are very low when it comes to Islamic
accounting. Hence, since there are limitations in terms of number of businesses wanting to
convert to shariah based accounting, the development of shariah auditing and accounting are
limited and cannot be widely achieved here.
Convergence
Currently, the world is moving towards convergence. Convergence here is in the context of
standardization of accounting principle across the globe. Hence, Islamic finance and shariah
auditing might be considered as a disintegrator. It is also due to the worldviews of conventional
economic and financial systems that are different from the Islamic economic and financial
systems.

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5.0 Recommendations

Shariah Audit Framework & Training

A body should be formed to provide shariah Audit Framework for entitys requiring it. Besides,
the body should also provide training for all the personnel involved. This body should be an
independent body and should be recognized by Bank Negara Malaysia and Malaysian
Accounting Standards Board (MASB)

Provide a specific Shariah Auditing Framework for all other entities including SMEs and
other businesses.
Currently, in Malaysia, only financial institutions are applying shariah accounting. Hence, the
scope of shariah auditing is limited to these institutions. Hence, if Shariah Accounting is
introduced to SMEs and other businesses, the scope of shariah auditing can be expanded.

Increase the demand for shariah accounting and auditing

There should several measures taken on the effort to increase the demand of shariah auditing and
accounting in Malaysia. Notably, this effort can be taken by the government by providing
incentives to companies that practice shariah auditing. The incentives can be in any means. For
example, tax incentives and so on.

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Shariah Risk Management Framework

Shariah risk considerations should be embedded into the risk management framework to help the
management and address shariah non-complaint risk effectively. With shariah risk management
framework, the institutions will be able to better manage their financial risks.
Another contribution of this framework is that it will increase the transparency of the shariah
audit. It is done through several methods, such as:
i.)

Categorizing each product in accordance with shariah requirements

ii.)

Conduct shariah audit instead of conventional audit using the framework

iii.)

Do a regular check up with Shariah Supervisory Board (SSB) to maintain the

credibility of shariah audit

6.0 Conclusion
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As a conclusion, it can be deduced that the development of shariah auditing in Malaysia is still at
its infant stage. This is because; only IFIs are applying shariah auditing. Other than that, the
frameworks and guidelines are still not as clear as the conventional audit framework and
guidelines. Next, it terms of acceptance, it can be said that there are still a lot of argument among
the Muslim countries on the implementation of shariah auditing as most prefer to adopt the
standards of IASB compared to AAOFI. Besides that, the lobby group such as IASB, MASB
and other bodies governing the accounting principles would resist in accepting the underlying
principles as the western world dominates the accounting policies throughout the globe.
Hence, in Malaysia itself, MASB faces some conflict in accepting shariah accounting principles
and stalls the discussion paper on this issue. In a nutshell, if the recommendations are
implemented and the limitations are resolved, there will be a vital improvement in the
development of shariah auditing in Malaysia.

7.0 References

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Zurina Shafii, Nor Aishah Mohd Ali and Nawal Kasim 2014, Shariah audit in Islamic
banks: an insight to the future shariah auditor labour market in Malaysia retrieved on 10
January 2015 from http://www.sciencedirect.com

Hisham Yaacob ,2012 Issues and challenges of shariah audit in islamic financial
institutions:

Contemporary

View

retrieved

on

10

January

2015

from

http://www.googlescholar.com

Rohana Othman, Azlan Md Thani, Erlane K Ghani (October 2009), Determinants of

Islamic Social Reporting Among Top Shariah-Approved Companies in Bursa Malaysia,
retrieved on 10 January 2015 from http://www.googlescholar.com

Zurina Shafii, Supiah Salleh, Syahidawati Hj Shahwan, March 2010, Management of

Shariah Non-Compliance Audit Risk in the Islamic Financial Institutions via the
Development of Shariah Compliance Audit Framework and Shariah Audit Programme
retrieved on 10 January 2015 from http://www.sciencedirect.com

Nawal binti Kasim, Assoc. Prof. Dr Shahul Hameed Mohamad Ibrahim, Prof. Dr Maliah
Sulaiman, 2008, Shariah Auditing in Islamic financial institutions: Exploring the gap
between the desired and the actual

retrieved on 10 January 2015 from

http://www.sciencedirect.com

Mohd Hairul Azrin Haji Besar, Mohd Edil Abd Sukor, Nuraishah Abdul Muthalib and
Alwin Yogaswara Gunawa, The Practice of Shariah Review as Undertaken by Islamic

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Banking Sector in Malaysia International Review of Business Research Papers Vol.5 No. 1
January 2009 Pp. 294-306 retrieved from http://www.googlescholar.com

Khatkhatay, M.H. and Nisar, S. (2007). Investment in Stocks: A Critical Review of Dow
Jones Shariah Screening Norms. Paper presented at the International Conference on
Islamic Capital Markets. Retrieved on 10 January 2015 from http://www.kantakji.com

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