Documente Academic
Documente Profesional
Documente Cultură
Submitted to
PROFESSOR DR ZULKARNAIN MUHAMAD SORI
Submitted by
Md Akther Uddin - 1400225
Yousuf Sultan - 1400226
Mosharrof Hosen - 1500176
Nazim Ullah - 1500015
Table of Contents
1. Introduction..................................................................................................................................... 1
1.1. Emergence of Islamic finance and need for Islamic accounting..............................................1
1.2. Objective of the Study.............................................................................................................. 1
2. Substance over Form...................................................................................................................... 2
2.1. Example: Ijra......................................................................................................................... 3
2.2. The concept of substance over form from the sharah point of view......................................3
2.3. The Resolution of the Sharah Advisory Council (SAC) of Bank Negara Malaysia (BNM)
on the Principle of Substance over Form........................................................................................ 4
2.4. Literature Review..................................................................................................................... 5
2.5. Commentary............................................................................................................................. 5
3. Time value of money...................................................................................................................... 6
3.1. Interest, Time Value of Money, Discounting Factor and Its Implications................................6
3.2. The concept of time value from the classical to contemporary jurists.....................................7
3.3. Commentary............................................................................................................................. 8
3.4. Literature Review..................................................................................................................... 8
3.4.1. Commentary...................................................................................................................... 9
3.5. Resolutions on the Time Value of Money................................................................................9
3.5.1. Commentary.................................................................................................................... 10
4. Fare value measurement................................................................................................................ 11
4.1. Classical view on fair value measurement.............................................................................11
4.2. Arguments supporting the fair value measurement................................................................12
4.3. Argument against fair value of money...................................................................................12
4.4. Interpretation.......................................................................................................................... 12
4.5. Commentary........................................................................................................................... 13
5. Application of Probability Principle.............................................................................................. 13
5.1. Estimation of Probability under AAOIFI and IFRS...............................................................13
5.2. Literature review.................................................................................................................... 14
5.3. Resolutions of the SAC of BNM on probability...................................................................14
5.4. Other Resolutions related to the concept of Probability.........................................................15
5.4.1. Commentary.................................................................................................................... 15
6. Do We Really Need Accounting for Islamic Financial Transactions?...........................................15
7. Conclusion.................................................................................................................................... 16
References:................................................................................................................................... 19
1. Introduction
Accounting principles are the rules and guidelines that companies must follow when reporting
financial data. Accounting principles differ across the world, and countries usually have their
own, slightly different, versions of International Financial Reporting Standards (IFRS).
Generally Accepted Accounting Principles (GAAP) was widely used and accepted until IFRS
has emerged to harmonize accounting standards and currently IFRS standards adapted or
adopted in more than 120 countries across the world set by the International Accounting
Standards Board (IASB). IFRS are principles based rather than rules based (GAAP) which
guide countries to formulate their own accounting standards according to their local needs,
rules and regulations. The acceptance of IFRS has grown significantly not only in European
countries but also in the USA, where GAAP was widely used before worldwide convergence
towards IFRS. This convergence of course helps not only international acceptance and rating of
sovereign but also give better comparability picture for multinational investors for whom it
would be easier to compare various potential investing companies from different jurisdictions.
For example, Malaysian Accounting Standard Board formulates their own accounting standards
based on the IFRS principles.
concern regarding this concept of substance over form is that, in applying it, the reporting of a
Sharah compliant transaction may render it virtually indistinguishable from an interestbearing transaction. Thus the difference between a transaction in conventional bank and an
Islamic Bank will be insignificant.
2.2. The concept of substance over form from the sharah point of view
The paper argues that Sharah gives importance to both the form and the substance of the
transaction. However, as most Islamic financial products are designed by using a series of
contracts, debates arise as to whether the effect of each contract in isolation is to be recorded,
hence recognizing the form of each contract; or whether the overall economic effect of the
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series of transactions is to be recorded, thus recognizing the economic substance of the overall
transaction.
It further argues that the principle of substance over form is in line with the legal maxims of
Sharah. The following two legal maxims give precedence to the substance.
Matters are determined according to intentions.1
In contracts, effect is given to intention and meaning and neither words nor forms.2
The words maqsid and maani refer to the intention indicated by the verbal clues found in the
contract that change it to another contract. For example awlah can be contracted in the
name of Kaflah and vice versa. Similarly, Hibah can become Bay if an exchange is
conditioned. In case of Mudarabah, if all the profit is conditioned for the Mudarib, the contract
will become a qardh contract. On the other hand, if all profits are conditioned for Rabb-alMaal, the money will be considered Amanah in the hands of Mudarib (Al-Zarqa', 1989).
The paper mentions that the principle of substance over form is supported by Sharah and
majority of the scholars have supported it, including the Hanafs, Maliks and Hanbals.
However, Shafii scholars have disagreed and favoured the form over substance.
2.3. The Resolution of the Sharah Advisory Council (SAC) of Bank Negara
Malaysia (BNM) on the Principle of Substance over Form
The SAC of BNM, in its 57th meeting 3, has resolved that in principle, substance and form
are equally important and highly taken into consideration by the Sharah. In this regard, the
Sharah emphasises that substance and form must be consistent and shall not contradict
one another. In the event of inconsistency between substance and form due to certain
factors, the Sharah places greater importance on substance rather than form (BNM,
2010).
SAC further states that the principle of substance over form is in line with the legal maxims of
Sharah. In case the substance conflicts with the form, the substance will have the precedence.
2.5. Commentary
As mentioned above, the ISRA paper supports the principle of substance over form in financial
reporting based on its literature review and sharah resolutions. We agree with it; however we
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think that the issue doesnt need to go much further. Substance over form in financial reporting
has no conflict with the Sharah in the first stance.
The verse in Al-Quran (2:282) which orders us to write a contract says:
O you who believe! When you deal with each other, in transactions involving future
obligations in a fixed period of time, reduce them to writing. Let a scribe write down
faithfully as between the parties. (2:282)
The word writing denotes the writing of the contracts, rather than recording in the financial
reports. The financial reports are just some records, where we can use any of the principles
from substance over form or form over substance. This can be easily understood by the
majority Tafseers like Ibn Katheer, Qurtubi etc. However, since the reports are means of
communication between the stakeholders, therefore they should have some clarity. And thus we
propose that IFRS should have some additional notes or sections that clarifies the types of
contracts used in the financial reports, so that they are distinguishable from the interest based
contracts.
4 Time value of money. (n.d.) Financial Glossary. (2011). Retrieved October 2 2015 from http://financial
dictionary.thefreedictionary.com/Time+value+of+money
3.1. Interest, Time Value of Money, Discounting Factor and Its Implications
Interest is defined in IAS 39 as the consideration for the time value of money and for the credit
risk associated with the principal amount outstanding during a particular period of time. As
the computation of the time value of money and the discounting technique used in calculating
Net Present Value (NPV) generally involve reference to the interest rate, many Muslim jurists
consider this non-permissible as it is in conflict with the outlawing of interest charges (Rib)
under the Sharah (AOSSG, 2010). In other words, as conventional finance revolves around
the interest rate, time value of money is acceptable principle, however, some controversies arise
in Islamic finance when we consider in credit sale the deferred price is higher than the spot
price, also interest rate as a discounting factor to get the NPV of future cash flows of a stock,
project, or company. Consequently, Islamic banking in its current form also appears to accept
the validity of charging higher prices for future payments in comparison with prices for
immediate payment, such as in the case of the murabaha (cost plus profit) contract. For
example, an Islamic bank may charge a customer MYR 2 million for a house if he chooses to
repay over twenty years, but only MYR 1.5 million if he pays immediately in full.
In the following section, based on the ISRA article we are going to discuss the concept of time
value of money and various issues from the fiqh sources starting from the Quran, the Sunnah,
classical and contemporary jurists and the fiqh scholars.
3.2. The concept of time value from the classical to contemporary jurists
The paper argues that a literature review shows that the Sharah does not totally rule out the
concept of the time value of money. Authors provided authentic Quranic verses (The Holy
Quran, 75: 20-21; The Holy Quran, 87:16-17) to support the permissibility of the time value of
money, however, some scholars tend to disagree and they argue that these verses have nothing
to do with the time value of money, it is mere admonishing of people who prefer life here than
life hereafter. However, we can argue that an innate human nature (fitrah) is to prefer present
gratification (al-Masri; Khan FM; al-Zarqa) even though higher reward granted by Allah
(SWT) for deferred gratification and some people still prefer not to spend money immediately
and save it for the future consumption (Al-Muwdudi, Khan MA). Furthermore, classical and
contemporary jurists of four major schools of thought like, Al-Dasuqi, Al-Kasani, Al-Sharbini,
and Ibn Taymiyyah support the concept of time value of money, but no sound opposition from
scholars are noted in the paper. Therefore, we can state that the time value of money concept in
exchange contracts is well accepted among majority scholars but not in loan contracts as the
subject matter is money rather than an underlying asset. In this manner, positive time
preference has been found acceptable to Sharah scholars in an exchange contract (Khan,
1991; Khaf, 1994; Ahmad and Hassan, 2004).
It is well argued in the article that Sharah permissibility of Bay al-Salam and Bay al-Istisna
further strengthens the support in favor of time value of money. However, we can argue that the
difference in the present and future values of the same commodity cannot be considered to have
been allowed just because of the pure time element involved (Khan, 1991). As Khan argues that
the jurists could have allowed this difference because they recognized that supply and demand
forces are different at different points of time. Refuting the idea that demand and supply in the
future must have been considered to permit bay muajjal, Kahf argues that the legitimacy of
bay muajjal and bay salam can be rationalized along the lines of musharakah, mudarabah,
and ijrah on the basis of ownership and the distinction between moneys anticipated and
realized time value (Kahf, 1994). According to Siddiqui, unlike Kahfs assertion, bay muajjal
is neither similar to mudarabah or musharakah, nor could its permissibility be linked to bay
salam.
While the paper argues that the time value of money concept is also applicable in evaluating
projects under construction and higher deferred price in future is settled. But the issue of using
interest rate in the discounting process, similar to the conventional practice, given that the
Sharah prohibits a fixed promised return on debt transactions, is a significant issue. The issue
was also raised by PricewaterhouseCoopers (2010) more specifically, the question is whether
the use of a discount rate benchmarked to the interest rate for calculation of fair value purposes
actually poses a problem in the context of Islamic financial transactions. Khir (2012) states that
there is no consensus regarding this among scholars, some argue there is no issue in using
interest rate as a benchmark as they consider this a human innovations which do not contradict
Sharah. On the contrary, Zarqa (1983) totally rejects it although he concluded that discounting
is accepted and even desirable for promoting investing efficiency, consequently he proposes to
use return on equity as the appropriate discounting rate.
3.3. Commentary
Based on the research paper, we can argue that economic agents in an Islamic economy will
have positive time preference and there will be indicators available in the economy to
approximate the rates of their time preferences. There is no justification to assume zero rate of
time preference in an lslamic economy as is done in many studies on investment behavior from
lslamic perspective (Khan, 1991; Khaf, 1994; Ahmad and Hassan, 2004). In the following
section, we are going to present a review of selected works on the time value of money from
Sharah perspective.
3.4.1. Commentary
From the above discussion, we can conclude that the principle of time value of money (TVM)
is controversial, as Sharah scholars hold differing views regarding its conceptual and practical
foundation in the Islamic financial system. The opponents of TVM have argued that
recognizing it will lead to acceptance of Rib, against which Islam is at war. (al Mawdudi,
Khan M A). There are arguments for time value of money as time can be given a counter-value
in association with real commercial activities; as a result, this concept should not be
disregarded in financial transactions, such as deferred sales, in order to uphold justice, given
that it must be applied in accord with the specific Sharah parameters. It can be concluded that
the Islamic legitimacy of TVM is established on four bases: 1) the concept of Positive Time
9
Preference (PTP); 2) the permissibility of a different price in a cash sale as opposed to a credit
sale; 3) the permissibility of bay al-salam and bayal-Istisna; and 4) Islamic legal maxims.
3.5.1. Commentary
By examining resolutions and guidelines regarding the application of time value of money in
Islamic financial transactions, we can argue that majority scholars accept the current use of
time value of money concept in murabaha financing as there is an underlying asset and higher
deferred price is justified due to risk associated. However, there is no resolution so far
regarding using interest rate as a discounting factor in capital budgeting technique but some
scholars seem there is no issue in using interest rate as a benchmark (Karim, 2001). Therefore,
we tend to agree based on the principle of permissibility in muamalat otherwise not prohibited
by Sharah is permissible, the time value of money is the fundamental principle of finance,
and majority scholars agree that time does have economic value, therefore they approve time
value of money concept in exchange contract and prohibit mere charging of interest on loan
contract.
values) rather than on other measurement bases such as the lower of historical cost or net
realizable value (Ibrahim, 2007).
It also appears that the principle of fair value is already being applied within the practice of
Islamic finance. For instance, fair value is recognized by all authorities in murabaha financing,
especially in the event of customer default. When a customer cannot afford to pay the
installments, the Islamic bank will usually sell the asset based on the market value rather than
the historical value.
4.4. Interpretation
Seng and Mean (2005) argued that both true value and historical value are important in the
organization. True value is needed to determine the investment and historical value is needed
12
for the real cash flow and indicate whether management has achieved operating results that
were budgeted or predicted.
According to Azmi (2010), while both AAOIFI and IFRS rely on the concept of fair value, their
views apparently differ when there is no active market, which makes assessment of fair value
more difficult. The IFRS view is that measurement of fair value may require the use of
valuation techniqueswhich often make use of discount ratesrather than relying on quoted
market prices. AAOIFIs (2010) FAS 25, Investment in Sukuk, Shares and Similar Instruments,
mentions the use of estimation techniques to derive fair value when quoted prices may not be
indicative of fair value, but it does not elaborate further regarding the permissibility of using
discount rates in determining fair value. Finally, AAOIFI and IFRS should be harmonized so
that to resolve the differences in the accounting treatment and disclosures of the financial
Islamic transaction.
4.5. Commentary
According to our opinion after analyzing ISRA paper and other related papers both fair value
and the historical cost are very significant for the institution, since fair value estimation will
help the institution for taking investment decision whereas historical cost will help it finding
actual cash flow estimation.
than one financial period, the Islamic banks share of profits for any period, resulting from
partial or final settlement between the Islamic bank and the mudarib, shall be recognised in its
account for that period to the extent that the profits are being distributed; the Islamic banks
share of losses for any period shall be recognised in its account for that period to the extent that
such losses are being deducted from the mudarabah capital (AAOIFI, 2010, FAS No. 3,
Paragraph 2.4).
In the case of ijrah muntahiyah bi al-tamlik, there is a lease with a wad to transfer ownership
of the leased asset. Under IFRS, if it is demonstrated that it is probable that the transfer of
ownership will occur and the value of the transferred item can be measured reliably, then the
transfer transaction should be recognised, leading to a finance lease treatment. This treatment is
different from AAOIFI, which would require the separation of the lease and transfer
transactions.
Based on the above discussion we can conclude that, AAOIFI favors recognition of actual
profit or loss calculation in deriving the banks share in mudarabah profit or losses. Further, it
is silent on accepting expected losses used in the impairment model espoused by the IFRS
exposure draft.
valid probability, which is defined as events yet to occur that do not contradict injunctions
from the Quran and Sunnah.
5.4.1. Commentary
There is no specific sharah resolution on the concept of probability in reporting Islamic
financial transactions has. From resolutions on the issue of wad (whether it is a binding or
non-binding promise), we can safely presume that the Sharah scholars dont have any
objection to adopting this concept. This is because all fatwa-issuing bodies agree that a promise
is binding on the promisor. If the promisor reneges on his promise, compensation must be paid
for damages caused as a result of its non-fulfillment without a justified excuse. Moreover,
AAOIFI (2008), in its Sharah Standard No. 8/2/3 (pp. 116-117) and its basis of the Sharah
rulings (p. 129), argued that the customer may be forced to fulfill his obligation based on the
general sources of the Quran and the Sunnah that require fulfillment of obligations and
undertakings. Dallah Al-Barakah does not mention clearly the Sharah justification of its
resolutions. In this regard, the principle of probability in Islamic financial reporting is
permissible.
15
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7. Conclusion
Accounting for Islamic financial transactions has been evolving as a separate discipline from
mere intellectual discourses among academia. The development of Islamic finance, namely,
Islamic banking has stimulated the need for separate accounting frameworks for financial
institutions which run on the principles of Islamic Sharah. Hence many proponents argue that
it is high time to develop unique standards in order to be distinct from conventional financial
system. Consequently AAOIFI has been established exclusively for developing accounting
standards of IFIs but the acceptability of its standards is not overwhelming and only confined
with few gulf and African countries. On the contrary, many argue that IFIs can easily
accommodate existing accounting standards issued by IFRS to comply with Sharah with
minimum modification, therefore, propose greater convergence towards IFRS like in Malaysia.
In doing so, scholars try to find controversial accounting principles that exist in IFRS
accounting standards which may contradict with Sharah principles and subsequently identify
four accounting principles: substance over form, the time value of money, fair value
measurement and probability.
The principle of substance over form in the reporting of a Sharah compliant financing
transaction means that the end result or substance of the transaction is recorded. The area of
concern regarding this concept of substance over form is that, in applying it, the reporting of a
Sharah compliant transaction may render it virtually indistinguishable from an interestbearing transaction. Thus, the difference between a transaction in conventional bank and an
Islamic Bank will be insignificant. As a result, we tend to argue that the issue doesnt need to
go much further as substance over form in financial reporting has no conflict with the Sharah
in the first stance. The financial reports are just some records, where we can use any of the
principles from substance over form or form over substance. This can be easily understood by
the majority Tafseers like Ibn Katheer, Qurtubi, etc. However, since the reports are means of
communication between management and the stakeholders, therefore they should have some
clarity. Therefore, we propose that IFRS should have some additional notes or sections that
clarify the types of contracts used in the financial reports, so that they are distinguishable from
the interest based contracts.
Time value of money is a fundamental concept in not only conventional finance but also in
Islamic finance as Sharah does not totally rule out this principle. Majority of scholars tend to
agree that time has economic value therefore it is necessary to take into consideration with
higher deferred price in credit sales, where payment will be made in the future and there might
be risk and uncertainty associated with it, subsequently to upheld justice for both parties in the
contract. It can be concluded that the Islamic legitimacy of TVM is established on four bases:
1) the concept of Positive Time Preference (PTP); 2) the permissibility of a different price in a
cash sale as opposed to a credit sale; 3) the permissibility of bayal-Salam and bayal-Istisna;
and 4) Islamic legal maxims. Although, there is no resolution so far regarding using interest
17
rate as a discounting factor in capital budgeting technique but some scholars consider there is
no issue in using interest rate as a benchmark (Karim, 2001). Therefore, we tend to agree based
on the principle of permissibility in muamalat otherwise not prohibited by Sharah is
permissible, consequently, time value of money concept is acceptable in exchange contract and
prohibit mere charging of interest on loan contract.
Fair value measurements have placed greater function in financial statements, because this
information is perceived as more relevant to investors and creditors than historical cost
information in making financial decision. Proponents of this concept tend to argue that such
values are useful to investors in their decision making. Such values stress current cash flow
expectations for financial assets as opposed to historical cost and amortized historical cost.
According to our opinion after analyzing ISRA paper and other related literature on both fair
value and the historical cost are very significant for the financial institution and scholars
consider the role of experts and the use of estimation techniques in determining the fair value
when there is no clear market price for a commodity. However, the issue of using interest rate
as a discounting factor in an estimation technique is still to be resolved.
The principle of probability refers to the practice of recording transaction although the contract
has not yet been completely concluded. In this regard, assets will be recorded once there is a
probability of economic resources inflow whilst liability will be recorded once there is a
probability of economic resources outflow due to current obligation and its amount can be
estimated with certainty. Even though the paper states that certainty is the highest level of
confidence in Islam but at present there is no specific sharah resolution except the SAC of
BNMon the concept of probability in reporting Islamic financial transactions. From resolutions
on the issue of wad (whether it is a binding or non-binding promise), we can safely presume
that the Sharah scholars dont have any objection to adopting this concept. This is because all
fatwa-issuing bodies agree that a promise is binding on the promisor. If the promisor reneges on
his promise, compensation must be paid for damages caused as a result of its non-fulfillment
without a justified excuse. As a result, we can argue that the principle of probability in Islamic
financial reporting is permissible.
Finally, we can confirm that four fundamental accounting principles are more often than not in
line with sharah principles based on opinions of classical and contemporary fiqh scholars
which are also supported by resolutions from various SAC in different countries. Although,
there is no specific sharah objection on these principles, there exist strong arguments for the
separate accounting principles for IFIs in order to be distinctive from conventional financial
system and ultimately fulfill the goal of Maqasid al- sharah.
18
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