Chapter 2: Recording

Transactions and Market Values

in Islam
Discussion Questions
1. Briefly describe the steps in the accounting process.
The accounting process starts with the identification of the business
transaction, then analyzing business transactions and events to ensure that only
those related to the business entity are included in the process. The recording of
the transactions in the journals takes place. Transactions are then posted to the
Ledger. The trial balance is prepared to test the equality of the debits and credits.
Adjusting entries are then prepared in applying the accrual basis of accounting. An
adjusted trial balance is prepared after adjusting entries are made and before the
financial statements are prepared. The outcome of the accounting process in any
Islamic organisation includes the following Islamic financial statements: the
balance sheet showing the financial position of the organisation, the income
statement showing the results of its operations in the form of income, and cash
flow statements.
2. Discuss the Islamic view of the profit recognition principle.
According to the accrual version of the profit recognition principle, profit
should be recognized when transactions take place irrespective of the timing and
movement of cash.
The application of the accrual basis in an Islamic business environment
results in the computation of the wealth subject to zakat that conforms to Islamic
principles. AAOIFI adopted the accrual concept referring to the saying of Umar,
the second Muslim caliph, to a trader “Evaluate it [your merchandise] and then
pay its due zakat” (AAOIFI, 1999a, p. 308).
3. How was the osher (Ottoman tax on agriculture products)
determined? To which accounting principle this relates?
Osher was determined after deducting the cost of fertilisers and other
expenses related to the cost of agriculture products. This is an application of the
matching concept.
4. Discuss the concept of full disclosure in Islamic accounting.
 The concept of full disclosure ensures that any and all information of
substance or interest to users, to which they are morally entitled under the Sharia,
is provided to assist them in decision-making. In these circumstances, the business
conduct of followers must be seen to be based on true, just, and fair principles. For
instance, information disclosed about companies’ activities and their impact on
society at large should be accurate, complete, reliable, and free of bias and reflect
equitable treatment of the parties involved
5. What are the main differences between conventional accounting and
Islamic accounting with regard to the definition of assets?
Assets are economic resources that are entrusted to organizations by God
according to the Quran. Organizations benefit from these assets in accordance with
the Islamic Sharia. AAOIFI defines an asset as that which the enterprise has
acquired rights to hold, use or dispose and does not recognize assets based on
ability to control through other than legal ownership. An asset, in the conventional
sense, is regarded as an asset when there is a future economic benefit embodied in
the asset, regardless of whether there is legal control by the reporting firm. In
Islamic finance, to qualify as an asset, the Islamic organisations should have
acquired the right to hold, use or dispose of the asset. Thus, it is not clear that
AAOIFI endorses the concept of ‘substance over form’.
6. The requirements in the Quran helped to develop an accounting
system for the early Islamic state, explain the main procedures that
were developed and applied by government authorities and
individual entrepreneurs during the Islamic state to record, classify,
and post transaction in the books.
Muslims are required to record their indebtedness in accordance with Aiah
282 and 283 of the second Surah of Al-Baqarah. Aiah 282 is known as the debts
Aiah. It is the longest Aiah in the Quran and specifies all the requirements for
writing debts and business transactions (Zaid (2004)?). It was up to Muslims to
work out the detail of the recording system to ensure compliance with the above
requirements. During the early Islamic state recording procedures were developed
and applied by government authorities and individual entrepreneurs. Accounting
books were used to record business transactions immediately upon their
occurrence. Transactions were classified according to their type. Receipts were
recorded on the right side of the page and were classified and disclosed. Payments
on the other hand were recorded on the left side of the page. An explanation was
provided for each transaction. Empty spaces between transactions were not
allowed, and clearly crossed by a line call Attrkeen if they exist. By the same
token, corrections, overwriting, or deletion of transactions were prohibited.
Accounts were formally closed with a signature to indicate this. Similar
transactions were posted from preliminary, specialized books maintained for that
type transaction. This task was performed by a person other than the one who
recorded the initial transactions. The account balance was computed and was
referred to as Al-Hasel. Reports from accounting data were prepared on monthly
or annual basis to assist in decision making (Zaid, 2004).
7. Islamic financial statements share the same broad classification of
conventional financial statements. However, value added is an
important outcome of the Islamic financial accounting system.
Explain, why does the similarity exist, and what are the reasons of
the emphasis on value added in Islamic accounting?
An Islamic financial accounting system should facilitate the production of a
statement of financial position to reflect the status of the financial position at a
particular point in time. It should also facilitate the production of an income
statement to identify the results of operations over a period of time. The system
should also facilitate the production of a cash flow statements to report the flow of
cash in an out of the firm. Value added is an important measure in Islamic
financial accounting as it helps to identify the benefit the accounting entity brings
to the community at large. The latter is one of the most significant objective of
business organisations in Islam.
8.“Historical cost can be misleading both as indicative of values and in
the computation of zakat”. Discuss
AAOIFI adopted the cost concept in its conceptual framework, on the basis
that it is the method that produces the most reliable information. However, given
that zakat is one of the five pillars of Islam, accounting should play an important
role in enabling Muslims to pay zakat. Historical cost can be misleading both as
indicative of values and in the computation of zakat. Misleading values or
information is at odds with the Islamic value of justice, fairness and truthfulness in
Islam. Accounting information should enable Muslims to account for their zakat.
This implies that accounts prepared in an Islamic business environment should use
current values instead of, or in addition to, historical costs. The measurement of
assets in the balance sheet should be driven by the zakat requirements. The use of
market values as well as costs leads to the recognition in financial statements of
the difference between cost and market values; this difference is subject to zakat,
but is not distributable.
9.Explain the principle of tandeed in Islam
The principle of tandeed in Islam requires companies not to distribute any
profit resulting from business transactions until the invested capital is recovered.
While some scholars believe that the initial capital invested should be maintain
prior to any distribution of profit. Other scholars argue that this principle requires
the real capital or economic value to be maintain as opposed to nominal capital
and as such they are favouring the use of current values. However, the practical
difficulties associated with the implementation of market values may necessitates
 the production of two balance sheet one prepared on historical cost basis and
another on the basis of market values.

Exercises
1. Post the following journal entries from the books of Aafaq Islamic
Finance to their respective T accounts and compute the October 31
balances.
General Ledger

Cash Accounts Receivable

12 Oct 6,000 7 Oct. 4000 9 Oct 1,500 22 Oct 1,000

22 Oct 1,000 16 Oct 2,000

31 Oct. Bal. 1,000 31 Oct. Bal. 500

Revenue Rent Expense

9 Oct 1,500 16 Oct 2,000

12 Oct 6,000

31 Oct. Bal. 7,500 31 Oct. Bal. 2000

Material Supplies Accounts Payable

3 Oct. 3,500 3 Oct. 3,500

7 Oct. 4,000

31 Oct. Bal.7,500 31 Oct. Bal. 3,500

2. The ledger accounts of Dar AlFatina shows the following account

balances as of March 31, 20X6. Prepare a trial balance for the
company as of the same date.

Dar Al Fatina – Trial Balance as of March 31, 20X6

Debit Credit
 Cash $3,000
Accounts Receivable 6,000
Supplies 600
Office Equipment 3,000
Accounts Payable $4,500
Owners’ Capital 6,600
Dividends 3,000
Service Revenue 9,000
Rent Expense 1500
Salaries 3,000
20,100 20,100

3. During the month of June, the following transactions took place at

the Islamic Finance Training Company. Prepare the journal entry
for each of these transactions.
1. Cash.................................................................................................... 75,000
Owner’s Capital .................................................................. 75,000

Investment by owner in the company

2. Office Equipment ........................................................................................ 5,000

Cash..................................................................................... 5,000

Purchase office equipment for cash

3. Material Supplies ……………………………………………….... 7,000

Accounts Payable……………………………………………. 7,000

Purchase material supplies on account

4. Rent Expense ............................................................................................... 4,000

Cash..................................................................................... 4,000

Rent paid by cash

5. Cash ..................................................................................................... 18,500

Revenue .............................................................................. 18,500

Cash sales received

6. Salaries .....................................................................................................… 9,000
Cash............................................................................................. 9,000

Monthly Salaries paid by cash

7. Accounts Receivable ................................................................................... 10,000

Revenue............................................................................... 10,000

Sales on account
8. Dividend .....................................................................................................4,000

Cash..................................................................................... 4,000

Cash dividend paid

9. Cash ............................................................................................................. 4,000

Accounts Receivable ........................................................... 4,000

Accounts receivable paid

4. The general journal book of Al Markaz shows the following entries
for the month of November 20X6 transactions. You are required to
post these entries to their respective accounts in the general ledger
and prepare a trial balance as of November 30 20X6.
General Ledger
Cash

Dr Cr
75000 5000
3500 20000
2000
200
750
3000
1500
78500 32450
Bal 46050

Accounts Material Accounts

Receivables Supplies Payable

Dr Cr Dr Cr Dr Cr
3000 5000 7000
1000 7000
Bal 4000 Bal 12000 Bal 7000
Office Rent
Equipment Expenses
Dr Cr Dr Cr
3000 2000
Bal 3000
Bal 2000

Revenue
Dr Cr Dividend
3000 Dr Cr
3500 750
1000 Bal 750
Bal 7500
Bal 7500

Salaries
Utility
Dr Cr Expenses
1500 Dr Cr
Bal 1500 200

Al Markaz
Trial Balance
November 30, 20X6
Accounts Debit Credit
Cash $46,050
Accounts Receivable 4,000
Material Supplies 12,000
Office Equipment 3,000
Company Cars 20,000
Accounts Payable $7,000
Owner Capital 75,000
Dividends 750
Revenue 7,500
Rent Expense 2,000
Salaries 1500
Utility Expense 200
Totals $89,500 $89,500
 5. During a routine check on the accounts of Dar Al Fatina the
following errors were identified. You are required to state which of
these error causes an unequal total in the trial balance and which of
these errors causes the trial balance to be misstated but not
unequal.
The trial balance totals will be The trial balance totals will be
unequal misstated but not unequal
Errors
1 X
2 X
3 X
4 X