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And We created not the heavens, the earth and all between them, merely in (idle) sport. We created
them not except for just ends. But most of them do not understand(Al-Qur’an, 44:38-39).
The establishment of objectives is an absolutely necessary first step in the reasoned development of
any purposive human behaviour. Objectives of financial statements must be discerned if subsequent
debate over alternative standards and reporting practices is to be resolved by reason (AAA, 1975, p41)
6.0 INTRODUCTION
In chapters 3, 4 and 5, the researcher discussed the need for an alternative “Islamic
accounting” which is more useful to Islamic organisations and Muslim users. These
factors which suggested the need were classified into the “Push” and “Pull Factors”.
In chapter 4, the push factors were discussed where the researcher attempted to
organisations. In the previous two chapters, the pull factors which make Islamic
In this chapter, the researcher shall attempt to define the objectives and
accounting will lead to Islamic organisations and other users of Islamic accounting
information to carry out tasks that will lead to achievement of the socioeconomic
objectives for which Islamic organisations were established in the first place. Further,
the researcher has so far avoided defining Islamic accounting. The reason for this is
that this research project is exploring an evolving discipline, which is not well defined.
In fact, part of the research project, is to explore the perception held by Muslim
an entity which will enable them to ensure that the entity is continuously operating
within the bounds of the Islamic Shari’ah and delivering its socioeconomic objectives.
Islamic accounting is also a tool, which enables Muslims to evaluate their own
The chapter proceeds as follows: in section 6.1, the methodology for constructing
accounting theories is discussed and arguments are presented for the methodology
businesses and Islamic accounting. The objectives of Islamic accounting are then
arrived at from the ethical objective of Islamic accounting users (i.e. to attain falah,
dual world success). The operational basis and main objective of Islamic accounting
(the notion of accountability) are then discussed in section 6.3 and a model of Islamic
information are identified in section 6.5, and their relative importance compared to
fund providers who are given prominence in conventional accounting, are discussed.
The characteristics of Islamic accounting are then suggested in section 6.5, in terms
of the type and nature of information which should be disclosed, the general
The methods used to test the proposals discussed in this chapter will be discussed in
How does one develop a theory of Islamic accounting? From the lessons of
“other” approaches. The “other” approaches include the events, behavioural, human
information system, and the predictive and positive approaches. However, the
be gauged from both Belakoui (1992) and AAA (1977); the empirical inductive
approach, the deductive approach and the information theory approach (Whittington,
1986).
the AICPA, and the CCAB, is one such approach; where standards are set as
For the past two decades, the empirical-inductive theory has slipped into the realm of
positive accounting theory (or PAT). The proposers of this theory, Watts &
Zimmerman (1986) attempted to argue that accounting theory should be positive i.e.
attempt to explain what is and help to predict future events, instead of trying to
preach what ought to be. This has led to capital market research becoming
There has been severe criticism of Positive Accounting Theory (e.g. Christenson,
1983;Tinker & Puxty, 1995). From an Islamic point of view, although what is should
a) The positive situation may reflect a deviation of the normative percepts of lslam;
can be conducted to discover the actual situation, to measure the extent of the
b) Islam has already eternal ethical and behavioural principles and objectives;
hence a purely positive approach that ignores the normative principles of Islam
will not lead to an Islamic society and the achievement of falah (see section
6.2.4.2).
Point (a) above is especially true, as is evident from the separation of the secular and
the sacred in Western life and the spread of that phenomenon to Islamic
derived from an empirical inductive approach seem to conflict with Islamic principles
(Gambling & Karim, 1991;Khan, 1994a; Adnan & Gaffikin, 1998). Despite this, the
tendency to be practical and to be compatible with the current vogue, has resulted in
(Abdelgader, 1994) and the same could happen if Islamic accounting theory is
principles. In Islam, where principles are not explicitly stated (and therefore
commanded) in the Qur’an or Sunnah but occur only in the form of general principles,
based on the interpretation of the principles in time and space, various different
rulings on the same issue can be arrived at. Here, Muslims usually take the opinion
Chapter 6 Page 225
of the majority of scholars (Jumhur) as the authentic one. In our times, since
the cooperation of traditional religious scholars (‘ulema) could perform the same
‘ulemas, scholars and the learned ones (accountants?) would be useful to establish
approach to accounting theory was the earliest form of the deductive approach. This
approach attempted to bring accounting profits in line with economic profits of the
economists, and hence depended heavily on economic theory. Gambling & Karim
(1991), however, have argued that the concept of ‘economic income’ is unacceptable
to Western Deductive theory that their removal would render any contribution to
Islamic theory of minimal significance” (p95). For example, the model of ‘economic
rate of return on capital’, which forms the basis of any calculation of ex-ante income,
assumes that money has a time value, which Gambling & Karim assert does not exist
in Islam (see also Tomkins & Karim, 1987). Hence that part of deductive accounting
Other writers such as Tinker (1985), Gray et al. (1996) and Cooper & Sherer (1984)
take sociology, democracy ethics and political economy as sources of ideas on which
to deduce theory. Gambling & Karim (1991) are of the view, that being positive
approaches to human behaviour, these social and political sciences only produce
tentative models, which lack the normative element. The researcher does not fully
concur with this view. Gambling & Karim (1991) do not seem to review the critical
Chapter 6 Page 226
perspective used in these studies (i.e. that of questioning the status quo or assessing
the ethical consequences of actions within the capitalist paradigm). Thus, these are
not just positive approaches to social sciences, but have normative and ethical/social
However, Gambling & Karim’s (1991) objections are not entirely unfounded. The
normative position just as the positive theory also has a normative content (e.g.
knowledge. Even in the West, the works of Berkeley and Hume denied the existence
of the material world1. Although critical writers are critical of positivism, they propose
observed perception. It does not refer to any divine criteria for its critique of the
determinism, are accepted without question as if they were absolute truth. They can
thus be subjected to the same criticism, that modernist and post-modernist thinkers
1
See for example, the arguments against positivism (Chua, 1986)
Chapter 6 Page 227
accounting standards as Muslims have to abide by the Shari’ah in both the social and
economic aspects of their lives. This approach according to them involves deducing
the objectives of financial reporting, the postulates of accounting and the definition of
accounting concepts from Shari’ah principles. This would then constitute the
foundation for a structural framework, which would act as a reference for the
researcher’s opinion too, as any principles and rules derived would be consistent with
Islamic worldview and values. This research aims to do this to some extent.
However, the way in which Gambling & Karim use the methodology seems to be
• Firstly, Gambling & Karim (1991) delve straight into technical concepts after
accounting. They therefore assert that Islamic accounting should be based on the
balance sheet rather than being transaction oriented i.e. profit is the difference of
net asset values at different dates. This objective of Zakat assessment is neither
is the main concern of Islamic accounting leads them directly into a critique of
concept and the substance over firm assumption, on the basis of valuation
theory.
Chapter 6 Page 228
other societies which have revealed doctrines and morals that govern all social,
economic and political aspects of life.” Although, the researcher agrees with the
arguments or empirical evidence to support. The authors never discuss how this
dichotomy came about and what the implications are for accounting. How they
came to this conclusion, after discussing a completely different subject i.e. the
There is limited discussion on ethics and accounting in Western society and very
little on Islamic ethics although Gambling & Karim title their book “Business and
Accounting ethics in Islam.” This has led the authors to ignore the ethical
theory. Instead they jump straight into criticising accounting principles and
valuation practices. Further, they also ignore the development of ethical based
(e.g. Donaldson, 1982) and the social and critical accounting literature, thereby
• Fourthly, they also come to the naive conclusion that Islamic accounting is always
accounts to “rentiers”. They arrive at this view because financial accounting aims
specific known users such as managers. They assert that since there can be no
financial accounts.
Chapter 6 Page 229
Although the researcher agrees with the authors, that in an Islamic economy, the
finance providers have to be concerned with and morally responsible for the
operations of the company in which they are investing, they need not be taking part
in administrative operations. Their duty is to monitor that the investee company does
not undertake operations in contravention of the Shari’ah, and this is where external
accounting.
Islamic prohibition of interest denies him a fixed return on his capital irrespective of
the performance of the investee company. Hence the evaluation of his investment
depends upon proper (external) Islamic accounting, as they may not have any other
source of information.
Further, the interests and welfare of the community and other stakeholders, which
we have seen is the main objective of the Islamic Shari’ah (see Chapter 3), dictates
that large business or governmental organisations whose activities affect the life of
the stakeholders should disclose information, so that they can be forced to abide by
the Shari’ah.
whether private or public, is essential and should be included in the remit of Islamic
accounting. This has been the history in the government accounting of the Islamic
state, where audited, detailed accounts were produced of the revenues and
expenses of the various units of government which performed many of the functions
that have been privatised to the corporate sector these days (Hamid et al.,
Islamic Banks by the AAOIFI (Pomeranz, 1997), suggests that Islamic accounting is
(1991) to develop an Islamic accounting Theory but attempts to avoid the problems
referred to in the previous section. Thus the objectives, characteristics and disclosure
As argued by Karim (1995), there are two methods whereby Islamic accounting
1) Establish objectives (and concepts) based on the principles of Islam and its
accounting thought.
them against the Islamic Shari’ah, accept those that are consistent with
Shari’ah and reject those that are not, and develop those that are unique.
The AAOIFI (1996) has adopted the second, easier approach in the development of
their “Statements of Financial Accounting” which they claim is “consistent with the
broader view of Islamic principles- a view which does not require that a concept be
always be derived from the Sharia”, (p24 and p37). This approach is in line with the
Hence, the concepts of decision useful accounting information such as relevance and
reliability are immediately embraced into Islamic accounting by the AAOIFI. This
approach has its supporters (e.g. Ahmad & Hamat 1992; Abdelgader, 1994).
However, this approach has been objected to earlier by Gambling & Karim (1991) on
the grounds that the conceptual framework of accounting currently applied in the
West is justified in a dichotomy between business morality and private morality. Thus
it cannot be implemented in other societies that have revealed doctrines and morals
that govern all social, economic and political aspects of life. Further objections to this
Chapter 6 Page 231
method arise because neither Western accounting theory nor Western accounting
standards explicitly deal with the morality of the objectives of commercial accounting
entities or even of the methods by which they are pursued (Gambling et al., 1993 as
Hence, the approach of not reinventing the wheel adopted by the AAOIFI may be
indefencible. The AAOIFI has adopted this approach not because of its correctness
“In order to gain the recognition and support of Islamic banks in the
implementation of its standards, the [AAOIFI] might find it necessary to
demonstrate to Islamic Banks that it has not completely discarded the
efforts that they have exerted in setting up their own accounting policies
with the help of their SSB”. (Karim, 1995, p292)
business and other activities which involves fiduciary or agency relationships and
then consider the implications for accounting. Compare these with the principles
capitalism.
2. Identify the main objective and subsidiary objectives of Islamic accounting based
modern accountants” (Mathews & Perera, 1991, p 334). The comparison with
accounting.
4. Identify the users of Islamic accounting information and examine what they use
the information for. To a certain extent, the uses are identifiable by considering
ethical principles and will achieve the objectives of Islamic accounting to the
exist in the Qur’an (Kamali, 1991). Further, if the researcher has correctly arrived
should agree as according to the Prophet’s Hadith “My Ummah (or people as a
disagreements.
further insights and to establish whether the deduced principles are wrong or whether
the disagreement.
Sir Adrian Cadbury, who was the chairman of the commission which produced the
Cadbury Report on Corporate Governance in 1992, stated that “the glue which holds
Chapter 6 Page 233
a company together is its beliefs and values, rather than its structures and systems”.
This should be truer of Islamic organisations, which have been specifically been set
1981;AlHabshi, 1987).
just society based on the divine ethical (Qu’anic) principles of ‘al-‘adl wa’l ihsan’ i.e.
the commandment of God to establish ‘justice and equity’. Hence, ethics should
In fact, the distinguishing feature of Islamic Organisations (both business and non-
profit) is that they are established to operate within the ethical framework of the
Shari’ah, which prescribes the dos and the don’ts under Islamic Law. Even, in the
and/or Muslim employees hope to operate under Islamic ethics or at least not
contrary to it, to the extent that “commercial realities” and/or the legal system allows -
incorporates the ethics, beliefs and objectives of Islam and which provides indicators
important that Muslim values and beliefs are recognised and respected, if the
organisation is to obtain the loyalty and effort of its employees and its stakeholders.
The organisation should not operate accounting and information systems which
results in behaviour, inconsistent with Islamic values, as this might result in goal
does not take into account Islamic cultural values, may result in behaviour
incongruent with the goals of the organisation in the long run due to tensions
between the ethical outlook and actions of Muslim managers and employees
Chapter 6 Page 234
not entirely in line with Islamic objectives, at least not inimical to its values.
Ethics has been defined as “the branch of philosophy that explores the nature of
moral virtue and (which) evaluates human actions” (White, 1993, p 1). It is the set of
moral principles on which actions are evaluated as right or wrong. The terms morals
and ethics are sometime used interchangeably and in this research, they are
Although Friedmann (1982) has argued that the only job of business is making profits
as long as it stays within the rules of the game, there is an increasingly vocal
objection to the amoral business in the form of intellectual arguments, the growing
power of the ethical consumer and the increasing development of ethical investor
movements. Old adages such as “business and ethics do not mix” and “the business
Drucker, 1981). These adages have been dubbed as the “Myth of the Amoral
Business enterprise” and strongly refuted by DeGeorge (1990) who argues that
business activity is a human activity which involves ethics and even business expect
ethical behaviour from their employees, customers and suppliers in order to operate
From a Western perspective, although there are many ethical systems, the two main
approaches. The teleological approach to ethics takes the view that “whether an
1990, p 40). Utilitarianism is the main form of teleological ethics strongly represented
calculus just like accounting. As accounting employs cost and benefit analysis to
pleasure and pain associated with an action to determine its morality; an action which
leads to the least pain or the greatest pleasure is a moral action. In fact,
Utilitarianism has been criticised as being unable to account for justice. The utilitarian
utilitarianism “results in saying that to do what is obviously unjust is the morally right
thing to do” (p53). Thus, this results in the conclusion that utilitarianism cannot be an
and utilitarians agree on which actions are just, the problem is that in business, the
hedonistic calculus induces and provides a surrogate for happiness i.e. profit. This
does not consider matters of justice for all as utilitarianism claims. One of the
objections against utilitarianism is that the granting of justice and rights to people
does not depend on the consequences of an action. Further, giving people what they
are due or what they deserve may not be the best use of resources. Hence,
actions.
Chapter 6 Page 236
The deontological approach to ethics, on the other hand, is based on the theory of
George, 1990, p 40). This approach denies that morality or ethics depend on the
consequences. In the West, this approach has its source in the Judeo-Christian
deontological ethics has led to its current influence in Western society despite the
post-enlightenment secularisation.
“The Judeo-Christian tradition has nurtured the morality of the West for
centuries and of our country (USA) since its inception. It is still an
extremely potent force.... these moral rules,....and their values have, to a
large degree, been absorbed into the secular life of the West in general”.
(DeGeorge, 1990, p 63)
Kant formulated the notion of the “categorical imperative” as the highest moral
of the biblical principle of “do unto others what you would have others do unto you”.
The second condition is that the action must befits the dignity and moral autonomy of
others. What is meant by duty poses a problem according to Beekun (1997). If only
acting from duty is ethical (as opposed to self-interest), then this means that the
intention of the agent has to be taken into account. In Islamic ethics, intention is
unethical act ethical. For example, in Islam, a business, which has the good intention
theological ethics. It was based on the acceptance of divine revelation of the Bible. A
similar position is taken by Islam which claims the Qur’an as the last revelation and
Chapter 6 Page 237
Prophet Muhammad as the last Prophet. The Qur’an has been interpreted by the
Prophet through the Hadith, which is also taken as divine revelation (or rather the
of God. However, new circumstances warrant new interpretations of both the Qur’an
and the Hadith which are undertaken by the ‘ulemas or religious scholars. The
authority of their opinions depends on the reputation and piety of the scholar.
moral values to non-believers and the charge of absolutism. The first is true of
Islamic ethics as well as Christian ethics. However, since the number of Muslims is
sufficient to form a separate market of their own with an economic system that can
communicate with but remain separate from the western capitalistic system, the
question of justifying Islamic ethics to non Muslims may not arise, although
socioeconomic system.
White (1993) claims that philosophical ethics are rational while religious ethics being
absolute are not. While this may be true, the researcher cannot concede the author’s
human happiness. Happiness and well being are spiritual and psychic experiences,
which throughout human history have been the domain of religion. This is especially
untrue of Islamic ethics which can be quite rational despite it authoritarian nature.
It is true, Islamic ethics based on divine revelation is authoritarian but this does not
preclude it from being rational nor is it arbitrary. The Qur’an usually gives reasons for
its prohibitions and duties in many cases. As reflection is encouraged by the Qur’an,
the scholars have always thought about the reasons for a command or a prohibition,
even when the Qur’an fails to provide reasons. Hence, a deontological approach to
Chapter 6 Page 238
ethics based on revelation could also be rational, as is Islamic ethics. In Islam, Ethics
Shari’ah (including ethics) have been declared by Ghazali and Ibnul Qayyim Al
Jawziah as the “wisdom and well-being of the people” (Chapra, 1992). The Shari’ah
is itself derived from the Qur’an and the Sunnah of the Prophet (pbuh) and is the
conventional accounting has some ethical problems including (i) the assumption of
the self-interested and greedy rational economic man despite the fact that man can
and is altruistic sometimes, (ii) utility is limited to material goods and services as can
be seen in the computation of the GDP, (iii) the price mechanism does not lead to
aggregate demand and spur economic growth may lead to negative social and
theory. In short, conventional economics can be termed as value and ethics free on
the question of production and distribution of resources, which is the main objection
& Sessions, 1994). It is an ethics-based system based on the principles and rules
contained in the Qur’an and Sunnah (Al-Habshi, 1987). The Islamic economic
paradigm is derived from the Qur’an and not conventional neo-classical economics.
“The world of nature is there for man to make a living out of it, promising
sufficiency for all human beings. Man has to ensure this through his
efforts for which he has freedom of ownership and enterprise (i.e.
business). Justice, must , however, be ensured, if necessary, through law,
Co-operation and benevolence rather than self-centredness and avarice
should be the norm in economic affairs. Allah (S.W.T.) being its real
owner, property has to be handled as a trust and all economic activity
conducted in the framework of trusteeship. Poverty is an empirical reality,
hence the rich must surrender a part of what they possess to the have-
nots. Trade is lawful, but riba (interest) is prohibited. Waste is sinful and
Chapter 6 Page 239
vicegerancy of man, assumes that God has provided enough resources for mankind.
Hence, any scarcity is not absolute but relative to the claims on those resources.
“The resources with which God has endowed this world are not unlimited.
They are sufficient to cater for the well-being of all, if used efficiently and
equitably”. (Chapra, 1992, p 203).
However, man should remember that although, he has the freedom to choose
between alternative uses of the resources, he is not the only vicegerent on earth.
There are millions of vicegerents like him. Thus, the efficient and equitable utilisation
of the God given resources to attain the well-being (falah) of all is only possible if
resources are used with a sense of responsibility and constraint determined by the
Divine Guidance and the objective (maqasid) of the Shari’ah (Chapra, 1991).
The ultimate objective of Islamic Economics (and thus Islamic accounting) is to lead
man to falah, i.e. well being or success in this world and the hereafter (Khan, 1985).
socioeconomic process which will facilitate the working of the Islamic economic
system.
The Qur’anic concept of falah, (which occurs in more than 40 verses), is seen as a
multi-dimensional concept which has implications for both individual and collective
It is said to have three components Khan (1985): (i) survival (Baqa) , (ii) freedom
relationships) and political survival (freedom and participation in affairs of the state).
Chapter 6 Page 240
Its macroeconomic implications are a healthy environment and medical aid for all, full
The concept of Ghana means that no one should live in abject poverty but also
assumes self-reliance and work rather than parasitic idleness. Its macroeconomic
The concept of ‘Izz means self respect, civil liberties, protection of honor and life for
the individual; and economic power, freedom from debts and military power to
Khan (1985) has categorised the conditions which lead to falah, from a perusal of the
verses in the Qur’an, into spiritual, economic, cultural and political factors. The
1. Infaq: to spend in the way of God on the poor, needy, relations, neighbours and
for the socio-ecoonomic good of the community. Infaq is not restricted to charity
but includes expenditure on one’s own family. The Qur’an instructs believers to
spend what is excess to their requirements. Islam recognises a right of the poor
in the wealth of the rich (Al-Qur’an 70:24 & 51:19). The compulsory part of infaq
is Zakat or the Islamic religious tax. According to Khan (1985) infaq assumes
asserts that infaq would not be possible if these traits are not present as wants
Zakat and other Islamic taxes such as kharaj and the importance of the voluntary
2. Prohibition of riba (interest). Kahn notes that riba is a subtle institution which is
exploitative and iniquitous. The Prophet (pbuh) took many measures to ensure
that riba, whether implicit or explicit, did not re-appear in another garb by
exchange and certain contracts of land-tenure which provided a definite share for
Chapter 6 Page 241
only one party. Khan rightly observes that the road to falah will remain blocked
sharing and risk bearing instruments. These have major implications for
Some interpreters of the Qur’an assert this also implies the fulfillment of the
implicit covenant (or the primordial covenant alluded to in the Qur’an) of meeting
one’s social and religious obligations to God, oneself, family, neighbours, the
perpetrator of Zulm cannot achieve falah (Al-Qur’an, 6:21, 6:135, 12:23, 28:37).
the rights of others and will lead to widespread inequalities, impaired incentives
5. Seeking God’s bounty: The believer is expected to show enterprise and effort to
achieve falah. A parasitic existence, idleness and beggary are prohibited in Islam
dignity of labour and the safeguarding of labour rights, earnings from labour and
spending on oneself and one’s family deprives the community of God’s bounty.
In the economic sense, this leads to low aggregate demand and a level of
Zakat is payable on idle wealth (money kept at home, in the bank or in shares
and stocks) and idle land can be taken away by the state from the owner and
given to somebody who can utilise it. Only with generosity and sacrifice as
All the above five elements of falah can be seen to involve accounting and taxation.
Hence falah can be taken to be ultimate objective of Islamic accounting as well but a
Accountability”.
Since the objective of Muslims and the Islamic economic system is to achieve falah,
activity to achieve this falah, as business activity is part of human activity and cannot
be separated from other daily activities (Beekun, 1997). Hence, the principles of profit
and wealth maximisation and the incessant concern with shareholder value, on which
capitalist businesses are based, are questionable from an Islamic framework. This is
especially so, since Islam has comprehensive ethical principles for business.
Since accounting cannot achieve falah directly but only by directing user behaviour
towards activities (mainly in the economic arena) which will lead them to achieve
which Islamic accounting is based on. Since, the researcher has already considered,
context and meaning it is now used, found it unsuitable for the purposes of Islamic
which can help operationalise falah in the socio-economic arena. This is an extension
Chapter 6 Page 243
6.3.1 Stewardship
Stewardship is said to be the duty to provide an account of the use(s) to which the
resources entrusted to a steward have been put (Gray et al., 1991, p 3). It has often
been confused with the notion of accountability (eg. Gjesdal, 1981). Stewardship can
difference between stewardship and accountability is that the former “says nothing
about the effects of those uses or about purposes behind entrusting of the resources
Chen (1975) asserts that the concept of stewardship arose from the religious, mainly
Christian, teachings that man is a steward of God for the resources given to him (a
(trusteeship)). Stewardship is said to arise in relation to property rights, i.e. the right
to own and use property. Man as God’s steward owes a responsibility to use the
property effectively not only for himself (which Chen defines as secondary
stewardship function) but also has a social responsibility for others around him (the
primary stewardship function). This concept later developed in the feudal and
manorial versions of stewardship, where resources especially lands were given to the
serfs to manage on the landlord’s behalf. Here, the serf was responsible for the
‘secondary stewardship function’ of taking care of the land for the landlord, whereas
the landlord had to take care of the primary stewardship function of responsibility to
the community.
With the development of capitalistic businesses, which absorbed the new social
form, the managers (stewards) who were effectively servants of the new capitalist
Chapter 6 Page 244
owners recognised only the secondary stewardship to their masters; the primary
proprietary theory, where the business was the property of the owners and stewards
were responsible to them only. Chen (1975) further observes that the development of
managerial capitalism (after the depression of 1929) and the world wars, led to the
acceptance of the entity theory and the managerial model of stewardship, where the
managers felt responsible, not only to the shareholders but to other parties as well.
Hence the primary stewardship function (i.e. the social responsibility) was recognised
Chen (1975) concludes that both forms of stewardship must be recognised i.e. the
owners. She suggests that a dual accounting system needs be developed and
regulated by the profession, who should provide guidelines to measure, report and
audit, both financial and social information in two separate reports, a financial
accounting for the owners and a social account to meet the needs of society.
preferring the social over the self. However, Chen’s suggestion of having two
• The owners are part of society, and as Muslims, their falah as well as that of
society are both concerns of Islam and Islamic accounting. The owner, especially
an ethically driven Muslim owner, would be interested to make sure that the
business activities are not only conducted within the letter of the Shari’ah but
within its spirit also thereby ensuring ihsan (equity and magnanimity).
effects of the business from the social ones e.g. downsizing may increase short-
term profits but create unemployment for the local community. Reporting this
Chapter 6 Page 245
separately, would imply, the owners do not care for the social impact of their
activities and can only be forced to act in the social interest through legislation
corporations and other entities which use significant community resources and
assets. It would imply that these corporations are publicly accountable for their
actions (ASSC, 1975; Gray et al., 1991). Hence, while the suggestion by Chen to
6.3.2 Accountability
an account of the extent to which the objectives for which the resources were
entrusted have been achieved. Various meanings and definitions have been given to
accountability in the literature (e.g. Ijiri 1983; Roberts & Scapens, 1985; Gray et al.,
1996).
1), is that of Gray et al. (1996) who define accountability as “ the duty to provide an
for which one is held responsible”. In this model, an Accountee (principal) enters into
a contractual relationship with an agent (Accountor). The Accountee gives the power
over resources along with instructions about actions and rewards to the accountor.
The accountor is supposed to take certain actions and refrain from others in
managing the resources given to him, to meet certain objectives and to account to
Social context
Accountee
(Principal)
Information, reports
of performance & non- , authority, responsibilities,
performance resources, rewards &
Relationship
(contract) reprimands
Accountor
(Agent) Social context
The first problem with the above definition is that it emphasises the discharge of
accountability rather than accountability itself. The actions for which the accountor is
responsible arise due to entrusting resources to him. Hence use (or misuse) of the
resources) is the action the accountee is responsible for and not merely the
accounting for it. However Gray et al. (1996) seem to have recognised this problem
definition. They suggest that it consists of two parts i.e. the responsibility to
undertake (or to refrain from) certain actions and to provide an account of these
actions.
The second problem with this definition is it is that not easy to define what actions the
directors for example would not be responsible for investing ethically, unless
The researcher suggests the following definition, which would perhaps, be better:
Accountability is the duty of an entity to use (and prevent the misuse of) the
resources entrusted it in an effective, efficient and economical manner, within
the boundaries of the moral and legal framework of the society, and to provide
an account of its actions to accountees who are not only the persons who
provided it with its financial resources but to groups within society and to society
at large.
In the researcher’s opinion, the accountor has a duty not only give an account (i.e.
report on the performance or non-performance of this duties) but also to act or refrain
from acting in a certain way. Since the accountee is usually not in close contact with
account makes the organisation transparent as well as providing a feedback for the
The use of the terms efficient and economical in the researcher’s proposed definition
may be problematic for critical and social accounting researchers, but the researcher
did not use them in a positivist or reductionist manner. Although the term
“economical” has become value laden in the eyes of socialists and “greens”, the
researcher uses it in the sense of “the least cost “. This is due to the fact that
choosing a higher priced option (in the absence of a social/moral reason) is contrary
Gray et al. (1996) recognise that two different categories of rights and responsibilities
exist; legal and non-legal, the latter arising from moral or natural rights and
responsibilities. They argue that the law lays down the minimum level of
any given country at a given time. They note however that while law establishes
responsibility for certain actions (e.g. equal opportunities) it does not provide an
Chapter 6 Page 248
equivalent responsibility to account in all cases. Thus the legal responsibility for
action and legal responsibility to account are not equal. The disparities in the two
The researcher fail to see the logic of insisting that a moral responsibility to account
exists (only) when a legal responsibility for action exists. The social contract and the
very fact that large organisations use significant community resources (see ASSC,
1975) should give rise to a moral responsibility for action even in the absence of
legislation.
organisations following the cue from Friedman (1962), might insist they had no such
and utility maximising capitalist society, there might be no other choice in the short
moral/philosophical rights and how they are determined. Gray et al. (1996)
where religious values do not seem to hold, even the absolute values are becoming
relative. The researcher agrees partially that debate, education and agreement can
achieve philosophical rights. However this is very difficult in view of the materialist
difficult to reach consensus and agreement when the society is so pluralist and
In an Islamic society, the ethical values are specified in the Qur’an (word of God) and
the traditions of the prophet (exemplification and interpretation the Quran in daily life).
Indeed the Prophet (peace be upon him) said “I was not sent except to perfect
character” and the Qur’an says of the prophet “In you, we have established the best
character.” The prophet is a model of virtue for the Muslim who tries to imitate his
more easily than Western societies, because the philosophical values of a Muslim
Gray et al. (1988 &1996) have used the accountability model as a theoretical
framework for corporate social and environmental reporting and mainly examined
framework, however, is a much broader concept, which can explain the workings of
Scapens (1985), it may help to integrate the technical and interpersonal aspects of
“...to be held accountable for one’s actions serves to sharpen one’s sense of
self and one’s actions. The practice of accountability focuses attention
within the flow of experiencing; it acknowledges and confirms self, and the
fact that one’s actions makes a difference. Conversely, in the absence of
being held accountable, there is a possibility of a weakening and blurring
of one’s sense of self and situation”. (Roberts, 1991, p 356)
perform certain action. Even corporate social and environmental disclosures could be
Chapter 6 Page 250
for reasons other than discharging accountability (e.g. for legitimation and
performance of the required actions (or the avoidance of certain actions) rather than
merely reporting the performance. However, since the ‘relevant publics’ are at a
distance and cannot observe the actions directly, the annual reports become the
Roberts & Scapens (1985), for example, give a broader definition of accountability
as “giving and demanding of reasons for conduct” and assert accountability (quoting
suggest new insights could be gained on how accounting systems construct and are
Roberts & Scapens (1985), use the term “systems of accountability” to refer to the
relationships created by the abstract ’accounting system’ which is the body of rules
and resources which are drawn upon in the practice of accounting. In hierarchical
2
“O You who believe!, when you contract a debt for a fixed period, write it down. Let a scribe
(accountant?) write it down in justice between you.....Let him who incur the liability dictate...And get
two witnesses out of your own men.....You should not become weary to write it down whether it be big
or small....that is more just with Allah, more solid as evidence and more convenient to prevent
doubts among yourselves, save when it is a present trade which you carry on , on the spot among
yourselves, then there is no sin on you if do not write it down.....”., Al-Qur’an (2:282). The relevance
of this verse to accounting can be seen by references to credit and writing as antecedents of
bookkeeping. Littleton (1966, p12).
Chapter 6 Page 251
defining the significance of events (Signification), They also embody a moral order: a
They find in the first instance, accounting information is interpreted and understood
However in situations which span physical distance such as divisions to head office,
visibility of the divisions in the absence of shared mutual knowledge (as the
becomes difficult for head office managers to interpret the reality (the physical and
According to Roberts & Scapens (1985), this distance makes trust more difficult and
senses of self and different relationships with others. Here accountability is defined
as
in a solitary and singular sense of self which is nervously preoccupied with other
On the other hand, socialising forms of accountability which flourishes in the informal
there are tensions and conflicts between the two forms of accountability and Roberts
destructive split of ethical and strategic concerns to the detriments of both. He calls
for a search into the possibilities of accountability, which is oriented towards the
It can thus be seen that Roberts (1991) and Roberts & Scapens (1985) use of
researcher sees this as an important part of Islamic accounting. The second part of
a continuum in Islamic Accountability which proceeds from the internal to the external
accountees.
Muslim community (Khir, 1992) and forms one of the core concepts of belief i.e the
belief in the hereafter, heaven and hell, accounting and punishment. Accountability
arises from the amanah or primordial trust (i.e. free- will, freedom to choose,
knowledge and reason) which was given to man only (Al-Faruqi, 1992). Other
creatures including angels, animals and non-living matter have no such ability. Hence
Chapter 6 Page 253
angels, animals and other creation will not be accountable as they have no choice
but to obey God and carry out their mission and purpose in life as He decreed.
Only Man has the freedom to choose or not to choose God’s way. Further the
that God has placed man in custody of the resources of not only this earth but the
entire heavens and the earth to be exercised in accordance with his instructions to
his benefit as well as all other human- beings and animals and the environment.
places special emphasis on accounting i.e. recording events or actions itself. The
Qur’an declares that there are two angels recording every action of man. One angel
records rightful actions and the rewards attributed to them (sawab) and the other
records sinful actions and the sin attributed to them (ithm). The translation of actions
into units of rewards and sins is unique to Islam. In fact there is a whole area of study
in Islam regarding the benefits of actions (al-fadhail). This acts as a motivation and a
deterrent to actions of Muslims. A good act gets up to 700 reward units depending on
the intention and effort. A good intention counts as one reward unit and when it is
undertaken merits at least 10 reward units. A bad intention without action does not
merit any debit (sin) units but when carried out gets one sin unit.
Further, Islamic scholars have classified the value of all actions into five categories;
Fard acts attract reward units and leaving them out attracts sin units. Sunnah acts
attract reward units but if left out do not attract sin units. Mubah acts do not attract
reward or sin units. Makruh acts do not attract sin units but leaving them out attracts
reward units and finally Haram acts attract sin units whereas leaving them out
Although neither the exact quantum of rewards or sins, nor their exact nature is
revealed to Muslims; it forms part of the core belief structure. On the day of
Chapter 6 Page 254
judgement, the person with more reward units will be given the book of records
(which the angel had kept) in the right hand. The person with a deficiency of reward
units will be given the book from the back (Al-Qur’an, 84:7-12) and they will be glad
or sad depending on the situation. Finally, the units will be placed on the Mizan
(measuring scale) and will be weighed. The person with more good units than bad
will be sent to heaven, whereas the person with a deficiency will land in hell. In order
to prevent a misfortune on the day of Judgement, the Muslim is asked by the Prophet
Muhammad (pbuh) “to take account before account is taken of you”. The pious
he has undertaken during the day and asks forgiveness for his sins and praises God
for the good he has done. This activity serves as a sort of feed-forward control to
It can thus be seen that for a believing Muslim, accountability and accounting is
Further, this accountability concept is not restricted to spiritual aspects but extends to
social, business and contractual dealings. The Qur’an declares that “And Fulfil
contract, Verily (fulfillment of) contracts will be questioned (on the day of reckoning)”
(Al-Qur’an, 17:34). Hence, it is thus logical to extend this ingrained accountability and
from some) and giving account of the actions taken (and not taken) by an
stakeholders towards falah. This will transform accounting into a social accountability
falah? From the conventional accounting literature (e.g. Hines, 1988) we know
accounting can give importance to certain notions i.e. what is accounted for becomes
compliance. Similarly, an alternate valuation system (in line with the Shari’ah) may
have to be conceived giving scores to events and actions which have social and
stakeholders, they will certainly point them towards what is important. Furthermore,
the control aspect is very important. If information users know that the entity has not
followed Shari’ah actions, they can demand explanations and take actions resulting
in the entity complying with the Shari’ah in the future, thus protecting the economic,
interactionists (e.g. Blumer, 1969), the self is the most important element of the
may internalise or reject. When an individual internalises the values of a society (or
Islam, for that matter), his covert (thinking) and overt actions will be actualised based
Chapter 6 Page 256
appearance of the reality depends on the surface of the mirror because as (Dillard,
Hence for Muslims with different value sets, Islamic accountability can be attenuated
Gaffikin, 1996).
Although the word, accountability is not used in the “objectives of financial accounting
for Islamic banks and financial institutions” (AAOIFI, 1996), the notion of
Further, the AAOIFI (1996) lists four objectives of financial accounting in the same
statement and only the last seems to be decision-usefulness; the first three pertain to
Islamic accountability. The statement lists the determination of rights and obligations
of all interested parties in accordance with the principles of the Shari’ah and its
concepts of fairness, charity and compliance with Islamic business values (Para
6/1(a)). It also includes the encouragement of compliance with Islamic Shari’ah in all
transactions and events (Para 6/1 (c)). Thus the notion of Islamic accountability is
(Pomeranz, 1997).
Adnan & Gaffikin (1997) advocate a slightly different view of accountability, basing
their findings from a reading of some Qur’anic verses. They assert that the primary
an accountability obligation to the real owner (Allah). However, they assert that the
overall accountability to act within the Shari’ah would be better operationalised, if the
Chapter 6 Page 257
considered God’s share of the wealth). They argue that this emphasis on accounting
for Zakat is logical because it is a prime Islamic socio-religious obligation, it will lead
watches over them and thus is aware of any wrong doing in this respect. One could
argue that God equally watches the faithful on all transactions and not only those
pertaining to Zakat. However, what the authors seem to imply is that, the
because both preparers and users realise that they cannot cheat God of his share.
This is a strong argument but the researcher believes that a broader concept of
other entities are not held Islamically accountable but only Zakat accountable, they
may pay Zakat on unlawful and immoral sources of income, which is forbidden by
Islam. This may create havoc for the economic, moral and spiritual health of
The researcher proposes the Islamic accountability model, based on the dual
stewardship model of Chen (1975), Gray et al.’s (1996) accountability model and
Islamic concept of Khilafa. The proposed model is illustrated in figure 6-3 and is
organisations (through their managers), and Muslim owners /investors having dual
accountabilities. The first or prime accountability arises through the concept of khilafa
(physical and intellectual). Under the khilafa concept, he is also accountable to Allah
Chapter 6 Page 258
for the care of other human beings (specifically local community, society and
accountability is made visible (through the revelation of the Qur’an and Hadith) to
both investors and managers, in the form of Islamic teachings. This is represented by
company). The solid arrows in the model represent this (3). The secondary
performs its activities the Islamic accounting system identifies, records, measures
system) to the investor thus discharging the secondary accountability. This is again
shown in the model by the solid arrows (4), as these are perceivable by the senses.
However, the Islamic accounting system also identifies, measures and reports the
other issues to both the owner/investor and the manager (5 & 6). Dashed arrows
show these information flows. The information thus disclosed enables both these
parties to monitor the activities of the organisation and ensure their primary
khalifas of Allah, are discharged. The Angels of course record these actions and
account this to Allah according to Islamic belief. However, as these latter information
flows (7) are not perceptible to the senses, they are shown as dotted arrows to
indicate their metaphysical nature. These information flows complete the primary
accountability cycle.
Chapter 6 Page 259
ALLAH/ GOD
(Primary
Accountee)
PRIMARY
PRIMARY ACCOUNTABILITY
ACCOUNTABILITY (Angelic Records)
PRIMARY ACCOUNTABILITY
(Angelic Records)
THROUGH THE QUR’AN &
HADITH
(Trusteeship of physical resources
and creatures arising from nature of
man as Khalifa)
7
7
2 2
KHALIFA KHALIFA
(Vicegerent: Primary (Vicegerent: Primary
Accountor) 6 Accountor)
6
MAN 5 MAN
4 ISLAMIC ACCOUNTING
INVESTOR SYSTEM 4 MANAGER
Secondary Accountee (Secondary
Accountor)
Managerial Contract
3 [SECONDARY 3
ACCOUNTABILITY]
Chapter 6 Page 260
The Islamic accountability model can thus be seen to have two accountability cycles,
one to God and one to men. The accountability to God is partly transcendent and is
objectives to further operationalise and refine the concept in practice. The researcher
proposes four subsidiary objectives for Islamic accounting; (i) Shari’ah compliance,
(ii) the proper assessment and distribution of Zakat , (iii) the equitable and fair
The first subsidiary objective would be to enable the activities of the entity to be
controlled to be in line with the Shari’ah. This was already partially covered in the
main objective but specific information on Shari’ah compliance would be a main part
of the Islamic accounting information framework. Here, not only is the immediate
activities meant, but also a broader more comprehensive view of the Shari’ah,
including the protection of the environment. Unfortunately, the case of Islamic banks
seems to indicate that Shari’ah compliance has become a technical compliance with
the letter of fiqh legal devices. For example, the significant use of mark-up
(murabaha) financing does not seem to realise the objectives of the Islamic economic
system for which Islamic banks were established. The researcher takes a broader
view of the Shari’ah, taking the maqasid (objectives of) al-Shari’ah approach of al-
Shatibi which was discussed in Chapter 2 (see Kamali, 1989). Thus, Shari’ah
compliance would include steps taken by the Islamic organisation to relieve poverty
Chapter 6 Page 261
keeping its contracts and promises, propagation of good and negation of evil, and
This is a very special case of Shari’ah compliance and wealth distribution. Under
consideration is given to the fact that less tax means less wealth distribution and less
money for public benefit. Accountants in the guise of tax consultants spend their
religious obligation on the same level as obligatory prayer. It is an act of honour, duty
and obligation to assess Zakat properly on the wealth and profits of an entity. Pious
Muslims always attempt to over rather than underestimate Zakat, as any excess is
The practice of Zakat assessment and collection has been carried out since the
Prophet’s time. Under the Islamic economic system, Zakat is a cornerstone of public
fiscal policy of in Islamic State. Even in the absence of a truly Islamic government,
many Muslim countries have departments to collect Zakat and distribute them.
Hence, the ability to assess the proper amount of Zakat to ensure that Zakat
Adnan & Gaffikin (1997) advocate Zakat assessment as the main objective of Islamic
accounting. They see accountability manifested “ in the form of how one can account
for his or her Zakat obligations properly” (p121). Gambling & Karim (1986) also
Chapter 6 Page 262
suggest that the way forward for Islamic accounting and finance is to develop the
concept of Zakat more fully. In fact, Gambling & Karim (1986) point out that the
need for an accounting system that is adequate to provide the required tax-base on
Since the recipients of Zakat are well defined in the Qur’an itself (mainly poor and
destitute), the payer may be motivated to pay more rather than less because the
Zakat payer knows it will be mostly used for the poor and the destitute. To make this
a reality, however, one may require more rather than less accounting.
The Zakat objective is further endorsed by the AAOIFI (1996) in their objectives of
financial accounting for Islamic Banks. Under the heading of “Objectives of financial
The objective of proper Zakat calculation is so important that the AAOIFI has come
out with an exposure draft on Accounting for Zakat (Financial Accounting Standard
No. 11) which gives detailed rules for determining the Zakat base and the asset
Further, Khan (1994a) suggests that since Zakat is an obligation on all individuals
(and organisations) with wealth of more than a certain minimum, every individual
(and organisations) has to keep account of his assets so that Zakat can be calculated
properly. Thus, the importance of Zakat assessment is one of the primary objectives
of Islamic accounting.
Chapter 6 Page 263
Justice and equity are two of the main objectives of Islam. Further, concentration of
wealth is discouraged by the Qur’an itself even if this is legally done. Hence,
Islamic accounting. Justice in Islam means to give everyone his or her due according
to Doi (1992).
Hence accounting information should enable all users to get their fair share of wealth
distribution above the bottom line through transfer pricing and other creative
practices. Thus, the “above the bottom line” distribution is especially important such
as the flows between locals and expatriates, Muslims and Non-Muslims, the ‘workers’
and managers. Managers can siphon off wealth in the form of perks and excessive
Tinker (1985) noted that conventional accounting with its neo-classical orientation
and corporations (tax liability) and business and public (in case of rate determination)
and business and society (pollution costs). Due to its marginalist dependency,
p172). According to Tinker, accounting has also suffered from social alienation
insiders).
The AAOIFI (1991) places the determination of the rights and obligations of all
interested parties” (p28) in accordance with the concept of fairness and charity under
the Shari’ah, as the first objective of financial accounting for Islamic banks and
financial institutions. This obviously includes the rightful share of wealth, which would
The Qur’an in verse 282 of Chapter 2, refers to the avoidance of doubts between
parties as the objective of recording deferred obligations. Doubts and suspicions are
termed Satanic and some suspicions are sins. Further, doubts can lead to mistrust,
enmity and breakdown of harmony. This is especially the case when money is
(1992a), for example, contends that accounting practice has been theorised in a
social and political vacuum, which have led to the misapprehension, silence and
position of power and knowledge” (p2) has not always been used responsibly as
She argues that accountants play changing roles as arbitrators, public policy makers,
obligated to take up Lehman’s (1992a) call for accounting to move beyond the
posture of ‘objectivity’ and ‘efficiency’ and to move towards the solidarity which
which results in financial losses and ultimately unfair competition such as by driving
When businesses were small and their effect on others external to the business
were negligible; it could be argued that owners and creditors are the most important
and crucial users of accounting information. However, in the current era “when
corporations rule the world” (Korten, 1995), the firm’s consumption of public
infrastructure and communal resources and their activities have positive and negative
effects on other groups in society and the environment. It is therefore essential that
these entities have “public accountabilities” to other groups in society (ASSC, 1975).
“stakeholders”, who have a stake in the organisation have rights to its accounting
information in order for them to assess the contribution of the organisation to society
1997;Shaoul,1998 ;Sutton & Arnold, 1998). Shaoul (1998) for example, questions the
their distribution as one big happy family. On the contrary, they assert that there is a
They question whether all economic life should be run in the interests of the few
seeking ever higher profits instead of meeting social and public needs of this and
coming generations. They suggest that accountants have refrained from analysing
even existing financial accounts from the perspective of other stakeholders because
Stanton (1997) on the other hand, advocates a rights based approach to ascertain
“investors, creditors and others” (FASB, 1978). Even the recent preliminary
to focus on meeting the needs of a subset of financial statement users who are
1998).
From an Islamic perspective, any organisation is accountable to Allah for its actions.
effect on others and would thus be accountable for their activities to society.
were the responsibility of the Islamic State. Given the current climate of privatisation,
previously publicly held resources are now turned over to them for the purpose of
efficiency and productivity. Hence, other user groups in society might rank equal in
Further, in Islam, as credit cannot be extended to anybody under fixed return terms
(i.e. interest), loan creditors, if they exist at all, would be Qardan Hasan (or
benevolent loan) creditors. These could include government giving soft loans and
becomes common, then these benevolent creditors would be a new major user
Chapter 6 Page 267
group. They would have a right to ensure that the organisation to which they have
lent their money, uses it properly and they are operating in a viable manner to ensure
collect and distribute Zakat, in the current political climate, this is being done by
organisations, such as Islamic banks and charitable bodies such as Muslim Aid in the
UK. In the case of Islamic Banks and business organisations, the organisation acts
as an agent for the Zakat payable by shareholders and employees. Hence they are
deducted from salaries and dividend distributions and credited to a separate fund
from which they are disbursed to the appropriate beneficiaries. In this climate, it is
very important for society to control the organisation to ensure the Zakat is properly
assessed and paid to the proper beneficiaries, in strict conformity to the Qur’an.
If the suggestion by Gambling & Karim (1986) for every Islamic bank to build up a
for, monitored and audited separately from the business. Such accounting would be
prominent in Islamic accounting. This will be due to the increased demand by Zakat
Besides the user groups mentioned above, the consumer/customer group and local
society. Consumers especially have more rights and a need for information to
ensure that the entity produces, markets and distributes products and services which
are halal (permitted) under the Shari’ah and are safe and morally desirable for the
The rest of the chapter discusses the characteristics of Islamic accounting discerned
from the literature as well as the researcher’s own ideas. The researcher shall first
discuss the similarities and differences between conventional and Islamic accounting
researcher shall then discuss the different types of Information needed. The valuation
and income measurement principles in Islam are then discussed. The researcher
concludes the chapter with the overall general characteristics of Islamic accounting
enterprise and the financial position of an enterprise as the two most important types
of information for investors and creditors to assess the continued financial viability of
the business (FASB, 1978; IASC, 1989 ;ASB, 1992). Hence profits, sales, assets and
liability information along with any subsequent or extraordinary events are the main
is for the users to make decisions on whether to hold, buy or sell the investments in
the company.
and other financial providers are members of society and they must get their due
rights. Justice is for everybody, not unlike in Marxist ideology, where the proletariat
must always get the upper hand over the bourgeois. In fact, since interest-based
debts are banned in Islam, equity capital becomes much more important. Hence the
calculation of profits are absolutely essential in order for various parties to get their
just and fair share. Further in a mudharaba transaction, where capital providers are
sleeping partners who bear the entire loss if any, the managers may have added
Chapter 6 Page 269
incentive to consume perks and produce a loss (Jensen & Meckling, 1976,
Obiyathullah, 1995), thus depriving the finance providers of their due share.
Hence, the AAOIFI (1996), for example, does recognise in its objective statement,
their importance. It states that information needed to estimate cash flows, its timing,
and risk associated with it should be provided to enable users in evaluating the
Islamic bank’s ability to generate income and convert it into adequate cash flows
Baydoun & Willet (1998) assert that unlike conventional accounting, in Islam the
focus is on God and the community rather than the individual demands a social
accountability perspective rather than the personal accountability found in the West.
based on the outcome of a political process but upon what ought to be disclosed in
order to serve the objective of social accountability. They conclude therefore, that the
differences in the objectives and the specific prescriptions of certain transactions lead
accounting.
Khan (1994a) insists that the information needs of an Islamic society are different
besides recording and reporting profitability, liquidity, solvency and efficiency, Muslim
• The true figure of Zakat payable and in the accounts of Zakat administration
• The extent to which the business keeps its promises and fulfill its contracts
• The extent to which the business adheres to the Islamic code of business ethics
while dealing with customers, competitors, government and other agencies and
Khan (1994a) observes that the point of reference is the overall objective of the
Shari’ah (not users’ rights or needs, cf. Gray et al. 1996). He opines that since
the social paradigm of Muslim society to an Islamic ethos, which will place demands
needs.
In addition, or large Muslim organisations, the researcher believes, the term financial
statements and financial reports are not appropriate as it tends to emphasise the
importance of one type of information and one category of users i.e. fund providers.
the term ‘accounting’ in these terminology to be used not in a financial sense but as a
From the above, Islamic accounting reports must provide the following type of
The basis of any activity of any Muslim- whether an individual or organisation - is the
government or not for profit, which has been set up especially to operate within the
specifically set up as an Islamic organisation, the Muslim manager and owners would
want to follow the Shari’ah to the extent possible, although, in practice they may act
in breach of its prescriptions. In case of Islamic banks, the reason for their existence
is the Islamic Shari’ah. Hence, their compliance with it and accounting for it assumes
primary importance.
accounting for Islamic banks and financial institutions. This statement lists
information regarding the Islamic Bank’s compliance with the Islamic Shari’ah in its
inadvertently because of factors outside its control (e.g. dealing with non-Muslim
institutions). Hence, the statement observes that financial reports of Islamic banks
expenditures, if any, which occurred, and of the manner in which these were
disposed off.
The researcher believes that this is true in the case of all Islamic and Muslim
business organisations, which cannot escape the realities of the multi-religious world.
Although Muslim or Islamic organisations would actively seek to refrain from Sharia’h
the Shari’ah Advisory Board of the Malaysian Securities and Exchange Commission
(SEC, 1998), allows investment in business which have Shari’ah prohibited income,
as long as it is not derived from the main activity of the business and forms only a
small part of the income. The prohibited income is seen as representing the customs
and the rights of non-Muslim living in the country and is excused as long the main
activity benefits the Muslims and the country. Further consideration is also given to
Other fund managers in Malaysia attempt to purify profits i.e. separate the prohibited
not investing at all and is allowed as a dharura (emergency) under Shari’ah rules as
otherwise Muslims may find themselves in a weak economic position in their own
information on the extent and the impact of earnings from prohibited activities. This is
to ensure that Muslims are aware of the forbidden portion of their income and also to
ensure that the activity is unavoidable and does not become a major activity. Hence it
is suggested that Islamic accounting provide the income arising from and the reason
Islamic banks have Shari’ah Supervisory Boards (SSB’s) to ensure that the policies
and instruments are and activities have been conducted in compliance with the
Shari’ah (Karim, 1990). These SSBs issue reports to this effect which forms part of
the Annual Report of Islamic banks. This is essential to instill credibility in the
accounting was discussed earlier. What is the form that this information should take?
Baydoun & Willet (1998) seems to suggest. The appropriation of wealth is linked
with the valuation system and income measurement model as well as the accounting
principles used. For example, the equity between present and future investors will not
be preserved if historical cost accounting, which does not recognise unrealised gains
is used, if the gain is realised in another period. This is further discussed in section
6.5.7 below.
However, Baydoun & Willet’s (1998) suggestion that Value Added Statement should
replace conventional profit and loss statement is radical and deserves comment.
They assert that the Value Added Statement (VAS) is a “more appropriate measure
brings through its commercial activities to the community as a whole. They assert the
VAS shifts focus from the individual accountability of the conventional income
accuse the profit and loss account of having the power to corrupt Islamic values
through its primary focus on just one dimension of the firm’s performance and
emphasizes the self at the expense of the community. For this reason, they believe
that there is no choice except to replace the income statement with the VAS.
The researcher tends to agree with Baydoun & Willet (1998) on the reasons for the
VAS. Nevertheless, he rejects the notion that the income statement should be
completely replaced. Baydoun & Willet seem to contradict their own suggestion of
using the transaction cost approach (the end result of which is the income statement)
necessarily evil and is recognised even in the Qur’an as the prime motivating factor
The value added statement also disregards Tinker’s (1985) warning on the above the
this results in intra-class alienation which arises due to conflict between different
customers and developing countries. Tinker’s (1985) study of the Sierra Leone
Mining corporations shows how wealth transfers take place above the bottom line
and are thus not exposed by conventional accounting. This oversight by conventional
entity and not as fractions of capital and other social constituencies. The value-
It can thus be seen that Islamic accounting should provide specific information on the
nature of related party activity. All such transfers should be revalued at arm’s length
information. The researcher agrees with Baydoun & Willet (1998) that a separate
statement of Sources and Application of Zakat and Qard Hassan Funds (Benevolent
Loan funds) be included in the Islamic accounting Reports. This would also enhance
Master and Servant, Employer and Employee. The Muslim manager will have to look
after the human interest and not only the economic contribution of the employee. The
ethical treatment of employees with regard to his religious duties (e.g. time off for
prayer), fair treatment (not to give undue work and responsibility) and fair wages are
all a must (Beekun, 1997). Further, the pay between managers and employees
should not be too different in order to encourage a spirit of brotherhood and fellow
feeling. This is not simply utopian thinking but a command of the Prophet (pbuh) who
is reported to have said “feed and clothe your workers the same as you eat and
wear”. This is the ideal wage level, which should be made an objective of Islamic
organisations. This certainly means that Managers cannot be paid fat bonuses,
perks and share options while the lower rungs hardly can make a living. The
minimum wage is a decent wage, which is enough to provide sufficiently for the
outlining the state of Employee relations and policies. Further, the wage band for
financial statements. These should include perks, bonuses and fixed expense
the positive and especially the negative effects of the activities of the organisation
exegesis to the purification of the environment. (Q 23:4, 87:14, 91:9). The emphasis
does not fit well in the Islamic concept of falah (Khan, 1985).
as the “Greenies” would like Western corporations to be. This is because, according
to Islamic belief, God has given the animal, plant and mineral kingdoms for the
benefit of man. Hence, Islam does not promote vegetarianism and prevention of
permitted. However, Islam is extremely abhorrent of cruelty and wanton killing and
maiming. If pets are kept, their maintenance is the responsibility of the keeper. Since
cosmetics and luxurious clothing is forbidden to Muslim, the case of animal testing for
developing such a product should not arise for Muslim businesses. Businesses are
certainly responsible for any pollution they cause especially in the pursuit of human
The concept of accounting ensures that only economic events, which are reliably
measurable in monetary terms, are measured and reported. Hence the so-called
externalities are left out. Since Islamic accounting has a social accountability
dimension (Baydoun & Willet, 1998), Islamic accounting cannot restrict itself to the
Islamic accounting, however, should not separate social and economic events into
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One further aspect is the Shari’ah audit. As stated earlier, Islamic Banks presently
such boards has been called into question because the members are currently
employees of the organisations (Karim, 1990). However, the SSBs sometime have
incorporation of the Islamic Banks such as the Faisal Islamic Bank of Egypt.
Research conducted in Bahrain (Bucheery & Hood, 1998) showed a low perception
except the religious auditors themselves! The same research showed that financial
compliance.
However, the effectiveness of the SSB Audits is called into question because of the
lack of auditing skills on the part of the members of the SSB. Furthermore, their remit
only be done, if conventional auditors familiarise themselves with the Shari’ah and
In future, all Muslim and Islamic Organisations should be audited by Islamic Auditors,
having a single qualification and belonging to a single professional body and who
procedures as:
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their Islamic credentials. Further, as Karim (1990) suggests, to ensure that business
precepts, accounting principles compatible with Islamic law (Islamic accounting) must
auditors.
view, both for its equitable distribution between different classes of stakeholders but
also for the calculation of Zakat. In addition, the prohibition of Interest makes profits
Zakat is basically a religious wealth and income tax and its payment is a religious
obligation. Its collection should be done by the state and redistributed mainly for
zero interest environment because there is a 2.5% tax on wealth. Zakat is levied on
wealth in case of gold and silver (or their money equivalent) and livestock. It is also
levied on income from agriculture (5% gross income or 10% net ) and on business
profit and current net worth. All these require valuation and income concepts in order
In the early days of Islam, where businesses were not capital intensive and wealth
trade (e.g. spices, clothes, jewelry etc.), the Zakat was levied on stock, debts, cash
(gold and silver) at market value. Zakat on livestock and agriculture was based on
numerical units rather than monetary units i.e. Zakat was based on number of
Chapter 6 Page 279
animals of a certain age rather than a percent of value. Hence, for a business which
trades in livestock using numerical units to calculate Zakat would solve the problem
statement are still prepared, then the Zakat paid would have to be converted to
There is presently a controversy on whether fixed assets are liable to Zakat (Kahf,
prevalent at the time of the Prophet (pbuh) have ruled that fixed assets are not
Zakatable. This follows the prophet’s exemption of Zakat on tools used by farmers
and artisans in the Prophet’s time. If this is true, then the problem of valuation will not
be that acute as the valuation of fixed assets presents the most problems in
conventional accounting.
minimize inventory (just in time, keiretsu, economies of scope, ABC) will almost
eliminate the Zakat base from business ventures which add the most value to the
economy and are very important sources in developing and industrializing Muslim
writers (for example, Kahf, 1991; Al Zarqa, 1984) have called for a re-thinking of this
issue.
Kahf (1991) refers to his earlier study in which he showed that if Zakat is levied on
these new sources of wealth and income, the amount of Zakat collected can be
doubled or tripled and the Zakat thus collected would be able to eradicate poverty in
The other major institution of concern here is the prohibition of interest. This rule has
in Islamic society. However, the absence of interest does not mean the cost of
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capital is zero in Islamic societies. What is illegal is the predetermined fixed rate on
capital, i.e. the return on money without sharing the corresponding risk of the
borrower. Islam allows and one can say even encourages profit and loss sharing
opportunity cost and risk involved in deferred and installment sales and allows the
deferred price to be higher than the cash price. It also allows operational leasing and
renting. However the strict prohibition on interest means, the main way a capitalist
these three legitimate methods require the computation of income and asset
In Islam, a business has social and moral obligations, which derives from the khilafa
property in Islam is not absolute but conditional. Hence Islam requires the investor to
be responsible for the management, activities and the liabilities of the business. This
is the reason why limited liability and the entity theory of the firm is frowned upon
(e.g. Khan, 1994a). Hence, it can be seen that income determination is more
The search for an alternative banking institution resulted in the creation of Islamic
banks and Insurance (takaful) companies in Muslim and Western countries which
finance their customers through these allowed methods. The creation of these
Islamic financial institutions has resulted in the mobilisation of funds from Muslims
on a safe custody basis with return of balance guaranteed but no interest is paid on
Chapter 6 Page 281
the deposits as in conventional banks. However the bank can utilize the ‘al-wadia’
funds while in its custody as long as the activities financed by the bank are not
against the Shari’ah such as gambling and alcoholic drinks industry. Banks are
allowed to pay a part of the profit they make to deposit holders as a ‘gift’ to the
advance.
Another type of deposit is the investment account. Here the depositor deposits the
money as an investor and the bank is the partner. The bank then shares any profit it
makes from the investment with the depositor on a pre-agreed percentage. Any loss
is borne by the depositor while the bank loses its effort. Thus there is no guarantee
Since Islamic banks are not allowed to lend on interest, they undertake Islamic
financing techniques. Although they use mostly murabaha (or cost plus pricing
It can be seen that both musharakah and mudaraba transactions (see Chapter 5)
require income numbers for both the determination and distribution of profit to deposit
Abdelgader’s (1990) study which found the following problems in his investigation of
1) The time lag between deposits and investments, as profits to depositors is partly
based on the length of deposit (as between depositors) holding whereas investments
2) The right of the depositor (savings account) and investment account to withdraw
his deposit at any time whereas the investment is not yet liquidated.
3) The need to ensure fairness for a depositor who has withdrawn but his share of
4) The pooling of various funds i.e. savings, investment, current account and the
equity of the bank itself as compared to division of profits from various activities of
banks.
All these problems show that income determination and valuation concepts are
measurement and valuation (Gambling & Karim, 1986) and reporting practices
(Baydoun & Willett, 1998). The implications for income measurement and valuation
will be discussed.
The first question is should there be a different accounting for different purposes or a
single ‘true’ income figure? According to Khan (1994), “the Shari’ah supports a
government, future investors or general public”(p 17). Thus different profit for
different purposes is not supported. The reason is that “the business firm in an
Islamic society has a social role as well, the most important manifestation of which is
the payment of Zakat. Hence accounting must provide information for businessmen
to determine their Zakat liability and pay it promptly. Under a conventional tax
system, the government may have priorities of expenditure and promotion of the
economy, certain industries, which result in different fiscal policies and thereby
enforcing certain rules such as capital allowances, expense exemptions and double
relief. This does not apply to Zakat calculations. The objective of Zakat assessment
would be to determine a fair share of the wealth and income to be distributed to the
3
See Adnan & Gaffikin, 1997 for a review of the literature on Islamic perspective of the accounting
concepts and conventions)
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poor. Even the Zakat rate is pre-determined and cannot be changed by the
government.
The next question is what valuation basis is to be used for the main objective of
calculating Zakat? Atiyah (1992) quotes a Hadith (tradition of the prophet) which is
quoted as : “Value at current value (market price) and then pay Zakat (on it)”. This
has been further refined to mean net realizable values by Al Qardawi (1979).
However, the Zakat laws do not offer much help for valuation of fixed assets for
currently they are not subject to Zakat as fixed assets were not very significant
component of a business at the time of the Prophet (pbuh) and a long time thereafter
until the Industrial Revolution. However, Gambling & Karim (1991) support
Muslims. This model uses the current cash equivalent to value assets of a business.
This is the amount of cash or purchasing power that could be realised in an orderly
liquidation and may be measured by quoted market prices for assets of a similar kind
and condition.
However, Islam frowns on unearned income and wishes the dignity of labour to be
recognised. Hence if we use the net change in value method, using NRV (Net
Realisable Value) or CCE (current cost equivalent), the operational aspect of the
business is not emphasised. Further the way in which the year end assets and
accounting ignore transactions based - historic cost accounting all together even, if
as Ijiri (1971) argues that , it might be the best system to avoid disputes?
The current conventions of historic cost and conservatism arose from the needs of
bankers and shareholders. However these concepts could be contrary to the idea of
fairness and justice for equitable transfer of property rights among different
stakeholders and disadvantaged members of society. This is due to the fact that
Zakat based on a historic cost valuation would yield lower receipts and consequently
Chapter 6 Page 284
lower transfer payments to the beneficiaries in times of inflation and rising costs. The
transaction basis of historic cost accounting, however, is still very important and
advocated by Baydoun & Willet (1998) as opposed to the economic valuation basis
of accounting These authors argue, that the economic value approach depending on
discounting future values which has the time value of money as its basis has been
rejected by themselves as well as Gambling & Karim (1991) and Khan (1994).
The researcher suggests that a trading/ income account to the gross profit stage be
based on historic costs transaction base i.e. the costs would be actual historic cost
as they are incurred and the sales would be the actual revenues earned. To this a
stock adjustment would be made in the profit and loss account to bring the closing
stock to current market value. A current cost depreciation adjustment would have to
be made taking the net realisable value or replacement cost (where NRV is not
available) of the fixed assets at the end of the period less the current cost at the
beginning of the period. No historical cost depreciation will be made. The final
income figure would be added to capital. Zakat can be paid either on the current
Variable income and economic income would not be suitable as income models as
they involve prediction of cash flows which are hypothetical and the use of an interest
6.7 CONCLUSION
In this chapter, the researcher has attempted to deduce the objective and
based on the ethical principles of the Shari’ah. The ethical principles are in turn
based on the Qur’an and Sunnah, the two primary sources of Islamic Law. The
researcher has argued that this methodology is consistent with the Principles of
falah. For the purposes of operationalising this in accounting, the concept of Islamic
Accountability was developed using a dual accountability model based on the Islamic
concept of Khilafa (vicegerency) and Amana (divine trust). The researcher proposes
Next the users of Islamic accounting information were considered, with the
and Zakat beneficiaries could be as important if not more important than the
traditional fund providers who are considered as the prime users of conventional
accounting.
The characteristics of Islamic accounting were discussed taking into account the
integrated measurement and reporting system, which uses both, monetary and non-
requirement for equitable Zakat and information distribution may required Islamic
accounting to be based on current valuation model rather than the historical cost
In the next chapter (Chapter 7), the research design and data collection techniques
used in the empirical data collection phase will be discussed. The objective of the
empirical part of this research is to gain data on the consensus of Malaysian Muslim
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Islamic accounting. Towards this end, some hypotheses will be presented in the next