Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565

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Advances in Accounting, incorporating Advances in

International Accounting
j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / a d i a c

AAOIFI reporting standards: Measuring compliance

Thea Vinnicombe
Faculty of Business (Fachberreich Wirtschaft), Fulda University of Applied Sciences (Hochschule Fulda), Marquardstrae 35 36039 Fulda, Germany

a r t i c l e i n f o a b s t r a c t

Keywords: Islamic banking and nance have grown rapidly in recent decades. Islamic banks offer a range of products, which,
Shari'a law in complying with Islamic law, often differ from traditional Western nancial products. Consequently, developing
Riba accounting standards to guide Islamic nancial reporting is now an important issue. To this end, the Accounting
Mudaraba
and Auditing Organization for Islamic Financial Organizations (AAOIFI), was established in Bahrain in 1991. While
Islamic accounting standards
the AAOIFI has published a substantial body of accounting and governance standards empirical research into
Murabaha
Zakah compliance with these standards is lacking. This article addresses that gap. A benchmark index is constructed to
measure the compliance of Islamic banks licensed and domiciled in Bahrain. The ndings of the study show
compliance to be very high with respect to the governance standard relating to the in-house supervisory boards of
Islamic banks, and reporting the Islamic murabaha contract. In contrast, compliance with the AAOIFI's
requirements regarding the zakah religious tax and the mudaraba contract is relatively low.
2010 Elsevier Ltd. All rights reserved.

1. Introduction standards and statements which relate to issues dominating the

The study of Islamic accounting has grown in recent years with
substantive contributions from scholars such as Baydoun and Willet
(1995, 1997), Gambling and Karim (1986) and Lewis and Algaoud
(2001). It is notable, however, that the focus of most of these studies is
descriptive or analytical in nature, emphasizing in particular, the
implications of Islam for accounting principles and practices, and the
theoretical framework from which accounting standards for Islamic
entities could potentially be derived (Baydoun and Willett, 2000; Lewis,
2001; Perera, 1989). There is little recognition that a practical response
to the need for Islamic accounting standards has emerged in the form of
the Accounting and Auditing Organization for Islamic Financial Institu-
tions (AAOIFI). This body was established in Bahrain in 1991 to develop
and disseminate accounting and auditing standards for implementation
by Islamic nancial institutions worldwide (AAOIFI, 2003/1421H1 p. ix;
Lewis and Algaoud, 2001, p. 171).
Over almost two decades the AAOIFI has promulgated a body of
Islamic accounting standards to inform the reports of Islamic nancial
institutions. To date no empirical investigation into compliance with
these accounting standards has been undertaken. This article is
intended to address that gap. An index is developed to measure the
compliance of Islamic banks with the accounting and governance
standards issued by the AAOIFI. The index items included do not
encompass the full set of standards. Instead, they are limited to those
Tel.: + 49 661 9640 254.
E-mail address: Thea.Vinnicombe@w.hs-fulda.de.
1
The second date represent the corresponding year in the Islamic calendar. It is the
practice of the AAOIFI to use a dual dating system.
theoretical literature on Islamic accounting. The literature is used as a
guide to identifying benchmark items which reect issues of primary
importance for Islamic reporting entities. Data is derived from the
annual reports of those banks operating under Islamic banking
licenses in Bahrain. Focus on one country avoids potentially complex
external factors which are likely to have differing inuences on
compliance with Islamic accounting standards. Moreover, the Bahrain
nancial sector provides an ideal environment for an initial study of
this nature. The state of Bahrain hosts the AAOIFI and encourages the
implementation of its standards through a number of initiatives.
These include mandatory nancial reporting requirements in accor-
dance with the AAOIFI standards as a basis for the licensing of Islamic
banks (Bahrain Monetary Authority (BMA), 2004, p. 8).
Deliberately selecting such a positive environment suggests that
the hypothesis of the study should be that compliance with the
standards will be high, which, to an extent, is veried by the ndings.
This begs the question as to the relevance of the research. That is, do
the requirements of the Central Bank of Bahrain (CBB) (formerly
Bahrain Monetary Authority) with respect to Islamic nancial
institutions render redundant a study into compliance with the
standards promulgated by the AAOIFI by Bahraini Islamic Banks? A
parallel can be drawn with studies measuring compliance with the
international nancial reporting standards (IFRSs) developed by the
International Accounting Standards Board (IASB). This research has
proven valuable in gauging the real compliance of reporting entities,
and hence the progress of the international accounting standards
harmonization project (Ali, 2005, p. 31). In a similar vein, it is hoped
that an index to test the compliance of Islamic banks with the
standards of the AAOIFI will be useful in facilitating the development
of these standards.

0882-6110/$ see front matter 2010 Elsevier Ltd. All rights reserved.
doi:10.1016/j.adiac.2010.02.009
56 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565
It may be asked why Islamic nancial institutions require a new
and seemingly different accounting treatment to that already existing
for Western entities. The answer may be found in the resurgence of
Islam in recent decades (Karim, 1990; Maurer, 2002). This resurgence
is reected in the desire of Muslims to apply Islamic principles to all
aspects of their lives, including business life. The result has been a
rapid development in Islamic economic and nancial theory, and a
subsequent need for accounting principles and practices that facilitate
the reporting of Islamic entities in a manner consistent with Islamic
principles.
The remainder of this study is organized as follows: the second
section outlines the historical development of the AAOIFI. Section 3
examines the literature on compliance indices. The fourth section
identies appropriate elements to include in the compliance index
through a survey of the Islamic accounting literature. The index is
developed in Section 5, where the sample and ndings of the study are
also discussed. Concluding remarks and suggestions for further study
follow.
2. The AAOIFI
This section explains the need for an Islamic accounting standard-
setting body, the history of the AAOIFI, its approach to developing
accounting standards, and the problems and challenges it faces. A
critical analysis of the standards produced by the AAAOIFI is not
provided in this article. The pragmatic approach taken by the AAOIFI
in developing its standards has been criticised in the context of the
conceptual framework debate which asks whether accounting
standards for Islamic entities can be adapted from conventional
Western standards, or whether they should proceed from an Islamic
framework (see for example, Ibrahaim [undated]). The AAOIFI chose
the former approach believing that the efciencies gained from
previous work will facilitate a timely implementation of their own
standards without compromising Shari'a law (AAOIFI, 2003/1424H,
pp.xxivxxv).
The need for Islamic accounting standards coincides with the
development of Islamic nancial products. New nancial products
require commensurate accounting treatments, especially where institu-
tions are required to produce annual nancial statements. However, the
rapid growth of Islamic nancial institutions from the 1970s onwards
outstripped the ability of accounting standard development to keep
pace (Pomeranz, 1997, p. 124). Moreover, the emphasis in the
Islamization of nancial products focused on developing nancial
institutions and nancial products, rather than a corresponding
regulatory framework.
Prior to the establishment of the AAOIFI, individual Islamic
institutions instituted (and continue to maintain) Shari'a Supervisory
Boards (SSBs) to ensure compliance with Islamic law in their
practices, including the production of their nancial statements.
Typically SSBs take the form of in-house advisory boards, but small
organizations may choose to hire individual consultants on a less
permanent basis. While there has been no overruling legal require-
ment for Islamic banks to employ SSBs, in some countries, for example
Bahrain, they must do so in order to be licensed. Individual SSBs have
expended considerable effort in examining, modifying and advising
on appropriate accounting treatments (Karim, 1995, p. 292). This
process has necessitated much duplication of work, as similar issues
are confronted by most Islamic nancial institutions in their search for
appropriate accounting treatments. Prior to the standards for SSBs
introduced by the AAOIFI, there were no guidelines for individual SSBs
to follow, and no guidelines for nancial institutions in establishing
their SSBs. These factors, along with differences between SSBs,
contributed to there being considerable variation in accounting
practices between institutions, and even within the same institution
over time. This became increasingly problematic during the 1980s. As
a result, Islamic nancial institutions faced increasing pressure to
conform to uniform accounting standards through the establishment
of one overriding standard-setting body which could develop
acceptable accounting treatments for a range of issues (Pomeranz,
1997, p. 127). At the same time, Islamic nancial institutions were
concerned that regulations would be imposed upon them by
individual regulatory bodies in the various jurisdictions where they
operated, so they were largely proactive in the promotion of the
AAOIFI (Karim, 1995, p. 288).
The AAOIFI commenced operations in Bahrain in March 1991
(11 Ramadam 1411H) (AAOIFI, 2003/1424H, p. ix). Initially known as
the Financial Accounting Organization for Islamic Banks and Financial
Institutions (FAOIBFI), the name change to the AAOIFI in 1995
reected a broadening of the brief for the organization to include
auditing and other standards in response to demands from the Islamic
nancial community. The AAOIFI has a two-tiered organizational
structure paralleling that of the IASB and other similar organizations
such as the Financial Accounting Standards Board in the United States.
The purpose of the two tiers is to separate the standard-setting
function from nancing the organization, so that the standard setters
are not subject to a conict of interest.
The aims of the AAOIFI have evolved since its formation. Today they
include the preparation and promulgation of accounting, auditing and
governance standards for Islamic nancial institutions with the goal of
achieving harmonization in the accounting adopted by [Islamic
nancial institutions] in the preparation of their nancial statements
(AAOIFI, 2003/1424H, p. ix). The AAOIFI also provides guidelines for
Islamic nancial institutions in a number of areas where they may
experience difculties in nding appropriate accounting treatments or
interpretations, such as issues relating to Islamic insurance and new
nancial products. Finally, it is the goal of the AAOIFI to promote the
adoption of its standards by Islamic nancial institutions through the
support of the relevant regulatory authorities in countries where these
institutions operate. To this end both national and transnational bodies,
including central banks, accounting organizations and the IASB, are
encouraged to become AAOIFI members.
In 1993, the then FAOIBFI issued Financial Accounting Statements
1 and 2 (FAS1 and FAS2) (Karim, 1996, p. 119). These two statements
represented nalization of the FAOIBFI's initial task to develop
objectives and concepts of nancial accounting for Islamic banks.
FAS1 outlined the objectives, and FAS2 the concepts (Karim, 1995,
p. 289). Taken together, the two statements are often described as
providing a framework for the further development of Islamic
accounting standards (Karim, 1996, p. 119). The two statements
were followed by Financial Accounting Standard Number 1 (FAST1),
which detailed requirements for the general presentation and
disclosure for nancial statements of Islamic banks.
The AAOIFI has now published twenty three Financial Accounting
Standards (FAST 123), as well as standards for Islamic insurance
companies, auditing standards, governance standards and codes of
ethics for accountants, auditors and employees of Islamic nancial
institutions. This constitutes a substantial body of work in a relatively
short period of time. In common with all accounting standard-setting
bodies, however, the AAOIFI faces a number of challenges. Its task is
comparable to that of the International Accounting Standards Board
(IASB) in that, unlike national accounting bodies, it must set standards
for banks located in vastly different parts of the world. The standards
therefore need to be acceptable to a variety of regulatory regimes and
a range of political, economic and social circumstances. The AAOIFI
has no power of enforcement, and must therefore proceed by gaining
the support of national regulatory bodies and the major Islamic banks
(Karim, 1995, p. 289).
Despite these problems, the AAOIFI has experienced considerable
success in terms of the standards it has produced, growing
membership and what appears to be increasing acceptance by the
regulatory authorities in many largely Islamic countries, such as
Bahrain, Qatar and Malaysia. It seems timely therefore to test the
 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565
extent to which the standards promulgated by the AAOIFI are
implemented by Islamic banks.
3. Measuring compliance
The area of empirical research pertinent to this study is the
literature on compliance indices. While there appear to be no previous
studies on compliance with Islamic accounting standards, it is possible
to draw on the literature relating to compliance with International
Accounting Standards (IASs). Tower, Hancock and Taplin (1998)
dene compliance with the IASB's standards as being the degree to
which entities comply with a multitude of issues in the international
accounting standards (IASs)/international nancial reporting stan-
dards (IFRSs) issued by the International Accounting Standards Board
(IASB). In a similar vein, compliance for the purpose of this study can
be dened as the degree to which Islamic nancial institutions comply
with the multitude of issues in the nancial accounting standards
(FASs) issued by the AAOIFI. Compliance with accounting standards is
therefore viewed as essentially value neutral, so that the nature of
resulting information is not at issue.
Of relevance to this study is the development of indices which are
used as benchmarks against which compliance is measured. The
pioneering study in this area is that of Nobes, 1990, which used annual
nancial statements to measure the compliance of a sample of listed
US companies with IASs. This was the rst study in which data from
annual reports were measured against a benchmark set of accounting
rules. Subsequent studies using a similar methodology include Purvis,
Gernon and Diamond (1991), Tower et al. (1998) and Street, Gray and
Bryant (1999). Interest in measuring compliance increased towards
the end of the 1990s and into the 21st Century as reporting in
accordance with IASs/IFRSs entered a new stage. For example, from
2005 all companies listed on stock exchanges in the European Union
have been required to prepare their nancial statements in accor-
dance with the IASBs accounting standards (International Accounting
Standards Plus, 2009). More recent studies show a corresponding
increase in compliance (Ali, 2005, p. 37). The benchmarks used in
these compliance studies are derived directly from the IASs/IFRSs.
4. Determinants of the compliance index
In order to measure compliance with the accounting standards
promulgated by the AAOIFI, the potential set of benchmark items
includes all standards and guidelines issued to date by the Accounting
and Auditing Standards Board (AASB) of the AAOIFI. A smaller set of
items is considered more likely to yield insight into the nature of current
compliance, which can then provide the basis for future research. This
study therefore restricts the index to those items included in the
standards and guidelines published by the AAOIFI that are considered
most important for users of Islamic nancial statements. These items
have been identied through a survey of the Islamic accounting
literature. Baydoun and Willett (2000) claim that all the essential
elements that need to be addressed in Islamic Corporate Reports (ICRs)
can be found in the seminal paper in this area, Gambling and Karim's
(1986) paper Islam and Social Accounting. These can be summarized
as follows: rst and foremost, the importance of Shari'a compliance;
secondly, the unity of Islam, thirdly, the ban on riba or usury found in
the Shari'a, and nally, the payment of the religious tax or zakah. These
topics are discussed below since they provide a background for
understanding why specic items have been selected for the compliance
index used in this study.
4.1. The importance of Shari'a compliance
Islamic banks are dened by their commitment to follow the
Shari'a (or Islamic law) in all aspects of their organization. The two
most important sources of Shari'a law are the Quran and sunna. The
57
revelations of God to the Arab world through the Prophet Mohammad
(PBUH)2 were recorded in the Muslim Holy Book, the Quran. This was
supplemented by the sunna, the recorded sayings and actions of the
Prophet (PBUH) during his lifetime, as well as those actions of his
followers of which he approved (Hussain, 1999, p. 28f). These two
primary sources have, over time, been supplemented by the works of
learned Islamic scholars. The commentaries, interpretations and new
laws to meet changed circumstances produced by Islamic jurists are
an important element of the Shari'a. They provide Islamic jurispru-
dence with the necessary exibility to meet changing circumstances,
and, in addition provide precedents not only with respect to
judgments, in a manner similar to Anglo/American case law, but
also precedents in the developments of new laws. This is particularly
relevant to the production of accounting standards for Islamic
nancial institutions in the late 20th and early 21st Centuries.
4.2. The importance of the Islamic community
The meaning of Islam is to submit oneself to God, and those who do
so form the umma, the community of Muslims (Lewis, 2001, p. 104). A
Muslim, is therefore, automatically part of the Islamic community, and is
also obliged to promote the well-being of that community including its
accounting, business and economic practices. Islamic banks are
expected to play a positive role in the Muslim community. According
to Lewis and Algaoud (2001, p. 165), the rst obligation incumbent upon
an Islamic bank is to serve Allah and develop a distinctive corporate
culture. By this they mean the bank must reect Islamic values in all its
activities, from providing Shari'a-compliant nancial products to the
treatment of its staff, and in its dealings with customers. In addition,
Islamic banks are seen as playing a pivotal role in facilitating economic
prosperity as the basis of a stable society in which Muslims can live a
good and faithful life.
It is in the context of Shari'a law and its application to all areas of
Islamic life that items for the compliance index, outlined below, are
selected. We begin with a discussion of the need for alternative
nancial products, then turn to the Islamic tax, zakah, and nally
Shari'a supervisory boards.
4.3. Mudaraba and musharaka nancing
The ban on riba, which is now widely understood as a ban on
interest-bearing nancial products, is both the most well-known aspect
of Islamic banking and nance, and that with the most far reaching
implications.3 Prot from the interest spread between deposits and
loans forms the basis of Western nance. Hence, its prohibition requires
alternative nancial products to facilitate the ow of funds between
lenders and borrowers in compliance with the Shari'a. Alternative
nancial products also require alternative reporting guidelines and
hence accounting standards. Contemporary Islamic scholars have
turned to the past to guide their development of appropriate nancial
products and reporting thereof. In theory, prot-and-loss (PLS) sharing
products are favoured as they promote the spirit of brotherhood and
community which Islamic nance intends to facilitate (Algaoud and
Lewis, 1999, p. 63). The PLS product which has received the most
2
It is customary in the Islamic literature to follow any mention of the Prophet
Muhammad's name with the words peace be upon him. This practice has also been
adopted by Westerners writing in the area, irrespective of religious afliation, as a
mark of respect. This paper follows Pomeranz (1997) in using the acronym PBUH.
3
The earlier Islamic accounting literature included some debate as to how riba
should be dened, and to what extent it should be interpreted as a complete ban on
interest in a contemporary context (Algaoud and Lewis, 1999; Karim, 1995). For some
time, however, the consensus has been that all interest-bearing deposits and nance,
and even valuation models using interest rates are subject to the prohibitions found in
the Quran (Karim, 1996).
58 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565
attention in the Islamic nance and accounting literature is mudaraba
nancing.
4.3.1. Mudaraba nancing
In early Islamic times a mudaraba was typically contracted between
two parties, one providing the capital and the other labour or expertise
for a commercial venture. Once the venture was concluded, any prots
would be divided between the provider of capital (the rab al-mal) and
the investor (the mudarib) according to a predetermined and agreed
upon ratio. The liability of the rab al-mal was limited to the amount of
his/her investment, and of the mudarib to his/her time and or labour
(Maali, Casson and Napier, 2006, p. 268). Maurer (2002, p. 653)
describes the modern mudaraba as essentially a scaled-up version of
the classic form.
The modern product is, however, considerably more complex, and as
such, presents challenges for accounting and nancial reporting. In the
rst instance, the mudaraba governs the relationship between an Islamic
bank and holders of Islamic investment accounts. The bank is the
mudarib, or manager of the funds, and investment account holders are
rab al-mal. These contracts can be restricted or unrestricted and
unilateral or bilateral (Karim, 1996, p. 120). In the case of the former,
the Islamic bank is able to use the investment account funds in a way
that is unrestricted with respect to the kind of activity, duration and
location of the enterprise (Algaoud and Lewis, 1999, p. 66). The one
important stricture is that all ventures funded by the bank must comply
with the Shari'a. Investors may, however, restrict the use of their funds,
for example, to certain nancial products used and/or an area of
investment activity.
Unrestricted investment accounts tend to be more common in
both number and amount. The funds in these accounts are typically
pooled by the bank and referred to as pooled mudaraba. Pooled funds
can be either bilateral or unilateral. In a unilateral fund, investments
are made entirely through the use of investment deposits, with no use
of bank equity. Bilateral funds are more commonly used by most
Islamic banks. In these, the investment funds can be commingled with
the bank's equity and/or other available funds, for example, those in
short-term deposit accounts (Karim, 1996, p. 6). The range of
potential investments to which bilateral unrestricted funds may be
directed is very wide, including not only domestic ventures, but also
foreign and non-Islamic investments (so long as the Shari'a is not
violated) (Hamid, Craig, & Clarcke, 1993, p. 141). Reporting and
accounting for such investments may become very complicated since
the bank acts as mudarab to the depositor investors, while, at the same
time, acts as rab al-mal in relation to a range of business ventures. As
with the traditional mudaraba account, prot is allocated at a
predetermined rate, both between the users of investment funds
and the bank, and the bank and investment fund holders.
Clearly, agency problems are heightened in such circumstances.
The Islamic bank can choose from a range of investment alternatives
of differing risk and return, and can potentially use different funding
combinations for different investments. Typically the bank also has
wide discretion in the use of commingled unrestricted investment
funds. It is therefore conceivable that a bank could take higher risks
with investors funds than its own by using unilateral funds for high
risk investments, and bilateral funds, or even its own equity alone for
safer ventures. In addition, because prots are shared at predeter-
mined rates, the users of the bank's funds have an incentive to
overstate costs and understate prots in order to increase their actual
returns. The bank has the same incentive with respect to investment
fund holders. Unbiased accounting standards for external reporting
purposes therefore become extremely important.
One of the most problematic issues for contemporary accounting is
the number of investors and the spread of pooled funds across multiple
investments. Historically mudaraba contracts usually involved only two
parties, the lender and borrower, and were made in order to carry out a
single business venture. The contracts were dissolved at the completion
of that venture. In contrast modern mudaraba contracts tend to be
numerous, continuous in nature and are usually not liquidated
simultaneously at the end of the nancial year (Karim, 1996, p. 125).
In addition, there may be an expectation of periodic prot allocation
regardless of the timing of the equity ventures and fund liquidations.
Financial reporting is therefore further complicated in two ways: rstly,
the timing of deposits into investment funds is not restricted to the start
of a venture. Secondly, the timing of maturity of the investment
accounts of different account holders and of different investment
ventures varies. The fund, however, does not normally liquidate at the
maturity of one investment. Most importantly, and underlying all the
above is the issue of multiple fund holders and multiple ventures. While
early PLS funds generally involved only two participants, modern funds
involve three categories of participants, account holders who are the
providers of funds, banks acting in their dual role as mudarib to
depositors and rab al-mal to borrowers, and nally the recipients of the
assets (Ibid).
A further difculty with respect to developing accounting standards
for mudaraba contracts is the calculation of income for the purpose of
allocating prot. It is argued that, for the purpose of income calculation,
current cash equivalent (CCE) should be the method employed to
determine asset value (Maurer, 2002, p. 656). The reason for this is
associated with commingled funds. The problem perceived by contem-
porary scholars in using historical cost valuation is that some investors
would potentially be deprived of unrealized gains, or may not be liable
for unrealized losses that result from appreciation or depreciation in
the value of jointly nanced assets (Karim, 1996, p. 10). This suggests
interim prot distributions based on CCE could be appropriate.
However, investors are also liable for losses up to the sum of their
investment. Problems would arise if there is a partial distribution of
prot during the term of the mudaraba and losses follow. The parties
who received the prot distribution would, in theory, be liable to return
a sum equal to their proportionate share of the losses. In practice, it is
difcult to imagine how this could be implemented (Hamid et al., 1993,
p. 141).
A nal problem respecting the calculation and distribution of prot
for both restricted and unrestricted mudaraba contracts relates to
appropriate costs to be deducted by the bank. While some banks
deduct only expenses directly related to specic investments, and a
management fee, others also deduct proportionate indirect expenses
(Lewis, 2001, p. 122). Guidance is therefore needed not only with
respect to determining the proportion of prot and loss to be divided
between the parties, but also in determining costs and expenses.
Mudaraba contracts are addressed by the AAOIFI in FAS2 and in
FAST3 and FAST5 (AAOIFI, 2003/1424H). FAS2 paragraph 25 distin-
guishes between the treatment of unrestricted and restricted
investment accounts. Unrestricted accounts are to be disclosed in
the Statement of Financial Position on the basis that a bank is able to
use these funds as they wish, including commingling with their own
equity. Because banks do not have the same liberty with the use of
restricted accounts the AAOIFI has determined that these should
disclosed in the notes to the nancial statements (Ibid). The separate
disclosure is potentially signicant in that returns on commingled as
opposed to restricted funds can be compared in terms of performance.
This may go some way to addressing the agency problems outlined
above (Karim, 1996, p. 122).
FAS2 also deals with asset valuation for both restricted and
unrestricted investment accounts (Paragraphs 9395). It is recognized
that asset valuation at historical cost may lead to inequities in the
distribution of prot, where account holders provide or withdraw
funds at different points of time during the life of the investment
(AAOIFI, 2003/1424H, FAS2, paragraph 93). Nevertheless the Account-
ing and Auditing Standards Board (AASB) of the AAOIFI is concerned as
to whether adequate means of revaluation to current value equivalent
are available. In consequence, historical cost for valuing assets and
liabilities is accepted in most instances (Ibid, paragraph 98). FAST3
 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565
addresses the recognition, measurement and disclosure requirements
between the bank as rab al-mal and the mudarib. FAST5 is intended to
establish rules that regulate the disclosure of such prot allocation in
order to standardize the bases of disclosure of this information among
Islamic banks and nancial institutions (Ibid, p. 191).
4.3.2. Murabaha nancing
Islamic banks have been successful in obtaining funds (deposits)
on a PLS basis, but the same degree of transformation to PLS
nancing has not yet developed (Algaoud and Lewis, 1999, p. 78). It
is considered permissible, by most contemporary Islamic scholars, for
nancial institutions to enter into cost plus mark-up forms of
nancing, the most common form of which is the murabaha contract.
Although often associated with replacing personal or mortgage loans
to individuals, these contracts can also be used to nance various
business activities. Under this form of nancing, the bank purchases a
single good, or perhaps a consignment of products, on behalf of a
customer, who repays the cost plus a mark-up. Repayments, including
the mark-up, are usually made according to a pre-arranged schedule.
Although the murabaha is a relatively straight-forward form of
nancing, a number of reporting issues have been identied. In
particular, prot recognition for reporting purposes varies signi-
cantly between banks (Karim, 1995). Prot may be recognized when
the contract is completed or over the life of the murabaha. If the latter,
it may be recognized according to the predetermined scheduled
repayments, or when the payments are actually received. Specica-
tion of accepted practice/s is therefore necessary. In addition, many
banks require guidelines as to the allocation of costs in order to better
standardize this practice. While it is recognized that a nancial
institution will incur costs in purchasing a product/s and transferring
the same between parties, calculating other costs, such as the mark-
up and the costs of establishing the murabaha contract are not so clear.
This issue of failure to meet scheduled repayments on the part of
the client must also be addressed by Islamic banks. The Quran
encourages lenders of capital to be lenient in this respect (Maali et al.,
2006, p. 276). In any case, Islamic banks are not permitted to request
nor to accept guarantees for murabaha contracts. However, it is
possible for a bank to request an initial deposit, from which overdue
instalments may be deducted. Where a client fails to meet scheduled
repayments because he or she is insolvent, Islamic law and the nature
of the murabaha contract prevent the nancial institution taking legal
action. Where a client is solvent, but fails to make scheduled
payments, the bank must determine appropriate action. Again, this
is an issue which can benet from guidance by the AAOIFI.
Murabaha contracts are addressed by the AAOIFI in FAST2,
Murabaha and Murabaha to the Purchase Orderer. This standard
covers the measurement of the value of assets covered by the contract
both at the time of and over the longer term by the Islamic bank.
Accounting for a decline in value of such assets is also covered. In
addition, FAST2 provides guidelines for prot recognition and
disclosure, for the purchaser, meaning the bank. Finally, procedures
for failure to meet payments, and insolvency are given (AAOIFI, 2003/
1424H, FAST2).
4.4. Zakah
One of the most important considerations for Islamic accounting
has been identied as the requirement incumbent upon all Muslims to
pay the religious tax or zakah. Along with prayer, fasting, almsgiving
and the pilgrimage to Mecca (for those with the means and health),
zakah is one of the ve pillars of Islam (Tayob, 1999, p. 98). Because
the Quranic injunction to pay zakah predates large corporations, the
varying tax levels specied in the Shari'a apply largely to individuals.
Consequently it is debated whether zakah should even be applied to
business organizations (Maali et al., 2006, p. 275). Some Islamic banks,
however, are required to pay zakah, either to comply with their
59
regulatory environment, or in accordance with their organizational
charter. Lewis (2001, p. 118) argues that where zakah is not required,
it becomes the duty of an Islamic bank to establish a zakah fund and
ensure the proceeds are distributed to the poor. In addition, Islamic
banks sometimes either pay zakah on behalf of their shareholders
and/or disclose the amount payable per share in their annual reports
(Karim, 1990).
The calculation of zakah in accordance with Shari'a guidelines in a
contemporary economic environment is complex. Calculating the
zakah base requires asset valuation, which is a problematic issue in
nancial reporting generally (Baydoun and Willet, 1997, p. 7). In the
Islamic accounting literature there appears to be agreement that, for
zakah purposes, assets should be divided into current and non-
current, and only the latter should be subject to the religious levy
(Baydoun and Willet, 1997; Gambling and Karim, 1986). It is argued
that xed capital or non-current assets are utilized capital, and
therefore not subject to the tax. Islamic scholars also argue that
current cost accounting (rather than historical cost) should be used
for accurate valuations. Gambling and Karim (1991) have pointed to
the need to use the lunar or Islamic calendar for valuations to be
precise. The overriding issue is that differing views between Islamic
nancial institutions with respect to asset valuation, including what
should be included and what accounting treatments should be used,
have led to a variety of accounting treatments, and the consequent
need for guidance in this area.
The AASB of the AAOIFI addresses this issue in Financial
Accounting Standard Nine (FAST 9), adopted in June 1998 [Saffar,
1419H]. Paragraph one refers to the scope of the standard which
encompasses accounting treatments to determine the Zakah base,
measurement of items included in the Zakah base and disclosure of
Zakah in the nancial statements of the Islamic bank (AAOIFI, 2003/
1424H, p. 276). The standard species the assets to be included, and
states that where no current value is clear, cash equivalent valuation
should be used. Guidance for valuing zakah according to both the
lunar (Islamic) and solar (Western) calendars are provided. Account-
ing treatments and disclosure requirements are specied differently
for banks required by law to pay zakah, and those not required to do
so.
4.5. The Shari'a Supervisory Board
The standards and guidelines published by the AAOIFI are viewed
not as a replacement for the individual SSBs, but as providing a means
to harmonize differences (Karim, 1995, p. 298). Maintaining and
formalizing the internal regulatory role of SSBs is considered vital as
these internal bodies are best placed to assist their individual
organizations in achieving Shari'a compliance, and thus play an
important role in the overall regulatory environment. (Algaoud and
Lewis, 1999, p. 81).
The AAOIFI has published a set of governance standards for Islamic
banks which address the issues relating to internal SSBs. Of relevance
for reporting purposes is Governance Standard for Islamic Financial
Institutions Number 1 (GSIFI 1), which species the composition of
the board, and the basic elements of its annual report. GSIFI 1 makes it
mandatory for all Islamic nancial institutions to appoint an SSB
through the shareholders annual general meeting. The qualications
of the board and its duties are also specied, including their expertise
in Islamic jurisprudence and nance (AAOIFI, 2003/1424H, Gover-
nance Standards, p. 5). Each board must be comprised of at least three
members. The board must produce an annual report, which must be
published with the bank's nancial statements. Basic elements to be
included in the report include a scope paragraph describing the nature
of the work performed and an opinion paragraph containing an
expression of opinion on the compliance of the Islamic nancial
institution with Islamic Shari'a Rules and Principles. The existence of
60 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565
the SSB, its composition and a summary of the specications are
included in the compliance index.
The AAOIFI's treatment of murabaha and mudaraba nancing, as
well as FAST9, Zakah, and GSIFI1 on the SSBs of individual banks
provide the basis for constructing the compliance index for this study.
The required disclosures based on the AAOIFI's treatment of the issues
above are summarized in Appendix A. The issues addressed by the
AAOIFI in the relevant statements and considered by the author to be
most signicant in terms of the literature review are delineated as the
benchmark compliance requirements. The items are divided into four
categories as determined in the discussion above. The annual reports
of a sample of Islamic banks were used to compare actual disclosures
with those identied in the benchmark in order to measure
compliance with the accounting standards developed and promul-
gated by the AAOIFI.
5. Empirical investigation and conclusions
5.1. Sample
The potential population for this study includes all fully agged
Islamic banks, meaning fully Islamic banks as opposed to those
offering only a limited range of Islamic products. Of this total
population, the country of origin of associate member banks ranges
from relatively stable and largely Islamic nations such as Bahrain and
the United Arab Emirates, to vastly diverse areas, including Russia,
Pakistan and South Africa. Clearly, exogenous political, economic,
social and geographic factors will impact the degree of AAOIFI
compliance amongst the member banks of different nations. Due to
this lack of homogeneity, it was decided to conne the study to
member banks in one nation only, Bahrain. Bahrain is the most
obvious choice for an initial study of AAOIFI compliance. Not only is it
the host nation for the AAOIFI, but, perhaps more importantly, it is a
requirement of the Central Bank of Bahrain (CBB) that all Islamic
nancial institutions licensed in Bahrain must comply with the
standards issued by the AAOIFI. In addition, the CBB, and the Bahrain
government more broadly, promote the nation as a leading Islamic
nancial centre in the Middle East, citing the growth in the number
and size of Islamic nancial institutions operating in Bahrain since the
1970s as evidence of their success in this initiative. In addition,
Bahrain has been identied by a number of researchers in Islamic
accounting and nance as the most suitable current locale to study
Islamic banking due to its leading regional role in conventional as well
as Islamic banking (for example, Algaoud and Lewis, 1999). Bahrain
therefore provides a stable and conducive environment for the
progressive development of Islamic banking and nance.
The sample for this study was therefore delineated as those fully
agged Islamic banks licensed in Bahrain, and listed as such on the
website of the CBB. Currently this list includes 26 banks, six of which
are categorized as retail banks and the remaining 20 as wholesale
banks (CBB, Licensing and Policy Directorate, 2009). Accordingly the
sample was divided into two groups encompassing the two lists in
order to better identify any differences associated with the different
bank types. Of the six retail banks, one, the Al-Baraka Bank, was found
to be part of a larger Islamic banking group, listed amongst the
wholesale group, and having only consolidated reports. This bank was
therefore deleted from the retail group. The Al-Amin bank, which
merged with Al-Baraka bank in 2007, was added to this group. Annual
reports were not available for a number of banks in the wholesale
category for various reasons, summarized in Appendix B. The nal
sample comprised nine wholesale banks and six retail banks and
covered the four year period from 2004 to 2007.
Compliance with the standards was limited to the period from
20042007 because a comprehensive set of standards used was rst
published only in 2003/1424H. Although the AAOIFI has since
published two updated versions of its accounting and governance
Table 1
Compliance items by category.
Category Number of items Weight
Shari'a 10 23.8
Mudaraba Finance 23 54.8
Murabaha Finance 5 11.9
Zakah 4 9.5
42 100
standards, the initial publication was deemed most appropriate for
testing compliance over the relevant time period, as it is clearly not
possible for banks in 2004 to comply with any adjustments made to
the standards in the following years. Moreover the focus of the
subsequent publications has been to provide an increasingly com-
prehensive set of standards, rather than to revise prior standards.
While the sample is relatively small, it is not considered too small
to yield insights into the nature of Islamic nancial reporting. There
are precedents for similar sized samples. For example, Tower et al.
(1998), examined the annual reports of only ten entities in each of six
countries. Moreover, the small sample size facilitated familiarity with
the annual reports and websites of the sample banks, thereby
providing additional information which supplemented that available
in the nancial reports and accompanying notes.
Being licensed in Bahrain and therefore subject to the regulatory
environment of the BMA, all fteen banks in the sample are required
to comply with the accounting and governance standards issued by
the AAOIFI. In addition, the independent auditor's reports accompa-
nying the nancial statements were examined to ensure rstly, that
the audit was conducted in accordance with the auditing standards
published by the AAOIFI, and secondly, that the opinion statement
conrmed that the nancial statements had been prepared in
accordance with the accounting standards published by the AAOIFI.
The audit report is considered to provide only a preliminary indication
of compliance. Previous studies have shown that even in cases of clean
audit reports, an entity may not score highly on compliance
measurements (for example, Nobes, 1990).
5.2. Data
The previous section discussed the disclosure items identied for
this study, grouped into four categories. These are shown in Appendix A.
Table 1 below shows the items in each category by number and as a
percentage of the total. The scoring in this study follows the approach
used by Buzby and Falk (1979), Inchausti (1997) and Maali et al. (2006)
(among others) in allocating clearly disclosed items a score of 1,
ambiguously disclosed items a score of 0.5 and undisclosed items a
score of 0. The individual items are therefore unweighted.4 Table 1,
however, indicates that in deriving items matched to categories, more
importance is unavoidably attributed to some categories as opposed to
others, and to the categories selected for the study as opposed to those
not selected. The number of items in each category tends to reect the
detail required in the AAOIFI's standards with respect to identifying
compliance, rather than the relative importance of each category. As
4
The literature on voluntary disclosure indices sheds more light on the issue of
weighting. While there is general agreement that weighting items according to their
importance may provide more insightful results, practical difculties have been
observed both in assigning weights, and the arbitrary nature by which this is done
(Barrett, 1976). Moreover, an early study conducted by Dhaliwal (1980), compared
the results of unweighted and weighted indices and found similar results, suggesting
therefore that weighting adds little value to the outcomes. In consequence, subsequent
studies tend to use unweighted indices.
 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565 61

Islamic accounting is an emerging area of research, and as Islamic Table 2

banking, Islamic nancial products and Islamic accounting, auditing and Level of compliance by bank and year.

governance standards are in the process of development, it is likely that Maximum items Compliance Compliance as a ratio
other issues of perceived interest and importance will become
2004
prominent. In short, the categories and items identied should not be Retail banks
seen as exhaustive, and caution should be exercised in associating the Bahrain Islamic Bank 37 30.0 82.4
relative number of items in each category with the relative importance Kuwait Finance House 38 25.5 67.1
Shamil Bank 39 30.5 78.2
of the categories.
Wholesale banks
Nevertheless, it should be noted that the number of items in the ARCAPITA Bank 19 13.5 71.1
mudaraba category (23) exceeds the sum of the number of items in Gulf Finance House 37 13.5 36.5
the three other categories (ten, ve and four). The mudaraba contract International Investment 30 14.0 47.0
is a product unique to Islamic nance and one which demonstrates House
Unicorn Investment Bank 19 12.5 65.8
some quite complex characteristics. It presents challenges for
accounting standard setters and nancial report preparers. These 2005
are not limited to reporting compliance. Islamic corporate reporting Retail banks
should ensure users are adequately informed as to the Shari'a Al-Amin Bank 39 31.0 79.5
Bahrain Islamic Bank 39 32.5 83.3
compliance of this product. The number of items in this category
Khaleeji Commercial Bank* 39 24.0 61.5
therefore reects the more complicated aspects of this product. Kuwait Finance House 40 27.5 68.8
Shamil Bank 40 34.0 85.0
Wholesale banks
6. Results Al-Baraka Bank 38 31.0 81.6
ARCAPITA Bank 37 28.5 77.0
Table 2 shows compliance for each bank over the three year period CAPIVEST Bank 38 26.0 68.0
by number and as a percentage of actual items relative to the Gulf Finance House 40 27.5 68.8
International Investment 30 15.5 52.0
maximum possible items for the bank in each period. Table 4 shows
House
the mean, median, minimum and maximum compliance scores for Investors Bank 39 16.0 41.0
each banking category over the 4 years. Unicorn Investment Bank 41 16.5 40.2
The total number of items identied for the compliance index is 43
2006
(see Appendix A). These are decomposed into categories as indicated
Retail banks
in Table 1. Not all items in the benchmark index are applicable to all Al-Amin Bank 39 30.5 78.2
the banks in the survey. Column 1 in Table 2 shows the total number Al-Salam Bank 37 26.0 70.3
of applicable items for each bank over each of the 3 years. For Bahrain Islamic Bank 35 33.0 94.0
example, in 2004, the maximum number of applicable items for both Khaleeji Commercial Bank* 39 27.0 69.2
Kuwait Finance House 36 22.5 63.0
Arcapita and Unicorn Wholesale Banks was only 19, while for Shamil
Shamil Bank 36 31.5 87.5
Bank it was 39. Compliance was measured by calculating the ratio of Wholesale banks
items actually reported (in the second column) to the number of Al-Baraka Bank 38 32.5 85.5
items in Column 1. This ratio is then shown in Column 3. Table 3 ARCAPITA Bank Change in reporting period from 2006 onward**
CAPIVEST Bank 35 27.0 77.0
shows the mean, maximum and minimum number of items in the
Citi Islamic Investment 21 10.0 48.0
four sampling periods (Table 4). Bank
While Table 2 suggests the number of items relevant for Gulf Finance House 39 26.5 67.9
compliance increases over time for some banks, this is not reected International Investment 30 17.0 57.0
in the mean number of compliance items for each year in Table 3. House
Investors Bank 39 18.0 46.2
Tables 2 and 3, suggest a higher number of compliance items are
Unicorn Investment Bank 18 13.5 75.0
associated with retail as opposed to wholesale banks. However, it
should be noted that the retail bank samples are more homogeneous 2007
and consistent over time than those of the wholesale banks. Retail banks
The small sample size also presents difculties in drawing Al-Salam Bank 37 25.5 69.0
Bahrain Islamic Bank 35 31.0 89.0
conclusions concerning improvements in compliance over time. It is Khaleeji Commercial Bank* 36 25.5 71.0
reasonable to suppose that as standards are in place over a longer Kuwait Finance House 36 25.5 71.0
period of time, they are better understood, and hence compliance Shamil Bank 36 28.5 79.0
increases. The data, however, does not support this assumption. Wholesale banks
Al-Baraka Bank 38 31.0 82.0
Friedman tests were carried out to examine the level of compliance as
ARCAPITA Bank Change in reporting period from 2006 onward**
the dependent variable over the 4 years. This test was performed for CAPIVEST Bank 34 26.5 78.0
the retail banks, the wholesale banks and for both groups combined. Citi Islamic Investment 21 10.0 48.0
The analysis found no signicant differences in compliance.5 In time, it Bank
should be possible to examine a larger and more consistent group of Gulf Finance House 36 25.5 71.0
International Investment 30 15.5 52.0
banks which could yield more insight into this issue. House
Tables 5a and 5b provide more information on disclosure by Investors Bank 32 24.5 77.0
category for both the retail and wholesale banks. The two areas where Unicorn Investment Bank 19 15.0 79.0
compliance is very high for both banking categories are the SSB report Venture Capital Bank 22 17.5 80.0

* Formerly Gulf Finance House.

** Reporting period is in the process of change from July 1 to June 30 during these
2 years and this bank is therefore excluded from 2006 onward.

5
The results of the tests are as follows: Wholesale banks 2 = (DF = 3, n = 7) =
2.880, p N 0.5: Retail banks 2 = (DF = 3, n = 5) = 0.40, p N 0.5: All banks 2 = (DF = 3,
n = 7) = .692, p N 0.5.
62 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565

Table 3 3 years in failing to meet this requirement, and had done so by 2007.
Descriptive statistics by number of items disclosed. The SSBs' reports were also mostly prepared in accordance with the
Mean Std dev Minimum Maximum requirements of the relevant governance standard (GSIFI 1). The high
level of compliance in this category is an important outcome given the
Retail banks
2004 38.00 1.00 37 39 signicance of individual SSBs in ensuring Shari'a compliance on the
2005 39.40 0.55 39 40 part of Islamic nancial institutions.
2006 37.00 1.67 35 39 Compliance is also high in the case of murabaha contracts.
2007 36.00 0.71 35 37
However, there are only ve items in this category, and all are
Wholelsale banks relatively straight forward. They include, for example, the presenta-
2004 26.25 8.85 19 37 tion of murabaha contracts in the nancial statements. The murabaha
2005 37.57 3.59 30 41 contract is in itself quite simple, mainly involving the purchase of a
2006 31.43 8.77 18 39 single item through scheduled repayments over a designated period.
2007 29.23 6.91 14 38
In contrast, the second category showing the level of compliance in
regard to mudaraba contracts is much more problematic. This is not
unexpected as mudaraba nancing is, as noted, quite complex.
Table 4 Accordingly, the AAOIFI standards require relatively detailed infor-
Descriptive statistics of compliance scores. mation respecting these contracts. This includes information relating
Mean Std dev. Median Range to the bank's fees as mudarib, the degree of commingling of mudaraba
Retail banks
funds with funds from other non-bank sources as well as more usual
2004 75.90 7.90 78.20 67.182.4 requirement relating to valuation and recognition. There is a high
2005 75.62 10.10 79.50 61.585.0 degree of non-compliance on the part of the sample banks with
2006 77.03 11.85 78.20 63.094.0 respect to these more detailed issues.
2007 75.80 8.32 71.00 69.089.0
This raises a particularly problematic issue in the measurement of
Wholesale banks compliance through compliance indices. There are generally many
2004 55.10 16.14 56.40 36.571.1 issues covered by accounting standards on which reporting entities
2005 73.85 6.57 72.90 68.081.6 are silent. The researcher must therefore determine if absence of
2006 65.23 15.16 67.9 46.285.5 information constitutes non-compliance or is simply an indication
2007 70.87 13.31 77.5 48.082.0
that the issue does not apply to the entity. There are different
All banks approaches to dealing with this problem. For instance, Tower et al.
2004 64.01 16.58 67.10 36.582.4 (1998) developed two ratios for their sample. The rst applied an easy
2005 76.67 8.54 79.50 61.585.0 rule to account for absence of information, assessing all instances of
2006 68.93 15.41 69.75 46.294.0
non-disclosure as meaning the item was not applicable. These items
2007 72.77 11.52 77 48.089.0
were then deducted from the total number of possible items, and the
compliance ratio was calculated as the number of disclosures over the
total number of relevant items. The median ratio resulting from this
and murabaha nancing. In nearly all instances banks complied with easy rule was very high at 0.9068. When a more stringent rule was
the requirement to include an annual report from the SSB with the applied, that is, no information is interpreted as non-compliance, the
nancial statements. Only one bank was consistent across the rst median ratio dropped to 0.4220.

Table 5a
Reporting by category retail banks percentage of items reported out of a possible 100% for each category.

Category Al-Amin Al-Salam Bahrain Khaleeji* Kuwait Shamil

Bank Bank Islamic Bank Commercial Bank Finance House Bank

2004
SSB Report 2004 Figures not available 2004 Figures not available 95.0 2004 Figures not available 85.0 95.0
Mudaraba Finance 72.2 63.2 67.5
Murabaha Finance 100.0 100.0 100.0
Zakah 75.0 0.0 62.5

2005
SSB Report 80.0 2005 Figures not available 90.0 90.0 80.0 70.0
Mudaraba Finance 73.6 71.0 45.0 64.0 88.0
Murabaha Finance 100 100.0 100.0 100.0 100.0
Zakah 100 100.0 25.0 25.0 87.5

2006
SSB Report 80.0 90.0 85.0 90.0 75.0 95.0
Mudaraba Finance 67.5 58.3 97.0 60.0 61.0 91.2
Murabaha Finance 100.0 100.0 1.00 100.0 75.0 100.0
Zakah 100.0 37.5 1.00 25.0 25.0 37.5

2007
SSB Report Merged-gures no longer available 90.0 80.0 65.0 75.0 60.0
Mudaraba Finance 53.0 88.0 67.0 72.0 97.0
Murabaha Finance 90.0 100.0 88.0 100.0 88.0
Zakah 67.0 100.0 88.0 25.0 38.0

* Formerly Gulf Finance House.

 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565 63

Table 5b
Reporting by category wholesale banks percentage of items reported out of a possible 100% for each category.

Category Al-Baraka ARCAPITA Capivest Citi Islamic Gulf International Investors Unicorn Venture
Banking Bank* Bank Invest Finance Invest Bank Invest Capital
Group Bank House House Bank Bank

2004
SSB Report 2004 Figures not 95.0 2004 Figures not 2004 Figures 15.0 70.0 10.0 80.0 2004 Figures not
Mudaraba available N/A available not available 27.8 25.0 100.0 N/A available
Murabaha 60.0 90.0 88.0 100.0 80.0
Zakah 25.0 62.5 13.0 12.5 12.5

2005
SSB Report 90.0 80.0 75.0 2005 Figures 85.0 80.0 15.0 90.0 2005 Figures not
Mudaraba 82.5 77.7 55.0 not available 41.3 29.0 52.5 16.0 available
Murabaha 90.0 100.0 100.0 90.0 88.0 30.0 40.0
Zakah 33.4 37.5 88.0 100.0 13.0 63.0 50.0

2006
SSB Report 80.0 Change in 95.0 15.0 90.0 90.0 15.0 90.0 2006 Figures not
Mudaraba 86.8 reporting period. 59.0 100.0 50.0 34.0 50.0 N/A available
Murabaha 100.0 100.0 100.0 100.0 88.0 100.0 75.0
Zakah 25.0 88.0 38.0 62.5 13.0 50.0 37.5

2007
SSB Report 75.0 Change in 90.0 15.0 80.0 90.0 95.0 90.0 80.0
Mudaraba 95.0 reporting period. 59.0 100.0 67.0 34.0 79.0 N/A 100.0
Murabaha 80.0 100.0 100.0 63.0 50.0 88.0 90.0 80.0
Zakah 38.0 100.0 50.0 75.0 13.0 50.0 38.0 63.0

* Reporting period is in the process of change from July 1 to June 30 during 20062007. ARCAPITA is therefore excluded from 2006 onward.

In this current study, where information was not readily available
in the nancial statements, the full Annual Reports and the banks'
websites were used as additional sources of information. In some
cases, for example, the qualications of the SSB members, the
required information was, for the most part, readily available from
these additional sources. Because this information was typically
available, where it was not, this was treated as non-compliance.
The mudaraba contracts proved more challenging. In some
instances items were easily identied as non-applicable to particular
banks, and could therefore be deducted from the total number of
items. For example, some banks clearly had no restricted mudaraba
investment deposits. In other instances, judgments were more
subjective. For instance, failure to supply any information regarding
the banks fees as a mudarib was treated as non-compliance, even
though some banks had stated they did not charge such fees, raising
the possibility that this was similarly the case for others. This
judgment was based on the author's perception of the importance
of such fees, and hence their disclosure, by way of reference to the
relevant literature. In contrast, if no information was provided as to
commingling of mudaraba funds with non-bank funds, this was
treated as not applicable.
The nal category in the study concerns reporting requirements
relating to the banks zakah obligations. Compliance in this category
was surprisingly low, with many banks, especially those in the
wholesale category, choosing to declare only that they were not
obliged to pay zakah on the part of their shareholders. The AAOIFI
standards clearly require more detail. In some instances, the wording
of the relevant note accompanying the nancial statement suggested
more information was available elsewhere, but subsequent searches
yielded nothing further.
6.1. Problems with the methodology
The main methodological problems have been identied. These
are, rst and foremost, the problems relating to non-disclosure, and
secondly the lack of consistency in the sample banks over the
sampling period. A further problem previously alluded to is the
means by which items are chosen for inclusion in the compliance
benchmark. These are intended to encompass the issues most
relevant to Islamic reporting. Inevitably the standards chosen to
reect these issues and the rules within the standards selected are
somewhat subjective and this may inuence the ndings with
respect to the degree of compliance. The problem is not unique to this
study. For instance, Aisbitt (2001) constructed a benchmark index
comprised of twenty items which she believed reected the essence
of nancial reporting. Although having recourse to the literature in
determining these items, she nevertheless recognized the process as
being subjective.
7. Concluding comments
This study has made a preliminary step in measuring the extent
to which Islamic nancial institutions comply with the accounting
and governance standards issued by the AAOIFI in their nancial
reporting. Because Islamic banks operate under vastly different
regulatory regimes and political and economic conditions across
the globe the sample banks were selected from the Gulf State of
Bahrain. To date, the AAOIFI has issued a substantial number of
reporting and governance standards. Rather than test compliance
against all, or even a specic number of standards, a compliance
benchmark was developed based on those items considered most
important for users of Islamic corporate reports. These items were
derived through a survey of the relevant literature. The results
show high levels of compliance in some areas, and relatively low
levels in other areas, most specically with respect to mudaraba
nancing and reporting zakah. Limitations with the methodology,
particularly relating to the treatment of non-disclosure were
discussed. This issue is especially relevant to mudaraba contracts,
so caution should be exercised in interpreting this section of the
data. Nevertheless, some problems in reporting this complicated
nancial product are not unexpected.
This study takes a rst step in addressing the gap in the empirical
analysis of compliance with the reporting standards thus far issued
by the AAOIFI. Future research could compare compliance in Bahrain
64 T. Vinnicombe / Advances in Accounting, incorporating Advances in International Accounting 26 (2010) 5565

initially with other banks in the region, and then across regions. Appendix B. Islamic banks in Bahrain as of March 2009
Testing whether or not there is a relationship between compliance
and performance would also be of considerable interest both in the
Islamic and non-Islamic world. Availability of reports and reasons for exclusion where relevant

Reports available
Acknowledgements 2004 2005 2006 2007

Retail banks
The author is grateful to Professors Mohammad Elbannan, SEC Al-Baraka Islamic Bank Included with parent company in the
Purvis and Philip Reckers for their helpful comments. wholesale category
Al-Salam Bank No No Yes Yes
Bahrain Islamic Bank Yes Yes Yes Yes
Khaleeji Commercial Bank Yes Yes Yes Yes
Appendix A. Compliance Items Note: Formerly Gulf Finance House
Commercial Bank
Kuwait Finance House Yes Yes Yes Yes
Shamil Bank of Bahrian Yes Yes Yes Yes
Item and corresponding AAOIFI standard/statement Al-Amin Bank* No Yes Yes No
Category 1. Shari'a Supervisory Board
1 Appointmment of the SSB GSIFI 1 Wholesale banks
2 Composition of the SSB ABC Islamic bank Part of the larger ABC Group
3 SSB Report published with the nancial statements consolidated reports only available
The following items are specied for inclusion in the SSB Report Al-Baraka Banking Group No Yes Yes Yes
4 Title GSIFI 1.10 Arab Islamic bank Not operating
5 Adressee GSIFI 1.11 ARCAPITA bank** Yes Yes Change in
6 Opening paragraph GSIFI 1.12 reporting period
7 Scope paragraph GSIFI 1319 Cappinova Investment Bank Recently established no nal reports
8 Opinion paragraph GSIFI 1.20 available
9 Date GSIFI 1.2223 Capivest No No Yes Yes
10 Signature GSIFI 1.24 Citi Islamic Investment Bank E.C. No No Yes Yes
10 Total number of items in category 1 Elaf Bank Recently established no nal reports
Category 2. Mudaraba nancing available
(i) Presentation First Energy Bank Recently established no nal reports
11 a) Restricted available
12 b) Unrestricted First Investment Bank Recently established no nal reports
(ii) Recognition available
13 Changes to prot (loss) Global Banking Corporation Recently established no nal reports
14 Note on the accounting policy adopted by the bank in recognizing prot (loss) available
(iii) Disclosure Gulf Finance House Yes Yes Yes Yes
15 The following items should be disclosed in the Income Statement (FAST 1.5) International Investment House Yes Yes Yes Yes
16 Revenues and gains from investments Investment Dar Banck Consolidated reports only
17 Expenses and losses from investments Investors Bank Yes Yes Yes Yes
18 Income (loss) from investments Kuwait Turkish Participation Bank Incorporated in Turkey branch only in
19 Account holders share before the bank's share as mudarib Bahrain
20 Bank's share in income (loss) from investments Liquidity Management Centre Larger non-bank organization
21 Bank's share as mudarib Seera Investment Bank Recently established no nal reports
22 Bank's fees as mudarib available
The following items relate to measurement and disclosure of mudaraba contracts Unicorn Investment Bank Yes Yes Yes Yes
23 Method used to allocate prot between the bank & mudarib holders Venture Capital Bank No No No Yes
24 Basis of charging expenses to unrestricted mudarib * Merged with Al-Baraka Islamic Bank in 2007.
25 Disclosure of total administrative expenses ** Reporting period is in the process of change from July 1 to June 30 during these
26 Proportionate allocation of prot between equity and investment account 2 years and this bank is therefore excluded from 2006 onward.
holders (where applicable) (Adapted from: Central Bank of Bahrain (2009) List of Islamic banks and nancial
27 Disclosure of increases in the bank's share of prot as mudarib (where applicable) institutions, Licensing and Policy Directorate, Bahrain, March 2009.)
28 Disclosure of comingling of mudarib funds with non-bank funds (where applicable)
29 Basis of revenue sharing between unrestricted and other accounts
30 Disclosure relating to sharing of revenue from unrestricted investment accounts
31 Basis of charging provisions against mudarib
32 Source of mudarib funds
33 Distribution of mudarib investments
34 Valuation technique
23 Total number of items in category 2 References
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