SHARI’AH AUDIT FOR ISLAMIC FINANCIAL

INSTITUTIONS: PERCEPTIONS OF
ACCOUNTING ACADEMICIANS, AUDIT
PRACTITIONERS, AND SHARI’AH
SCHOLARS

BY

RATNA MULYANY

A dissertation submitted in partial fulfilment of the

requirements for the degree of Master of Science in
Accounting

Kulliyyah of Economics and Management Sciences

International Islamic University Malaysia

FEBRUARY 2008
 ABSTRACT

Shariah auditing has currently emerged as an important subject of discussion inline

with the advanced development of Islamic Financial Institutions (IFIs) which
subsequently demand for the proper governance of the Shari’ah compliance issues. As
a new emerging discipline, its scope of study, subject matter and body of knowledge is
still in the process of development. This research aims to discern the perceptions of
accounting academicians, audit practitioners and Shari’ah scholars on the subject of
Shari’ah auditing. By focusing on the fundamental issues of Shari’ah auditing for IFIs,
the study has utilized the literature in this area and mail questionnaires to gather the
data. The questionnaires aims at obtaining the respondents’ perceptions towards the
fundamental issues in Shari’ah auditing which become the research questions of this
study, i.e. the understanding of the term “Shari’ah audit”, the appointment of Shari’ah
auditors as well as their qualification requirements, areas to be audited under Shari’ah
audit, the content of Shari’ah audit report, regulatory framework for Shari’ah audit
practice, and the standards to be applied in performing Shari’ah audit. The mail
questionnaires were distributed to the Muslim accounting lecturers teaching in the
Accounting Program at public universities in Malaysia, Muslim audit practitioners,
and Shari’ah committee members of the Islamic commercial banks (ICB) and Islamic
subsidiaries of the commercial banks (ISCB) in Malaysia. This study reports an urgent
call for the systematic development of the discipline Shari’ah audit. It involves from
the very basic of: 1) defining the subject in an appropriate manner, 2) standardizing
the qualification and competence requirements for Shari’ah auditors who are well
equipped not only with accounting and auditing techniques but also specifically
certified in Shari’ah audit, 3) identifying the scope, the extent, and the timing of
Shari’ah audit, 4) regulating and standardizing the content of Shari’ah audit report, 5)
establishing an independent body to regulate and enforce the standards and empower
this body with other relevant roles such as to evaluate the practice of Shari’ah audit
and to promote research and education in Shari’ah audit, and 6) applying the AAOIFI
standards into the practice of Shari’ah audit.

ii
 APPROVAL PAGE

I certify that I have supervised and read this study and that in my opinion, it conforms
to acceptable standards of scholarly presentation and is fully adequate, in scope and
quality, as a dissertation for the degree of Master of Science in Accounting.

…………………………………………..
Shahul Hameed Hj. Mohamed Ibrahim
Supervisor

I certify that I have read this study and that in my opinion it conforms to acceptable
standards of scholarly presentation and is fully adequate, in scope and quality, as a
dissertation for the degree of Master of Science in Accounting.

…………………………………………..
Fatima Abdul Hamid
Examiner

This dissertation was submitted to the Department of Accounting and is accepted as a

partial fulfilment of the requirements for the degree of Master of Science in
Accounting.

…………………………………………..
Nazli Anum Mohd. Ghazali
Head, Department of Accounting

This dissertation was submitted to the Kulliyyah of Economics and Management

Sciences and is accepted as partial fulfilment of the requirements for the degree of
Master of Science in Accounting.

…………………………………………..
Jamil Bin Hj. Osman
Dean, Kulliyyah of Economics and
Management Sciences

iv
 DECLARATION

I hereby declare that this dissertation is the result of my own investigations, except

where otherwise stated. I also declare that it has not been previously or concurrently

submitted as a whole for any other degrees at IIUM or other institutions.

Ratna Mulyany

Signature …………………………………… Date ……………………..

v
 INTERNATIONAL ISLAMIC UNIVERSITY
MALAYSIA

DECLARATION OF COPYRIGHT AND

AFFIRMATION OF FAIR USE OF UNPUBLISHED
RESEARCH

Copyright © 2008 Ratna Mulyany. All rights reserved.

SHARI’AH AUDIT FOR ISLAMIC FINANCIAL INSTITUTIONS:

PERCEPTIONS OF ACCOUNTING ACADEMICIANS, AUDIT
PRACTITIONERS AND SHARI’AH SCHOLARS

No part of this unpublished research may be reproduced, stored in a retrieval

system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise without prior written permission of the
copyright holder except as provided below.

1. Any material contained in or derived from this unpublished research may

only be used by others in their writing with due acknowledgement.

2. IIUM or its library will have the right to make and transmit copies (print or
electronic) for institutional and academic purposes.

3. The IIUM library will have the right to make, store in a retrieval system
and supply copies of this unpublished research if requested by other
universities and research libraries.

Affirmed by Ratna Mulyany

………………………… …………………
Signature Date

vi
 THIS WORK IS DEDICATED FOR:

Allah SWT, The Almighty.

Prophet Muhammad SAW.
I humbly hope that this work would contribute to the development of the Ummah.

My Late Brother, Badrul Tamam

Who passed away in the Tsunami 26 December 2004, Banda Acheh.
He was not only the best brother to me but a very good friend with whom I shared my
stories. I always pray that he will be in Jannah InshaAllah.

My Parents, Muhammad Amin & Juwairiah Daud

Who endlessly sacrifice their life for the sake of my success in this life and hereafter.
May Allah reward them properly in this dunya and akhirah.

My Husband, Hafas Furqani

Who patiently accompanies and supports me in the hard and happy time.

My late Mother in-law, Dra Nazri

My late Brother and Sisters in-law, Hanif Aulia, Hayatul Fitria, and Yusrawati
All relatives and friends
Who passed away in the Tsunami 26 December 2004, Banda Acheh. May Allah place
them in Jannah.

My beloved Achenees community

Let us be reminded that our greatest responsibility is to restore the values of Islam in
the life of Achenees people.

vii
 ACKNOWLEDGEMENTS

In the name of Allah SWT, the Most Compassionate and the Most Merciful. All praise
due to Allah SWT and peace and blessings be upon His prophet Muhammad SAW. A
long list of individuals have to be acknowledged for their support given in one way or
another in completing this work. My special appreciation goes to my parents,
Muhammad Amin and Juwairiah Daud, my late brother Badrul Tamam (May Allah
blesses him and places him in Jannah), and my brothers Denny Safrizal and Muhajir,
for their endless support and encouragement, without them certainly I would not go
this far. Surely the major credit goes to my supervisor, Assoc. Prof. Dr. Shahul
Hameed Hj. Mohamed Ibrahim for his invaluable ideas, guidance, patience, and
comments throughout the process of writing this thesis. I am particularly indebted to
Dr Fatima Abdul Hamid for her endless help in answering my queries on statistical
matters. My deepest appreciation also goes to all my lecturers: the late Dr. Unvar
Rahman Abdul Muthalib (May Allah blesses him and places him in Jannah), Prof.
Maliah Sulaiman, Mdm. Putri Nor Suad Megat Mohd. Noor, Assoc. Prof. Dr. Nik
Nazli Nik Ahmad, Assoc. Prof. Dr. Abdul Rahim Abdul Rahman, Dr. Asyraf Wajdi
Hj. Dato’ Dusuki, Dr. Hafiz Majdi Ab. Rashid, Assoc. Prof. Siti Normala Sheikh
Obid, Assoc. Prof. Muhd Akhyar Adnan and all other lecturers who have patiently
guided me in the quest of knowledge. I would like to also extend my thanks to the
leadership of the KENMS and Department of Accounting especially, and all the staff
who have been helping me whenever I need it (especially to Kak Yati and Kak Zura at
the DOA who have collected my questionnaires and to Kak Norma and Kak Suria
who have assisted me in many administrative matters). This list of acknowledgements
would be incomplete if I failed to mention my beloved husband, Hafas Furqani, who
certainly deserves a very special place for all his encouragement, support,
understanding, and prayers. I would like to also thank our son, Haziq Muharrir, whose
smile, laugh and cries have cheered me up and motivated me to finish this research. I
always pray to Allah, hopefully he will become a great Muslim scholar and dedicate
his life in the struggle for the victory of Islam. Amiin.

viii
 TABLE OF CONTENTS

Abstract ………………………………………………………………………….. ii
Abstract in Arabic ……………………………………………………………….. iii
Approval Page …………………………………………………………………… iv
Declaration Page ………………………………………………………………… v
Copyright Page ………………………………………………………………….. vi
Dedication ……………………………………………………………………….. vii
Acknowledgements ……………………………………………………………… viii
List of Tables ……………………………………………………………………. xii
List of Figures …………………………………………………………………… xiv
List of Abbreviations ……………………………………………………………. xv

CHAPTER 1: INTRODUCTION ……………………………………………… 1

1.1 Background of the Study ……………………………………………… 1
1.2 Objective of the Study ………………………………………………… 5
1.3 Motivation of the Study ………………………………………………. 6
1.4 Significance of the study ……………………………………………… 7
1.5 Organization of the Thesis ……………………………………………. 8

CHAPTER 2: THE EVOLUTION OF AUDITING ........................................ 10

2.1 Introduction …………………………………………………………… 10
2.2 The emergence of auditing and financial statement audit ……………. 12
2.2.1 Historical background of auditing …………………………. 12
2.2.2 Financial statement audit …………………………………… 16
2.3 Performance audit …………………………………………………….. 22
2.4 Social and environmental auditing: a new paradigm of auditing? ……. 27
2.4.1 Social audit …………………………………………………. 28
2.4.2 Environmental audit ………………………………………… 37
2.5 Path of the evolution of auditing …………………………………….... 43
2.6 Summary of the chapter ………………………………………………. 49

CHAPTER 3:AUDITING IN THE ISLAMIC FRAMEWORK …………….. 50

3.1 Introduction ………………………………………………………….... 50
3.2 Islamic Worldview and auditing ……………………………………… 50
3.3 Islamic Accountability and Auditing …………………………………. 55
3.4 The Development of Shari’ah Auditing: A Survey of Literature …….. 58
3.4.1 Exploring the meaning of Shari’ah audit …………………… 58
3.4.2 The emergence of Shari’ah audit …………………………… 62
3.4.3 The characteristics of Shari’ah audit ……………………….. 65
3.4.3.1 The scope and the extent of Shari’ah audit . 66
3.4.3.2 The role of Shari’ah auditors …………….. 69

ix
 3.4.3.3 Qualifications and competence requirements
for Shari’ah auditors ………………………. 72
3.4.4 Shari’ah auditing: The challenges ahead ……………………. 74
3.4.4.1 The conceptual framework of Shari’ah audit.75
3.4.4.2 Lack of internationally accepted
comprehensive Shari’ah auditing standards
or guidelines ………………………………. 76
3.4.4.3 Who should carry the function of Shari’ah
Audit ………………………………………. 79
3.5 Gap of the existing literatures on Shari’ah audit ……………………… 85
3.6 Summary of the chapter ……………………………………………….. 94

CHAPTER 4: RESEARCH DESIGN & METHODOLOGY ………………… 96

4.1 Introduction ……………………………………………………………. 96
4.2 Research Objective and Research Questions ………………………….. 96
4.3 Data Collection Method ……………………………………………….. 97
4.3.1 Questionnaire Design ……………………………………….. 98
4.3.2 Administering Postal Questionnaire ………………………… 101
4.4 Population and Sample ………………………………………………… 102
4.4.1 Respondents’ background and Sample selection …………… 102
4.5 Pilot Testing …………………………………………………………… 105
4.6 Data analysis …………………………………………………………… 106
4.7 Summary of the chapter ……………………………………………….. 107

CHAPTER 5: FINDINGS AND ANALYSIS ……………………………………108

5.1 Introduction ……………………………………………………………. 108
5.2 Response Rate …………………………………………………………. 108
5.3 Non-Response Bias Test ………………………………………………. 109
5.4 Validity and reliability test ……………………………………………. 113
5.4.1 Reliability test for part A of the questionnaire …………….…114
5.4.2 Reliability test for part B of the questionnaire ………….…… 115
5.4.3 Reliability test for part C of the questionnaire ………….…… 116
5.4.4 Reliability test for part D of the questionnaire …………….…117
5.5 Demographic analysis ……………………………………………….… 118
5.6 Statistical analysis for each research questions …………………….…. 121
5.6.1 Research Question No.1 ………………………………….…. 121
5.6.2 Research Question No.2 ………………………………….…. 124
5.6.3 Research Question No.3 ………………………………….…. 129
5.6.4 Research Question No.4 ………………………………….…. 136
5.7 Summary of the chapter ……………………………………………..… 139

CHAPTER 6: CONCLUSION ………………………………………………….. 142

6.1 Introduction …………………………………………………………… 142
6.2 Conclusion for each research question ………………………………... 142
6.2.1 Research question No.1 …………………………………….. 143
6.2.2 Research question No.2 ……………………………………... 145

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 6.2.3 Research question No.3 ……………………………………... 147
6.2.4 Research question No.4 ……………………………………... 149
6.3 Limitations of the study ……………………………………………….. 151
6.4 Contribution of the study ……………………………………………… 151
6.5 Suggestions for future research ………………………………………...152

BIBLIOGRAPHY ……………………………………………………………….. 154

APPENDIX 1 : Cover letter …………………………………………………….. 167

APPENDIX II : Questionnaire …………………………………………………. 168

xi
 LIST OF TABLES

Table No. Page No.

2.1 The characteristics of different auditing models 47

3.1 The existing literature on (or related to) Shari’ah audit 89

4.1 Derivation of the sample size for accounting academicians 103

4.2 Composition of audit practitioners participating in this study 104

4.3 Details of samples of Shari’ah committee members 105

5.1 Response rate 109

5.2 Non-response bias test for part A and part B of the questionnaire 111

5.3 Non-response bias test for part C of the questionnaire 112

5.4 Non-response bias test for part D of the questionnaire 112

5.5 Respondents’ gender and age 118

5.6 Respondents’ educational background & working experience 119

5.7 Job position of auditors 120

5.8 Awareness of the term “Shari’ah Audit” 122

5.9 The importance of developing the discipline “Shari’ah Audit” 123

5.10 Who should perform Shari’ah audit for IFIs 125

5.11 Who should appoint Shari’ah auditors for IFIs 126

5.12 Competence and qualification requirements of Shari’ah auditors 128

5.13 Areas to be audited under Shari’ah audit 129

5.14 To what extent Shari’ah Audit should be performed? 131

5.15 When should Shari’ah audit be performed? 131

5.16 The importance of Shari’ah audit report 133

xii
5.17 The content of Shari’ah audit report 134

5.18 The extension of Shari’ah audit to other Islamic institutions 136

5.19 The regulatory body for Shari’ah audit 137

5.20 The standards to be applied in performing Shari’ah audit 138

xiii
 LIST OF FIGURES

Figure No. Page No.

2.1 The broadening scope of auditing 45

3.1 Effective framework to monitor and assess Shari’ah compliance 85

5.1 Reliability analysis for part A of the questionnaire 115

5.2 Reliability analysis for part B of the questionnaire 116

5.3 Reliability analysis for part C of the questionnaire 117

5.4 Reliability analysis for part D of the questionnaire 117

xiv
 CHAPTER 1

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

The emergence of Islamic financial institutions (IFIs) has created a new reality within

the global finance arena, and supported the development of Islamic economy in

particular. At its core, the research conducted on Islamic economy has increased

tremendously in the past few decades. Though the effort to formulate the ideal Islamic

economic system is still ongoing but its development triggers significant changes in

many aspects of business activities, such as in the areas of accounting and auditing.

In the field of auditing, the establishment of IFIs results in a new dimension of

auditing, i.e. Shari’ah audit, which is in addition to conventional audit. Its

philosophies and basic principles are however, not new, having been practiced in the

time of Prophet Muhammad (p.b.u.h) and His companions. Subsequently, those

principles also were carried over during the time of Ummayyads and Abbasids (Khan,

2001). However, it is not the purpose of this study to provide in depth discussion on

auditing practices in the early Islamic era.

Shari’ah audit might be simply defined as an audit to attest for Shari’ah

compliance. However, how to comprehensively define the discipline of Shari’ah

audit? Who are qualified to perform the task? What is the scope of Shari’ah audit?

How to actually audit various aspects of Shari’ah? Does Shari’ah audit necessitate a

dedicated regulatory and supervisory framework on its own? These are among the

questions that are yet to be resolved with regards to the Shari’ah audit. As a result, the

theory of Shari’ah audit as well its practice is little known and heterogeneous across

1
the countries. To date, there has been no an established framework for Shari’ah

auditing that can serve as a guide as compared to the conventional audit.

Ideally, there should not be any separation between “conventional audit”,

which refers to financial audit, and Shari’ah audit. In line with this, Karim (1990)

contends that religious auditors and external (i.e. financial) auditors are supposed to

come from the same organizational body since Islam does not separate between

religion and business. Islam perceives all human activities are integrated and they

should not be seen as exclusive from one to another. If those activities, e.g. business,

rituals, etc., are performed with the right intention, they will be accounted as ibadah in

the eye of Allah and rewarded accordingly. Therefore, if Shari’ah is explored and

understood in the right way, it would be very comprehensive and covers all elements

of human life. Hence, financial matters, social and environmental issues are all the

concerns of the Shari’ah. This is supported by Khan (2001) where he asserts that in

public life, the objectives of Shari’ah may be summarized as evolving a society in

which the values of freedom, mutual trust, consultation, accountability, public

welfare, transparency in public policy, the rule of law, and elimination of injustice,

corruption and fraud are supreme.

In the previous studies such as Hood & Bucheery (1999), Karim (1990) and

Khan (1985), the term “Shari’ah audit” has been interchangeably used with “religious

audit” or “auditing in the Islamic framework”. The term “Shari’ah audit” has not been

popularly used until recently by the contemporary scholars. Khan (1985) which

probably provides one of the initial discussions on auditing in Islamic framework

refers auditing in the Islamic economy as a normative art inspired from the moral code

of the Shari’ah.

2
 In a practical way, perhaps the definition of Shari’ah review given by AAOIFI

in Governance Standard for Islamic Financial Institutions (GSIFI) is also parallel to

our discussion on Shari’ah audit. GSIFI No.2, para. 3 defines that Shari’ah review is

“an examination of the extent of an Islamic financial institution’s compliance, in all it

activities with the Shari’ah” (AAOIFI, 2002). This paragraph further states that the

examination should cover contracts, agreements, policies, products, transactions,

memorandum and articles of association, financial statements, reports (especially

internal audit and central bank inspection), circulars, etc. In performing this

assessment, Shari’ah Supervisory Board (SSB) shall have completed and unhindered

access to all documents, transactions, and information from all sources including

professional advisers and the IFI employees.

Currently, auditing practice of IFIs in various countries depicts that besides

external auditors who are responsible for financial audit; almost all Islamic banks have

in-house SSB whose main duty is to certify the adherence of the banks to the Shari’ah

principles. Observing the Shari’ah audit practices in different countries, it is

interesting to note that in Sudan, different types of SSB with different level of

jurisdictions have taken place (Abdallah, 1994). He further explained that some of

Sudanese Islamic banks have opted to appoint Shari’ah consultant whose duty is to

ensure that the banks activities are in compliant with Shari’ah rules. On the other

hand, other Islamic banks have established SSB who pursue similar role as Shari’ah

consultant and carry out their duties on part time basis.

Abdallah (1994) also stated that another innovation in Sudan is through the

establishment of Department of Fatwa and Research (DFR) in the Islamic banks. This

model of SSB is considered to have wider scope of responsibility where they work on

full time basis and collaborates with all divisions of the banks. On the top of all these

3
models of SSBs, the experience of Shari’ah supervision and control in Sudan has

further developed into another higher tier of control which is Higher Shari’ah

Supervisory Board who serves as main governing body of SSBs at individual bank

level.

In Bahrain for instance where the country is a primary financial market in the

Gulf, religious audit is a must in addition to regular financial audit for any Islamic

financial institution that declares that its activities adhere to Islamic principles (Hood

& Buchery, 1999).

In term of its legislative ruling, Shari’ah audit of IFIs in Malaysia is expected

to be very much similar to the above countries. However, the current practice might

not reveal the best to be practiced. For instance, a study on the responsibility and

independence of Shari’ah advisors of Islamic banks in Malaysia by Abdul Rahman et

al. (2004) provide preliminary evidence on the immediate need for proper regulation

on the role and function of Shari’ah advisors in order to enhance the credibility of

Malaysian Islamic banking. Their finding indicates that some improvement initiatives

have to be embarked in term of the regulatory and supervisory framework of Shari’ah

audit.

Emphasizing the above argument that even though general picture on Shari’ah

audit practice is probably known, yet, the theoretical framework of Shari’ah audit has

not been well established and put into practice. If a particular body is to certify

whether or not an entity is in compliance with Shari’ah, then the comprehensive

understanding of Shari’ah should be put as fundamental guidelines to carry out such

assessment. It is believed that Shari’ah audit should not only be confined in assessing

whether business entities are engaged with riba and non-halal activities but it should

4
be beyond these issues. Hence, given the complex issues of Shari’ah audit,

examination on the framework of Shari’ah audit is perceived to be vital.

1.2 OBJECTIVES OF THE STUDY

This research aims to explore the perceptions of Muslim accounting academicians,

Muslim audit practitioners and Shari’ah committee (SSB) members or named as

Shari’ah scholars in Malaysia with regards to the fundamental issues of Shari’ah

auditing. It is the vision of the researcher that through the opinions derived from the

study, the subject of Shari’ah audit will be further enriched and nurtured as a distinct

discipline.

To accomplish the above objective hence four research questions are

formulated as follow:

1. What should be the definition of Shari’ah audit? This question examines

the awareness of respondents of the term Shari’ah audit, the importance of

establishing the discipline of Shari’ah audit and its definition.

2. What are the qualification requirements for Shari’ah auditors? This

question seeks to identify who are supposed to perform Shari’ah audit,

what are the qualification and competence requirements for Shari’ah

auditors, and the appointment of Shari’ah auditors.

3. What is the scope of Shari’ah audit? This question encompasses the

investigation on the business areas to be audited under Shari’ah audit, the

extent of Shari’ah audit, timing of Shari’ah audit, the importance and

content of Shari’ah audit report.

4. What is the regulatory framework for Shari’ah audit? This question seeks

to identify the framework of regulation and supervision of Shari’ah audit

5
 in terms of regulatory body and its role, and also on the standards to be

applied in the Shari’ah audit practice.

To answer the above research questions, sample groups from Muslim

accounting academicians teaching in the Accounting program in the public

universities in peninsular Malaysia, Muslim audit practitioners, and Shari’ah

committee (i.e. SSB) members of the Islamic commercial banks (ICB) and Islamic

subsidiaries of the commercial banks (ISCB) in Malaysia are selected as respondents

for this study. These individuals are selected due to the belief that they have expertise,

understanding and involvement in the area of the subject of this study. Hence it is

expected that the respondents would provide relevant particulars sought by the study.

1.3 MOTIVATION OF THE STUDY

This study is mainly motivated by lack of research in the field of Shari’ah audit.

Several studies on Shari’ah audit are merely general in nature and none attempts to

explore the comprehensive conception of Shari’ah audit. Indeed the discussion of

Shari’ah audit in majority of these studies is only part of their discussion for their

main topic. Apart from that, though several scholars have initiated to discuss on

auditing in the Islamic perspective, yet there has been no extensive continuation of

these initiatives.

In addition, despite its importance in current development of IFIs, however, it

is interesting to note that so far no specific standard on Shari’ah audit has been

promulgated and made compulsory for Islamic financial institutions to follow as

compared to conventional auditing. This intriguing fact necessitates further

investigation on the regulatory and supervisory framework for Shari’ah audit itself.

Currently, Governance Standard on Shari’ah review by Accounting and Auditing

6
Organization for Islamic Financial Institutions (AAOIFI) is probably the most relevant

guideline available for Shari’ah audit practice. However, whether the standard is able

to cater the practice of Shari’ah audit in comprehensive manner is still another

question to ponder. According to the Study on the Adoption and Acceptance of

AAOIFI standard by AAOIFI (2006), it was found that only three countries adopted

AAOIFI standard (Bahrain, Sudan and Jordan) while in other countries the standard

are either voluntarily used or used as guidelines in establishing national standards or

not used at all. Their findings further revealed that among the major obstacles in

adopting AAOIFI standard are the prohibitive statutory and/or legal framework, the

additional cost of disclosure and risk of standard overload, and the question on the

quality of AAOIFI standard.

1.4 SIGNIFICANCE OF THE STUDY

This study is significant in various ways. Through exploring the framework of

Shari’ah audit it will contribute to the development of Shari’ah audit as one distinct

discipline of knowledge and provides accounting educators with information

pertaining to the curriculum development. In a broader perspective, the establishment

of Shari’ah audit as a discipline of knowledge will also support the initiative of

Islamization of knowledge.

In particular, the study will benefit the IFIs in achieving its objectives mainly

in the aspect of Shari’ah compliance. Having an overview of what should constitute

the practice of Shari’ah audit, it will indicate necessary improvements to be done on

this significant area and thus it will enhance the confidence of IFIs stakeholders.

The study also hopes to assist standards setters and regulatory bodies, not only

confined to Malaysian environment, in setting up the relevant policies or governance

7
standards with regards to Shari’ah audit. In addition, it is also important for Muslim

scholars to identify the key issues of Shari’ah audit in order to institute the

comprehensive theory of Shari’ah audit. Finally, hopefully this research will inspire

further research to be conducted in this area and enrich the existing knowledge and

literature.

1.5 ORGANIZATION OF THE THESIS

This thesis will be organized into six chapters, which includes this chapter as the

introduction of the thesis. Chapter two will review the literature in the evolution of

auditing. Specifically, chapter two will explore the evolution of auditing by discussing

different types of auditing that have emerged from time to time and relate it to the

current necessity of formulating the discipline Shari’ah audit.

Chapter three aims to provide a review of literature in the area of auditing from

the Islamic perspective. In particular, the chapter attempts to explore how far

literatures have progressed in the area of Shari’ah auditing. The chapter is organized

into three sections. First section examines the understanding of Islamic worldview and

how it moulds the different concept of auditing. Secondly, the chapter analyses the

concept of auditing and accountability in the Islamic institutions. Finally the chapter

reviews the literature development in Shari’ah auditing.

Chapter four aims to discuss the research method of the study. The chapter

begins with the presentation of research questions, followed with the discussion on the

research design which covers the sample selection, respondents’ background as well

as method used and questionnaire design. Apart from that, the chapter also highlights

the pilot testing, data collection procedure, and method of data analysis.

8
 Subsequently, the findings and analysis of the study will be thoroughly

explored in chapter five. Finally, chapter six provides the conclusion of the study.

9
 CHAPTER 2

THE EVOLUTION OF AUDITING

2.1 INTRODUCTION

This chapter aims to explore the evolution of auditing so that the researcher could

relate it to the current emergence of Shari’ah audit. Principally, the literature relevant

to the range of issues in auditing is extensive. However, literature which specifically

addresses the development of auditing is quite limited. As compared to many writings

and debates on accounting history (see for e.g. Edwards, 1989; Parker & Yamey,

1994; Bryer, 1998; Merino, 1998; Napier, 1998; Poullaos, 1998; Bryer, 2000;

Edwards, 2000; Arnold & McCartney, 2003; Walker, 2004; Walker, 2005; Beattie &

Davie, 2006; Napier, 2006; etc.), there seems to be a rather limited interest in the

auditing history. The reasons could be either the history of auditing has been included

in the sub discussion of accounting history or auditing has been commonly regarded

as part of the domain of accounting.

Auditing has evolved considerably ever since its emergence until today. Its

theoretical dimension as well as its practical issues have been evolving in response to

the growing public expectations of accountability, the rapidly advancement of

technology, and other socio-economic developments which take place in the society.

Since the subject (i.e. auditing) itself is very broad and encompasses various

issues, this chapter will specifically look into the emergence and the development of

different auditing areas (e.g. financial statement audit, social and environmental audit,

etc.) and briefly discuss the framework and related issues of each of the major

auditing areas identified. Even by specializing to those areas it is still impossible to

10
present a comprehensive review of the historical development of auditing within the

limited space of this chapter. However, by briefly highlighting the milestone and

framework of those auditing areas, hopefully the researcher can get an overall

portrayal of how the existing auditing areas have emerged, what motivations triggered

their establishment, and the important changes in the discipline of auditing. Finally the

researcher could relate this evolution into the necessity of the establishment of

Shari’ah audit in the present time. In light with this objective, the researcher broadly

classifies the themes of auditing into four major categories namely financial statement

audit, performance audit, environmental audit and social audit.

To strategize the above discussions, this chapter will be structured into five

sections. First section will briefly explore the historical background of auditing and

highlight the emergence of financial statement audit. Secondly, the chapter will

discuss the performance based audit. Thirdly, it will review the emergence of social

and environmental auditing and their critics to the mainstream auditing. Fourthly, it

will summarize and tabulate the path in the development of auditing and relate it to

the current emergence of Shari’ah audit. Finally, the last section will provide summary

of the chapter.

11
2.2 THE EMERGENCE OF AUDITING AND FINANCIAL STATEMENT
AUDIT

2.2.1 Historical Background of Auditing

The word ‘Audit’ comes from a Latin word audire, meaning ‘he hears’ (Woolf, 1979).

In the late middle ages in Britain, both accounts of revenue (tax receipts) and

expenditure for manors and estates were “heard” by an auditor, whose task was to

examine such accounts (Cosserat, 2004). Basically there is no single definition of

auditing. Funkhouser & Greeno (1984) define auditing as a methodical examination,

involving analyses, tests, and confirmations, of local procedures and practices leading

to a verification of their compliance with legal requirements, corporate policies, and

accepted practices. Another similar definition comes from Arens & Loebbecke (1998)

who define auditing as the process by which a competent, independent person

accumulates and evaluates evidence about quantifiable information related to a

specific economic entity for the purpose of determining and reporting on the degree of

the correspondences between the quantifiable information and established criteria.

Perhaps the above definitions of auditing are originated from A Statement of

Basic Auditing Concepts (ASOBAC), published by the American Accounting

Association (AAA) Committee on Basic Auditing Concepts which defines auditing as

follow:

auditing is a systematic process of objectively obtaining and evaluating

evidence regarding assertions about economic actions and events to
ascertain the degree of correspondence between those assertions and
established criteria and communicating the results to interested users
(Committee on Basic Auditing Concepts [COBAC], 1972: 2).

The above definition implies three significant points, that auditing is a process

of investigating the compliance of certain entities towards certain established criteria

and reporting it to the interested users. These three points; 1) investigation, 2)

12
obtaining and evaluating evidence based on certain established criteria, and 3)

reporting, are supposed to be the main elements in an audit work. The AAA

Committee noted that its definition was intentionally quite broad and encompassed

“the many different purposes for which an audit might be conducted and the variety of

subject matter that might be focused on in a specific audit engagement” (COBAC,

1972: 2). For example, in the case of financial audits, generally accepted accounting

principles (GAAP) are the established criteria against which the assertions are

measured (Sullivan et al., 1985).

With reference to the AAA’s definition of auditing, other areas of audit with

distinctive established criteria seems to be possible as well. Hence the emergence of

other types of audit beside financial audit is not only possible but also legitimate if it

is based on the above understanding of auditing. This implies that the emergence and

establishment of auditing which based on religious values such as Islam (in this

context i.e. Shari’ah audit) is legitimate as well. Moreover, COBAC (1972: 2) further

affirms that “the types of evidence obtained and the criteria employed to evaluate

evidence may vary from audit to audit, but all audits center on the process of obtaining

and evaluating evidence.” For instance GAAP is the criteria used in performing

financial statement audit, other types of audit such as Shari’ah audit might employ

other criteria.

Interestingly, even though AAA claimed that its definition of auditing was

intentionally broad, however if we explore further the above definition, it seems that

the AAA somehow has limited the auditing activities with “assertions about economic

actions and events” solely. On one side, the AAA intentionally provided a broad

understanding of auditing by intending to the many different purposes for which an

audit might be conducted and the variety of subject matter that might be focused on in

13
a specific audit engagement, but on the other hand restricted the scope of auditing to

merely concern with economic activities. Perhaps the concentration on the economic

activities should be broadened to other relevant activities deemed important in the

society because other types of audit which emerge later on have indeed embraced non-

economic activities. For example social and environmental audit which go beyond the

scope of financial audit and explore the social and environmental dimensions of

organizational activities and also the current proposed subject of Shari’ah audit which

even attempts to look into the aspects of compliance towards Islamic religious

principles.

Historically, auditing, in some forms, has existed for as long as men have been

required to account for their transactions, but auditing, as we understand it now, has

its roots for two to three hundred years ago, in the first division of interests between

those engaged in a business undertaking (the entrepreneurs) and those who made the

finance available without necessarily becoming directly involved in day-to-day

management (Woolf, 1979). Early audit activity can probably be traced to the ancient

Egyptians who have required tax receipts to be recorded by two independent officials,

and Romans who are known to have cross-checked expenditure authorizations with

actual payments (Ricchiute, 1989). Unfortunately, none of any Western literature

acknowledges the practice of auditing in the early Islamic era among the Arabs, even

the auditing which has existed in the pre-Islamic era which in fact precedes the

records of the Egyptians and Romans. The researcher would elaborate the emergence

of auditing in the Muslim world in the next chapter.

Despite the above early evidence of isolated audit activity, there is only

limited evidence of systematic auditing prior to the nineteenth century. Indeed,

auditing in a form that we know today can actually be traced back to the development

14
of joint-stock corporations in the United Kingdom (UK) during the Industrial

Revolution in the early 1800s (Cosserat, 2004). The first contemporary audit-related

legislation appeared in the British Joint Stock Companies Act of 1844. The 1844 Act,

revised and reissued as the Companies Clauses Consolidation Act of 1845, required

that one or more stockholders examine balance sheets prepared by company directors.

The balance sheet and accompanying stock-auditor report were filled with the

Registrar of Joint Stock Companies, with copies forwarded to all stockholders.

In the early 1920s, auditing development has shifted from the UK to the USA

and the emphasis of auditing was gradually extended to the assessment of Profit and

Loss but the evaluation of Balance Sheet remained important (Porter et al, 2000). This

period was marked with the continued growth of modern corporations and the

development of securities markets and credit-granting institutions, designed to serve

the financial needs of the growing economic entities. Later on, auditing, as a generic

term, has been expanding in its scope, methodology and the extent of responsibility to

meet the needs of changing environment. In the 1970s, auditing has seen the demand

for greater social and environmental responsibility and the period was marked with the

birth and the blossoming interest in social and environmental accounting/auditing. It

proved that auditing has changed with the times in the past, and definitely there are

always indications that it should be prepared to change with the times now and in the

future. However, If we analyze and compare the present format of audits with the

earlier examinations of accounts, we find considerable changes in the methodology

and scope of audit, but relatively little change in purpose or point of view, where

Mautz & Sharaf (1993) opined that the purpose of an audit still seems to provide

certain interested parties with an attestation of the reliability of certain information

supplied by those entrusted property of others.

15
2.2.2 Financial Statement Audit

Financial statement audit appeared to be the first auditing mechanism used ever since

human being dealt with business activities. Basically, the emergence of auditing as

discussed in the previous section translated to the emergence of financial statement

auditing consequently. The emphasis of financial statement audit on attesting financial

information has seen it to become the mainstream form of auditing from the time it

was invented until today. Consequently the financial statement audit has been made

compulsory, imposed by whatever Company Acts applicable in any country. Not only

this, the curriculum of higher education has also recognized financial statement audit

as the dominant discussion in the auditing subject. Perhaps it is not wrong to say that

when people discuss auditing it automatically refers to the financial statement audit.

International Standards on Auditing (ISA) 200, Objective and General

Principles Governing an Audit of Financial Statements, states that “the objective of an

audit of financial statements is to enable the auditor to express an opinion whether the

financial statements are prepared, in all material respects, in accordance with an

applicable financial reporting framework.” If we could recall the various definitions of

auditing highlighted in the previous section, perhaps it can be stated that an audit of

financial statements is conducted to determine whether the overall financial

statements, the quantifiable information being investigated, are stated in accordance

with specified criteria and to report the result of the investigation to the interested

users (perhaps the main interested user in a financial audit is the shareholder). Such an

investigation is needed to enhance the credibility of financial statements by reducing

information risk (Cosserat, 2004).

To date, the literature on financial statement audit comprise of a range of

issues, from the discussion on the standards used to perform financial statement audit

16
and whether those standards have served well in meeting the audit objectives such as

preventing/detecting fraud in the business entities, or literature which examine the

independence of the auditors who perform financial audit, or literature concerned with

the impact of technological progress on the auditing procedures, and other various

issues. For the purpose of illustration, it is perhaps worthy to explore some of the

research which specifically addresses the concerns related to financial audit

particularly from the year 2000 onwards.

For example, Siddiqui & Podder (2002) assess the effectiveness of financial

audit of banking companies operating within Bangladesh found that seven sample

companies that have actually overstated their profits while ironically the firms

auditing those financial statements have failed to issue qualified audit reports.

Therefore, the study questions the level of independence, objectivity and competence

of the auditors assigned for auditing banking companies.

Casabona & Grego (2003) explore the major requirements of SAS No. 99:

“Consideration of Fraud in a Financial Statement Audit,” and discuss its impact on

financial statement audits. The new auditing standard should have a major effect on

the planning of audit engagements. It will require additional control testing of how

and why journal entries are recorded, as well as enhanced preliminary analytical

procedures for revenue. Finally, new substantive testing procedures are required for

testing estimates for bias (a retroactive review of prior-year estimates), updating

interim conclusions, unusual journal entries, complex transactions, and the evaluation

of business purpose for significant unusual transactions.

Herring (1982) analyzes financial audits of county and city school systems in

Alabama as related to Generally Accepted Auditing Standards. He found that the level

of compliance with generally accepted audited standards was 100%. In addition, his

17
findings also concluded that persons who are full-time auditors with proper

professional training should be more effective than those who are involved in other

accounting activities.

Fogarty et. al. (2006) discuss the process of assessing and responding to risks

and controls, leading to the concept of the risk of material misstatement. The Audit

Risk Standards are designed to result in more effective audits as a result of better risk

assessments and improved design and performance of audit procedures to respond to

the risks. Mat Zain et al (2006) examine the relation between audit committee

characteristics, internal audit function characteristics and internal auditors’ assessment

of their contribution to financial statement audits. The results indicate that more

effective audit committees and well-resourced internal audit units tend to be positively

associated with the internal auditors assessment of their contribution to the external

audit.

In light with the rapid development of technology, many of the literature which

discuss financial audit have been attempting to investigate the impact of technology

advancement to the auditing process. Even though the objective of audit in an IT

environment does not change, nevertheless the methods and procedures used are

significantly different from the conventional one. To anticipate this phenomenon,

several organizations in the US such as the American Institute of Certified Public

Accountants (AICPA), the International Federation of Accountants (IFAC), and the

International Federation of Accountants and the Information Systems Audit and

Control Association (ISACA), have issued standards in this area to be observed by

their members in performing an IT audit so that the auditors are properly guided in

their audit works (Munter & Ratcliffe, 1985; William, 1992; Abdolmohammadi, 2001;

Ratcliffe & Munter, 2002; Yang & Guan, 2004; Debreceny et al., 2005).

18
 Munter & Ratcliffe (1985) state that ever since businesses began using

computers to process part of their transactions, the auditing professions have seen a

need to provide guidance for audits conducted in an Electronic Data Processing

(EDP). Williams (1992) explores the internal control and auditing issues which

surround two technologies – end-user computing and electronic data interchange and

concludes by suggesting that there may be a need for a review of audit methodologies

which, in principle, remain focused on the large bureaucratic paper-based systems of

the early 1950s. Abdolmohammadi (2001) study reports on changes in the extent to

which decision aids are perceived to be useful for performing detailed financial audit

tasks. His finding indicates that while the data shows an increase in the choice of tasks

for decision aids use between the two years (i.e. 1988 and 1996), the fact remains that

a majority of the responses (79% in 1988 and 69% in 1996) indicated human

processing (HP) only.

Yang & Guan (2004) examine various US IT auditing and internal control

standards in financial statement audits and discuss their significance for the auditing

profession, believed that the trend of IT audit would continue well in the future which

probably would result in more pronouncements being issued in this area, hence the

auditors are required to comprehend well those pronouncements, standards, and

guidelines. Debreceny et al. (2005) evaluate the nature and extent of the utilization of

CAATs in financial institutions, specifically to establish the extent and nature of use

of GAS by bank internal auditors and their external auditors. They found that the

extent and range of use of GAS varies widely between the institutions in the sample.

What we can extract from the above literature is basically that financial

statement audit has somehow become a stable and systematic discipline of auditing in

the sense that it has a proper regulatory framework, a well-established theory and

19
practice, a global acceptance and a systematic process and procedures added with the

growing invention in IT decision-aids tools. However, despite the rapid development

in financial statement audit, it has actually never been free from critique. The many

issues inherent with auditing profession who perform financial audit seem to center on

the critical question over the auditor independence, which becomes a never-ending

strain in the world of financial audit. Besides the question over their independence,

there are also doubts over their integrity and ethical conduct. Perhaps an auditing with

inherent ethical/religious values, different set of qualification and competence

requirements for the auditors, different regulatory framework and a broader scope is

needed in this context. Particularly such need is imperative in accommodating the

contemporary development of Islamic financial practices in the Muslim society.

Undoubtedly a great deal has been written since in the past times until recently

on the “crisis” of financial audit. Problems of legitimacy have been generated by

publicly visible scandals and questions of independence, of reporting responsibilities

and of the burden of litigation preoccupy both academics and practitioners (Power,

1996). The cases of Enron, WorldCom, Xerox and others too numerous to mention

have turned the audit function as an affirmation of reporting integrity to be an object

of derision (Woolf, 2003). Many initiatives were put forward to correct such

malpractice in financial audit which in its climax marked with the enactment the

Sarbanes-Oxley Act of 2002 in the USA. Among the consequences of the Enron

collapse in 2001, auditors are then required to evaluate the effectiveness of an entity’s

risk management framework in preventing misstatements whether through fraud or

other wise, in all audits and they are also required to be more proactive in their search

for fraud. They are required to identify the likelihood of fraud occurrance (Cosserat,

2004).

20
 Even with the introduction of new legislation there is still doubt on how far this

new legislation can solve the everlasting problems inherent to the accounting

profession. Woolf (2003) further points out that corporate governance; more power for

audit committees and non- executive directors; rotation of audits/audit partners;

banning of non-audit services are not actually the answer to recover the practice of

auditing. She instead suggests few points that might be working in fixing the

malpractice in financial auditing. First, the need for independence in auditing demands

that the audit appointment should not be the gift of management. Only the Financial

Services Agency or an equivalent agency should be responsible for major listed

company audit appointments, with a five-year maximum tenure to safeguard

independence, coupled with a system of proportionate liability or contractual capping.

The size of global corporations renders them practically unauditable, the 'capability'

factor therefore needs to be addressed. Corners should not be cut merely to cope with

the scale of transactions and subsidiaries should therefore be audited by different

firms, if that is what it takes to do it properly.

Interestingly, despite all critiques and problems confronting financial audit

practice, financial audit seems to be remarkably durable either in the private sector as

well as in the public one. However, with the increasing awareness of the Muslim

society towards their religious values which further translates into the growing

acceptance of the Islamic financial services, an audit which can fulfill the Islamic

requirements is perceived vital to take place, perhaps in place of or in addition to the

existing financial audit.

21
2.3 PERFORMANCE AUDIT

Performance audit or management audit is claimed to be originated from external

financial auditing, internal operational auditing and management consultancies (Innes

& Lyon, 1994). Historically, performance types of audit have actually existed much

earlier times in few countries. For example, in Japan performance type audits have

emerged since 1889 and in Sweden it has even existed since 1657 (Burrowes &

Persson, 2000).

Performance audit is equated with other few terms such as operational auditing,

management auditing, integrated auditing, efficiency and effectiveness auditing, value

for money auditing (VFM), administration auditing and comprehensive auditing

(O’Reilly et. al., 1999; Burrowes & Persson, 2000; Cosserat, 2004). Parker (1986: 2)

has identified a common ground at the descriptive level if the conceptual definitions

of these guises are reviewed “. . . different terms appear to be used to identify

concepts of the same meaning, or alternatively the same term may be used for

different concepts.”

“Performance audit” is a term used primarily in the USA in the public sector

while the term “operational auditing” is also used primarily in the USA in both the

public and private sector for the whole organization of financial and non-financial

operations (Burrowes & Persson, 2000). Cosserat (2004) highlights that the term VFM

audit is more common in the public sector while the other terms are popular for both

sectors. Vinten (1996: 76) on the other spectrum views the term “management audit''

as being the most embracing one when he elaborates that “management audit is the

all-embracing, comprehensive term, with the others forming segments of it. The

financial audit could form part of either an operational or management audit.”

22
 Management auditing can be defined as “an evaluation of management and the

organization's functioning and performance with respect to economy, efficiency and

effectiveness of operating areas, activities and results” (Parker, 1986: 10). Cosserat

(2004) defines VFM audit in the public sector as an independent, expert and

systematic examination of the management of an organization or function for the

purposes of forming an opinion about the extent of the economy, efficiency and

effectiveness; and the adequacy of internal procedures for promoting and monitoring

the economy, efficiency and effectiveness.

Government Auditing Standards, issued by the U.S General Accounting Office

and revised in 1994, defines performance audit as:

economy and efficiency audits include determining (1) whether the

entity is acquiring, protecting, and using its resources (such as
personnel, property, and space) economically and efficiently, (2) the
causes of inefficiencies or uneconomical practices, and (3) whether the
entity has complied with laws and regulations concerning matters of
economy and efficiency. Program audits include determining (1) the
extent to which the desired results or benefits established by the
legislature or other authoritative body are being achieved, (2) the
effectiveness of organizations, programs, activities, or functions, and (3)
whether the entity has complied with significant laws and regulations
applicable to the program.

The establishment of performance auditing has been largely motivated by the

belief that financial audit solely is not sufficient to ensure the assessment on the

effectiveness of the institutions. Particularly, the relevance of performance auditing

has mostly been associated with the public sector despite its considerable benefits to

the private sector as well. This phenomenon is further reinforced by substantial

literature on performance auditing which specifically cater the issues of implementing

performance auditing in the government institutions. There are many writings which

look at the relevance and significance of implementing performance based auditing in

the public sector.

23
 Public demand for greater government accountability has resulted in

performance measurement initiatives in the public sector (Heaton et al, 1993).

Performance measurement in the government sector has been of interest to a number

of authors since the early 1970s (Heaton et al, 1993). Performance auditing, or VFM

auditing, has been a long-standing component of accountability in public

administration. During 1980s and 1990s, performance auditing has allegedly been

increasingly adopted in the new public management (Johnsen et al, 2001). Activities

shaping the development of performance auditing in municipalities and other

governmental entities include an evolution of auditing standards, the development of

performance measurement, and progress in performance reporting.

Dittenhover (2001) asserts that for the public sector, performance auditing

contributes in providing accountability because it provides an independent assessment

of the performance of a government organization, program, activity, or function in

order to provide information to improve public accountability and facilitate decision

making by parties with responsibility to oversee or initiate corrective action. He

further elaborates that to realize governmental accountability, the citizens, their

elected representatives, and program managers need information to asses the integrity,

performance, and stewardship of the government’s activities.

Johnsen et al (2001) observe that while there has been much research on public

management and performance auditing in central government, local government has

been relatively neglected in the literature. Hence their study explores how

performance auditing practices, including performance measurements, are used to

assess and verify value for money in local government and to enhance the

accountability of municipalities and counties. Their study analyzes how informants

from both auditors and auditees in Finland and Norway perceive the efficiency of

24
conducting performance audits in local government. Despite some problems related to

the quality of the performance audit reports, the informants perceived performance

audit to function as a useful, rational public management tool.

Heaton et al (1993) conduct a survey to assess the current state of performance

auditing in 186 cities particularly to determine the extent and authority of the

performance audit function. This survey indicates that a significant number of cities

are conducting performance audits, but only a minority have charter mandated rights

and responsibilities. The results show that while current performance audit reports are

of high quality, few incorporate service effort and accomplishment reporting.

Muri (1994) proposes that the art and science of program evaluation can be

improved by merging the two traditions used to assess program performance in

government (i.e. program evaluation and performance auditing) on both a theoretical

and applied basis, and that a performance monitoring system (PMS) can be a vehicle

to achieve this merger. The study suggests that a performance monitoring system that

combines the two traditions can assist managers in meeting their multiple

accountability requirements.

Regardless of its popularity in the public sector auditing, performance audit

still has to face the challenges in various ways. Even though there is a claim that with

citizens, regulatory agencies and elected officials demanding greater accountability,

the importance of government performance audit will continue to grow, unfortunately

for instance, performance auditing as practiced in Australia has been far from

successful (Guthrie, 1992).

Guthrie (1992: 32) rightly illustrates the challenges of performance auditing in

government entities when he argues that:

25
 despite the importance of the public sector auditing debate, practical
progress in the area will be slow. It is easier to promote and practice a
product that attests to the “truth and fairness” of financial information
and forms an opinion on compliance, rather than a product that
professes to provide an independent evaluation of a public sector
manager’s “performance”. The latter involves the attributes of good
management, effectiveness, efficiency and value for money in a highly
unstable and politically charged environment.

Nevertheless, Khan (2001) believes the imperative need for the Supreme Audit

Institutions (SAIs) of the Islamic countries to practice performance audit on a large

scale. He opined that the values of frugality, moderation, and ethics as dominated in

the concept of performance audit are in line with the Islamic perspective. The

adoption of performance audit in the Islamic countries will promote the greater

accountability among the public managers for the resources entrusted to them.

Perhaps in a broader perspective, if performance auditing is to be incorporated

in the concept of Shari’ah audit, not only the government entities of the Islamic

countries would benefit from the implementation of the audit program but also the

private sector. For example, Islamic banks, which handle public funds as a trust and

also as a business partners, should be subjected to performance auditing (Khan, 2001).

The introduction of an auditing system in the Muslim society which instill the values

and the objectives promoted in performance audit will improve the economy,

effectiveness, efficiency, and most importantly the accountability of the accountee of

the resources entrusted primarily by God and public at large either in public or private

institutions.

26
2.4 SOCIAL & ENVIRONMENTAL AUDITING: A NEW PARADIGM OF
THE AUDITING?

In the last few decades there have been major changes to the discipline of accounting

and subsequently to auditing. If previously accounting and auditing were merely

concerned with satisfying the needs of specific groups who mainly have financial

interest in the business entities, the disciplines have embraced a bigger perspective

which calls for the significant emphasis on the social and environmental

responsibilities.

According to Bebbington (1997: 365), at the core of social and environmental

accounting (SEA) research activity are two concerns:

1. There is dissatisfaction with conventional accounting practices, either in

terms of the social and environmental consequences which arise from the

application of accounting tools and techniques, or with the theoretical

basis which underlies conventional accounting (Gray et al., 1996).

2. SEA has been concerned with exploring and developing new forms of

accounting which are more socially and environmentally benign and

which have the potential to create a fairer more just society.

The movement for social and environmental accounting is usually assumed to

have started in the early 1970s (Gray et al., 1996). Besides the wide use of the term

“social and environmental accounting” (SEA), many other terms are used in the

discussion of this field. To mention a few, we have social and environmental

responsibility (SER), social responsibility accounting, social audit, environmental

audit, ‘social accounting, reporting and auditing’ and the popularly known term

nowadays Corporate Social Responsibility (CSR). Gray et al (1997) illustrate that all

the discussion and the practice hold a number of central ideas in common but, through

27
the use of a diverse terminology, feature these central ideas with different degrees of

exactitude. Ross (1971) suggests that the various names given to “social accounting”

do not matter as long they all deal with the measurement and communication of what

people do and concerned with integrating the social and economic criteria in

measuring the effectiveness of social programmes or assessing the social impact of

environmental pollution.

Despite its variety of terminology, as the researcher intends to explore

specifically the auditing themes of social accounting (or any other title which might

apply), hence this section will not provide further discussion on the generic term of

social accounting. Specifically to auditing, social accounting movement has witnessed

the emergence of social audit, environmental audit, and few have also come forward

to propose a CSR audit. Perhaps it is not wrong to say that the auditing areas under the

umbrella of social accounting have not been fully organized as in the case of financial

statement audit and the search for an ideal theoretical framework as well as practical

guidelines is still taking place. To a certain extent, the proposal for social audit seems

to embrace environmental concerns, but environmental audit as an independent

discipline and auditing area is gaining better momentum and acceptance in the

contemporary society. Hopefully, there will be an attempt to harmonize these two

subjects of auditing (i.e. social and environmental auditing) or perhaps integrate it thus

it can effectively manifest the sacred mission of social accounting.

2.4.1 Social Audit

The role of auditor in the modern society as the attestation of financial performance of

organizations has been widely criticized. It is suggested that a new paradigm of social

perspective of auditing is needed. Flint (1971: 287) highlights that:

28
 what is needed in auditing is something dynamic, a critical, penetrating,
enquiring attitude of mind, and a deep conviction of a vital social
purpose. In some respects this last aspect is the most important. The
practice of auditing cannot evolve satisfactorily in a changing world if it
is not conceived and exercised in the context of a social philosophy of
audit and accountability.

The call for this area of auditing, named as “social audit”, is in parallel with the

movement of social accounting. Johnson (2001) argues that if companies were to be

held responsible for their society and environment then an annual social audit, similar

to the annual financial audit, would seem to be an ideal mechanism for such

evaluation. He further defines social audit as a standard process for identifying,

measuring and reporting the ethical, social and environmental impact of an

organization. Dilley (2006) proposes a comprehensive definition of social audit, which

is:

an investigation of an enterprise’s performance as a member of the

community in which it has its primary impact; such investigation
consisting of the preparation of an inventory of the socially relevant
activities of the enterprise, a monetary quantification of the social cost
and benefits resulting from those activities, and compilation of other
quantitative information providing insight into the social performance of
the enterprise.

Social audit is indeed not a new subject in auditing. It was proposed in the

1930s in the United Kingdom (Henriques, 2000). Carroll & Beiler (1975) argue that

the earliest usage of the term social audit can be referred to a monograph entitled

“Measurement of the Social Performance of Business” (Monograph No.7) which was

written by Theodore J. Kreps, then Professor of Business Economics at Stanford

University. In addition to the term, Kreps (1940: 2) also provides a concept of social

audit which is in the same nature to the latter development of social audit. Part of his

discussion on social performance was:

there is no doubt, for example, that the American people want their
economic system of free enterprise to promote (1) the growth, health,

29
 and education of the population; (2) resourfulness and invention; (3) the
democratization of business organization; (4) reason and effectiveness
in labor organization; (5) international peace; (6) the enlargement of
individual liberty; (7) increased opportunity for each individual to
develop to the full all his intellectual, aesthetic, spiritual, and economic
capacities.

Since it was first suggested, social audit has experienced rise, decline, and

resurgence either in the research interest or in the corporate practice. For instance, the

late 1980s and early 1990s witnessed a re-emergence of interest in social audit activity

which had enjoyed a previous, all too brief, heyday in the early 1970s (Gray, 1997;

Owen et al., 2000). Confirming this point Johnson (2001) states that discussion on

corporate social audit was practically nonexistent by 1980 after it was first seriously

suggested in the midst of 1950 and increasingly discussed afterwards. Henriques

(2000) argues that the reason behind the demise of social auditing in the 1980s was

the unending success of the stock market which has caused the companies to loose

their interest in understanding their social performance. As result of this, Henriques

(2000) states that the principal social duty of a company was to make money and this

wisdom even still exist today.

Nevertheless, in the 1990s, a new landmark in the evolution of social auditing

has come. Led by a group of ethically-oriented companies, a new, very much more

systematic approach to social auditing has emerged. This approach was developed

first by Traidcraft, a fair trading company, together with the New Economics

Foundation, UK and soon to be taken up by the Body Shop, a cosmetics and toiletries

retailer and manufacturer, and by a wide ranging group of companies, consultants and

NGOs who together formed the Institute of Social and Ethical Accountability to gain

further consensus as to how the social auditing should be practiced (Henriques, 2000).

30
 Just like an institute which is newly set up, the pioneers and later on the other

academics and practitioners who advocate the concept of social audit have to face

many challenges in resolving many issues concerning the subject. One of the core

obstacles for social audit to develop and establish itself (theoretically and practically)

as a systematic auditing area is because of the measurement problems. This has been

highlighted by most of the academics who discuss the subject of social audit (see e.g.

Dilley, 2006; Bauer & Fenn, 1972; Elliott, 1973; Butcher, 1973; Davis & Bromstrom,

1975). However this issue should not be an excuse from letting the progress of social

audit being stuck, even using estimated values of social responsibility is better rather

than ignoring the problem entirely (Dilley, 2006). As more experimentation in social

auditing and social responsibility takes place, the measurement problem is likely to be

solved.

The New Economics Foundation (1996) explains a categorization of areas to

be measured as follows:

• Core aims of the organization, generally reflected in a mission statement.

• Specific stakeholder aims, identified during a consultation process with

identified stakeholder groups.

• Societal aims, benchmark concerns established in the socities where the

organization is active, including, for example, social norms made explicit

through statutory means, such as in equal opportunities legislation.

Above all, it has been argued that social accountants should actually measure

the cost of social activities and also the benefits they produce. However, the benefits

(or, for that matter the detriments) to society of a corporation’s actions are scarcely

susceptible to measurement (Bauer & Fenn, 1972; Elliott, 1973; Butcher, 1973; Davis

& Bromstrom, 1975). Since it is virtually impossible in many cases to assess the

31
impacts of a company’s social program on society at large, most of academics in the

1970s seem to agree on the process audit approach (what is being done through a

particular social program) rather than a performance approach (to measure what is

being accomplished and how effective it is) because of the difficulties to measure the

social performance of corporations and the lack of accepted standards against which to

measure performance.

Bauer & Fenn (1972), one of the pioneers in social audit, suggest an alternate

form of performance measurement that they label a “process audit”. This procedure

requires a detailed description of a company’s endeavors in each social area, and a

statement of what is the “best known practice” in each area. These are then compared

and corporate action is modified where required. Butcher (1973) who attempts to

bring a little order to the subject of social audit, explain in some detail one concept

(i.e. program management approach) of the social audit and to place the concept in its

proper perspective. In his dissertation, Dilley (2006) proposes to utilize Benefit-Cost

analysis in measuring and quantifying social costs and benefits. As it was an initial

attempt to adopt such approach, Dilley (2006) sees the importance of more empirical

research to be done to test the accuracy of the methodology. In a recent development,

Boele & Kemp (2005) explore the hybrid approach (i.e. merging the social science

and the traditional financial accounting approach) of social audit when highlighting

the three approaches in social auditing; social science, traditional financial accounting

and the hybrid approach.

Besides measurement problems, there is also lack of agreement on what should

constitute social values as there are no religious backed eternal values in secular

society. Some might see certain issues should be associated with societal concern but

others might perceive differently. This different perspective is also changing and

32
evolving throughout the time. Different interpretations on what should constitute

social values can be a major challenge in implementing social audit. Unlike in the case

of Shari’ah, Islam has a set of fixed laws and commonly agreed values which make it

easier to form an auditing system and establish its framework accordingly. The

available guidelines and laws in the Islamic society will allow and better facilitate the

institution of an auditing system, (i.e. Shari’ah audit) as those guidelines are used as

reference in the development of the theoretical framework and the implementation of

Shari’ah audit.

Despite the various issues in social audit, there have been initiatives to test and

experiment its applicability in various settings. For example Dawson (1998) examines

what social auditing has to offer an NGO organization such as Oxfam in terms of

improving the quality of their work, increasing their accountability to stakeholders,

and their capacity to achieve impact in terms of their institutional goals. While

recognizing its importance for accountability and its potential for guiding

organizations such as Oxfam towards the real interests of their stakeholders, social

auditing holds a number of major potential issues to be resolved. They are; the cost –

would this be deemed an efficient use of resources, given its charitable objects?, the

enormity, diversity and contradictory nature of the demand which could flood such

organizations, given the breadth of interests of major stakeholders – the poor, and the

contradictions even within groups of stakeholders, and the possibility of damage to

organizational reputations by communicating negative results to the general public. To

solve these issues, Dawson (1998) believes that if social auditing principles are

integrated into strategic planning and evaluation systems, cost can be reduced.

Hill et al (1998) in his interpretive research project examines the feasibility of

implementing social audit within the general medical practice setting. The study aims

33
to communicate patients’ voices to aid evaluation of the potential contribution of

social audit to the public health sector and also addresses particular conceptual

problems which arise when attempting to implement social audit within this

environment. They suggest that social audit paradigm may bring benefits which are

especially relevant to such primary health care (PHC) environment. They found that

the ideas and process of social audit were viewed positively by their patient

respondents. Patients were able to demonstrate a capacity for grasping accountability

issues and balanced reasoning. There was an acute awareness of the constraints which

exist in public services. The study concludes that an involved and negotiative dialogue

process of implementing social audit could provide beneficial understanding and ideas

to the organization which may further researched.

Mraovic (2003) emphasizes the need for a continual evaluation of IT

management programmes in the organization, as well as the importance of its

assessment not only from the point of view of its technical effectiveness, but also from

the point of view of social audit and accountability in management. Social audit

becomes an important agent of social change, providing the involvement of different

actors in the realization of these changes. First of all, accountability in management is

increased, which triggers changes in organizational behavior not only towards the

external environment in the sense of its greater responsiveness and accountability

towards stakeholders, but also within its internal structure, meeting the requirements

for greater individual rights of the employees. Through social audit, and owing to the

internet, the technical mind is subordinated to social goals, giving opportunity to men

to become the masters of technology, not its victims. In this way technology

contributes to the changes of power relations in the sense that it emphasizes the impact

34
of technology at the expense of autocratic behavior of managers, which then

ultimately leads to changes of strategy related to corporate social responsibility.

Gao & Zhang (2006) aim to identify the applicability of social auditing as an

approach of engaging stakeholders in assessing and reporting on corporate

sustainability and its performance. Their finding is that there is a “match” between

corporate sustainability and social auditing, as both aim at improving the social,

environmental and economic performance of an organization, considering the well-

being of a wider range of stakeholders and requiring the engagement of stakeholders

in the process. They further suggest that social auditing through engaging stakeholders

via dialogue could be applied to build trusts, identify commitment and promote co-

operation amongst stakeholders and corporations.

Along with the considerable interest that have been devoted to the concept of

social audit, it is clear that in the concept of social auditing there have emerged

significant variations in the purposes, uses, issues to be audited, methodologies, and

other characteristics of the social audit. Carroll & Beiler (1975) believe that the

complex array of goals facing the typical organization in modern times suggests that

management undoubtedly will require additional planning and control devices for

coping with expectations that society will place on business. This phenomenon is

marked with an increasing number of companies - as well as public and voluntary

sector organizations - are trying to assess their social performance systematically

which include multinationals such as Shell, BP and General Motors (Henriques,

2000). For instance, sustainability reporting and social auditing in Australia has

burgeoned and witnessed the increasing interest from various parties in the recent

years where a significant body of social auditing work is being undertaken by large

accounting, environmental and/or engineering firms (Boele & Kemp, 2005)

35
 Despite its acclaimed philosophy of social audit where Davis & Bromstrom

(1975) sum up its benefits as to supply data to the organization for comparison with

policies and standards, to increase concern for social performance, to compare

different types of programs and cost/benefit, and to supply data for external social

reporting, however, Owen et. al (2000) perceive that without real change in corporate

governance structure, social audit could be monopolized by consultants and/or

corporate management and therefore amount to little more than a skillfully controlled

public relation exercise. They believe that looking at the current situation, where the

auditors are basically appointed by the organization and responsible to the

organization, hence such situation essentially does not support the realization of the

prevailing aim of social audit in promoting organizational transparency and

accountability to all stakeholders. Social auditing will be unnecessary only when all

parts of society are as involved as they want or need to be in the direction of all social

institutions (Henriques, 2001). This is increasingly talked about as 'stakeholder

governance', that is the explicit involvement of stakeholders with the major decisions

made by organizations.

Obviously theorist, practitioners, and the regulatory bodies must work hard to

develop and harmonize the auditing theory as well as the practice of auditing in this

field. Much works must be done in developing definitions, establishing social auditing

standards, developing and standardizing the measurement techniques and reporting

format, and ensuring that these audits are practiced in congruent with the underlying

missions of social accounting which is one of those is to create a better and a fairer

world (not the otherwise which can be used as a corporate capture/agenda).

36
2.4.2 Environmental Audit

While financial auditing is nearly as old as the entire field of business itself,

environmental auditing, as a discipline and profession, has only emerged in the last

few decades. Environmental audit has come to light along with the increasing

awareness and the call for Corporate Social Responsibility (CSR). As a separate and

distinct compliance management tool, environmental auditing had its beginnings in

the late 1970s and early 1980s where the Securities and Exchange Commission (SEC)

of the USA required a number of companies (e.g. U.S. Steel) to undertake a corporate-

wide audits to determine the extent of the environmental liability they faced (Cahill,

2001). The practice of environmental audit starts to blossom when the regulatory

framework for environmental reporting was beginning to emerge in the mid-1990s

(Gray et al., 1996)

Funkhouser & Greeno (1984) state that although the discipline has been

evolving rapidly, yet it is still a young enough discipline that the phrase itself connotes

a wide range of practices, some modeled closely after a financial audit, some with a

strong emphasis on risk, and others less rigidly defined-perhaps more like an

assessment or professional opinion than a conventional audit.

The International Chamber of Commerce [ICC] (1991: 3) defines

environmental audit as:

a management tool comprising a systematic, documented, periodic and

objective evaluation of how well environmental organization,
management and equipment are performing with the aim of helping to
safeguard the environment by: (i) facilitating management control of
environmental practices; and (ii) assessing compliance with company
policies, which would include meeting regulatory requirements.

Meanwhile the Environmental Protection Agency (EPA) defines an

environmental audit as a “systematic, documented, periodic, and objective review by

37
regulated entities of facility operations and practices related to meeting environmental

requirements” (quoted from McGaw, 1993).

The campaigners of environmental auditing basically believe that

environmental auditing brings many advantages to the corporations and society at

large. Palmisano (1984) argues that environmental audit does not only determine a

company’s compliance with relevant environmental regulations, it also provides the

corporation with information (not just statistical data) on which environmental

decisions and planning can be based. Vinten (1996) highlights among the advantages

of a sound environmental audit are that it will:

• Demonstrate company commitment to environmental protection to

employees, the public and the authorities;

• Provide an environmental database for planning, plant modification and

emergency planning;

• Safeguard the environment;

• Verify compliance with local and national laws;

• Indicate current or potential future problems that need to be addressed;

• Reduce exposure to litigation, incidents and adverse publicity;

• Increase employee awareness of environmental matters;

• Assess training programmes and provide data to assist in training;

• Enable companies to build on good environmental performance, give

credit where appropriate and highlight deficiencies;

• Assist the exchange and comparison of information between different

plants or subsidiary companies;

• Identify potential cost savings, such as from waste minimization.

38
 The literature on environmental auditing demonstrated that there have been

variations in the motivations of the corporations in exercising environmental audit.

Funkhouser & Greeno (1984) assert that the corporations have from time to time

shifted their reason for conducting environmental audit program which they

summarize as from management assurance to risk management. In the earlier phase,

the corporations opt to undertake environmental audit as to avoid the environmental

incidents, ensuring the compliance to the regulations, identify and manage hazards

that are not yet regulated. Later they begin to employ environmental audit as a tool to

provide assurance to top management and board of directors, verify the compliance,

and detect risks.

Stafford (2006) examines the factors that affect state adoption of environmental

audit legislation and self-policing policies. The results of both a cross-section probit

and a Weibull proportional hazard model suggest that political context and state-

federal relationships are key factors in adoption decisions while environmental

conditions are less significant and institutional capacity is the least important. Overall,

the results for audit privilege and immunity legislation are very similar, but several

explanatory factors affect adoption of audit legislation and self-policing policies in

opposite ways. Finally, these results also suggest that EPA opposition to audit

legislation has had a significant deterrent effect.

McGaw (1993) illustrates among the reason for instituting an environmental

audit are in regard to the compliance audit which is undertaken to evaluate the

conformance of facility with a specific set of regulations. Another reason is in

conjunction with liability or risk management audit. A risk management audit goes

beyond strict compliance with the laws and regulations to look at activities that, while

they may be in compliance with today’s requirements, may also be creating risks or

39
liabilities in the long term. The last reason highlighted by McGaw (1993) is to conduct

environmental audit in relation to property transfer assessment where the audit aims at

identifying any environmental liabilities associated with a site so that the purchaser

(and the lending institution) can be protected from future responsibility for

remediation of the site if contamination is discovered after the purchase is completed.

Besides the motivational issue in the adoption of environmental audit by the

corporations, the task of environmental audit has been questioned on whether the

accounting professions are capable of getting involved in this field. Where the other

auditing areas have been dominantly occupied by the accounting profession,

environmental audit appears to be handled by the engineers and scientists working as,

or for, “environmental consultants” or regional councils. The accounting profession

seems to have lack of expertise in performing environmental audit as the issues

covered under environmental audit are inimitably different from other types of audit

hence it requires special skills and proficiency which is currently closely related to the

engineering profession. This phenomenon proves that different types of audit require

different set of qualification and competence requirements for the auditors. In line

with the proposal of this study that the namely Shari’ah auditors must also be

equipped with a distinctive qualification and competence where probably the existing

accounting profession are yet to posses such qualification and competence

requirements.

With regards to environmental audit, the international accounting profession is

actively seeking opportunities to position itself within the potentially lucrative

environmental audit market (Lightbody, 2000). To date, accountants have utilized a

number of strategies to advocate for a greater role in this field. However, accountants

appear to have had limited success in achieving such outcomes. As a short term

40
alternative to a direct management role in environmental audits, Lightbody (2000)

proposes that the accounting profession utilize their expertise to facilitate training in

audit theory and methodology to overcome the substantial 'gaps' that currently exist in

the knowledge base of the professional groups dominating the conduct of

environmental audits.

Collier (1993) believes that there is a major opportunity for the financial

auditing profession to apply its skills to environmental auditing. As it does, a large

new area of work opens up for its members and, more importantly, the organizational,

management, ethical, training and reporting standards of financial auditing are made

available to environmental auditing as well. Renger & Nathanson (1992) describe the

issues of an environmental audit might range from management systems, atmosphere,

water, waste, noise, vibration, energy, storage and use of hazardous materials,

transport, land use, liaison with regulators and life-cycle analysis. Hence clearly skills

in all these areas cannot be found under one roof, but financial auditors are already

accustomed to using specialists where necessary, and know how to control and

manage field audit teams on a day to day basis.

Chiang & Lightbody (2004) review the involvement of financial auditors in the

conduct of environmental audits in New Zealand in 2001. Despite the research

conducted by Lambert (1991) and Tozer and Mathews (1994) indicate a very limited

involvement of accountants in such practices, however, Chiang & Lightbody (2004)

believe as the extent of environmental management practices adopted by organizations

can be expected to have increased substantially since this time, there is reason to

anticipate that the engagement of financial auditors with environmental audits may

also have changed over the last decade. The study suggests that the numbers of

financial auditors involved in environmental audits, particularly in a management role,

41
are gradually increasing. However, the majority of financial auditors were not

providing environmental audit services, claiming that there was currently no demand

for environmental audits or that they did not have the appropriate expertise.

In spite of the debate of who should perform environmental audit, industry and

commerce, as well as the public sector, have a crucial role to play in formulating an

effective approach to set up an environmental or green audit. Today, environmental

audit is no longer a merely conceptual proposal which is vacuum in its practicality in

the real world. Environmental audit has captured the interest of many parties including

the standard setters who continuously upgraded the policies to be complied and the

theorist who continuously conduct the research in the area. The global concern about

environmental damage that underlines this development has somehow forced the

organizations to respond appropriately. Vinten, (1991) who also calls environmental

audit as the “green audit” believes that such audit can be used to demonstrate

compliance with new legislation; more importantly it provides management with

information on environmental performance. Vinten (1996) interestingly provides a

detail of the content of environmental audit in several phases: the pre-audit phase,

setting objectives, preparation, drawing up documentation, areas to audit, data

processing, reporting, implementation and post-audit review. Other manuals have also

been written in this area such as a manual for performing environmental audit which

has been published by Environmental Resource Center which described the

procedures that need to be taken in conducting environmental audit and overview of

major environmental laws and regulations applicable (McGaw, 1993).

With the blossoming of rules and regulations enacted with regards to

environmental protection and the increasing public awareness of environmental issues,

it can be anticipated that the combined impact of these two factors will have resulted

42
in an increasing number of such audits being undertaken. The applicability of

environmental audit has spread beyond the basic chemical industry to all types of

industries and even government agencies (Cahill, 2001).

2.5 PATH OF THE EVOLUTION OF AUDITING

The above discussion on several types of audit has revealed that audit as a subject or a

discipline seems to evolve appropriately in adapting to the changes and challenges in

the society. Where financial audit appears to be durable despite of many critiques

confronting it, other areas of auditing such as social and environmental auditing on the

other hand are creating their path to be systematic, well developed subjects, and

gaining the acceptance of the international public widely.

Most importantly, looking at the development of the discipline of auditing it

proves that the discipline does not stay the same as it was practiced in its earlier

periods. The discipline has changed very fast in its response to the changing needs of

its environment. Indeed it is still exposed and susceptible to the new development

such as in the response to the current development of Islamic financial industry. The

fast growing Islamic financial industry worldwide essentially needs a special audit

which can embrace the unique characteristics of the industry.

Since there has been no single audit type is able to satisfy every objective of

the audit that deemed necessary by the many parties in public generally (e.g. society,

authorities, business owners etc.) therefore each audit aims at catering specific

dimension of the business or organizational activities to achieve specific purposes. In

this regard, Shari’ah audit is perceived relevant to be established as a new discipline in

auditing. While other areas of audit have already set up their framework with the

varying degree of achievement, Shari’ah audit is a subject with question marks on its

43
framework. Hence it significantly needs for the efforts from the relevant individuals

and institutions to develop it and make it as a well-established discipline.

From the discussion on the different types of audit in the previous sections, it

can be seen that the scope of audit has become wider. From merely concentrating on

the attestation of financial information, it later on embraced many aspects deemed

necessary in society with the main objective of discharging greater accountability to

the society at large. The figure below portrays the changing scope of audit to include a

wider array of socio-economic issues in society. Where financial statement audit

precedes the other types of audit and limits its scope on financial information,

performance audit broaden the auditing perspective into the management of resource

utilization, programs and functions. In the later stage, social and environmental audit

come with a wider scope to incorporate social and environmental issues to be the

subject of auditing. The emergence of Shari’ah audit is expected to offer wider

perspective of the existing auditing areas because it is not only concerned with

financial, operational, social and environmental issues but also with the compliance

towards religious principles.

44
 Figure 2.1 The Broadening Scope of Auditing

Financial Audit Performance Audit Social & Environmental Audit Shari’ah Audit

Economy, effectiveness Social contribution & Every aspect of

and efficiency of environmental organization’s activities as
Financial statements
resource utilization, compliance concerned by Islamic
programs and activities religious teaching

Late 1800s/1900s 1960s/1970s 1970s 2000s

45
 To portray the changes in the auditing discipline and see the different features

of different auditing areas, the following table presents the path of audit evolution.

Certainly each audit type has also undergone the changes in its characteristics and

different perspectives in approaching and understanding each audit type has

undeniably caused the subject to be differently defined and characterized. It is difficult

to capture the whole process of audit evolution; as such only general changes are

described here.

46
 Table 2.1
The Characteristics of Different Auditing Models

Audit Type Criteria By Whom Regulatory

No Objective Motives Scope of Audit Intended Users
Conducted Framework
1. Prior to 1500 AD • To detect fraud, e.g. to • Fraud prevention • Financial records • Internal • Appointed • Resource • Internal
(Maintaining the prevent defalcations within and detection directives scribes Owners
separate records by the treasuries and to ensure
two scribes) the honesty of those
responsible for the custody
of resources

2. Financial • To enable the auditor to • Principal-agent • Financial • GAAP • Appointed • Shareholders • Formal,
Statement audit express an opinion whether relationship information qualified • Potential Companies
the financial statements are mainly in Balance external Investors Acts, PCOAB,
prepared, in all material Sheet, Profit & audit Professional
respects, in accordance with Loss statement, firms. bodies &
an applicable financial and cash Flow • Internal standards.
reporting framework” Statement Auditors

3. Performance audit • To determine the • Public demand for • The economy, • Key • Appointed • Public (in case • Auditor General
organization’s performance greater government efficiency, and performance qualified of public sector) (Supreme Audit
with respect to economy, accountability effectiveness, of indicators external • Management of Institutions)
efficiency and effectiveness • Insufficient resource audit firms the organization • Government
of operating areas, activities information by utilization, • Internal & shareholders Audit Standards
and results. relying on the programs, auditors (Private) Board
financial audit activities or • Government • Professional
especially for public functions auditors bodies
sector

47
 Table 2.1 - Continued

Audit Type Criteria By Whom Regulatory

No Objective Motives Scope of Audit Intended Users
Conducted Framework
4. Social audit • To identify, measure and • Dissatisfaction with • Community • Social • Internal • Society • Voluntary
report the ethical, social conventional auditing relations indicators Personnel of • Management
and environmental impact practices • Human Resource (Basically the to identify
of an organization • The initiative to issues there is no organization social
develop a more • Working single • Consultant performance
socially responsible conditions commonly
auditing practice • Pollution/environ agreed criteria)
mental damage
5. Environmental • To evaluate and report the • The increasing • Waste • Environmental Appointed • Management • Environmental
audit environmental environmental • Storage & use of Protection Act Environmental to control its Protection
performance of the regulations hazardous • Other auditors environmental Agency
organization in facilitating requirements materials Environmental (Mostly impact and
management control of • Management assurance • Noise laws & environmental comply with
environmental practices in avoiding/minimizing • Land use legislations consultants regulation.
and assessing compliance environmental liability • Water issues applicable in who are • Regulatory
with regulatory • Liaison with individual dominated by agencies
requirements. regulators, etc. country engineers) • Society
6. Shari’ah audit • To ensure that the activities • The development of • Business • Shari’ah Shari’ah • God, Allah • An
carried out by an Islamic financial policies?? rulings & auditors?? SWT?? independent
organization do not practice which lead to • Processes & fatwas • Public?? body
contravene Shari’ah the necessity of procedures?? • Shari’ah • Other established to
principles?? establishing an • Contracts & principles stakeholders? oversee its
auditing system agreements?? • Maqasid al- practice??
compatible with the • Financial system Shari’ah?? • Professional
Islamic requirements?? & reporting?? body (e.g.
• HRM AAOIFI) and
• Social & standards??
environmental
• Marketing &
advertising
• Zakah, etc.

48
2.6 SUMMARY OF THE CHAPTER

This chapter has attempted to provide a review of the evolution of auditing.

Specifically this chapter has looked into the emergence and the development of

different auditing areas (e.g. financial statement audit, social and environmental audit,

etc.) and discussed the framework and related issues of each of the major auditing

areas identified.

Due to the limited space, the chapter might not provide a comprehensive story

of the development of each auditing areas identified, however, it has briefly identified

the milestones and discussed some of the issues concerning each auditing area. First

section of the chapter has basically traced the historical background of auditing and

highlighted the emergence of financial statement audit. In the second section, the

chapter has discussed the performance based audit. Section three finally reviewed the

emergence of social and environmental auditing and their critique of mainstream

auditing. The discussion on social and environmental auditing was intentionally

lengthier than the previous two audit areas as it gives a wider and new perspective of

auditing and perhaps the researcher could relate this to the proposed establishment of

Shari’ah audit. Finally, to link the discussion of the evolution in the auditing to this

study, this chapter has tabulated the path of the evolution and identified the relevance

and necessity for the establishment of the subject of Shari’ah audit. However, in depth

discussion on the subject will be explored in the next chapter.

49
 CHAPTER 3

AUDITING IN THE ISLAMIC FRAMEWORK

3.1 INTRODUCTION

While the previous chapter has elaborated the evolution of auditing and highlighted

the relevance of formulating the discipline of Shari’ah audit, this chapter aims to

provide a review of literature in the area of auditing from the Islamic perspective. The

chapter, in particular, attempts to explore how far literature has progressed in the area

of Shari’ah auditing.

This chapter is organized into five sections. First section will examine the

understanding of Islamic worldview and how it moulds a different concept of

auditing. Secondly, this chapter will briefly highlight the concept of Islamic

accountability and its relevance to auditing discipline. Thirdly, the chapter will review

the development of Shari’ah auditing from the early Islamic era until now and explore

the characteristics and issues encountered with regards to Shari’ah audit. Fourthly, it

will explore the gap of the existing literature on Shari’ah audit. Finally, the last section

will conclude the chapter.

3.2 ISLAMIC WORLDVIEW AND AUDITING

As noted earlier that the establishment of Islamic financial institutions with its

distinctive characteristics has basically demanded a new aspect of auditing that can

cope with the underlying Islamic principles. In line with this, Karim (1990) points out

that different societal rule of business behavior result in different financial operation,

accounting policies and financial analysis. Hence, Muslim society who carries

50
distinctive values and principles would definitely need its own financial system that

can cater their own belief system. In this section, the researcher would explore the

Islamic worldview and how the worldview moulds and necessitates for a different

concept of auditing.

Worldview (weltanschauung) as defined by al-Faruqi (1982) is “the way in

which a person sees and explains the world and his place in it,” whereby Chapra

(1992) defines worldview as “the set of implicit and explicit assumptions about the

origin of the universe and the nature and purpose of human life,” and Choudhury

(1999: 26) defines worldview as “the unified comprehension of the universe and all its

sub-systems.”

Worldview is a very essential element that needs to be discussed clearly in

establishing the discipline of Shari’ah audit, for it is the ideological foundation that

mainly contributes to develop, in our case, the Shari’ah auditing framework. Furqani

(2006) asserts that any economic system is founded on a specific worldview which

provides the basis and objectives as well as a set of axioms and principles on which

that system operates. The same goes to the auditing in the Islamic framework; it must

be founded on a specific world view which dictates the principles, objectives, and the

procedures of the Shari’ah audit. In this regard, Nasr (1986) asserts that a system of

thought should always associate with worldview that initiates changes and

development of that particular system.

On the face of it, conventional auditing is claimed to be a neutral knowledge

which deal with the accounting data and value-free figures (Khan, 1985). However,

like all other branches of knowledge, the conceptual framework of modern auditing is

developed from the worldview, ideology, vision which is constructed from the

secularist-materialist worldview of Western civilization or what Khan (1985) called as

51
capitalist ideology. Triyuwono and Gaffikin (1996) also argue that accounting is not

value-neutral; it is a social construction which develops and changes in the social

sphere. The appearance of accounting is greatly influenced by the values in which it

socially grows and is practiced.

Therefore, conventional accounting/auditing in this case is neither neutral (as

they argue it to be objective and unbiased, merely describing phenomenon and not

bearing any ideological contents) nor universal (to be applied to all human kind and

all human civilizations as it has been ‘neutralized’ through proper and universal

methods of analysis). Conventional Accounting/Auditing is indeed partial i.e. derived

and analysed within the capitalist/Western framework and fails to represent the whole

domain of reality and to some extent contradicts with the principles of Islam. Al-Attas

(1993: 133) in this regard affirms that:

it seems to be important to emphasize that knowledge is not neutral, and

can indeed be infused with a nature and content that masquerades as
knowledge. Yet it is in fact, taken as a whole, not true knowledge but its
interpretation through the prism, as it were, the world-view, the
intellectual vision and psychological perception of the civilization that
now plays the key role in its formulation and dissemination. What is
formulated and disseminated is knowledge infused with the character
and personality of that civilization – knowledge presented and conveyed
as knowledge in that guise to subtly fused together with the real so that
others take it unaware in toto to be the real knowledge per se.

Since Hasan (1995) opines that no economic discipline (in this case applies to

accounting/auditing) is value neutral, the difference then lies in how each discipline

treats the “right” values and selects them. Mainstream accounting in this regard relies

only on its rationalistic aspect to arrive at values, while Islamic accounting does not

dichotomize intellectual reasoning and the role of spirituality in value selection.

Therefore, the worldview of capitalism as dominating the world today can not be

entirely applied to Muslim society as it is based on different philosophical

52
foundations. Human beings, societies and civilizations have their own worldview and

vision that are not identical from one to another. Therefore, according to Hameed

(2000a), Triyuwono and Ghaffikin (1996), since alternative worldviews, ideologies

and values exist, different types of accounting (and consequently auditing) are not

only possible but natural and legitimate as well.

The Islamic worldview has a spiritual-transcendental dimension. The way

Islam perceives reality is not like the West, devoid of the Divine. Al-Attas (1993)

notes the meaning of worldview in Islam as ru’yat al-Islām li al-wujūd and not nazrat

al-Islām li al-kawn. In other words, a worldview in Islam is not merely the mind’s

view of the physical world and of man’s historical, social, political and cultural

involvement in it (as the latter phrase denotes). It is beyond that. Worldview in Islam

is the way Islam looks at the existences (al-wujūd) of God, human-beings and the total

universe, and not the way Islam looks at merely the physical universe (al-kawn),

which usually leads to God-negation metaphysics and a purely materialistic view of

reality. Worldview is the vision of reality and truth that appears before our mind’s eye

revealing what existence is all about; for it is the world of existence in its totality that

Islam is projecting.

Therefore, the ‘worldview’ according to the Islamic perspective “encompasses

both al-dunyā (this world) and al-ākhirah (the hereafter), in which the dunyā-aspect

must be related in a profound and inseparable way to the ākhirah-aspect, and in which

the ākhirah-aspect has ultimate and final significance” (Al–Attas, 1993).

Contemporary western economics does not share this ākhirah dimension. This has

significant implications for other foundational and applied theoretical areas of

economics. For example in conceiving the nature of man with his relation to the

economic matters, Islamic economics admits God as the centre of this relationship and

53
construct the economics based on God injunctions. Conventional economics on the

other hand, considers man as the centre and simply removes God from man’s

economic sphere and hence frees economics from any of God injunctions.

Al-Attas (1995: 4-5) delineates the characteristics of worldview of Islam as

follows:

the Islamic worldview is characterized by an authenticity and a finality

that points to what is ultimate, and it projects a view of reality and truth
that encompasses existence and life altogether in total perspective
whose fundamental elements are permanently established. These are to
mention the most salient ones, the nature of God; of Revelation (i.e. the
Qur’an); of His creation; of Man and the psychology of the human soul;
of knowledge; of religion; of freedom; of values and virtues; of
happiness – all of which together with the key terms and concepts that
they unfold, have profound bearing upon our ideas about change,
development, and progress.

The Islamic worldview contains socio-scientific explanatory power that would

give a clear and correct direction to scientific activity. It is on this worldview that the

science of a genuinely Islamic character should be based. Secular worldview, on the

other hand, mainly lays its view on materialism-secularism and does not take into

account the Divine position. This materialist worldview is presently underpinning the

establishment of contemporary secular economic system and institutions which

includes the methodologies applied, the theories produced and the policies

recommended. This particular worldview which underlies the philosophy of

mainstream accounting, possesses certain strengths but has restricted the range of

problems studied and the use of research methods and by changing them, new insights

may be gained which can potentially extend our knowledge of accounting in action

within organizational and societal contexts (Chua, 1986).

Due to the above fundamental difference between the worldview of Islam and

the West, many Muslim scholars attempt to revisit the existing knowledge and

54
critically asses their suitability to the Islamic worldview, a process known as

Islamization of knowledge (Al-Faruqi, 1982).1 Many found that the existing

knowledge discipline have basically been absent of the Islamic philosophy. As a

result, those scholars try to formulate new disciples in various fields that can cope

with the Islamic vision. As for auditing, several Muslim scholars have been also

aiming to find an alternative auditing system that could portray properly an Islamic

point of view on auditing and establish its own foundational framework.

3.3 ISLAMIC ACCOUNTABILITY AND AUDITING

To date, the discussion on auditing has most of the time been associated with the issue

of accountability. The researcher believes that the purpose of conducting audit is

basically to ensure that accountability is properly discharged. It has been identified

that of the many factors posited as causes of the Asia crisis, lack of accountability and

poor, if not mischievous, auditing and governance standards emerged as one of the

most controversial (Asia Pacific Management Forum [APMF], 1999). The forum

further insisted that people often refer to accounting and finance in the same breath,

but not only finance can be audited, but also other areas of management and

management as a whole, the environment, and even social systems.

Historically, poor accountability has witnessed the collapse of several big

corporations all over the world. We are all aware of how horrifying the impact of

improper corporate and auditing accountability in the case of Enron’s bankruptcy. The

collapse of Enron was even followed by other big companies such as WorldCom.

These scandals undeniably have resulted in a decline of public trust in auditing and

reporting practices. In response to a number of major corporate and accounting

1
For a comprehensive survey of the meaning, rationale, sources and scope of Islamization of
knowledge see Haneef (2005).

55
scandals including those affecting Enron, Tyco International, Peregrine Systems and

WorldCom, the Sarbanes-Oxley Act of 2002 (Pub. L. No. 107-204, 116 Stat. 745),

also known as the Public Company Accounting Reform and Investor Protection Act of

2002 and commonly called SOX or Sarbox; signed into law on July 30, 2002.

In Malaysia for instance, the recent huge loss of Bank Islam Malaysia Bhd,

which was publicly announced in October 2005, has definitely triggered our mind to

question the credibility of IFIs particularly the Islamic banks. Whatever the

justification highlighted, say the incompetence of the workforce, does not actually

evade the critique over the accountability of the institution. Does this indicate that

accountability is not properly discharged within the institution? Does not auditing

processes exist that aims to give reasonable assurance on the organizational

transparency and accountability? Or the current auditing system is not suitable with

the unique requirements of the IFIs? And does it also lead to the need to discover and

formulate a new audit process that can satisfy and suit to the unique characteristics of

the operation and management of IFIs?

In the above cases, we could conclude that auditing has basically failed to

exercise its “noble” objective of ensuring the accountability is properly discharged.

For sure it is not the fault of auditing as a discipline of knowledge but there might be

elements of auditing which have loopholes for the people to violate. Besides, the

concept of accountability within the Western sphere is limited to the financial

dimension of subordinate and superior, agent and principal, management and

shareholders.

On the other hand, in Islam, the implication of Islamic worldview which based

on tauhid further translates to the distinctive understanding on the accountability of

business entity. The accountability within Islamic sphere is totally different from the

56
understanding of other system of belief such as capitalist or even socialist. As

compared to the conventional one, accountability from the Islamic point of view is

more comprehensive.

In Islam, accountability which the concept is emanated from the theory of

Tauhid is dual-dimension accountability. The concept of accountability here can be

referred to the definition of 'Islamic accountability' as proposed by Hameed (2000a)

which he believes it should be the primary objective of Islamic accounting. Islamic

accountability is based on dual accountability which translates the accountability of

Islamic organizations as well as the owners primarily through the concept of khilafah

(vicegerent). This means that man as khalifah is primarily accountable for resources

entrusted to him by Allah. In addition, man, refer to manager, is also accountable to

secondary accountee (investors) through the contract established between both parties.

Therefore, when a man (entity) is committed to perform his activities in

accordance with Islamic principles then he is automatically bounded to the above

conception on accountability. A man in a business community is accountable and

answerable not only to The Creator but also to the large number of stakeholders in

which his business is operating. He must be committed to uphold the values of

“amanah” for the wealth trusted by The Creator and he must be also committed to

ensure that the “maslahah” of all his stakeholders is well taken care and protected. To

ensure this commitment is fulfilled and the accountability is discharged accordingly,

proper supervision and controlling system is needed. At this point, Shari’ah audit is

supposed to take place instead of conventional audit which derived from a different

worldview and system of belief. It is however undeniable that technical aspect of

conventional audit might be still applicable in performing Shari’ah audit.

57
3.4 THE DEVELOPMENT OF SHARI’AH AUDITING: A SURVEY OF
LITERATURE

Very limited studies have been devoted to the subject of Shari’ah audit. The society at

large and the business world particularly, are still confined to conventional audit

which mainly focuses on financial statement audit. Even though certain groups of

academicians have embarked on the idea of social or ethical audit which has initiated

a different view on auditing, however this movement is still challenged in term of

recognition (Gray et. al., 1996). As mentioned earlier, due to the development in

Islamic banking and the comprehensive criteria covered under the umbrella of

Shari’ah, therefore, conventional audit or even social audit cannot fully satisfy these

requirements.

In this section, the researcher would highlight and discuss the development of

Shari’ah audit to discover how far the literature have progressed in the field of

Shari’ah audit. The discussion will begin with exploring the meaning and

understanding of the term “Shari’ah audit” followed by the highlights on the

emergence of auditing in the Islamic world and finally the characteristics as well as

the challenges facing the discipline of Shari’ah auditing will be studied accordingly.

3.4.1 Exploring the meaning of Shari’ah Audit

There seems to be confusion over the various terms used in referring to the auditing in

the Islamic perspective. Some call it “religious audit” while others name it as “Islamic

audit” or “Shari’ah audit”. Several scholars even use the terms interchangeably. In the

context of this study, the researcher prefers to employ the term “Shari’ah audit” as the

implication of the word “Shari’ah” is very much comprehensive and its denotation is

more appropriate to the issue of Shari’ah compliance in the IFIs.

58
 Since it is preferred to use the term “Shari’ah audit”, it is then believed that the

central idea of such term is on the interpretation and understanding of the meaning of

the term “Shari’ah” as well as the objective of Shari’ah. Failing to interpret the

Shari’ah elements in the aspect of auditing would distort the unique attributes of

Shari’ah audit as compared to the conventional one. Therefore, attempt has to be made

to view, understand and apply audit from the perspective of Shari’ah, hence it can be

called as Shari’ah audit. In this section the study aims to explore the conception of

Shari’ah, its purposes as well as principles and how the concept is associated with

auditing.

Shari'ah literally means the straight path, and it is often equated with the

Islamic law (Choudhury, 1997). Shari’ah provides a comprehensive guidance on the

human life and specifies the principles which aim to protect the interest of the human

being. Shari’ah presents both the social contract and the scientific groundwork for the

new global order that is premised on the episteme of Divine unity (Choudhury, 1997).

The content, scope, and objective of Shari’ah is broader rather than merely on legal

issues as wrongly interpreted by some traditional opinions (Berghout, 2006). The

objective of Shari’ah or popularly known as Maqasid al-Shari’ah should be looked in

a general perspective that contains principles and guidelines for the construction and

orientation of the community of vicegerency and civilization.

Maqasid al-Shari’ah is the most important ingredient of Shari'ah that contains

the overall objective of the Shari’ah which is to set things to right (maslahah) and

remove corruption (mafsadah) in all kinds of human activities (Ibn ‘Ashur, 2006: 88).

Maqasid al-Shari’ah aims at realizing the benefits either to the individual or the

community in general. It is based on Islam’s concepts of human well-being (falah)

and good life (hayatan tayyibah) which give utmost importance to brotherhood and

59
socio-economic justice and require a balanced satisfaction of both the material and the

spiritual needs of all human beings (Chapra: 1992). In one short statement, Ibn ‘Ashur

(2006: 87), asserts that “the all-purpose principle (maqsad ‘amm) of Islamic

legislation is to preserve the social order of the community and ensure its healthy

progress by promoting the well-being and righteousness (salah) of that which prevails

in it, namely the human species”.

The scope of maqasid al-Shari’ah revolves around man’s interest in this world

(dunya) and in the hereafter (akhirah) and it also concerns to the benefit of material

and spiritual aspect of mankind either individual (maslahah juz’iyyah) or society at

large (maslahah kulliyyah). Maqasid al-Shari’ah, in this regard, is developed to protect

and improve the condition of human life in all dimensions (Ibn ‘Ashur, 2006: 126).

From the past until present, Maqasid al-Shari’ah has been extensively

discussed by Muslim scholars reflecting its significance to fully understand the

application of Shari’ah in life. Among the classical scholars who have deeply explored

this subject are al-Ghazali (d. 505H), Fakhr- al-Din al-Razi (d. 606H), al- ‘Izz ibn Abd

al-Salam (d. 660H), Ibn Taimiyyah (d. 728H), Ibn al-Subki (d. 771H), and al-Shatibi

(d. 790H). Currently, Contemporary Muslim scholars from various fields of

knowledge have been attempting to explore further the theory of Maqasid al-Shari’ah

and its applicability to other disciplines of knowledge and also to any contemporary

issues facing the Muslim society. Berghout (2006) in this regard opines that the study

on the maqasidi framework is fundamental to provide principles, guidelines and

methods of discovering and implementation of the objectives of Islam in a real

practical context. The current phenomena according to Hallaq (2006) are an attempt

by the contemporary Muslim scholars to redefine and modify the maqasid to

accommodate the exigencies of the modern world.

60
 With regards to Islamic finance, the studies have been conducted to examine

the applicability and realization of the concept of maqasid al-Shari’ah to the issues of

economics and finance, for instances, the implication of maqasid on the modern

Islamic finance (Kahf, 2006), the Shari’ah objectives of financial contracts and

Islamic banking (Akram Laldin, 2006), the application of maqasid in insurance

(Abdul Aziz, 2006) and the application of maqasid to the framework of Corporate

Social Responsibility (Dusuki, 2006).

Specifically to auditing, the researcher believes that Maqasid al-Shari’ah plays

an important role in prescribing the scope, framework and objective of Shari’ah audit.

Shari’ah audit in the Islamic Financial Institutions must aim at guaranteeing the

maslahah of all the stakeholders of those institutions. The priorities of the needs of the

stakeholders must be ranked according to the categorization of the maqasid. The

maslahah should be interpreted comprehensively in conducting the auditing

procedures to sufficiently protect the interest of the stakeholders. In this regard,

Chapra (1992) opines that al-maqasid al-shari’ah include everything that is needed to

realize falah and hayat tayyibah within the constraint of shari’ah. For instance,

Shari’ah audit should cover the entire business activities of the IFIs including non-

financial matters such as business policies, human resource management, societal and

environmental impact of the IFIs’ activities, marketing and advertising, etc. As the

maqasid extents the concept of falah to the hereafter, Shari’ah audit must be set to

realize such objective through its procedures hence both the Shari’ah auditors and the

stakeholders of the IFIs are assertively leading their way to achieve falah in the

hereafter.

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3.4.2 The Emergence of Shari’ah Audit

Auditing is indeed not a new discourse in the Islamic scientific tradition. Earlier,

Muslim scholars have actually dealt with auditing issues. Accounting and auditing

issues, although may not be dominant, have occupied the minds of philosophers,

jurists, sufis, etc., with each responding in their own way. During that time,

accounting and auditing thought in Islam can be seen as the Muslim scholars' response

to the economic challenges of their times. Their thinking and involvement in the

economics issues were aided and guided by the Qur'an and Sunnah as well as by

intellectual reasoning and observation.

Khan (1985) opines that accounting and auditing have existed in the pre-

Islamic Arabia. He argued that since the people of pre-Islamic Arabia had actively

involved in many commercial activities such as foreign exchange and trade, traditional

banking, and speculation, hence he believed that those activities would not be possible

without having some concept of accounting and auditing.

In fact, Khadija listened to the accounts of her business from Muhammad

(p.b.u.h) or in contemporary expression she audited these accounts (Khan, 1985). In

addition, necessary verification was made from the personal evidence of her salve

Maysara who accompanied the Prophet. The nature of business activities at that time

also indicates that they were aware of and put into practice the concept of

accountability.

The development of auditing in the time of Prophet and His companions was

further marked with the establishment of the institution of the Hisba. The term Hisba

is derived from the root h.s.b. which means “arithmetical problem”; “sum” or

“reward” (Khan, 1982). According to Al-Quran, 4:6, 17:14, and 33:39, the term Hisba

also means “to account”, “to compute”, and “to measure”. The person who carries the

62
functions of Hisba is called Muhtasib. The Prophet can be regarded as the first

Muhtasib in the history of Hisba. The main responsibility of Muhtasib is to enjoin the

virtue and prohibit the evil (al-‘Amr bi’l Ma’ruf wa-n-nahi ‘an al-Munkar). The

tradition of Hisba was maintained during khulafa al-rasyidin until it was formally

instituted in the time of Abbasids during Khalifah Al-Mansur (Furqani, 2003). Since

then Hisba has been widely established in many Muslim territories such as Egypt,

Spain, and other Muslim countries. However with the fall of Ottoman Empire in 1922,

the existence of Hisba can hardly be traced (Furqani, 2003).

Principally, the functions of Hisba are parallel to the functions of Shari’ah

audit at a broader level. Hisba was instituted to help regulating the society and

economy and ensuring the full flowering of the Islamic norms of behavior (Ibn

Taymiyah, trans. 1982). Hisba is a moral as well as a socio-economic institution and

its raison d’etre lies in the Quranic command of al-‘Amr bi’l Ma’ruf wa-n-nahi ‘an al-

Munkar, that is, to ordain good and forbid evil (Ibn Taymiyah, trans. 1982). Based on

the available literature, Khan (1982) summarizes three fundamental functions of

Muhtasib which are:

1) To see that the community as a whole had proper organization and

facilities for performance of ‘Ibadat.

2) To be responsible in the implementation of ‘adl (justice) in the society.

3) To pay special heed to various municipal services especially the hygienic

condition in the town.

Even though the role of Muhtasib is considered broad which basically aim for

the benefit of the society at large but if we analyze further the institutional framework

of Hisba, it reveals that Shari’ah audit at a wider scope seems to resemble the

functions of Hisba. If Shari’ah audit is applied at the higher institution such as

63
government or even to the lowest governmental structure, hence the functions of

Shari’ah audit can be equalized to the role of Hisba which aims to uphold the justice

in the society.

Actually these days, most of the functions that traditionally were carried out by

a muhtasib have been assigned to different departments of the state (Khan, 1982).

However it is sad to see that the high moral standard and the spirit of al-‘Amr bi’l

Ma’ruf wa-n-nahi ‘an al-Munkar are significantly absent, leading to a high degree of

corruption, disregard of public funds, a callous indifference towards justice and fair

play in dealings and selfish individualism. Khan (1982: 136) further elaborates that:

with the advent of Western colonialism most of the Muslim institutions

underwent drastic modifications. Like many other institutions, the Hisba
also declined in effectiveness. It either disintegrated into a number of
departments or remained an ineffective appendage of the state organs.
By the 19th century, Persia, Turkey, Egypt and India had already
transformed the Hisba function into a number of secular departments
discarding its religious contents as irrelevant.

The relevance of Hisbah in contemporary days has also been studied by

Gambling and Karim (1993) who opines on the role of Hisbah in supervising ethics in

business and accounting, Al-Buraey (1990) who considers Hisbah as a necessary

institution in Islamic management and administration, and Abdul Rahman (1998) who

sees the significance of Hisbah in corporate accountability and governance.

Having so far analyzing the birth and the expansion of Shari’ah audit in the

early Islamic era, we might probably wonder why the discipline of Shari’ah auditing

was not well developed at that time when Muslims dominated the world’s scientific

tradition. In fact, a particular discipline of auditing with its systematic framework of

study had not been developed in the Islamic civilization but only later in the history of

mankind. One of the explanations to this phenomenon is maybe the lack of complexity

of the business nature at that time. Society of the early Islamic era was involved with

64
the simple commercial activities which only necessitate simple accounting and

auditing techniques.

Despite its lack of systematic development in the early Islamic Era, Shari’ah

auditing starts to receive attention from modern Muslim scholars in its way to become

as a discipline of knowledge. Even though the interests shown in the Shari’ah audit

can still be considered minimal, yet it has been continuously discussed and explored

by several scholars in various countries. The call for the establishment of Shari’ah

audit has been reflected in a number of the scholarly articles, books, and postgraduate

theses/dissertations. Among of these literature are the writings by Khan (1985), Abu

Mouamer (1989), Karim (1990), Al Abji (1989), Hood & Bucheery (1999), Khan

(2001), Janahi (2000), and Simpson & Willing (2000), and Harahap (2002).

The movement in modern Shari’ah audit has been largely driven by the growth

of Islamic finance and the belief of urgency to reform the current auditing system in

the Islamic financial institutions. Muslim scholars have been triggered to explore

many issues that yet to be resolved with regards to Shari’ah audit. Hence the

emergence of modern Shari’ah auditing is hoped to benefit all Islamic institutions and

realizing the sacred objective of Shari’ah.

3.4.3 The Characteristics of Shari’ah Auditing

What actually makes Shari’ah audit different from the conventional one? Besides its

foundation which based on the Islamic worldview, what are the distinctive features of

Shari’ah audit as compared to the conventional audit? The literature on Shari’ah audit

have demonstrated few features which distinguish Shari’ah audit from its counterpart.

Among the unique characteristics embedded with Shari’ah audit are its underlying

65
worldview (as discussed earlier), its scope, the distinctive role of Shari’ah auditors as

well as their qualification requirements.

3.4.3.1 The Scope and the Extent of Shari’ah Audit

One of the major uniqueness of Shari’ah audit as contrast to its conventional

counterpart is its scope. The terms “scope” and “scale” here should be understood in a

broader context so as to cover the scope of audit works, the identification of business

activities to be covered under Shari’ah audit, and possible extension of Shari’ah audit

to other Islamic institutions.

AAOIFI (2002) defines “scope of an audit” as the audit procedures deemed

necessary by the auditor in the circumstances to achieve the objective of the audit. It

further explained as:

the procedures required to conduct an audit in accordance with ASIFIS

should be determined by the auditor having regard to the requirements
of appropriate Islamic rules and Principles, ASIFIs, relevant
professional bodies, legislation, regulations, which do not contravene
Islamic rules and Principles, and, where appropriate, the terms of audit
engagement and reporting requirements, International Standards on
Auditing (ISAs) shall apply in respect of matters not covered in detail
by ASIFIs providing these do not contravene Islamic Rules and
Principles.

The above statement by AAOIFI indicates the heavier duties and

responsibilities of Shari’ah auditors in conforming to the underlined procedures.

Unlike the conventional auditors who can clearly identify specific scope of audit

engagement as well as its procedures to follow, Shari’ah auditor for instance carries

broader rules and guidelines to follow. This also signifies that Shari’ah audit carries

comprehensive audit coverage.

66
 On the business area that needs to be covered under Shari’ah audit, there have

been calls for expanding the audit not to only mainly concern on the permissibility

(halal) of the financial products. The permissibility of the products is only part of the

wide range coverage of audit for Islamic banks. Ziauddin (1991) opines that for

Islamic banks to be entitled the label “Islamic”, they must not only operate according

to interest-free principles but also aim towards socio-economic justice. He further

argues that among the elements of socio economic justice are:

1) Prioritizing finance to uplift disadvantaged sections of society,

2) Preventing the financing of immoral and wasteful consumption

3) Intra organizational action i.e. a just employer-employee relationship, a

good and safe working environment, fair promotion practices, a caring

culture i.e. demotion of the profit motive in favor of solidarity and co-

operation and caring e.g. towards employment.

4) Discharge of societal and environmental responsibilities e.g. involvement

in medium and low cost housing, environmental consciousness of its own

and in the approval of financing facilities of industry, support of

community and collection and payment of zakat, interest-free loans. Etc.

5) Information flow to external parties on these accountabilities.

Based on the above notion, it is clear that the existence of an Islamic institution

such as an IFI is fundamentally to benefit the public at large. Therefore, the task of

auditor in such environment is to ensure that objective is properly achieved. The

points highlighted by Ziauddin (1991) give us basic framework of the coverage of

Shari’ah audit. Among the business areas to be audited (besides the financial control

system of the IFI) could be the societal and environmental contribution of IFI, human

67
resource management, assessment of Zakah calculation and payment, and other

business activities of IFI.

Besides on the scope of audit itself, Shari’ah audit should probably be extended

to other Islamic institutions. Hameed (2000b) stresses that there is a need for research

of a more fundamental nature in Islamic accounting to establish its theory on a firm

footing from which detailed rules can then be derived, not only for Islamic banks but

all Islamic organizations whether in the business, public or voluntary sectors.

The construction of Shari’ah audit should probably include the government

institution as highlighted by Khan (2001) who discusses the role of Supreme Audit

Institutions (SAI) in the Islamic countries. As we have highlighted before that

Shari’ah audit should not only be extended to the IFIs, but all the Islamic institutions

which probably include government institution. Hence the relevance of Khan’s idea

on the functions of SAI is vital to the formulation of Shari’ah audit discipline. Khan’s

study (2001) illustrated the newer expectations of the SAIs which covers 15 areas,

namely accountability, transparency, corruption and fraud, performance auditing,

evaluation of policies, audit of expenditure management systems, audit of

privatization, evaluation of regulators, audit of public debt, environmental audits,

leadership role in reforming government accounting, audit of social services and

public administration, and lastly the framework for realizing Shariah goals through the

SAIs. Basically he sees the need of expanding the scope of SAIs as a response to the

international pressures and the Islamic value system. He urged that the expanded

scope, as visualized in his paper, would enable the SAIs to play an effective role in

realizing the objectives of an Islamic economy.

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3.4.3.2 The Role of Shari’ah Auditors

The role of conventional auditor in the Islamic framework has been widely criticized

by many Muslim scholars. Due to the establishment of Islamic Economic system, the

functions of auditors need to be revised to suit to the requirements of the system

(Khan, 1985; Al Abji, 1989). It has been opined that as opposed to auditors in the

capitalist framework, auditors in the Islamic economy are not only answerable to the

management but also to the society at large (Khan, 1985). Auditors, while assessing

the Shari’ah adherence of entity’s financial statements, are expected to carry out their

main responsibility of ‘amr bil ma’ruf wa nahi ‘an al-munkar (enjoining the proper

and forbidding the improper). Hood & Bucheery (1999) opine that religious auditors

are guided by religious beliefs prescribed in Quran, Sunnah (the traditions and sayings

of the Prophet), and ijma’ (jurisprudence) which would be more highly regarded as

compared to the legal rules and professional code of ethics.

Al Abji (1989) seems to support Khan’s (1985) argument where he criticizes

the function of conventional auditors in Islamic investment companies and banks. He

does not specifically address the issue of Shari’ah audit, however, his main concern is

that the function and responsibility of auditors have to be revised in order to meet the

requirements of the unique characteristics of investment in Islamic banks. As Khan

(1985) distinguishes the characteristics of auditors in capitalist framework versus

Islamic economy, Al Abji (1989) with the same point of view also argues that official

duty of the auditor will change in all its dimensions in accordance with the economic,

political and social changes that take place.

Thus, Al Abji (1989) contends that the establishment of Islamic economic

system absolutely gives impact on the duties of auditors. While the auditors are

mainly the accredited representatives of all the shareholders of the unit, it is really

69
ironic to see that there has been nobody nor legislator has ever shown interest in or

considered ways of ensuring that the group of depositors is in custodia legis. By

specifically looking at the issues of functions of auditors in Islamic banks, therefore

Al Abji (1989) suggests to develop the responsibility of the auditors so as to cover the

group of depositors and for depositors to form an organizational system (i.e. general

assembly for depositors). Unfortunately, despite the perceived importance of the

depositors, Abdul Rahman et al (2004) indicate that bank managers (the Islamic banks

and conventional banks that offer Islamic banking services) perceived that the

depositors are to be the least likely party for the Shari’ah advisors to be appointed by

and reported to. Abdul Rahman et al. (2004) rationalize this finding as due to the

absence of legal relationship between depositors and Shari’ah advisors, and in line

with the opinion of Al Abji (1989), they further contended that the depositors group is

not homogenous and there is no formal arrangement that institutionalize the depositors

through a body recognized by the banking law of the country.

Specifically Briston & El-Ashker (1986) state that the functions of religious

auditors lie in three main areas; a) to provide advice, b) to check actual religious

performance, and c) to report to the management on the Zakah fund. Provision of

advice here means advising the board of director and managing directors on the

entity’s operation, to ensure that all are in conformity with the Islamic Shari’ah.

Checking the performance for instance indicates the process of investigating and

monitoring the Shari’ah compliance of the top management and all financial

transactions. Lastly, the task of religious auditor is to ensure that Zakah is properly

calculated and administered.

The functions of religious auditors as highlighted by Briston & El-Ashker

(1986) are undeniably essential however its scope seems to be rather too narrow.

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There has been a common understanding among the people in general that the major

concern of an IFI is on the assessment and payment of Zakah fund and this focus has

also been reflected in the Briston & El-Ashker’s (1986) elaboration on the functions

of Shari’ah auditors. Perhaps this assumption has to be further expanded that IFI or

other Islamic institutions are not only about Zakah but many other areas as well. Apart

from that, their proposed functions of religious auditors are limited in the sense it still

much concentrated on the financial information of the entity.

If we could simplify, the functions of Shari’ah auditors in the Islamic Financial

Institutions and other Islamic institutions might be summarized as to ensure the

Shari’ah compliance of all those institutions. In this regard, Simpson & Willing

(2000) perceives such role as very significant given the impact that the products may

not longer be acceptable by its targets market. If we could relate the Objective of

Shari’ah (Al Maqasid Al Shari’ah) into the objective of Shari’ah audit, hence it is

believed that the role and functions of Shari’ah auditors can be translated according to

the stated objective. The existence of Shari’ah audit is to preserve the maslahah of the

stakeholders of the Islamic institutions. In the case of IFIs, thus the role of Shari’ah

auditors is to ensure the Shari’ah compliance in all aspects of the business activities

and guarantee the protection of interest of all stakeholders not only confined for the

achievement of maslahah in this world but also extended for the realization of falah in

the hereafter. In addition, while the Shari’ah auditors are responsible and accountable

to all the stakeholders they are also accountable to the Creator, Allah SWT, as

illuminated in the concept of Islamic accountability discussed in the previous section.

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3.4.3.3 Qualifications and Competence Requirements for Sharia’h Auditors

The International Federation of Accountants (IFAC) Education Committee (1998)

defines “competency” as “the ability to perform the tasks and roles expected of a

professional accountant, both newly qualified and experienced, to the standard

expected by employers and the general public.” The questions over the requirements

for the competence and qualification of auditors have been central in the discussion of

mainstream auditing, i.e. financial statement audits. Various trust and competency

issues have specifically arisen due to the many accounting scandals involving the

profession of auditors and accountants (Palmer et. al, 2004). In regaining the public

trust, the auditors are required not to only have necessary competence and skills levels

but they are also urged to have strong integrity and ethical levels.

Likewise to the Shari’ah auditors, the issue becomes slightly unique as they

have to carry the religious values in their conduct and they are not only accountable to

the auditee and public in general but also to Allah SWT. Certainly to have a good

professionalism and standards they must also be required to be well equipped with the

necessary level of competence, expertise and qualifications. Besides upholding the

highest religious and ethical values, the profession of Shari’ah auditors must not

forget to address the fundamental need for conforming to the required qualification

and competence requirements. These requirements are expected to be significantly

different from the standard of conventional auditors. Perhaps the initial step to provide

a foundation and inculcate as well as establish a standardized level of qualification

and competence of Shari’ah auditors is through education.

In the Islamic literature, probably there has been no a clear definition of what

constitute the “qualification” and “competency” of auditors. While the ethics code for

accountants/auditors has been identified by AAOIFI (2002), however the discussion

72
of the competency of auditors in the Islamic context is rarely found. Zaid (2000)

illustrates that the appointment qualifications of accountants (referred as Al-Katib) in

the early Islamic era were regarded significant but these appointment requirements

started to lose ground with the colonization of parts of the Muslim world by the

United Kingdom, France and Italy in the nineteenth century.

Khan (2001) emphasizes that among the element of framework for realizing

Shari’ah goals through Supreme Audit Institution is to train the auditors. He

elaborated further that The SAI (perhaps to apply to the regulator of Shari’ah audit

practice in general) would need to determine the knowledge and skill requirements of

its staff for the expanded role of auditors in the context of Islamic economy. It would

need to re-design and re equip its training programs, teaching materials and training

methods. Khan (2001) also argues that the training program should encompass ethics

component to enable the auditors to audit against corruption and fraud, as well as to

display the highest integrity level in their professional conduct.

Nevertheless with the recent immense growth of Islamic finance, several

qualifications such as CIFP by INCEIF, CIPA and also the recently launched CSAA

program by AAOIFI have been established to provide qualification for Muslim

professionals and several subjects such as Islamic finance and Islamic accounting are

included in the curriculum in the selected universities. What urgently needed now is to

standardize the qualification and competence requirements for every Muslim

professional working in different field including the Shari’ah auditors. The university

education system in this regards has to also be improved. The degree curriculum

structure has to expose the accounting students or Shari’ah students to the knowledge

on Shari’ah audit.

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 As the professional certification is perceived to be significant in today’s

accounting profession, perhaps it is also necessary to establish a professional

certification in Shari’ah audit. Such program is expected to give a well-focus

education in preparing the auditors who should not only be expert in the auditing field

but also on the Shari’ah requirements and also the uniqueness characteristics of IFIs or

other Islamic institutions. The most recent certification of Certified Shari'a Adviser

and Auditor (CSAA) by AAOIFI which was launched in August 2007 must be

regarded as a good effort by the institution in responding to the market needs. Even

though, the focus of the program is among others on the Shari’ah review process, it is

hoped that gradually a more comprehensive concept of Shari’ah audit as proposed by

this study will be incorporated into the program accordingly.

3.4.4 Shari’ah Auditing: The Challenges Ahead

Apparently, Shari’ah audit is still in its infancy phase and urgently needs for major

contributions from various parties including the scholars, standard setters, audit

practitioners, government, and all other related parties to develop its body of

knowledge properly.

Shari’ah audit, in this regard is challenged by various issues that need to be

immediately resolved. Basically, the challenges of Shari’ah audit can be categorized

into several groups of issues. Among these issues are the absence of theoretical

framework of Shari’ah audit, lack of internationally accepted standards and

guidelines, and the dilemma of to whom the function Shari’ah auditor should be

delegated. All these obstacles are in fact interrelated and resolving one of the major

issues might also help answering other related issues in this field.

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3.4.4.1 The Conceptual Framework of Shari’ah Audit

The main significant absence in Shari’ah auditing is the theoretical framework of the

subject. While there are so many issues to be resolved with regards to this subject,

there has been no an established theoretical foundation of this topic in comprehensive

manner.

Abu Mouamer (1989), Janahi (2000) and Harahap (2002) have shared the same

concern over the absence of the concept of Shari’ah audit. Abu Mouamer (1989)

argues that despite the importance of financial control in Islamic banks, the

understanding of the Shari’ah control system remains quite limited, either in the

theoretical formulation and empirical characterization of the Shari’ah control system.

Janahi (2000) believes that the introduction of the concept of Shari’ah audit would

ensure Shari’ah and fiduciary compliance and would also assign formal responsibility

to ensure such compliance. Meanwhile Harahap (2002) stresses the importance of

formulating a philosophical foundation of auditing theory from an Islamic perspective

as the absence of a philosophical foundation would lead to the variation and lack of

focus in the development of Islamic auditing as a discipline and in practice.

Among the earliest studies that attempted to provide the conceptual framework

of Sharia’h audit is a study by Khan (1985) who provides an initial discussion on the

framework of auditing from the Islamic perspective. He introduced the issue of

Islamic auditing by exploring auditing practices in the early age of Islam. Deriving

from that background, Khan (1985) proposes a framework of auditing in the Islamic

economy. Khan (1985) refers auditing in Islamic economy as a normative art which

inspired from the moral code of the Shari’ah.

Perhaps another significant work on the theoretical framework of Shari’ah

audit is by Harahap (2002) who writes a book in Indonesian language on Auditing

75
from the Islamic Perspective. Harahap (2002) discusses the development of

accounting and auditing in the Islamic sphere and urges the Muslim Intellectuals to

develop the discipline of Islamic auditing as it is inline with the development of

Islamic Financial System. Among other future initiatives to be taken with regards to

Islamic auditing as noted by Harahap (2002) are the need to transform the social

system into Shari’ah based system where currently Muslim society are very much tied

to the Western ideology and civilization, and the need for a harmonization among all

the Muslim either individually or as communities across the countries.

Like any other discipline of knowledge in the Islamic economy which are

continuously developing, Shari’ah audit has also to step up its efforts to be an

established branch of knowledge. In this regards, many related parties have to put

their efforts to realize that objective.

3.4.4.2 Lack of an Internationally Accepted Comprehensive Shari’ah Auditing

Standards or Guidelines

Secondly, there have been concerns by many scholars of the lack of internationally

accepted comprehensive standards and auditing guidelines on Shari’ah auditing.

Karim (1990) for instance suggests that accounting principles compatible with Islamic

law must be developed as guidance for those who conduct the financial audit for

Islamic financial institutions or Islamic enterprises and be familiar with various

religious rulings which have a bearing on the financial matters of the bank. Abdul

Rahman et al. (2004) in their study which was based on the perceptions of bank

managers found that there is a significant need for proper regulation by the BNM on

the role and function of Shari’ah advisors in order to give more credibility to the

Islamic banking activities in Malaysia.

76
 Simpson & Willing (2000) emphasizes that one of the relevance of the Islamic

banking industry’s infancy is highlighted by the continued lack of an internationally

accepted framework of uniform and comprehensive accounting standards or auditing

guidelines. In fact since the late 1990s the Islamic banking world has stepped up

efforts to standardize regulation and supervision (El Qorchi, 2005). This effort has

been manifested through the establishment of the Accounting and Auditing

Organization for Islamic Financial Institutions (AAOIFI) in 1991 which aims at

promulgating the Islamic accounting and auditing standards for Islamic financial

institutions. To mitigate the diversities of the adoption of accounting and auditing

standards in the IFIs, several international institutions are currently working to set

Shariah-compliant standards and harmonize them across countries. These include the

Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI),

the Islamic Finance Service Board (IFSB), the International Islamic Financial Market,

the Liquidity Management Center, and the International Islamic Rating Agency (El

Qorchi, 2005).

AAOIFI have been contributing significantly in initiating and promulgating the

accounting, auditing and governance standards for IFIs and these standards have been

recognized by many countries practicing the Islamic finance. However, AAOIFI has

been facing challenges in getting the acceptance from the member countries.

According to the Study on the Adoption and Acceptance of AAOIFI standard by

AAOIFI (2006), it was found that AAOIFI standards are currently adopted in eight

jurisdictions (Bahrain, Sudan, DIFC, Syiria, Qatar and Jordan) while in other

countries the standard are either voluntarily used or used as guidelines in establishing

national standards or not used at all. Their findings further revealed that among the

major obstacles in adopting AAOIFI standard are the prohibitive statutory and/or legal

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framework, the additional cost of disclosure and risk of standard overload, and the

question on the quality of AAOIFI standards.

In addition, the AAOIFI standards have yet to cover specifically on the issues

and conceptual framework of Shari’ah audit. The current AAOIFI standards provide

different set of standards for the financial statement audit (i.e. auditing standard for

IFIs) which is conducted by external auditors and Shari’ah review which is performed

by the SSB. Although the objective, criteria, and standards to be followed in

conducting financial statement audit for IFIs (as envisaged by AAOIFI) is different

from the conventional financial statement audit, however the scope of this financial

audit has yet to cover the broader concept of Shari’ah audit which proposes an audit

for all activities of IFIs. On the other hand, even though GSIFI No.2 on Shari’ah

review states that “Shari’ah review is an examination of the extent of an IFI’s

compliance in all its activities with the Shari’ah” (AAOIFI, 2002: 15), however the

detailed guidelines seem to focus on the contracts and transactions (See GSIFI No.1,

para 20 and GSIFI No.2 para 12).

In the absence of a specific standard on Shari’ah audit, AAOIFI should

probably promulgate a particular standard on Shari’ah audit which explains the

definition of Shari’ah audit, its scope, who should perform, its regulatory framework,

etc. Perhaps the current perception that Shari’ah review can be equated with the

concept of Shari’ah audit may give rise to the question over the distinctive

understanding of the term “review” and “audit”. While the former implicate a lower

assurance level, the latter has a more comprehensive assurance level. CPA Australia

(2006: 44) states that “review engagement is a service where the auditor’s objective is

to provide a moderate level of assurance, being a lower level of assurance than that

provided by an audit.” Review has also been defined as “a formal assessment of an

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activity with the intention of suggesting or implementing changes” or a review

“implies an audit type investigation that does not meet the full requirements of

Generally Accepted Auditing Standards (GAAS)” (O’Regan, 2004: 224-225).

3.4.4.3 Who should carry the function of Shari’ah audit?

Based on the current scenario of the operation of the IFIs, there has been question over

who should actually carry the functions of Shari’ah audit. Should the task be delegated

to the external auditors (i.e. financial auditors) or in-house Shari’ah Supervisory

Board (SSB), or do we need for new professional called as Shari’ah auditors? To date,

most of the time in the literature, SSB has been regarded as “religious auditors” and

the functions of religious audit are equated with the functions of SSB.

In the ASIFIS No.1 of AAOIFI (2002), it is explicitly indicated that external

auditors are responsible for investigating and reporting that financial statements of

IFIs are prepared according to the Shari’ah principles. It states in para 2 (AAOIFI,

2002: 4) that:

the objective of an audit of financial statements is to enable the auditor

to express an opinion as to whether the financial statements are
prepared, in all material respects, in accordance with the Shari’ah Rules
and Principles, the accounting standards of the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) and relevant
national accounting standards and practices in the country in which the
financial institution operates.

The ASIFIS No.2 para.17 (AAOIFI, 2002: 13) illustrates that the opinion

paragraph of the auditor report to state that:

the auditor’s report should clearly state the auditor’s opinion as to

whether the financial statements give true and fair view in accordance
with the Islamic Shari’ah Rules and Principles as determined by the
Shari’ah Supervisory Board of the Islamic Financial Institutions and the
financial reporting framework and, where appropriate, whether the
financial statements comply with statutory requirements.

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 Furthermore, para.9, ASIFIS No.3 highlights that “… the auditor is responsible

for attesting to whether the management has adhered to the fatwas, rulings and

guidelines issued by the Shari’ah Supervisory Board of the IFI,” and para 10 states

that “the management of the IFI should provide the auditor with all the fatwas, rulings

and guidelines issued by its SSB, and other relevant documents, e.g., reports of the

SSB” (AAOIFI, 2002: 26). Scope of the work of external auditors in the IFIs is further

illustrated in a more detailed in the ASIFIS NO.4 (para. 9 to 15). Based on this

paragraph, it is clear that the focus of an audit in the AAOIFI standards is not much

different from the conventional one (i.e. financial statement audit) however the

guidelines that have to be used by the auditors are different.

In terms of who should carry out the function of Shari’ah audit, the above

standards by AAOIFI indicate that the functions of Shari’ah audit seems to be

distributed to different entities, i.e. SSB and external auditors. While external auditors

are empowered to carry the financial audit in accordance to the Shari’ah Principles,

SSB’s duty is more comprehensive in providing guidelines (fatwa), reviewing and

supervising the activities of the IFIs in order to ensure that the IFIs are in compliance

with Shari’ah principles. GSIFI No.1 states that “… the SSB is entrusted with the duty

of directing, reviewing and supervising the activities of the IFIs in order to ensure that

they are in compliance with Islamic Shari’ah rules and principles. The fatwas and

rulings of the SSB shall be binding on the IFIs” (AAOIFI, 2002: 5).

The task of Shari’ah review as entrusted to the SSB maybe equated to the

concept of Shari’ah audit as it implicates a comprehensive understanding in ensuring

Shari’ah compliance of the IFIs. Shari’ah review as defined in the GSIFI No.2, para. 3

is “an examination of the extent of an IFI’s compliance, in all its activities with the

Shari’a. This examination includes contracts, agreements, policies, products,

80
transactions, memorandum and articles of association, financial statements, reports

(especially internal audit and central bank inspection), circulars, etc” (AAOIFI, 2002:

15).

Based on the above standards, the SSB are required to exercise the “pre-audit”

as well as “post-audit” functions. They are not just entrusted to issue fatwas and to

supervise the activities of IFIs are in line with the Shari’ah precepts, but also to review

the activities of IFIs whether those activities have been in compliance with the

Shari’ah principles. Interestingly, Abu Mouamer (1989) finds that although the

Shari’ah Control Committee (SCC) plays an effective role in increasing halal

(permissible) activities in Islamic Banks, its role in most of the banks is the “pre-

audit” function, without referring to financial books and documents to assure that their

Fatwa (Religious decisions) is carried out correctly. One reason to this finding is

perhaps in the time Abu Mouamer (1989) conducts his study the role and functions of

SSB (or what he referred as SCC) has not been very much regulated and enforced.

As for the issue of the independence of the two parties (i.e. SSB and external

auditors), Karim (1990), Abu Mouamer (1989), Hood & Bucheery (1999) and Abdul

Rahman et al. (2004) provide the analysis on the factors affecting the notion of the

independence of SSB versus the external auditors. Karim (1990) for instance argues

that the perceived independence of the SSB is very much influenced by moral-

religious values, while that of the external auditors is largely affected by economic

factors. He also opines that another incentive for SSB’s independence is due to the

belief that a rational management would be very keen to adhere to religious precepts

since the cost it would bear for a reported breach would be more than the cost it can

impose on the SSB. He further elaborated that if religious auditors report any

misrepresentation in the bank’s financial statements that are due to a violation of

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Islamic principles, hence the consumers of these statements are likely to react in a

manner which could be detrimental to the bank’s management. By referring Shari’ah

Control Committee (SCC) or what now known as Shari’ah Supervisory Board (SSB),

Abu Mouamer’s study (1989) indicates that 80% of his respondents believe that the

committee is independent.

Supporting the above findings, Hood & Bucheery (1999) find that most of the

respondents in their study believe that financial auditors are not independent. This

may partly due to the structure of the privately owned organization in Bahrain (i.e.

boards put too much responsibility on management, who therefore have too much

control over the appointment of auditors). On the other hand, their study found that

religious auditors are generally seen as being independent. However this view may be

held for several reasons, including negative ones such as, ignorance of what religious

audit is, or even seeing it as irrelevant (the latter may oppose the process of

Islamization in the financial world).

The SSB, as found in the above studies, might be generally perceived as

independent due to their strong religious credentials (Karim, 1990), however, the

independence of SSB can be challenged by its dual role in the IFIs, being both

‘advisory’ and ‘review’. IFAC Code of Ethics for Professional Accountants Section

100.10 highlights that “compliance with the fundamental principles may potentially be

threatened by a broad range of circumstances, which is one of it is self review threat,

that may occur when a previous judgment needs to be reevaluated by the professional

accountant responsible for that judgment” (International Federation of Accountants

[IFAC], 2005:6).

Abdul Rahman et al. (2004) provide preliminary assessment on the

responsibility & independence of Shari’ah advisors of Islamic banks. The sample of

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the study consists of bank managers of Islamic banks and Islamic banking windows in

Malaysia. The study indicates that the Shari’ah advisors are expected to be more

legally, socially and religiously responsible toward external stakeholders. Abdul

Rahman et al. (2004) find several factors which can improve the independence of the

Shari’ah advisors. They are the existence of SSB, the level of Shari’ah background,

the reputation of Shari’ah advisors, being members of National Shari’ah Advisory

Council,2 and non-executive role of the Shari’ah advisors. In addition, to enhance the

responsibility and independence level of the Shari’ah advisors, the bank managers

favor the Shari’ah advisors to be appointed by and reported to the regulatory agency

such as Bank Negara Malaysia.

Based on his analysis on the above notion of the independence, Karim (1990)

opines that ideally both SSB and external auditors should be from one organizational

body since Islam does not recognize any separation between business and religion.

Supporting the opinion of Karim (1990), Janahi (2000) suggest that in order to ensure

that Islamic banks are in compliant with the Shari’ah principles, close cooperation

between Religious Supervisory Board and external auditor is vital. This view has been

supported by Hood & Bucheery (1999) who found that most respondents in their

study strongly supported the idea of increased interaction between religious and

financial auditors. However to date there has been no formal rules and regulations

pertaining to this matter. As most respondents in their study strongly supported the

idea of increased interaction between religious and financial auditors, Hood &

Bucheery’s study (1999) also illustrates possible levels of interaction between

financial and religious auditors, which range from no-interaction, minimum

interaction, financial in control, religious in control, to cooperation and independence.

2
This is not allowed in Malaysia.

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 Janahi (2000) for instance elaborates that Shari’ah audit might be carried out

either by external auditor or the Religious Supervisory Board. However, either one of

the options has its advantages as well as its disadvantages. Delegating the task of

Shari’ah audit to the external auditors would ensure the independence but lack of

competence and expertise on Shari’ah audit by external auditors. On the other hand, if

Religious Supervisory Board were to carry out the task of Shari’ah audit, they might

be questioned in terms of their independence and necessary expertise on accounting

and auditing matters. He asserts that in any of these scenarios, both external auditors

and Religious Supervisory Board must work closely to address and resolve any issues

related to Shari’ah and fiduciary compliance. In the end, the establishment of proper

rules and regulations, as well as a code of practice, for the Shari’ah audit would

effectively ensure performance of the Islamic banks in terms of its fiduciary and

Shari’ah compliance.

The current phenomenon reveals that the role of external auditors in the Islamic

banks is seen to be complex due largely to the lack of experience of most external

auditors on the Shari’ah principles (Simpson & Willing, 2000). As a result of this fact,

external auditors often rely on the Shari’ah Supervisory Board which should

theoretically be independent from the commercial interest of the bank. They further

opined that while the auditor must take steps to satisfy himself on this matter mainly

as he has to rely on other’s opinion, his task is also complicated due to the subjectivity

of the Shari’ah interpretations by different Shari’ah boards. Therefore, Simpson &

Willing (2000) believe that establishment of rules and regulations would enhance the

effectiveness of the banks and ensure its compliance to the Shari’ah.

Grais and Pellegrini (2006) on the other hand propose a more comprehensive

solution to the above issue. They suggested an effective framework consisting the

84
internal as well as external process to monitor and asses the Shari’ah compliance of

the IFIs. The Shari’ah auditors as proposed by this study are in line with the external

workforce in Grais and Pellegrini’s framework. While the SSB and Shari’ah review

unit are integral with the IFIs, the Shari’ah auditors should be independent from the

management of the IFIs and come from external party.

Internal IIFS External

process Process

SSB Standard Setter

Shari’ah
Audit Firm
Shari’ah
Review Unit

Reputable
Agents

Source: Grais & Pellegrini (2006)

Figure 3.1 Effective Framework to Monitor and Asses Shari’ah Compliance

3.5 GAP OF THE EXISTING LITERATURE ON SHARI’AH AUDIT

The review of literature in the previous chapter and the above sections has

significantly revealed that specific empirical studies on Shari’ah auditing is currently

not available, however discussions on auditing from an Islamic perspective and its

associated issues have been explored by a number of scholars even though they can

still be considered minimum.

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 Since there are very limited studies exploring the auditing from an Islamic

perspective hence this study has attempted to explore the writings which can be

related to the field of this study. The following Table 4.2 summarizes the existing

literature related to Shari’ah audit. To date we have writings which attempt to explore

the conceptual framework of auditing from an Islamic perspective (e.g. Khan, 1985;

Briston & El Ashker, 1986; Harahap, 2002), writings which highlight the auditing

issues in Islamic banks (Al Abji, 1989; Janahi, 2000; Simpson & Willing, 2000) and

the studies on the role, functions, responsibility and independence of Shari’ah advisors

(for example Abu Mouamer, 1989; Abdallah, 1990; Abdul Rahman et al., 2004;

Shafei, 2005).

Apart from the above, there are also studies that compare the different models

of the roles of SSB and external auditors in Islamic banks (Banaga, 1994), the notion

of independence between SSB and external auditors (Karim, 1990) and possible

interaction between the two parties (Hood & Bucheery, 1999). The relevance of

Islamic auditing to the public audit institutions has for instance been explored by

Khan (2001) who analyzed the role of Supreme Audit Institutions (SAIs) in the

Islamic economy. The latest study which is more comprehensive in identifying the

issues and challenges of Shari’ah compliance process in the IFIs is a paper by Grais &

Pellegrini (2006). Their study has explored the limitations in relying the Shari’ah

compliance assurance to the internal party (i.e. SSB) and proposed an effective

framework to monitor and asses Shari’ah compliance.

Of the various concerns highlighted by those writings, there has been one

common proposal stressed by the scholars which is the need for a proper theoretical,

practical as well as regulatory framework of Shari’ah compliance assessment in the

IFIs or even in the other Islamic institutions. The researcher believes this phenomenon

86
is the fundamental milestone which call for the systematic institution of the discipline

Shari’ah audit. Even though many scholars have regarded SSB as religious auditors

and equate the functions of SSB as the functions of religious (i.e. Shari’ah) auditing

(see for example Briston & El Ashker, 1986; Abu Mouamer, 1989; Karim, 1990;

Abdallah, 1994; Hood & Bucheery, 1999), there seems a limitation in such

assumption.

As highlighted by several of the above studies, considering the current

structure of the SSBs there seem to be major concern of whether SSBs are well

qualified and also independent enough to perform the duty of Shari’ah audit. And

should the concept of Shari’ah audit be confined to the current functions of SSBs?

This has been supported by Grais & Pallegrini (2006) who see that whilst the SSB

might offer stakeholders a level of comfort but they also face with number of

challenges relating to their independence, the confidentiality of institution-specific

proprietary information, the limited availability of professionals with both Shari’ah

scholarship and financial skills, and the need for consistency in pronouncements

between the various SSBs. On the other hand, empowering the external auditors to

perform Shari’ah audit might also create a dilemma of whether they have necessary

expertise and qualification in the field of Shari’ah.

Obviously, by analyzing the existing literature and the current state of auditing

for Islamic banks one should realize that Shari’ah auditing face many unresolved

issues. One of the fundamental absences in Shari’ah auditing is surely its theoretical

foundation and besides that there are a lot of other things to explore in this subject.

Hence this study aims at instituting a more comprehensive understanding of Shari’ah

audit, viewing Shari’ah audit in the context of Islamic financial institutions from a

broader perspective where it is an independent discipline which encompasses a bigger

87
audit scope and hence serious concern should be undertaken to establish the subject

systematically, and put it in practice accordingly. The specific research objective of

this study would be discussed in the following section.

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 Table 3.1
The Existing Literature on (or related to) Shari’ah Audit

Year
Author Research Main Findings/
No

Field of Study/Topic Sample

(s) Method Suggestions

1. Khan 1985 Auditing in Islamic Qualitative – None • Elaborates on the concept of auditing, role and the qualities of an
framework Conceptual auditor in Islamic framework.
study • Propose to establish an independent body called Islamic Foundation
of Audit (IFA) with the functions of appointing auditors, and other
regulatory responsibilities.
2. Briston & 1986 Religious Audit Qualitative – None • Enterprises which operate based on Islamic principles should
El-Ashker Conceptual maintain a system of religious audit.
study • Islamic religious auditing lie in three main areas; provision of
advice, monitoring performance and audit of Zakah fund.
• Religious audit can be reported directly by publishing a special
report in the annual report or indirectly by providing the report to the
financial auditor who will testify in their report whether the
company is in compliance with Shari’ah.
3. Al-Abji 1989 Developing the Qualitative – None • The responsibility of auditor should change in accordance to the
auditor’s Conceptual nature and characteristics of Islamic banks.
responsibility to meet study • To develop the responsibility of auditors so as to cover the group of
the investment depositors.
requirements in the • To form an organizational system (e.g. general assembly) for
Islamic banks depositors.

4. Abu 1989 Analysis of the role Quantitative – • SSB members • The role of SSB is different form one Islamic Bank to another
Mouamer and function of the Survey • Top • The SSB plays an effective role in increasing Halal activities but its
Shari’ah control in (Questionnaire management of role in most of Islamic banks is the “pre-audit” function, without
Islamic Banks & Interview) Islamic Banks referring to financial books and documents to assure that their fatwa
• The clients of is carried out correctly.
Islamic Banks • The SSB also plays an effective role in attracting new investments
and clients for Islamic banks, but they have to submit a religious
auditor’s report to the clients confirming the Halal activities of
Islamic banks

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 Table 3.1 - Continued

5. Karim 1990 The independence of Qualitative – None • The perceived independence of the SSB is very much influenced by
religious and external Conceptual moral values while that of external auditors is largely affected by
auditors in the study economic factors.
Islamic banks • The consumers of Islamic banks may act in a manner which could
be detrimental to the bank if religious auditors (i.e. SSB) would have
to report bank’s violation to the Shari’ah principles.
• It is necessary that both SSB and the external auditors are perceived
independence to ensure the credibility of financial statements.
6. Abdallah 1994 The role of Shari’ah Qualitative - None • SSBs have been charged with a wide spectrum of objectives, duties
Supervisory Boards Explanatory and powers, so much so that their role covers the supervision and
in setting accounting control of almost all the activities of Islamic with respect to
policies in Islamic adherence to the Shari’ah and the issues arising thereon.
banks • Different SSBs in various countries are expected to vary in the level
of their performance to meet the above expectations.
7. Banaga et al 1994 External audit and Field Research • The different models of SSB in Islamic banks have been evidenced
corporate governance and discourse by their variation in the degree of monitoring, from a position of no
in Islamic banks analysis monitoring to that full of monitoring
• Different models of external auditors also emerge in performing
audit in Islamic banks, from the one that does not see it is the
responsibility of external auditor to audit according to Shari’ah, to
the model who believes that external auditor should even audit
social activities.
• The legal liability of external auditors who assume different models
would vary accordingly and it is also influenced by different roles
played by the SSB.
• The regulation of financial reporting of Islamic banks would require
external auditors to go beyond their conventional audit approach to
the Shari’ah compliance assessment.

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 Table 3.1 - Continued

8. Hood & 1999 The interaction of Quantitative - • Financial & • Audit expectation gap does exist in Bahrain.
Bucheery financial and Survey Religious • Religious auditors are seen independent while financial auditors are
religious (Islamic) auditors not.
auditors with • Users of FS • Financial auditors and religious auditors are not aware what each
reference to the audit (Loan officers other does.
expectation gap in and investment • To suggest more interaction between financial and religious auditors
Bahrain analysts)
• General public
(undergraduate
s & lawyers)
9. Janahi 2000 Auditing of Islamic Qualitative – • The introduction of the concept of the “Shari’ah audit” would ensure
Banks – a Conceptual Shari’ah and fiduciary compliance and would also assign formal
practitioner’s study responsibility to ensure such compliance
perspective • Delegating the task of Shari’ah audit to the external auditors would
ensure the independence but lack of competence and expertise on
Shari’ah audit while SSB might be questioned in terms of their
independence and necessary expertise on accounting and auditing
matters.
• The establishment of rules and regulations as well as code of
practice for Shari’ah audit would effectively ensure the Shari’ah
compliance by Islamic banks.
10. Simpson & 2000 Accounting and Qualitative – • Shari’ah compliance is essential for the Islamic banks given the
Willing auditing issues in Conceptual impact that their products may no longer be acceptable if they fail to
Islamic banking study comply.
• The role of external auditors in the Islamic banks is seen to be
complex due largely to the lack of experience of most external
auditors on the Shari’ah principles
• The establishment of rules and regulations would enhance the
effectiveness of the banks and ensure its compliance to the Shari’ah.

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 Table 3.1 - Continued

11. Khan 2001 Role of Supreme Qualitative – None • The scope of Supreme Audit Institutions (SAIs) in the Islamic
Audit Institutions in Conceptual countries need to be expanded to play an effective role in realizing
the Islamic economy study the objectives of an Islamic economy which stands for freedom,
justice, fairness, protection of public interest and elimination of and
corruption.
12. Harahap 2002 Auditing in the Qualitative – • It is important formulate a philosophical foundation of the Islamic
Islamic perspective Conceptual auditing as such absence would lead to the variation and lack of
study focus in the development of Islamic auditing as a discipline and in
practice.
• Among other future initiatives to be taken are the need to transform
the social system into Shari’ah based system and the need for a
harmonization among all the Muslim.
13. Abdul 2004 The responsibility & Quantitative - • Bank managers • Among the factors that can improve the level of independence of
Rahman et independence of Survey Shari’ah advisors (SA) are; the existence of SSB, the level of
al Syari’ah advisors of Shari’ah background, the SAs that are also members of the National
Islamic banks Shari’ah Advisory Council (NSAC), and non-executive role of SA
• The SAs should be appointed by and report to the regulatory agency
such as BNM
• Proper regulation on the role and functions of the SAs is urgently
needed
14. Shafei 2005 The responsibility Quantitative – • Bank managers • The main responsibility of SAs is to monitor and ensure that all IBs
and independence of Survey • Shari’ah products, transactions and activities are in line with Shari’ah.
Shari’ah advisors and (Questionnaire advisors • SAs should be legally, religiously/socially responsible to the Muslim
the Shari’ah review and Interview) society, NSAC and Central Bank.
process of the • Factors that can improve the level of independence of SAs are by
Indonesian Islamic outlawing them from becoming consultants or majority shareholders
banks for the IBs where they act as SAC members, disallowing SAs to act
as members of NSAC, and empowering the Central Bank to
administer the SAs’ remuneration.
• The SAs should be appointed by and report to the regulatory agency
such as NSAC or Central Bank.

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 Table 3.1 - Continued

15. Grais & 2006 Corporate Qualitative – • The engagement of SSB as the internal party for ensuring Shari’ah
Pellegrini governance and Conceptual compliance certainly offer stakeholders a level of comfort but it
Shari’ah compliance study faces the issues relating to SSB’s independence, confidentiality, the
in institutions limited availability of professionals with both Shari’ah scholarship
offering Islamic and financial skills, and the need for consistency in pronouncements
financial services between the various SSBs.
• Proposed structures and processes internal and external to an IFI that
can jointly provide an effective framework to monitor and asses
Shari’ah compliance.

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3.6 SUMMARY OF THE CHAPTER

In this chapter, the researcher has discussed auditing from the Islamic perspective by

elaborating the concept of Islamic worldview and how it necessitates for a distinctive

auditing concept apart from the conventional one and briefly discussed the concept of

Islamic accountability and its relevance in the concept of auditing.

Apart from the above, the chapter has also reviewed the development of

Shari’ah auditing by exploring the meaning of Shari’ah audit, identifying the root of

Shari’ah audit, highlighting the features of Shari’ah audit and presenting the

challenges facing this subject.

In conclusion, the literature review above demonstrates the urgent need for

more writings and intensive research on Shari’ah audit. Even the available studies are

mainly theoretical and very few using empirical analysis. Such phenomena has also

been highlighted by Hameed (200b) where he opines that there is a clear absence of

empirical based research in Islamic Accounting, a lack of reference to original Islamic

sources and a tendency to look at Islamic accounting through the spectacles of western

concepts and institutions.

Therefore, the current study attempts to fill up the gap in the literature by

investigating the fundamental pillars of Shari’ah audit theory by utilizing the opinion

of accounting academicians and specifically, Shari’ah experts who are appointed as

Shari’ah advisors for IFIs. With reference to Hameed (2000b) who hopes to see more

articles on Islamic accounting specifically on Auditing, Management Accounting and

Zakah/taxation, this study is also inspired to extend the literature in auditing from

Islamic perspective.

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 CHAPTER 4

RESEARCH DESIGN AND METHODOLOGY

4.1 INTRODUCTION

In the previous two chapters, the researcher has illustrated the evolution of auditing

and linked it to the need of establishing the discipline of Shari’ah audit, reviewed the

literature, highlighted the issues on the auditing from the Islamic framework, and

identified the gap of the existing literature on Shari’ah audit. This chapter aims at

explaining the research design and method of this study.

There are basically two types of research design: experimental designs and

survey/correlational design (Bryman & Cramer, 2001). In an experimental design, the

researcher manipulates aspects of a setting, either in the laboratory or in the field

situation, and observes the effects of that manipulation on experimental subjects,

whereby with a survey/correlational design, the researcher does not manipulate any of

the variables of interest and data relating to all variables are collected simultaneously

(Bryman & Cramer, 2001).

This study for instance uses survey design where the researcher cannot

manipulate the variables and instead collect the data on the variables concurrently. As

the objective of the study is to identify the perception of accounting academicians,

audit practitioners, and Shari’ah scholars on the subject of Shari’ah auditing which is a

very new field, hence this study is not really concerned about the cause-and-effect

relationships among the variables.

This chapter proceeds as follows. First, it would elaborate research objective

and research questions of this study. Second, the chapter would discuss the method of

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data collection employed by this study. Third, it will explain the population and the

sample selection. Fourth, the chapter then proceeds with describing the pilot testing

which was done to identify the weaknesses of the questionnaire and further improve it

before sending it to the respondents. In the fifth section, data analysis would be

discussed accordingly. Finally, the last section concludes.

4.2 RESEARCH OBJECTIVE AND RESEARCH QUESTIONS

The discussion in the previous chapters revealed a clear absence on empirical studies

specifically looking at the core issues of Shari’ah audit. Despite its importance in the

current scene which evidence the aggressive growth of the Islamic finance sector,

unfortunately there are still little efforts to look at this issue intensely.

Based on the gap of the literature on Shari’ah audit (or related literature to it),

therefore, the objective of this study is to gather the opinions of pertinent sources

whom are believed to have ideas that can contribute to the establishment of Shari’ah

audit in theory as well as practice. Specifically, this research aims to explore the

perceptions of accounting academicians, audit practitioners and Shari’ah scholars in

Malaysia with regards to the issues of Shari’ah auditing. It is the vision of the

researcher that through the opinions derived from the study, the subject of Shari’ah

audit will be further enriched and nurtured as a distinct discipline.

To accomplish the above objective hence four research questions are

formulated as follow:

1. What should be the definition of Shari’ah audit? This question examines

the awareness of respondents of the term Shari’ah audit, the importance of

establishing the discipline of Shari’ah audit and its definition.

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 2. What are the qualification requirements for Shari’ah auditors? This

question seeks to identify who are supposed to perform Shari’ah audit,

what are the qualification and competence requirements for Shari’ah

auditors, and the appointment of Shari’ah auditors.

3. What is the scope of Shari’ah audit? This question encompasses the

investigation on the business areas to be audited under Shari’ah audit, the

extent of Shari’ah audit, timing of Shari’ah audit, and dimension of

Shari’ah audit report.

4. What is the regulatory framework of Shari’ah audit? This question seeks

to identify the framework of regulation and supervision of Shari’ah audit

in terms of the regulatory body and its role, and also on standard

application.

4.3 DATA COLLECTION METHOD

Research data may be obtained from primary or secondary sources. Sekaran (2003:

219) defines primary data as the information obtained firsthand by the researcher on

the variables of interest for a specific purpose of study. The sources of primary data

may come from individuals, focus group or group of respondents from whom the

researcher intend to seek their opinion. On the other hand, secondary data is the

information gathered from the existing sources which may be obtained from the

company records or archives, publications, industry analysis, and so on.

This study uses primary data as the nature and objective of the study is to

explore the perceptions of certain groups of professional which are closely related to

the subject of this study. As highlighted in the above introduction, this study is very

much exploratory in nature and one of the ways to develop the subject of this research

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(i.e. Shari’ah audit) is to seek the opinion of the experts and knowledgeable

individuals either the academicians or practitioners.

Sekaran (2003) outlines various methods of data collection that include

interviews – face-to-face interviews, telephone interviews, computer assisted

interviews, and interviews through the electronic media; questionnaires that are either

personally administered, sent through mail, or electronically administered; observation

of individuals and events with or without videotaping or audio recording; and a

variety of other motivational techniques such as projective tests. He opines that the

choice of data collection methods depends on the facilities available, the degree of the

accuracy required, the expertise of the researcher, the time span of the study, and other

costs and resources associated with and available for data gathering.

It has been suggested that long-term participant observation in an

organizational setting, multi-stage interviews and case studies would be appropriate

data collection methods in conducting research within the “Islamic” paradigm (Shahul,

2000a). However, this study uses the questionnaire due to considerations of several

factors as highlighted above by Sekaran (2003) especially the time span of the study,

cost and resources available for data collection. The description of questionnaire

design and procedure of administering the postal questionnaires are briefly discussed

below.

4.3.1 Questionnaire Design

The term ‘questionnaire’ has been used in different ways. Some practitioners reserve

the term exclusively for self-administered and postal questionnaires, while others

include interview schedules (administered face-to-face or by telephone) under the

term ‘questionnaire’ (Oppenheim, 2001).

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 McClelland (1994) illustrates that there are two types of survey questionnaires:

standardized and custom designed (original). While the questions in a standardized

questionnaire usually have been developed over a period of time and tested in terms of

validity and reliability, on the other hand custom designed questionnaire needs

substantial work in designing and testing the reliability and validity of the questions.

Since this study is exploratory in nature, the questionnaire has been self-

developed by the researcher with the suggestions and guidance from the supervisor.

The survey questionnaire has been constructed based on research questions discussed

in the introduction. Various measurement scales consist of nominal and likert-scale

have been utilized to effectively gauge the answers from each question. The scaling

for each question has been carefully analyzed so that meaningful answers can be

found through the survey.

The questionnaire has also employed the combination of both closed and open-

ended questions. The combination of closed and open-ended questions is particularly

useful in the early stages of research in an area, as it gives an indication of whether the

defined response categories adequately cover all the responses that respondents wish

to give (Pallant, 2003).

The questionnaire is divided into six sections. The first section, Part A, aims at

answering the first research question of the study through identifying the awareness

level of respondents about the term “Shari’ah Audit”, indicating their agreement to the

development of Shari’ah audit and finding general agreement on what should be the

definition of Shari’ah audit.

The second part of the questionnaire, Part B, intends to gauge the perceptions

of the respondents on the qualification requirements for Shari’ah auditors, which is the

second research question. This is done through inquiring the respondents to identify

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who should perform Shari’ah audit, who should appoint Shari’ah auditors, whether it

is important for a body to establish qualification and competence requirements for

Shari’ah auditors, and most importantly what should be the minimum qualification of

Shari’ah auditors.

Part C of the questionnaire is to address the research question number three

which is what should be the scope and the scale of Shari’ah audit. In this section, the

respondents are required to indicate their level of agreement on the areas to be audited

under Shari’ah audit, the importance of issuing Shari’ah audit report and its content

and possible extension of the concept of Shari’ah audit to other Islamic institutions

(e.g. Islamic companies, Waqf and Zakat institutions) besides IFIs. Apart from that,

this section also covers the questions of how and when Shari’ah audit should be

performed.

The last research question of this study is on the regulatory framework for

Shari’ah audit which is inculcated in the Part D of the questionnaire. In this section,

the respondents are asked to indicate their agreements to the necessity of establishing

an independent body to oversee Shari’ah audit practice, who should be members of

such body, the roles of the body and relevant standards to be used in performing

Shari’ah audit.

Part E of the questionnaire is an open-ended question where the respondents

are asked whether they have any suggestion or recommendation pertaining to Shari’ah

audit. Sekaran (2003) highlights that many questionnaires end with a final open-ended

question that invites respondents to comment on topics that might not have been

covered fully or adequately. Finally, the last section of the questionnaire aims at

identifying the demographic background of respondents.

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4.3.2 Administering Postal Questionnaires

In this study, a postal questionnaire is chosen as the method of data collection. The

main advantage of mail questionnaires as highlighted by Sekaran (2003) is that a wide

geographical area can be covered in the survey. In addition, it is a low cost method of

data collection (Oppenheim, 2001). The survey questionnaires were mailed to all

respondents in January and early February 2007. The questionnaires were sent to

respondents with their names and positions printed on the front envelope and enclosed

with a cover letter signed by the supervisor which inform the respondents on the

objective of the study, the confidentiality and anonymity of the respondents and their

answers to the questionnaires. In addition, self-addressed, stamped return envelope

was enclosed for the convenience of the respondents. Sekaran (2003) asserts that

enclosing the self-addressed, stamped return envelope can improve the response rate

in mail questionnaires which are normally low.

The researcher allocated two months period for the questionnaires to be

returned by the respondents with the hope that the response rate will be high.

Unfortunately, due to budget constraint and the large number of respondents and their

diverse locations, the researcher could not perform pre-survey contact and follow-up

procedures for the questionnaires that have been posted. The total number of

respondents which consist of three groups namely; accounting academician, audit

practitioners, and Shari’ah scholars is about three hundred (300) and they are

dispersed across the peninsular Malaysia.

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4.4 POPULATION AND SAMPLE

4.4.1 Respondents’ Background & Sample Selection

The targeted respondents for this study comprise of the Muslim accounting

academicians of public universities in peninsular Malaysia, Muslim audit practitioners

in peninsular Malaysia, and members of Shari’ah committee of Islamic commercial

banks (ICB) and Islamic subsidiaries of commercial banks (ISCB) in Malaysia. These

individuals are selected due to the belief that they have understanding, expertise and

involvement in the area of the subject of this study. Perhaps not many of the

respondents might be aware of the subject Shari’ah audit however their involvement

either in the academia, the Shari’ah reviews of IFIs or in the audit practice would

necessarily give interesting insight into the field of this study. Hence it is expected

that the respondents would provide the relevant particulars sought by the study.

This study has adopted various sampling methods to achieve the desired

sample. Fridah (n.d) supports that when selecting a sampling strategy it is necessary

that it fits the purpose of the study, the resources available, the question being asked

and the constraints being faced. All these factors have been taken into consideration

by the researcher in determining sampling strategy as well as sample size of this study.

Several steps have been taken in identifying the respondents’ background. For

the respondent group of Muslim accounting academicians, the researcher did the

internet search to identify the public universities in Malaysia. Muslim accounting

academicians are defined as Muslim lecturers teaching at the Accounting Program in

any of public universities in peninsular Malaysia. The researcher intentionally

excludes public universities outside peninsular Malaysia for the purpose of

convenience. There are basically eight public universities in peninsular Malaysia

which offer Accounting Program.

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 In the next step, the researcher searched the listing of accounting lecturers of

each university in its respective website to identify the total population of this group.

In deriving the total population, non-Muslim accounting lecturers have been excluded

accordingly. In addition, the researcher employed proportionate stratified random

sampling in calculating the sample size. It was decided to have a sample size of 50%

out of total population. The derivation of sample for accounting academician is

presented in Table 4.1.

Table 4.1
Derivation of the Sample Size for Accounting Academicians

No. of Muslim
No. List of Public Universities Acctg. Accounting Sample
Program Lecturers
1 Universiti Malaya (UM) √ 31 16
2 Universiti Kebangsaan Malaysia (UKM) √ 40 20
3 Universiti Teknologi Mara (UiTM) √ 86 43
4 International Islamic University (IIUM) √ 34 17
5 Universiti Putra Malaysia (UPM) √ 38 19
6 Universiti Utara Malaysia (UUM) √ 126 63
7 Universiti Sains Malaysia (USM) √ 9 5
8 Universiti Darul Iman Malaysia (UDM) √ 10 5
Total Population/Sample 374 187

The second population for this study is the audit practitioners. Initially the

researcher intends to apply to the Malaysian Institute of Accountant (MIA) to obtain

membership data for the survey. However, due to the length of time required and the

complicated procedures involved in doing so, the researcher decided to find other

alternatives. It was found that the MIA publishes the list of delegates to their National

Accounting Conference (NAC) 2006 which was held in November 2006. Hence it was

decided to extract the list of audit practitioner from that file and search the particulars

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(e.g. address) in the Member Firms Directory which can be accessed from MIA

website. In addition, the researcher utilized several contact persons of the practical

training audit firms listing from Department of Accounting, IIUM, to make up a

bigger number of sample size.

The selected auditors are Muslim (with reference to their names) and range

from partners of the firms, principals, managers, audit seniors, and few are audit

associates and assistants. The table below depicts the summary of the composition of

the sample size fro audit practitioners.

Table 4.2
Composition of Audit Practitioners Participating in this Study

No Audit Practitioners No. of Respondents

1. Partners 41
2. Principals 3
3. Managers 48
4. Audit Seniors 27
5. Others 7
Total 126

The third population of this study is the members of Shari’ah Committee or

Shari’ah Supervisory Board (SSB) of the Islamic commercial banks and Islamic

subsidiaries of commercial banks in Malaysia. Based on the data published by Bank

Negara Malaysia, as at November 2006, there are two Islamic commercial banks and

eight Islamic subsidiaries of commercial banks in Malaysia. Since the population is

small, the sample size would consist of the entire population. The details of the

population group are derived from the websites of respective Islamic commercial

banks and Islamic subsidiaries of commercial banks in Malaysia. To obtain a high

response rate, since the researcher believe that most of SSB members are not working

full time in IFIs and most of them are lecturers (teaching subjects of Fiqh, law, and

104
Islamic studies) in various academic institutions in Malaysia, hence the researcher

mailed the questionnaire to their respective universities. For those whose full time

jobs were not known the researcher only mailed the questionnaires to the respective

banks where they are sitting as members of SSB.

Table 4.3
Details of Samples of Shari’ah Committee Members

No. of Sharia'h
No. ICB/ISCB
Committee Members
1 Bank Islam 7
2 Bank Muamalat 4
3 HSBC Amanah 4
4 CIMB Islamic 5
5 Kuwait Finance House 6
6 RHB Islamic Bank 4
7 Affin Islamic Bank 4
8 AmIslamic Bank 3
9 Hong Leong Islamic Bank 3
10 EONCAP Islamic Bank 5

Total Population/Sample 45

4.5 PILOT TESTING

Schwab (2005) highlights that no matter how much care is used, questionnaire

construction remains an imprecise research procedure. Therefore he suggests that

before using a questionnaire for substantive research, it is essential to obtain

information by pilot testing the questionnaires on individuals similar to those who will

be asked to complete it as a part of the substantive research. Pilot testing has been

regarded as one of the factors that can maximize the response rates, validity and

reliability of the data to be collected (Saunders et al, 2003). It can also help the

researcher with wording of questions, ordering of question sequences and the design

of the letter of introduction (Oppenheim, 2001:47).

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 In lieu of the above notion, a pilot test for this study was conducted in August

2006. The pilot questionnaires were distributed to thirteen (13) individuals, consist of

ten accounting lecturers at the International Islamic University Malaysia (IIUM) and

three students from Master of Science in Accounting Program at the same university

respectively. While the replies of twelve pilot questionnaires were returned within two

weeks, one respondent was unable to respond due to his tight schedule.

Overall, the responses were positive and some respondents were even

willingly sparing their times to discuss in depth about the pilot questionnaire. Most of

the respondents took about ten to twenty minutes to answer the questionnaire. Except

for few questions, in general the questions and instructions were understandable and

clear and the respondents believe that the content of the survey meets the objective of

the study and it has been covered to an appropriate degree of breadth.

Following the pilot test, the content of the questionnaire has not been

significantly changed even though the modifications have been done to the survey title,

its instructions, measurement scale of some questions and the overall layout of the

questionnaire. In addition, the cover letter has also been modified to accommodate

the comments received during the pilot test.

4.6 DATA ANALYSIS

This study utilizes several statistical analyses. Non response bias test was conducted

to ensure that there is no difference in the response by those who have not answered.

Validity and reliability tests were also used to analyze the soundness of the data and

the consistency of the responses. The findings were analyzed using software such as

SPSS version 11.0 and Microsoft Excel in order to tabulate and graph the results.

106
 Research questions were explored using appropriate statistical tests.

Descriptive statistics will be used to measure the frequencies, central tendency and

dispersion. To compare the three groups of respondents, this study utilized Kruskal-

Wallis Test, the non-parametric alternative to a one-way between-groups analysis of

variance. As the sample was not normally distributed, Pallant (2003) highlights that

this type of non-parametric statistic allows the comparison of the scores on some

continuous variables for three or more groups.

4.7 SUMMARY OF THE CHAPTER

This chapter has briefly highlighted the research design of this study and explained the

objective as well as research questions of this study. The chapter has also elaborated

the data collection technique, questionnaire design, respondents’ background and

sample selection.

In addition, pilot testing together with its overall results were presented

accordingly. Finally, methods of data analysis were briefly explained.

107
 CHAPTER 5

FINDINGS AND ANALYSIS

5.1 INTRODUCTION

This chapter presents the data analysis and research findings. The chapter is structured

in the following manner. First, it illustrates the response rate of the questionnaires.

Second, it presents the tests conducted on the questionnaires, i.e. non-response bias

test, validity and also reliability test. This is followed by the discussion demographic

background of the respondents. Finally, the statistical analysis for each research

question is accordingly presented and discussed in the last section.

5.2 RESPONSE RATE

The questionnaires were mailed to 187 accounting lecturers, 126 audit practitioners,

and 45 Shari’ah committee members of the ICB and ISCB in peninsular Malaysia

(please refer to the previous chapter section 4.4 for details of sample derivation).

Out of the total of 359 questionnaires distributed, 100 were returned which

results in an overall response rate of 28 percent. Of the total questionnaires returned,

two questionnaires were intentionally left unanswered by the respondents. Even

though certain questions have been unanswered by some respondents, however these

incomplete questionnaires were considered usable in this study since the incompletion

of certain parts of the questionnaires is regarded as minimal and does not affect the

overall analysis. Table 5.1 provides the summary of the overall response rate for each

group of respondents.

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 Table 5.1
Response Rate

Total Total Total Response

No. Respondents Distributed Received Used Rate (%)
No % No % No %
1. Accounting lectures 187 52.1 62 62 60 61.2 33.2

2. Auditors 126 35.1 27 27 27 27.6 21.4

3. Shari’ah Committee 46 12.8 11 11 11 11.2 23.9

Total 359 100 100 100 98 100 27.9

5.3 NON-RESPONSE BIAS TEST

Non-response bias has been claimed as one of the drawbacks of the mail

questionnaire. If individuals who respond differ significantly from non-respondents, it

would subsequently prevent the generalization of the results of the study to the

population. Armstrong & Overton (1977) highlight several approaches that can be

used in dealing with non-response bias, they are: 1) to reduce the non-response itself,

2) to sample the non-respondents, for example to sub-sample certain percentage from

non-respondents and get the responses from them, and 3) to estimate the effects of

non-response, which is the one adopted in this study. This last approach may be used

due to cost consideration and time constraint.

Armstrong & Overton (1977) outline three ways of estimating non-response

bias; 1) comparisons with known values for the population, 2) subjective estimates,

and 3) extrapolation. They further explain that to perform the first method, results

from a given survey can be compared with “known” values for the population (e.g.,

age, income). However, as the known values come from a different source instrument,

differences may occur as a result of response bias rather than non-response bias. In the

subjective estimates, it is however not clear how one should obtain these subjective

109
estimates of bias, although several approaches have been proposed. One approach is to

determine socioeconomic differences between respondents and non-respondents. For

example, respondents are assumed to be better educated than non-respondents.

Extrapolation methods are based on the assumption that subjects who respond

less readily are more like non-respondents. “Less readily” has been defined as

answering later or as requiring more stimulus to answer. One of the bases for

extrapolation is ‘time trends’ (which is adopted by this study), whereby persons

responding later are assumed to be more similar to non-respondents. The method of

time trends has an advantage over the use of stimulus in that the possibility of a bias

being introduced by the stimulus itself can be eliminated.

The non-response bias test conducted in this study is based on the ‘time trends’

method underlined above. This test is conducted based on the assumption that

respondents who returned their questionnaires very late are providing the same

responses to the non-respondents. To conduct this test, the ten earliest responses were

grouped together as one group and will be compared to another group of ten very late

responses. The comparison of the two groups’ responses is done using Mann-Whitney

U test, SPSS version 11.0. This statistical tool is a non-parametric alternative to test

the differences between two independent groups on continuous variables (Pallant,

2003).

Except for demographic section, all items of the questionnaire have been

selected for the purpose of this test. The results of the test are displayed in the

following tables. It can be seen that out of 52 items tested in Part A, B, C, and D, only

two items are found to have statistical differences between the ten earliest responses

and the ten very late responses. These two items are:

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 ƒ The agreement on defining the term “Shari’ah audit” based on the

definition of Shari’ah review given by AAOIFI.

ƒ The agreement on having the representative from central bank to sit as a

member of an external independent body which is established to oversee

the practice of Shari’ah audit.

Despite the above significant difference for those two items, however as a

whole, the non-response bias test performed for the ten earliest responses and the ten

very late responses shows that there were no differences in the responses made

between the two groups for almost all parts of the questionnaire. Thus it can be

concluded that there is no material non-responses bias exist in this study.

Table 5.2
Test Statisticsb– Non – Response Bias for Part A and Part B of the Questionnaire

Item Statement Man-Whitney Asymp.Sig Exact Sig.

Wilcoxon W Z
No. U (2-tailed) [2*(1-tailed Sig.)]
1. 2 45 100 -.457 .648 .739a
2. 3 19.5 74.5 -2.265 .023 .035a
3. 4a 45 100 -1 .317 .739a
4. 4b 45 100 -.610 .542 .739a
5. 4c 45 100 -.457 .648 .739a
6. 4d 45 100 -.610 .542 .739a
7. 4e 40 95 -1.453 .146 .481a
8. 5a 40 95 -1.090 .276 .481a
9. 5b 45 100 -.610 .542 .739a
10. 5c 45 100 -.503 .615 .739a
11. 5d 40 95 -.890 .374 .481a
12. 6 50 105 .000 1 1a
13. 7a 9 37 -2.322 .020 .053a
14. 7b 20.5 48.5 -1.386 .166 .526a
15. 7c 38.5 83.5 -.634 .526 .604a

a. Not corrected for ties.

b. Grouping Variable: Non-response Bias

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 Table 5.3
Test Statisticsb – Non – Response Bias for Part C of the Questionnaire

Statement Wilcoxon Asymp. Sig (2- Exact Sig.

Item Man-Whitney U Z
No. W tailed) [2*(1-tailed Sig.)]
16. 8a 43.5 98.5 -.135 .892 .905a
17. 8b 38.5 83.5 -.591 .554 .604a
18. 8c 32 77 -1.219 .223 .315a
19. 8d 41 96 -.765 .445 .529a
20. 8e 31 76 -1.233 .218 .278a
21. 8f 37.5 92.5 -1.029 .304 .353a
22. 8g 35 90 -1.223 .221 .280a
23. 8h 36 91 -1.161 .246 .315a
24. 8i 38 93 -1.011 .312 .393a
25. 8j 50 105 .000 1 1a
26. 8k 27.5 82.5 -1.802 .072 .089a
27. 9 45.5 100.5 -.363 .717 .739a
28. 10 50 105 .000 1 1a
29. 11 45 100 -.503 .615 .739a
30. 12a 45 100 -.503 .615 .739a
31. 12b 45 100 -.503 .615 .739a
32. 12c 40 95 -.951 .342 .481a
33. 12d 40 95 -.951 .342 .481a
34. 12e 45 100 -.503 .615 .739a
35. 12f 44 99 -.536 .592 .684a
36. 13 40 95 -.951 .342 .481a
37. 14 38 93 -.985 .325 .393a

a. Not corrected for ties.

b. Grouping Variable: Non-response Bias

Table 5.4
Test Statisticsb – Non – Response Bias for Part D of the Questionnaire

Statement Man-Whitney Asymp. Sig Exact Sig.

Item Wilcoxon W Z
No. U (2-tailed) [2*(1-tailed Sig.)]
38. 15 50 105 .000 1 1a
39. 16a 35 90 -1.510 .131 .280a
40. 16b 19 64 -2.451 .014 .035a
41. 16c 37 82 -.741 .458 .549a
42. 17a 35 90 -1.510 .131 .280a
43. 17b 36.5 91.5 -1.128 .259 .315a
44. 17c 33.5 88.5 -1.420 .156 .218a
45. 17d 40 95 -.890 .374 .481a
46. 17e 47.5 102.5 -.213 .831 .853a
47. 18a 32.5 87.5 -1.220 .223 .315a
48. 18b 45 100 -.457 .648 .739a
49. 18c 34 89 -.979 .328 .400a
50. 18d 34 79 -.646 .518 .605a
51. 18e 33 88 -1.081 .280 .356a
52. 18f 31.5 76.5 -.493 .622 .673a

a. Not corrected for ties.

b. Grouping Variable: Non-response Bias

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5.4 VALIDITY AND RELIABILITY TESTS

Validity refers to whether the question, item or score measures what it is supposed to

measure and reliability informs us about the consistency of a measure, to the

probability of obtaining the same results again if the measure were to be duplicated

(Oppenheim, 2001). As for the validity test, Pallant (2003) signifies that there is no

one clear-cut indicator of validity. She highlights that the main types of validity

discussed are content validity, criterion validity and construct validity. This study for

instance has adopted content validity which refers to the measure of the adequacy and

representations of items that tap the concept (Sekaran, 2003). In other word, content

validity analyzes the extent to which the instrument provides sufficient coverage of

the investigative questions guiding the study (Cooper & Schindler, 2001).

Sekaran (2003) explains that a panel of judges can attest to the content validity

of the instrument. As highlighted in the previous chapter in section 4.5, the

questionnaire has been evaluated by 12 individuals, consisting of nine accounting

lecturers at the International Islamic University Malaysia (IIUM) and three students

from Masters of Science in Accounting Program at the same university respectively.

Since these individuals have been selected due to their expertise in the field closely or

directly related to the topic of this study and they have been also considered to

represent the respondents of this study, hence the content of the instrument of this

study can be considered valid and adequate.

As for the reliability analysis, Pallant (2003) highlights that there are a number

of different aspects to reliability and internal consistency is one of the main concerns

in reliability test. Sekaran (2003) describes the internal consistency of measures is

where the items should “hang together as a set” and be capable of independently

measuring the same concept so that the respondents attach the same overall meaning

113
to each of the items. To measure the consistency of measures, this study has adopted

the inter-item consistency reliability using the most popular test of Cronbach’s alpha

coefficient. Values in the range 0.70 and above are generally acceptable and those

over 0.80 are considered good (Godard et. al, 2001; Sekaran, 2003). However, the

interpretation of the alpha coefficient is affected by the number of items, the degree of

correlation between the items and the number of dimensions of the concept being

studied which can be unidimensional or multidimensional (Cortina, 1993; Kopalle and

Lehman, 1997; Peterson, 1994). The reliability test has been performed to each part of

the questionnaire except for the demographic section. The analysis is presented as

follows.

5.4.1 Reliability Test for Part A of the Questionnaire

Part A of the questionnaire contains the questions that request the respondents to

indicate their: 1) awareness to the term Shari’ah audit, 2) level of agreement to the

importance of establishing the discipline of Shari’ah audit, and 3) level of agreement

to the definition of Shari’ah review to be equated with the definition of Shari’ah audit.

For the purpose of reliability analysis, only questions (items) 2 and 3 will be

considered as the first question does not use likert-scale but instead uses nominal

scale.

Figure 5.1 shows that alpha coefficient is 0.68 which is almost in the range of

acceptable values of 0.70. Sekaran (2003) illustrates that alpha values below 0.60 as

poor but she does not interpret what should the scores in the range of 0.60 be in term

of label (i.e. fair, poor, etc.?). The widely-accepted social science cut-off is that alpha

should be 0.70 or higher for a set of items to be considered a scale, but some use 0.75

or .80 while others are as lenient as 0.60 (Garson, n.d.).

114
 The relatively low alpha coefficient here might be due to the low correlation

between the two items or because the number of items which is small. The

respondents mostly in a strong agreement with item no.2 but several do not see that

the definition of “Shari’ah review” can also be a definition of “Shari’ah audit” (For

more detailed discussion, refer to the statistical analysis for each research question,

section 5.6.1). Since the score of 0.68 does not fall under the category of poor

coefficients and almost within the range of acceptable scores of 0.70 as classified by

Sekaran (2003), it is therefore considered acceptable in this study.

Figure 5.1
Reliability Analysis for Part A of the Questionnaire

****** Method 1 (space saver) will be used for this analysis ******

R E L I A B I L I T Y A N A L Y S I S - S C A L E (A L P H A)

Reliability Coefficients

N of Cases = 97.0 N of Items = 2

Alpha = .6830

5.4.2 Reliability Test for Part B of the Questionnaire

Part B of the questionnaire is to examine the concept of competence and qualification

requirements for Shari’ah auditors. Two items have been identified for the reliability

analysis, they are; 1) the importance for a body to set up qualification and competence

requirements for Shari’ah auditors, and 2) Minimum qualification of Shari’ah auditors

is degree/professional qualification in accounting and specialized certification in

115
Shari’ah audit. Figure 5.2 shows that alpha coefficient is 0.79 which can be considered

acceptable and almost in the range of good coefficient of 0.80.

Figure 5.2
Reliability Analysis for Part B of the Questionnaire

****** Method 1 (space saver) will be used for this analysis ******
_

R E L I A B I L I T Y A N A L Y S I S - S C A L E (A L P H A)

Reliability Coefficients

N of Cases = 85.0 N of Items = 2

Alpha = .7973

5.4.3 Reliability Test for Part C of the Questionnaire

Part C of the questionnaire aims at investigating the scope and the extent of Shari’ah

audit by the areas to be audited under Shari’ah audit, the importance of issuing and

publishing Shari’ah audit report, the contents of Shari’ah audit report, and the

possibility of extending Shari’ah audit to other Islamic institutions besides IFIs. In

total, there are 20 items tested for reliability analysis in this part.

Figure 5.3 indicates that alpha coefficient derived from the test is 0.91. The

closer the reliability value gets to 1.0, the better (Sekaran, 2003). While the cautions

still need to be addressed carefully in interpreting the alpha coefficient, the relatively

high alpha coefficient for this part shows that the respondents understand the

questions well and their answers are consistent and reliable.

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 Figure 5.3
Reliability Analysis for Part C of the Questionnaire

****** Method 1 (space saver) will be used for this analysis ******
_

R E L I A B I L I T Y A N A L Y S I S - S C A L E (A L P H A)

Reliability Coefficients

N of Cases = 85.0 N of Items = 20

Alpha = .9182

5.4.4 Reliability Test for Part D of the Questionnaire

In part D, the study attempts to asses the regulatory framework of Shari’ah audit by

identifying the importance of establishing an external independent body to oversee the

practice of Shari’ah audit, who should sit as members of such body and what should

be their roles, and which standards are most appropriate to be adopted in Shari’ah

audit practice. There are 15 items in total to be included for the purpose of reliability

test for this section.

Figure 5.4
Reliability Analysis for Part D of the Questionnaire

****** Method 1 (space saver) will be used for this analysis ******

R E L I A B I L I T Y A N A L Y S I S - S C A L E (A L P H A)

Reliability Coefficients

N of Cases = 72.0 N of Items = 15

Alpha = .9171

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 As it can be seen from figure 5.4, the alpha value is about 0.91 which can be

considered good in measuring the reliability of the measures. The relatively high alpha

coefficient indicates that the internal consistency of the measures used in this study

can be considered good.

5.5 DEMOGRAPHIC ANALYSIS

To identify demographic information of the respondents, the respondents were

requested to answer eight questions regarding gender, age, job/position, organization,

highest qualification, specialization, professional qualification in accounting, and

working experience. Since the information on job position, organization, and

specialization are mostly unanswered by the respondents, these three particulars will

not be presented in this section. Table 5.5, 5.6, and 5.7 summarize the demographic

background of the respondents.

Table 5.5
Respondents’ Gender and Age

Accounting Shari'ah
Auditors Total
Lecturers scholars
N % N % N % N %
Gender:
Male 17 28.3 19 70.4 9 81.8 45 45.9
Female 37 61.7 8 29.6 2 18.2 47 47.9
Missing 6 10 - - - 6 6.1
60 100 27 100 11 100 98 100
Age:
20-29 years 5 8.3 3 11.1 8 8.2
30-39 years 33 55 14 51.9 1 9.1 48 49
40-49 years 12 20 8 29.6 6 54.5 26 26.5
Above 50 years 6 10 2 7.4 4 36.4 12 12.2
Missing 4 6.7 - - - 4 4.1
60 100 27 100 11 100 98 100

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 From Table 5.5., it can be seen that in overall, 45.9 percent of the respondents

are male and 47.9 percent are female. Based on the group classification, accounting

lecturers are however dominated by female respondents, whereby most of the

respondents for the auditors and the Shari’ah scholars are male. In term of the age of

the respondents, nearly half (49%) of the respondents are within the range of 30 to 39

years old, 30 percent are within 40 to 49 years old, 12 percent are above 50 years and

only 8 percent are within 20 to 29 years. Even though age might not be an absolute

indication of level of maturity, however these figures somehow reflect that the

majority of the respondents in this study are considered matured.

Table 5.6
Respondents’ Educational Background & Working Experience

Accounting Shari'ah
Auditors Total
Lecturers scholars
N % N % N % N %
Highest Qualification:
Diploma - - - - 1 9.1 1 1
Degree - - 23 85.2 - - 23 23.5
Master 44 73.3 3 11.1 2 18.2 49 50
PhD 14 23.3 - - 7 63.6 21 21.4
Missing 2 3.3 1 3.7 1 9.1 4 4.1
60 100 27 100 11 100 98 100
Professional Qualification
in Accounting:
Yes 26 43.3 22 81.5 1 9.1 49 50
No 32 53.3 4 14.8 9 81.8 45 45.9
Missing 2 3.3 1 3.7 1 9.1 4 4.1
60 100 27 100 11 100 98 100
Working Experience:
0 – 5 Years 10 16.7 3 11.1 - - 13 13.3
6 – 15 Years 36 60.0 14 51.9 3 27.3 53 54.1
16 – 20 Years 6 10.0 7 25.9 2 18.2 15 15.3
Above 20 Years 6 10.0 3 11.1 5 45.5 14 14.3
Missing 2 3.3 - - 1 9.1 3 3
60 100 27 100 11 100 98 100

Table 5.6 further illustrates the education and working experience of the

respondents. In overall, 50 percent of the respondents are possessing Masters degree

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while the rest are partly degree holders and PhD holders accordingly. While

academicians and Shari’ah committee members are mostly Masters Degree holders,

auditors on the other hand are degree holders and only 3 respondents are having

Masters. This composition can be rationalized since auditors are mostly degree

graduates and having Masters Qualification is perhaps not popular among the auditors.

In addition, 50 percent of total respondents are having professional

qualification in accounting. While 43% of the academicians have professional

certification in accounting, majority of the auditors (81%) possess the certification and

only one of the Shari’ah scholars has the certification. In term of working experience,

more than half of respondents (54%) have been working for about 6-15 years and the

rest of respondents are almost equally divided into the other ranges of working years.

Given that majority of respondents posses Masters Degree and professional

qualification and have been working for about 6-15 years, therefore it is expected that

they would give fruitful and credible responses to this study.

Table 5.7
Job Position of Auditors

N %
Partner/Owner 10 37
Manager 7 25.9
Supervisor 5 18.5
Associates 2 7.4
Missing 3 11.1
Total 27 100

Since there is no significant variation in the job position of accounting

academicians (Most of the respondents fill up their positions as “lecturer”) and

Shari’ah committee members, table 5.7 presents the job position of auditors only. It

can be seen that most of the auditors participating in this study are owners or partners

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of the audit firms (37%) followed by managers (26%), supervisors (19%) and

associates for only 7 %. More participation from higher level of audit practitioners

would hopefully enrich the opinion gathered from this study.

5.6 STATISTICAL ANALYSIS FOR EACH OF RESEARCH QUESTIONS

This section will tabulate and comment the findings for every research question. As

explained in the previous chapter that since this study is exploratory in nature hence

neither hypothesis nor preposition is formulated.

The responses will be analyzed using descriptive statistics of SPSS for

Windows version 11. To conduct “between-groups” analysis, this study will utilize

Kruskal-Wallis Test, the non-parametric alternative to a one-way between-groups

analysis of variance. Pallant (2003) highlights that this type of non-parametric statistic

allows the comparison of the scores on some continuous variables for three or more

groups. Based on the Kruskal-Wallis test, if the significant level (presented as Asymp.

Sig.) is a value less than .05 then it can be concluded that there is a statistically

significant difference across the three groups (Pallant, 2003).

5.6.1 Research Question No.1

The first research question is to identify the importance of establishing the discipline

of Shari’ah audit and its definition. This question examines the awareness of

respondents of the term Shari’ah audit and the importance of establishing the

discipline of Shari’ah audit. Since there has been no standardized and formal

definition given to Shari’ah audit, this question also examines the appropriateness of

the definition of “Shari’ah review” by AAOIFI to be equated to the understanding of

Shari’ah audit. Tables 5.8 and 5.9 present the findings for each question investigated.

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 Table 5.8
Awareness of the term “Shari’ah Audit”

Acctg. Shari'ah
Auditors
Lecturers scholars Overall

No. Statement
N % N % N % N %

1. Awareness of the term

“Shari’ah Audit”:
Yes 28 46.7 7 26 7 63.6 42 42.8
Not Sure 9 15 5 18.5 - - 14 14.3
No 22 36.6 14 51.8 3 27.3 39 39.8
Missing 1 1.7 1 3.7 1 9.1 3 3.1
60 100 27 100 11 100 98 100

As the issue of Shari’ah audit is closely associated with the position of SSB,

hence as expected that most of the Shari’ah scholars (64%) are aware of the term

“Shari’ah audit” as opposed to most of the auditors (70%) who are not aware or not

sure of the term “Shari’ah audit”. Whereby for the academicians, nearly 50% are

aware of the term “Shari’ah audit” and the rest are not sure or not aware of such term.

According to the findings in table 5.9, it can be inferred that in overall

respondents highly believed the importance of establishing the discipline of Shari’ah

audit (mean of 4.50 and median of 5), but to the lesser extent regard the

appropriateness of the definition of “Shari’ah review” by AAOIFI to be equated to the

understanding of Shari’ah audit. Even though the mean and median for statement no.3

is still considered high (4.23 and 5 respectively) but it is still quite lower than the

mean score for the previous statement (statement no.2).

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 Table 5.9
The Importance of Developing the Discipline of “Shari’ah Audit”

Kruskal-
Wallis
Acctg. Shari'ah
Auditors Test
Lecturers scholars Overall
(Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

2. It is important to develop
another discipline namely
“Shari’ah audit” apart from
60 4.55 5 27 4.29 5 11 4.73 5 98 4.50 5 0.081
the existing auditing areas
(e.g. financial audit, social
audit, etc.)
3. The definition of Shari’ah
audit for IFIs can be
equated to the definition of
“Shari’ah review” by
AAOIFI which is: 59 4.15 4 27 4.37 4 11 4.27 4 97 4.23 4 0.831
“An examination of the
extent of an IFI’s
compliance, in all its
activities with the Shari’ah”

Among the reasons given by some of the respondents who disagree to define

Shari’ah audit based on such definition are; 1) Shari’ah review (AAOIFI) is not an

audit, 2) compliance only is not sufficient, it must truly accord with the spirit of the

Shari’ah, 3) the definition should not only limit to “activities” of IFIs but also

“products and services”, 4) benchmark is essential to measure the extent of

compliance. Without a doubt that the definition of Shari’ah review by AAOIFI is not

intended to comprehend the term Shari’ah audit, therefore further effort need to be

initiated, perhaps by AAOIFI, to formulate the proper definition of Shari’ah audit and

implement it in the practice of IFIs all over the world.

Moreover, the term “review” should be understood differently from the term

“audit”. While the former implicate a lower assurance level, the latter has a more

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comprehensive assurance level. CPA Australia (2006: 44) states that “review

engagement is a service where the auditor’s objective is to provide a moderate level of

assurance, being a lower level of assurance than that provided by an audit”. Review

has also been defined as “a formal assessment of an activity with the intention of

suggesting or implementing changes” or a review “implies an audit type investigation

that does not meet the full requirements of Generally Accepted Auditing Standards

(GAAS)” (O’Regan, 2004: 224-225). Therefore, perhaps Shari’ah review should not

be equated with the term Shari’ah audit as the understanding of the terminology

between the two terms is significantly different.

As for between-group analysis, the Kruskall-Wallis test reveals no significant

difference between the three groups’ opinions on the statement no.2 and no.3. This

indicates that the respondents from various backgrounds are basically in the same

inclination in their responses towards these two statements.

5.6.2 Research Question No.2

The second research question is to investigate the qualification requirements for

Shari’ah auditors. This question seeks to identify who should perform Shari’ah audit,

who should appoint Shari’ah auditors and what are the qualification and competence

requirements for Shari’ah auditors.

To investigate the respondents’ perception on who should perform Shari’ah

audit, the respondents were requested to select among the five categories which are; 1)

conventional external auditor, 2) Islamic Jurists (‘Ulama), 3) Internal auditors under

supervision of SSB, 4) SSB, and 5) Shari’ah auditors – a new group of professionals

who are specifically certified in Shari’ah audit. Interestingly about 87% of

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respondents opt for Shari’ah auditors (new group professionals who are specifically

certified in Shari’ah audit) to perform the function of Shari’ah audit.

Table 5.10
Who Should Perform Shari’ah Audit for IFIs

Acctg Lecturers Auditors Shari'ah scholars Total

No Statement
N % N % N % N %
4a. Conventional external auditors
Yes 2 3.3 5 18.5 - 7 7.1
No 58 96.7 22 81.5 11 100 91 92.9
60 100 27 100 11 100 98 100
4b. Islamic Jurists (‘Ulama)
Yes 7 11.7 3 11.1 2 18.2 12 12.2
No 53 88.3 24 88.9 9 81.8 86 87.8
60 100 27 100 11 100 98 100
4c. Internal auditors under
supervision of Shari’ah
Supervisory Board (SSB)
Yes 14 23.3 10 37 5 45.5 29 29.6
No 46 76.7 17 63 6 54.5 69 70.4
60 100 27 100 11 100 98 100
4d. Shari’ah Supervisory Board
Yes 16 26.7 5 18.5 2 18.2 23 23.5
No 44 73.3 22 81.5 9 81.8 75 76.5
60 100 27 100 11 100 98 100
4e. Shari’ah auditors – A new group
of professionals who are
specifically certified in Shari’ah
audit
Yes 53 88.3 22 81.5 10 90.9 85 86.7
No 7 11.7 5 18.5 1 9.1 13 13.3
60 100 27 100 11 100 98 100

The findings in Table 5.10 indicate a demand for the new profession so called

Shari’ah auditors to be established instead of delegating to the existing parties such as

SSB or external financial auditors to perform the function of Shari’ah audit. The

profession of Shari’ah auditors as proposed by this study is congruent to the concept

of effective framework to monitor and assess Shari’ah compliance in IFIs as suggested

by Grais & Pellegrini (2006) where they place Shari’ah audit firm as part of the

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external process of monitoring and assessing the Shari’ah compliance and SSB is

positioned in the internal process accordingly.

However, before such profession is properly instituted perhaps the idea of

Hood and Bucheery (1999) to have more interaction between religious auditors

(referred to SSB members) and financial auditors is deemed necessary since the

competence and knowledge background from these two groups are complementary

towards the successful achievement of Shari’ah audit program.

The following table for instance presents the findings on who should appoint

Shari’ah auditors.

Table 5.11
Who should appoint Shari’ah auditors for IFIs

Acctg Shari'ah
Auditors Total
No Statement Lecturers scholars
N % N % N % N %
5a. Shareholders of the respective
IFI through its AGM
Yes 6 10 7 25.9 3 27.3 16 16.3
No 54 90 20 74.1 8 72.7 82 83.7
60 100 27 100 11 100 98 100
5b. Bank Negara of Malaysia
Yes 5 8.3 4 14.8 2 18.2 11 11.2
No 55 91.7 23 85.2 9 81.8 87 88.8
60 100 27 100 11 100 98 100
5c. Islamic Financial Service
Board (IFSB)
Yes 23 38.3 16 59.3 1 9.1 40 40.8
No 37 61.7 11 40.7 10 90.9 58 59.2
60 100 27 100 11 100 98 100
5d. A newly established
regulatory and supervisory
body dedicated to oversee the
practice of Shari’ah audit
Yes 46 76.7 14 51.9 5 45.5 65 66.3
No 14 23.3 13 48.1 6 54.5 33 33.7
60 100 27 100 11 100 98 100

For the appointment of Shari’ah auditors, 60% of the overall respondents

perceive that Shari’ah auditors should be appointed by a newly established regulatory

126
and supervisory body which is dedicated to oversee the practice of Shari’ah audit. The

reason could be that other parties might be perceived as not sufficiently independent

to appoint the auditors. In conventional auditing practice, it has been widely criticized

that shareholders are not in the best party to appoint the auditors (Woolf, 2003) and

this idea seems to hold in the case of Shari’ah audit shown by the respondents who

mostly disagree to the statement no. 5a.

On the appointment of Shari’ah advisors (SSB), the above finding corresponds

to the result of the study by Abdul Rahman et. al. (2004) where they found that the

SSB should be appointed by the regulatory agency such as BNM instead of the current

arrangement where they are appointed by the shareholders in the Annual General

Meeting (AGM) of the IFIs.

Apart from that, the mean score of 4.65 and median of 5 as presented in table

5.12 shows that the respondents also highly agree on the importance of establishing

the competence and qualification requirements for Shari’ah auditors. Interestingly the

respondents subsequently demand the Shari’ah auditors to have a minimum

qualification of degree or professional qualification in accounting and specialized

certification in Shari’ah audit (mean of 4.53 and median of 5). Although the mean and

median score for statement no. 7b is also considered high (4.31 and 4), however it is

not as high as the scores for statement no. 7c. This finding is congruent with the

finding in the statement no 4 where the respondents support the establishment of new

professionals so called Shari’ah auditors who are specifically certified in Shari’ah

audit. What more can be conveyed here that we need to start somewhere to institute

the profession of Shari’ah auditors by inculcating proper curriculum in the universities

or even establishing a dedicated institution offering a professional certification in

Shari’ah audit.

127
 Table 5.12
Competence and Qualification Requirements of Shari’ah Auditors

Kruskal-
Wallis
Acctg. Shari'ah
Auditors Test
Lecturers scholars Overall
(Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

6. It is important for a
body to set up
qualification and
59 4.68 5 27 4.48 5 9 5 5 95 4.65 5 .023
competence
requirements for
Shari’ah auditors
7. Minimum
qualification of the
Shari’ah auditor1:
a) Degree/Profession 38 3.76 4 21 4.29 4 4 3.75 4 63 3.94 4 .193
al in accounting
b) Degree/Profession 43 4.42 5 24 4.08 4 6 4.50 4.5 73 4.31 4 .094
al in accounting &
Fiqh (Islamic
Law)
c) Degree/Profession 54 4.54 5 24 4.37 4.5 10 4.90 5 88 4.53 5 .076
al qualification in
accounting and
specialized
certification in
Shari’ah audit

Since the significance level for statement no 6 is 0.023, therefore it suggests

that there has been a significant difference between the three groups’ responses on the

statement no. 6. An inspection of the mean ranks for the groups further suggests that

Shari’ah scholars had the highest scores, with the auditors reporting the lowest. This

could be due to the high awareness of the Shari’ah scholars on the nature of Shari’ah

audit work and therefore they see the utmost significance of establishing a proper

qualification and competence requirements for Shari’ah auditors.

1
Most of the respondents tend to respond to one of the options that they mostly prefer instead of
responding to each of the options.

128
 5.6.3 Research Question No.3

The third research question is to examine the scope of Shari’ah audit. This question

encompasses the investigation on the business areas to be audited under Shari’ah

audit, the extent of Shari’ah audit, timing of Shari’ah audit, and the importance and

content of Shari’ah audit report.

Table 5.13
Areas to be Audited Under Shari’ah audit

Kruskal-
Acctg. Shari'ah
Auditors Wallis Test
Lecturers scholars Overall
(Asymp. Sig.)
No Statement
Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

8a. Business policies 58 4.46 5 27 4.41 5 11 4.54 5 96 4.46 5 .772

8b. Processes and 59 4.54 5 27 4.55 5 11 4.82 5 97 4.58 5 .461
procedures
8c. Contracts and 59 4.59 5 27 4.52 5 11 4.82 5 97 4.60 5 .294
agreements
8d. Financial system & 60 4.53 5 27 4.41 5 10 4.30 4 97 4.47 5 .342
reporting
8e. Human resource 58 4.12 4 25 3.48 3 11 3.64 4 94 3.90 4 .001
management
8f. Social activities & 60 4.17 4 26 3.77 4 11 4 4 97 4.04 4 .071
contribution
8g. Environmental 59 4.17 4 26 3.65 4 11 3.91 4 96 4.00 4 .071
impact of operations
8h. Marketing & 59 4.15 4 26 3.50 3.5 11 4.36 4 96 4.00 4 .002
advertising
8i. Reports & circulars 59 4.12 4 26 4.00 4 11 4.18 4 96 4.09 4 .671
8j. Zakat calculation & 59 4.66 5 27 4.59 5 11 4.82 5 97 4.66 5 .474
payment
8k. IT system 56 3.70 4 27 3.78 4 11 3.54 4 94 3.70 4 .832

From table 5.13 it can be seen that Zakat matter is regarded as the most

significant aspect to be audited in the IFI with mean of 4.66. Other areas which are

regarded as highly important by most of the respondents are contracts and agreements

(mean of 4.60 and median of 5), processes and procedures (mean of 4.58 and median

129
of 5), financial system & reporting (mean of 4.47 and median of 5) and business

policies (mean of 4.46 and median of 5). Except for those areas, interestingly the

respondents do not regard other aspects of business activities as highly important as

the previously mentioned areas especially in the aspect of human resource

management (mean of 3.90) and IT system (mean of 3.70).

For non-parametric test on the areas to be audited under Shari’ah audit, the

study found significant difference across the three groups’ responses for statement no.

8e (human resource management) and statement no. 8h (marketing and advertising).

Comparing the mean ranks for the three sets of scores, it appears that accounting

academicians put highest significance on the aspect of human resource management

as compared with the other groups, and the auditors report the lowest. Perhaps this

variation lies in the different perspectives of “theorist/idealist” (academicians) and

“practitioners” (auditors) on this issue where the former might believe that human

resource management is one of the areas that need to be concerned in an ethical

auditing process such as Shari’ah auditing and the latter might not see the significance

of this area or it is perhaps not practical (measurable) for them to audit this area of the

IFIs operations.

With regards to the issue of “marketing and advertising”, the mean ranks

comparison shows that Shari’ah scholars had the highest score whilst the auditors had

the lowest. One possible explanation is perhaps that Shari’ah scholars might see

marketing and advertising as one of the sensitive issues in the IFIs operations. It is

where perhaps Shari’ah violence could occur where Shari’ah principles might not be

fully observed when introducing, marketing and advertising the IFIs products or

services to the consumers.

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 Table 5.14 and 5.15 are concerned with the extent of Shari’ah audit and when

it should be performed.

Table 5.14
To What Extent Shari’ah Audit Should be Performed?

Acctg.
Auditors Shari'ah scholars
Lecturers Overall

No Statement
N % N % N % N %

9a. Every single activity 20 33.9 5 18.5 4 44.4 29 30.5

9b. As assumed satisfactory by the 19 32.2 6 22.2 2 22.2 27 28.4
auditors
9b. Using sampling method 20 33.9 16 59.3 3 33.3 39 41.1
59 100 27 100 9 100 95 100

Table 5.15
When Should Shari’ah Audit be Performed?

Acctg. Shari'ah
Auditors
Lecturers scholars Overall

No Statement
N % N % N % N %

10a. Throughout financial year 32 53.3 15 57.7 3 33.3 50 52.6

10b. During new product application - - 3 11.5 1 9.1 4 4.2
10c. At the end of financial year 28 46.7 8 30.8 5 55.6 41 43.1
60 100 26 100 9 100 95 100

It can be seen from table 5.14 that even though highest percentage of

respondents (41%) prefer the adoption of sampling method in Shari’ah audit, however

the difference in the percentages among the three choices is not that significant. While

30% of the respondents argue for Shari’ah audit to be performed for every single

activity of the IFI, for instance another 28% leave it to the auditors to decide.

131
 As for the view of when Shari’ah audit should be performed, almost 53% of

the respondents urge for Shari’ah audit to be performed throughout financial year, and

43% see it should be performed at the end of financial year and only 4% opine the

audit to be performed only during new product application. This statement is very

closely linked to the previous statement (statement no.9). Apart from the variation of

the responses for statement no. 9, the results of statement no. 10 somehow signal that

the respondents are in favour of more extensive or more comprehensive audit for IFIs

since more than 50% of them opt for Shari’ah audit to be performed throughout

financial year.

The above findings signify that respondents are significantly varied in their

selection to which extent Shari’ah audit should be performed. Since the term

“Shari’ah compliance” implies a broader understanding, responsibility and

accountability (i.e. in this world and hereafter), there could be a dilemma of whether

the audit to attest such compliance is sufficient by relying on the sampling method or

to the satisfaction of the auditors, or we should go beyond those assumptions by

checking and assuring every single activity of the IFIs are in compliant with the

Shari’ah precepts. To opt for full audit might be time consuming and costly or some

people might claim it is inefficient. On the other hand, how the auditors would be

responsible and accountable of their opinion if it is based only on partial audit (i.e. by

using sampling method). Here further intense scholarly discussions and research by

the prominent scholars in Islamic accounting and finance are needed to resolve this

issue.

The following table presents the findings on the importance of Shari’ah audit

report. With no statistical difference across the three groups’ opinions, the mean score

132
of 4.64 confirms that the respondents highly believe in the utmost significance of

issuing and publishing the Shari’ah audit report.

Table 5.16
The Importance of Shari’ah Audit Report

Kruskal-
Acctg. Shari'ah Overall Wallis Test
Auditors
Lecturers scholars (Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

11. It is important for Shari’ah 60 4.70 5 27 4.44 5 11 4.82 5 98 4.64 5 .051

auditors to issue and publish
Shari’ah audit report.

Shari’ah audit report is strongly perceived important as yet there is no detailed

Shari’ah audit report issued by any IFI in Malaysia. Therefore, it is the aim of the

findings in table 5.17 to identify what should be the contents of the report. As shown

in table 5.17, all of the proposed contents of Shari’ah audit report are perceived

important at varying degrees. Among the most significant matters to be included in the

report are; the opinion on the extent of Shari’ah compliance (mean of 4.68 and median

of 5), process and procedures taken in performing Shari’ah audit (mean of 4.65 and

median of 5), findings i.e. detailed breach and violence of Shari’ah principles by IFIs

(mean of 4.64 and median of 5), and the objective of Shari’ah audit (mean of 4.63 and

median of 5). Even though the mean scores for statements no.16 & 17 are slightly

lower than the other statements, however they are still considered high with the mean

of 4.47 and 4.44 accordingly. These findings suggest that although with the varying

degree of the perceived importance of each of the proposed content of Shari’ah audit

report, yet they are all seen as important by most of the respondents.

133
 Table 5.17
The Content of Shari’ah Audit Report

Kruskal-
Wallis
Acctg. Shari'ah
Auditors Test
Lecturers scholars Overall
(Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

12. The objective of Shari’ah audit 59 4.66 5 27 4.55 5 11 4.63 5 97 4.63 5 .402
13. Process and procedures taken in 60 4.70 5 27 4.52 5 11 4.73 5 98 4.65 5 .281
performing Shari’ah audit
14. Opinion on the extent of 59 4.69 5 27 4.59 5 11 4.82 5 97 4.68 5 .270
Shari’ah compliance
15. Findings (e.g. detailed breach 60 4.70 5 27 4.48 5 11 4.73 5 98 4.64 5 .281
and violence of Shari’ah
principles by IFIs)
16. Implications 60 4.60 5 26 4.15 4 10 4.50 4.5 96 4.47 5 .034
17. Recommendations for 59 4.57 5 26 4.08 4 11 4.54 5 96 4.44 5 .011
improvements

The findings in table 5.17 clearly hint for an urgent call to go beyond the

current Shari’ah audit report, especially in the case of Malaysia, which only contain a

short statement reporting that “the IFIs operation is in compliance with Shari’ah

principles”. A more detailed report is deemed necessary for; 1) the consumers to be

assured that the IFIs are in compliance with the Shari’ah principles, 2) the Shari’ah

auditors to be more accountable and transparent in their job, and for 3) the IFIs to

identify their performance in term of Shari’ah compliance.

Interestingly, Meezan bank in Pakistan has been publishing a more detailed

Shari’ah advisor’s report which explains the areas covered under Shari’ah audit work

and outlines necessary recommendations for the management of the bank (Meezan

Bank Annual Report, 2006). Even though Shari’ah audit activities is a part of the

Shari’ah advisor’s report, however the report provides the explanation of the SSB’s

review on the Shari’ah compliance of the IFI as well as the recommendation for the

134
IFI to improve certain aspects of business operation which is deemed necessary by the

SSB. With the various models of Shari’ah audit report across the IFIs in the Muslim

countries, perhaps AAOIFI and other relevant parties have to look into the efforts at

further standardizing and harmonizing the practice.

With regards to the “between-groups” analysis, the study found significant

differences for statements no.16 and 17. The mean ranks for both statements indicate

that the accounting academicians had the highest scores while the auditors had the

lowest. It is believed that the work background between the academicians and the

auditors have very much influenced their responses towards these statements. The

academicians who are “idealist” in nature might see these two items as important to be

included in the report while the auditors who are experienced in the auditing

environment, are somehow neutral of whether the items are appropriate to be included

as these matters might be considered sensitive and should not be disclosed to the

public.

Apart from examining the importance of Shari’ah audit report and its contents,

this section also seeks to explore the possibility of extending the concept of Shari’ah

audit to other Islamic institutions such as Islamic companies or Waqf & Zakat

institutions. As shown in table 5.18 there is a high demand for the concept to be also

applied to other Islamic institutions besides the IFIs. This is evidenced by a high mean

score of 4.66 and median of 5 resulted and furthermore there is no significant

difference between the group means.

In addition, the respondents were also requested to give their view on the need

to rank the performance of IFIs based on the outcomes of Shari’ah audit. However

such need is not perceived to be as strongly important (mean 4.02 and median of 4) as

135
compared to the previous statement. There are no statistically significant differences

in the responses between the three groups on these two statements.

Table 5.18
The Extension of Shari’ah Audit to Other Islamic Institutions

Kruskal-
Wallis
Acctg. Shari'ah
Auditors Test
Lecturers scholars Overall
(Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

18. Shari’ah audit should be 60 4.68 5 27 4.63 5 11 4.64 5 98 4.66 5 .665

extended to other
Islamic institutions (e.g.
Islamic companies,
Waqf & Zakat
institutions etc.)
19. The performance of IFIs 60 4.08 4 27 3.85 4 11 4.09 4 98 4.02 4 .323
(based on Shari’ah
audit) should be ranked.

5.6.4 Research Question No.4

The last research question is to investigate the regulatory framework of Shari’ah audit.

This question seeks to identify the framework of regulation and supervision of

Shari’ah audit in terms of the regulatory body and its role, and also on the standards to

be applied in performing Shari’ah audit.

The findings in table 5.19 imply that in overall the respondents highly perceive

the importance of establishing an external independent body to oversee the practice of

Shari’ah audit. Specifically, they mostly agree to the prominent Islamic and

accounting scholars to be members of the body, followed by the representative from

country’s central bank.

136
 Table 5.19
The Regulatory Body for Shari’ah Audit

Kruskal-
Wallis
Acctg. Shari'ah
Auditors Test
Lecturers scholars Overall
(Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

20. It is important to set up an 59 4.49 5 26 4.34 5 11 4.45 5 96 4.45 5 .665

external independent body
to oversee the Shari’ah
audit practice
21. The members of the body:
a) Prominent Islamic and 59 4.63 5 27 4.41 5 11 4.64 5 97 4.57 5 .286
accounting scholars

b) Representative of 58 4.24 4 26 4.27 4 7 4.00 4 91 4.23 4 .670

country’s central bank

c) Partners of big audit 56 3.86 4 26 3.54 4 8 3.62 4 90 3.74 4 .718

firms
22. Roles of the body:
a) Regulating the 60 4.62 5 26 4.46 5 10 4.90 5 96 4.60 5 .117
standards to be
adopted in performing
Shari’ah audit

b) Promoting research 60 4.35 4.5 25 4.40 5 10 4.30 4 95 4.36 4 .893

and education in
Shari’ah audit

c) Licensing, appointing, 60 4.48 5 26 4.11 4 10 4.20 4.5 96 4.35 5 .325

supervising,
monitoring and
disciplining the
Shari’ah auditors

d) Evaluating the practice 59 4.56 5 26 4.23 4 10 4.70 5 95 4.48 5 .060

of Shari’ah audit

e) Ranking the
performance of IFIs in 60 4.27 4 26 4.12 4 10 4.60 5 96 4.26 4 .236
term of Shari’ah
compliance (based on
the result of Shari’ah
audit)

137
 The proposed roles of such body have been seen important by the respondents

at varying degrees. Predominantly the body is expected to regulate the standards in

performing Shari’ah audit (mean of 4.60 and median of 5), evaluating the practice of

Shari’ah audit (mean of 4.48 and median of 5), promoting research and education in

Shari’ah audit (mean of 4.36 and median of 4), licensing, appointing, supervising,

monitoring and disciplining the Shari’ah auditors (mean of 4.35 and median of 4), and

ranking the performance of IFIs in term of Shari’ah compliance (mean of 4.26 and

median of 4).

Apparently there are no statistical significant differences of the three groups’

opinions on all the statements in the table 19. Finally, table 5.20 indicates that

AAOIFI Shari’ah standards (mean of 4.53 and median of 5) as well as AAOIFI

accounting standards (mean of 4.44 and median of 5) are viewed as the most

appropriate standards to be applied in Shari’ah audit followed by local Shari’ah

standards (mean of 4.32 and median of 4). It is clear that the standards promulgated by

AAOIFI are regarded as the most appropriate guidelines in conducting Shari’ah audit

for IFIs. However significant effort has to also be made to ensure its enforcement in

the practice.

Table 5.20
The Standards to be Applied in Performing Shari’ah Audit

Kruskal-
Acctg. Shari'ah Wallis Test
Auditors
Lecturers scholars Overall (Asymp.
Sig.)
No Statement
Median

Median

Median

Median
Mean

Mean

Mean

Mean

N N N N

23a. AAOIFI 57 4.39 4 23 4.39 5 11 4.82 5 91 4.44 5 .116

accounting
standards

138
 Table 5.20 – Continued

Kruskal-
Acctg. Shari'ah Wallis Test
Auditors
Lecturers scholars Overall (Asymp.
Sig.)
No Statement

Median

Median

Median

Median
Mean

Mean

Mean

Mean
N N N N

23b. AAOIFI Shari’ah 60 4.50 5 22 4.50 5 10 4.80 5 92 4.53 5 .338

standards
23c. Central bank’s 58 4.09 4 21 3.81 4 10 4.70 5 89 4.09 4 .021
standards
23d. Local Shari’ah 57 4.35 4 22 4.18 4 10 4.50 4.5 89 4.32 4 .767
standards
23e. International 57 3.88 4 21 4.00 4 10 4.40 5 88 3.97 4 .140
auditing standards
23f. Local accounting 54 3.83 4 18 3.94 4 10 4.40 5 82 3.93 4 .074
standards

5.7 SUMMARY OF THE CHAPTER

This chapter has presented the data analysis and research findings. First, it illustrated

the response rate of the questionnaires. This is followed by the discussion on the tests

conducted on the questionnaires and the sample distribution (i.e. non-response bias

test, validity and also reliability test). Third, it described the profile of respondents

through demographic analysis. Finally, the statistical analysis for each research

question has been presented and discussed in the last section.

To summarize this chapter, the following are the main findings of this study:

• It is important to develop the discipline of Shari’ah audit and define the

subject in a comprehensive manner.

• Shari’ah audit should be performed by new professionals called “Shari’ah

auditors” who are specifically certified in Shari’ah audit and they must be

appointed by a new independent body dedicated to oversee the practice of

Shari’ah audit.

139
• It is important to establish and standardize the qualification and

competence requirements for Shari’ah auditor who should at least have

degree/professional qualification in accounting and specialized

certification in Shari’ah audit.

• Among the areas of business activities that should be looked intensely in

Shari’ah audit work are; Zakat calculation and payment, contracts and

agreements, processes and procedures, financial system & reporting, and

business policies. However, it is also believed that the scope of Shari’ah

audit work should probably be extended to other aspects such as

marketing & advertising, human resource management, and social &

environmental contributions, as Shari’ah encompasses every aspect of

human life.

• In performing Shari’ah audit, it is important to find a mechanism besides

the sampling method as the nature of the responsibility and accountability

is different from the conventional one.

• It is important to issue and publish Shari’ah audit report which should

contain the objective of Shari’ah audit, process and procedures taken in

performing Shari’ah audit, the opinion on the extent of Shari’ah

compliance, findings i.e. detailed breach and violence of Shari’ah

principles by IFIs, , implications, and recommendations for improvement.

• Shari’ah audit should be extended to other Islamic institutions such as

waqf & Zakat institutions and Islamic companies.

• It is important of establishing an external independent body to oversee the

practice of Shari’ah audit which might consist of the prominent Islamic

140
 and accounting scholars and the representative from country’s central

bank.

• Predominantly the body is responsible to regulate the standards in

performing Shari’ah audit, evaluating the practice of Shari’ah audit,

promoting research and education in Shari’ah audit, licensing, appointing,

supervising, monitoring and disciplining the Shari’ah auditors, and

ranking the performance of IFIs in term of Shari’ah compliance.

• AAOIFI Shari’ah standards, AAOIFI accounting standards, and local

Shari’ah standards are viewed as the most appropriate standards to be

applied in Shari’ah audit.

141
 CHAPTER 6

CONCLUSION

6.1 INTRODUCTION

This chapter discusses the main findings presented in the previous chapter and

concludes the study accordingly. The chapter is organized in the following sequence.

First, it provides the overall conclusion for the study and also the conclusion for each

research question. Second, the chapter highlights the implications of the study. Thirdly,

limitations of the study are discussed. Then, it underlines the contribution of the study.

Finally, it proposes potential areas for future research in relation to this study.

6.2 CONCLUSION FOR EACH RESEARCH QUESTION

Currently, the structures and processes established within an Islamic Financial

Institutions (IFIs) for monitoring and evaluating Shari’ah compliance rely essentially

on the arrangements internal to the institutions, i.e. SSB (Grais & Pellegrini, 2006).

This arrangement has its advantages as well the limitations. While the paper of Grais

& Pellegrini (2006) has suggested a framework for an effective assurance of Shari’ah

compliance which includes the internal and external process, this study has extended

their study by examining the framework of Shari’ah audit which falls under the

external process of their proposed framework.

Despite the different profession of the respondents, this study found the

common agreement of the respondents towards establishing the discipline of Shari’ah

audit and develop the necessary framework and infrastructure for the discipline

accordingly. Certainly this has proven that in the evolution of auditing, the

establishment of the subject of Shari’ah audit is not only theoretically legitimate but

142
also relevant and significant in the opinion of pertinent individuals as selected in this

study. Since the respondents of this study are all Muslims, the influence of the Islamic

worldview might very much characterize their views on the issues of this study.

In conclusion, this study found an urgent call for the systematic development

of the discipline of Shari’ah audit. It involves from the very basic of: 1) defining the

subject in an appropriate manner, 2) standardizing the qualification and competence

requirements for Shari’ah auditors who are well equipped not only with accounting

and auditing techniques but also specifically certified in Shari’ah audit, 3) identifying

the scope, the extent, and the timing of Shari’ah audit, 4) regulating and standardizing

the content of Shari’ah audit report, 5) establishing an independent body to regulate

and enforce the standards and empower this body with other relevant roles such as to

evaluate the practice of Shari’ah audit and to promote the research and education in

Shari’ah audit, and 6) applying the AAOIFI standards into the practice of Shari’ah

audit.

It is clearly long overdue for the relevant parties to resolve the above issues.

While this paper might not give the complete solution to this very new emerging field,

it however has provided pointers for further research and discussions to this area.

Hopefully the proposed ideas in this study can be further utilized for the benefit of the

enrichment of the subject of Shari’ah audit.

To identify the detailed conclusion and discussion to the findings of this study,

the summary of each research question is discussed

6.2.1 Research Question No.1 – Understanding the Term “Shari’ah Audit”

The first research question is to identify the importance of establishing the discipline

of Shari’ah audit and its definition. This question examines the awareness of

143
respondents of the term Shari’ah audit and the importance of establishing the

discipline of Shari’ah audit. Since there has been no standardized and formal

definition given to Shari’ah audit, this question also examines the appropriateness of

the definition of “Shari’ah review” by AAOIFI to be equated to the understanding of

Shari’ah audit.

Based on the findings of the awareness level of the respondents towards the

term “Shari’ah audit”, it is clear that while the subject of Shari’ah audit is gradually

attracting the attentions from relevant parties such as scholars in the field of Islamic

finance, however, generally it has yet to become a popular subject to the academic

individuals in the accounting field and to the audit professionals especially. Auditors

should be more exposed to this new development as they might be one of the potential

professionals who should build up the expertise and competence in this area and

expand their current expertise accordingly. Apart from that, the academics are the one

who perhaps should establish and sustain knowledge in this field by initiating more

research and looking at the opportunity to incorporate the subject of Shari’ah audit

into the university curriculum.

Interestingly, apart from the respondents’ varying degree of awareness, it is

very encouraging to discover that the respondents highly regarded the importance to

develop the discipline of Shari’ah audit and define the subject in a comprehensive

manner. This finding perhaps shows the notable concern of the respondents to their

religious matter and to the development of an Islamic subject in the auditing field.

Consequently this finding is in support of the initiative of Islamization of knowledge

in the discipline of auditing where several Muslim scholars have been aiming to find

an alternative auditing system that portrays an Islamic point of view on auditing and to

establish its own foundational framework.

144
 While many of the respondents tend to agree towards defining the term

Shari’ah audit based on the definition of Shari’ah review by AAOIFI, several other

respondents have instead sees the inappropriateness of such an association. It is

probably due to the current absence of a specific definition for Shari’ah audit which

lead to the agreement of the respondents towards equating the definition of Shari’ah

audit with Shari’ah review. Besides, the lack of awareness of the respondents on this

subject might also contribute to this finding. On the other hand, some respondents

who disagree perhaps see the essential difference between the term “review” and

“audit” (for more explanation, please refer to the previous chapter) and also perceive

that the definition of Shari’ah audit should be more comprehensive than the available

definition of Shari’ah review. This finding implies a call to the establishment of a

dedicated definition and understanding of the term Shari’ah audit to prevent confusion

in understanding and differentiating the term “Shari’ah audit” and “Shari’ah review”.

6.2.2 Research Question No.2 – Qualification & Competence Requirements of

Shari’ah Auditors

The second research question is to investigate the qualification requirements for

Shari’ah auditors. This question seeks to identify who are supposed to perform

Shari’ah audit, who should appoint the Shari’ah auditors and what are the

qualification and competence requirements for Shari’ah auditors.

As compared to the conventional financial audit where the profession of

auditors who conduct financial audit has been properly established, there is a dilemma

over who should conduct an audit for Shari’ah compliance in the context of IFIs, as

the nature of audit is significantly different. The other issues are who should appoint

these “Shari’ah auditors” and what should be their minimum qualification.

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 As for the view on who should perform the function of Shari’ah audit, the

respondents believed that it should be performed by new professionals called

“Shari’ah auditors” who are specifically certified in Shari’ah audit and they must be

appointed by a new independent body dedicated to oversee the practice of Shari’ah

audit. This finding illuminate that despite the growing effort of the several institutions

in offering professional certification in Islamic finance there should also be an attempt

to seriously look at the opportunity of offering a professional qualification in Shari’ah

audit. The most recent certification of Certified Shari'a Adviser and Auditor (CSAA)

by AAOIFI which was launched in August 2007 must be regarded as a good effort by

the institution in responding to the market needs. Even though, the focus of the

program is among others on the Shari’ah review process, however it is hoped that

gradually the more comprehensive concept of Shari’ah audit as proposed by this study

will be incorporated into the program accordingly. Surely such initiative will have to

depend on the establishment of a regulatory enforcement to make Shari’ah audit

compulsory for the IFIs or probably for other Islamic institutions as well. If such

regulation has been in place, an effort has to then be made to look into the

establishment of a dedicated body to appoint the Shari’ah auditors because the finding

of this study revealed that the respondents are not in favour of the current arrangement

where the auditors are appointed by the shareholders through the AGM. The findings

on the role of this independent body will be explored further in the discussion of the

conclusion for research question no 4.

Supporting the above findings, the respondents also highly perceive the

importance to establish and standardize the qualification and competence

requirements for Shari’ah auditor who are supposed to have minimum

degree/professional qualification in accounting and specialized certification in

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Shari’ah audit. In this regard, the existing conventional professional certification of

auditors is believed deficient in meeting the unique characteristics of the post of

“Shari’ah auditors”.

6.2.3 Research Question No.3 – The Scope of Shari’ah Audit

The third research question is to examine the scope of Shari’ah audit. This question

encompasses the investigation on the business areas to be audited under Shari’ah audit,

the extent of Shari’ah audit, timing of Shari’ah audit, and the importance and content

of Shari’ah audit report.

Among the areas of the business activities that should be looked at intensely in

Shari’ah audit work are; Zakat calculation and payment, contracts and agreements,

processes and procedures, financial system & reporting, and business policies. The

reason why the findings indicate that Zakat matters as the most important aspect to be

audited is probably because Zakat is one of the Islamic pillars hence it is considered to

be very closely associated with religious obligation and responsibility. However, even

though Zakat is important, the scope of Shari’ah audit work should also probably be

extended to other aspects highlighted above and also other areas such as marketing

and advertising, human resource management, and social and environmental

contributions, as Shari’ah encompasses every aspect of human life.

In performing Shari’ah audit, it is important to find a mechanism besides the

sampling method as the nature of the responsibility and accountability in the Islamic

financial industry is different from the conventional one. Even though the highest

percentage of respondents (41%) prefer the adoption of sampling method in Shari’ah

audit however the difference in the percentages among the three choices is not that

significant and moreover, the majority of the respondents (53%) preferred Shari’ah

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audit to be conducted throughout the financial year (Please refer to previous chapter

for detailed findings). Since the term “Shari’ah compliance” implies a broader

understanding, responsibility and accountability (i.e. in this world and hereafter), there

could be a dilemma of whether the audit to attest such compliance is sufficient by

relying on the sampling method or the extent deemed satisfactory by the auditors, or

we should go beyond those assumptions by checking and assuring every single

activity of the IFIs are in compliance with the Shari’ah precepts.

With regards to the importance of Shari’ah audit report, the respondents

believed that it is important to issue and publish Shari’ah audit report which should

contain the objective of Shari’ah audit, process and procedures taken in performing

Shari’ah audit, the opinion on the extent of Shari’ah compliance, findings i.e. detailed

breach and violence of Shari’ah principles by IFIs, implications, and

recommendations for improvement.

Apart from the above findings, the study also found that the respondents are in

support that Shari’ah audit should be extended to other Islamic institutions such as

Waqf and Zakat institutions and Islamic companies. Currently, the discussions and

debates on the issues of Shari’ah compliance are very much concentrated in the

context of the IFIs and does not cover the other Islamic institutions which certainly

have the same important role as IFIs in the Muslim society. Therefore, the current

major focus on the IFIs should be also expanded to other Islamic institutions as these

institutions have the same responsibility as IFIs in discharging their accountabilities in

line with the Shari’ah. Specifically, Waqf and Zakat institutions, comes to mind

although, perhaps the nature of Shari’ah compliance exercise is slightly different as

the management and operational mechanism are different from the IFIs.

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6.2.4 Research Question No.4 – The Regulatory Framework of Shari’ah Audit

The last research question is to investigate the regulatory framework of Shari’ah audit.

This question seeks to identify the framework of regulation and supervision of

Shari’ah audit in terms of the regulatory body and its role, and also on the standards to

be applied in performing Shari’ah audit.

As for the view on the importance of establishing the external regulatory body

for evaluating the practice of Shari’ah audit, the respondents highly perceived that it is

important to establish an external independent body to oversee the practice of Shari’ah

audit which might consist of the prominent Islamic and accounting scholars and the

representative from country’s central bank. Predominantly, the respondents regarded

that the body has to play the role in regulating the standards in performing Shari’ah

audit, evaluating the practice of Shari’ah audit, promoting research and education in

Shari’ah audit, licensing, appointing, supervising, monitoring and disciplining the

Shari’ah auditors, and ranking the performance of IFIs in term of Shari’ah compliance.

To effectively exercise their roles, it has to be ensured that the members of such a

regulatory body are truly independent and competent in the field of Shari’ah audit.

With regards to the opinion on which standards are most suitable for Shari’ah

audit practice, the respondents strongly agree that AAOIFI Shari’ah standards,

AAOIFI accounting standards, and local Shari’ah standards are the most appropriate

standards to be applied in Shari’ah audit. If these standards are viewed as the best

guidelines in Shari’ah audit practice, it is believed that more enforcement is needed to

ensure that they are applied and referred to accordingly. Nevertheless, it is seen

necessary to promulgate a specific standard on Shari’ah audit which provides

comprehensive guidelines to the Shari’ah audit practice. The Shari’ah auditors and the

auditee (i.e. IFIs) and other relevant parties are supposed to get familiar and be

149
acquainted with these standards so that these standards can be fully accepted

worldwide just like the existing conventional auditing standards.

6.3 IMPLICATIONS OF THE STUDY

This study has important implications to several parties such as standard setters,

academic institutions and scholars in the field of Islamic finance. The findings in this

study mainly imply that there must be initiatives from relevant parties (e.g. standard

setters, scholars, etc.) to develop the theoretical framework of Shari’ah audit for the

purpose of development of standard in this field.

Apart from that, perhaps the curriculum for a university degree in

accounting/Shari’ah has to embark on the courses on Shari’ah audit. To produce

dedicated professionals in Shari’ah audit, professional certification in Shari’ah audit is

believed to be very relevant to be established in response to the need of the Islamic

financial industry towards the profession of Shari’ah auditors.

It is also believed that the current Shari’ah audit reporting style has to be

improved and standardized urgently. The regulators and standard setters have to look

into this matter intensely as the Shari’ah audit report serves as the external reporting

tool to the users who rely on the opinion of the auditors in assessing the Shari’ah

compliance of the IFIs.

To implement the best practice of Shari’ah audit, the regulatory agencies have

to establish a proper regulatory framework for Shari’ah compliance in the IFIs and

specifically for Shari’ah audit process and enforce the standards to be used in

performing Shari’ah audit process.

150
6.4 LIMITATIONS OF THE STUDY

Despite its contribution as a preliminary survey in a very new emerging field, this

study is limited in the sense it is still exploratory in nature. Due to limited literature

available in this field, therefore, there is no specific theory existing on this subject.

However, with support of other relevant literature perhaps this study can be one of

initial effort in building up an established theory for Shari’ah audit.

Another limitation is the instrument used in this study which is the self-

developed questionnaire. Since it was developed by the researcher with the advice

from her supervisor, and it has not been tested widely, it might have deficiencies and

perhaps its content might not have been covered to an appropriate degree of breadth

and depth to meet the objective of the study.

In addition, the response rate of this study is considered quite low. Even though

it is still acceptable, a low response rate could affect the generalization of the result.

Apart from that, since the population size for SSB members is very small as there are

not many SSB members in Malaysia, hence, it subsequently result in a very small

responses derived from the SSB members as compared to other groups of respondents.

The very small responses might somehow affect the statistical analysis especially for

the between-group analysis.

6.5 CONTRIBUTION OF THE STUDY

This study is significant in various ways. Through exploring the framework of

Shari’ah auditing it will contribute to the development of Shari’ah audit as one distinct

discipline of knowledge and provides accounting educators with information

pertaining to curriculum development. In a broader perspective, the establishment of

151
Shari’ah audit as a discipline of knowledge will also support the initiative of

Islamization of knowledge.

Particularly the study will also benefit the IFIs in achieving its objectives

mainly in the aspect of Shari’ah compliance. Having a clear picture of how Shari’ah

audit should be practiced will indicate further improvements to be done on this

significant area thus it will enhance the confidence of IFIs’ stakeholders.

The study is also hoped to assist standards setters and regulatory bodies, not

only confined to the Malaysian environment, in setting up the relevant policies or

governance standards with regards to Shari’ah audit thus it will enhance the credibility

of Islamic banks.

Finally, hopefully this research will inspire further research to be conducted in

this area and enrich the existing knowledge and literature.

6.6 SUGGESTIONS FOR FUTURE RESEARCH

As the subject of Shari’ah audit is very new and currently emerging in the

contemporary discussion of the Islamic financial industry, there are a lot of

dimensions to explore within this field. In a more extensive manner, a comprehensive

theoretical framework of Shari’ah audit is a long overdue assignment for the scholars

and researchers to undertake.

It is also urgent to investigate the current state of Shari’ah audit practices of the

IFIs either in Malaysia or in other countries. Another major research that can be done

is by performing comparative studies of Shari’ah audit practices across the Muslim

countries or non-Muslim countries which have IFIs operating in their countries. This

investigation would significantly contribute to the identification of the overall picture

of Shari’ah audit practices worldwide, which subsequently leads to the development

152
of proper standards or guidelines to harmonize the practices. In a smaller scope, a case

study can be performed in examining different Islamic banks in implementing

Shari’ah audit in a specific country such as Malaysia. To date, there has been no study

to analyze the actual practice of Shari’ah audit in any IFI.

Another interesting area of study is on Shari’ah audit reporting style. It has

been noticed that different countries which have IFIs operating in their countries

publish different formats of Shari’ah audit report. Some IFIs in certain countries have

been issuing a short report confirming that the operations of IFIs are in compliant with

Shari’ah principles while other IFIs publish a lengthier report explaining more

detailed the Shari’ah audit procedures and the areas of the IFIs operations that have

been covered under the auditing procedures accordingly. A research on this variation

could give meaningful insights into the practices and perhaps the study could further

identify the role model and lead to the standardization of the practices.

There is also potential to conduct research on the same topic but with bigger

sample size or different groups of respondents and different locations to test the nature

of responses across the different groups. The potential groups of respondents might be

extended to the bankers of the IFIs or the users of the IFIs so that the study can get the

picture of the users’ perception on the issue of Shari’ah compliance of IFIs and on

Shari’ah audit particularly. It is also possible to examine the opinion of the prominent

Shari’ah scholars or practitioners in the field related to Shari’ah audit in other Muslim

countries besides Malaysia. Perhaps the opinion of non-Muslim audit practitioners or

academicians would also give fruitful ideas to the subject.

With the growing research interest in the above areas, it is hoped that the

subject of Shari’ah audit will finally become a distinct discipline of knowledge.

153
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 APPENDIX 1: COVER LETTER

4th December 2006

RE: RESEARCH SURVEY ON SHARI’AH AUDIT

Dear respected respondent,

I am a graduate student at the Department of Accounting, Kulliyyah of Economics &

Management Sciences, International Islamic University Malaysia (IIUM). As part of the
requirements for my master's degree I am conducting a study titled: Shari’ah audit for
Islamic Financial Institutions (IFIs): Perceptions of Accounting Academicians, Audit
Practitioners, and Shari’ah Scholars.

Shari’ah audit is a newly emerging subject in line with the establishment of Islamic Financial
Institutions (IFIs). Even though its philosophies and basic principles are not new, having been
practiced in the time of Prophet Muhammad (p.b.u.h) and His companions, yet its
comprehensive theory and practice have not been well established.

The enclosed questionnaire elicits information that will help me to discern your perception
towards Shari’ah audit. This information would be useful to both theorists and practitioners in
the field of Islamic banking, accounting and auditing. Confidentiality and anonymity are
guaranteed, as you do not need to reveal your name in the individual questionnaires; only the
investigator has access to the survey data.

Please respond to every item in this questionnaire as the instruction in every section. Should
you need further clarification, please contact me, Ratna Mulyany, email:
seulanga_aceh@yahoo.com, mobile phone: 016 252 9545.

Thank you very much for your cooperation; it is really appreciated. For your convenience,
please return the questionnaire in the enclosed self-addressed stamped envelope.

Sincerely yours, Supervisor:

(Ratna Mulyany) (Dr. Shahul Hameed Hj. Mohamed Ibrahim)

Candidate of MSc in Accounting Head of Department of Accounting, IIUM.

167
 APPENDIX II: QUESTIONNAIRE
PART B: QUALIFICATION REQUIREMENTS FOR SHARI’AH
PART A: UNDERSTANDING THE TERM “SHARI’AH AUDIT” AUDITOR
(√) Please tick whichever is applicable (√) Please tick the box. (Choose the most preferred, you may tick more than
one).
1. Are you aware of the term “Shari’ah audit”?
1. Shari’ah audit for Islamic Financial Institutions should be performed by:
Yes No Not sure
Financial auditors

(√) Please indicate your level of agreement with each of the following items Islamic jurists (‘Ulama)
based on the scales of: Internal auditors under supervision of Shari’ah Supervisory Board (SSB)
1 = Strongly agree (SA)
2 = Agree (A) Shari’ah Supervisory Board (SSB)
3 = Neutral (N) Shari’ah auditors – a new group of professionals who are specifically
4 = Disagree (D)
certified in Shari’ah audit
17168

5 = Strongly Disagree (SD)

Other (Please specify):
1 2 3 4 5
No STATEMENTS (SA) (A) (N) (D) (SD) ___________________________________________________________
1. It is important to develop another discipline
___________________________________________________________
namely “Shari’ah audit” apart from the
existing auditing areas (e.g. financial audit, ___________________________________________________________
social audit, etc.).
2. The term “Shari’ah audit’ can be defined
based on the following definition of Shari’ah
review given by AAOIFI:
“An examination of the extent of an Islamic
financial institution’s compliance, in all its
activities with the Shari’ah”

If you do not agree, please state your reason:

2. To uphold the integrity and independence of Shari’ah auditors for Islamic PART C: IDENTIFYING THE SCOPE AND THE SCALE OF SHARI’AH
Financial Institutions (IFI), Shari’ah auditors should be appointed by: AUDIT
Shareholders of respective IFI through its Annual General Meeting
Bank Negara of Malaysia (√) Please indicate your level of agreement with each of the following items
Islamic Financial Service Board (IFSB) based on the scales of:
A newly established regulatory and supervisory body dedicated to 1 = Strongly agree (SA) 4 = Disagree (D)
oversee the practice of Shari’ah audit 2 = Agree (A) 5 = Strongly Disagree (SD)
Other (Please specify): 3 = Neutral (N)

1 2 3 4 5
No STATEMENTS (SA) (A) (N) (D) (SD)
1. Areas to be audited under Shari’ah audit
(√)Please indicate your level of agreement with each of the following items for Islamic Financial Institutions:
based on the scales of: (a) Business policies
1 = Strongly agree (SA)
2 = Agree (A) (b) Processes and procedures
3 = Neutral (N) (c) Contracts & agreements
4 = Disagree (D)
5 = Strongly Disagree (SD) (d) Financial system and reporting

1 2 3 4 5 (e) Human Resources

No STATEMENTS (SA) (A) (N) (D) (SD)
(f) Social activities & contribution
1. It is important for a body to set up
qualification and competence (g) Environmental impact of
requirements for Shari’ah auditors banking activities
2. Minimum qualification of the Shari’ah
(h) Marketing and advertising
auditor:
(a) Degree/Professional in Accounting (i) Reports and circulars
(b) Degree/Professional in Accounting (j) Zakat calculation and payment
and Fiqh (Islamic Law)
(c) Degree/Professional qualification (k) IT system
in accounting and specialized
certification in Shari’ah audit
(√) Please tick whichever is applicable) (d) Implications

2. To what extent should each area be assessed under Shari’ah audit: (e) Recommendations for
improvemenet
Every single activity 3. Shari’ah audit should be extended to
As assumed satisfactory by the auditors other Islamic Institutions (e.g. Islamic
Using sampling method as practiced in conventional auditing companies, Waqf and Zakat Institutions,
etc.)
3. Shari’ah audit should be performed: 4. The performance of Islamic Financial
Institution (based on Shari’ah audit)
Throughout financial year should be ranked. (For example using 3
Only during new product application star system*).
At the end of financial year
* Star system is referred to for example:
- 3 stars = mostly compliant to Shari’ah
(√) Please indicate your level of agreement with each of the following items - 2 stars = minor breach to the Shari’ah principles
based on the following scales: - 1 star = IFI with major breach to the Shari’ah principles
1 = Strongly agree (SA)
2 = Agree (A)
3 = Neutral (N)
4 = Disagree (D)
5 = Strongly Disagree (SD)

1 2 3 4 5
No STATEMENTS (SA) (A) (N) (D) (SD)
1. It is important for Shari’ah auditors to
issue and publish Shari’ah audit report
2. The content of Shari’ah audit report
must include:
(a) The Objective of Shari’ah audit

(b) Process and procedures taken in

performing Shari’ah audit
(c) Findings (e.g. detailed breach and
violence of Shari’ah principles by
IFIs)
PART D: REGULATORY FRAMEWORK FOR SHARI’AH AUDITING
(√) Please indicate your level of agreement with each of the following items
based on the following scales:
1 = Strongly agree (SA)
2 = Agree (A)
3 = Neutral (N)
4 = Disagree (D)
5 = Strongly Disagree (SD)
No Statements
1. It is important to set up an external
independent body to oversee the
Shari’ah audit practice
2. The members of such body consist of:
(a) Prominent Islamic and
accounting scholars
(b) Representative from respective
country’s central bank
(c) Partners of big auditing firms
(d) Others (Specify):
3. Role of such body:
(a) Regulating the standards to be
adopted in performing Shari’ah
audit
(b) Promoting research and
education in
Shari’
(c) Licensing, appointing,
supervising, monitoring, and
disciplining the Shari’ah
auditors
(d) Evaluating the practice of
Shari’ah audit
(e) Ranking the performance of IFIs
in term of Shari’ah compliance
(Based on the result of Shari’ah
audit)
4. Relevant standards to be adopted in
performing Shari’ah audit:
(a) AAOIFI accounting standards
(b) AAOIFI Shari’ah standards
(c) Central Bank’s standards
1 2 3 4 5
(SA) (A) (N) (D) (SD) (d) Local Shari’ah standards
(e) IAS
(f) Local accounting standards
PART E: SUGGESTION AND RECOMMENDATION
Do you have any suggestion or recommendation with regards to
Shari’ah auditing?
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
_________________________________________________________
PART F: BACKGROUND OF RESPONDENT 9. Are you willing to be interviewed?

Please tick (√) whichever is applicable and fill up the required information
Yes No
accordingly.

1. Gender : Male Female If yes please attach business card

2. Age : 20 – 30 years 30 – 39 years

40 – 49 years Above 50 years

3. Job/Position : _________________________________________

4. Organization : _________________________________________

5. Highest Qualification: Diploma Master

Degree Ph.D

6. Field of specialization:
Undergraduate ________________________________________
Postgraduate _________________________________________

7. Professional accounting Yes No

8. Working experience 0 – 5 years 6 – 16 years

16 – 20 years Above 20 years