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AFS2033 Islamic Accounting

Lecture 13:
Auditing in Islamic Accounting

 To understand the concepts, the needs,
objectives and principles of (Shariah)
 To identify the nature of Shariah Advisory
 To comprehend the Shariah Governance
 Illustrations of Shariah Audit
 Audits are performed to ascertain the validity and
reliability of information and to provide an assessment of
a system’s internal control.
 The goal of an audit is to express an opinion on the
 Due to practical constraints, an audit often is conducted
on sampling basis, hence audit engagements usually seeks
to provide only reasonable assurance, not absolute
assurance, that the statements are free from material
 Audit provides an independent and impartial assurance
to the shareholders and other stakeholders of a
company on the financial statements.
 For IFIs, the scope of audit extends to Shari’ah
compliance in execution of Islamic financial transactions.
Audit of Financial Statements
 Auditing is the accumulation and evaluation of evidence
about information to determine and report on the degree
of correspondence between information and established
 Audit of financial statements is an independent assessment
of the fairness by which company′s financial statements are
presented by its management.
 It is performed by competent, independent and objective
person(s) known as external auditors, who issue an
auditors’ report based on the results of the audit.
 An audit seeks to provide only reasonable assurance that
the financial statement are free from material error based
on statistical sampling – True and Fair View
Objective of An Audit for IFIs
 To enable the Auditor to express opinion as to whether the financial
statements are prepared, in all material aspects, in accordance with
Shari’ah rules and principles and relevant accounting standards and
practices in the country in which the financial institution operates.
 Auditior’s Opinion
 True and Fair View
 Auditor’s opinion should enhance the credibility of financial statements
 The user, however, cannot assume that the opinion is an assurance as to the
future viability of the financial institution nor can the user assume as to the
efficiency and effectiveness with which the management has conducted the affairs
of IFIs
 An audit is designed to provide reasonable assurance that the financial
statements taken as a whole are free from misstatement.
 Reasonable assurance is a concept relating to the accumulation of the
audit evidence necessary for the auditor to make a conclusion
 In the case of IFIs, the auditor in theory, should have additional task to
provide reasonable assurance that the transactions examined comply
with Shari’ah rules and principles as determined by Shari’ah Board of
Principles of An Audit
Righteousness • An Auditor must be in the right position and mindset

• An Auditor should be trusted and render trustworthiness

Trustworthiness in performing audit tasks.

Fairness • An Auditor should be fair, no discrimination

• An Auditor must honestly produce correct report for the

Honesty financial statements.

• An Auditor must be independence and not be influenced

Independence by the third party when making decisions.

• An auditing work produces fair decision for company and

Objectivity user.

• The auditing work must be in closed basis, only intended

Confidentiality party can see the work
Reporting Areas by Auditor
 Islamic Banks should not involve in these activities:

elements such as tax
Any non-fulfillment of
Hoarding practices evasions,
the terms of contract
misstatement of


Companny’s Any events causing

responsibility to Extravagance damage to other
perform Zakat practices party in weights and
obligation measurements
Issues of Independence: SAB and
 If both SAB and external auditor are
independence, the report is more credible.
 If both SAB and external auditor are not
independent, the reports cannot be relied to
make investment decisions
 If one of SAB or external auditor is independent:
◦ Reaction would be less predictable
◦ Customers and investors concerned with Shariah
compliance will not be happy with non-independent
◦ Customers and investors concerned with economic
reasons will not be happy with non-independent
external auditor
Nature of Shariah Supervisory
 An independent body of specialised jurists in fiqh al muamalat
(Islamic commercial jurisprudence) that is entrusted with the duty
of directing, reviewing and supervising the activities of the IFI in
order to ensure that they are in compliance with Shari’ah rules and
 In the case of Malaysia, there are a centralised Shari’ah Advisory
Council (SAC) and internal Shari’ah Committee in each Islamic
financial institution
 Scope of Supervision
 Product development
 Financial reporting and Shari’ah opinion
 Approval of Shari’ah financial services and products
 Approval of listed securities and investment funds
The Needs for Audit in Islamic Banks
 External financial auditors only legally responsible to audit
conventional financial and operational systems, processes, activities,
policies etc
 Shari’ah advisors only focused on Shari’ah compliance on products
and policies
 Internal auditors only focused on internal control and operational
 Thus, there is a need for purposely a designed Shari’ah audit
programme to ensure reasonable assurance of shari’ah compliance
for Islamic banking activities
 Shari’ah audit will include auditing and assurance processes for
products, transactions, disbursements of financing, profit
distribution, policy for depositors, penalty charges, accounting
recognition and measurement and as well as financial reporting etc
 Thus, Shari’ah auditors need to be well trained in Shari’ah, auditing,
accounting etc
 So far, we don’t have educational and professional training
programme to develop and produce Shari’ah auditors
The Importance of Shariah Audit
• To enhance shareholders’ value and confidence of
the stakeholders. If stakeholders are suspicious of
Shari’ah compliance, it will seriously affect the
integrity of Islamic finance
• To reduce Shari’ah non-compliance risks through
adequate systems and controls
• To ensure compliance with the Shari’ah rules ie.
Rulings and fatwas of the SSC are implemented
throughout the financial institutions.
• To monitor the Shari’ah risk management system
and internal control that should supplement the
external and internal Shari’ah audit requirements
Shariah Governance Framework -
 Adopted on 1 January 2011, Shari’ah Governance
Framework (SGF) for Islamic financial institutions
(IFIs) supersedes the Guidelines on
the Governance of Shari’ah Committees of IFIs
introduced by Bank Negara Malaysia (BNM), the
central bank, in 2004
 According to the Malaysian central bank, the primary
objective of the SGF is to enhance “the role of the
Board, the Shariah committee and the management in
relation to Shariah matters, including enhancing the
relevant key organs having the responsibility to
execute the Shariah compliance and research
functions aimed at the attainment of a Shariah-based
operating environment.”
Shariah Governance Framework -
A Key of SGF is the Shariah Audit
 Provides assurance to stakeholders independently
by ensuring conformance with Shari’ah including
products and services offered by IFIs and Takaful
 Performed by internal auditor who have adequate
Shari’ah related knowledge and skills – to ensure
a sound and effective internal controls system of
Shari’ah compliance
 May engage the expertise of the IFI’s Shari’ah
officers in performing the audit, as long as the
objectivity of the audit is not compromised
 Also can appoint external party to conduct
Shari’ah audit
Shariah Review
 According to Shari’ah Governance Framework issued
by Bank Negara Malaysia, Shari’ah review function
refers to regular assessment of Shari’ah compliance in
the activities and operations of the Islamic banks, with
the objective to ensure that the activities and
operations carried out by the Islamic banks do not
contravene with Shari’ah
 The function involves examining and evaluating the
Islamic banks’ level of compliance to Shari’ah, remedial
rectification measures to resolve non-compliances
and control mechanism to avoid recurrences
 The scope covers the business operations, including
end to end product development process from pre-
product approval to post product approval process
Shariah Audit
 Shari’ah audit refers to the periodical
assessment conducted from time to time,
to provide an independent assessment
and objective assurance designed to add
value and improve the Islamic bank’s
compliance, with its main objective in
ensuring a sound and effective internal
control system for Shari’ah compliance
Illustration 1: Murabahah
 Audit the terms and conditions
Auditing Murabahah
Illustration 2: Takaful Model
Illustration 2: Takaful Model
Takaful Shariah Audit
Scope Objectives References Types of
Segregation of Funds To ensure the takaful TOF 9.1; IFSA
operators to segregate the Division 6, no.
assets of the takaful fund from 91;
the assets of the takaful

To ensure within the takaful TOF 9.1

funds, takaful operators
maintain separate takaful
funds in respect of family
takaful business and general
takaful business.
Takaful Shariah Audit
Scope Objectives References Types of Risk
Management of To ensure that parties connected TOF 10.2
Takaful Funds to the business operations are
Operations competent and well trained to
perform their functions.

To ensure TO, in the marketing TOF 10.2

and sales process, be responsible
to establish appropriate
procedures for their respective
distribution channels, placing
strong emphasis on good
marketing ethics, conduct, and
Exam Tips
 4 questions – 25 marks each
 Section A – Choose ONE from two
 Section B – Choose THREE from four
 Theory, calculations, accounting
treatment, financial statements
 2.5 hours
 Life begins at 40.
 One’s life has not began unless your heart
truly knows Allah.
 Life is short (60 – 80 yrs on average),
Afterlife is eternity.
 Settle your liabilities by 40 and FOCUS
on preparation for the afterlife.

 Continue doing what you do best for the
benefits of Ummah, for the sake of Allah.
 Never stop learning – Fardhu Ain and
 Doa: