Role of Audit in

Islamic Banking and Finance

Abdur Rashid Mirza

University of Lahore
School of Accountancy and Finance
Lecture no.10
Corporate Governance Transparency and Risk
Management
Types of auditing and review
 Sharī`ah Supervisory Board (“SSB”)

 SSB is a specific organ of governance. It should be

concerned with monitoring Shariah compliance
and not just issuing fatwas.
 Since SSB members may lack monitoring skills, auditors
and audit committee should act in concert to assist SSB.
 Transparency in Financial
Reporting
The current financial reporting practices do not provide adequate
information to their IAH regarding the revenues and expenses
accruing to their particular investment fund
IAH is rightfully entitled to transparency, e.g. calculation of Muḍārib
share and profit allocation
Financial Statement Audit
• International Standards on Auditing (ISA), 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”.
 Audit Definition
Broader definition of audit
“a systematic process of objectively obtaining
and evaluating evidence regarding
declarations about economic actions and
events to establish the degree of
correspondence between those declarations
and established criteria and communicating
the results to interested users” (Committee on
Basic Auditing Concepts [COBAC], 1972: 2)
 Comparison between conventional and islamic auditing
Element Conventional Audit Islamic Auditing

3 party relationship Entity, auditor, user Entity, auditor and broader

range of users
Subject matter Financial statement Processes, contracts,
declarations personnel, systems,
performance, financial
statements
Suitable criteria IFRS Shari’a principles and rules,
aaoifi standards and
appropriate parts of IFRS

Sufficient Sufficient and appropriate Fatwas of international and

appropriate evidence national fiqh boards, plus all
evidence other conventional evidence

Written assurance Standard audit report A more detailed report

report prepared by auditor prepared by a shari’a
auditor
 Evolution of Auditing

Social &
Financial Audit Performance Audit Shari’ah Audit
Environmental Audit

Every aspect of
Economy, Social contribution & organization’s
Financial effectiveness and environmental activities as required
statements efficiency of resource compliance by Islamic religiious
utilization, programs teaching
& activities

Late 1800s/1900s 1960s/1970s 1970s 2000s

Need for shariah auditing research


 The advanced development of Islamic financial
industry necessitates for an auditing mechanism
which can fulfill the unique requirements of the
industry
 Shariah auditing definition
According to AAOIFI,
Shari’a review 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, transactions, memorandum and articles of
association, financial statements, reports (especially
internal audit and central bank inspection), circulars,
etc. The objective of a Shari’a review is to ensure that
the activities carried out by an IFI do not contravene the
Shari’a.

• The AAOIFI definition is broad “in all its activities”

• It uses the word “review” instead of the word audit
• Perhaps in the beginning this is better than a full scale audit,
however, the scope in AAOIFI is quite broad
 Shariah auditing standards
In the conventional accounting world, the IAASB develops
International standards on auditing and assurance services and
these are pretty established and accepted globally
In the case of shariah auditing, the Accounting and Auditing
Association for Islamic Financial Institutions (AAOIFI ) has a
set of standards both for conventional and shariah auditing of IFIs.
The shariah auditing standards were reclassified as Governance
standards. These are :
Shari’a Supervisory Board: Appointment, Composition and Report
Shari’a Review
Internal Shari’a Review
Audit and Governance Committee for Islamic Financial Institutions
Independence of Shari’a Supervisory Board (new)
Statement on Governance Principles for Islamic Financial Institutions (new)
Corporate Social Responsibility (under development)
 A unique corporate governance mechanism of Islamic financial
Institutions is the shari’a supervisory board (SSB) which is
theoretically an independent external body similar to external
auditors.
 Consisting of at least 3 scholars in fiqh muamalat, who may be
supported by experts in Islamic banking with knowledge of fiqh
muamalat- problem may not have accounting or auditing expertise
 The board is supposed to direct, supervise and review the activities
of the Islamic Financial Institution to ensure shari’a compliance in all
its activities.
 The SSB is known under various names
◦ In Malaysia, Bank Negara calls it shari’a committee, although Bank Islam Malaysia
Bhd., uses the term Shariah Supervisory Council,
◦ whereas Meezan Bank of Pakistan has both a Shari’a Advisor (who issued the Shari’a
Report) and a SSB,
◦ Shamil Bank of Bahrain uses Religious Supervisory Board,
◦ and al Baraka Bank uses the term Shari’a Board.
 Who should Conduct Shari’ah Audit?

New
Professionals
called
Shari’ah
auditors??

Internal
External Shari’ah auditors
Islamic Supervisory
Financial under
Jurists Board??
auditors?? supervision
(Ulama)?
of SSB??
 Qualification & Competence
Requirements
Degree/Professional
qualification in accounting
and specialized certification
in Shari’ah audit??

Degree/Professional
? Degree/Professional
qualification in
accounting & Fiqh qualification in
(Islamic Law)?? accounting??

Trax Associates, Sept 2003

 Scope of Shari’ah Audit
Business
Processes &
Policies??
Human Procedures??
resource
Management??

Zakat calculation
Scope of
& payment??
Marketing & Shari’ah
advertising??
Audit

Social Contracts &

contribution?? agreements??

Environmental
impact of
operation??
 To What Extent & When Should Shari’ah
Audit be Performed?

To what extent? When?

Every single activity? Throughout financial

To the extent deemed year?
satisfactory by the During new product
auditors? application?
Using sampling method? At the end of financial
year?
 IFSB PRINCIPLES OF CORPORATE GOVERNANCE

Principle 1.1
Shall establish a comprehensive governance policy
framework which sets out the strategic roles and
functions of each organs of governance and
mechanisms for balancing their accountabilities to
various stakeholders.
IFSB PRINCIPLES OF CORPORATE GOVERNANCE

Principle 1.2
Shall ensure that the reporting of their financial and
non-financial information meets the requirements of
internationally recognised accounting standards
which are in compliance with Shariah rules and
principles and are applicable to the Islamic financial
services industry as recognised by the supervisory
authorities.
 IFSB PRINCIPLES OF CORPORATE
GOVERNANCE

Principle 2.1
Shall acknowledge the IAH’s rights to monitor the
performance of their investments and the
associated risks, and put into place adequate means
to ensure that these rights are observed and
exercised.
 IFSB PRINCIPLES OF CORPORATE
GOVERNANCE

Principle 2.2
Shall adopt a sound investment strategy which is
appropriately aligned to the risk and return
expectations of IAH (bearing in mind the distinction
between restricted and unrestricted IAH), and be
transparent in smoothing any returns.
 IFSB PRINCIPLES OF CORPORATE
GOVERNANCE

Principle 3.1
Shall have in place an appropriate mechanism for
obtaining Shariah rulings, application of fatwas
and monitoring of Shariah compliance in all
aspects of their products and operations.
 IFSB PRINCIPLES OF CORPORATE
GOVERNANCE

Principle 3.2
Sshall comply with the Shariah rules and principles
as expressed in the rulings of the Shariah scholars and
shall make these rules and principles available to
the public.
 IFSB PRINCIPLES OF CORPORATE GOVERNANCE

Principle 4.1
Shall make adequate and timely disclosure to IAH
and the public, of material and relevant information
on the investment accounts that they manage.
The End

Wassalamu’alaikum
Thank You!