Conceptual Framework for

Financial Reporting by Islamic

Financial Institutions
ACCT 202 – Theory and Concepts of
Accounting – Islamic Perspective
 Introduction
Reason for development of the Conceptual Framework is
to:
• Establish a common framework for accounting and
financial reporting.
• Demonstrate to the users as to compliance of the
Compliance with Sharia
entities with principles and rules of the Sharia in their Common
Relationship
Framework
financial and other dealings
• Relationship between Islamic Financial Institutions and
the parties differs from those who deals with
Conventional entities.
 Importance of establishing the conceptual
framework
• It helps in better understanding of accounting information
• Harmonization in selecting the appropriate accounting treatment;
• Guidance for development of future accounting standards;
• Assists in dealing with transactions, events, etc. not dealt with by financial
accounting standard developed by AAOIFI;
• Assists users of financial reports in interpreting the financial information;
• Assists national standard setting bodies in developing standards;
• Provides information about approach to formulating financial accounting standards
 The approach used in developing the
conceptual framework
• Identification of accounting concepts consistent with Islamic principles;
• Identification of aspects that require disclosure and greater transparency;
• Identification and development of new relevant concepts for the purpose of
reporting by IFIs;
• Development of concepts to address the unique nature of certain transactions or
events.
• Identification of the major users to obtain access to information not included in
general purpose financial reports;
• Determination of the information needs of the user of financial information.
 Users of financial information
The information needs of users of financial reports increase and vary with the increase
in the categories of users, for example, investors including equity and investment
accountholders
• Information which can assist in evaluating the IFI's compliance with the principles of
shari’a;
• Information which can assist the user in assessing the risks associated with the IFIs;
• Information which can assist in evaluating the IFI's ability in:
• Using the economic resources available
• Carrying out its social responsibilities
• Providing for the economic needs
• Maintaining liquidity at appropriate levels

• Information which can those employed by the IFI in evaluating their relationship and
future.
 Objectives of Financial Accounting and
Financial Reports for IFIs
• To determine the rights and obligations of all interested parties;
• To contribute to the enhancement of the managerial and productive capabilities of the
IFI and encourage compliance with shari’a;
• To provide useful information to the users through financial reports;
• Information about the IFI's compliance with the shari’a;
• Information regarding the way in which prohibited earnings and expenditures, if any, were
recorded and dealt with;
• Assist in the determination of zakah;
• Information about the IFI's discharge of its fiduciary responsibilities
• Information about the IFI's discharge of its social responsibilities
 Limitations of financial information
• Unable to produce information to assist in the evaluation of the IFI's ability to achieve
objectives;
• Financial accounting does not differentiate, through its processes, between the IFI's
performance and that of its management.
• Financial information is historical in nature which may or may not be indicative of the
future.
• Financial reporting information is based on estimates, judgments and models of the
financial effects.

Factors beyond
Achievement of Historic Use of Estimates
management
Objectives information and Judgements
control
 Financial Reports and Process
Reports which are intended to provide for the common financial information needs of
external users could be divided into the following two broad categories:
• General Purpose: Those that are currently produced in the form of financial statements
and related notes.
• Special Purpose: Those that are produced for a specific purpose and targeted at
identified users.
Elements of Financial Statements
 Financial Accounting Process, Recognition,
Measurement Concepts and Accounting
Assumptions

RECOGNITION MEASUREMENT PRESENTATION REPORTING

Qualitative Characteristics of Accounting
Information

True and Fair Decision-useful Transparent High Quality

 Qualitative Characteristics of Accounting
Information
Reliability:
Users of financial accounting information prefer
that such information has a high degree of
reliability. Reliability is the characteristic which
permits users to depend upon information with
confidence.
Neutrality:
The accounting information should serve the
common information needs of its users without
bias or unfair information advantage given to one
group of users at the expense of others. Lack of
neutrality affects the reliability of accounting
information.
Representational faithfulness:
The information should reflect a faithful
representation of what it purports to represent.
That is there is close correspondence between
such information and reality.
Substance and form:
If information is to represent faithfully the
transactions and other events that it purports to
represent, it is necessary that they are accounted
for and presented in accordance with its
substance and economic reality as well as the
legal form.
 Qualitative Characteristics of Accounting
Information
Completeness:
To be reliable, the information in the financial
reports must be complete within the bounds of
materiality and cost.
Consistency:
An IFI should be consistent in its application of
accounting measurement and disclosure methods
from one period to another. However, this does
not mean that the IFI should keep using the same
measurement and disclosure methods for the
same transaction if there is a genuine reason to
use other methods.
Verifiability:
Verifiability is the quality of information that
helps assure users that information faithfully
represents the economic phenomena that it
purports to represent.
Prudence:
Prudence is the inclusion of a degree of caution
in the exercise of the judgments needed in
making the estimates required under conditions
of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not
understated.
 Preparation and Presentation of Accounting
Information

Providing useful Inherent importance of Inherent importance of The amount of the item The magnitude of the
financial reporting the transaction, event or the item as an indicator relative to normal item in relation to an
information is limited circumstance of probable course of expectations; appropriate base.
by two pervasive future events;
constraints, materiality
and cost.
Financial Accounting Standard 1 -
General Presentation and Disclosure
in the Financial Statements of
Islamic Banks and Financial
Institutions
ACCT 202 – Theory and Concepts of
Accounting – Islamic Perspective
 General Provisions
A statement of financial position (balance sheet)

An income statement

A statement of cash flows

Statement of changes in owners' equity or a statement of retained

earnings

A statement of changes in restricted investment

Statement of sources and uses of funds in the Zakah and charity

Statement of sources and uses of funds in the Qard fund Financial

statements
Any statements, reports and other data which assist in providing
information
 General Disclosures in the Financial Statements
Adequate disclosure of material
information:
All material information that is necessary to
make those financial statements adequate,
relevant and reliable for their users.
Disclosure of significant accounting
policies:
Accounting policies refer to the accounting
principles, bases, rules and methods which have
been adopted by the Islamic bank's management
for the preparation and publication of the
financial statements.
Disclosure of the currency used for accounting
measurement:
• Currency used for accounting measurement.
• The accounting method used for translating
foreign currency balances and transactions.
Disclosure of earnings or expenditures
prohibited by Shari’a:
The financial statements should disclose the
amount and nature of earnings that have been
realized from sources or by means which are not
permitted by Shari’a.
 General Disclosures in the Financial Statements
Disclosures of concentrations of asset risks
• An economic sector (e.g., the agriculture sector, the service sector, the manufacturing sector, the
real estate sector, etc.);
• A customer, including another bank or a financial institution without stating the customer's name;
• A domestic geographical area with unique economic characteristics;
• Foreign countries.

Disclosure of contingencies: Disclosure of compensating balances

Disclosure should be made in the financial
statements of contingencies existing as of the
Statement of Financial Position date including
those resulting from the issuance of letters of
credit or guaranty, documentary credit and
similar instruments.
Disclosure should be made in the financial
statements of any amounts the Islamic bank is
obligated to deposit with others as compensating
balances.
 Disclosure of accounting changes
Change in an accounting policy
1) Description of the change and its justification
2) Effect of the change on net income for the current period and prior periods

Change in a non-routine accounting estimate

3) Description of the change and the reasons thereof
4) Effect of the change on net income or profits

Correction of an error in prior period financial statements

5) Nature of the error and the prior period(s)
6) Effect of the error correction on net income or profits (losses)
 Related parties
a) Members of the Islamic banks board of directors
b) Relatives of those mentioned in (a) above to the second degree
c) Entity which directly or indirectly owns
d) Any entity in which any person in (a), (b) or (c) above either directly or indirectly
e) Subsidiaries and other affiliates of the Islamic bank
f) Entity in which the Islamic bank directly or indirectly
 Disclosures in the Statement of Financial Position
The date of statement of financial position
The statement of financial position should include the
Islamic bank's assets, its liabilities, equity of its
unrestricted investment accountholders and their
equivalent, and its owners' equity.
Assets should not be set-off against liabilities and
liabilities should not be set-off against assets
Assets and liabilities should not be classified between
current and non-current.
Receivables shall be categorized as Murabaha
receivables, Salmi receivables and Istisnia receivables.
Disclosure should be made of the net realizable value of
an asset if such value is less than the asset's recorded
amount.
Significant items of assets, liabilities, unrestricted
investment accounts and their equivalent or owner's
equity should not be combined on the face of the
statement of financial position without disclosure.
Disclosure should be made of the historical cost of assets
or the historical amounts of liabilities.
A consolidated statement of financial position should
disclose the minority interest and that interest should be
shown on the statement as a separate item between
unrestricted investment accounts and owner's equity.
separate disclosures of assets jointly financed by the
Islamic bank and unrestricted investment accountholders
and those exclusively financed by the Islamic bank.
 Disclosures in the Income Statement
The period covered by the income statement should be
disclosed.
Investment revenues, expenses, gains and losses should
be disclosed by type.
The nature of material revenues, expenses, gains and
losses from other activities should be disclosed.
Where applicable, estimated gains and losses from the
revaluation of assets and liabilities to their cash
equivalent values should be disclosed
Revenues and gains from investments
Income / (loss) from investments.
Expenses and losses from investments.
Net income (loss) before Zakah and taxes.
Net income / (loss).
The minority interest.
The Islamic bank's share in income / (loss) from
investments.
The Islamic bank's share in unrestricted investment
income as a Mudarib.
The Islamic bank's share in restricted investment profits
as a Mudarib.
Share of unrestricted investment accountholders in
income / (loss) from investments before the bank's share
as a Mudarib.
The Islamic bank's fixed fee as an investment agent for
restricted investments.
Other revenues, expenses, gains, and losses.
General and administrative expenses.
Zakah and taxes (to be separately disclosed).
The Zakah base should be disclosed whenever the
Islamic bank is obligated to pay such Zakah on behalf of
all owners.
 Disclosures in the Statement of Cash flows
The period covered by the statement should be disclosed.
The statement of cash flows should disclose the net
increase / (decrease) in cash and cash equivalent
The Islamic bank's policy with respect to the components
of cash and cash equivalent used as a basis for the
preparation of the statement of cash flows should be
disclosed.
The statement of cash flows should differentiate between
cash flows from operations, cash flows from investing
activities and cash flows from financing activities.
Transactions and other transfers that do not require the
payment of or do not result in the receipt of cash and
cash equivalent should be disclosed.
The Islamic bank's share in restricted investment profits
as a Mudarib.
 Disclosures in the Statement of changes in owners'
equity or statement of retained earnings
The period covered by the statement of changes in Paid-in-capital, legal and discretionary reserves
owners' equity or the statement of retained earnings separately, and retained earnings as of the beginning and
should be disclosed. end of the period with separate disclosure.
Capital contribution by owners during the period. Net income / (loss) for the period.
Distributions to owners during the period. Increase / (decrease) in legal and discretionary reserves
during the period.
 Disclosures in the Statement of sources and uses of
funds in the Zakah and charity fund
The period covered by the statement of sources and uses
of funds in the Zakah and charity fund should be
disclosed.
Other sources of funds in the Zakah and charity fund
should be disclosed.
Disclosure should be made of the Islamic bank's
responsibility for the payment of Zakah and whether the
bank collects and pays Zakah on behalf of owners of
unrestricted investment accountholders.
Disclosure should be made of the funds paid by the
Islamic bank from the Zakah and charity
 Disclosures in the Statement of sources and uses of
funds in the Qard fund
The period covered by the statement of sources and uses
of funds in the Qard fund should be disclosed.
The amounts and sources of funds contributed to the
fund during the period should be disclosed by source.
The balances of Qard outstanding and funds available in
the fund at the beginning of the period should be
disclosed by type.
The amounts and uses of funds during the period should
be disclosed by type.
 Treatment of Changes in Accounting Policies
1. Balance of retained earnings at the beginning of the first period presented should be adjusted
2. Disclosure should be made as to whether prior periods presented have been restated to reflect the
effect of the change in an accounting policy on unrestricted investment accounts owners' share in
income / (loss)
3. The effects of multiple changes in accounting policies should not be netted and should be
disclosed separately
4. A change in accounting policy should be disclosed even when its effect is not material either in
the current or prior periods
 Treatment of Changes in Non-Routine Accounting
Estimates
The effect of a change in a non-routine accounting estimate should be reflected in:
a) The period of the change if the effect of the change is limited to that period.
b) The period of the change and future periods if the change affects the current and future periods.
Treatment of Correction of an Error in Prior Period
Financial Statements
An error in prior period financial statements should be corrected retroactively by restating the
financial statements for all prior periods presented which have been affected by the error.
• Disclosure should be made as to whether such an error affects the rights and obligations of the
Islamic bank towards others.
• Retained earnings at the beginning of the first period presented should be adjusted to reflect the
cumulative effect of the correction of the error on the periods