ISLAMIC ACCOUNTING &

FINANCE

Accounting concepts from an

Islamic perspective

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Conventional Accounting Concepts
 Usually accounting deals with three
functions:
• Recognition
• Measurement
• Presentation/disclosure
 The elements of financial statements
are:
• Assets, liabilities, revenue, expenses &
equity.

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Conventional Accounting Concepts
 Recognition is to test whether the
elements of financial statements has
taken place.
• Recognition deals with timing of the
financial events.
 Measurement is the amount at which
the element is to be recorded.
 Presentation is how the financial
event or transaction is disclosed in
the financial statements.
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 Assumptions, principles, concepts
and practices
 Three basic assumption to be applied for
preparing and presentation of financial
statements:
• Accruals
• Periodicity
• Going concern
Accruals
 Accruals is the basis of accounting to
recognize business transactions and
events. Transactions are recognized &
recorded when they occur.
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 Assumptions, principles, concepts
and practices
Periodicity
 Periodic reports of financial positions
as of a given date, and divided into
reporting periods (normally annual)
• Accounting for zakat based on “haul”
(one year complete ownership)
Going concern
 Contracts assumed to continue until
there is evidence to the contrary.
• The business has no intention to liquidate or
cease its operation
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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting recognition:
 It refers to recording the basic
elements of financial statements.
 It is to determine the timing of the
revenue, expenses, gains and loss
recognition in the statements.
 AAOIFI –SFA 2, recommends that
“revenue should be recognized when
realized”.
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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting recognition:
 Realization of revenue shall take place
if one of the following is met:
• The entity has the right to receive the
revenue.
• There is an obligation on the part of
another party to remit, and
• The amount of revenue should be known
and collectible with reasonable degree of
certainty.
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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting recognition:
 These 3 conditions indicate the use of
accrual basis accounting.
• Accrual basis of income recognition does
meet the requirement of Islamic objectives
as it aims to measure the real wealth of an
entity.
• Cash basis most likely provides
underestimate value of wealth as recognition
is based on actual cash received and paid.

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An Islamic assessment of the main
assumptions, principles & concepts
Accounting basis and Shariah:
• Shariah jurists have determined that cash
basis of accounting to be a mode of
practices to account for Islamic
transactions in the past.
• Because the “recognition time” of the
income is important for the distribution of
business profit.
• Cash basis is not appropriate to the
requirements of the most Islamic business
contracts, such as; mudarabah and
musharakah.
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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting basis and Shariah:
 Some IFIs use modified cash basis is
practiced (e.g. Malaysia)
 Even though modern business
transactions are mainly based on
accrual basis, however, adopting both
cash basis & accrual basis are
permissible with the condition that
unrealized profit cannot be distributed.

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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting basis and Shariah:
 As practiced by IFIs in Malaysia, if cash
basis is used, the necessary financial
info must be disclosed in the notes of
financial statements.

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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting Measurement:
 In CA, Accounting measurement is
based on the cost concept that
considers the acquisition cost.
 From Islamic point of view, this
historical concept is questionable due to
its limitation.
 For the purpose of zakat calculation,
zakatable wealth is valued at the
current (or market) price at the due
date. 12
 An Islamic assessment of the main
assumptions, principles & concepts
Accounting Measurement:
 Valuation of assets at HC, is derived
from the concept of conservatism.
 Conservatism concept conflicts with
the needs of the Muslims to their zakat
be calculated accurately.
 Adoption of these CA concepts may
lead to the under/over –statement of
assets which in turn may affect the
zakatable wealth & zakat amount.
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 An Islamic assessment of the main
assumptions, principles & concepts
Accounting Measurement:
 Zakat for trade is normally determined
on the current market price (or cash
equivalent value).
 So, the HC concept may create
measurement problems in the context
of zakat management.
 AAOIFI recommends the cash
equivalent value for the assets sold by
cash.
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 An Islamic assessment of the main
assumptions, principles & concepts
 However, AAOIFI asserts that
measurement should be guided by the
qualitative characteristics of:
 Relevance
 Reliability, and
 Comparability
 Consistency
 Understandability
 ….of the information provided to the
information users.
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 Desirable Characteristics of
Accounting Information
1. RELEVANCE
 Predictive Value (ability to predict

potential outcome)
 Feedback Value (ability to verify the

accuracy of prior prediction)

 Timeliness (available as soon as after the

reported events)

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 Desirable Characteristics of
Accounting Information
2. RELIABILITY
 Representational faithfulness
(information reflect what it purports to
present)
 Objectivity (measurement and disclosure
appropriately used and if replicated by
independent person gives the same result)
 Neutrality (accounting information
directed towards common needs of users
and not needs of particular group of users)

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 Desirable Characteristics of
Accounting Information
3. COMPARABILITY
• Able to make comparison of the entity’s
performance and position over time and
with other similar institutions.
4. CONSISTENCY
• Consistent in applying accounting
measurement, valuation and disclosure
methods from one period to another

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 Desirable Characteristics of
Accounting Information
5. Understandability
 Aware of the abilities and limitations of

those for whom accounting information is

provided

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An Islamic assessment of the main
assumptions, principles & concepts
Accounting Disclosure
 There are at least 4 objectives of
accounting disclosure for an Islamic firm.
• Avoid Riba,
• Pay zakat
• Social Accountability, and
• Full disclosure

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 Juridical Meaning of Riba
 Literally means excess, increase, expansion,
growth.
• Hanafi’s School: A surplus of commodity or an
excess in return without counter value
• Riba is a predetermined excess or surplus over
and above the loan received by the creditor
conditionally in relation to a specified time
period
 Riba was made forbidden in the 8th or 9th
year after the Hijrah (flight from Makkah)

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An Islamic assessment of the main
assumptions, principles & concepts
 Zakat is the spiritual purification resulting
from giving zakat. It is the transfer of
ownership of specific wealth to specific
individual or individuals under specific
conditions.
 Islamic concept of social
responsibility encompasses the
accountability ultimately to ALLAH.
• The wealth is made available to
individuals in a form of trust.
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An Islamic assessment of the main
assumptions, principles & concepts
 The success of the individuals in the life of
hereafter depends on their performance in
this world.
 The concept of social responsibility is
related to the concept of full disclosure .
 Full disclosure does not mean to disclose
everything down to every minute detail of
transactions.
 … adequate disclosure is required. It is to
provide sufficient details to meet the users
needs for decision making.
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