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Financial reporting of Islamic financial institutions: The rationale, the present, and the future In early 2015, the Asian-Oceanian Standard-Setters Group (AOSSG) Islamic Finance Working Group published a study report that was prepared based on their review of the financial statements of 132 Islamic financial institutions in 31 countries. One of the objectives of the study was to determine the financial reporting standards that Islamic financial institutions are legally required to comply with. MEZBAH UDDIN AHMED explores. The study identified that 38% or 50 Islamic financial institutions apply a differential requirement for the financial reporting of Islamic financial transactions, whereas 60% or 80 Islamic financial institutions do not apply a differential requirement. About 2% or two Islamic financial institutions did not specify the accounting standards that they apply. From the findings of the AOSSG study, it is evident that the Islamic finance world is divided in the financial reporting of Islamic financial transactions, primarily between the International Financial Reporting Standards (IFRS) and the AAOIFI Financial Accounting Standards (FAS). The IFRS are developed by the International Accounting Standards Board (IASB). The mission of the IASB is to develop a set of standards that bring transparency, accountability and efficiency
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to global financial markets. Currently, 116 jurisdictions mandate the IFRS for all or most domestic publicly accountable entities. The IFRS currently have become the de facto global standard for financial reporting. Amid the wide acceptance of the IFRS by the majority of the countries in the world, the rationale given by AAOIFI in developing a separate set of accounting standards for Islamic financial institutions is that Islamic financial institutions need to demonstrate to the common users of general purpose financial statements that Islamic financial institutions comply with the principles and rules of Shariah in their financial and other dealings. Financial statements as a language of the business may give a wrong signal to users if financial statements of Islamic financial institutions mimic the financial statements of
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conventional financial institutions. The relationship between Islamic financial institutions and their clients differ from the relationship between conventional financial institutions and their clients. Islamic financial institutions primarily engage with their clients in trade (for example, Murabahah) and partnership (for example, Mudarabah)-based arrangements, whereas conventional financial institutions engage only in interestbearing lending and borrowing arrangements. The information needs of users of the financial statements of Islamic financial institutions are also unique in the sense that the financial statements of Islamic financial institutions need to provide information which can assist users in evaluating the Islamic financial institution’s compliance with the principles of Shariah. The financial statements should also provide information regarding the manner in which any prohibited earnings and expenditures were recorded and dealt with. The IFRS do not stipulate any specific recognition, measurement, or disclosure requirement pertinent to these matters that may result in differences in practice across the IFRS regime and with the jurisdictions that adopted the AAOIFI FAS. However, a full adoption of the AAOIFI FAS is also not the complete solution at the current stage. Unlike the IFRS, the coverage of the AAOIFI FAS is not extensive and the standards deal only with a few Islamic financial contracts. Hence, those who apply the AAOIFI FAS, also apply the IFRS for the financial reporting of activities that are not covered by AAOIFI.
With the differences between the IFRS and the AAOIFI FAS in concepts and in requirements, the like-for-like, cross-border comparison may remain as a challenge Review of 2015 In bridging the gap between conventional and Islamic-based financial reporting, the IASB has formed a Consultative Group on Shariah Compliant Instruments and Transactions. The IASB Consultative Group intends to focus on challenges that may arise in the application of the IFRS in the financial reporting of common Islamic financial instruments and transactions and to invite papers on those challenges and to make recommendations about steps that the IASB might take. In December 2014, AAOIFI accepted the membership of this IASB Consultative Group, and in April 2015. AAOIFI and the IASB held an outreach meeting with the international Islamic finance industry in Bahrain. The meeting was attended by 50 participants from over 15 countries. The meeting was a step toward strengthening cooperation between AAOIFI and the IASB toward a better understanding of issues relating to the financial reporting of Islamic financial institutions and reducing the gap between the two sets of standards.
Table 1: Jurisdictions where Islamic financial institutions apply AAOIFI FAS or other Shariah-based accounting standards Bahrain
Mauritius
Bangladesh
Oman
Egypt
Pakistan
Indonesia
Qatar
Jordan
Sudan
Lebanon
Yemen
Table 2: Jurisdictions where Islamic financial institutions apply IFRS or other accounting standards without a differential treatment for Islamic financial transactions Albania
Kuwait
Thailand
Australia
Malaysia
Turkey
Bosnia
the Philippines
the UAE
Brunei
Saudi Arabia
the UK
India
South Africa
the US
Iran
Sri Lanka
Kazakhstan
Switzerland
also not announced any joint work plan toward harmonization that may reduce financial reporting differences among Islamic financial institutions around the world.
Conclusion The objective of global standard-setters is to help users of financial statements by providing the ability to compare the financial performance of publicly responsible companies on a like-for-like basis with their international peers. With the differences between the IFRS and the AAOIFI FAS in concepts and in requirements, the like-for-like, cross-border comparison may remain as a challenge. While we may hope for a single set of globally accepted financial reporting standards for Islamic financial institutions in the future, as experience dictates, the development process of new standards may require a number of years to complete. Considering the rapid growth of the global Islamic finance industry and the pressing need, at the initial stage the IASB Consultative Group can prioritize the projects that can be completed sooner. Developing standards on disclosure requirements for Islamic financial institutions can be a consulting good start. www.IslamicFinanceConsulting.com www.IslamicFinanceEvents.com www.IslamicFinanceNews.com
www.IslamicFinanceTraining.com www.MIFforum.com
Mezbah Uddin Ahmed is a member of the Association of Chartered Certified Accountants (ACCA) and holds the AAOIFI Certified Islamic Professional Accountant (CIPA) qualification. Currently, he is working as a research officer at the International Shariah Research Academy (ISRA). He can be contacted at
[email protected]. www.MIFmonthly.com www.MIFtraining.com
www.REDmoneyBooks.com
Preview of 2016 The IASB Consultative Group currently calls for papers to determine whether some or all of the Islamic products are classified at amortised cost. If the answer is ‘yes’, then on what basis? If the answer is ‘no’, what steps, if any, can the IASB take to clarify the classification of these contracts or to amend IFRS 9 Financial Instruments? However, the IASB Consultative Group has not laid down any timeline for the completion of the project and also has not announced the agendas to be added in the near future. Both the IASB and AAOIFI have
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