islamic2

1.0 Introduction

Consumers are discussed in the context of the marketplace; however, with globalisation, the scope of the marketplace has now expanded beyond the traditional boundaries, diffusing national borders and making the world a more approachable market. Similarly, keen investors are going global, looking for opportunities not just in their home countries but also in the economies where laws are flexible and a reasonable accord for their investments is promised. Strategic managers are now strategizing not just to expand into international markets but also to plan opportunities for investors to attract individuals from around the world. However, if all investors understood the same language, interpreting investment opportunities would be easier. Financial records, accounting treatments and valuations of companies would be easily understandable and comparable. However, the world is not an ideal place, and neither are the accounting treatments around the world; they vary across industries, countries and regions.

The following paper is aimed at highlighting the need to harmonise accounting treatments in light of the International Financial Reporting Standards (IFRS) and the International Accounting Standards (IAS). This paper will briefly introduce the procedures adapted by respective bodies to formulate standards, followed by a discussion of the limitations that restrict the successful harmonisation of these two sources of accounting standards.

Accounting is of paramount importance as it binds together the financial insight of each business process and conclusively presents the financial position of a company at any moment in time (Archer et al. 2013). However, accounting treatments have been developed in response to the expectations and requirements of the business and other related parties who influence the business directly or indirectly. The development of standards in response to expectations are rather inspirational; norms and practices have been formalised and then scrutinised with real-life applications.

The need for standardised accounting treatments across the globe will lead to more meaningful financial comparisons and will allow international benchmarks to be set for multi-national corporations to succeed. The need for redoing financial statements will be eliminated, saving many operational costs and a lot more confusion (Beke, 2013). Apart from attaining comparability, standardised accounting treatments will strengthen the ability to understand and allow space for foreign investments to flow across country borders. Consolidation will be much easier in this case, providing less room for manipulation and higher cost savings due to the reduced technicality of the work (Vinnicombe, 2012). The varying applications of accounting standards add to the confusion of investors; they ask for an absolute understanding of the applied standards, which may then be questioned for credibility, undermining the confusion caused by contradictions. Consistency in forming accounting standards and follow up in the international community will strengthen investor faith regarding financial statements being prepared in accordance with these standards (Beke, 2010). However, several streams demonstrate appropriate accounting procedures, forming standards that are applicable under certain conditions.

Harmonisation may save costs but it is expensive to achieve. The development of a standardised treatment will lead to changes throughout the world, involving a lot of confusion and plenty of room for manipulation. Changing practices is not easy; there are economic, political, legal, social and cultural aspects that play important roles (Archer et al., 2013). For instance, taxation incentives play their role in the determination of a company’s accounting quality. Islamic institutions do not allow riba (interest) to run through their systems; they account for investments on different grounds (Ahmed & Karim, 2011).

The International Accounting Standards Board (IASB), formed in 2001, offers IFRS and IAS that provide guidelines for the accounting treatments of economic and social activities, which are generally applicable to every industry. The International Accounting Standards Committee (IASC) oversees the operation of the body and it maintains governance of the activities the body undertakes while arranging for funding. The objective of the IASB remains to provide understandable, comparable and verifiable accounting treatments that maintain relevance and faithfulness to the financial representation (IFRS, 2014).

IASB supervises the overall process of IFRS drafting and formation. Any issues regarding the current standards or previously undisclosed areas are presented in an exposure draft that is openly discussed in the IASB meetings (IFRS, 2014). Following the comments from international delegates and members, the board reconsiders the issue in light of raised concerns to understand if the current standards appropriately address the issues. Once a consensus is reached over the issue, the standard is put to draft. An external body independently reviews the draft and after approval, is it put through balloting for final approval. This ensures a consensus of representatives and the adaption of international standards by respective countries. Meetings held at IASB are usually public and they are broadcast through webinars. This allows respective stakeholders to participate actively and to be informed about the transparent nature of the body. The accounting principles are generally the same throughout the world; however, Islamic institutions deploy Shariah law, applying accounting standards that set different requirements (Eisenberg, 2012).

The adaption of Islamic financial systems has provoked the need for the standardisation of practices in countries where Islamic law is practiced. This need was triggered by the formation of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in 1991. The AAOIFI was created to prepare accounting standards and procedures that are to be respected across the countries practicing Islamic accounting systems. Based in Bahrain, the formation of the body was supported by the financial institutions proclaiming Islamic financial systems and professionals in the areas of accounting and auditing. In order to keep the produced standards aligned with the IASB’s recommendations, the representation of IASB is not being maintained by the AAOIFI board, and compliance was ensured with regard to the IFRS requirements to create harmonisation across all members (Archer et al., 2013).

Shariah-compliant financial transactions have different conceptualisations due to the involvement of different laws. Financial products are offered under strict compliance with Shariah law, supervised by the Shariah Council. Based on the requirements of the products, its contractual obligations and relative documentation are prepared by financial institutions in light of the requirements set forth by Shariah law. AAOIFI reviews the contractual obligations and deduces the accounting standards that will ensure compliance with Shariah law—as based on the developed practices—consequently laying the foundation for the auditing standards that will suffice as the scrutinising framework. Since these laws are specific to Islamic financial institutions, AAOIFI makes sure to publish relevant material for the understanding of these standards across all registered members; they also provide relevant training and support. As a token of acknowledgment, AAOIFI (2014) provides a Contract Certification Program to bring on board those institutions that have adopted and complied with their undersigned standards. This certification provides the harmonised adaption of standards across institutions in more than 40 countries complying with Shariah law. Likewise, the tag itself promotes investors’ confidences and provides a further endorsement of the application support of these standards.

The Islamic Financial Services Board (IFSB), developed in 2003 and headquartered in Malaysia, has the ultimate aim of providing Shariah-compliant accounting treatments in the areas of capital adequacy, corporate governance, risk management and transparency, broadly covering banking, capital markets and insurance industries. Furthermore, their work extends to the areas of Islamic Money Markets (IMM) and Islamic Capital Markets (ICM) (Salman, 2013). Along with AAOIFI, the IFSB has provided Shariah law a determinant lifeline in financial institutions around the world, promoting Islamic financing even in regions where Islam is not predominant.

The standard setting activities of the IFSB (2012) are exhaustive and they promote transparency. Proper guidelines and procedures are developed to formulate the whole process in a transparent way. Working groups are formed out of technical committees who are in turn responsible for writing the appropriate guidelines for the standards. Each group works with a respective consultant to maintain the latest insight into the industry. Based on recommendations from each working group, an exposure draft is prepared by the project manager and the associated consultants, which is then presented for discussion. Exposure drafts are also available over the websites for participants to make comments. After considering all the voices and forming a consensus, the exposure draft is presented to Shariah scholars for final approval. After their acceptance, the draft will be finalised into a standard (IFSB, 2012).

With the expansion of Islamic financial institutions into the world’s developed economies, Shariah scholars are interested in progressing these Islamic practices worldwide. However, since these practices are different from traditional practices, there is a need for a harmonised approach to standards governing both traditional practices and Islamic laws. This concerns some scholars, as Matherat (2003) questioned if the formation and adoption of these standards together will replace domestic standards, resulting in work being wasted. Alternatively, will these standards continue to imply the principle of prudence, while exposing risk-baring instruments to artificial volatility? Financial instruments are a complex division of these institutions; Islamic laws need better explanations in the respective areas.

Harmonisation is one thing, but compliance is absolute necessary before these laws are considered internationally. It is only after ensuring compliance with these standards that harmonisation can be developed as a real-life application (Abdullah et al., 2014). The real-time application of these standards provides essential feedback to the authorities regarding whether these standards meet the desired reporting objectives or if there are any loopholes that need addressing. AAOIFI (2014) aims to create harmony through successful deployment and monitoring of these standards in member countries. In the absence of compliance monitoring, the harmonisation of accounting treatments cannot be ensured; hence, investor confidence will not be maintained in the financial reporting by the organisations. Likewise, the adaption of AAOIFI and IASB simultaneously, as in the cases of the UK and Australia, asks for better political and economic diversity while creating these standards (Abdullah et al., 2014). Cultural orientation in member countries cannot be ignored altogether, as this will limit the application of these standards in those countries. Lack of power substance in the central body for enforcing and monitoring these standards is also limiting their adaption at the international level (Salman, 2013).

Since AAOIFI only introduces accounting treatments where there are no IFRS, or they are not applicable under Shariah law, it calls for various practitioners to contribute their points of view. There are six ways of recognising profit generated through Murabaha transactions, and it needs to be verified if institutions are using more than one method to recognise that profit. Likewise, for reference, AAOIFI (2014) standards may only be available in hard copies, which need to be purchased to fund the body. The differences in opinions raise questions over the objectivity of the standard; the customer needs to know what he or she is purchasing, how the price is being determined and how the return was calculated. AAOIFI and IFSB need to make sure that differences in opinions do not create corporate governance issues, resulting in the loss of investors’ confidences in Islamic financial products (Salman, 2013).

Despite the consolidation of the two accounting bodies, there exists some structural differences between AAOIFI and IASB. Standards issued by AAOIFI are specific to Islamic institutions and their practices, and reporting needs to be compliant with Shariah law, which is implemented in Muslim countries. They are specifically applicable to the Islamic finance industry, wherever it exists in the world (AAIOFI, 2014). On the other hand, IFRS issued by the IASC are generic in nature, not industry specific and they are applicable to all economic (for-profit) and social (not-for-profit) activities. Member countries use these standards as a major guideline while reporting financial positions each year. Since the scope of IFRS is general in nature, the standards issued cover specific activities dealing with different situations while providing a thorough guide for the financial objects involved, such as how revenue is recognised under projects or when an operating lease may actually be a finance lease. Their primary focus remains on providing accounting standards. On the other hand, AAOIFI plays an all-incorporating role; they do not just comply with Shariah law while making these standards, but their spectrum of work also covers accounting, auditing, ethics and corporate governance codes (Archer et al., 2013).

The IFRS provides generic standards, but the fundamentals of Islamic financial institutions are against the deposition of interest and gambling. Thus, the fundamentals of Islamic financing are different, calling for specific accounting treatments that are governed by an Islamic board (AAOIFI, 2014). Thus, AAOIFI (2014) concentrates on covering the areas where IFRS cannot be adopted. For instance, Financial Accounting Standard (FAS) 1, issued by AAOIFI, covers the presentation of financial statements and the areas of cash flow and revenue, which are otherwise independently covered in IAS 1, IAS 7 and IAS 18. Moreover, some activities are adopted in Islamic financial institutions. These activities are not covered in the IFRS as they are covered solely by AAOIFI. This includes the treatment of loss in Mudarba, treatments of Murabaha, Murabaha to the purchase orderer (FAS 2) and Salam and parallel Salam (FAS 7). Finally, the areas that are not discreet in both traditional and Islamic financing are able to be adopted as per IASB practices, including the treatment of post-balance-sheet-date events (IAS 10) and disclosures of related parties and their transactions (IAS 24) (AAOIFI, 2014).

The IASB monitors the increasing use of Islamic financial products. Therefore, the comparability of these standards is questioned, as they are not applicable to Islamic products. In 2013, IASB established an Islamic finance consultation group, which was responsible for providing an assessment of probable future strategies regarding the possible standardisation of accounting treatments. This may even constitute the inclusion of Islamic standards within the IFRS, but the future is yet to be determined unless not all concerned stakeholders are taken in confidence. Islamic Shariah scholars and experts form part of that consultation group as well as other bodies working in similar areas, including IFSB. However, AAIOFI has still not clarified its stance on these efforts. There could be a fear that the harmonisation of Islamic and traditional standards may alter the essence of Shariah law, or it may temper the position of AAOIFI once everything is constituted within IFRS (Vizcaino, 2014). The future of the Islamic financing industry is definitely improving with relevance to its offerings; however, the timeliness of the future of accounting harmonisation is yet unclear.

The importance of a standardised accounting system is unquestionable as investors seek more transparency and understanding of their investments following reckless losses due to credit crunch and false accounting practices. In the wake of the twenty-first century, Islamic financing has gained popularity among investors, and AAOIFI and IFSB have done their parts in regulating these practices. However, the investors’ confidences lie in understanding these standards, realising the transparency in operations and developing the ability to compare the investment opportunities meaningfully. For international investors, IFRS and AAOIFI are rooted differently; Shariah law differentiates the application of one to the other. The absence of standardised accounting systems creates confusion, costs money and prevents many from investing due to unclear information. The future lies in finding a common ground and forming a consensus regarding the optimum situation for all stakeholders.