Financial accounting
Financial accounting plays an important role in Islamic banking in regulating and establishing a harmonious integration among different parties involved in banking transactions. Islamic accounting provides the information which users of the financial statements of Islamic banks depend on in assessing the Islamic bank’s extent of compliance with Shari’ah and determining rights and obligations of all interested parties in accordance with the principles of Shari’ah. There are many similarities between Islamic and conventional accounting, as both are about providing useful economic information to permit users to make rational decisions by facilitating comparisons and thereby minimising the cost of assessing alternatives investments. However, the nature of transactions in Islamic organisations which deal within a Shari’ah framework is different as Islamic organisations have a duty to contribute to socioeconomic justice and stability.
While Conventional Accounting is based upon modern commercial law, Islamic accounting is based upon ethical law originating in the Qur’an and Sunnah which ultimate purpose is to ensure that Islamic organisations abide by the principles of the Shari’ah in their dealings. Information provided by conventional accounting focus on individuals who control resources while Islamic accounting information concentrates on the community who participate in exploiting resources. They aim at promoting efficiency, leadership and commitment to justice. The differences lies also in the type of information needed in both types of accounting, and how is it measured and valued, recorded and communicated. Conventional accounting is based on economic events and transactions, while Islamic accounting is based socioeconomic and religious events and transactions. In fact, conventional accounting mainly uses historic cost to measure and values assets and liabilities; which restricts this model due to assumptions of the monetary unit and its inflation. From an Islamic point of view, both financial and non-financial measures regarding the specific events and transactions are measured and reported. To calculate the amount of Zakat, assets need to be measured in contemporary terms, not in historical cost. The dual system of asset valuation using both historical cost and market selling prices is likely to enable Islamic organizations to accommodate contracts and to discharge their social obligations. For that purpose, Islamic accounting may also require different statements for that in order to reduce the focus on profits by the income statement provided by conventional accounting.
Another difference between conventional accounting and Islamic accounting is in the users of the information. The management of Islamic corporations is accountable not only to the shareholders it is accountable to the Society as a whole. These users need to evaluate that the Islamic corporation makes money in an ethical way and in accordance with Shari’ah principles, and deploy its resources in a profitable manner; hence Islamic organizations should disclose additional information to their reporting, such as the liquidity, solvency, risks taken, and contribution in fulfilling social responsibilities, such as protection of the environment and contribution toward charitable activities. Apart from the emphasis on the profit and loss statement, balance sheet, and cash flow statement, a considerable amount of further information would be provided. This would include a value-added statement and disclosure about social performance activities of the firm.
While Conventional Accounting is based upon modern commercial law, Islamic accounting is based upon ethical law originating in the Qur’an and Sunnah which ultimate purpose is to ensure that Islamic organisations abide by the principles of the Shari’ah in their dealings. Information provided by conventional accounting focus on individuals who control resources while Islamic accounting information concentrates on the community who participate in exploiting resources. They aim at promoting efficiency, leadership and commitment to justice. The differences lies also in the type of information needed in both types of accounting, and how is it measured and valued, recorded and communicated. Conventional accounting is based on economic events and transactions, while Islamic accounting is based socioeconomic and religious events and transactions. In fact, conventional accounting mainly uses historic cost to measure and values assets and liabilities; which restricts this model due to assumptions of the monetary unit and its inflation. From an Islamic point of view, both financial and non-financial measures regarding the specific events and transactions are measured and reported. To calculate the amount of Zakat, assets need to be measured in contemporary terms, not in historical cost. The dual system of asset valuation using both historical cost and market selling prices is likely to enable Islamic organizations to accommodate contracts and to discharge their social obligations. For that purpose, Islamic accounting may also require different statements for that in order to reduce the focus on profits by the income statement provided by conventional accounting.
Another difference between conventional accounting and Islamic accounting is in the users of the information. The management of Islamic corporations is accountable not only to the shareholders it is accountable to the Society as a whole. These users need to evaluate that the Islamic corporation makes money in an ethical way and in accordance with Shari’ah principles, and deploy its resources in a profitable manner; hence Islamic organizations should disclose additional information to their reporting, such as the liquidity, solvency, risks taken, and contribution in fulfilling social responsibilities, such as protection of the environment and contribution toward charitable activities. Apart from the emphasis on the profit and loss statement, balance sheet, and cash flow statement, a considerable amount of further information would be provided. This would include a value-added statement and disclosure about social performance activities of the firm.
Financial statements
Financial accounting plays an important role in Islamic banking in regulating and establishing a harmonious integration among different parties involved in banking transactions. Islamic accounting provides the information which users of the financial statements of Islamic banks depend on in assessing the Islamic bank’s extent of compliance with Shari’ah and determining rights and obligations of all interested parties in accordance with the principles of Shari’ah. There are many similarities between Islamic and conventional accounting, as both are about providing useful economic information to permit users to make rational decisions by facilitating comparisons and thereby minimising the cost of assessing alternatives investments. However, the nature of transactions in Islamic organisations which deal within a Shari’ah framework is different as Islamic organisations have a duty to contribute to socioeconomic justice and stability.
While Conventional Accounting is based upon modern commercial law, Islamic accounting is based upon ethical law originating in the Qur’an and Sunnah which ultimate purpose is to ensure that Islamic organisations abide by the principles of the Shari’ah in their dealings. Information provided by conventional accounting focus on individuals who control resources while Islamic accounting information concentrates on the community who participate in exploiting resources. They aim at promoting efficiency, leadership and commitment to justice. The differences lies also in the type of information needed in both types of accounting, and how is it measured and valued, recorded and communicated. Conventional accounting is based on economic events and transactions, while Islamic accounting is based socioeconomic and religious events and transactions. In fact, conventional accounting mainly uses historic cost to measure and values assets and liabilities; which restricts this model due to assumptions of the monetary unit and its inflation. From an Islamic point of view, both financial and non-financial measures regarding the specific events and transactions are measured and reported. To calculate the amount of Zakat, assets need to be measured in contemporary terms, not in historical cost. The dual system of asset valuation using both historical cost and market selling prices is likely to enable Islamic organizations to accommodate contracts and to discharge their social obligations. For that purpose, Islamic accounting may also require different statements for that in order to reduce the focus on profits by the income statement provided by conventional accounting.
Another difference between conventional accounting and Islamic accounting is in the users of the information. The management of Islamic corporations is accountable not only to the shareholders it is accountable to the Society as a whole. These users need to evaluate that the Islamic corporation makes money in an ethical way and in accordance with Shari’ah principles, and deploy its resources in a profitable manner; hence Islamic organizations should disclose additional information to their reporting, such as the liquidity, solvency, risks taken, and contribution in fulfilling social responsibilities, such as protection of the environment and contribution toward charitable activities. Apart from the emphasis on the profit and loss statement, balance sheet, and cash flow statement, a considerable amount of further information would be provided. This would include a value-added statement and disclosure about social performance activities of the firm.
While Conventional Accounting is based upon modern commercial law, Islamic accounting is based upon ethical law originating in the Qur’an and Sunnah which ultimate purpose is to ensure that Islamic organisations abide by the principles of the Shari’ah in their dealings. Information provided by conventional accounting focus on individuals who control resources while Islamic accounting information concentrates on the community who participate in exploiting resources. They aim at promoting efficiency, leadership and commitment to justice. The differences lies also in the type of information needed in both types of accounting, and how is it measured and valued, recorded and communicated. Conventional accounting is based on economic events and transactions, while Islamic accounting is based socioeconomic and religious events and transactions. In fact, conventional accounting mainly uses historic cost to measure and values assets and liabilities; which restricts this model due to assumptions of the monetary unit and its inflation. From an Islamic point of view, both financial and non-financial measures regarding the specific events and transactions are measured and reported. To calculate the amount of Zakat, assets need to be measured in contemporary terms, not in historical cost. The dual system of asset valuation using both historical cost and market selling prices is likely to enable Islamic organizations to accommodate contracts and to discharge their social obligations. For that purpose, Islamic accounting may also require different statements for that in order to reduce the focus on profits by the income statement provided by conventional accounting.
Another difference between conventional accounting and Islamic accounting is in the users of the information. The management of Islamic corporations is accountable not only to the shareholders it is accountable to the Society as a whole. These users need to evaluate that the Islamic corporation makes money in an ethical way and in accordance with Shari’ah principles, and deploy its resources in a profitable manner; hence Islamic organizations should disclose additional information to their reporting, such as the liquidity, solvency, risks taken, and contribution in fulfilling social responsibilities, such as protection of the environment and contribution toward charitable activities. Apart from the emphasis on the profit and loss statement, balance sheet, and cash flow statement, a considerable amount of further information would be provided. This would include a value-added statement and disclosure about social performance activities of the firm.
Issue of taxation
Unfair taxation of Islamic products is an important issue for Islamic banks. In fact, Islamic banking was build up in relatively tax free environment, and has now come to a maturity that made many countries adapt their taxation laws to include specific provisions for Islamic products and services. One of these countries is the UK, where, as a rule any interest payments made by banks to its depositors is deductible from gross income before tax is calculated, but interest payments related to the profit made by a bank considered as dividend payments. As a consequence, its amount is not allowed to be deducted from gross income and was considered as distribution of profit after tax. This resulted in a much higher tax charge for Islamic banks and made some banks such as IBB economically unviable. There was also an issue with double incidence of Stamp Duty on property financed using Islamic structures. In fact, whenever property is purchased, the buyer is required to pay a government Stamp Duty. The Islamic bank that buys the property before selling it on to the customer had a double Stamp Duties payable.
To overcome this injustice and ensure that Shari’ah compliant products are taxed in an equitable way than equivalent conventional banking products, the UK government amended the Stamp Duty rules that excluded payment of double Stamp Duty on mortgage finance arrangements and established a special Inland Revenue task force to review the taxation of Islamic products. Islamic products were defined as “alternative Financial Arrangements” and specific structures of the arrangements were added in the legislation. This only impacts the specific structures of the products but not their principles. Profit and loss share agreements that are economically equivalent to conventional banking products, but are not interest or speculative returns are taxed no more or less favourably than equivalent finance arrangements involving interest. Islamic deposits were taxed on the same basis as conventional deposits, and the profit payments made for Islamic deposits are treated for tax purposes as any interest payments.
The UK Finance Act 2005 defined the arrangements that give rise to profit share return in case of Islamic deposit based on Mudarabah, as follows : a person deposits money with a financial institution, the money, together with money deposited with the institution by other persons, is used by the institution with a view to producing a profit, from time to time the institution makes or credits a payment to the depositor, in proportion to the amount deposited by him, out of any profit resulting from the use of the money, and the payments so made or credited by the institution equate, in substance, to the return on an investment of money at interest.
To overcome this injustice and ensure that Shari’ah compliant products are taxed in an equitable way than equivalent conventional banking products, the UK government amended the Stamp Duty rules that excluded payment of double Stamp Duty on mortgage finance arrangements and established a special Inland Revenue task force to review the taxation of Islamic products. Islamic products were defined as “alternative Financial Arrangements” and specific structures of the arrangements were added in the legislation. This only impacts the specific structures of the products but not their principles. Profit and loss share agreements that are economically equivalent to conventional banking products, but are not interest or speculative returns are taxed no more or less favourably than equivalent finance arrangements involving interest. Islamic deposits were taxed on the same basis as conventional deposits, and the profit payments made for Islamic deposits are treated for tax purposes as any interest payments.
The UK Finance Act 2005 defined the arrangements that give rise to profit share return in case of Islamic deposit based on Mudarabah, as follows : a person deposits money with a financial institution, the money, together with money deposited with the institution by other persons, is used by the institution with a view to producing a profit, from time to time the institution makes or credits a payment to the depositor, in proportion to the amount deposited by him, out of any profit resulting from the use of the money, and the payments so made or credited by the institution equate, in substance, to the return on an investment of money at interest.