FIGURE 1: RESULT OF INCONGRUENCY
BETWEEN ECONOMIC SYSTEM AND CCOUNTING SYSTEM(Source; shahul, 2001)
1. Introduction
To professional accountants who have been brought-up on the idea of accounting as an ‘objective’, technical and value-free discipline, the idea of attaching a religious adjective to accounting may seem to be embarrassing, unprofessional and even dangerous. This is especially true when the adjective is Islam (Christian or Buddhist may at least sound more peaceful) which is media-hyped to be synonymous with terrorism.
On the other hand, the development of Islamic banking and finance now embraced even by ardent capitalist institutions such as Citibank, HSBC and ANZ banks may interest accountants to the possibility of new opportunities for the profession (especially in the wake of lay offs and downsizing by the big four firms). Perhaps, the Enron affair has rekindled an interest in having a more honest profession who truly care about the public interest in addition to their pockets. Whatever the interest or curiosity, we hope accountants will find this series of articles interesting, informative, and profitable and yes we hope it may even lead to a bit of soul searching.
In this month’s article, we try to explain what is Islamic accounting (although it will not be the final definition) together with a discussion of the main differences between Islamic and conventional accounting, provide some justifications for the addition of the world ‘Islamic’ to the word accounting, make a prima facie case for Islamic accounting and finally make the important distinction between accounting for Islamic banks and Islamic accounting, which is presently thought of by many people as synonymous.
2. Meaning of Islamic Accounting
Islamic accounting can be defined as the “accounting process” which
provides appropriate information (not necessarily limited to financial data) to
stakeholders of an entity which will enable them to ensure that the entity is
continuously operating within the bounds of the Islamic Shari’ah and delivering
on its socioeconomic objectives. Islamic accounting is also a tool, which
enables Muslims to evaluate their own accountabilities to God (in respect of
inter-human/environmental transactions).
The meaning of Islamic accounting would be clearer if we compare this
with the definition of “conventional” accounting. (Conventional) accounting as we know it is
defined to be the identification, recording, classification, interpreting and
communication economic events to permit users to make informed decisions (AAA, 1966). From this, it
can be seen that both Islamic and conventional accounting is in the business of
providing information. The differences lie in the following:
Ø
The
objectives of providing the information
Ø
What
type of information is identified, and
how is it measured and valued, recorded
and communicated, and
Ø
To
whom is it communicated (the users)
While conventional accounting aims to permit informed decisions whose
ultimate purpose is to efficiently allocate scarce resources available to their
most efficient (and profitable) uses by providing information efficiency in the
market (FASB, 1978). Apparently this is achieved by the user making the
appropriate, buy, sell or hold decisions on their investments. Islamic Accounting,
on the other hand, hopes to enable users to ensure that Islamic organisations
(whether business, government or NFP) abide by the principles of the Shari’ah
or Islamic Law in its dealings and enables the assessment of whether the
objectives of the organisation are being met. At the very basic level, it can
be said that Islamic organisations (whether business or otherwise) differ from
their conventional counterparts by having to adhere to certain Shari’ah
principles and rules and also try to achieve certain socio-economic objectives
encouraged by Islam.
Following from the above, the type of information which Islamic
accounting identifies, measures is different. Conventional accounting
concentrates on identifying economic events
and transactions, while Islamic accounting must identify socio-economic and religious events
and transactions. A few of us, older ones, might still remember when we did our
first accounting or book-keeping courses, we had to do final accounts (i.e. balance sheet and trading, profit and loss account. However,
Americanization of the curriculum has popularised the term financial statements. Hence, the concentration of accounting has
moved from stewards manorial accounts to accounting for money (accentuated by
the monetary measurement concept).
This is not to say that Islamic accounting is not concerned with money
(especially when accounting for businesses). On the contrary due to prohibition
of interest-based income or expense, profit determination is more important in
Islamic accounting than conventional accounting. However, Islamic accounting
must be holistic in its reporting Hence, both financial and non-financial
measures regarding the economic, social, environmental and religious events and
transactions are measured and reported.
Conventional accounting mainly uses historic cost (or lower) to measure
and values assets and liabilities. The profession is well aware of the
limitations of the stable unit of measure
assumption of the monetary unit and to its credit has tried in the past in its
inflation accounting initiatives. However, despite recommendation from its own
research efforts (True blood committee?), the idea of using current values was
given up due to its complexity and presumed lack of objectivity. From an
Islamic point of view, at least for the purpose of computation of Zakat,
current valuation is obligatory (see for example, Clarke et al, 1996) prompting
calls for a current value Balance Sheet (Baydoun and Willet, 2000).
A further difference is, Islamic accounting may require a different
statement altogether to deemphasize the focus on profits by the income
statement provided by conventional accounting. Baydoun and Willlet (2000) have
suggested a Value Added Statement to replace the Income Statement in Islamic
Corporate Reports. They argue that this shows and encourages a cooperative
environment in business as opposed to a destructive competitive environment.
The third category of differences is in the users of the information.
Although the profession has recognised various stakeholders as users of
accounting information (see for example, the Corporate Report, 1975), the users
which it focuses on are shareholders and creditors (i.e. Financiers – those who
provide the funds). This is obvious from the fact the FASB’s SFAC 1 dismisses a
whole range of stakeholders by the term
“and others”. From recent developments in finance and financial markets,
accounting seems to be serving an elite group of financiers – market players
and banks and other financial institutions. It has been accused of helping a
group of rich people get richer (Gray et al., 1996)- a grave charge since the
profession always justifies its monopoly on audit services by virtue of the public interest.
Islamic accounting serves the whole gamut of stakeholders recognised by the
corporate report, not that each group can serve its own interest best, but
society as a whole can make corporations accountable for their actions and
ensure they comply with Shari’ah principles and do not harm others while making
money ethically and achieve a equitable allocation and distribution of wealth
among members of society especially the stakeholders of the concerned
corporation.
3. Religion and accounting- an
explosive mix?
Now we come to the question, is it wise to add the adjective “Islamic” to
accounting? Why not accounting for Islamic organisations or accounting from the
Islamic perspective?. The worry is that the addition of any religious adjective
may compromise the objectivity of the discipline as religion is mostly seen as
an unchanging dogma and code not subject to pragmatic or logical
considerations.
We will take this matter in two stages:
a) Is conventional accounting value free and objective as it portrayed to
be or is there a hidden adjective attached to it?
b) The problem of epistemology- the nature and sources of knowledge
What are the implicit assumptions behind the theory and practice of
conventional accounting, in other words – what is the worldview behind
conventional accounting? Some years back, European and communist states adopted
a different system of accounting. In a centrally planned or a socialist state,
there is a lack of profit motive or not too much of it. Hence, the conventional
accounting i.e. Profit and loss account, balance sheet did not make much sense in
that economic system. This is why the accounting profession never developed in
the communist countries. It is only after liberalisation i.e. conversion to
capitalism that these states are trying to catch up with the West. A little more reflection and we come to the
conclusion that the conventional accounting system in which we were educated
and work in is in fact Capitalist Accounting.
The adjective ‘capitalist’ is not used before the word accounting, because it
would not then appear neutral as capitalism
is a philosophy and many ways a religion. Its sacred symbols of private
property, the hudud (literal meaning
the definitive borders) of the market and its God- wealth for the creation of
which, business and finance exists. Capitalism is not only the economic system
which allows choices and opportunities but a philosophy and religion which
forsakes equity for efficiency and the wants of a few for the needs of the
many. It can be said to be the dominant ‘religion’ of the world (both in Muslim
and Non-Muslim countries).
Hence, to call a spade, a spade, accounting should be renamed capitalist
accounting, economics as capitalist economics and so forth. Hence, faculty of
economics in our universities should be renamed faculty of capitalist
economics. However, we do not because it is not necessary, it is assumed and
implicit. Due to the non-explicitness of
this assumption, we sometime forget that accounting is not objective, neutral
and value-free as it is portrayed to be.
Secondly, we discuss the problem of epistemology- the nature and sources
of knowledge. Ever since the so-called ‘enlightenment’, science has gained the upper
hand and has replaced religion as the authority in defining what is knowledge.
Modern research emphasises positivism i.e. what is. Knowledge is only what is
perceptible through our senses through observation and experiment or what
appears logical to our mind. Revelation is not considered a source of knowledge
as religious truths cannot be verified by our senses. Accounting is considered a
science (many US and
However, as Chapra (2000) argues science and religion deals with
different levels of reality. While sciences
deal with the physical universe perceptible by the senses, religion deals with
a higher level of reality which is transcendental and beyond the sense of
perception. The sources of scientific knowledge are reason and its method
observation and experiment. It describes and analyse ‘what is’ and tries to
predict what will happen in the future (e.g. Forecast earnings from models).
When dealing with the physical universe, it is exact in its description and
analysis and more accurate in its predictive power (e.g. in Physics or
Chemistry). However, when it deals with human beings who do not behave in a
consistent manner, unlike the revolution of the planets above, its analysis is
less precise and its predictions less accurate. The recent move by the SC on
insisting on a 10% accuracy on profit forecasts reports by accountants has
given a headache for accountants as forecasting is not an accurate science as
it deals with behaviour of human beings in the marketplace.
Unlike science, religion depends on Revelation as well as reason for its knowledge.
Its objective is to help transform the human condition from ‘what is’ (e.g.
Enron, WorldCom) to what should be (perhaps, Johnson & Johnson under
Burke). It should bring about individual and social change to conform to its
worldview and values and institutions that it provides.
The ultimate objective of both science and religion is to bring about the
well-being of human beings. One addresses the physical and material while the
other addresses the social, mental, emotional and the spiritual. Chapra (2000)
further argues that if both of these are important, then both science and
religion can better serve mankind by greater cooperation and coordination
between them. Religion can help science by reminding it of its ultimate
objectives and limitations, to use the power and mastery over the universe for
well-being rather than destruction. Science can help religion by helping it
realise ‘what ought to be’ by providing a better description of ‘what is’ ,
facilitating prediction and providing better technology for a more efficient
use of all available resources.
It can thus be seen that rather then becoming an explosive mix, the
mixing of science and religion can be fruitful and in fact serve to stabilise
society from the instability of a world dominated either by science or religion
alone.
4. A Prima-facie case for
Islamic Accounting
Accounting is a tool to achieve certain objectives. In order to be
useful, it must be relevant to its purpose. The purpose of accounting has been
extended by the American Accounting Association in 1975 (presumably concerned
to promote the public interest responsibility of the profession) which defined
the purpose of accounting “to permit informed decisions which will enable
scarce resources to be allocated efficiently thereby achieving social welfare”.
Hence, like it or not, the accounting profession is entrusted with the
responsibility of helping to achieve social welfare by providing its services.
It is common sense, that one must use the right tool for the right job.
If one were to use a sledgehammer to crack a nut, we would get paste instead of
nuts! Hence, Islamic accounting may be more appropriate to achieve the
socio-economic and religions objectives of Islamic institutions and Muslim
users. The diagram below (Shahul, 2001) shows the situation of match and
mismatch.
FIGURE 1: RESULT OF INCONGRUENCY
BETWEEN ECONOMIC SYSTEM AND CCOUNTING SYSTEM(Source; shahul, 2001)
Briefly, Islamic institutions such as Islamic
banks, Tabung Haji etc. are established to meet the socio-economic objectives
of the Shariah (Islamic Law) through the implementation of an Islamic economic
system. Hence, these institutions should logically use Islamic accounting,
especially for monitoring these institutions to achieve their objectives which
are different from capitalist institutions. However, if conventional accounting
which developed to meet the needs of a capitalist economy is used instead in
these institutions, a mismatch is likely. This will lead to the institutions
not meeting the Shari’ate socio-economic objectives and even worse may turn
these Islamic institutions into capitalist institutions by providing
materialist profit-focused information instead of the holistic information
provided by Islamic accounting.
It can thus be seen that it is not at all unscientific or objectionable,
to use Islamic accounting and would in fact be more logical to use it as it would result in an ethical based accounting
system which measures not only profits but social, environmental and religious
performance.
Finally, it must be borne in mind that accounting for Islamic banks and
financial institutions is not Islamic Accounting but only a subset of it.
Although the efforts of AAOFI must be appreciated for developing standards for
Islamic Banks, the methodology and hence the outcome is questionable. This is
discussed elsewhere (see Karim, 1995). Islamic accounting is not the just
technicalities of accounting for Islamic financial instruments employed by
Islamic banks but much more requiring whole new areas of performance
measurement including the social, environmental, economic and the Shariate. We
will explore the reasons why conventional accounting is unsuitable for Islamic institutions
as well as more details of what is the content of Islamic articles in later
articles.
References:
AAA(1966), A Statement of Basic Accounting
Baydoun and Willet (2000), “The Islamic Corporate Report”, Abacus, Vol.
36, No. 1, 2000.
Chapra, U (2000), The Future of Economics, An Islamic Perspective,
Clarke F., R Craig and S. Hamid (1996), “Physical Asset Valuation and
Zakat: Insights and Implications, Advances in International Accounting ,
vol. 9., 1996.
Corporate Report (1975), The
Corporate Report,
FASB (1978), Statement of Financial Accounting Concept 1:Objectives of
Financial Reporting by Business Enterprises,
Gray, RH, Owens K and Maunders K (1996), Accounting and
Accountability: Changes and Challenges in Corporate Social and Environmental
Accounting,
Karim, RAA (1995), “The Nature and Rationale for a Conceptual Framework
for Financial Reporting by Islamic Banks”, Accounting and Business Research,
Vol 25, No. 100, pp285-300.
Shahul Hameed (2001), “Islamic Accounting – Accounting for the New
Millenium?”, Paper presented at the Asia Pacific Conference 1, Kota Bahru,
Kelantan, October 10-12, 2001,
[1] The author is Assistant Professor and Head, Department of Accounting,
Kulliyah of Economics and Management Sciences, International Islamic University