Chapter One

Accounting and Islamic Worldview

Introduction

Accounting is like ‘language of businesses’.

Accounting is the system that measures business activities, processes that

information into reports, and communicates these findings to decision-makers.
The better you understand the language, the better you can manage the
financial aspects of business.
Financial planning investments, loans, taxes and many other aspects of
modern business activities rely critically on accounting.
Cont..

• The output of accounting process is in the form of financial

statements.

• Financial statements are documents that report on an individual’s or

organization’s business in monetary terms.

• The accounting process relies on bookkeeping in the form of double

entry system.
Accounting and Its Environments

• The role of accounting is to serve the accountability of the agent towards the
principle of a business wealth due to the separation of ownership and control of
the corporation.

• Accounting can be distinguished into two basic functions:

A. Financial Accounting: provides information to people outside the firm

B. Financial Management: generates confidential information for internal

decision makers such as top executives, departments heads.
Cont..

• Accounting is also shaped by the environment in which it operates.

• Since this differs from country to country (due to legal, economic, political,
cultural etc. difference), very diverse national financial accounting systems
have developed.

• However, in an expanding global economy where management and investors

are increasingly making cross-border decisions, comparability of
international financial information is essential.
Accounting Standards

• Accounting standards are codified rules and guidelines of accounting

principles and practices for various types of business transactions and issues.

• Malaysia have their own national standards to comply with (International

Accounting Standards Committee IASC).

• IASC consists of representatives from accounting bodies from all over the
world.
 Elements of Financial Statements and The Accounting
Equation

• There are five elements of financial statements namely assets,

liabilities, equity, income and expenses.

• In accounting terms, a business transaction is any event that both

affects the financial position of the business entity and will be
recorded.
 Islamic Worldview and Accounting
 The Islamic worldview are not merely derived from cultural and philosophical elements
aided by science, but one whose original source is revelation, affirmed by intellectual and
intuitive principles

 Islam literally meaning ‘Peace’ and ‘obedient’ to God and to appreciate the purpose of their
existence in this world.

 Allah is said to have proclaimed that “ I did not create the jinn and mankind except to
worship me (The verse is part of Surah Adh-Dhariya)

 Muslims consider humans to be vicegerents of gods, thus, whatever worldly possession a

Muslim has is to be held in a stewardship capacity – that is simply in trust from God.
Cont..
Islamic worldview: Islamic principles profoundly influence accounting
practices, creating a system that aligns with shariah Islamic law.
These principles emphasize ethical conduct fairness, transparency, and
accountability to Allah, stakeholders, and society.
The accountant in Islam is not only required to maintain good relationship
with superiors, clients, or the management but also maintain, improve and
strengthen his relationship with his master by fulfilling the religious
obligations.
Some Islamic Principles define accounting
practices
1. Accountability to Allah (Tawhid): All actions, including financial
dealings, are accountable to Allah.

2. Justice and Fairness: financial records should reflect the true and
fair state of affairs without misrepresentation or fraud.

3. Transparency: Full disclosure of financial transactions is required

to avoid exploitation or misunderstanding.
Cont..

4. Prohibition of Riba:

5. Social Responsibility: Businesses must contribute positively to

society, promoting the welfare of the community.

- Accounting practices should highlight social and environmental

responsibilities, ensuring compliance with Islamic ethical standards.

6. Zakat and Sadaqaha: Islamic accounting involves calculating and

reporting zakat (obligatory charity) accurately, which is a
fundamental pillar of Islam.
Cont..

7. Ethical profit and wealth Distribution: Profits should be earned

ethically and distributed justly.

8. Adherence to Islamic Accounting Standards (AAOIFI. Auditing

Organization for Islamic Financial Institutions).
 Accounting Objectives: An Islamic Perspective

• The growth of Islamic financial markets and institutions, culminating in the

growing interest in Islamic banking, insurance and capital markets reiterates
the need for different accounting requirements.

• Islamic accounting is needed to serve different principles of financial

instruments that are founded on Islamic worldwide and Shar’ah requirements.
 AAOIFI (Accounting and Auditing Organizations of
Islamic financial institutions)

• The efforts of accounting and auditing organizations of Islamic financial

institutions in the 1990s to develop accounting standards for Islamic financial
institutions are commendable as a positive contribution towards harmonization
accounting practices of Islamic financial institutions.

• The standard are expected to facilitate the needs of the users of accounting
information of Islamic financial institutions who demand different sets of
information.
Cont..

• Contrary, conventionally, accounting objectives and concepts are needed to

guide existing accounting practice, prescribe future accounting issues.

• Islamic banks depends on in assessing the bank’s compliance with the precepts
of Shari’ah.
Based on the above verses we can conclude
that the objectives of accounting should be:

1. To ensure fair and just financial transactions between human beings.

 Accounting information is expected to require such information.

However, primary objective of accounting information must be to fulfill the

ultimate accountability to Allah.

In addition to fulfilling the ultimate accountability to Allah, the preparers of

financial information must know the common information needs of users of
financial reports.
 Lessons of Surah Al-Baqarah verse 282 for Islamic
accounting policy making.

1. Proper, complete and transparent recording of financial and business transactions

by responsible accountants are the fundamentals of Islamic accounting.

2. Written contract is the main requirements for all significant financial and business
transactions especially for debt contract.

3. Islamic witnesses to provide a check and balance mechanism, ensure proper

accountability, and ensure parties of the contract properly honour their financial
obligation.
Cont.

4. Materiality as an accounting concept in Islam is ultimately to a single cent to

ensure proper recognition of financial rights and obligations of the
contractual parties.

5. Fear God for all the contractual parties including the witnesses and the
accountant to ensure fairness and justice in accounting for financial and
business transactions.
Objective of Accounting for Islamic financial institutions according to AAOIFI:

1) Determine rights and obligation of interested parties to ensure fairness and

justice to all contractual parties:

2) Safeguard entity assets and rights of others to ensure proper accounting

recognition (Recording).

- In the case of diminishing musharaka, rights to the assets or project are

reflected by the capital ownership.

- Proper accounting profit sharing and loss according to capital contribution

ratio (CCR) throughout the contractual periods.
Cont..

• In the case of murabahah, the rights of assets are transferred to the real
owner, in the Bank’s balance sheet, it is recorded as financing asset
(receivable) to reflect the rights of the bank to receive payments of the
bank to receive payments form customers.
 According AAOIFI; the main categories of users of the
external financial reports for Islamic financial institutions
are
a) Equity holders
b) Holders of investment accounts
c) Other depositor
d) Current and saving account holder
e) Others who transact business with the Islamic financial institutions, who are
not equity or account holders.
f) Zakat agencies
g) Regulatory agencies
 In addition, AAOIFI has also established the objectives of
financial reports as follows:

1. Information about the Islamic bank’s compliance with the Shariah

and its objectives and to establish such compliance and information
establishing the separation of prohibited earnings and expenditures.

2. Information about the Islamic bank’s economic resources and related

obligation, and the effect of transactions.

- Evaluate the adequacy of the Islamic Bank’s capital to absorb losses

and business risks.

- Assessing the risk inherent in its investments and the liquidity

requirements for meeting it other obligation.
 Cont..

3. Information to assist the concerned party in the determination of zakat on the Islamic
bank’s funds and the purpose for which it will be disbursed.

4. Information to assist in estimating cash flows that might be realized from dealing with
the Islamic bank, the timing of those flows and the risk associated with their realization.

5. Information to assist in evaluating the Islamic bank’s discharge of its fiduciary

responsibility to safeguard fund and to invest them at reasonable rates of return.
Auditing

• An audit is a systematic, independent, and documented process for obtaining

evidence and evaluating it to determine the extent to which specific criteria are
met.

• Audits are essential tools for ensuring compliance, improving processes, and
maintaining trust in financial and operational activities.
Types of Audits

I. Financial Audit: Reviews financial statements to ensure accuracy and compliance

with accounting standards.

II. Operational Audit

III. Compliance Audit

IV. Information System Audit

V. Internal Audit

VI. External Audit

The process

1. Planning and Preparation:

- Identify the scope and purpose of the audit

- Establish standards or benchmarks to assess against.

- Assign roles and responsibility to qualified auditors

- Preparing a detailed strategy, including timelines, resources and

methodologies.
2. Risk Assessment

- Identify areas of high risk or complexity

- Prioritize activities to focus resources on critical areas.

3. Evidence Collection:

- Collect necessary documents, records, and other relevant materials.

- Conduct discussions with stakeholders and employees.

- Verify processes, transactions, and controls using sampling or full-scope testing.

Cont..
4. Evaluation and Analysis:
- Compare evidence against established criteria
- Identify gaps, risks, or non-compliance
- Document findings clearly and systematically.

5. Reporting:
- Summarize findings, conclusion and recommendations
- Allow feedback and discussion on observations
- Provide an official document with key insights and actionable steps
 Principles of an Effective Audit

a) Independence

b) Competence: team member should have the necessary skills and expertise

c) Confidentiality: sensitive information should be protected

d) Professionalism: ethical standards and diligence are essential throughout

the process.

e) Systematic approach
Case Study

• Enron Scandal and Accounting Fraud