Times of Oman
Dec 01, 2015 LAST UPDATED AT 11:16 PM GMT
Reporting and disclosure dilemma
February 11, 2013 | 12:00 AM

Islamic finance is a sub-set of the conventional global financial system. It is not a parallel system to the conventional financial system. The conventional financial system has been in operation and has evolved significantly over the last 300 years, whereas Islamic finance is relatively new and has been in existence for just over 30 years.

As a result of this age difference and for practical reasons, financial markets, the banking industry, regulators, tax authorities, investors, and the general public are all familiar with the IFRS (International Financial Reporting System) format, which is broadly used for capital adequacy, taxation, investment, credit analysis, and industry-comparison purposes.

This explains why, globally, out of 57 Islamic countries and more than 10 non-Islamic countries hosting the Islamic finance system, only eight jurisdictions — Bahrain, DIFC (Dubai), Oman, Jordan, Lebanon, Qatar, Sudan, and Syria —h ave made compliance with Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) standards mandatory. Some larger jurisdictions, such as Malaysia, Indonesia, Pakistan, Saudi Arabia, South Africa, and Australia, have issued guidelines based on AAOIFI standards.

Thus, the IFRS is the global financial standard of choice and is used or permitted in more than 100 countries. It was designed, however, with conventional finance in mind and does not recognise Islamic modes of financing.

Applying the IFRS to Islamic financial institutions (IFIs) has, therefore, led to difficulties in interpretation that ignore the nuances of Islamic finance principles.  AAOIFI has addressed this gap and developed standards to accommodate Sharia precepts in the recording and disclosure of an IFI's financial transactions.

The chairman of the Malaysian Accounting Standards Board (MASB) spoke on the subject: "We believe that we can use the IFRS unless someone can show us that there is a clear prohibition in the Sharia', and then we will amend it accordingly. Until then, we'll use the IFRS."

Islamic finance nuances
There are peculiarities and nuances unique to Islamic finance that are not recognised in the appropriate way by the IFRS. Some of these issues are discussed in further detail below.
The concept of assets increasing in value over time and the idea that money can grow in value without being used in trade are not permitted in Islamic Finance.

Among the three traditional functions of money, that is, as a "medium of exchange," a "unit of measurement," and a "store of value," only the last function is not recognised in Islamic finance. Money does not beget money in Islamic Finance. On the other hand, the conventional financial system is heavily dependent on money being used as a store of value not just for pricing assets but also for assigning cost and revenue to capital, exchange rates, and so on. 

Islamic Sharia recognises modes of financing in Islamic finance that are based on assets, trade, or sale contracts. AAOIFI standards provide recognition to those forms and modes of financing and prescribe an appropriate accounting treatment. The IFRS, on the other hand, ignores the form in favour of the substance and treats Islamic modes of financing by drawing a parallel to their financial equivalents in conventional finance.

Morabaha, for example, is considered the "Buying or Selling of Assets" by AAOIFI, but a mere interest-based financing transaction under the IFRS ignores the underlying asset sale/purchase.

Modaraba: The IFRS considers the "Constructive obligation to return" to be a liability status; otherwise the item is treated as equity, which is also supported by established practice and regulatory expectations. AAOIFI, however, splits them into Restricted and Unrestricted Investment Accounts (RIAs and URIAs).

The IFRS treats RIAs as "Fund Investments," and hence, they're booked off the balance sheet. On the other hand, URIAs are considered liabilities.


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