ISLAMIC ACCOUNTING STANDARDS

2.11 ISLAMIC ACCOUNTING STANDARDS

The data presented by financial institutions in their balance sheets, income and cash flow statements and other such statements are indispensable for determining the soundness of these institutions. The information provided in these statements is utilised by shareholders, depositors, investors and regulators. If all these statements are prepared on the basis of uniform standards, it facilitates objective comparison between different financial institutions and enables the market discipline to work more effectively. The standards set by the International

Accounting Standards Committee (IASC) are by and large followed by financial institutions around the world. A number of developments during the past few years have increased the significance of such standardised information. 61

The general purpose financial statements of the Islamic financial institutions are by and large based on international accounting standards (IAS), IAS30 of which specifically provides for the format of preparing and presenting financial statements by banks. The AAOIFI, has done a valuable job of adapting

the international standards to suit the Islamic financial institutions. 62 Such an adaptation is necessary for a number of reasons, including the

following. First, interest-based lending has been replaced by the Islamic modes of finance. These modes comprise of diverse contracts, each one having its own accounting requirements. Leasing operations of Islamic banks may be partially covered by IAS 17, but totally new standards are required for istisn ā‘, salam and mur ābahah. Second, the accounting standards for Islamic modes of finance need to be uniform across time, regions and institutions. Third, the accounting standards used by Islamic financial institutions are also necessary to fulfil other Islamic requirements, the most important of which relates to zak ā t. Fourth, the Islamic accounting standards have to facilitate the work of the Shar ī‘ah supervisors. Fifth, transparency is also needed with respect to the liability side of

61 Some of these developments are indicated below. First, markets and economies have opened up and an interaction between institutions has increased due to the

liberalisation policies. It has also brought with it the challenges of the associated risks and uncertainties. Second, development of technology, financial markets and instruments has enhanced the role of information and market discipline. Third, differences between the activities of commercial banks, investments banks and, to some extent, insurance firms has largely faded away, increasing the need for coordination of activities between standard setters, various types of institutions and regulators. 62 See, AAOIFI (1999)

Islamic banks. Finally, almost all Islamic banks originate from developing countries. These institutions, therefore, carry the same or similar systemic characteristics as other financial institutions in these countries.

The AAOIFI standards were introduced for the first time in 1993 for Islamic financial institutions. Nevertheless, these have so far not become reflected in their accounts even though the standards setting committees of the AAOIFI had representatives from a number of these institutions themselves, the central banks, and fiqh scholars. Given such representation, one would have expected that the practices of Islamic banks would converge to the AAOIFI standards.

It needs to be appreciated that the objectives of accounting standards are different for regulatory and supervisory authorities from those of accountants. For example, the central concern of IAS 39 is to adopt standards for liability reporting at cost and for asset reporting at fair values. However, according to the BCBS, this standard will increase the volatility of reported earnings and equity, making the measurement of the true risk of a financial institution difficult. To remove such conflicts, accounting standard setters, banks, other market participants, and regulatory authorities must come together to set best accounting standards, which can enhance the risk management objectives of banks. Therefore, the BCBS, IOSCO, IASC and the IAIS are working together to review international

accounting standards with the objective of setting principles of best practices. 63 The AAOIFI needs to take part in this joint effort and in any future efforts

for setting supervisory standards for Islamic financial institutions. The concern for global financial stability has made it necessary to make the IASs more dynamic. The BCBS has, therefore, undertaken a quick review of IAS 30 and a more

thorough review of IAS 39. 64 The finding of the review was that, since IAS 30 has not been updated after 1991, it was necessary to update it to encompass current best practices in terms of disclosure of risk exposures and risk management policies of financial institutions. These standards are hence under full review during 2000.

The debate on the review of IAS 30 and IAS 39 is equally valid for Islamic financial institutions, particularly, for the AAOIFI. IAS 30, which provides for the

63 See BCBS (April 2000). 64 IAS 30 deals with disclosures in the financial statements of banks and similar financial

institutions.

format of general purpose financial statements, is being reviewed to cover the dynamic requirements of the financial markets, and IAS 39 is a new standard covering financial instruments. The debate on these standards between standard setters, financial institutions, and regulators needs to be followed up by the AAOIFI, Islamic financial institutions, regulators and other relevant institutions. For this purpose, the following may be suggested:

i. The concern for risk management should be incorporated into the AAOIFI standards

ii. Islamic banks should keep themselves fully involved, on their own as well as through the platform of the AAOIFI, with the ongoing reviews of IAS 30 and IAS 39.

iii. The international standard setters should also include Islamic banks as concerned institutions while distributing consultation papers

during the review process. iv. The relationship between AAOIFI and regulatory and supervisory

standard setters for Islamic financial institutions needs to be strengthened for adopting the AAOIFI standards.

v. Since subscription to the Special Data Dissemination Standards (SDDS) of the IMF has important implications for IDB member

countries, the AAOIFI accounting standards must also take note of these standards. The IAS constitutes the basis of the SDDS and, therefore, while adapting IAS, the AAOIFI may also consider the requirements of the SDDS.