VoL 13, N o.l2,D esem ber 2005 © Centre f o r Indonesian A ccounting an d M anagem ent Research
ABSTRACT
Prior studies on
Ijarah were mainly focusing on the economics,
legal and financial aspects, there was, however, so far no in depth study on accounting for
Ijarah. The main objective of this
is to explore the nature of accounting practices as practiced by Malaysian financial institutions. First, the study makes
study
Accounting Standard on leasing (IAS 17); the accounting standard for
Ijarah
and Auditing Organization for Islamic Financial Institutions (AAOIFI); and the Malaysian Accounting Standard Board (MASB 10). The study found that there are major differences as to the nature of leasing and
(FAS 8) as developed
Ijarah, and as a result accounting principles that
have driven all the three standards as well as accounting techniques developed for leasing and
Ijarah are significantly
different. Secondly, the study examines the level of acceptability of the
Malaysian financial institutions. The result of the questionnaire survey shows a low level of acceptability of FAS 8 and the result from the interview
AAOIFI’s
survey further confirms this
This study indicates, subject to further studies on other Islamic financial instruments and other Islamic countries, that the effort to harmonise the accounting practices on Islamic financing practices by financial institutions internationally may be a difficult task. Secondly, until and unless the AAOIFI
finding.
is adopted by the regulator}' agency as in the case of Malaysia, Bank Negara Malaysia, AAOIFI standards will remain only as a reference but do not have the legal authority. Consequently, the quality and comparability of accounting information of Islamic financing such as
standard
Ijarah will be seriously at a stake.
VoL 13, NoA/2,Desember 2005 €> Centre f o r Indonesian Accounting and M anagement Research P ostgraduate Program, Brawijaya University
46 An Exploratiory S tudy o f A ccounting on Ijarah ...
Introduction
Ijarah has been conceptually understood as a contract of exchange where one party enjoys the
another party in return for a consideration for the services rendered and from the use of an asset. Scholars of the four schools of Islamic jurisprudence (Shafi’ie, Maliki, Hanbali and Hanafi) have cited various definitions of the contract of
benefit arising
from
employment by
Ijarah. In brief, these definitions agree on the fact
that the contract of
Ijarah is a c o n t r a c t o n u s i n g t h e b e n e f i t s o r s e r v i c e s i n r e t u r n f o r
compensation (Kharofa, 1997).
T h e r e is a c o n s i d e r a b l e b o d y o f r e s e a r c h o n t h e I s l a m i c f i n a n c i a l s y s t e m in g e n e r a l . However, literature that specifically discusses the
c o n t r a c t i s l i m i t e d . T h e s t u d y is m o t i v a t e d t o e x p l o r e a c c o u n t i n g i s s u e s in
Ijarah
Ijarah due to the lack of studies on Ijarah. The
scarce availability of literature written on the topic of
Ijarah is d u e t o s e v e r a l p o s s i b l e
r e a s o n s . T h e m o s t f u n d a m e n t a l r e a s o n is t h e - i n f a n c y s t a g e o f I s l a m i c b a n k i n g a n d finance as compared to conventional finance. The idea of Islamic finance was inspired
b y . th e f i r s t c o n f e r e n c e o n I s l a m i c e c o n o m i c s i n 1 9 7 6 . O b v i o u s l y ,
Ijarah , which is part of
Islamic finance, is very much in its early stages of development.
The first objective of this study is to examine the nature of
Ijarah financing and its
legal and accounting p e r s p e c t i v e s . T h i s is c o n s i d e r e d a s i m p o r t a n t b e c a u s e w i t h o u t a p r o p e r u n d e r s t a n d i n g o n the nature of
differences with conventional
leasing, the conceptualization of the accounting implications for
Ijarah and the differences compared to conventional
Ijarah may not be complete.
Consequently, the second objective of this study is to determine the level of acceptability o f A c c o u n t i n g a n d A u d i t i n g O r g a n i z a t i o n o f I s l a m i c F i n a n c i a l I n s t i t u t i o n ’s ( A A O I F I ) accounting standard on
Ijarah in Malaysia using questionnaire and interview survey
among Malaysian’s commercial banks. This is important to explore the current practices in Malaysia vis-^-vis AAOIFI standard. The findings will hopefully provide some insights into the nature and issues of accounting practices of an Islamic financial instrument.
Islamic Fin ancing Principles
Islamic finance is an ethical, indigenous and equitable mode of finance, which derives its principles from the
Qu 'ran (The revealed book of Muslims), the traditions of the Prophet
Muhammad (peace be upon him), and the
Shari'ah Is la m i’ah (Islamic law), which is
based on the
Qu ’ran and Sunnah. There are clear distinctions between Islamic finance
a n d ‘c o n v e n t i o n a l ’ f i n a n c e ( Q u r e s h i a n d M i l l e t , 1 9 9 9 ) . T h e s e d i f f e r e n c e s a r e d e r i v e d from three main prohibitions by the
Shari'ah Islam i'ah. The first prohibition is against rib a ' ( u s u r y ) . T h i s p r o h i b i t i o n is i n t e n d e d t o p r e v e n t e x p l o i t a t i o n a n d t o m a x i m i z e s o c i a l benefits.
Secondly, Islam
prohibits
gharar (uncertainty)
in activities.
Gharar is
considered as not Islamic because it can cause injustice to another party. The third p r o h i b i t i o n is a g a i n s t
maisir (gambling).
VoL 13, N o.l/2,D esem ber 2005 © Centre f o r Indonesian A ccounting an d M anagem ent Research Postgraduate Program , Brawijaya University
The International Journal o f Accounting and Business Society 47
O n e o f t h e m o s t i m p o r t a n t p r i n c i p l e s o f I s l a m i c f i n a n c e is t h e s c r i p t u r a l i n j u n c t i o n
against
rib a '
a n d t h e r e is n o w a g e n e r a l c o n s e n s u s a m o n g M u s l i m e c o n o m i s t s t h a t
r ib a ’
is n o t r e s t r i c t e d t o u s u r y b u t e n c o m p a s s e s i n t e r e s t a s w e l l . T h e p r o h i b i t i o n o f u s u r y is o r d a i n e d in I s l a m in a ll f o r m s a n d i n t e n t . T h i s p r o h i b i t i o n is s t r i c t , a b s o l u t e a n d
Q u r’an in v e r s e 2 7 8 o f S u r a h A l - B a q a r a h s t a t e s : "O y e who believe! Fear Allah and give up what remains o f your dem and fo r riba, i f ye are indeed believers ”, and verse 2: 279 says "Ifyou do it not, take notice o f war from Allah and His Messenger, but i f ye turn back, ye shall ha\’e your capital sums. Deal not unjustly and
unambiguous. The Holy
you shall not be dealt with unjustly”.
Riba ’ can be defined as predetermined payment over and above the actual amount of the principal. It is prohibited becausc while profit is legitimately allowed, the parties cannot p r e d e t e r m i n e a g u a r a n t e e d p r o f i t . T h i s is b a s e d o n t h e p r i n c i p l e o f “ u n c e r t a i n g a i n s ”
which, on a strict interpretation, does not even allow an undertaking from the customer to repay the borrowed principal plus an amount to take into account inflation.
Riba is a l s o p r o h i b i t e d a s it l e a d s t o i n j u s t i c e ( zulm ) a n d I s l a m is a g a i n s t a l l f o r m s o f injustice and exploitation and pleads for an economic system, which aims at securing extensive socio-economic justice. The Islamic law of prohibition of
riba, which includes
interest, was originally not based on economic theory but on Divine Authority, which
c o n s i d e r s t h e c h a r g i n g o f u s u r y is a s a n a c t o f i n j u s t i c e . ’
Gharar is from the Arabic word which means risk, peril and uncertainty. It is a kind of s a l e , w h i c h i n v o l v e s g i v i n g a n u n d e r t a k i n g , w h i c h t h e s e l l e r is n o t c e r t a i n t o f u l f i l l s u c h as the sale of fish before they are caught. The prohibition of
gharar is b e c a u s e i t a f f e c t s
both the subject-matter and the price, which can generate unearned profit or an unacceptably huge loss. Hence, the motive behind the prohibition of
gharar is t h e
a v o i d a n c e o f r i s k in s a l e . A n o t h e r r a t i o n a l e b e h i n d t h e p r o h i b i t i o n o f
gharar
i s t h a t , it
d e p e n d s n o t o n t h e e x i s t e n c e o r n o n - e x i s t e n c e o f t h e g o o d s , b u t o n t h e v e n d o r ’s o b l i g a t i o n t o d e l i v e r t h e s u b j e c t - m a t t e r o f t h e s a l e . I f h e is n o t in a p o s i t i o n t o d o s o , because, for example the contract contains an element of
gharar risk, the transaction will
be void according to the degree of
gharar involved.
Developm ent o f Islamic Financial Institutions
T h e p i o n e e r i n g e f f o r t t o e s t a b l i s h I s l a m i c b a n k c a n b e t r a c e d in E g y p t a n d i t t o o k t h e form of a saving bank based on profit-sharing in the town of Mit Ghamr in the early
1960s. Later on, the Organization of Islamic Conference (OIC) initiated the Islamic
'siddiqui, S. H. Islamic Banking: True Modes of Financing. http://www.islamic-banking.com/ ibanking/ ibankingaom/shsiddiqui.php
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48 An E xploratory Stu dy o f Accounting on Ijarah ...
D e v e l o p m e n t B a n k ( I D B ) i n 1 9 7 5 , b u t it w a s p r i m a r i l y a n i n t e r g o v e r n m e n t a l b a n k a i m e d at providing funds for development projects in member countries. The IDB now also extends to the private sector for project and trade finance facilities.
I n t h e m i d - s e v e n t i e s , I s l a m i c b a n k s c a m e i n t o e x i s t e n c e in S a u d i A r a b i a a n d t h e U n i t e d Arab Emirates. Since then, Islamic financial institutions have emerged in a large number of Muslim countries including Kuwait, Bahrain, Qatar, Turkey, Pakistan, Indonesia and
a belt of other IDB member countries. These institutions have taken the form of commercial banks, investment banks, investment and finance companies, insurance companies, etc.' In the early years, investments and products used by most Islamic financial institutions were driven by the concept of
M udharabah (referred to as trust
financing) and focused on short-term investments. During this period,
Murabahcih (cost-
plus finance) emerged as the instrument most widely used by Islamic banks, accounting for over 80 percent of a portfolio of an Islamic bank.3
T h e l a s t f e w y e a r s h a v e s e e n a g r o w t h in t h e n u m b e r o f c o n v e n t i o n a l b a n k s , w h i c h o f f e r Islamic banking products (Cunningham, 1994). Indeed, conventional banks have also
b e g u n t o r e a l i z e t h a t o f f e r i n g I s l a m i c p r o d u c t s is a w a y o f c a p t u r i n g d e p o s i t s . M a n y
i n v e s t o r s k e e p m o s t o f t h e i r m o n e y in a c o n v e n t i o n a l a c c o u n t , b u t l i k e t o p l a c e p a r t o f their funds in Islamic accounts. A conventional bank with an Islamic finance division can capture all of such a client’s business rather than just a limited part.
In M a l a y s i a , t h e r e is a d u a l b a n k i n g s y s t e m w h e r e b y t h e I s l a m i c b a n k i n g s y s t e m a n d t h e conventional banking system exist side-by-side. The legal basis for the establishment of Islamic banks was the Islamic Banking Act (IBA), which came into effect on 7 April
1983. The IBA provides Bank Negara Malaysia with powers to supervise and regulate Islamic banks, similar to the case of other licensed banks. The Government Investment
A c t 1 9 8 3 w 'a s a l s o e n a c t e d a t t h e s a m e t i m e t o e m p o w e r t h e G o v e r n m e n t o f M a l a y s i a t o issue government securities issued based on
Shari'ah principles. The first Islamic bank
t o b e e s t a b l i s h e d in t h e c o u n t r y w a s B a n k I s l a m M a l a y s i a B e r h a d ( B I M B ) , w h i c h commenced operations on 1 July 1983.
In contrast, other institutions come under the jurisdiction of the Banking and Financial
I n s t i t u t i o n s A c t 1 9 8 9 ( B A F I A ) . T h e B A F I A , w h i c h c a m e i n t o f o r c e o n O c t o b e r 1, 1 9 8 9 , provides for the licensing and regulation of institutions earning on banking, finance companies, merchant banks, discount houses and money-broking businesses. However, the Islamic banks are not the only financial institutions involved in Islamic banking. In
2K h a n , I. I s s u e s a n d R e l e v a n c e o f I s l a m i c F i n a n c e i n B r i t a i n .
http://www.islamic-banking.com/ ibanking/ ibanking_aom/ia_khan.php 3
K h a n , I. I s s u e s a n d R e l e v a n c e o r I s l a m i c F i n a n c e i n B r i t a i n . http://www.islamic-banking.com/ ibanking/ibanking_aom/ia_khan.php
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The International Journal o f Accounting and Business Society 49
1993, other financial institutions can also offer Islamic banking services through the “Islamic Banking Scheme”.
Nature o f Ijarah Financing
There are many types of
A l-K a ra ’ (Contract of employment), Ijarah Al- Tashyghiliah (Operational Leasing) and
Ijarah such as
Ijarah Al- M asrafiah (Financial Leasing).
Literally,
Ijarah means to give something on rent. As a term of Islamic fiq h , Ijarah can
a l s o r e f e r t o w a g e s p a i d t o a p e r s o n in c o n s i d e r a t i o n o f t h e s e r v i c e s r e n d e r e d b y h i m . I n the following discussion, the term
Ijarah is u s e d t o r e p r e s e n t t h e u s u f r u c t o f a s s e t s a n d
p r o p e r t i e s , a n d n o t t h e s e r v i c e o f h u m a n b e i n g s . In t h e c o n t e x t o f I s l a m i c b a n k i n g ,
Ijarah
c a n b e d e f i n e d a s a p r o c e s s b y w h i c h t h e “ u s u f r u c t o f a p a r t i c u l a r p r o p e r t y is t r a n s f e r r e d t o a n o t h e r p e r s o n in e x c h a n g e f o r a r e n t c l a i m e d f r o m h i m / h e r ” ( H a i r e t d i n o v , 1 9 9 8 ) .
Ijarah
h a s b e e n c o n c e p t u a l l y u n d e r s t o o d a s a c o n t r a c t o f e x c h a n g e in w h i c h o n e p a r t y enjoys the
another party in return for a consideration for the services rendered and from the use of an asset. This classical definition was the basis of many of the contracts of exchange even before the times of the Prophet and was popular amongst the
benefit arising
a s d o c u m e n t e d in m u c h o f t h e literature. Since that time, the operation of these contracts developed to a higher level of sophistication during the period of the companions of the Prophet (p.b.u.h.). However, the basis of operation remained confined to simple
fu q a h a
Ijarah contracts.
The basic feature of the
c o n t r a c t h a s b e e n t h a t it is a c o n t r a c t o f e x c h a n g e b e t w e e n one to another party (hereinafter called one-to-one
Ijarah
Ijarah).
F o r e x a m p l e , o n e p a r t y is
given the right to use the services of a person or of a given asset from another party for a consideration. This contract has not involved the transfer of ownership to the other party as there has been no intention to purchase or to own the
Ijarah object by the interested
party. Over time, however, this concept has developed into transactions with more complex features that give rise to variations from the basic structure of the
Ijarah
transactions.
T h e d i s t i n g u i s h i n g f e a t u r e o f t h i s m o d e is t h a t t h e a s s e t s r e m a i n t h e p r o p e r t y o f t h e Islamic bank to put them up for rent every time the lease period terminates so that they do not remain unutilized for long periods of time. Furthermore, there are some conditions that
Ijarah t r a n s a c t i o n s n e e d t o f o l l o w in o r d e r t o b e in c o n s o n a n c e w i t h t h e
principles of Islamic finance. These conditions are mainly concerned with the object leased, the contract and the maintenance of the leased assets.
Basically, the lease contract must state the lease period clearly. Renewal terms must also
b e s t a t e d c l e a r l y , a n d t h i n g s l i k e t h e r e n t a l s f o r a ll s u b s e q u e n t y e a r s , a f t e r t h e f i r s t y e a r , s h o u l d n o t c o n t a i n c l a u s e s l i k e “ l e f t t o t h e s o l e d i s c r e t i o n o f t h e l e s s o r ” a n d t h e l i k e . I t is also a condition that the subject of the contract must actually and legally be attainable. It is n o t p e r m i s s i b l e t o l e a s e s o m e t h i n g t h a t c a n n o t b e d e l i v e r e d . F u r t h e r m o r e , i t is
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50 An Exploratiory Study o f Accounting on Ijarah ...
permissible for the two parties to agree during the lease period to review the lease period o r t h e r e n t a l o r b o t h . T h a t is b e c a u s e t h e l e a s e c o n t r a c t o c c u r s p e r i o d i c a l l y u n l i k e t h e s a l e
c o n t r a c t w h e r e t h e t r a n s f e r - o f o w n e r s h i p is i m m e d i a t e . P a r t o f t h e c o n d i t i o n s a l s o s t a t e that the lessor bears the liabilities when leasing the asset such as damage, payment of p r e m i u m c o s t a n d b a s i c m a i n t e n a n c e . T h e r e is n o o b j e c t i o n t o a u t h o r i z i n g t h e l e s s e e t o undertake all the above but the costs thereof must be borne by the lessor or owner.
T h e Need for A cc oun ting Standard on Ijarah
T h e n e e d f o r a n a c c o u n t i n g s t a n d a r d is n o t v e r y d i f f e r e n t f r o m t h e n e e d f o r a n y o t h e r kind of standards, whether they be standards for weights and measures, or standards for
clothing sizes, grades of beef,
Baydoun, 2000). The goal or objective of an Islamic accounting standard is to facilitate comparisons and thereby m i n i m i z e t h e s o c i a l a n d e c o n o m i c c o s t s o f a s s e s s i n g t h e a l t e r n a t i v e s w i t h w h i c h o n e is faced in making rational decisions.
or
baseball statistics
(Mirza
and
Unless a proper disclosure with regard to the financial reporting, the underlying
Shari'ah
principles and the accounting methods adopted is made, the information contained in the financial statement will not be useful for a comparison of the performance of different
Islamic banks (Hamat,
Inadequate disclosure of the underlying
Shari'ah
principles will subject the Islamic banks’ activities to a lot of questions with regard to their Islamicity. Thus, the need for standard accounting practices in the reporting of
I s l a m i c b a n k s ’ o p e r a t i o n s is v e r y c l e a r .
institutions as relatively new organizations and the great challenge they face to successfully serve the societies in which they operate, have led them, together with specialists in Islamic
The emergence of Islamic
SharVah and
accounting, to seek the most appropriate means through which accounting standards could be developed and implemented in order to present adequate, reliable, and relevant information to users of the financial statements of such organizations. The presentation of such information is critical to the economic decision making process by parties who deal with Islamic banks and would also have a significant effect on the distribution of
economic resources for the benefit of society.4
The structure and processes of Islamic banks do not readily fit in with those of conventional universal banking, which combines both commercial and investment businesses. This seems to have resulted in supervisory bodies adopting different approaches to regulate Islamic banking. Such variations in the regulation of Islamic
b a n k i n g a p p e a r , i n t u r n , t o h a v e r e s u l t e d in I s l a m i c b a n k s a d o p t i n g d i f f e r e n t a c c o u n t i n g treatments for the same transaction. This rendered the financial statements of Islamic banks non-comparable (Karim, n.d.).
4 Concepts of Financial Accounting For Islamic Banks and Financial Institutions,
A A O I F I , P a r a 1.
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The International Journal o f Accounting an d Business Society 51
A n o t h e r m a j o r p r o b l e m i n t h e a c c o u n t i n g a n d o p e r a t i o n o f I s l a m i c b a n k s is t h e l a c k o f precision, in the application of the
Shari'ah principle to Islamic banking. The S h a ri’ah
d o e s n o t r e f e r d i r e c t l y t o b a n k i n g o r i ts a c c o u n t i n g , b u t t o b r o a d i s s u e s r e l a t i n g t o t h e prohibition of the paying and receiving of
riba , transactions relating to pork, gambling,
speculation, etc. Therefore, for Islamic countries to operate, in a practical manner, the application of
Shari'ah p r i n c i p l e s t o t h e a c c o u n t i n g a n d o p e r a t i o n s o f I s l a m i c b a n k s is
important (Naser and Pendlebury, 1997.)
However, even though the need for Islamic accounting standards for the reporting of
obvious, this does not mean that Islamic banks must come up with complete sets of new accounting standards (Hamat, 1994). The existing standards can continue to
I s l a m i c b a n k s ’ o p e r a t i o n s is
very
be applicable, as long as they do not go against the requirements of the
S h a r i’ah.
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an organization that seeks to support the faith of Islam by developing accounting
s t a n d a r d s f o r I s l a m i c i n v e s t m e n t v e h i c l e s . I n 19 9 1 , s e v e r a l p a r t i e s i n c l u d i n g p r a c t i c i n g accountants and
S h a r i’ah scholars helped set up the AAOIFI- a private sector standard-
setting body in Bahrain with the aim of producing international accounting standards based on the
S h a ri’ah precepts for Islamic banks and financial institutions.
In regulating the financial reporting of Islamic banks, the AAOIFI claims that financial accounting plays an important role in providing the information which the users of the
f i n a n c i a l s t a t e m e n t s o f I s l a m i c b a n k s d e p e n d o n i n a s s e s s i n g t h e b a n k ’s c o m p l i a n c e w i t h the precepts of the
Shari ’ak. However, to perform this role effectively, accounting
standards need to be developed and complied with by Islamic banks. The development of such standards must be based on clear objectives of financial accounting and agreed upon definitions of its concepts (Karim, 1995).
T h e g r o w i n g n e e d f o r a c c o u n t i n g s t a n d a r d s a n d t h e A A O I F I ’s r e g u l a t o r y e f f o r t h a v e been focusing on certain of the Islamic investment vehicles (Pomeranz, 1997). The AAOIFI also expected to strengthen the effectiveness of
S h a r i’ah committees by
f a c i l i t a t i n g t h e e v a l u a t i o n o f e m e r g i n g f i n a n c i n g i n s t r u m e n t s a n d b y a i d i n g in t h e implementation of Islamic ethics. Nonetheless, the AAOIFI seeks the implementation of it s r u l e s p a r t l y b y g e t t i n g c e n t r a l b a n k s t o a d o p t t h e m a n d p a r t l y b y t r y i n g t o p e r s u a d e Islamic institutions of their usefulness.
regulatory bodies (e.g. central banks) nor the power
Furthermore, at present, the AAOIFI has neither the consent
of
Islamic banks to implement its proposed standards ( K a r i m , 1 9 9 5 ) . H e n c e , in
to force
order to
ensure compliance with its standards, the AAOIFI
may have no choice but to obtain the support of the regulatory bodies concerned or to try to secure the cooperation of at least the major Islamic banks and their auditors.
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52 An Exploratiory Study o f A ccounting on Ijarah ...
Research Methods
A review of the literature has shown the lack of studies undertaken to understand accounting practices for
Ijarah. Most of the literature looked at the description of Ijarah
financing (Qureshi and Millet, 1999; Hairetdinov, 1998; Al-Hathal, 1997; Cunningham, 1994; De Beider et al, 1993;). Some of the literature touched on the beefing up by
Islamic financial institutions of their
Ijarah (leasing) capacity in expectation of
u n p r e c e d e n t e d f u t u r e d e m a n d . I t is a l s o r a p i d l y b e c o m i n g t h e m o s t p o p u l a r f o r m o f Islamic finance (Collett, 1996; Collet, 1995). This creates a need to study the dynamics
of this type of financing in order to address the lack of awareness and understanding of the accounting treatment of
Ijarah financing.
T h e r e a r e t h r e e r e s e a r c h q u e s t i o n s in t h i s s t u d y . T h e f i r s t r e s e a r c h q u e s t i o n is : “ W h a t a r e the differences between
Ijarah and conventional leasing from legal (definitions, types
a n d p r i n c i p l e s ) a n d a c c o u n t i n g p e r s p e c t i v e s ? ” T h e s e c o n d r e s e a r c h q u e s t i o n is : “ W h a t are the current accounting practices of
Ijarah by Malaysian financial institutions?”
F i n a l l y , t h e t h i r d r e s e a r c h q u e s t i o n is : “ T o w h a t e x t e n t t h e A A O I F I ’ s a c c o u n t i n g standard on
Ijarah ( F A S 8 ) is a d o p t e d in a n d a c c e p t a b l e t o t h e M a l a y s i a n f i n a n c i a l
institutions?”
The data collection for the first question involves the review of the accounting standards. T h u s , f o r t h e f i r s t o b j e c t i v e , in o r d e r t o h a v e a b e t t e r c o m p a r i s o n b e t w e e n t h e
Ijarah
standard and conventional leasing, it is necessary to study the standard of
Ijarah
recommended by the AAOIFI and compare it with the conventional leasing standard set by the International Accounting Standard (IAS 17) and the Malaysian Accounting Standard Board (MASB 10).
For the second and third questions, a survey research method is chosen to measure the l e v e l o f a c c e p t a b i l i t y o f t h e A A O I F I ’s s t a n d a r d o n
Ijarah. Since the AAOIFI is the only
standard setter for Islamic financial products, this research hopes to find evidence of its level of acceptability in Malaysia. This survey investigation attempts to explore the
nature of accounting practices on
Ijarah. The questionnaire for this research was sent to
the Islamic Banking Division of the financial institutions. The questionnaires were sent to a total of 14 financial institutions operating in Malaysia and the questionnaires were addressed to the manager or head of the Islamic Banking Division. Out of the 14 questionnaires,
13 replies were received and covering almost all of the financial institutions that were involved in
Ijarah financing.
In order to ensure the reliability and validity of the analysis and findings of the q u e s t i o n n a i r e s u r v e y , a s e m i - s t r u c t u r e d i n t e r v i e w v i a t e l e p h o n e is c h o s e n . I n t h e interviews, five financial institutions were selected based on their adoption of accounting standards. The interviews were directed to the same person that responded to the earlier q u e s t i o n n a i r e s u r v e y . T h i s is t o g e t c l a r i f i c a t i o n o n s e l e c t e d i s s u e s t h a t t h e y h a d
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The International Journal o f Accounting and Business Society 53
a n s w e r e d in t h e q u e s t i o n n a i r e s u r v e y . T h e a d o p t i o n o f m u l t i p l e d a t a s o u r c e s is a n attempt to ensure the reliability and the validity of the questionnaire findings.
Comparative Study of AAOIFI FAS 8, IAS 17 and MASB 10 .
This section discusses the descriptive analysis of the comparative study between the AAOlFl’s standard on
Ijarah (FAS 8) and the leasing standards set by the International
Accounting Standard (IAS 17) and the Malaysian Accounting Standard Board (MASB
10 ). '
Legal Perspective
a s “ o w n e r s h i p o f t h e r i g h t t o t h e b e n e f i t o f u s i n g a n a s s e t in return for consideration”(please refer to appendix (B) Juristic Rules, FAS 8, Paragraph 1/1). Some
The AAOIFI defines
Ijarah
Islamic scholars have included the duration of the benefit in the definition.
A s f o r l e a s i n g , t h e I A S 17 d e f i n e d a l e a s e a s “ a n a g r e e m e n t w h e r e b y t h e l e s s o r c o n v e y s t o t h e l e s s e e in r e t u r n f o r r e n t t h e r i g h t t o u s e a n a s s e t f o r a n a g r e e d p e r i o d o f t i m e ” . T h e
d e f i n i t i o n g i v e n b y t h e M A S B 1 0 is q u i t e s i m i l a r t o t h e d e f i n i t i o n g i v e n b y t h e I A S 1 7 . The MASB 10 defined lease as “an agreement whereby the lessor conveys to the lessee in r e t u r n f o r a p a y m e n t o r s e r i e s o f p a y m e n t s t h e r i g h t t o u s e a n a s s e t f o r a n a g r e e d
period of time”.
All the above definitions capture the element of exchange of usufruct for money t r a n s a c t i o n s . N e v e r t h e l e s s , t h e d e f i n i t i o n g i v e n b y t h e A A O I F I is f u r n i s h e d w i t h e x t r a conditions, which will distinguish
Ijarah from conventional leasing. Juristic Rule 1/3/3/2
in t h e A A O I F I ’s s t a n d a r d ( F A S 8 ) s t a t e s t h a t t h e f u l f i l l m e n t o f t h e b e n e f i t s h o u l d b e o f a p e r m i s s i b l e n a t u r e a n d t h e b e n e f i t s h o u l d b e in a c c o r d a n c e w i t h t h e
Shari'ah. Thus, the
A A O I F I ’s s t a n d a r d g i v e s m o r e d e t a i l w i t h r e s p e c t t o t h e l a w f u l n e s s o f b o t h u s u f r u c t a n d the rent. This is to ensure that
Ijarah only signifies such an arrangement where both the
usufruct and the return are permissible by the
S h a ri’ah.
In contrast, the IAS 17 and the MASB 10 adopt a broader aspect of usufruct and return s i n c e r e l i g i o n is n e v e r a n e l e m e n t t o b e o b s e r v e d b y t h e s t a n d a r d - s e t t e r s . T h u s , s t r i c t l y speaking,
Ijarah cannot be equated to conventional leasing. The second aspect to be s c r u t i n i z e d is t h e t y p e s a n d p r i n c i p l e s o f
a n d l e a s i n g . T h e A A O I F I ’s s t a n d a r d classifies
Ijarah
Ijarah as Operating Ijarah and Ijarah Munta'nia Bittamleek. The main criterion u s e d in t h e c l a s s i f i c a t i o n is w h e t h e r t h e l e a s e i n c l u d e s a p r o m i s e t h a t t h e l e g a l t i t l e in t h e leased asset will pass to the lessee at the end of the lease term.
The AAOIFI’s standard on
Ijarah states that when a lease does not include a promise
t h a t a l e g a l t i t l e w i l l p a s s t o t h e l e s s e e , it is c l a s s i f i e d a s O p e r a t i n g
a n d i f t h e r e is a p r o m i s e it is
Ijarah
Ijarah Muntahia Bittamleek. !n essence, the subtle difference between Ijarah and Ijarah Muntahia Bittamleek l i e s in t h e p r e - e x i s t e n c e o f t h a t p r o m i s e w h e r e b y
a lease concludes with the legal title passing to the lessee through either: (i) gift (transfer
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54 An Exploratiory Study o f Accounting on Ijarah ...
of legal title for no consideration); (ii) token consideration or other amount as specified in t h e l e a s e ; ( i i i ) t r a n s f e r p r i o r t o t h e e n d o f a l e a s e f o r a p r i c e e q u i v a l e n t t o t h e remaining
Ijarah installments; or (iv) a gradual transfer of the legal title (sale) of the
leased asset.
In t h e I A S 1 7 a n d t h e M A S B 1 0 , a l e a s e is c l a s s i f i e d a s a f i n a n c e l e a s e i f it t r a n s f e r s substantially all the risks and rewards incident to ownership of the asset from the lessor to the lessee. Title may or may not eventually be transferred. All other leases, which do not meet this criterion, are to be classified as operating leases.
A hire purchase contract for the hire of an asset would also fall within the definition of a finance lease. Hire purchase contracts
in M a l a y s i a c o n t a i n p r o v i s i o n s , which transfer the title of the asset to the hirer upon payment of all the hire purchase installments.
Al-Ijarah Thumma Al-Bai'"\s t h e I s l a m i c a l t e r n a t i v e t o c o n v e n t i o n a l h i r e p u r c h a s e in M a l a y s i a . I t is a l e a s i n g e n d i n g w i t h s a l e a n d c o n s i s t s o f t w o d i f f e r e n t c o n t r a c t s i . e . t h e c o n t r a c t o f lease and the contract of sale.
However, the standard does not elaborate the meaning of “transfer substantially all risks
a n d r e w a r d s i n c i d e n t t o o w n e r s h i p ” . It r e l i e s o n t h e c o n s i d e r a t i o n o f s u b s t a n c e o v e r f o r m ( I A S 1) i n d e c i d i n g w h e t h e r a l e a s e s h o u l d b e c l a s s i f i e d a s a f i n a n c e l e a s e o r a n operating lease. The promise of the lessor to transfer the ownership of the leased asset to t h e l e s s e e in t h e
Ijarah M untahia Bittamleek is n o t t h e s a m e a s t h e s u b s t a n c e o v e r f o r m
r u l e a s in t h e I A S 1 7 a n d t h e M A S B 1 0 .
In the conventional lease, the referred component relates to the risk and reward incidental to ownership of the leased asset. In
Ijarah, the lessor holds the ownership
rights and obligations from the very beginning till the end of the contract. The lessor must accept responsibility for any defects of the leased asset, which impair the intended use of the asset, and may not exclude his liability for any impairment that the leased
property may sustain.
N o t e t h a t i m p a i r m e n t c a u s e d b y t h e l e s s e e ' s m i s c o n d u c t is n o t b o r n e b y t h e l e s s o r b u t b y t h e l e s s e e h i m s e l f . H o w e v e r , m a i n t e n a n c e c o s t s s h o u l d b e t a k e n f r o m t h e l e s s o r ’s p o c k e t s i n c e it i s h i s d u t y t o m a i n t a i n t h e a s s e t . J u r i s t i c R u l e s 1 /6 s u m s u p t h e a b o v e p r i n c i p l e s w h e r e i t s t a t e s , “ t h e l e a s e p r o p e r t y is t h e r e s p o n s i b i l i t y o f t h e l e s s o r t h r o u g h o u t t h e duration of the
Ijarah , unless the lessee commits misconduct or negligence”.
As for the right of the lessor, Juristic Rule 1/5/2 outlines that “the lessee must use the l e a s e d a s s e t i n a s u i t a b l e m a n n e r o r in c o n f o r m i t y w i t h c o m m o n p r a c t i c e a n d c o m p l y
w i t h c o n d i t i o n s w h i c h a r e a c c e p t a b l e in t h e
Shari'ah. He must also avoid causing
damage to the leased asset by misuse through misconduct or negligence”.
Therefore, in the
Ijarah agreement, the ownership rights and usufructary rights are
treated differently as they are detachable according to Islamic commercial law. In
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The International Journal o f Accounting an d Business Society 55
contrast, there seems to be no distinction
ownership rights and u s u f r u c t a r y r i g h t s b y t h e I A S 1 7 a n d t h e M A S B 1 0 . In o t h e r . w o r d s , t h e r e c a n n e v e r b e a t r a n s f e r o f o w n e r s h i p r i s k in t h e
made between
c o n t r a c t a s it d e a l s o n l y w i t h t h e t r a n s f e r o f usufruct. In the case of
Ijarah
Ijarah Muntahia Bi((amleek, transfer of ownership only takes
place when both parties enter into a contract separate from the
Ijarah contract (see
J u r i s t i c R u l e 2 / 3 ) . T h e s e c o n d c o n t r a c t is d r a w n u p w h e n t h e p r o m i s e is f u l f i l l e d .
A cc ou n tin g Perspective
Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) s t a n d a r d w a s a d o p t e d in J u n e 1 9 9 7 a n d it h a s g o n e t h r o u g h s e v e r a l p u b l i c h e a r i n g s attended by representatives
banks, accounting firms,
S h a r i’ah scholars, and academics for their recommendations and comments. AAOIFI
FAS 8 provides representation of accounting principles such as revenue and expenses recognition, measurement methods, disclosure requirements and classification of
Ijarah.
B e t w e e n t h e A A O I F I a n d t h e I A S 17 a n d t h e M A S B 1 0 , t h e m a j o r d i f f e r e n c e s a r e t h e revenue recognition and the effect of residual value since the contracts of
Ijarah and
lease are different in their substance. In addition, the IAS 17 reminds the lessor to record the uncertainties of collectability of lease rentals income and the future level of interest rates. As for the AAOIFI, no provision is recorded on interest rate uncertainty because
the rental is fixed throughout the
Ijarah term or the terms of payment are determined up
front and the lessor cannot increase the rent unilaterally.
Furthermore, the AAOIFI does not mention the provision for doubtful debt in the case of Ijarah , a s it m i g h t b e u n d e r s t o o d t h a t t h e p r o v i s i o n is c o m m o n l y p r a c t i c e d b u t t h e AAOIFI recommends the financial institutions to establish a provision for the repair of
leased assets if the repair expenses differ from year to year over the lease term. This provision is significant under the Ijarah contract because ownership risk is borne by the lessor. Not recording the provision would underestimate the lessor's obligation.
Nevertheless, the AAOIFI is also concerned about the recording of the transaction of permanent impairment of the leased asset before the legal title is passed to the lessee. If t h a t w a s d u e t o t h e l e s s e e ’s a c t i o n s a n d t h e i n s t a l l m e n t p a i d w a s m o r e t h a n t h e f a i r r e n t a l amount, then the lessor has to record the transaction as his liability and recognize it as a loss, which will be posted to the income statement. No such emphasis was given in the IAS 17 or the MASB 10.
On the issue of disclosure, all standards require the major class of assets of accumulated
d e p r e c i a t i o n t o b e s t a t e d . I n t h e I A S 1 7 a s w e l l a s in t h e M A S B 1 0 , t h e m e t h o d f o r income recognition and future minimum lease payment to be received for specified future payment must be disclosed. However, in the AAOIFI, since only one method of
i n c o m e r e c o g n i t i o n i s r e c o m m e n d e d , n o s u c h d i s c l o s u r e is n e e d e d . I n a d d i t i o n , a u n i q u e r e q u i r e m e n t in t h e A A O I F I d i s c l o s u r e is t h a t l e a s e a s s e t s f o r o p e r a t i n g
Ijarah and Ijarah
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56 An E xploration' Study o f Accounting on Ijarah ...
Muntahia Bittamleek are to be distinguishable whereby assets for operating Ijarah are r e c o r d e d a s i n v e s t m e n t in
Ijarah assets while assets for Ijarah M untahia Bittamleek are
recorded as
Ijarah M untahia Bittamleek assets.
Results of Questionnaire and Interview Survey
Most of the financial institutions adopted the MASB rather than the IAS and AAOIFI standards. A total
11 o u t o f t h e 13 i n s t i t u t i o n s a d o p t e d t h e M A S B in t h e i r p r a c t i c e . The reason that
of t h e r e g u l a t o r ) ' b o d 'e s . P r i o r t o t h e e x i s t e n c e o f t h e M A S B , m o s t o f the fmancin! instir'.::ions
followed
the
IAS requirements. Hence, the IAS still enioys a
h i g h e r p o p u l a r i t y t h a n t h e A A O I F I s t a n d a r d . T h i s is s h o w n in t h a t 4 f i n a n c i a l i n s t i t u t i o n s still use the IAS.
A s f o r t h e A A O I F I , it is a n e w o r g a n i z a t i o n c o m p a r e d t o t h e I A S . I n a d d i t i o n , t h e
A A O I F I is a i m e d a t I s l a m i c f i n a n c i a l i n s t i t u t i o n s . T h e c o n v e n t i o n a l f i n a n c i a l i n s t i t u t i o n s may not be aware of the existence of the AAOIFI standard.
Furthermore, this o r g a n i z a t i o n is b a s e d in B a h r a i n . O f t h e t h r e e s t a n d a r d s , t h e A A O I F I g a i n e d t h e l e a s t number of adoptions by the financial institutions. Out of 13, only 2 institutions had