By Mezbah Uddin Ahmed
There are mainly two contenders in the Islamic financial reporting world. These are namely, Financial Accounting Standards (FAS) issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB). FAS are Islamic finance industry-specific standards, whereas IFRS can be applied in any types of industry. The industry players and regulators, particularly in jurisdictions where Islamic finance is new, face the big question – Which accounting standard is the most suitable for Islamic finance activities?
Compliance with AAOIFI Shariah standards is seen highly in the Islamic finance world. However, it must be noted that compliance with AAOIFI Shariah standards does not require compliance with its accounting standards. Compliance with the Shariah standards and accounting standards are completely two different aspects. The Malaysian Accounting Standards Board (MASB) have concluded that the financial reporting principles in the IFRS do not conflict with Shariah, and financial reporting is a recording function that would neither sanctify nor nullify the Shariah validity of a transaction. A study by AOSSG (2011) showed that to be compatible with IFRS, 78% of the jurisdictions did not opt for differential treatment for Islamic finance.
Some institutions offering Islamic financial services (IIFS) discloses in their financial statements that they comply with AAOIFI standards, without differentiating between accounting and Shariah standards. A mere claim of compliance with AAOIFI standards are ambiguous, and in cases misleading were they at the same time claim compliance with IFRS. They must clarify that whether they comply with the Shariah standards or the accounting standards.
Due to the following difficulties, an entity may decide to fully adopt IFRS instead of FAS for financial reporting of Islamic finance activities.
1. Adoption of FAS means the adoption of two sets of standards (FAS & IFRS)
The AAOIFI accounting standards cover only selected aspects of a selected set of Islamic finance contracts. This means that the IIFS will still require to apply IFRS for an accounting of the items that are not covered by FAS. For example, there are no FAS for Qard or Wadiah contracts or for accounting of property, plant and equipment assets. Hence, IFRS is applicable for accounting of these items.
2. Comparability of financial statements of the IIFS
Adoption of FAS will mean that the accounting of the Islamic finance contracts will be different from the conventional contracts. This will raise the issue of comparability between the Islamic and conventional financial institutions. The consequences of differences will be in profit recognition and asset and liability balances.
3. Two sets of accounts for Islamic finance activities
If FAS is applied for financial reporting of the Islamic finance activities, the conventional financial institutions with window or subsidiary based Islamic finance activities will need to prepare two sets of accounts, one applying FAS and the other applying IFRS. This is because IFRS 10: Paragraph B87 requires uniform accounting policies in preparing consolidated financial statements.
If a member of the group uses accounting policies other than those adopted in the consolidated financial statements for like transactions and events in similar circumstances, appropriate adjustments are made to that group member’s financial statements in preparing the consolidated financial statements to ensure conformity with the group’s accounting policies. [IFRS 10: Paragraph B87]
4. The IIFS cannot claim that their financial statements comply with IFRS
. . . An entity shall not describe financial statements as complying with IFRSs unless they comply with all the requirements of IFRSs. [IAS 1: Paragraph 16]
Application of FAS means that the IIFS will need to make certain departures from the IFRS requirements in preparing the financial statements. This will restrict the IIFS from claiming in their notes that their financial statements comply with the IFRS, whereas the law or accounting regulations of the country may require that the financial statements of all financial institutions including IIFS shall be prepared in conformity with the IFRS.
5. Additional disclosures to be made to remain compliant with IFRS
If an IIFS wishes to continue to claim that their financial statements comply with IFRS even after applying several departures due to compliance with FAS, the IIFS will need to make additional disclosures as required by IAS 1: Paragraph 20. This includes the alternate accounting treatment following IFRS and the financial effect of the departure.
When an entity departs from a requirement of an IFRS in accordance with paragraph 19, it shall disclose:
This effectively means that the IIFS will need to maintain accounting records applying two sets of accounting standards if they wish to adopt FAS but at the same time wishes to claim that their financial statements comply with IFRS.
Non-compliance with IFRS may also raise issues during the external audit of financial statements as the law of the jurisdictions may require the auditors to audit the financial statements and form their opinion based on IFRS compliance.
6. Shortage of human resource who are proficient in both IFRS and FAS
Regulators, auditors as well as IIFSs may face difficulty in finding personnel who are proficient in both IFRS and FAS. Building up human resource with such capabilities and retaining them may mean additional expenses for them.
7. Costs in developing an IT system suitable for two sets of standards
Developing an IT system that can accommodate two sets of standards, will add additional costs for the IIFS. There will also be additional costs for training of employees.