Slide 1

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 2

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 3

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 4

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 5

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 6

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 7

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 8

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 9

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 10

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 11

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 12

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 13

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 14

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 15

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 16

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 17

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 18

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 19

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 20

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 21

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 22

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 23

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 24

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 25

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 26

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 27

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 28

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 29

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 30

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 31

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 32

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 33

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 34

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 35

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 36

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 37

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 38

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 39

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue


Slide 40

Introduction to Islamic Banking and Finance:
Principles and Practice
M. Kabir Hassan, Rasem N. Kayed, and Umar A. Oseni

Chapter 4
Financial Accounting for
Islamic Banking Products

Learning Objectives
Upon completion of this chapter, the reader should be able to:

•

Understand the definition of accounting from both
conventional and Islamic perspectives, respectively, and its
significance in financial decision-making

•

Explain the relevance of International Financial Reporting
Standards (IFRS) in international accounting regulation

•

Understand the basic principles of accounting

•

Understand the basic principles of Islamic accounting

•

Differentiate between the accrual and cash flow accounting
methods

•

Draft the main financial statements for Islamic finance
products

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Financial Accounting?
Financial accounting is a process where business operations
and their activities are measured and measurements are
processed into information for these decision-makers:
- Internal decision makers include the management of
the company
- External decision makers are mainly investors and
customers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The definition of accounting involves the following main issues:
1. Recognizing, recording, classifying and summarizing
business transactions
2. Measuring, analyzing, processing, interpreting operating
results
3. Reporting and presenting the financial position

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

What is Islamic Accounting?
… is ‘the accounting process that provides appropriate
information to stakeholders of an entity that will enable them
to ensure that the entity is continuously operating within the

bounds of the Islamic Sharī‘ah and delivering on its
socioeconomic objectives’

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

•

The general definition of financial accounting is acceptable
within the Islamic finance framework if it complies with
Islamic Sharī‘ah

•

Financial accounting in both Islamic and conventional
frameworks enable stakeholders to make informed decisions

•

Financial accounting fulfills the needs of external decisionmakers

The Definition and the Significance
of Accounting in Financial Decisionmaking

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

Accountability in Islam
•

The Holy Qur’an emphasizes the need and requirement of
accountability ‘hisab’ in every human activity

•

Transparency and fair dealings involve a great commitment
towards accountability in financial transactions

•

Muslim accountants have more responsibilities than nonMuslim counterparts

The Significance of Accountability
in Islam

Learning Objective 4.1
Understand the definition of
accounting from both
conventional and Islamic
perspectives, respectively, and
its significance in financial
decision-making

The significance of accountability with particular reference to
financial transactions is evidenced by the following Islamic
concepts:
•

Khilafah (vicegenrency)

•

Taklif (responsibility)

•

Documentation of financial dealings

•

Islamic law of inheritance (mawarith)

•

Calculation of obligatory alms (zakat)

•

The underlying concept of tawhid (unity of God)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

•

IFRS standards developed by independent, non-for-profit
organisation (International Accounting Standards Board [IASB])

•

The IASB is the standard-setting body of the IFRS Foundation

•

The IFRS provides globally acceptable standards for public
companies preparing and disclosing financial statements

•

The IFRS contains general guidelines for financial reporting

•

The IFRS is more relevant to multinational companies

•

IFRS replaced the International Accounting Standards (IAS)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2
Explain the relevance of
International Financial
Reporting Standards (IFRS) in
international accounting
regulation

The Different Aspects of the Structure of IFRS
•

International Financial Reporting Standards (IFRS)—
standards issued after 2001

•

International Accounting Standards (IAS)—standards issued
before 2001

•

Interpretations originated from the International Financial
Reporting Interpretations Committee (IFRIC)—issued after
2001

•

Standing Interpretations Committee (SIC)—issued before
2001

•

Conceptual Framework for the Preparation and Presentation
of Financial Statements (2010)

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

IFRS and Islamic Banks and Financial Institutions
•

IFRS designed for conventional forms of business

•

Islamic banks have specific requirements e.g. transactions,
reporting and disclosures

•

Therefore, the Islamic finance industry requires alternative
sets of accounting and financial reporting standards

•

The establishment of the Bahrain-based Accounting &
Auditing Organization for Islamic Financial Institutions
(AAOIFI) in 1991

International Financial Reporting
Standards (IFRS)

Learning Objective 4.2 Explain
the relevance of International
Financial Reporting Standards
(IFRS) in international
accounting regulation

Differences between Islamic Accounting and Conventional
Accounting

-

Financial instruments

-

Accounting standards

-

Accounting treatment

-

Types of information contained in financial
statements

-

Financial reporting

-

Functions of commercial/financial contracts

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Accounting comprises two main business activities:

•

Bookkeeping The detailed recording of all financial
transactions in the business

•

The preparation of financial statements or financial
accounting (periodically) Depending on the policy and
the accounting standards adopted by the business

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Recording Financial Information
•

Records for every financial transaction must be kept

•

Information recorded must reflect revenue and
expenditures

•

Journal: Accounting record where financial transactions of a
business are originally entered

•

Account or Ledger or (T Account): Ledger account
format resembling the letter T originating from process of
using debits and credits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting.

Double Entry Bookkeeping
•

Every financial transaction has two main aspects:
1- Debit aspect: the receiving, incoming or
expenses/loss aspect of financial transactions
2- Credit aspect: the giving, outgoing or
income/gain aspect of financial transactions

•

For every debit, there must be a corresponding credit of an
equal amount

•

For every credit, there must be a corresponding debit of an
equal amount

•

In a balanced account, total debits must equal total debits

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Figure 4.1: The Basics of the Double Entry System

Basic Principles of Accounting
The Branches of Accounting

•

Cost and management accounting

•

Financial accounting

•

Auditing

Figure 4.2: The
Three Branches
of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Cost and Management Accounting
The information generated in cost and management accounting
- Provides relevant information helping managers make
informed decisions in managing the business

- Is useful in planning, controlling and the measurement of
performance

Basic Principles of Accounting

Learning Objective 4.3
Understand the basic principles
of accounting

Financial Accounting
•

Provides relevant information to interested parties
(stakeholders) outside the domain of the business such as
investors, banks, future partners, regulatory bodies,
government agencies, stockholders, prospective buyers

•

Allows stakeholders in the industry to make sound economic
decisions that could have an impact on the populace

Learning Objective 4.3
Understand the basic principles
of accounting

Basic Principles of Accounting
Auditing
•

Determines the authenticity, validity and reliability of the
financial information recorded or disclosed during a financial
period

•

Forms of auditing:
- Internal auditing where the business carries out auditing
- External auditing when the business engages an outside
company, usually an auditing firm, to conduct auditing

•

Modern practices combine internal and external auditing for
a particular financial year

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

The objectives of Islamic accounting are diverse
depending on the approach used

•

The purposes of Islamic accounting include:
- reporting of accurate income information
- promotion of efficiency and leadership

- compliance with the Sharī'ah
- commitment to justice
- reporting best practices and adapting to social change
through corporate social responsibility

Basic Principles of Islamic
Accounting
•

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic
Banks
The most popular method of communicating financial
information to consumers or users is through the use of
financial statements

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Consumers of Accounting Information for Islamic Banks
•

Equity holders

•

Holders of investment accounts

•

Other deposits

•

Current and saving account holders

•

Others who transact business with the Islamic bank, who
are not equity or account holders

•

Zakah agencies (if there is no legal obligation for payment)

•

Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

(SFA No. 1) requires information intended for external users:
•

Information about the bank’s compliance with Sharī'ah and
its objectives to establish such compliance

•

Information about the Islamic bank’s economic resources
and related obligations

•

To assist in the determination of Zakah on the Islamic
bank’s funds

•

To assist in estimating cash flows from dealing with the
bank

•

To assist in evaluating the bank’s discharge of fiduciary
responsibility

•

Information about the Islamic bank’s social responsibilities

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

An Islamic Perspective of Accounting Concepts
•

The Qur’an and prophetic precedents emphasise
accountability in commercial transactions

•

Full disclosure, social and financial accountability

•

Ethics for accountant entails trustworthiness and objectivity

•

The Islamic financial institution needs to provide relevant
information on all transactions for the user. The Islamic
bank needs to account for social responsibilities

•

The religious-spiritual element in financial transactions is as
important as the element of profitability

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

Accounting and Auditing Organization for Islamic Financial
Institutions Standards
•

(AAOIFI): Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) established in Algiers in 1990
as an independent non-governmental organization based on
Agreement of Association among financial institutions from
different Muslim countries

•

AAOIFI issued the first accounting auditing, governance and
Sharī'ah standards in 1991 followed by a series of relevant
standards for specific Islamic finance products

•

Many countries have adopted AAOIFI accounting standards

Basic Principles of Islamic
Accounting

Learning Objective 4.4
Understand the basic principles
of Islamic accounting

•

Some countries like Bahrain, Jordan and Sudan have
required Islamic financial institutions in their respective
jurisdictions to abide by the AAOIFI reporting standards

•

Others allow such Islamic financial institutions to adopt the
standards voluntarily

Accrual and Cash flow Accounting
Methods

Learning Objective 4.5
Differentiate between the
accrual and cash flow accounting
methods

Accrual and Cash flow Accounting Method
1. The cash flow accounting method - based on frequency of
cash flow (requires an actual exchange of cash)
2. The accrual accounting method - based on the
occurrence of a transaction regardless of whether there is
exchange of cash

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

•Financial statement is the formal record of the financial
activities (transactions) of a business entity
•Transactions are duly sorted, classified and presented in
accordance with principles of bookkeeping
•The transactions being recorded comprise any business
transacted between the business entity and other corporate
bodies, organisations or individuals
•The end product of all financial transactions is the financial
statement

Financial Statements in Islamic
Banks and Financial Institutions

Figure 4.3:

Flow of Financial Transactions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

• Comparative financial statements of a corporate entity
• Gives direction of business change in at least two financial
periods
• Provides top management with information for decisions
• Comparative financial statements analysis (Horizontal
analysis)
• Determines the performance of the business

• Provides necessary information about sustained performance
or poor performance
• Islamic banks and financial institutions are required to publish
comparative financial statements

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Four Basic Financial Statements
•

Balance sheets

•

Income statements

•

Cash flow statements

•

Statement of retained earnings or shareholders’ equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Balance Sheets also known as the Statement of Financial
Position): a summary of financial balances of a company
Income Statements The income statement is a financial
statement that measures the financial performance of a
company over a specific period of time indicating how the
revenue is transformed into net income
The income statement may also be referred to as
i) The Profit and Loss Statement
ii) Statement of Operations
iii) Statement of Income

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Cash Flow Statements
• Also called statement of cash flow or funds flow statement

• Indicates how changes in the balance sheet accounts and
income statements affect cash and its equivalent
• Purpose is for identification of the sources and uses of cash
during the financial year in question
• FAS 1, para 54 states the statement of cash flows should
differentiate between cash flows from operations, from
investing activities and from financing activates

Financial Statements in Islamic
Banks and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
•

A financial statement explaining changes in retained
earnings of a company over a period of time

•

The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single
proprietorship)
- Statement of partners’ equity (in a partnership)

- Statement of retained earnings and stockholders'
equity (for corporations)

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

Statement of Retained Earnings or Shareholders’ Equity
The owners’ equity and retained earnings may be calculated
using the following formulae:
Owners’ equity = Assets – Liability

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

There are three major categories
The first category comprises the financial statements
that are meant to reflect the position of the Islamic
bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of
Changes in Owners’ Equity

Financial Statements in Islamic Banks
and Financial Institutions

Learning Objective 4.6 Draft
the main financial statements
for Islamic finance products

AAOIFI Proposed Set of Financial Statements for Islamic Banks
•

The second category focuses on the financial reporting of
restricted investments managed by the Islamic bank for the
benefit of others. Such a statement will be referred to as
“Statement of Changes in Restricted Investments”

•

The third category includes financial statements reflecting
the Islamic bank’s role as a fiduciary of funds made
available for social services
Statement of Sources and Uses of Funds in the Zakah
and Charity Fund
Statement of Sources and Uses of Funds in the Qard
Fund

Key Terms and Concepts

•

AAOIFI

•

Double entry bookkeeping

•

Account receivable

•

Credit

•

Accrual method of
accounting

•

Debt

•

Deferred payment

•

Equity of unrestricted
account holders

•

Expenditure

•

External auditing

•

American Accounting
Association

•

Bookkeeping

•

Cash flow method of
accounting

•

Cash flow statement

•

Financial accounting

•

Compound accounting

•

Horizontal analysis

Key Terms and Concepts

•

Income statement

•

Statement of retained
earnings

•

Internal auditing

•

Islamic worldview

•

T account or ledger

•

Journal

•

Waqf

•

Journal entry

•

Zakah

•

Last Day

•

Net income

•

Periodicity concept

•

Qard Fund

•

Revenue