ISRA RESEARCH PAPER

Appraisal of the Principles Underlying IFRS: Shariah

Perspective
Section1
Group 9

Mohamad Aiman Bin Adnan

Muhammad Syafiq Nazmi Bin Jasmi
Mohd Sharel Ishak Bin Ilyas
Ahmad Muzammil Bin MD Nor
Muhammad Syakir Bin Abdullah

1114657
1126433
1120609
1119359
1122541

INTRODUCTION

IASB
IFRS

MASB
MFRS
AAOFI
FAS

QUESTION???

Does the accounting for Islamic

financial transaction should also be
coverage towards IFRS adoption

Does the key principle under IFRS

are acceptable form Shariah
perspective?

What is the main Shariah issue

that will arise in the application of
IFRS principle

Asian- Oceania Standard Setters

Group
To discuss issue and share experience on
the adoption of IFRS of Islamic financial
transaction.
AAOSG Islamic Finance Working Group
To facilitate the consideration and
application of IFRS by AAOSG members
Providing input and feedback to the IASB on
the adequacy and appropriateness of
proposed and existing IFRS to Islamic
financial transaction and event

APPROACHES

1) Applying a
separate set of
Islamic accounting
standards

2) Applying IFRS
along with meeting
some additional
guidelines.

PRINCIPLES
IN IFRS

Substance over form

Time value of money

Fair value measurement

Recognition based on probability

Substance over form

Record a transaction based on its economic substance or
financial reality & not necessarily on its legal form
Greater weight on economic substance for recognition and
measurement.
It means that the end result of transaction is recorded.
If used SOF principle, IFI must distinguish between halal and
haram contract
Suggestion:Repudiate SOF altogether and recognize the legal form in
financial statement
Measure the individual financial effects of each contracts
as when it take places

Time value of money

Value of money today is more than in the
future
NPV
Times has economic value concept
Discount rate - -Difference in value due to
time
Prohibition of interest

Fair value measurement

Asset-the price of an asset at which that
assets could be bought or sell in a current
transaction between market participants in
the reference market.
Liability- The price at which liabilty could be
incurred or paid in a current transaction.
Provides more relevant information to
investor

 Fair value is determined using a

referenced market price
Factors:1) Cost of the assets
2) Supply vs demand
3) Individually perceived utility
4) Risk characteristic

PROBLEM??
Use management judgement
What happens if the published prices not
available?
Interest rates in discounting or valuation
technique??

Recognition Based on Probability

Degree of uncertainty that the future
economic benefits associated with the
item will flow to or from the entity.
Items has a cost or value that can be
measured with reliability
Does it any shariah prohibition that would
prevent recognition based on when they
are probable to occurs rather than waiting
for it to actually occur

WORLDVIEW

APPROACHES

EXCLUSIVITY
APPROACH

HARMONIZATION
APPROACH

CONVERGENCE
APPROACH

EXCLUSIVITY APPROACH
Different world view not capitalist
Difference in objective- ACCOUNTABILITY
TO ALLAH AND SHARIAH COMPLIANCE
Different function and contract
Fundamental issue:1) Whether the aim of financial reporting
of IFIs should simply be to provide
information to a wide range of users
2) Whether the financial reporting of IFIs
should reflect their religious obligation

 Reporting should be one channel to

indicate Shariah compliance
Must not report form of interest based
element

AAOFI
Difference recognition and measurement
approach of financial instrument and leases
Requires disclosure to convey Shariah compliance
and provide guidance of certain unique items
Provision and contigent liabilities
Emphasise the legal forms of contracts approved
by its Shariah Board
Disclosure of unrestricted investment account
No elaboration on how to determine fair value by
using estimation technique

HARMONISATION APPROACH
Compare the similarities and differences of
accounting practices between nation
The process of bringing international
accounting standards into some sort of
agreement so that the financial statements
from different countries are prepared
according to a common set of standard.
Litle attention had been given to the religion
factor
Harmonizing IFRS standard and AAOFI
standards

CONVERGENCE APPROACH
Full convergence of accounting standards for
Islamic financial transaction with IFRS
Process of harmonising accounting standards
issued by different regulatory bodies
Examples :- MFRS-( SOP i-1)
Do not conflict with Shariah methodology
Conflict of Substance over form principle
Additional disclosure are required

EXCLUSIVITY
APROACH
Not really work
for dual banking
system
Requires original
Islamic
accounting
standards

HARMONISATION
APPROACH
Only work in
practice in
jurisdiction where
compliance with
IFRS is still
optional
Arise a
comparability
issue at
international level

CONVERGENCE
APPROACH
Best approach
when the
convergence of
IFRS had been
abide by law
Must includes
additional
disclosure

SHARIAH
PERSPECTIVE

1.Substance Over Form

In principle, the Shariah emphasizes that
every contract must comply with its legal
formi.e., the essential requirements as
well as its nature and implication.
This implies that both the form and the
substance of the transaction are important
Ijarah
Bay al-inah

 Debates arise as to whether the effect of

each contract in isolation is to be recorded,
hence recognizing the form of each contract;
Or whether the overall economic effect of the
series of transactions is to be recorded, thus
recognizing the economic substance of the
overall transaction.
A third scenario would be to consider both
the form and the substance of a transaction
when arriving at an opinion.

AL- IJARAH

PROPERTY

BANK
(Lessor)

(1) Bank buys property

(3) Customer pays rental

(2) Bank leases property

CUSTOMER
(Lessee)

Usually a promise
will be make to
transfer
the ownership of
the asset to the
lessee at the end
of lease period
by Sale Contract

 The financial statements will recognize only 1

transaction, which is to account for the final
sale similar to the case of a conventional
hire-purchase agreement whereby the 2
contracts of lease (hire) and sale (purchase)
are combined into 1.
If the principle of form over substance is used

(1) Rental is recognized throughout the ijarah

period.
(2) A sale is recognized when the contract to
transfer the leased item is entered into.

 The principle of substance over form in

Islamic law is derived from the legal
maxim that states:
In contracts, [primary] consideration is given to
intention and meaning, not to words and forms
(Haydar, 1991, Article No. 3).

This maxim stems from one of the five

major legal maxims:
Matters are determined by intentions (Haydar,
1991, Article No. 2).

Different view in Fiqh Mazhab

The majority of scholars, including the Hanafis,
Malikis and Hanbalis adopted this principle.
Shafies scholars,however, disagreed; they
favoured the principle of form over substance.
But they dont reject it , instead apply it on other
contract.For instance, Shafies legalised Bay al
Inah because he treated it as two separate
contracts.

The Resolution of the Shariah Advisory Council

(SAC) of Bank Negara Malaysia (BNM) on the
Principle of Substance over Form

Generally, the review made by the SAC of BNM does

not perceive the concept of substance over form as
contradicting the principles of Shariah per se.
While it recognizes the importance of both substance
and form, in cases of conflict between the two, the
SAC of BNM advocated the primacy of substance
over form.

2.The Time Value of Money

The Shariah does not totally disregard the
concept of the time value of money.
Ahmad and Hassan (2004) found from
their review of fiqh literature that times
monetary valuation is not ruled out as long
as it is not based on a lending relationship
where it is claimed as a predetermined
value.

 Scholars agreed that the time factor earns a

portion of the price in murabahah contracts
on the ground of mans natural preference for
present consumption of money over future
consumption.
positive time preference

As a result, Muslim scholars argued that the

present is superior to the future and, hence,
the present value of an asset should be
higher than its future value.

 Consequently, if payment for an asset is

delayed to a specified time in the future,
the deferred price should be higher than
the spot price to strike a balance of benefit
in the contract of exchange and to uphold
justice (adl) between the contracting
parties.

Arguments of Muslim jurists in

favour of the time value of money.
i.e Murabahah

The seller in a murabahah transaction

must make clear the deferred payment
period by which he bought the good as it
comprises a portion of the price.

Factors that allow time value of

money except for loan contract
Legitimacy of murabahah profits is that the
murabahah sale is based on an
underlying asset.
Hence, it must be based on justice ,
concept of counter value whereas loan is
based on the principle of ihsan
(benevolenc).

Other contract that support Time

value of money :
Bay al salam
Bay al istisna
Discounting when evaluating projects
under construction.
However

Opinion on uses of interest rate in

discounting process among
scholars
Favor

Oppose
That interest is
just a benchmark
rate

Human
innovations that
are not contrary
to Islamic
teaching

Zarqa (1983)
proposed that the
rate of ROE be
considered the
proper discount
rate to be applied
to reflect the
uncertain risks of
a projects cash
flows

Resolutions of the SAC of BNM

on the Time Value of Money
Permissible only for exchange contracts that involve
deferred payment. However, the SAC prohibits the
charging of an extra sum for the deferred repayment
of qard (loan).
The SAC explained that the fuqaha had long
accepted that there is an economic value to time and
quoted various classical statements permitting an
increase in value due to the lapse of time.

3.Fair Value Measurement

A hadith on the prohibition of several
forms of sales known to the medieval
Arabs whereby different ways of
manipulating market conditions take place
to affect the market priceindicates that
Islamic commercial transactions must be
carried out based on fair value.
Talaqqi alrukban
Najash

Illustration on Mudarabah Contract

In a mudarabah contract, the subsistence
(nafaqah) of the agent-manager while travelling is
chargeable to the mudarabah account.
The possibility exists that an agent-manager could
cheats on his expenses to reduce the business
profit.

Hence, the classical jurists unanimously agreed

that the determination of the subsistence should
be based on the fair value.

Determination of fair value

For rare commodity , require benchmarking
to the known price to get the equivalent price
(fair value).

Can be affected by certain circumstances

such as shortage of supply of goods due to
market manipulation, war and emergency.
Therefore, Islamic law recognizes the role of
experts in determining the fair value.

Views on the use of discount rates

as an estimation technique
IFRS
Measurement of fair
value may require the use
of valuation techniques
which often make use of
discount ratesrather
than relying on quoted
market prices.

AAOIFI
In FAS 25, Investment in
Sukuk,Shares and Similar
Instruments, mentions the
use of estimation
techniques to derive fair
value when quoted prices
may not be indicative of
fair value, but it does not
elaborate further regarding
the permissibility of using
discount rates in
determining fair value.

Resolutions on Fair Value

The fatwa-issuing authorities in Islamic finance, such
as the OIC International Islamic Fiqh Academy and
the SACs of BNM, Kuwait Finance House, Dubai
Islamic Bank and al-Rajhi Bank have not yet issued
specific fatwas relating to
(i) the principle of fair value,
(ii) the issue of discounting,
(iii) the use of an interest rate for discounting or in
valuation techniques for determining fair value

4.Recognition Based on
Probability
Examples of recognition based on probability
in an IFI are:
(i) recognizing a liability for expected payments
to
murabahah account holders
(ii) recognizing murabahah receivables using
the expected rate of profit
(iii)recognizing income and expenses based on
expected future cash flows

View on Recognition Based on

Probability
Despite the emphasis on certainty, Islam
also recognizes uncertain circumstances.
This is because, in reality, Muslims are
faced with many probable occurrences.
Example :
Considering his capability to earn money,
he cannot be categorized as poor
The possibility of paying zakah before its
hawl (time of obligation).

Deduction from legal maxim

Concept of probability is accepted in
arriving at certain fiqh rulings.
However, the jurists emphasize the
concept of valid probability, which is
defined as events yet to occur that do not
contradict injunctions from the Quran and
Sunnah.
Only record the high probability to happen
event

The Resolution of the SAC of

BNM on Recognition Based on
Probability
The application of the probability principle in Islamic
financial reporting is permissible as it does not
contradict the general fiqh principles.
Legal maxim bases :
Consideration is given to the predominant and
widespread, not to the rare (Al-Zarqa, 1989)

Principles vs. Practice: Possible

Discrepancies?

IFRS standard that raise Shariah

concern

Key areas relating to the operations of IFIs that

are not covered by IFRS, notably:
the classification and presentation of mudarabah
investment accounts in the financial statements
the accounting treatment of the profit equalization
reserve (PER) under mudarabah investment
accounts
the requirement for additional disclosures such as
zakah calculation, cleansing of Shariah noncompliant income, and Shariah compliance risk

Conclusion & Recommendation

The research is of the view that harmonization is the
most appropriate approach. But only work in practice
in jurisdictions where compliance with IFRS is still
optional.

As for jurisdictions which have already converged

with IFRS, IFI need to include disclosures to the
accounts to explain the differences in the Shariah
treatment of the transactions

 regulators in those jurisdictions should interact proactively with IASB to lobby for increased recognition
of Islamic financial transactions and seek solutions
for the Shariah issues arising with the application of
IFRS.
Recommends that IASB consider providing
guidelines on disclosure that reflect the Shariahbased transactions and products that are utilized by
Islamic financial institutions in their operations

 It is noted that the MASB recommended that there

should be additional disclosures in the Notes to the
Accounts to describe the nature of relevant contracts
as applied by the IFIs
Example
must differentiate it from its conventional
counterpart through disclosure about its legal form
in addition to its economic reality.