Corporate Governance &

Financial Reporting
Shariah Committee & Audit Report of IFI
 Financial Reporting and Corporate Governance (CG)

• A dual relationship between financial reporting & CG

• The important elements that influence a system of CG, where some failures in CG might
be attributed to an inadequate financial reports
• On the other hand, some problems of financial reporting process may have their origins
in deficiencies of the system of CG (e.g. lack of auditor independence)
 Financial Reporting & CG:
The themes of the recent concerns about CG:

• Creative Accounting
• Mgmt. will try as far as possible to present a firm’s performance in a favourable situation. The
problem with regard to the action taken by the mgmt. is that the shareholders might be fooled
with such information.
• Business Failures
• Recent business failures, which include big corporations, raise the anxieties by the public on
the appropriateness on the measures of CG instituted in such organisations.
 Example

• Methods to window dress financial statements to improve the current and quick ratios:
1. Pay off accounts payable with cash. This would have the effect of reducing both current assets and
current liabilities by the same amount, thus increasing the current ratio and quick ratio.
2. Invest additional capital funds at year end. This would increase cash without affecting current
liabilities.
3. Sell fixed assets for cash or short term notes. This would increase current assets, but decrease only
fixed assets. Thus, the current and quick ratios would improve.
4. Borrow cash by incurring long term liabilities (notes or bonds). This would increase cash, but would
not affect current liabilities, since the purpose is to make them long term liabilities.
5. Defer incurring various expenses, such as advertising, research and development, and marketing,
along with reducing capital expenditures.
6. Keep the cash receipts books open longer, in an effort to show higher receivables or collections. This
method is a highly irregular and manipulative device.
 Capital Structure Composition and Solvency

Asset-Based Measures of Solvency

• Asset composition in solvency analysis

• Important tool in assessing capital structure risk exposure.
• Typically evaluated using common-size statements of asset balances.
 MODEL OF CORPORATE GOVERNANACE
(A schematic view of the UK system of corporate governance)

PROVIDERS OF FINANCE

SHAREHOLDERS LENDERS

FINANCIAL ACCOUNTS VOTES COVENANTS FINANCIAL ACCOUNTS

(External Audit) (External Audit)

DIRECTORS
(EXECUTIVE AND NON-EXECUTIVES)

INSTRUCTIONS MANAGEMENT ACCOUNTS

(Internal Audit)

MANAGEMENT
 Financial Reporting and Corporate Governance

• In order to monitor the mgmt. & directors, the shareholders & the creditors need information.
There should be a fundamental problem of informational asymmetry between the directors &
managers, who have access to inside information & the shareholders & creditors, who are the
external parties.
• Therefore, the first monitoring device based on Figure 1 (previous slide) is the financial reports
by the mgmt. & directors to the providers of finance & the external audit process. These
reports and external audit check will then relieve the informational asymmetry between the
providers of finance & the directors & mgmt.
• A further monitoring device based on Figure 1 is the composition of non-executive directors in
the board’s composition to check the actions by the executive directors.
 Financial Reporting & Corporate Governance

• Systemic problems of CG, with regard to financial reporting:

• Supply of accounting information
• Imperfections in the financial reporting process will therefore cause imperfections in the effectiveness of
the system of CG. This is supported by the evidence of increasing use of creative accounting, which might
lead to the failure of financial reporting to fulfill its roles correctly.
• Therefore, we have seen the evolvement of various CG committees worldwide to address the issue of the
supply of accounting information (e.g. in the UK, the Cadbury Committee, Greenbury Committee and
Hampel Committee)
• Demand for information
• Even if the first systematic problem (I.e. supply of accounting information) could be rectified where good
accounting information is supplied, this does not ensure that it prevents the failure of monitoring by the
shareholders, if the shareholders fail to use such accounting information.
 Informational Asymmetry

barrier for the

Processing shareholders to Monitoring
Cost use accounting cost
information
 Financial Reporting and Corporate Governance

• The barrier for the shareholders to use such accounting information is the cost to process it. Such cost might be too
costly for small shareholders, compared to benefits that they might received.
• The answer for this problem is that if we can hold to the semi-strong assumption of EMH, then the small
shareholders can free-ride on the sophisticated judgments by the large institutional investors in evaluating the
publicly available information. However, two fundamental problems with regard to EMH are:
• Quite many of the literature on EMH, found evidence on the apparent departure from the EMH assumption [e.g. Basu (1977)
and Dimson (1988)]
• EMH only refers to informational efficiency (i.e. the ability of the market to instantaneously reflect the new information in
security prices), rather than fundamental efficiency. CG, taken from a whole economy, should reflect fundamental efficiency.

• Monitoring costs
• Apart from information processing costs, shareholders might incur very significant costs in exercising their
monitoring functions, particularly where shareholders are diffuse.
 Financial Reporting and Corporate Governance

• The shareholders must combine with the others to form a significant voting group which can pose a real threat to
the appointment of directors. However, this cost of combining might be more prohibitive, rather than beneficial.
There are two possible solutions within the present CG system:
• Large institutional shareholders may combine, either formally or informally, to exert control on the directors. In Germany, for
example, the voting power of the small shareholders could be pooled by the institutional investors such as banks who hold
proxies and exert similar discipline on the directors.
• The threat of take-over mechanism can give the shareholders the opportunity to exercise their voting power in a decision as to
accept the hostile bid. This has been a long trend in the US and UK. However, the exercise of the take-over is somewhat a blunt
instrument since it should take into consideration a well-informed prospective bidder and a sufficient under-performance by the
management.
 Financial Reporting and Corporate Governance:
2 forms of regulations

• The self-regulation, which is the oldest and most pervasive form of regulation, is regulation
by the accountants, auditors or other preparers of financial information, normally done by
professional accounting bodies (e.g. ICAEW in the UK, AICPA in the USA, and MICPA in
Malaysia), in order to facilitate the works of their members.
• The more broadly-based private sector regulation, is a regulation by a private sector such as
ASB (in the UK) and FASB (in the USA)with some degree of government backing in the
standard-setting process.
 Reporting Guidelines for IFI

• BNM has issued in 2005, the GP8-i: Guidelines on Financial Reporting for
Licensed Islamic Banks to provide guidelines for presentation & disclosure of
reports & FSs of IB in carrying out its banking & finance activities.
• GP8-i set out the minimum disclosure requirements.
• BNM also issued guidelines on the format & content of the SBB Report in the
SGF 2011.
• BNM has issued on 28 June 2013, Financial Reporting for Islamic Banking
Institutions (FRIBI 2013). According to this guidelines, a licensed person is
required under the Financial Services Act 2013 & the Islamic Financial Services
Act 2013 (IFSA 2013) to prepare its FS in accordance with the MFRS.
 Reporting Guidelines for IFI (cont.)

• IFRS and IFRS-based standards are used in over 100 jurisdictions. However,
in some jurisdictions, differential accounting requirements apply to Islamic
financial transactions &/or IFIs. These requirements are usually AAOIFI FAS
or local requirements based on them.
 AAOIFI standards
• AAOIFI was established in 1990 and registered in Bahrain in 1991. As its name
implies, its objectives are:
• To develop accounting and auditing thoughts relevant to IFIs;
• To disseminate accounting and auditing thoughts relevant to IFIs and its applications
through training, seminars, publication of periodical newsletters, carrying out and
commissioning of research and other means;
• To prepare, promulgate and interpret accounting and auditing standards for IFIs; and
• To review and amend accounting and auditing standards for IFIs
• To date, AAOIFI has issued 48 shariah standards, 26 financial accounting
standards, 5 auditing standards, 7 governance standards, 2 ethics standards as
well as a conceptual framework and guidance on first-time adoption.
 AAOIFI FAS

• AAOIFI FAS focus on issues which AAOIFI believes conventional standards do

not adequately or appropriately address. AAOIFI states other matters “should
be dealt with within the framework of generally accepted accounting principles
(GAAP)”.
• Some AAOIFI recognition and measurement requirements differ from IFRS
requirements for similar transactions.
• Additionally, AAOIFI believes that the objectives of financial accounting should
“encourage… compliance with Sharia in all transactions and events”.
 AAOIFI FAS

• Many standard-setters, regulators & IFIs do not share AAOIFI’s views on

accounting or what constitutes compliance with shariah. Hence, AAOIFI FAS
are not universally accepted. On the contrary, empirical study indicates that
IFRS are the more commonly used standards for financial reporting by IFIs.
 Financial reporting framework for IFIs

• Many of the FSs asserted compliance with IFRS-based accounting standards & other
local financial reporting requirements. It was not always apparent to what extent
those standards and local requirements were consistent with IFRS.
• 4 types of reporting standards based on the following criteria:
• IFRS – If the FSs included a statement of compliance with IFRS.
• IFRS as adopted by a specific jurisdiction – If the FSs included a statement of compliance with
IFRS as adopted the jurisdiction, e.g. “IFRS as adopted by the EU”, “IFRS as adopted by the
State of Kuwait” or “IFRS which were translated into the Bosnian language”.
• Local GAAP – If the FSs included a statement of compliance with local GAAP; or if it included a
statement of compliance with IFRS but with a departure(s) to comply with local law.
• AAOIFI FAS – If there was a statement of compliance with AAOIFI FAS.
 Financial reporting framework for IFIs:
Malaysia

• The Financial Reporting Act, 1997 established the MASB and empowered it to
determine and issue accounting standards for the preparation of FSs which are
required to be prepared or lodged under any law administered by the Securities
Commission, the Central Bank or the Registrar of Companies.

• MASB requires ‘an entity other than a private entity’ to apply Malaysian Financial
Reporting Standards (MFRS) for annual periods beginning on or after 1 January 2012,
with the exception of entities that are permitted in the alternative to apply an earlier
framework.
• Compliance with MFRS constitutes compliance with IFRS.
 Financial reporting framework for IFIs:
Malaysia
• The financial report must be prepared in accordance with the provisions of
the Companies Act 2016 and approved accounting standards issued by
MASB.
• The specific MASB standard that is referred to is Technical Release-
Presentation of FSs of IFIs (TR i-3). This technical release complements the
FRS101 Presentation of FSs and it should be complied as long as it does not
contradict Sharia requirements.
• Additionally MASB also issued Statement of Principles: Financial Reporting
from an Islamic Perspective (SOP i-1) that can be referred as well.
 Financial reporting framework for IFIs:
Malaysia

• Consequently, a listed entity must be an entity other than a private entity and must,
therefore, apply MFRS for financial reporting.

• BNM circulars, Financial Reporting & Financial Reporting for Islamic Banking
Institutions issued on 28 June 2013 (FRIBI2013), require a licensed IBI to comply with
MFRS. As stated in paragraph 8.1 of both circulars:
• …a licensed person shall ensure that FSs are prepared in accordance with the MFRS… and
shall disclose a statement to that effect in the FSs…
 Financial reporting framework for IFIs:
Malaysia

• 2 samples, Bank Rakyat and the Development Bank of Malaysia, are

‘prescribed institutions’ subject to the Development Financial Institutions
Act 2002.
• Section 73 requires a ‘prescribed institution’ to submit audited FSs to BNM.
Section 75 states: “A prescribed institution shall maintain its accounts in
compliance with approved accounting standards”, which would be the
MFRS as explained above.
 Entities Financial year end Standards Independent auditor
Complied
1. Malayan Banking Berhad* 31 December 2013 IFRS Ernst & Young
2. Bank Rakyat 31 December 2013 IFRS Auditor General of
Malaysia
3. CIMB Group Holdings* 31 December 2013 IFRS PwC Kuala Lumpur
4. Bank Islam Malaysia Berhad 31 December 2013 IFRS KPMG Desa Megat &
Co, Kuala Lumpur
5. AMMB Holdings Berhad* 31 March 2014 IFRS Ernst & Young
6. Public Islamic Bank Berhad 31 December 2013 IFRS KPMG
7. Development Bank of 31 December 2013 IFRS Ernst & Young
Malaysia
8. RHB Capital* 31 December 2013 IFRS PwC Kuala Lumpur
9. AIA Berhad 30 November 2013 IFRS PwC Kuala Lumpur
10. Hong Leong Islamic Bank 31 December 2013 IFRS PwC Kuala Lumpur
Berhad
* Listed on Bursa Malaysia
 • Sharia Committee’s Report as part of the Annual Report, should be signed by not less than 2
Sharia Committee members. The Sharia Committee’s Report shall contain the following
information (BNM FRIBI 2013):

opening or introductory i. identification of the purpose of the Sharia Committee’s

paragraph
scope paragraph describing the
nature of the work performed;
paragraph expressing the Sharia
Committee’s opinion on the
licensed IBI’s compliance with
Sharia in respect of;
engagement; and
ii. a clear statement of management’s responsibility in ensuring
compliance with Sharia principles
confirmation that the Sharia Committee has performed
appropriate tests, procedures and review work as appropriate
i. contracts and related documentation used;
ii. appropriateness of Sharia basis for the allocation of profit between
shareholders and investment account holders; and where appropriate
iii. disposal of any earnings from prohibited sources/means to charitable
causes;
iv. zakat computation; and
v. any known non-compliance with Sharia & action taken to remedy
such non-compliance as reported by the licensed person as specified
in the Circular on Sharia Non Compliance Reporting.
Shariah Governance
Framework, BNM
(2010)
 Annual financial statements (BNM FRIBI 2013)

• Within 3 months after the close of each financial year, a licensed IBI is required
to submit to Jabatan Penyeliaan Konglomerat Kewangan or Jabatan
Penyeliaan Perbankan of BNM, the following:
a. its annual audited FSs;
b. the audited FSs of its principal subsidiaries, as applicable and where relevant
information in respect of the licensed IFI’s operations in each country outside Malaysia
c. its Auditor’s Report, including a report on the follow-up actions taken by its BODs; in the
case of the consolidated FS, a report by its BODs on its operations in the financial year,
including an analysis (both quantitative and narrative), of the overall assessment of the
group’s financial performance.
 Financial report requirements for IFI in M’sia:
publication requirements (BNM FRIBI 2013)

• A licensed IBI shall –

a. publish an abridged format of the audited annual FSs in at least 2 local daily
newspapers, one of which shall be in the national language and the other in English;
and
b. make available the full set of the audited annual FSs on its website,
• within 14 calendar days after the laying of the FSs at its general meeting.
• A licensed IBI shall make available a copy of the audited annual FSs at every
branch of the licensed IBI in Malaysia
 Financial report requirements for IFI in M’sia:
publication requirements (BNM FRIBI 2013)
• format of the FSs to be published in the newspapers shall, at a minimum,
consist of the following:
• (a) a statement of financial position;
• (b) a statement of comprehensive income;
• (c) a statement of changes in equity;
• (d) a statement of cash flows;
• (e) the Auditors’ Report; and
• (f) the Shariah Committee Report.
 Interim financial reports

• A licensed IBI shall make available on its website or the website of its financial group, the
interim financial reports prepared on a quarterly and half-yearly basis, as the case may be, no
earlier than 5 working days after the date of submission of the information to the Bank but not
later than 8 weeks after the close of the interim period.

• Where the audited annual FSs for the preceding financial year has yet to be published by end
of the 8 week after the close of the interim period, a licensed IBI shall disclose on its website
the first quarter interim financial reports on the same day or not later than three working days
after the publication of the audited annual FSs.
 Effect of IFSA2013 on AUDITING

• According to IFSA 2013 under ‘Transparency Requirements’ division, sec. 73 requires the IFI to
maintain proper accounting records and information as it will enable the IFI to prepare its FSs.
Those records need to be kept in such manner as to enable them to be conveniently and
properly audited.

• Based on Sec. 74, IFI need to prepare its FSs in accordance with the approved accounting
standards; or in the absence of any approved accounting standards, any standards as may be
specified by the Bank.

• Sec.75 also mentioned about the need to publish the audited FSs.
 Reporting obligations of auditor under IFSA 2013
• An auditor shall report such matter to the Bank immediately in writing if, in the course of
carrying out his duties as an auditor of an institution, he is satisfied that:
1. there has been a breach or contravention of any provision of the Act or a non-compliance of any standards
which may have a material effect on the financial position of the institution;
2. an offence involving fraud or dishonesty under any written law has been committed by the institution or by any
director or officer of the institution;
3. any irregularity which may have a material effect on the financial position of the institution, including any
irregularity which jeopardizes or may jeopardize the interests of the depositors, investment account holders,
takaful participants, creditors of the institution, participants or users, or any other serious irregularity, has
occurred
4. he is unable to confirm that claims of depositors, investment account holders, takaful participants, creditors of
the institution, participants or users, are covered by the assets of the institution or assets attributable to the
investment accounts or takaful fund, managed by the institution;
5. there is any weakness in the internal controls which is relevant to the financial reporting process undertaken by
the institution; or
6. the financial position of the institution is likely to be or has been materially affected by any event, conduct of
activity by the institution or any weakness in the internal controls of the institution.
 Differences between Shariah Committee Report &
Auditors Report

• SCR and AR is a form of reporting to indicate a certain level of assurance for the
stakeholders of IFI.
• SCR provides assurance to stakeholders that the Shariah Committee members had
perform necessary review and assessment on the overall operations of the IFI to
determine whether it had complied with Shariah principles.
• AR conventionally provides assurance that the FSs are true & fair, & free from
material misstatements. AR is prepared by independent external auditors & not by
the IFI’s Shariah Committee members.
 Differences between Shariah Committee Report & Auditors
Report
• The guidelines on the content of these 2 reports are provided by BNM Shariah Governance
Framework, FRIBI 2013 and MASB (MFRS)
Shariah Committee Report Independent Auditors Report
Purpose/ Review principles and contracts in relation to Audit the FSs and to express an opinion
introduction transactions and applications used by IFI. on the FS based on the audit.

Form an opinion whether the IFI have complied with

Shariah principles, Shariah rulings issued by the SAC of
BNM and the Shariah Committee’s decision.
Scope of SC members assess the work carried out by Shariah
work review and Shariah audit that include examining on
performed test basis each type of transaction, relevant
documentation and procedures adopted by IFI.
Plan and perform review in order to obtain all
information and explanations for evidence.
Plan & perform audit to obtain
reasonable assurance about whether FS
are free from material misstatements.
Examine on test basis, evidence used to
support the amounts and disclosure in
FS.
Assess accounting principles used.
Evaluate overall FS presentation.
 Differences between Shariah Committee Report &
Auditors Report
Shariah Committee Report
Opinion Provide opinion whether items that have been
reviewed are in compliance with Shariah principles.
Some of the items reviewed:
i. Contracts, transactions and dealings
ii. Allocation of profit and charging of losses
iii. All earnings realized from sources prohibited by
Shariah have been disposed to charity
iv. Calculation of zakat.
OR
SC members confirm that the IFI’s operations for the
financial year is in conformity with Shariah principles.
Independent Auditors Report
Provide opinion whether the FS have
been prepared in accordance to the
Companies Act 2016, BNM guidelines &
approved accounting standards in
Malaysia, to give true & fair view.
i. The state of affairs of the bank,
results & cash flows
ii. Accounting & other records and
registers to be kept as required by
Companies Act 2016.
Shariah audit reports
 AAOIFI’S SHARIAH AUDIT REPORT
In the name of Allah, The Beneficent, The Merciful

To the Shareholders of The Example Islamic Financial Institution

Assalam Alaikum Wa Rahmat Allah Wa Barakatuh

In compliance with the letter of appointment, we are required to submit the following report:
We have reviewed the principles and the contracts relating to the transactions and applications introduced by the Example Islamic
Financial Institution during the period ended. We have also conducted our review to form an opinion as to whether the Example Islamic
Financial Institution has complied with Shari’a Rules and Principles and also with the specific fatwas, rulings and guidelines issued by
us.
The Example Islamic Financial Institution’s management is responsible for ensuring that the financial institution conducts its business
in accordance with Islamic Shari’a Rules and Principles. It is our responsibility to form an independent opinion, based on our review of
the operations of the Example Islamic Financial Institution, and to report to you.
We conducted our review which included examining, on a test basis of each type of transaction, the relevant documentation and
procedures adopted by the Example Islamic Financial Institution
We planned and performed our review so as to obtain all the information and explanations which we considered necessary in order to
provide us with sufficient evidence to give reasonable assurance that the Example Islamic Financial Institution has not violated Islamic
Shari’a Rules and Principles.

In our opinion:
a) the contracts, transactions and dealings entered into by the Example Islamic Financial Institution during the year ended ... that we
have reviewed are in compliance with the Islamic Shari’a Rules and Principles;
b) the allocation of profit and charging of losses relating to investment accounts conform to the basis that had been approved by us in
accordance with Islamic Shari’a Rules and Principles;
(where appropriate, the opinion paragraph shall also include the following matters:)
c) all earnings that have been realized from sources or by means prohibited by Islamic Shari’a Rules and Principles have been
disposed of to charitable causes; and
d) the calculation of Zakah is in compliance with Islamic Shari’a Rules and Principles.
We beg Allah the Almighty to grant us all the success and straight-forwardness.
Wassalam Alaikum Wa Rahmat Allah Wa Barakatuh
(Names and signature of the members of the Shari’a supervisory board)
Place and Date
EXTREMES IN PRACTICE - TOO BRIEF (THE MALAYSIAN CASE)
EXTREMES IN PRACTICE – THE GOLD STANDARD – MEEZAN BANK OF PAKISTAN
EXTREMES IN PRACTICE – THE GOLD STANDARD – MEEZAN BANK OF PAKISTAN