Differences between Islamic accounting and Conventional Accounting
To professional accountants and those who have received a conventional accounting education and who have been brought-up on the idea of accounting as an ‘objective’, technical and value-free discipline, the idea of attaching a religious adjective to accounting may seem to be embarrassing and unprofessional.
On the other hand, the development of Islamic banking and finance now embraced even by ardent capitalist institutions such as Citibank, HSBC and ANZ banks may interest accountants and other job seekers to the possibility of new opportunities in this new discipline. Perhaps, the Enron affair has rekindled an interest in having a more honest profession who truly care about the public interest in addition to their pockets. Whatever the interest or curiosity, we hope readers will find this chapter (and hopefully the entire book) interesting, informative, and profitable and yes we hope it may even lead to a bit of soul searching.
· Meaning of Islamic Accounting
Islamic accounting can be defined as the “accounting process” which provides appropriate information (not necessarily limited to financial data) to stakeholders of an entity which will enable them to ensure that the entity is continuously operating within the bounds of the Islamic Shari’a and delivering on its socioeconomic objectives. Islamic accounting is also a tool, which enables Muslims to evaluate their own accountabilities to God (in respect of inter-human/environmental transactions).
The above diagram illustrates the purpose of Islamic accounting. Muslims believe in the hereafter. All business activities should be in line with the shari’a or Islamic law, including business. In life, people transact through institutions such as business. These activities are classified, recorded and summarized using a philosophic filter (shari’a and Islamic accounting standards) to produce accounting statements, which people act on. If the information produced is useful and appropriate to make economic or social decisions through a moral framework, then the users will act in ways to correct their ‘sins’ and increase good behaviour leading to God’s pleasure in the hereafter. If the accounting information system misinforms or does not provide appropriate information, the business might be undertaking sinful activities, the responsibility for which will be borne by the investor as he is a participant. This may lead him to Hell.
The meaning of Islamic accounting would be clearer if we compare this with the definition of “conventional” accounting. (Conventional) accounting as we know is defined to be the identification, recording, classification, interpreting and communication economic events to permit users to make informed decisions (AAA, 1966). From this, it can be seen that both Islamic and conventional accounting is in the business of providing information. The differences lie in the following:
Ø The objectives of providing the information
Ø What type of information is identified, and how is it measured and valued, recorded and communicated, and
Ø To whom is it communicated (the users)
Conventional accounting aims to permit informed decisions by users, whose ultimate purpose is to efficiently allocate scarce resources available to their most efficient (and profitable) uses by providing information efficiency in the market (FASB, 1978). Apparently this is achieved by the user making the appropriate, buy, sell or hold decisions on their investments. Islamic Accounting, on the other hand, hopes to enable users to ensure that Islamic organisations (whether business, government or NFP) abide by the principles of the Shari’a or Islamic Law in its dealings and enables the assessment of whether the objectives of the organisation are being met. At the very basic level, it can be said that Islamic organisations (whether business or otherwise) differ from their conventional counterparts by having to adhere to certain Shari’a principles and rules and also try to achieve certain socio-economic objectives encouraged by Islam.
Following from the above, the type of information which Islamic accounting identifies and measures is different. Conventional accounting concentrates on identifying economic events and transactions, while Islamic accounting must identify socio-economic and religious events and transactions. Older accountants may still remember when they first learnt accounting. They had to prepare final accounts (i.e. balance sheet and profit and loss account). However, Americanization of the curriculum has popularised the term financial statements. Hence, the concentration of accounting has moved from stewardship based manorial accounts to accounting for money (accentuated by the monetary measurement concept).
This is not to say that Islamic accounting is not concerned with money (especially when accounting for businesses). On the contrary due to prohibition of interest-based income or expense, profit determination is more important in Islamic accounting than conventional accounting. However, Islamic accounting must be holistic in its reporting. Hence, both financial and non-financial measures regarding the economic, social, environmental and religious events and transactions are measured and reported.
Conventional accounting mainly uses historic cost (or lower) to measure and values assets and liabilities (although the new IFRS seeks to introduce fair value measurements). The profession is well aware of the limitations of the stable unit of measure assumption of the monetary unit and to its credit has tried in the past in its inflation accounting initiatives. However, despite recommendation from its own research efforts (True blood committee?), the idea of using current values was given up due to its complexity and presumed lack of verifiability. From an Islamic point of view, at least for the purpose of computation of Zakat, current valuation is obligatory (see for example, Clarke et al, 1996) prompting calls for a current value Balance Sheet (Baydoun and Willet, 2000).
A further difference is, Islamic accounting may require a different statement altogether to deemphasize the focus on profits by the income statement provided by conventional accounting. Baydoun and Willlet (2000) have suggested a Value Added Statement to replace the Income Statement in Islamic Corporate Reports. They argue that this shows and encourages a cooperative environment in business as opposed to a destructive competitive environment.
The third category of differences is in the users of the information. Although the profession has recognised various stakeholders as users of accounting information (see for example, the Corporate Report, 1975), the users which it focuses on are shareholders and creditors (i.e. Financiers – those who provide the funds). This is obvious from the fact the FASB’s SFAC 1 dismisses a whole range of stakeholders by the term “and others”. From recent developments in finance and financial markets, accounting seems to be serving an elite group of financiers – market players and banks and other financial institutions. It has been accused of helping a group of rich people get richer (Gray et al., 1996)- a grave charge since the profession always justifies its monopoly on audit services by virtue of the public interest.
Islamic accounting serves the whole gamut of stakeholders. Society as a whole can make corporations accountable for their actions and ensure they comply with Shari’a principles and do not harm others while making money ethically and achieve an equitable allocation and distribution of wealth among members of society especially the stakeholders of the concerned corporation.