Comparison Study Between IFRS and AAOIFI Accounting Standards: A Case Study of the United Arab Emirates
By Mohammad Sharairi
3 months ago
Comparison Study Between IFRS and AAOIFI Accounting Standards: A Case Study of the United Arab Emirates
- Communications on Stochastic Analysis Vol. 12, No. 5 (Special Issue 2019), 23-32 COMPARISON STUDY BETWEEN IFRS AND AAOIFI ACCOUNTING STANDARDS: A CASE STUDY OF ISLAMIC BANKS IN THE UNITED ARAB EMIRATES * SHARAIRI, M. H. AND ** ISLAM, J. ABSTRACT: This paper aimed to examine the International Financial Reporting Standards (IFRS) currently in use by Islamic banks in the UAE, as compared to the AAOIFI accounting standards, in order to identify the differences and determine which system may better satisfy user needs in the UAE, as judged from the perspective of respondents to a research survey. Data was collected for this purpose through examination of documents and conducting a questionnaire survey with professionals and managers of Islamic banks in the UAE. This paper found that there is a serious concern, particularly in the Islamic countries, with regard to the IFRS dealing with transactions involving interest (Riba) and Zakat. One implication of this study was that in the era of globalization, accounting standard setters who came from different ideological and religious backgrounds should communicate with each other because their reporting standards and their different backgrounds can have global implications beyond their jurisdictions. Therefore, the findings suggest support for not replacing IFRS, but to find a way to comply with AAOIFI standards as well as to continue using IFRS by Islamic banks in the UAE. 1. Introduction Prior studies tried to identify the need for accounting standards for Islamic banks. Some authors tried to explain the objectives, characteristics, ethics and social responsibilities of AAOIFI accounting standards. According to Maurer (2002), the demand for consistent accounting standards for Islamic business enterprises is advocated at least in part, on the need for standardization in the financial reporting practices of Islamic business organizations and Islamic financial institutions, to meet the needs of users. Lewis and Algaoud (2001) argued that the demand for Islamic accounting standards is a response to the significant growth in Islamic banks and financial institutions that has occurred in recent years. They illustrated that the Holy Quran is a source of principles and guidelines, containing approximately 500 injunctions of a legal nature, 20 of which are on economics (Lewis &Algaoud 2001, p. 21). For instance, the injunction against Riba is derived directly from the Holy Quran, where the prohibition is mentioned four times (Lewis &Algaoud 2001, p. 29). Another important consideration for Islamic accounting standards is the requirement enshrined in the Holy Quran requiring the payment of Zakat (Lewis &Algaoud * Mohammad Haroun Sharairi, Assistant Professor, College of Business, Al Ain University of Science & Technology, UAE. E-mail: firstname.lastname@example.org ** Jesmin Islam, Assistant Professor, Faculty of Business, Government & Law. University of Canberra, Australia, E-mail: Jesmin.Islam@canberra.edu.au
- 24 SHARAIRI , M. H. AND ISLAM, J. 2001, p. xii). Sulaiman (2001) specified two essential principles underlying the concept of accountability in Islam; full disclosure and social accountability. She explained that from an Islamic perspective, the emphasis on social accountability would mean that financial reports should enable Muslims to determine Zakat liability. In terms of the number of Shariah principles followed by Islamic banks, Haron (1998) indicated that Islamic banks in many countries (especially Middle Eastern countries) operate with a minimum number of principles. Many additional principles have been introduced in countries such as Malaysia, Bangladesh, Pakistan and Iran. Hassan (2008) stated that Islamic Banks are trying to adopt Basel-II but facing different kinds of impediments such as liquidity risk, a complex mechanism of profit and loss, product standardization, and the absence of Shariah-compliant short term instruments for the management of mismatched assets and liabilities. He argued that Islamic banks face a challenge in adopting IFRS and some of the risk models may expose Islamic banks to other risks that are not apparent for conventional banks. Kamla, Gallhofer and Haslam (2006) also commented that western transnational corporations have sought to promote their particular brand of corporate social and environmental responsibility accounting in Arab countries. They pointed out that accounting would not be limited to a financial or materialistic basis and there is nothing to restrict the form of accounting. Khan (1994) commented that the scope of disclosure is another unresolved issue of accounting discipline and that whether disclosure of accounting policies or treatments was judged material is critical in determining the results for a financial period. The regulating authorities in most countries are trying to raise the scope of disclosure. Hameed (2000) states that many reports (income statement and balance sheet) prepared in accord with conventional accounting principles are useful for Islamic accounting and could be used in Islamic accounting processes as well. However, a complete acceptance of conventional accounting standards would not well serve Islamic businesses. The widespread adoption of IFRS according to Choi & Mueller (1992), will increase understandability of financial statements, save time and money, ease interpretation and improve the credibility of the financial reporting process and profession. But the domain of international accounting standard-setting is dominated by the Anglo-American model. Some of the IFRS do not reflect Islamic practices particularly in regard to interest transactions (Bhattacharjee& Islam 2009). On the other hand, El-Din (2004) indicated that the objectives of financial accounting for Islamic banks and institutions were to verify the rights and obligations of all interested parties in accordance with the principles and concepts of fairness, clarity and business ethics of Shariah principles; participate in the preservation of Islamic banks assets, the rights of Islamic banks and the rights of others in an appropriate manner. Zaini (2007) commented that due to the lack of proper accounting standard Auditing Islamic financial institutions (IFIs) rely on different accounting methods for the preparation of financial reports. IFIs faced problems in the preparation of various accounting reports such as profit and loss account, balance sheet because conventional accounting standards do not satisfy the needs of Islamic business
- COMPARISON STUDY BETWEEN IFRS AND AAOIFI ACCOUNTING... 25 entities. Shadia (2007) stated that Islamic accounting standards, which can be adopted by all Islamic business entities, will help in the comparisons of financial statements of peer financial institutions so that true valuations of these companies may be judged by investors and society. Lovett (2002) documented that, with financial statements prepared under different accounting standards a problem possibly will exist in comparability, creditability and reliability of financial statements prepared globally. However many researchers in different Islamic countries have claimed that a single accounting standard will increase the number of companies complying with AAOIFI standards. Abongwa (2006) claimed that accounting standards reflect the culture of the particular country so it should be made accordingly. On the same issue, Karim (2001) pointed out that AAOIFI accounting standards applied Shariah laws and issued accounting standards which could be easily interpreted by users. 2. Objectives and significance of this paper In the light of the above gap in the literature,this paperis aimed to comparethe specific accounting standards which have been developed by the AAOIFI and the applied IFRS in the UAE Islamic banks, to ascertain whether Islamic banks in the UAE should continue to follow the IFRS issued by theInternational Accounting Standards Board (IASB), or adopt the Islamic accounting standards issued by the AAOIFI. Therefore, IFRS and AAOIFI accounting standards were compared in order to identify the main differences between them and use these differences to explore which system was most suitable for satisfying users needs, through the use of questionnaires. To analyse the differences between the systems, qualitative methods were adopted and applied at the initial stage to focus on the issues which allowed me to examine individual accounting standards. This study will lead to a better understanding of the above issues as well as a better understanding of the similarities and differences in the application of IFRS and AAOIFI accounting standards to the UAE Islamic banks. Although the UAE may differ from some Islamic countries, this study may be useful for other Islamic countries in gaining a clearer picture of the differences between Islamic countries by comparing the findings of this study with other studies, and applying the results to their countries. This paper contributed to existing knowledge and practices not only in Islamic countries but also in western countries in terms of a deeper understanding of the Islamic accounting standards and how the adoption of AAOIFI accounting standards could influence the Islamic banking process, activities and financial reporting.In addition, Islamic bank managers and shareholders will gain an insight into the factors which led to the development of the AAOIFI accounting standards and how these factors could influence the Islamic institutions processes, activities and financial reports. Moreover, this study may provide useful material for researchers and academics with an interest in Islamic accounting research in general, and also in the UAE, as there is a dearth of studies and research regarding accounting standards and AAOIFI standards in particular. Other interested parties, such as local and foreign investors and universities in the UAE, may find this study useful if expanding their courses in Islamic accounting.
- 26 SHARAIRI , M. H. AND ISLAM, J. To identify the differences and similarities between AAOIFI standards and IFRS, and to explore professionals perceptions of which system may better serve their needs and which they would prefer to be applied in the UAE. The principal question here is: What are the main differences and similarities between the applications of AAOIFI Accounting Standards and the IFRS? And, which system can better satisfy users needs in the UAE? This question is divided into three subsidiary questions: Who are the users of accounting information of Islamic Banks in the UAE? What are the user needs for accounting information in the UAE Islamic banks? Are these user needs different from those of Western countries? 3. Research design and methods The choice of research method and how a researcher conducts research depends on their own ontological and epistemological beliefs; in other words, their beliefs about the social world and what is known about it, and the nature of knowledge and how it can be acquired (Snape & Spencer 2004). The research or method adopted in this case can be depicted by analysis of the implementation of IFRS and Islamic Accounting Standards as prescribed by AAOIFI in the UAE and comparing between these two standards. Explanatory methods design was usedas described in Creswell (2005). This paper acquired knowledge through exploring the perspectives of individuals included in the study sample. Both the culture and environment of researcher and participants also played a large part in determining the research approach taken (Snape & Spencer 2004). The research philosophy included a set of fundamental assumptions and beliefs as to how the world is perceived which then served as a framework for thinking about what guides the behaviour of the researcher (Jonker & Pennink 2010). This paper used questionnaire surveys to a comparison between AAOIFI accounting standards and IFRS.The survey method using a questionnaire helped in identifying key aspects of the study directly related to understanding the feasibility of the adoption of Islamic Banking Standards in the UAE Islamic banks. This method was based on the preparation of an appropriate questionnaire comprising of a set of questions that are related to the defined research objectives, so that required data could be collected from selected participants (Bryman & Bell 2007). The questionnaire was administered to current managers and professionals who already apply Islamic financial transactions and methods. The questionnaire was designed to be completed within a 1520 minute time frame so that banks would not find it burdensome. The questionnaire included closed questions scored using a Likert scale and also included some open-ended questions which were analysed using qualitative methods for those questions where managers wanted to provide more information than a Likert scale allowed. Among the main branches of thesevenfull-fledged Islamic banks in the UAE, a total of 175 questionnaires were randomly distributed to managers and professionals. These managers and professionals were selected because they had been involved with Islamic banks
- COMPARISON STUDY BETWEEN IFRS AND AAOIFI ACCOUNTING... 27 transactions on a daily basis and it was expected that they would have an understanding of the accounting standards as applied in the Islamic banks. 4. Analysis of data collected The data collected from the questionnaire survey was analysed through the SPSS statistics for windows (Version 17.0) software providing significant assistance in evaluation of the descriptive statistics relating to the research questions. The results of this paper were offered to the banks that allowed the researcher to questionnaire survey their managers. The identities of those respondent managers were kept confidential.Qualitative analysis was used with regard to open-ended questions that were included in the questionnaire. Qualitative method was used for analysing open-ended questions, helping to make sense of the unstructured information through the provision of workspace and tools. The analysis of the results relating to the potential adoption of AAOIFI accounting standards, were subjected to the KruskalWallis test: level of significance, Skewness, Cronbachs alpha and Exploratory Factor Analysis (EFA), between the variables. This study also used Confirmatory Factor Analysis (CFA). 5. Findings and Discussion This section investigates the different perceptions of professionals, managers and key players in the UAE concerning the suitability of the IFRS and AAOIFI accounting standards to Islamic banks. The section will therefore present the respondents opinions on this issue as well as other related issues such as, comparing the IFRS and AAOIFI accounting standards. The aim of this section is to provide a general picture of the findings of the questionnaire survey. This section is based on an analysis of the questionnaires returned by professionals and managers in the Islamic banking sector. 5.1. Following Shariah principles in Islamic banks Islamic banks exist to produce Islamic financial services. Thus, survey respondents were asked about Islamic banking services and transactions, and to what extent they agreed that Islamic bank financial transactions follow Shariah principles and how these transactions differ from those of commercial banks. Though Islamic banks have attempted to follow the requirements of Shariah principles, they vary in their interpretation of which principles are the most significant to achieve compliance. Some respondents were of the opinion that general concepts of Islamic financial transactions which applied in the Islamic banks were not enough to fully comply with the expectations of Muslims society regarding the Islamic framework accountability. Respondents pointed out that Islamic banks have transactions that could not sustain the application of the accounting concepts of IFRS as these were skewed towards conventional banking practices and do not reflect the Islamic financial principles of Islamic financial institutions. Some respondents added that IFRS has been drafted to account for conventional products and can be adopted only in specific parts by the Islamic banks in the UAE.
- 28 SHARAIRI , M. H. AND ISLAM, J. Hence, there exists a feeling amongst the majority of respondents that the Shariah principles are not given a higher priority and influence over IFRS in current considerations of Islamic financial transactions in the Islamic banks. This contributed to the suggestion that Islamic banks attempted to hide the fact that they were ignoring the interests of local investors among the current adoption of IFRS. 5.2. Disclosure of information by Islamic banks The financial reports should provide complete disclosure and serve local needs, specifically the requirements of Shariah, such as Zakat (Benston 2000). The survey respondents were asked to what extent the financial reports of the Islamic banks included full disclosure of any and all relevant information which facilitates the users economic and religious decision making. Most respondents remarked that Islamic banks had complied by implementing the corporate guidelines of Shariah principles to provide more significant information, and specific disclosures. Some respondents were also of the view that the current level of compliance inadequacy relating to disclosure, together with the simultaneous limitations of enforcement bodies, considerably reduced the users ability to make correct decisions. Additionally, respondents indicated that the listed Islamic banks in the stock market are subject to monitoring by the UAE securities and commodities authority. Since the development of the UAE securities and commodities authority, the listed Islamic banks have been obliged to provide additional information along with their financial reports, thus enhancing financial analysis and better informing investors. Respondents also agreed that local investors and stockholders need this additional information such as a Shariah compliance report along with the financial reports of the listed Islamic banks. This statement agrees with Moores (1997) opinion that the securities and commodities authority assisted investors and stockholders to obtain information important for making investment decisions. Some respondents also made additional comments that the requirements of disclosure of additional information which confirm Shariah compliance of Islamic banks transactions will improve and develop the stock market of these Islamic banks by attracting more Muslim investors and protecting the interests of Islamic society. Despite the improvements in disclosure as a result of the development of the UAE securities and commodities authority, the majority of the respondents in this study were still dissatisfied with the current state of information transparency and disclosure in terms of the practicality of Shariah principles. Therefore, the findings suggest that the relevant disclosures of financial reports of Islamic banks from the perspective of Shariah principles have a limited influence on the current adoption of accounting standards in the Islamic banks. 5.3. Fatwa and Shariah Supervisory Board among Islamic banks The survey respondentswere asked how to solve the problems of Islamic banks transactions which were not following the Shariah principles. The findings reveal that specific respondents showed willingness for the Fatwa and Shariah Supervisory Board to work more closely with Islamic banks to improve the disclosure of
- COMPARISON STUDY BETWEEN IFRS AND AAOIFI ACCOUNTING... 29 information requested by Shariah, such as Zakat, for the investors. One of the respondents noted that even though there has been inadequate disclosure, there has been recent improvement in disclosure, resulting from the presence of the Fatwa and Shariah Supervisory Board. Some of respondents suggested that there is no need to adopt AAOIFI accounting standards because the assistant and supervisory role of Fatwa and Shariah Supervisory Board prove the compliance with Shariah principles in the Islamic banks. However, other respondents also suggested improving the role of the Fatwa and Shariah Supervisory Board regarding the permissibility of Shariah principles in the Islamic banks, rather than adopting AAOIFI accounting standards. 5.4. Comparison between IFRS and AAOIFI accounting standards This section discusses the findings that answer the research questions related to respondents perceptions regarding the main differences between the application of AAOIFI accounting standards and the IFRS, identifying the system that better satisfies users needs. There was a general agreement among the respondents that the adoption of the AAOIFI accounting standard may result in the availability, or greater disclosure, of more detailed information to local investors with respect to Shariahprinciples. However, the respondents agreed that foreign investors will receive greater benefit from adopting the IFRS rather than the AAOIFI standards. 5.5. Comparing the financial reports of Islamic banks under IFRS and AAOIFI accounting standards According to IASC all relevant information needs to be disclosed in financial reports (IASC 1989). Respondents agreed that the financial reports prepared under AAOIFI accounting standards will provide more information for Muslim users than those prepared under IFRS, improving the disclosure of relevant information to facilitate local users economic and religious decision making. The findings focus on some differences between the application of IFRS and AAOIFI standards in the Islamic banks, indicating that a majority of respondents believed that the application of the IFRS to all transactions of Islamic banks would be very difficult and rigorous in nature. For example, lease transactions, contracts of a restricted nature and investment accounting, were major areas of differences. These differences have been raised for two major reasons. First, the IFRS have been developed according to the requirements of the western society objectives and cultures. Second, there were significant differences in understanding the principles and practices between Islamic banks and conventional banks. According to respondents, financial reports are based on two key models of Islamic banks, namely a trading model and a financing model. In the financing model, Islamic banks focused solely on providing finance on the basis of Shariah principles. Some respondents expressed concern regarding the application of IFRS for particular financial transactions of the Islamic banks, questioning whether there should be a different framework of accounting to record the financial transactions of Islamic banks.
- 30 SHARAIRI , M. H. AND ISLAM, J. Some respondents felt that applying AAOIFI standards is the only option for Islamic banks if they want to address the specific requirements of accounting for Muslim users. However, the majority of respondents showed a preference for the financial reports that had been prepared under IFRS because of their understandability and their implementation at reasonable cost and also because IFRS allow for the exercise of appropriate professional judgment. This implied that IASB is perceived by respondents as more rigorous and more capable regulatory body vis-a-vis the AAOIFI. 5.6. Comparing the application of Zakat under IFRS and AAOIFI accounting standards Zakat is one of the major differences between IFRS and AAOIFI standards.One of the key objectives related to accounting from the perspective of Islamic banks in Muslim society, is enabling each and every investor to determine the value of Zakatbeing owed by them. Shariah principles heavily emphasize the concepts of Zakat. It is regarded as an important religious rule and needs separate accounting treatments(Lewis 2001). A question in the questionnaire survey asked to what extent the financial reports of Islamic banks included information that enables Muslims to determine the amount of Zakat. The respondents indicated strong support for the idea that relevant and sufficient information related to Zakat is not included in financial reports of Islamic banks under IFRS. They added that Islamic banks do not include sufficient information that enables Muslims to determine the amount of Zakat. For example, the respondents noted that the IFRS allow the use of fair value measurement of investment property under (IAS 40) which doesnt provide accurate information for Zakat. However, under AAOIFI standards it must be measured at historical cost under (FAS 9) which provides accurate information for Zakat as agreed by the majority of respondents. Some respondents indicated that IFRS also did not consider the Zakatentry as a charity obligation. A majority of the respondents agreed that the financial reports of Islamic banks with the existing adoption of IFRS do not have methods for providing information regarding Zakat, even though some effort has been made through Islamic banks by the Fatwa and Shariah Supervisory Board to follow the principles of Shariah. Specific respondents noted that this leads to most Muslim investors not relying on financial reports issued by the Islamic banks. This implies the inappropriateness of the application of IFRS within the framework of Islamic accountability. As a consequence, the users of Islamic accounting did not have the ability to make fully-informed decisions. On the other hand, the majority of respondents also considered that adopting AAOIFI standards by Islamic banks could provide data associated with the requirements of Shariahprinciples. This could be prepared and disclosed in accordance with assessments of fair value which could also be relevant for Zakat calculations. 5.7. Islamic banks and interest rates The survey respondents were asked to what extent the financial reports of Islamic banks included financial instruments not related to interest rates. They were also
- COMPARISON STUDY BETWEEN IFRS AND AAOIFI ACCOUNTING... 31 asked whether the financial reports of Islamic banks included the disclosure of paid interest, if it existed at all, and the steps which should be taken to avoid such interest rate transactions in the future. As a starting point, according to most survey respondents the interest rate is the core factor differentiating the services of Islamic banks from commercial banks. Notwithstanding the Islamic perspective on interest rates, survey responses in this particular study show that certain transactions related to Islamic banks have involved an interest component. Some respondents indicated that even though there had been interest involved in some transactions by Islamic banks, they did not possess the requisite knowledge to be clear as to the details, particularly given the disclosures involved the rate of interest being recorded under different terms in a category of special commissions. Some respondents indicated that the tendency to classify interest as a special commission was due to the attention that Muslim investors directed towards the term, interest. It was also mentioned that there is interest applied on late payments by Islamic banks. This approach may have been intended to ensure that Islamic banks were compared on a similar basis to commercial banks. It was confirmed by some of the respondents that Islamic banks provided loans which involved the payment of interest. One questionnaire respondent suggested that such interest charged by Islamic banks should be provided to charities. 6. Conclusion To achieve the main objectives of this paper, a pragmatic approach was applied. This process allowed the researcher to adopt a research design based on a combination of quantitative and qualitative methods. A general picture was formed of the challenges and barriers confronting the potential adoption of AAOIFI standards in Islamic banks compared with the current adopted IFRS. A more detailed investigation was based on qualitative methods extended by interpretive processes, allowing meaningful conclusions to be drawn from the main findings.According to some respondents, significant issues of culture and religion have arisen as a consequence of the IFRS adoption by the Islamic banks, such as the specific terminology of Shariah principles and language translation from English to Arabic. This also indicates a probable issue for listed Islamic banks in the stock market and may also present a challenge for Islamic banks at the local level because of resource limitations. The findings indicate that interest is included in certain transactions by various Islamic banks reporting in the stock market. Study respondents have suggested that disclosure by Islamic banks was insufficient for the purposes of applying Shariah principles, such as disclosing data that helps to calculate the Zakatamount. Even though most of the respondents were not satisfied with the present level of disclosure and the inclusion of interest in some transactions, they were more satisfied with the financial reports prepared under the IFRS regime as compared to those prepared in accordance with AAOIFI standards. The paper findings confirm that the factors of religion and culture have a limited effect on systems of accounting.
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