Islamic Accounting Systems and Practices

Dr. Syed Mohammad Ather FCMA

Department of Management Studies
Faculty of Business Administration
University of Chittagong
Chittagong, Bangladesh.
E-Mail: prof_ather_cu05@yahoo.com
Mobile Number: 01818897628

Md. Hafij Ullah

Department of Business Administration
Faculty of Business Studies
International Islamic University Chittagong
240, Nawab Siraj Uddowla Road,
Chawk Bazar, Chittagong-4203.
E-Mail: hafij_1980@yahoo.com
Mobile Number: 01818177051

Reference:
Ather, S. M. & Ullah, M.H., (2009), Islamic Accounting Systems and Practices, The Cost
and Management, Volume XXXVII, Number 6, November December, 2009, ISSN 1817-
5090, pp. 9-16.

1
 Islamic Accounting Systems and Practices
Abstract
Allah (SWT) and His Messenger Mohammad (SAW) gave us guidelines regarding all aspects of our life to deal
successfully in this earth and to get salvation in hereafter. Accounting is also an integral part of our life. This article
gives us an introduction to Islamic Accounting and its contrast to Traditional Accounting. This article also identifies
the basic features and objectives of Islamic Accounting, justifies the need for the development of a separate
accounting system for the Islamic Organizations, and analyzes the traditional concepts of accounting in the Islamic
point of view. The proposition of the article is that the role of accounting and accountants would be more accurate,
effective, complete and fair if any firms and organizations follow Islamic accounting.

Key Words:
Islamic Accounting, Conventional Accounting, Islamic Shariah.

1. Introduction:
Islam is a complete code of life (Al-Quran, 5:3) because Allah (SWT) and Allahs messenger
Prophet Mohammad (SAW) gave us guidelines regarding every aspect of human life to be dealt
with (Al-Quran, 16:89). Allah (SWT) said, This day, I have perfected your religion for you,
completed My favor upon you, and have chosen for Islam as your religion--.(Al-Quran, 5:3)
So, Islam is not only a religion like other religion based on belief but it is an integrated way of
life combining all spheres of life such as individual, social, economic, political, cultural,
religious, etc. Accounting is an integral part of the economic life of a person or organization to
recognize, measure, record the financial transactions and present the financial position in
different financial statements. The interested parties use these statements for making different
decisions which is highly affected based on the accuracy, reliability and objectivity of the
information and its presentation. Such decisions are expected to be effective and relevant for the
Muslims when the presentation of accounting information is done following Islamic ethics and
values. About recording, Allah (SWT) said (Al-Quran, 2:282); O you who believe! When you
contract a debt for a fixed period, write it down. Let a Scribe write it down in justice between
you. Let not the Scribe refuse to write as Allah has taught him, so let him write.---you should not
become weary (your contract), whether it be small or big, for its fixed term, that is more just with
Allah; more solid as evidence, and more convenient to prevent doubt among yourselves....
Accounting is an important way of presenting the performance (financial and economic) of an
organization. But the presentation or practices of accounting differ from country to country and
organization to organization due to educational, sociological, economic, political, legal,
technological factors and organizational typology (Hye, 1988). In business organization the
accounting practices are influenced by its profit motive while in the non-profit organization the
same is affected by its service orientation (Hossain & Rashid, 1992). Ideological or ethical
differences may also influence accounting practices. The different worldviews and values give
rise to different economic systems and thus need different accounting systems being consistent
with them (Hameed, 2000). As per the survey result, 100% of the respondents agreed that the
concepts of traditional accounting and Islamic accounting are not same (See Appendix-2).

2. Rationale of the Study:

Islamic Accounting is a new concept which is now highly recognized by the Muslim
Accountants throughout the world for applying in recording and presenting the financial
transactions of different organizations. As far as our knowledge concerns, very few works were

2
done to enrich this field to be applied practically. Hence, this work is a modest endeavor to
develop the field of Islamic Accounting for practical application.

3. Objectives of the Study:

The main objective of the study is two-fold, i.e., to give an overview of Islamic Accounting
System and its adjustments for use and applications in the streams of Islamic economy and
business by the Muslims. To achieve the main objective, the study sets the following specific
objectives:
1. To justify the need for an Islamic Accounting system.
2. To evaluate the existing concepts of traditional accounting in Islamic perspective.
3. To differentiate between Conventional Accounting and Islamic Accounting.
4. To delineate a process of Islamic Accounting to be applied in the organization.

4. Methodology of the Study:

The methodology followed in this study is mainly of library work basically based on the study of
the Holy Quran, Hadiths and related literatures written in conventional and Islamic perspective.
Of course some primary survey of opinion data was also made. Thus the article is a hybrid of
primary and secondary data. Opinion data were measured by Likert type summated rating scales.
Simple statistical techniques e. g. frequency table and modal averages were used to summarize
the primary data and information.

5. Islamic Accounting Defined:

The branch of accounting which sets its goals and performs all of its activities to achieve those
goals ethically and objectively within the limits and boundary of Islamic Shariah is called
Islamic Accounting. According to Hameed (1), Islamic Accounting may 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 Shariah and delivering on its
socioeconomic objectives to evaluate their own accountabilities to Allah.
6. Features and Objectives of Islamic Accounting:
Islamic accounting has some features and objectives which are highly differentiated from
traditional accounting. Triyuwono (2000) stated some features and objectives of Islamic
accounting such as: (a) the transformation from profit maximization to Zakat maximization (as
an emphasis of the welfare of the society, not only individual interest), (b) Any activity
(accounting) policy must comply with the Islamic Shariah (as Muslims are bound to do this), (c)
it would inherently incorporate a balance between individual character and social character
(Muslims are the most generous community who look after the welfare of others), (d) the
enterprise would be encouraged to participate in releasing humans from the oppression of
economic, social and intellectual factors and releasing the environment from human exploitation
(providing accurate and appropriate information for making decision, setting appropriate prices
of the products, through equitable distribution of wealth, and retaining the environment favorable
through green reporting), (e) it provides a bridge between the world and the hereafter (every
Muslim has a final goal is to enter into Jannat achieving the satisfaction of Allah through
performing good deeds in this world).

3
7. Needs and Development of Islamic Accounting:
As per the survey result, 90% of the respondents agreed (among them 50% strongly agreed)
that it is necessary to have a separate Accounting system for Islamic organizations to achieve
their specific Islamic objectives (See Appendix-2). The new dimension of accounting, i.e.,
Islamic Accounting is essential for some practical reasons which are discussed below:
7.1. Limitations of Conventional accounting:
The conventional accounting provides only the information required to make different
decisions by the users of accounting information but it does not disclose the environmental
effects, social costs, other religious transactions of an entity. Therefore, the traditional
accounting provides the partial information which might lead to wrong decision and wrong
dealings of the organizations. On the other hand, Islamic accounting provides all the
information including social, environmental, and religious transactions as per their
accountability and justice to the related parties and also as per their accountability to almighty
Allah (SWT) (Shahul and Yaya, 2003).

7.2. Compliance to Quran and Sunnah:

Every Muslim has a final purpose of life of having the satisfaction of Allah (SWTA) through
obeying the Shariah. This is because Muslim believes in oneness of Allah, who is Almighty
and All-powerful in haven and earth and He created man just for His servitude and following
Him (Al-Quran, 51:56). So, it is required to know and abide by the Halals (Allowed) and
Harams (Forbidden) in Islam. Interest-based traditional accounting do not reveal appropriate
value of assets in the Balance Sheet for determining accurate amount of Zakat, the compulsory
yearly payment by the rich to the poor. Undue cost controlling and cost reduction techniques in
traditional accounting sometimes lead to unjust and inhuman behavior to the employees of the
organization, which is forbidden (Haram) in Islam (Shahul-2). Therefore, to avoid these sorts of
accounting practices and to comply with the principles of Quran and Sunnah, it is essential to
follow Islamic accounting in the Muslim world and Islamic organization replacing current
traditional or conventional accounting.

7.3. Alternative Accounting system for Islamic Organizations:

At present, thousands of various Islamic organizations including business organizations such as
bank, insurance and investment companies are operating with specific Islamic objectives. But
their use of interest-based traditional accounting in these organizations is not fully compatible
with these Islamic objectives. Islamic accounting will be more appropriate to achieve the
socio-economic and religious objectives of Islamic institutions and Muslim users (Shahul,
2001).
7.4. Contradiction between Traditional Accounting and Islamic Principles:
The basis of Islamic accounting is profit while the basis of traditional accounting is interest
which is completely Haram (forbidden) in Islam (Al-Quran, 2:278 & 2:279). Like interest,
the futures and options, short sale, preferred stock, interest-based modern investment modes
related transactions are also practiced in traditional accounting which is in sharp contrasts with
the Islamic principles (Shahul-2). Traditional accounting is also unable to avoid and control
misappropriation of wealth and power and also unsocial behavior of the dominating
businessmen or companies (Gray et. al, 1988). Hence, to avoid these undesirable activities and
transactions accounting conceptions on the principles of Islamic Shariah through Islamic
accounting is a must.

4
 7.5. Islamization of knowledge:
Islam, a way of life directed by Allah (SWT), is compatible with the nature of the people and
also a source of happiness in this earth and also hereafter (Al-Quran, 2:201). After
experiencing the difficulties and sufferings of capitalism, socialism and communism, the
people are now returning to their natural way of life through Islam (Shahul-2). To accomplish
all the activities (including social, political, cultural, legal and educational activities, etc.) in the
way of Islam, it is now required to redefine, restructure the available knowledge and also
develop new knowledge based on Islamic norms and principles. At present there is movement
towards Islamization of knowledge and disciplines (IIIT, 1988). Therefore, accounting is also
necessary to be developed based on Islamic principles for implementing justice to all, for
equitable distribution of wealth and providing accurate information to the people in the society
(Al-Quran, 4:122).

8. Accounting Concepts-Islamic Perspective:

The basis of Islamic Accounting is acceptance of the postulates of Tawhid (Oneness and Unity
of God-As Islam is a code/way of life given by Allah SWT), Adl (Maintenance of Justice for
all), Ihsan (Goodness/ Kindness to all concerned parties), Amanah (Maintenance of Honesty in
all aspects), Tawakkal (Trust in God in doing all activities), Infaq (Spending to meet social
obligations/responsibilities), Sabr (Maintenance of Patience), Istislah (Maintenance of Public
Interest), and avoidance of the Riba (Avoidance of Interest), Ihtikaar (Avoidance of Hoarding),
Zulm (Avoidance of Tyranny), Hirs (Avoidance of Greed), Israf (Avoidance of Extravagance)
(Lewis, 2006). Keeping in view these postulates of Islamic accounting, the authors, in the
following paras, endeavour to analyze the existing concepts of traditional accounting in the
perspective Islamic accounting.

8.1. Entity Concept:

The entity concept states that the firm and its owners are separate entities and one firm is
separate from another firm. Therefore, the owners (in some cases) are not liable for the
liabilities of the firms. Hence, Islamic Shariah disagrees with the concept because the owners
are not liable for the companys debt at the time of bankruptcy but have the rights to residual
profits which is unlawful and similar to gambling (Napier, 2007). Some others accepted the
concept as at the early age of Islamic State there were Mosques or Baitul-Mal with separate
financial status and (Abdul-Rahman, 1996 and AAOIFI, 1999). However, in Islamic
accounting, if the owners become bankrupt, then the liabilities may be distributed to their
successors or legal inheritors, and, it will be better for the owners because he will be asked for
it in hereafter (Al-Quran, 23:115). As per the survey result, 85% of the respondents agreed to
accept the entity concept as a concept of Islamic accounting and 10% of the respondents
disagreed in this regard (See Appendix-2). Hence, entity concept may be taken as a concept of
Islamic accounting.

8.2. Going Concern Concept:

According to this concept it is assumed that the business will continue for indefinite period of
time and therefore the accountants show acquisition of any fixed assets as cost but not as the
expense of that period. In Islamic view, only the Allah will exist indefinitely, so it cannot be
accepted in Islamic accounting. It is possible to avoid this conflict if we say that final and
permanent existence is true only for Allah (SWTA) and a business organization will continue
indefinitely (if Allah wishes). We know, Mudaraba contract, which is also for specific period,

5
but assumed to continue until one or all of the parties involved decide to terminate the contract
(Al-Obji, 1996). Islam emphasizes the continuity of business activities because they are the
source of Zakat, (to pay Zakat, business must continue) which is paid every year. As per the
survey result, 80% of the respondents agreed to accept the going concern concept as a concept
of Islamic accounting and 20% of the respondents disagreed in this regard (See Appendix-2).
Hence, going concern concept may be accepted as a concept of Islamic accounting.

8.3. Accounting Period Concept:

The financial statements representing the financial performance and financial position of the
business are periodically disclosed based on this concept. In Islamic points of view, this
concept may be accepted based on the ground that Zakat is paid annually and conditions for
applicability of Zakat is holding of assets for one year. Accounting statements should be
prepared for a particular period, showing the amounts on which Zakat would be levied (Adnan
and Gaffikin, 1997). Attiah (1989) noted that the budget of the Baitul-Mal was prepared on an
annual basis, and the employees in the Islamic states were paid annually.

8.4. Money Measurement Concept:

The money measurement concept states that the events recorded in accounting must be
measurable in terms of money and it facilitates to record the heterogeneous objects to be
expressed in a common denominator. But the objects that cannot be expressed in terms of
money are not recorded and the purchasing power of money is unstable in inflationary
environment and it affects future financial rights and obligations. Therefore, the role of money
as a standard of measure is questioned by different Islamic scholars. Ahmed (1990) stated that
using money as a unit of measurement is questionable from Islamic perspective in an
inflationary situation and hence money is unable to serve as a just and honest unit of account.
But most of the scholars argued that because of unavailability of any suitable standard money
can be taken as a standard of expressing diverse objects in a common denominator (Napier,
2007). In an interest-free economy money may be used in recording transactions without any
question. Islamic accounting records and prepares reports relating to some transactions which
may not be possible to measure in terms of money (for example, environmental damages/
degradation by the firm). As per the survey result, 85% of the respondents agreed to accept the
money measurement concept as a concept of Islamic accounting and 15% of the respondents
disagreed in this respect (See Appendix-2). Hence, money measurement concept may also be
taken as a concept of Islamic accounting.

8.5. Cost Concept:

According to this concept, the assets acquired should be recorded and stated in the financial
statements at its cost because the cost amount is objective and verifiable. But for the purpose
calculation of Zakat, the assets are required to be recorded at current market value. This is
because the real (just and fair) picture of the organizations cannot be revealed with these
misleading out dated figures. The cost concept for valuation corrupts the principle of disclosing
the truth to the interested users (Al-Quran 2:42). On the other hand, if current value is used,
then profit or dividend may be distributed among the stockholders before it is earned, that
cannot be approved under Islamic system of accounting. As current value also creates some
problems and because of non-availability of alternative way and therefore, this concept can be
used in Islamic Accounting practices. Mirza and Baydoun (2000) suggest using both the
valuation methods in Islamic Accounting, i.e., the contractual transactions with other parties

6
should be based on cost and Zakat calculation (assets Valuation) should be based on current
market value. Attiah (1989) stated that major four schools of Islamic thought agree upon this
concept. As per our survey result, 70% of the respondents agreed to accept the cost concept as
a concept of Islamic accounting but 30% of the respondents disagreed in this regard (See
Appendix-2). Hence, the scholars should think over the matter.

8.6. Conservatism Concept:

The basis of the concept is Anticipate for no profit but provide for all possible losses. It
states that if the accountant has reasonable choice, accountant records assets and revenues at
lower figures and liabilities and expenses at higher figures. It acts as a constraint to the
presentation of relevant and reliable data (Belkaoui, 2000). This concept contradicts with
Quran and Sunnah because it would lead to understatement of assets which is the basis of
Zakat calculation. Ahmed (1990) stated that though this concept contradicts with Islamic
Principles but it restricts overoptimistic valuations and distribution of unearned profit. Allah
(SWTA) also asks Muslims to choose and follow medium paths avoiding the extremes (Al-
Quran, 25:67 & 17:29). Therefore, justified market value (the current value of the largest
trading market or average values of the larger markets) can be taken into account for
accounting records. As per the survey result, 70% of the respondents agreed to accept the
conservatism concept as a concept of Islamic accounting but 25% of the respondents disagreed
in this regard (See Appendix-2). Hence, the scholars should think over the matter.

8.7. Full Disclosure Concept:

The main purpose of accounting is to provide necessary information to the interested users for
making decisions. According to this concept, all the information relating to the organization
should be disclosed fairly and completely in the financial statements so that the intended users
can understand the statements without any clarification from the accountants. So, traditional
accounting emphasizes on users requirement of information while Islamic accounting
emphasizes on accountability of the accountants in disclosing the information. Islam also gives
emphasis on ethical disclosure as the accountability to the nation, because Allah (SWTA)
knows every thing what we conceal and disclose (Al Quran, 14:38). --And nothing is hidden
from your lord (so much as) the weight of an atom (or small ant) on the earth or in the heaven
(Al-Quran 10:61). Not what is less than that or what is greater than that but is written in a
clear record. (Al-Quran 18:49)---They will say: Woe to us! What sort of Book is this that
leaves neither a small thing nor a big thing, but has recorded it with numbers!-- And they will
find all that they did, placed before them, and your lord treats no one with injustice. Allah said
(Al-Quran 2:42): Do not cover the truth with falsehood and do not conceal truth when you
know it. Hence, this concept is fully compatible with the Islamic Shariah.

8.8. Materiality Concept:

The accountant does not attempt to record a great many events which are so insignificant that
recording of them in books is no at all justified by the usefulness of the result (Khan, 1995). In
some cases it may be impossible to understand and present the statements in a convenient way
if all the information is incorporated therein. But Islam always emphasizes on justice, and it
may not be possible to maintain justice in presenting information if materiality concept is
applied. The word material is a relative term and varies person to person and organization to
organization. For maintaining justice Allah (SWTA) always emphasizes on full recording and
disclosure (Al-Quran, 99:7-8 and 50:18). In Islamic accounting, (where possible and easier)

7
 full disclosure of information is preferable, and (where not possible to present fully) materiality
concept can be used if there is available safeguards against misuse or if accountants
committee furnish a qualitative guidelines on the concept of materiality to arrive at the uniform
practice (Islam, 2000). As per the survey result, 75% of the respondents agreed to accept the
materiality concept as a concept of Islamic accounting, 10% of the respondents disagreed and
10% of the respondents were indifferent in this regard (See Appendix-2). Hence, materiality
concept may be taken as a concept of Islamic accounting but should be used carefully.

8.9. Accrual Concept:

As per accrual concept revenues are recognized and recorded in the books of account when it is
generated, but not when it is received in cash and expenses are recognized and recorded in the
books of account when it is incurred, but not when it is paid in cash (Khan, 1995). But
application of this concept requires subjective judgment which may be biased and created
doubts in account. In accrual basis of accounting, profits may be distributed collecting cash
from other sources before collecting cash from that account which may turn into bad (Napier,
2007). Since Islam is based on truthfulness and accuracy, it seems that for Islamic Accounting
the cash basis of accounting rather than the accrual basis of accounting will be more
appropriate. As per the survey result, 85% of the respondents agreed to accept the accrual
concept as a concept of Islamic accounting and 15% of the respondents disagreed in this
respect (See Appendix-2). Hence, Accrual concept may be taken as a concept of Islamic
accounting.

8.10. Other Concepts:

There are some other concepts of accounting such as Dual Aspect, Matching, Reliability,
Consistency, and Objectivity Concepts which are followed in recording and presenting the
information to the interested users fairly, truly and appropriately. Though there are some
different opinions regarding the acceptability of some of these concepts in Islamic accounting
but none of these are conflicting with the basic principles of Islamic Shariah. For fair, clear,
and appropriate recording and presentation of the information relating to the operating results
and financial position of the organization, these concepts are sometimes compulsorily required
in Islamic accounting. Therefore, these concepts may be accepted in practicing Islamic
accounting.

9. Differences between Islamic Accounting and Traditional/Conventional Accounting:

Islamic Accounting and Traditional/Conventional Accounting have got differences in many
points among which the basic ones have been highlighted in the following table.
Points Islamic Accounting Traditional Accounting
1. Definition Accounting process which Accounting process aims to allow
provides appropriate information informed decisions whose
(not only financial data) to ultimate purpose is to efficiently
stakeholders of an entity that allocate scarce resources available
will enable them to ensure that to their most efficient (and
the entity is continuously profitable) uses by providing
operating within the limits of information efficiency in the
Islamic Shariah and delivering market. (Without any compliance
on its socioeconomic objectives. to Islamic Shariah.)

8
2. Operations In operational, it performs In operational, it allows
everything within the limits of everything to achieve maximum
Islamic Shariah. profit.
3. Nature It is conceptualized based on the It is conceptualized based on
Islamic principles. principles of secularism and
capitalism.
4. Governance It is governed by Al-Quran and It is govern by Accounting and
Sunnah or Islamic Shariah. commercial law and Secular
Ethics.
5. Normative or There is no difference between There is difference between
Descriptive Normative and Descriptive normative accounting descriptive
accounting. accounting.
6. Orientation It is always society or It is always firm or individual
community oriented. oriented.
7. Basis Unity of God (Allah). Economic rationalism.
(Tawhidism)
8. Entity Concept Firm does not have separate Firm and Owner have separate
financial obligation. entity and financial obligation.
9. Cost or Price Market or Selling price rather Historical cost rather than Market
than Historical cost is preferred. price is preferred.
10. Disclosure Full disclosure to satisfy any Limited disclosure provision of
reasonable demand for information subject to public
information in accordance with interest.
the Shariah.
11. Going Business continues not forever Business continues forever or
Concern but depends on contractual unlimited period of time.
agreement between parties.
12. Consistency Consistency based on Shariah. Consistency based on GAAP.
Most favorable to society Most favorable impact on owners
13.Conservatism (justice). and least favorable to society.
14. Accounting One lunar year for Zakat Periodical measurement of
Period calculation. performance.
14. Unit of Quantity based and monetary Monetary value based.
Measurement based (Zakat calculation).
Public accountability focusing Personal accountability focusing
15.Accountability on the community who on individuals who control
participate in exploiting resources.
resources.
16. Equity Recognize each party equally. Survival of the fittest.
17. Profit Determine accurate and Tries to maximize profit.
reasonable profit.
18. Ownership It recognizes relative ownership It recognizes absolute ownership
on assets and firm. on assets and firm.
19. Reports Reports socio-economic and Reports only economic events and
religious events and transactions. transactions.
Source: Developed through literature review and research.

9
10. Islamic Accounting Systems and Practices:
Islamic accounting does not avoid all methods and techniques applied in conventional
accounting saying illegal but it justifies all these things through the testing stone of Quran and
Sunnah. Islamic accounting accepts a conventional method if it is not conflicting with the values
and principles of Shariah and rejects if it conflicts and it also incorporates some other norms and
values not practiced by conventional accounting for establishment of justice. The basic principles
governing summarization of financial transactions are as follows (Ahmed, 1994): (a) Interest is
prohibited while trade is permitted (subject to restrictions), (b) Illegal or unjustified transaction is
prohibited, (c) Uncertainty (al-Garer) in trade contract is not allowed, (d) All transactions must
be conducive to welfare of all concerned. Some aspects of Islamic accounting practices are
enumerated as below:

10.1. International Accounting Standards (IAS):

Accounting Standards are the norms of accounting policies and practices issued by the
accounting bodies for the guidance of their members regarding the treatment of items which
makes up the financial statements and the disclosure therein (Hye, 2000). The IAS which is
currently practiced was developed interest-based western socio-economic culture and
environment. But Islamic organizations, established and operated based on Islamic Shariah to
achieve a legitimate objective, work in a different environment using different financial
instruments and perform some transactions which are unknown to the western world. Hence,
The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is an
Islamic international autonomous not-for-profit corporate body that was established in Bahrain
to prepare accounting, auditing, governance, ethics and Shari'ah standards for Islamic financial
institutions and the industry on 26th February, 1990 to attain the following objectives (1) to
develop accounting and auditing thoughts relevant to Islamic financial institutions; (2) to
disseminate accounting and auditing thoughts relevant to Islamic financial institutions and its
applications through training, seminars, publication of periodical newsletters, carrying out and
commissioning of research and other means; (3) to prepare, promulgate and interpret
accounting and auditing standards for Islamic financial institutions; and (4) to review and
amend accounting and auditing standards for Islamic financial institutions.
10.2. Accounting Cycle:
The order or sequence in which accounting procedures are performed is known as Accounting
Cycle (Khan, 1995) or it is a process by which accountants produce an entitys financial
statements for a specific period of time (Horngren and Harrison, 1992). Accounting cycle is an
organized way to reach the destination of accounting objectives and which basically consists
five steps-Recording (through journal), Classifying (through ledger), Summarizing (through
Trial Balance), Preparation of financial statements and Interpretation and Analysis of financial
statements. In Islamic accounting this accounting cycle may be applied fully for the financial
transactions only but not for non-financial transactions. Islamic accounting records and
prepares reports relating to some transactions which may not be possible to measure in terms of
money (for example, environmental damages/ degradation by the firm) and double entry
accounting system may not be appropriately followed for these types of transactions because
the firm generally is not compensating anything to the community. In interpretation and
analysis the accountants should justify the performance of the organization calculating new
ratios regarding contribution to employees, and employees development, contribution to
society and also to the environment in relation to value added (Mirza and Baydoun, 2000).

10
10.3. Preparation of Financial Statements:
Each entity prepares different financial statements as per the directions of law and of the
requirements of the information of the users of those statements. These financial statements
include income statement, owners equity statement, cash flow statement and balance sheet.
But Islamic accounting in addition requires preparation of: (a) Reports of Funds for Zakat and
Their Uses detailing the sources of funds for Zakat, methods of its collection including controls
to safeguard these funds and their uses; (b) Reports about prohibited Income & Expenses to
disclose income earned from prohibited transactions or sources and expenditures prohibited by
the Shariah and how those earnings were disposed of and also the causes of these income; (c)
Social Responsibility Reports, and Human Resources Development Reports (AAOIFI 3). Some
scholars recommended preparing value added statement. A value added statement (Appendix-
1) stresses entity performance from a community viewpoint as opposed to focusing on owners,
which is consistent with the Islamic view that firms are accountable to the community (Napier,
2007). To represent the accurate financial position of the firm, Baydoun and Willett (2000)
suggested preparing current value balance sheet at the end of the accounting period. Fictitious
Assets should not be revealed in the balance sheet and for determining the net realizable
receivables, direct method of written-off should be adopted, that is, revalue the account to
determine the extent of the loss to be specifically provided for (Hamat, 1994).

10.4. Zakat Calculation:

The word Zakat literally means purification. One of the five pillars of Islam is Zakat. A rich
Muslim or a solvent business is compulsorily required to pay Zakat once a year basically to the
poor to diminish poverty and minimize the financial gap between them. Zakat has been
described as the cornerstone of the financial structure in an Islamic State (Siddiqi, 1982).
Muslim sole proprietors and partners are obliged to pay Zakat on both personal wealth and on
business (Faris, 1966). For payment of Zakat the assets must possess the characteristics which
are (a) Perfect ownership on assets, (b) assets is growing or productive, (c) assets above the
basic requirement or surplus assets (d) assets owned for a full year. For calculation of Zakat,
valuation of assets should be according to the current market price or net realizable value.
Inventories valuation should not be the lower amount of cost or market price or there should
not be maintained any allowance for doubtful accounts receivable (Clarke et al., 1996).
10.5. Dealing with Interest:
Interest is the predetermined fixed charge on borrowing or investing money but any
transactions relating to interest (in any form) is strictly prohibited by Islamic Shariah. Hence,
Islamic organizations (banks) use alternative modes of borrowings/investments to meet their
needs of financing. The alternatives are discussed below:

a) Mudarabah (trust financing): The bank acts as a partner, providing cash to the borrower
and sharing in the net profits and net losses of the business (Haqiqi & Pomeranz, 1987). The
loan is for an undetermined period, although the contract may be rescinded by either party.
Kahf (1978) defines Mudarabah as: An Islamic mechanism for introducing monetary assets
into production activity by transforming them into real factors of production as a result of a
joint action between the owner of the assets and the entrepreneur. As this method, the lender
supplies capital to an agent for trading purposes and the borrower would contribute only his
work and experience. Afterwards, the net profit is divided between the two parties according to
the ratios agreed in advance in the contract. In case of loss from normal business causes or

11
 natural causes, however, the lender bears all the loss and the borrower receives no reward for
his effort. This is consistent with the prohibition of a fixed return, i.e., interest on one's capital.

b) Murabaha (cost-plus trade financing): The bank, as a partner, provides the finance for
purchasing goods for a share of the profit once the goods are sold. The bank may or may not
share in any losses incurred. Repayment may be either in lump sum or in installments. The
accounting entries for these transactions are: when the bank buys goods and pays cash; Debit-
cost of goods; and Credit-amount in bankers-check (Cash); When the bank sells the goods to
the client on a deferred payment basis: Debit-Investment (cost-plus-profit), Credit-Cost of
goods (cost) and Credit-Unearned profit (profit margin) (Hamat, 1994a).

c) Musharaka (Participation financing): Musharaka is another mode of interest-free

financing where the bank and the client agree to join in a temporary partnership to effect a
certain operation within an agreed period of time. Under this mode of financing both parties
contribute to the capital of the operation in varying degrees, and agree to divide the net
profits/losses actually earned in the ratios agreed upon in advance.

d) Ijara (Rental/lease financing): Ijara may be defined as an agreement whereby the lessor
conveys the right to use a specified asset to the lessee for an agreed period of time in return of
a fair rent. In Ijara financing bank purchases fixed assets and allows the clients/businesses to
use in return for rental income. There are two types of lease arrangements; finance lease (A
long-time lease where the lessee gets the ownership of the asset) and operating lease (A short-
time lease where the lessor retains the ownership of the asset). There is no Shariah restriction
with regards to income recognition, or presentation. But, if the profit margin is tied to the
interest rate, this is not permitted as it creates uncertainties. The lessees' total rental payable or
the banks' total rental income varies according to changes in the rate of return of the bank. In
case of finance lease, lease receivable, less the profit margin which is not received, should be
recorded as fixed assets in the balance sheet, and In the case of operating lease, the lease, assets
should be recorded as fixed assets in the balance sheet of the lessor and depreciation for these
assets is provided periodically (Hamat, 1994b).

10.6. Islamic Accounting Model:

At this stage Islamic Accounting model is pertained below. The model indicates that Islamic
Accounting works under the peripheries of Islamic rules and Shariah and Islamic society and
produces some differential reports not required in traditional/conventional accounting.

12
 The Rules of Islamic Shariah

Islamic Society

Firms/Organizations

Contracts/Transactions
Accounting and Reporting Standards
Accounting Policies
Accounting Cycle

Recording Classifying Summarizing Preparation of Interpretation

(Journal) (Ledger) (Trial Balance) Financial Statements and Analysis

a) Income Statement/Value Added Statement

b) Owners Equity Statement
c) Balance Sheet
d) Cash flow Statement
e) Reports of Funds for Zakat and Their Uses
f) Reports about prohibited Income & Expenses
g) Social Responsibility Reports
h) Human Resources Development Reports

Figure-1: Modified from Mirza and Baydoun (2000).

11. Policy Implications:
Among others the major policy implications of this research are as follows:
(a) Muslim owners of business firms and concerns are expected to have guidelines from this
article to report their firms financial recording and reporting under Islamic accounting
systems.
(b) The researchers in Islamic Accounting may usefully use the issues raised in this article for
more comprehensive studies in Islamic Accounting and practices in a Muslim majority
country like Bangladesh.
(c) The Government, for ensuring social welfare and proper Zakat collection and distribution,
may practice Islamic Accounting as enunciated in this article.

12. Conclusion:
So far a modest attempt has been made to reveal the objectives, nature and need of Islamic
Accounting contrasting it with the traditional or conventional accounting. The issues raised on
principles and practices of Islamic Accounting here will work as stepping stones for further
research and analysis in this emerging and essential field of knowledge for the Muslim owners
and proprietors of profit and not-for-profit organizations.

13
References:

Ahmed, E. A. (1994), Accounting Postulates and Principles from an Islamic Perspective,

Review of Islamic Economics, Vol-3, No. 2.

Abdul-Rahman, A. (1996), Legal Systems for Islamic Banks, Cairo: The International Institute of
Islamic Thought.

AAOIFI (1999), Accounting, Auditing and Governance Standards for Islamic Financial
Institutions, Manama, p. 58.

Adnan, M. and Gaffikin, M. (1997), The Shariah, Islamic Banks and Accounting Concepts and
Practices, Paper presented at Accounting, Commerce and Finance: The Islamic Perspective
International Conference, University of Western Sydney, Macarthur.

Ahmed, E. (1990), Islamic Banking: Distribution of Profit, Unpublished Ph.D. Thesis,

University of Hull.
Al-Obji, K. (1996), Measurement and Distribution of Profit in Islamic Banks, Cairo: The
International Institute of Islamic Thought, p. 35.

Attiah, M. (1989), Financial Accounting Theory in Islamic Thought, Islamic Banks International
Union.

Baydoun, N. and Willett, R. (2000), Islamic Corporate Reports, Abacus, Vol. 36, No. 1, pp. 71-
90.

Belkaoui, A. (2000), Accounting Theory, London: International Thomson Business Press.

Clarke, F., Craig, R. & Hamid, S. (1996). Physical asset valuation and Zakat: Insights and
implications. Advances in International Accounting, 9, pp. 195-208.

Faris, N. (1966). The mysteries of almsgiving: A translation from the Arabic of the Kitab Asrar
al-Zakah of Al-Ghazzali's Ihya "Ulum al-Din. Beirut: The American University of Beirut, p.8.

Gray R., D. Owen and K. Maaunders (1988), Corporate Social Reporting: Emerging Trends in
Accountability and Social Contract, Accounting, Auditing and Accountability Journal, Vol. 1,
No.1, (1988).

Hamat, M. (1994a), The Accounting System in Islamic Banking, Conference on Interest-Free

Banking Islamic Financial System, Malaysia, January-1994.

Hamat, M. (1994b), Accounting Standards and Tax Laws in Islamic Banking, Conference on
Interest-Free Banking Islamic Financial System, Malaysia, January-1994.

Hameed, S. (2000), The Need for Islamic Accounting: Perception of Its Objectives and
Characteristics by Malaysian Accountants and Academics, Ph.D. Thesis, University of Dundee.

14
Haqiqi, A. & Pomeranz, F. (1987), Accounting needs of Islamic banking, Advances in
International Accounting, 1, pp. 153-168

Horngren, C.T. and Harrison, Jr., W.T., (1992), Accounting, Second Edition, Prentice Hall
Englewood Cliffs, New Jersey-07632, 1992, p.145.

Hossain, A.T.M.Tofazzel & Rashid, Harunur (1992), A Study of the Efficiency and Efficacy of
Accounting System of Chittagong University, Chittagong University Studies, (Commerce) Vol. 8,
p.23.

Hye, M. A. (1988), A Study of the Accounting And Reporting Practices of Bangladesh Shipping
Corporation, Chittagong University Studies, (Commerce) Vol. 4, p.167.

Hye, M. A. (2000), Accounting Theory, Yeasmin Prokashoni, Third Edition, p.15.

IIIT (1988), Islam: Source and purpose of Knowledge, Herndon, Virginia: International Institute
of Islamic Thought, Islamization of Knowledge Series No.5, 1988.

Islam, M.Z. (2000), Accounting: Philosophy, Ethics and Principles-The Islamic Perspective,
Bangladesh Institute of Islamic Thought (BIIT), Dhaka, p. 64.

Kahf, M. (1978), The Islamic Economy: Analytical Study of the Functioning of the Islamic
Economic System (Plainfield, Indiana: Muslim Students Association of the United States and
Canada. 1978), p. 71.

Khan, M.M. (1995), Advanced Accounting, Eighth Edition, Ideal Library, Dhaka, 1995, p.23 and
p.31.

Lewis, M.K. (2006), Accountability and Islam, Fourth International Conference on Accounting
and Finance in Transition, Adelaide, April 10-12, 2006.

Mirza, M. and Baydoun, N. (2000), Accounting policy in a Riba Free Environment, Accounting,
Commerce, and Finance: The Islamic Perspective Journal, No. 4 (1), pp.30-40.

Napier, C. (2007), Other Cultures, other accountings? Islamic Accounting from past to present,
5th Accounting History International Conference, Banff, Canada, August 9-11.

Shahul H. (2001), Islamic AccountingAccounting for the New Millennium? Paper presented
at the Asia Pacific Conference 1, Kota Bahru, Kelantan, October 10-12, 2001.

Shahul H. and Yaya, R. (2003), The Future of Islamic Corporate Reporting: Lessons from
Alternative Western Accounting Reports, The International Conference on Quality Financial
Reporting and Corporate Governance, 28-29 July, 2003.

Siddiqi, S. (1982). Public Finance in Islam. Delhi: Adam Publishers, p.8.

15
Triyuwono, I. (2000), Shariah Accounting: Implementation of Justice in a form of trust
metaphor, Journal of Accountancy and Auditing, Indonesia, No. 4(1), pp.1-34.

Web Address:
(1) Hameed, Islamic AccountingA Premier, http://www.iiu.edu.my/iaw/Articles.
(2) Shahul, H.--The Need for Fundamental Research in Islamic Accounting,
http://www.iiu.edu.my/iaw/Articles.
(3) AAOIFI web site: www.aaoifi.com

Appendix-1
Conventional Income Statement versus Value Added Statement (Shahul and Yaya, 2003).
Conventional Income Statement Amount Value Added Statement Amount
Sales Revenue 2,000,000 Sales Revenue... 2,000,000
Less: Material used.. 200,000 Less: Bought in materials 200,000
Wages...400,000 Services purchase...600,000
Services purchase.600,000 Depreciation ....80,000 880,000
Interest.....120,000 Value Added to distribute. 1,120,000
Depreciation.. 80,000 1,400,000 Distributions:
Profit before tax... 600,000 To employees 400,000
Less: Income tax (Assume 20%)... 120,000 To capital providers:
Profit after tax . 480,000 Interests.120,000
Less: Dividend payable. 200,000 Dividends. 200,000 320,000
Retained earning for the year..... 280,000 To Government.. 120,000
Retained earnings... 280,000
1,120,000

Appendix-2
Questionnaire of Opinion Survey
Findings and Analysis
A study has been conducted on the experts in accounting to justify their opinion regarding the
acceptance of principles of Islamic accounting. The educational qualifications of the respondents
are 100% Masters in Business Studies and all of the respondents are Muslim. As per their
profession, the position of the respondents is given below:
Explanation University High level Mid-level Junior Total
Teachers Executives Executives Officials
No. of Respondents 28 24 20 08 80
Percentage 35 30 25 10 100

As per the organization, the position of the respondents is given below:

Explanation University of IIUC Islamic Others Total
Chittagong Banks
No. of Respondents 24 28 16 12 80
Percentage 30 35 20 15 100

To make the analysis easier, Coding has been taken as: +3 = Strongly Agree; +2 = Agree; +1 =
Some What Agree; 0 = No Response; -1 = Some What Disagree; -2 = Disagree; -3 = Strongly
Disagree. The result and analysis of the survey is stated below:

16
1. The concepts of Traditional Accounting and Islamic Accounting are not same:
Coding Frequency Percent Mean
+3 12 15
+2 44 55
+1 24 30
0 0 - +1.85
-1 0 -
-2 0 -
-3 0 -
Total 80 100
2. It is necessary to have a separate Accounting system for Islamic organizations:
Coding Frequency Percent Mean
+3 40 50
+2 24 30
+1 8 10
0 0 - +2.05
-1 4 05
-2 4 05
-3 0 -
Total 80 100

3. Entity Concept may be taken as a concept of Islamic Accounting:

Coding Frequency Percent Mean
+3 28 35
+2 24 30
+1 16 20
0 4 05 +1.55
-1 0 -
-2 0 -
-3 8 10
Total 80 100

4. Going Concern Concept may be taken as a concept of Islamic Accounting.

Coding Frequency Percent Mean
+3 12 15
+2 40 50
+1 12 15
0 0 - +1.20
-1 8 10
-2 0 -
-3 8 10
Total 80 100

5. Cost Concept may be taken as a concept of Islamic Accounting.

Coding Frequency Percent Mean
+3 16 20
+2 36 45
+1 4 05
0 0 - +1.00
-1 4 05
-2 20 25
-3 0 -
Total 80 100

17
6. Conservatism concept may be taken as a concept of Islamic Accounting.
Coding Frequency Percent Mean
+3 28 35
+2 16 20
+1 12 15
0 4 05 +1.05
-1 4 05
-2 8 10
-3 8 10
Total 80 100

7. Materiality concept may be taken as a concept of Islamic Accounting.

Coding Frequency Percent Mean
+3 16 20
+2 40 50
+1 4 05
0 12 15 +1.50
-1 4 05
-2 4 05
-3 0 -
Total 80 100

8. Money Measurement concept may be taken as a concept of Islamic Accounting.

Coding Frequency Percent Mean
+3 16 20
+2 52 65
+1 0 -
0 0 - +1.70
-1 8 10
-2 4 05
-3 0 -
Total 80 100

9. Accrual concept may be taken as a concept of Islamic Accounting.

Coding Frequency Percent Mean
+3 12 15
+2 44 55
+1 12 15
0 0 - +1.40
-1 4 05
-2 4 05
-3 4 05
Total 80 100

10. Do you think that there would be any problem(s) in implementing Islamic accounting in your
organization? If yes, Please mention the problems below.

11. What accounting principles & practices do you observe now to be contradictory to Islamic
Shariah? Please mention, if any.

18