Lesson 2 - The Need for Islamic Accounting-Push Factors

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ACC6810 Islamic Accounting and Finance SH

Introduction Topics in Lesson 1

The problems of conventional accounting in detail

Problems with the decision-usefulness framework of Conventional Accounting (CA) -objective Problems with concepts of CA -building blocks of measurement and valuation and disclosure rules. Macro Implications of C.A.- externalities Micro behavioural consequences

Islamic Perspective of Critique

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The Problems with Decision Usefulness Objective of CA.

Definition
The objective of accounting is to provide information to enable users (shareholders creditors and others) to permit informed decisions which in turn enables the scarce resources in the economy to be efficiently allocated resulting in social welfare (AAA 1975)

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ACC6810 Islamic Accounting and Finance SH

Decision Usefulness- Problems.

A change from stewardship to decision usefulness framework AICPAs study group on Objectives of Accounting (Lehman,1992) Not superfluous but calculated to reinforce the role of accounting being crucial to the efficient allocation of resources by individuals,enterprises and government. Dominant paradigm of successive accounting frameworks (eg. IASC 1989, ASB 1992, AAOIFI 1996?)

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ACC6810 Islamic Accounting and Finance SH

Decision Usefulness- Problems.

1.

2.

3. 4.

the economic-environmental context in which it was developed and therefore the environment under which it may be appropriate; the economic assumptions underlying decisionusefulness, the under-specification and achievability of social welfare; the decision-users who are targeted; and the societal assumptions underlying decisionusefulness.

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ACC6810 Islamic Accounting and Finance SH

Decision Usefulness- Problems. Inappropriate economicenvironmental context

DU paradigm born in the US where the underlying economic environment is very different (advanced exchange economies with a developed capital market) from that which operates in Muslim countries Thus

The US is a highly developed exchange economy where large amounts of capital is required for maintaining the complex production processes which result in the production and exchange of goods and services. These processes require economic resources, which is allocated by the market mechanism. The effectiveness of individuals (through buying, selling or holding shares & bonds) and enterprises, markets and government in allocating scarce resources among competing uses is enhanced (.i.e. allocated to enterprises that use them efficiently) if those who make economic decisions have information regarding the standing and performance of business. (FASB, 1978, p 5-8).
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Decision Usefulness- Problems.

BUT economic realities in Muslim countries are different ,

Many Muslim countries do not have established or developed stock exchanges. Many industries are government owned (although privatisation has started in earnest in Malaysia, Pakistan, Turkey and Egypt). A large section of the economy is non-monetised and most people are involved in agriculture which do not produce huge financial surpluses.

therefore a decision-usefulness form of accounting oriented towards market participants does not make a great deal of social or economic sense except as a tool for overseas capitalists interested in appropriating the wealth of these countries (see Tinker, 1985).

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ACC6810 Islamic Accounting and Finance SH

Decision Usefulness- Problems.

In Muslim countries where stock exchanges are fairly developed (such as Malaysia), the decision-usefulness orientation serves the same role as in the West with the same undesirable consequences of financial hyperreality (McGoun, 1997) ; these consequences are not desirable from an Islamic perspective.

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ACC6810 Islamic Accounting and Finance SH

The Ceteris Paribus of Decision Usefulness.

Accounting route to social welfare
Accounting

Information Efficiency

Better Economic Decisions

Efficient Allocation of Resources

Social Welfare

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Link between welfare and du is tenacious (bertahan)

The links between individual self-interest (greed as manifested in conventional economic, finance and accounting literature) and social welfare cannot be demonstrated. It is vaguely possible that such a link existsand in very specific circumstances might actually do so but it cannot be show to hold for everyday western economics. (Gray et al., 1996, p 20)
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The Ceteris Paribus of Decision Usefulness.

(i) The breakdown of the assumption about perfect competition leads to inconsistencies and problematic implications for the role of accounting. Does accounting leads to efficient allocation of resources or whether markets are efficient in spite of accounting regulation. (ii) The generalisation of individual preferences to collective preferences by aggregating individual utilities of shareholders who have heterogeneous interests, to obtain societys collective preferences is questionable. This has resulted in the recognition by Beaver & Demski (1974) that choice among reporting alternatives has social consequences that affect non-users and users of accounting information in terms of the distribution of wealth. Hence, ethical judgements must be made as to whose well being should be enhanced and whose should be diminished.

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The Ceteris Paribus of Decision Usefulness.

(iii) The separation of social and economic spheres of analysis is problematic. For example, Lehman (1992) contends these two spheres cannot be separated. He questions the maxim that it is inappropriate for accounting to consider the distribution of resources of income and wealth while at the same time insisting that it leads to social welfare by maximising wealth. It is not logically possible to develop production conditions independent of distribution conditions. The neo-classical economic model (marginal productivity theory), by seeking to ignore income and wealth distribution becomes a tautology as when determining the optimal vector of factor input prices, one needs to assume a given distribution of income, which in turn is what the model tries to explain. Problem of too many ifs. Thus: If all agents were equal, and if markets were information efficient and if, ,this led to allocative efficiency and if, this led in turn to economic growth and if , this ensured maximum social welfare and if, maximum social welfare is the aim of the society then accounting is morally, economically and socially justifiable. (Gray et al., 1996, p 17).
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The Meaning of Social Welfare

welfare and goodness again depend on the value system of the community. Despite universal values, Islamic values are different. Falah (success includes hereafter) material welfare does not suffice. Efficiency cannot undermine equity. Problems with concentration of wealth

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The Societal Assumptions of Decision-usefulness

Pristine Liberal Economic Democracy

Provides normative justification for accountants acting in under this conception of society thus:
Decision usefulness has little positive value ...(as)..the research literature (indicates)....that current financial statements do not represent the information that investors most desire...(therefore).. ...there is no justification for the normative position of decision usefulness....if it is to be useful, why should it be only useful to investors? ....we can only justify such an assumption in a pristine liberal economic world. ( ibid., p 74-75).

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Accounting Principles- Problems

Historical cost and realisation concepts

May Cause inequitable distribution of wealth zakat and investors

Entity concept ignores externalities harusnya proprietory theory (khan, 1994) Monetary measurement concepts- leaves out important events and transactions

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Macro Implications of Acc

Causes social and environmental disasters (Love canal Tinker, 1985, Falconbridge, Buhr 1988,) Insider trading and fraud and scandals(Briloff 1990) Unemployment (Arnold and Cooper 1999) Rationalise privatisation when non exists (Shaoul, 1988) Transfer wealth from developing to developed countries (Hove, Tinker, 1985) Promote gender discrimination (Reiter, 1997) Promotes social conflict (Lehman 1992)
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Neg. Implications of Acc

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Micro behavioural consequences

Behavioural problems of budgeting and performance evaluation

Padding, tensions, ketegangan domination, manipulation, fault finding, inter-dept strife, perselisihan unhappiness.

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Islamic Perspectives

The substitution of selfishness (egois) for caring, confrontation for co-operation, a short term you only live once paradigm for a long-term spiritual dual world-view to is both socially and religiously unacceptable from an Islamic viewpoint. The concern becomes more acute (hangat) if these individuals are charged with the altruistic Islamic mission of guiding Islamic organisations which are specifically established to achieve Islamic socioeconomic objectives. This will certainly lead to goal incongruence between Islamic organisations and the Muslims or other employees who work for these organisations, the consequences of which, are not only economic but social and moral. Islamic organisations will certainly be unable to achieve their objectives while Muslim organisations will become the breeding ground of un-Islamic misfits.
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Summary

The objectives of conventional accounting based on decision usefulness may not be acceptable from an Islamic point of view because it seeks to concentrate and accumulate wealth to certain sections of society i.e. shareholders and creditors. Neither the assumptions of pristine liberal economic democracy nor the developed exchange economy with a developed stock market is valid for many Muslim countries. The accounting principles on which conventional accounting reports are prepared may be unsuitable for the direct and indirect equitable distribution of wealth and the calculation of Zakat which is the one of the most important objective of Islamic accounting. The problem with historic cost income models becomes more problematic in a Muslim environment where profit is the main means of ascertaining divisible returns to finance providers as interest is prohibited.
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