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ISRA RESEARCH PAPER
Appraisal of the Principles Underlying IFRS Shariah
Perspective
Section1Group 9
Mohamad Aiman Bin Adnan 1114657Muhammad Syafiq Nazmi Bin Jasmi 1126433
Mohd Sharel Ishak Bin Ilyas 1120609
Ahmad Muzammil Bin MD Nor 1119359
Muhammad Syakir Bin Abdullah 1122541
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INTRODUCTION
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IASB
IFRS
MASB
MFRS
AAOFIFAS
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QUESTION???
Does the accounting for Islamicfinancial transaction should also becoverage towards IFRS adoption1
Does the key principle under IFRSare acceptable form Shariahperspective?2
What is the main Shariah issuethat will arise in the application ofIFRS principle3
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Asian- Oceania Standard Setters
Group
To discuss issue and share experience onthe adoption of IFRS of Islamic financialtransaction.
AAOSG Islamic Finance Working GroupTo facilitate the consideration and
application of IFRS by AAOSG members
Providing input and feedback to the IASB onthe adequacy and appropriateness ofproposed and existing IFRS to Islamicfinancial transaction and event
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APPROACHES
1) Applying aseparate set of
Islamic accountingstandards
2) Applying IFRSalong with meeting
some additionalguidelines.
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PRINCIPLES
IN IFRS
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Substance over form
Time value of money
Fair value measurement
Recognition based on probability
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Substance over form
Record a transaction based on its economic substance orfinancial reality & not necessarily on its legal form
Greater weight on economic substance for recognition andmeasurement.
It means that the end result of transaction is recorded.
If used SOF principle, IFI must distinguish between halal andharam contract
Suggestion:-
Repudiate SOF altogether and recognize the legal form in
financial statement
Measure the individual financial effects of each contractsas when it take places
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Fair value measurement
Asset-the price of an asset at which that
assets could be bought or sell in a current
transaction between market participants in
the reference market.
Liability- The price at which liabilty could be
incurred or paid in a current transaction. Provides more relevant information to
investor
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Fair value is determined using a
referenced market price
Factors:-
1) Cost of the assets
2) Supply vs demand
3) Individually perceived utility4) Risk characteristic
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WORLDVIEW
APPROACHES
EXCLUSIVITY
APPROACH
HARMONIZATION
APPROACH
CONVERGENCE
APPROACH
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EXCLUSIVITY APPROACH
Different world viewnot capitalist
Difference in objective- ACCOUNTABILITYTO ALLAH AND SHARIAH COMPLIANCE
Different function and contract Fundamental issue:-
1) Whether the aim of financial reportingof IFIs should simply be to provide
information to a wide range of users2) Whether the financial reporting of IFIsshould reflect their religious obligation
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Reporting should be one channel to
indicate Shariah compliance
Must not report form of interest based
element
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AAOFI
Difference recognition and measurementapproach of financial instrument and leases
Requires disclosure to convey Shariah complianceand provide guidance of certain unique items
Provision and contigent liabilities
Emphasise the legal forms of contracts approvedby its Shariah Board
Disclosure of unrestricted investment account No elaboration on how to determine fair value by
using estimation technique
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HARMONISATION APPROACH
Compare the similarities and differences ofaccounting practices between nation
The process of bringing internationalaccounting standards into some sort ofagreement so that the financial statementsfrom different countries are preparedaccording to a common set of standard.
Litle attention had been given to the religion
factor Harmonizing IFRS standard and AAOFI
standards
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CONVERGENCE APPROACH
Full convergence of accounting standards for
Islamic financial transaction with IFRS
Process of harmonising accounting standards
issued by different regulatory bodies
Examples :- MFRS-( SOP i-1)
Do not conflict with Shariah methodology
Conflict of Substance over form principle
Additional disclosure are required
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EXCLUSIVITYAPROACH
Not really work
for dual bankingsystem
Requires originalIslamicaccountingstandards
HARMONISATIONAPPROACH
Only work in
practice injurisdiction wherecompliance withIFRS is stilloptional
Arise a
comparabilityissue atinternational level
CONVERGENCEAPPROACH
Best approach
when theconvergence ofIFRS had beenabide by law
Must includesadditional
disclosure
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SHARIAH
PERSPECTIVE
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1.Substance Over Form In principle, the Shariah emphasizes that
every contract must comply with its legal
formi.e., the essential requirements aswell as its nature and implication.
This implies that both the form and thesubstance of the transaction are important
Ijarah
Bay al-inah
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Debates arise as to whether the effect ofeach contract in isolation is to be recorded,hence recognizing the form of each contract;
Or whether the overall economic effect of theseries of transactions is to be recorded, thusrecognizing the economic substance of theoverall transaction.
A third scenario would be to consider boththe form and the substance of a transactionwhen arriving at an opinion.
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BANK
(Lessor)
PROPERTY
CUSTOMER
(Lessee)
(2) Bank leases property
(1) Bank buysproperty
AL- IJARAH
(3) Customer pays rental
Usually a promise
will be make to
transfer
the ownership ofthe asset to the
lessee at the end
of lease period
by Sale Contract
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The financial statements will recognize only 1transaction, which is to account for the final
sale similar to the case of a conventionalhire-purchase agreement whereby the 2contracts of lease (hire) and sale (purchase)are combined into 1.
(1) Rental is recognized throughout the ijarahperiod.
(2) A sale is recognized when the contract totransfer the leased item is entered into.
If the principle of form over substance is used
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The principle of substance over form in
Islamic law is derived from the legal
maxim that states:
This maxim stems from one of the five
major legal maxims:
In contracts, [primary] consideration is given to
intention and meaning, not to words and forms
(Haydar, 1991, Article No. 3).
Matters are determined by intentions (Haydar,
1991, Article No. 2).
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Different view in Fiqh Mazhab
The majority of scholars, including the Hanafis,Malikis and Hanbalis adopted this principle.
Shafies scholars,however, disagreed; theyfavoured the principle of form over substance.
But they dont reject it , instead apply it on othercontract.For instance, Shafies legalised Bay alInah because he treated it as two separatecontracts.
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The Reso lut ion of the Shar iah Adv isory Cou nc i l
(SAC) of Bank Negara Malays ia (BNM) on the
Principle of Substance ov er Form
Generally, the review made by the SAC of BNM doesnot perceive the concept of substance over form as
contradicting the principles of Shariah per se.
While it recognizes the importance of both substance
and form, in cases of conflict between the two, theSAC of BNM advocated the primacyof substance
over form.
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2.The Time Value of Money
The Shariah does not totally disregard theconcept of the time value of money.
Ahmad and Hassan (2004) found fromtheir review of fiqh literature that timesmonetary valuation is not ruled out as long
as it is not based on a lending relationshipwhere it is claimed as a predeterminedvalue.
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Scholars agreed that the time factor earns a
portion of the price in murabahah contractson the ground of mans natural preference forpresent consumption of money over futureconsumption.
As a result, Muslim scholars argued that thepresent is superior to the future and, hence,the present value of an asset should be
higher than its future value.
positive time preference
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Consequently, if payment for an asset isdelayed to a specified time in the future,
the deferred price should be higher than
the spot price to strike a balance of benefit
in the contract of exchange and to uphold
justice (adl) between the contracting
parties.
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Factors that allow time value of
money except for loan contract
Legitimacy of murabahah profits is that the
murabahah sale is based on an
underlying asset. Hence, it must be based on justice ,
concept of counter value whereas loan is
based on the principle of ihsan(benevolenc).
Other contract that support Time
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Other contract that support Time
value of money :
Bay al salam
Bay al istisna Discounting when evaluating projects
under construction.
However
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Opinion on uses of interest rate in
discounting process amongscholars
That interest isjust a benchmarkrate
Humaninnovations thatare not contraryto Islamicteaching
FavorZarqa (1983)proposed that therate of ROE beconsidered theproper discount
rate to be appliedto reflect theuncertain risks ofa projects cashflows
Oppose
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Reso lut ions o f the SAC of BNM
on the Time Value of Money
Permissible only for exchange contracts that involve
deferred payment. However, the SAC prohibits the
charging of an extra sum for the deferred repaymentof qard (loan).
The SAC explained that the fuqaha had long
accepted that there is an economic value to time andquoted various classical statements permitting an
increase in value due to the lapse of time.
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3.Fair Value Measurement
A hadith on the prohibition of severalforms of sales known to the medieval
Arabs whereby different ways of
manipulating market conditions take placeto affect the market priceindicates thatIslamic commercial transactions must becarried out based on fair value.
Talaqqi alrukban
Najash
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Illustration on Mudarabah Contract
In a mudarabah contract, the subsistence(nafaqah) of the agent-manager while travelling ischargeable to the mudarabahaccount.
The possibility exists that an agent-manager couldcheats on his expenses to reduce the businessprofit.
Hence, the classical jurists unanimously agreedthat the determination of the subsistence shouldbe based on the fair value.
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Determination of fair value
For rare commodity , require benchmarking
to the known price to get the equivalent price
(fair value).
Can be affected by certain circumstances
such as shortage of supply of goods due to
market manipulation, war and emergency.Therefore, Islamic law recognizes the role of
experts in determining the fair value.
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Views on the use of discount rates
as an estimation technique
IFRS
Measurement of fair
value may require the use
of valuation techniques
which often make use of
discount ratesrather
than relying on quoted
market prices.
AAOIFI
In FAS 25, Investment inSukuk,Shares and Similar
Instruments, mentionstheuse of estimationtechniques to derive fairvalue when quoted pricesmay not be indicative of
fair value, but it does notelaborate further regardingthe permissibility of usingdiscount rates indetermining fair value.
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Reso lut ions on Fair Value
The fatwa-issuing authorities in Islamic finance, such
as the OIC International Islamic FiqhAcademy and
the SACs of BNM, Kuwait Finance House, Dubai
Islamic Bank and al-Rajhi Bank have not yet issuedspecific fatwas relating to
(i) the principle of fair value,
(ii) the issue of discounting,
(iii) the use of an interest rate for discounting or in
valuation techniques for determining fair value
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4.Recognition Based on
Probability
Examples of recognition based on probabilityin an IFI are:
(i) recognizing a liability for expected paymentsto murabahah account holders
(ii) recognizing murabahah receivables usingthe expected rate of profit
(iii)recognizing income and expenses based onexpected future cash flows
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View on Recognition Based on
Probability Despite the emphasis on certainty, Islam
also recognizes uncertain circumstances.This is because, in reality, Muslims are
faced with many probable occurrences. Example :
Considering his capability to earn money,
he cannot be categorized as poorThe possibility of paying zakah before its
hawl (time of obligation).
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Deduction from legal maxim
Concept of probability is accepted in
arriving at certain fiqh rulings.
However, the jurists emphasize the
concept of valid probability, which is
defined as events yet to occur that do not
contradict injunctions from the Quran and
Sunnah. Only record the highprobability to happen
event
The Resolution of the SAC of
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The Resolution of the SAC of
BNM on Recognition Based on
Probability
The application of the probability principle in Islamic
financial reporting is permissible as it does notcontradict the general fiqh principles.
Legal maxim bases :
Consideration is given to the predominant and
widespread, not to the rare (Al-Zarqa, 1989)
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Principles vs. Practice: Possible
Discrepancies?
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IFRS standard that raise Shariah
concern Key areas relating to the operations of IFIs that
are not covered by IFRS, notably:
the classification and presentation of mudarabah
investment accounts in the financial statements
the accounting treatment of the profit equalizationreserve (PER) under mudarabah investmentaccounts
the requirement for additional disclosures such aszakah calculation, cleansing of Shariah non-compliant income, and Shariah compliance risk
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Conclusion & Recommendation
The research is of the view that harmonization is the
most appropriate approach. But only work in practice
in jurisdictions where compliance with IFRS is stilloptional.
As for jurisdictions which have already converged
with IFRS, IFI need to include disclosures to the
accounts to explain the differences in the Shariah
treatment of the transactions
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regulators in those jurisdictions should interact pro-actively with IASB to lobby for increased recognition
of Islamic financial transactions and seek solutions
for the Shariah issues arising with the application of
IFRS.
Recommends that IASB consider providing
guidelines on disclosure that reflect the Shariah-
based transactions and products that are utilized byIslamic financial institutions in their operations
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It is noted that the MASB recommended that there
should be additional disclosures in the Notes to the
Accounts to describe the nature of relevant contracts
as applied by the IFIs
Example
must differentiate it from its conventional
counterpart through disclosure about its legal formin addition to its economic reality.
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