The Differences of Conventional and Islamic Accounting

Prof. Sofyan S. Harahap

Trisakti University, Indonesia

Corporation and Society

• “Corporation have emerged as the dominant governance institution on the planet, with the largest among them reaching into virtually every country in the world an exceeding most government in size and power, increasingly, it is the corporate interest more than the human interest that define the policy agendas of state and international body although the reality and its implication have gone largerly unnoticed and unaddressed” (Korten, 1995)

• Accounting Western Model contributes to this situation

Muslim Population and Countries

• 25% of World population (> 1 billions)• Arab: Saudi, Kuwait, Egypt, Syria, Libanon, Yemen,

Jordan, Iraq.• SE ASIA: Indonesia, Malaysia, Brunei, Thailand.• Africa: Mauritania, Senegal, Nigeria, Sudan,

Somalia, Ethiopia, etc)• Sub-continent: Pakistan, Bangladesh, India)• Inner Asia: Iran, Uzbekistan, Kazakhstan,

Turkmenistan, Tajikistan, Kirgizia and China)• Canada, Europe, East Europe, Australasia, USA.

Occident Vs Islam

• IslamUnity of God and Power is hold by God

• There is a judgment day in which mankind pay responsibility during his/her life before the God

• There is hell and heaven fulfilled by mankind

• Social justice

• OccidentPower hold by mankind (ratio)

• No judgment day, world is the end of life. No judgment day.

• No heaven and no hell• Individual welfare

The future of Conventional Accounting

• “The traditional Western double-entry based accounting technology is well-suited to an orthodox, positivist society of any kind. It is not surprising that it is proving inadequate, as people are returning to more integrated world views, whether Islamic or otherwise” (Hayashi, 1989)

Critics on Conventional Accounting

• Externalities is not included in financial report (Lee Parker, environmental accounting)

• Intangible asset cannot be measured adequately(Lev Baruch)

• Human resources and employee reporting interest are not included.

• Social Interest is overlooked• Promote the exploitation of capitalist over labor and

society.• Promote the concentration of wealth and power o the

hand of the rich.

What is Islam?

• Literally meaning:• “Peace” (in this world and hereafter) • “obedience” to Allah as his/her God, comply with

the motivation of God’s creation of Man, which is “to serve Allah”, to be “his viceregent on earth”.

• A comprehensive worldview, a unity of God, and an integration between world and hereafter.

• Islamic principles: truth, justice, fair, goodwill, honesty, benevolent, accountability before the God.

Islam’s epistemology of Devine Unity:

• “The Islamic world view is thereby, the comprehensive and universalizing, overreaching and complementing design of reality that is premise on the epistemology of divine unity and is evolved into intellection through the process orientation model of unification of knowledge in world system as derived from the primal sources of divine unity”.

Islamic Rules:

• Allah (God) gives two guidance for mankind:• al-Quran (revealed world of God ) and• Hadist/Sunnah: Prophet Saying, God’s inspired

acts, description of the conduct of the prophet’s companion of which Mohammad was uncritical.

• Ijtihad/ijma’: shuratic and consensus process.• Guidance are related to all daily life of mankind

including in business, management, and finance.• The phenomena of nature can be also a sign of

God’s power and existence.

The purpose of shariah (Islamic law) (Al-Gazali: 1058-1111)

• To promote the welfare of the people which lies on:

• Safeguarding of their faith

• Their life

• Their intellect

• Their posterity and

• Their Wealth

Quranic verse on Accounting

• i.e. Albaqarah (2) ayah 282:• “Oh you who believe! When you deal with each

other, in transaction involving future obligations in a fixed period of time, reduce them in writing. Let a scribe write down faithfully as between parties”.

• There is an integration between worship ritual and socio-economy-politico and daily life of mankind.

• Allah rules out business and accounting.

Islamic accounting: Hayashi

• “is an integrated discipline with social, political and economic domain ruled by Allah or “meta rule”. Islamic accounting should regulate and establish a harmonious integration among the parties of these diverse domain”.

Ancient Accounting Role in Islamic State is Muhasabah, it means:

• Calculation of one’s act• Clear the account, make neutral• To take care of, to try to find• To anticipate a reward in the hereafter• To take into account, into consideration• To order Muslim to perform their duties• To avoid fraudulent practices in business and society,

to check illegal contract, keep free market and fair price, prevent necessities from being hoarded. (Hayashi, 1989)

Islamic Accounting

• 1. To report accurate income determination• 2. To promote efficiency and leadership• 3. To comply with the shariah (Islamic

principles)• 4. Commitment to justice• 5. To report a good things• 6. To adapt to positive social change.

(Khan, in Harahap, 1992)

Accounting and Culture• Culture (i.e. religion) influences accounting (Hofstede,

1983, Gray, 1998)• Culture: “all those social, political, and other factors

which influence individual’s behavior” (Hamid, et. al, 1993)

• Different culture, different economico-sociol-politico systems demand different accounting system

• Islam is different from Occident (Capitalist ideology), so it must have its own accounting system (Gambling and Karim, 1986: Triyuwono, 2001: Hameed, 2001)

Conventional Vs Islamic Accounting

• Conventional Accounting:• Based upon modern

commercial law-permissive rather than ethical

• Limited disclosure (provision of information subject to public interest)

•  Personal accountability (focus on individuals who control resources)

• Islamic Accounting:• Based upon ethical law

originating in the Qur’an (Islamic law, As-Sunnah)

•  Full disclosure (to satisfy any reasonable demand for information in accordance with the Shari’a)

•   Public accountability (focus on the community who participate in exploiting resources)

Conventional vs Islamic Accounting:(Boudyn and Willet, Islamic Corporate Reports, Abacus, Vol.

36, No.1, 2000).

• Conventional Acc.• Economic rationalism•  Secular•  Individualistic• Profit maximization• Survival of fittest• Process• Absolute ownership• (Ec. rationalism: the desire to stand

apart from others, to compete, to manipulate and to amass surplus”)

• Islamic Acct.

• Unity of God

• Religious

• Communal

• Reasonable profit

• Equity

• Environment

• Relative ownership

Toshikazu Hayashi, “On Islamic Accounting,

IMES Working Paper Series No.18.

• Islamic Accounting• Society – oriented •  Focus on society aspect •  

• Basically Al Qur’an & As Sunnah (Shariah)

• Religious (must responsibility to God at the Judgment Day)

• Conventional Accounting

• Individuality – oriented

•  Focus on individuality aspect without consider any social aspects

•  Accounting Law and Ethics

•  Secular

Hayashi (Continued)

• Islamic Accounting• No differentiation between

Normative and Descriptive Accounting (They always going simultaneously)

•  In operational, they do everything in boundaries of Islam (Shariah)

•  • Measure as saleable value• Market (selling) price rather

than historical cost

• Conventional Accounting• The normative accounting

always influencing descriptive accounting or individuality interest

•  

• In operational, they permit everything to reach the highest profit

• Measure as highest possible profit

• Historical Cost

Haniffa and Hudaib (2001)

• [Entity]Separation between business and owners

• [going concern] Business continues forever

• [Accounting period] Periodical measurement of performance

• [unit of measure] Monetary Value• [Full disclosure principle] Decision

making process• [objectivity] Reliability of

measurement• [Materiality] Relative importance of

information for decision making• [Consistency] Consistency based on

GAAP• [Conservatism] Use least favorable

impact on owners

• Firm doses not have separate financial obligation (I.e profit sharing scheme)

• Depend on contractual agreement between party

• One lunar year for zakat calculation• Quantity based and monetary based

(zakat calculation)• Importance for fulfillment of duties

and obligation to God, society and individual.

• Clear conscience with God in fulfilling all duties.

• Consistence to shariah rules• Most favorable to society (justice)

Problems of Rationalism

• The supreme power lies on human or power holder not on God

• Man guided by the concept of self interest and overlook the social interest

• Man has no inherent justice but true opportunists.• Social imbalance and social conflicts due to

concentration of wealth and power in a few elites• Global ecological destruction

Examples of Unlawful Business Practices in Islam:

• There is lawful (halal) and unlawful (haram) in business

• Riba, usury or interest on credit: increment over and above the amount of of capital loaned.

• Favor Equity financing than debt financing• Pork, Alcoholic drinks• speculative transaction, gambling, dishonesty,

collusion, uncertainty, manipulation, fraud, free market interference, exploitation, hoarding.

Altruism and Mankind’s Records

• Islam advocates altruism and ethical behavior.• Allah is aware of what mankind do in his/her

everyday life.• All activities of mankind are recorded in siijin

(bad deeds) and illiyin (good deeds)• Mankind is responsible for what he/she did in the

world. Mankind can be go to hell or heaven, it depends on his/her records

• Allah provides a true justice in hereafter.

Zakat and Social Accountability

• Zakat is one out of five Islamic pillars (Recognition, Prayer, Zakat, fasting in ramadhan month and doing haj)

• Zakat is levied on wealth and on rich people. Calculated on business transactions, on assets and on revenues.

• Zakat is used to help the needy.• Zakat is calculated based on current price.

International/National Body on Islamic accounting

• AAOIFI (Accounting Auditing Organization for Islamic Financial Institution based in Bahrain.

• In 2002, Indonesia has a financial accounting standard on Islamic banking reporting.

What next?

• The Islamic accounting which has implicit economic, political and religious meaning (an integrated world view system, author), has the possibility to show the key to a post Newtonian Accounting (Western Secular based accounting, author)” (Hayashi, 1989)

Religious (Cultural) based Accounting

• Japan that has a strong commitment to its traditional culture has a strong ability to formulate, to implement, its own accounting philosophy and principles difference from that of capitalistic society.

• Shinto for example has a potential drive to establish a Shinto based Accounting.

Future

I hope this discussion may help us to establish our own system

comply with our traditional culture and believe, not

interfered by other believes.

Many thanks for your attention

See you in other occasions