ACCOUNTANTS FOR BUSINESS

Global alignment: bringing consistency to

reporting of Islamic finance through IFRS

A joint report from ACCA and KPMG

About ACCA
Islamic finance (IF) is growing
ACCA (the Association of Chartered Certified
Accountants) is the global body for professional
rapidly, worldwide. Many IF
accountants. We aim to offer business-relevant, first- institutions prefer to report in the
choice qualifications to people of application, ability and
ambition around the world who seek a rewarding career
principal global accounting
in accountancy, finance and management. regime, International Financial
Founded in 1904, ACCA has consistently held unique Reporting Standards (IFRS) – but
core values: opportunity, diversity, innovation, integrity because of the particular
and accountability. We believe that accountants bring
value to economies in all stages of development. We aim characteristics and nuances within
to develop capacity in the profession and encourage the IF, many jurisdictions require these
adoption of consistent global standards. Our values are
aligned to the needs of employers in all sectors and we institutions to apply accounting
ensure that, through our qualifications, we prepare
accountants for business. We work to open up the
practices that take into account
profession to people of all backgrounds and remove those differences, rather than
artificial barriers to entry, ensuring that our qualifications
and their delivery meet the diverse needs of trainee
purely applying IFRS.
professionals and their employers.

We support our 154,000 members and 432,000 students So how can the financial reporting
in 170 countries, helping them to develop successful
careers in accounting and business, with the skills needed
of Islamic Finance be harmonised
by employers. We work through a network of over 80 and made more consistent
offices and centres and more than 8,400 Approved
Employers worldwide, who provide high standards of internationally?
employee learning and development

About Accountants for Business ACCA and KPMG held three high-
level roundtables in Malaysia,
ACCA’s global programme, Accountants for Business,
champions the role of finance professionals in all sectors Dubai and London to address the
as true value creators in organisations. Through people, key issues and produce a package
process and professionalism, accountants are central to
great performance. They shape business strategy through of recommendations. This report
a deep understanding of financial drivers and seek
opportunities for long-term success. By focusing on the
summarises the discussions.
critical role professional accountants play in economies at
all stages of development around the world, and in
diverse organisations, ACCA seeks to highlight and
enhance the role the accountancy profession plays in
supporting a healthy global economy.

www.accaglobal.com/ri

© The Association of Chartered Certified Accountants,

November
2 2012
Foreword from Helen Brand
ACCA CHIEF EXECUTIVE

Islamic finance (IF) is a subject dear to ACCA’s heart. With many of our members being based in the main
IF centres of Malaysia, Pakistan, Indonesia and the Middle-East, as well as in the UK and Ireland where
momentum in IF is growing fast, ACCA is keen to be at the forefront of developments in this sector. We
have incorporated an IF option into our core examination syllabus as recognition of the growing
importance of this area.
Helen Brand
ACCA chief executive
We also believe strongly in the importance and the benefits to business of global standards. We were the
first body to qualify accountants in International Financial Reporting Standards and have carried out
research projects that have shown that IFRS adoption enhances access to capital and reduces its cost
– more important than ever in these challenging economic times. Many IF institutions want to report
using IFRS, but the particular nuances within IF mean that adoption of IFRS is not straightforward. If these
issues are to be resolved, standard-setters and the industry need to work together to ensure that the
benefits of global standards can be fully realised.

We have been very pleased to work with KPMG on this report, and on the three high-level roundtables in
Kuala Lumpur, Dubai and London on which it is based. We believe that, by bringing experts together in
these markets and collecting their thoughts on the key issues, we have taken the debate forward and
hope that the report stimulates fresh thinking among all interested stakeholders. We look forward to
pursuing its recommendations with regulators and standard-setters.

Foreword from Jeremy Anderson

CHAIRMAN, GLOBAL FINANCIAL SERVICES PRACTICE, KPMG

Islamic finance has huge growth potential, with Muslims representing a significant proportion of the
global population in all corners of the world. The ethics embedded within Islamic finance fit well with a
world looking for more consumer protection.

At KPMG, we are committed to supporting the growth and development of the Islamic finance market.
We were named Best Islamic Assurance and Advisory Services Provider by Euromoney this year for the Jeremy Anderson,
chairman, Global
fifth year running – an unparalleled achievement and a demonstration of our firmly rooted commitment to
Financial Services
helping clients meet challenges and respond to opportunities in the industry. We have built up a global Practice, KPMG
network of experts across KPMG offices to ensure that we meet the increasingly sophisticated and global
needs of clients operating in the industry.

As Islamic finance continues to develop and mature, international financial reporting needs to develop to
accommodate some of its specific complexities. While international financial reporting standards are
increasingly being adopted all over the world, they pose a particular challenge to Islamic financial
institutions because they have been specifically designed for conventional finance, not for Islamic finance.

The Financial Stability Board is focused intently on the harmonisation of disclosures, through the
Extended Disclosure Task Force, as it continues to help governments and regulators learn the lessons of
the financial crisis. We need to ensure that the financial reporting of Islamic finance is included in this
harmonisation, balancing the key aims of simplicity, usability, insight and comparability. We are delighted
to have worked with ACCA in hosting three high-level roundtables to listen to the thoughts of experts,
standard-setters and other key stakeholders in the industry around the world. We are pleased that these
views and recommendations will develop both the debate and the practice around financial reporting for
Islamic financial instruments.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 3

1. Introduction

Some industry observers argue that had host of other countries. While the UK competitive reasons or rating purposes,
Islamic finance principles been more and Ireland have been at the forefront it is not surprising that many Islamic
widely adopted, the global meltdown in of these, many other non-Islamic financial institutions would prefer to
financial markets could have been economies have seen the sustainable report in the global accounting
averted. While it is clear that the value in facilitating Islamic finance. language of choice, International
inherently conservative discipline that Financial Reporting Standards (IFRS).
generally underpins Islamic finance was This is reflected in the increased
distinctly lacking in the centres of the number of financial institutions as well Islamic finance is, however, by definition
global financial crisis, it remains a bold as supportive professional service distinct from conventional finance.
assumption to make. What is more organisations specialising in and Because of the nuances within it, many
evident is that Islamic finance has offering Islamic finance solutions. countries require their Islamic finance
remained fairly resilient, continuing to Similarly, conventional, multinational institutions (IFIs) to apply accounting
grow at unprecedented levels. Those financial institutions are also offering practices that take into account those
sustained levels of growth meant that in Sharia’a-compliant products in an effort differences, rather than simply applying
2011 the global assets managed by to take advantage of rising market the IFRS suite of standards.
Islamic finance reached $1 trillion, , demand, alternative investment
according to the Banker magazine. opportunities and new means of The fact that institutions can report and
accessing finance. disclose similar transactions in different
Markets such as Malaysia, the Gulf, ways poses problems for those
Pakistan and Indonesia continue to be Islamic financial institutions, wherever institutions themselves as well as for the
at the forefront of this space. they operate, do so within the same development of Islamic finance in
Nonetheless, through innovative and global financial system as their general. In particular, these relate to the
pragmatic regulatory changes, as well conventional counterparts and users of inherent uncertainty created for market
as often ready-made professional their financial reports need to make participants when assessing and
expertise, the presence of Islamic similar decisions to those of comparing IFIs with each other and with
finance has become more visible in a conventional banks. Thus for their conventional counterparts.

4
SCOPE AND OBJECTIVES In each discussion, participants were include such countries as Indonesia,
encouraged to share their experiences Iran, Malaysia, Pakistan, Saudi Arabia
Recognising the growing significance of and views openly on all aspects of and Turkey, many of whom are also
Islamic finance and as strong financial reporting practices pertaining active members of the Asian-Oceanian
proponents of the overarching benefits to Islamic finance. In order to give Standards-Setters Group (AOSSG). This
of global standards, ACCA and KPMG structure to the discussions, however, group of national standard setters was
firms have sought to engage with participants were also asked to consider created to look at regional issues in the
leading experts and stakeholders and reflect on a series of key questions implementation and application of IFRS
internationally and directly through a of particular interest to the broader and to lobby the International
series of round tables in three leading international debate. Accounting Standards Board (IASB)
hubs of Islamic finance: Kuala Lumpur, accordingly. Following the first meeting
Dubai and London. These centres have KPMG and ACCA also recognise the of the group in November 2009, AOSSG
influence throughout the international pivotal role that the International has been at the forefront of attempts to
Islamic finance industry, and have Accounting Standards Board (IASB) address issues relating to financial
already helped to drive its development could play in this process, and are reporting for Islamic finance.
through sound expertise and thought thankful for the support the IASB has
leadership. They also offer quite distinct offered throughout this project, with its ACCA and KPMG believe that this
views on the application of standards director of international activities report, which summarises the key
and principles to reporting Islamic participating in the series of debates. themes that emerged from the
finance. With the spread of IFRS internationally roundtable discussions, will offer some
cementing their position as the global high-level insights and
Delegates at the roundtables included accounting standards of choice, many recommendations to the IASB and
CFOs, technical experts, lawyers, countries where Islamic finance is other standard setters, to aid the
scholars, auditors, ratings agencies, prevalent have either incorporated IFRS further development of policies and
Islamic and conventional banks, and into their financial reporting frameworks propositions to strengthen the financial
regulators. or have committed to doing so. These reporting of Islamic finance.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 5

2. Financial reporting of Islamic finance

IFRS are used or permitted in over 100 Financial Institutions (AAOIFI) has
countries around the world because of looked to address this, by establishing
the recognition that they provide reporting standards for IFIs and taking General conceptual issues
decision-relevant information for market into account the nuances of Islamic
participants. Equally, there is little finance transactions as well as attending  It must be established whether
doubt that these standards were to the needs of users of IFI financial the users and the objectives of
designed with conventional finance and reports. The sphere of influence of financial reporting by Islamic
operations in mind, and the needs of AAOIFI has, however, been limited financial institutions are
users akin to dealing with such historically, and even where there is an different from those of
institutions. Therefore, IFIs and their acceptance of its standards’ prevalence conventional financial
accountants have had to apply them to among IFIs, there has not been institutions.
products and transactions for which universal and consistent application of
they were not developed. This these standards. This has been made  If there is a need to use
uncertainty has led to differing even more complicated by regulatory distinct Islamic accounting
interpretations as to how to apply requirements to report under IFRS in principles to provide a faithful
generally accepted accounting some countries that also require representation of the nature of
principles to IFIs. The Accounting and AAOIFI-based reporting. Islamic finance transactions,
Auditing Organisation for Islamic such principles must be
defined.

6
KEY INSIGHTS: MATCHING disclosure requirements for IFIs would Nonetheless, the majority of panellists
PRINCIPLES WITH RULES be particularly beneficial. For example, across all the roundtables echoed an
with regard to conventional institutions earlier statement from the chairman of
In general, it was agreed that the user operating ‘windows’ offering Islamic the Malaysian Accounting Standards
groups of financial statements for IFIs finance, there was concurrence that Board (MASB) that: ‘We feel that we can
and conventional financial institutions people who put their funds in windows use the International Financial
were essentially the same. Even so, would like to see an indication of Reporting Standards (IFRS) unless
users of IFI statements would probably performance; therefore there should be someone can show us that there is a
have additional needs, over and above additional disclosure and transparency clear prohibition in the Sharia’a, and
the requirements of users of the to observe through that window. then we will amend it accordingly. Until
financial statements of conventional such a time, we’ll use the IFRS’. Similarly,
institutions – a review of Sharia’a This reflects the strong view that Islamic from a rating agency point of view, the
compliance being a desired additional finance does present unique accounting need for consistency was paramount,
requirement of many of the roundtable issues, both to consumers and and as they and investors are generally
participants. Nevertheless, the providers of Islamic finance products. most concerned about who bears the
overarching sentiment was that for IFIs ultimate risk while awarding risk ratings.
to remain competitive with their On this front, it was clearly evident that Thus a sound substance over form
conventional counterparts, their there was a more pronounced view principle, as underpins IFRS, would be
financial reports needed to be from some members of the Dubai more appropriate than a dual system of
comparable. Thus in order to compete roundtable. Some roundtable reporting.
for the same sources of finance, IFIs participants stressed the need for
across borders have to be comparable, financial reports to mention specifically In its survey report entitled Accounting
while domestically and internationally it that the business of the Islamic bank for Islamic Financial Transactions and
is vital for analysts to be able to reported on is conducted strictly in Entities, AOSSG note that 78% of
benchmark and rate them against their accordance with Sharia’a rules, and respondents stated that providing
conventional counterparts. therefore strongly argued that the different accounting standards for
accounting treatments should reflect Islamic finance would be incompatible
While it was acknowledged that Islamic how those transactions were with IFRS convergence. Reflecting the
transactions are different in nature to conducted. They argued forcefully that views of other participants at the Dubai
their conventional counterparts, it was the business models of Islamic banks roundtable, Dubai was among five
stressed that there must be consistency are quite distinct from those of jurisdictions that argued that IFIs could
in their treatment. There was therefore conventional banks and therefore be subject to specific requirements for
widespread support for the use of IFRS differences in financial reporting would reporting about Islamic finance
as the most applicable globally be inherent, firmly believing that the operations, while also applying IFRS –
accepted set of accounting standards. IASB should include a separate set of largely if those ‘additional’
Panellists were equally in agreement financial reporting standards for Islamic requirements were disclosure related.
that additional guidance in relation to banking.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 7

3. Compatibility of IFRS with Islamic finance principles

TIME VALUE OF MONEY KEY INSIGHTS: WHERE’S THE

INTEREST?
The prohibition of partaking in interest- Measuring the time value of
based transactions is central to Islamic money The key issue in this respect was argued
finance. Increasing aspects of financial to be that of valuing assets and
reporting require the use of discounted This debate has a pervasive liabilities. The concept of fair value was
cash flows to derive an approximation impact on transactions in Islamic agreed to be wholly appropriate as the
of a market value. While this clearly in finance. For example: means of measuring those assets and
itself does not constitute an interest liabilities, especially where there were
charge, discounting and time value of  the profit under a murabaha- active markets and relevant market
money are generally calculated with type sale contract (see Chapter price mechanisms as a means of
reference to interest rates, which 4) could be viewed as being benchmarking those values.
continues to raise concerns over the akin to interest, and therefore
compatibility of IFRS with Sharia’a under IFRS would be As Sharia’a markets are less liquid than
principles. accounted for as interest conventional markets, however, there
revenue was a consensus that discounted cash
flow models were commonplace as a
 similarly, the resulting means of valuation in the absence of a
capitalised asset could be direct market price, and that using a
measured at contractual price base similar to LIBOR (such as the
or split between finance costs KLIBOR in Malaysia) to value a
transaction for accounting purposes
 there can be problems with should not necessarily nullify the
measuring assets and liabilities contract itself, which itself has been
generated through Islamic deemed Sharia’a compliant.
finance transactions, especially
in the absence of active On the other hand, it was felt that the
markets. accounting treatment should reflect the
way the transaction is set up. For
example, with a murabaha profit rate
swap, the mark-up is apportioned over
the time period; therefore, the use of
the amortised cost method – whereby
the financial cost is a function of the
balance of the principal outstanding
and hence decreases with each
instalment paid – would be
inappropriate. Even if the cash flows
and pricing were identical to those of a
conventional swap, it was agreed that
the substance of the transaction is not
an amortised cost type of operation
and the accounting treatment should
reflect this.

8
SUBSTANCE OVER FORM KEY INSIGHTS: SUBSTANTIALLY THE
SAME
A key concept which has historically
been incorporated in many financial This conflict is particularly salient when
reporting frameworks is the notion of accounting for mudaraba-based
‘substance over form’, whereby a investment accounts (ie profit-sharing
transaction is measured and reported in investment accounts), profit
accordance with its economic equalisation reserves and ijara (see
substance rather than its legal form. As Chapter 4) transactions. Insights
Islamic financial transactions are legally relating to these specific items are
underpinned by Sharia’a principles, it is discussed in more depth in the next
sometimes argued that it would be section. However, conceptually, almost
inappropriate to apply substance over all participants were clear that it was
form to such transactions, because it is crucial to report on the substance of a
the Islamic legal form that will ultimately transaction to provide the most useful
determine the accounting treatment. information for users. Although there
were specific transactional issues, it was
important to report with this general
premise to ensure that appropriate
guidance and understanding were
available to reassure stakeholders that
there was no contradiction to the
intended spirit of the Islamic finance
transaction.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 9

4. Reporting unique Islamic finance transactions

MUDARABA-BASED INVESTMENT There are two common types of in order to ensure a smoothed return to
ACCOUNTS mudaraba investment account: customers, would point to a form of
liability not dissimilar to conventional
Many Islamic financial institutions • restricted – investment of money in deposits.
operate a mudaraba-based investment these funds by the IFI is restricted to
structure, which is a popular form of investments stipulated by the In practice, Islamic banks in most
deposit mechanism for customers. The depositor, while the IFI shares the countries present URIA as liabilities on
specific features of these accounts profits or losses of the related their balance sheets, whether they use
create a distinct difference between investments once realised, and IFRS or local GAAP (Malaysia), again
them and conventional deposit reflecting the substance of the
accounts, which in turn affects how they • unrestricted – where the IFI has arrangements. Only IFIs reporting
might be reported. unconditional rights to manage under AAOIFI standards tend to report
those funds without restrictions them at the mezzanine level between
The key features of mudaraba imposed by the depositor. liability and equity.
investment accounts include the
following. The nature of unrestricted investment From a prudential standpoint, the
accounts (URIA) means that they are Islamic Financial Services Board (IFSB)
• All mudaraba investment accounts treated as a quasi form of equity under also does not include any profit-sharing
work on a profit-sharing basis, with some Islamic accounting standards (eg (mudaraba) investment accounts as
the IFI essentially acting as an AAOIFI’s FAS6, Equity of Investment eligible capital for capital adequacy
investment manager. Account Holders and their Equivalent). purposes, which is similar to
The fact that any losses in the requirements under Basel II.
• The down-side investment risk falls investment are borne by the investor
on the investor only. suggests that the latter is in principle a Restricted mudaraba investment
type of residual claimant or equity accounts are in many respects more
• Any assets acquired by the IFI in investor. Nonetheless, the losses could akin to a pure investment management
relation to the account are ultimately fall on the IFI were it proved to be undertaking by the IFI, restricted to the
owned by the investor with returns negligent, and IFIs increasingly provide specific conditions imposed by the
and profits shared on a pre-agreed a ‘trespass or omission’ guarantee to investors. As the IFI is acting as an
basis. customers. This, coupled with the agent in a fiduciary capacity for the
commercial necessity faced by accounts, such contracts would be
internationally competing IFIs of treated as ‘off-balance sheet’.
absorbing losses from URIA themselves,

10
 KEY INSIGHTS: SOMEWHERE IN THE there is a constructive obligation arising
MIDDLE? out of established practices and
Treatment of mudaraba regulatory expectations. Nevertheless,
investment accounts The debate on legal form versus there was some agreement that legally
substantive reality was classically such accounts did display elements of
A key point for consideration is evident in relation to mudaraba. There equity instruments. In Malaysia, it was
whether mudaraba investment was unanimous agreement that noted that the national regulator was
accounts represent equity, as restricted investment accounts proposing changes to the disclosure
there is no ‘obligation’ to return, represent funds under management requirements such that elements of the
or whether there is a constructive and should be kept off-balance sheet. It investment risk disclosure associated
obligation associated with such was, however, suggested that there with such instruments would in the
accounts that make them a form should be additional disclosures in the future have to be segregated between
of liability. Other issues financial statements regarding this side equity and liability elements.
considered included: of the business, as embedded in
Sharia’a is the requirement to be as Others were of the opinion that
 where the bank is essentially transparent as possible, and disclose unrestricted mudaraba accounts are
carrying out a fund fully. neither liabilities (as there is no
management role, whether it contractual liability on the IFI) nor
would be appropriate to keep It was noted that unrestricted mudaraba equity (as the depositor has no voting
such mudaraba accounts off accounts in general are treated as akin rights and is not represented in the
balance sheet, on the basis of to deposits and shown on the balance Board), and should instead be classified
the level of control over these sheet as liabilities, as although there is as a separate item in the statement of
assets and what type of no contractual liability of repayment, financial position under ‘Investor Funds’
disclosure should be required or any other appropriate name.
in such cases

 with regard to measurement of

such investment accounts,
would this essentially depend
on whether the return is fixed
or variable?

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 11

PROFIT-EQUALISATION RESERVES Profit-sharing reserves are usually of
(PERs) AND INVESTMENT RISK two types.
RESERVES (IRRs) Accounting for PERs
• In profit equalisation reserves (PERs),
Under strict Sharia’a rules, if there is a the reserves are set aside from A key concern was that in the
loss from a mudaraba investment, it is profits before applying the profit- case of PERs, in particular, the
the depositing customer who bears the sharing distribution. Typically, in IFI’s share of the profits is
full loss. In practice, in such such arrangements, the IFI gives up included, thereby effectively
circumstances or when the overall profit a part, or its entire share, of profits, creating an expected loss
levels have been low, as was the case in order to match current market provision, and this has in turn led
during the global financial crisis, IFIs returns. to inconsistency in how IFIs
have forgone their own share of profits around the world account for
to ensure that the depositor receives a • In investment risk reserves (IRR), the PERs. Thus participants debated
comparable market return – even if reserves are set aside from the part whether:
there is no legal compulsion to do so. of the profits allocated to investors,
which can be used only to absorb  this was a true liability under
The IFSB describes this provision of principal losses during a financial IFRS, or
competitive returns as ‘displaced period.
commercial risk’. Principally applied to  it was in fact, simply a
URIA, an IFI achieves this risk-sharing by The accounting for these reserves regulatory or presentation
using reserves set aside from mudaraba under IFRS would depend on whether issue.
profits. the IFI is deemed to have an obligation
to pay depositors from the reserve. As
was noted in the ACCA report,
Harmonising Financial Reporting of
Islamic Finance,1 there remains stark
inconsistency as to how PERs are
accounted for. This was further echoed
in the AOSSG survey, which showed
that of the five countries in the survey
that did have Islamic accounting
standards, Indonesia does not permit
PER, some Pakistani IFIs accounted for
them within liabilities, and the others,
consistent with AAOIFI’s FAS11,
accounted for them within equity.

1. http://www.accaglobal.com/content/dam/acca/
global/PDF-technical/financial-reporting/tech-af-
hfrif.pdf

12
KEY INSIGHTS: SMOOTHING during periods of low profitability. The
EXPECTATIONS treatment does not necessarily reflect
the loss-sharing concept required under
A number of panellists raised concerns Sharia’a, with the portion due to the
about the concept of the PER, bank in particular perhaps more
especially in the context of accounting appropriately reflected as equity (albeit
for such variable rate products. frozen equity) or deferred profit.
Concerns were also raised about the
level of awareness that depositors had Given the inconsistency around the
about banks keeping their profits as application of some of the requirements
reserves and who should receive the in IFRS relating to provisions, it was
profits – future depositors or the broadly agreed that supplementary
depositors to whom the profits belong. disclosure on the nature and risks of
such arrangements would be beneficial.
Although there is inconsistency in the Indeed, in Malaysia, the national
accounting treatment for these types of regulator was in the process of
reserve across the industry, common reviewing the PER mechanism, and such
practice in Malaysia is that both the reserves were already being reduced by
portion due to the bank and the many IFIs in anticipation of these
depositors’ share of profits are guidelines.
accounted for as liabilities. There was
acknowledgement that the treatment The inconsistency in the classification of
had evolved as a consequence of the PERs across the industry indicates this
need for IFIs to achieve a counter- as being an important area where
cyclical ability to pay profit to customers clearer guidance is required.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 13

IJARA BITAMLEEK: FINANCE-TYPE By contrast, under both IFAS2 Ijarah (as
LEASES issued by the Institute of Chartered
Accountants of Pakistan) and AAOIFI’s Accounting for quasi finance
Ijara-based finance structures have FAS8, the legal form of the contract is leases
proved to be highly common across the paramount, meaning that the ownership
Islamic finance industry. Effectively of the asset remains with the lessor, Some commentators take the
forms of leasing arrangement, Ijara until legal title is transferred at the end view that under Sharia’a
contracts also come in various forms. of the lease period. In this case the IFI principles, a finance lease should
The pure Ijara is essentially an operating would remain the owner, and record the be accounted for as two distinct
lease and there is little conflict in asset on its balance sheet in the same contracts – the leasing
accounting for this (either for the lessor way as an operating lease or operating arrangement and the transfer of
or the lessee) under the requirements Ijara. the asset. The key consideration
of IAS17. that was posed to participants
In Islamic finance, the salient feature was whether combining the two
Increasingly used forms of leasing by appears to be the fact that both Ijarah contracts would conflict with
IFIs are the ijara muntahia bittamleek and Ijarah MB are purely leasing Sharia’a principles.
(ijara MB) or ijara wa iqtina, which are transactions in which the subject matter
similar to hire purchase agreements is the usufruct of the asset (ie the right
popular in conventional finance. This is to enjoy it even though one does not
essentially a form of financing which, own it) and not the financing of the
under IFRS, is treated as a finance lease asset, as is the case for a finance lease.
because, as with a hire purchase Thus it has been argued that given that
agreement, the risks and rewards the legal title remains with the lessor,
associated with owning the asset are in for the accounting to be consistent with
substance transferred to the lessee. the Sharia’a principle, the lessor would
Thus under IAS17 the asset would be necessarily have to account for the
booked as such by the lessee, while the leased asset – hence the treatments
lessor (the financer) would book a under AAOIFI and other Islamic
receivable for the rent and related principles-based accounting standards.
interest receivable.

14
KEY INSIGHT: LESSER BALANCE Even so, certain panellists raised
SHEETS concerns that it would be inappropriate,
under Sharia’a principles, to combine
Again, there was a general acceptance the purchase option with the lease, in
that the key issue in relation to the same contract.
accounting for ijara contracts revolved
around the debate on substance over Panellists were unclear as to whether
form. Most panellists agreed that under current proposals from the IASB would
Sharia’a principles, a typical ijara facilitate the resolution of the various
contract with purchase option would be accounting issues from the perspective
separated into two distinct contracts, of IFIs. To some extent, the recognition
one being an operating lease of the right of use of an asset would
arrangement and the other being the appear to fall within the principles of
transfer (sale) of the asset. Sharia’a and therefore reconcile
differences between IFRS and other
Under current IFRS, although the lessor Sharia’a-based accounting standards.
retains a number of responsibilities of Others argued that the new proposals
ownership, in most cases the treatment would broaden the differences,
of ijara contracts would tend towards especially if the asset would need to be
that of a finance lease, taking the recorded on the lessee’s balance sheet
contract as a whole. Some panellists under any lease contract.
agreed that this was the most
appropriate treatment as the two parts This was a particular area where it was
to the contract were inextricably linked believed that the Islamic finance
and accounting for them as separate industry needed to do further research
components could result in financial and be more engaged with the IASB’s
engineering. standard-setting process, or else the
industry could be faced with significant
reporting dilemmas.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 15

SUKUK KEY INSIGHTS: HOW SHOULD The other major issue was around
SUKUK BE BACKED? valuation of sukuk. Given the reality of
As sukuk transactions continue to be how sukuk are traded – many Sharia’a
the driving force for Islamic finance There was agreement that the Supervisory Boards (SSBs) and
globally, it is imperative that reporting classification should be based on the individual scholars insist on these
issues relating to sukuk are consistent contractual features and structure of instruments being held rather than
across jurisdictions and in generally each sukuk, and as a result could be traded – the sukuk market is relatively
accepted accounting principles. Often off-balance sheet or on-balance sheet. illiquid, which in turn makes valuation
structured similarly to conventional There are strong indications that in based on a quoted price in an active
bonds, sukuk represents the holder’s practice the majority of sukuk are market difficult or less relevant. Using
right to cash flows arising from a asset-backed (as opposed to asset- proxies for measurement again raised
beneficial interest in an underlying based) and are therefore, in principle, the debate around using interest-based
asset. essentially a form of financing vehicle, instruments as appropriate surrogates
with the intention being to sell the asset for ascertaining a fair value, as
to an SPV in order to generate the funds discussed earlier.
to pay to bondholders.
Nonetheless, at the same time it was
Recognising and valuing sukuk Thus the key question arises as to argued that in reality the majority of
whether it should be just the cash flows sukuk, held for trading, are measured at
Key points for consideration that are accounted for. the price they were sold for - their fair
include whether the asset should value (again owing to a lack of
be shown in the books of the IFI In practice, it appears that in most observable prices). It was not likely that
or the special purpose vehicle cases SPVs are consolidated with a the fair value would be calculated on
(SPV – see below), and corresponding liability booked, the basis of the (proportional) value of
appropriate valuation methods suggesting that an asset transfer has the underlying asset represented by the
for sukuk. occurred. sukuk.

Given the approach in IFRS 9,

which is based on the business
model of the entity, would sukuk
be generally measured at
amortised cost or fair value?

With secondary markets for sukuk

still quite limited, would it be
appropriate from a Sharia’a
perspective to measure at fair
value using techniques where
discounted cash flows are
required (in the absence of
observable traded prices)?

16
MOVING FORWARD: THE OPTIMAL KEY INSIGHTS: IFRS FRAMEWORK Ultimately, the majority of panellists
APPROACH TO FINANCIAL agreed that application guidance within
REPORTING OF ISLAMIC FINANCE It was universally agreed that it was the suite of IFRS would be the most
imperative to recognise that there are appropriate short-to-medium-term
Whether it is best that reporting for important and genuine challenges recourse.
Islamic finance be carried out within the unique to Sharia’a-compliant
wider IFRS framework or through a transactions, where the form of It was also suggested that the IASB
parallel set of globally accepted transactions is linked to the basic should consider establishing an
accounting standards for the Islamic principles underlying them. international advisory group, akin to the
finance industry will depend on the SME Advisory Group that was set up
needs of all stakeholders in the All panellists agreed that harmonisation when formulating and reviewing the
industry. of financial reporting for Islamic financial IFRS for SMEs. This should necessarily
products would ideally be within the include an outreach programme across
IFRS framework. While some believed relevant jurisdictions advising on the
that the optimal approach would application of IFRS in the context of
involve the issuance of separate Islamic finance, helping to bridge
standards, specific to Islamic finance, by differences in interpretation of IFRS
Optimising financial reporting the IASB, the majority were comfortable application in the industry and
of Islamic finance that the IASB should consider a accounting treatment requirements
presentation and disclosure standard. issued by national regulators.
The question of how Something similar to the former
harmonisation of financial standard, IAS30 Disclosures in the
reporting for Islamic financial Financial Statements of Banks and
products, both by IFIs and Similar Financial Institutions, could be
conventional banks offering an ideal way to progress.
Islamic ‘windows’, can be
achieved was posed to
participants. In particular, they
were asked whether IFIs would
benefit from reporting:

 within the existing IFRS

framework, supplemented by
application guidance and/or
the presentation of a
reconciliation from IFRS to
accepted Islamic accounting
principles, or

 within the IFRS framework but

with a specific standard for
Islamic finance, or

 through a globally recognised

suite of Islamic financial
standards and/or the
presentation of a reconciliation
to IFRS.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 17

5. Observations and conclusions

The December 2011 survey conducted IFRS-based framework. Finance leasing decision-usefulness of financial
by AOSSG, Accounting for Islamic was one area where it was argued to be information for users is diminished.
Financial Transactions and Entities,2 particularly important for the Islamic Given ACCA and KPMG’s views that the
noted that IFIs and Islamic windows in finance industry to conduct further investor must be placed at the heart of
conventional financial institutions report research and be more engaged with the financial reporting, this is a crucial issue
through various reporting frameworks, IASB’s standard-setting process. If not,
on the basis of their own national it was stressed that the industry could There is overarching agreement that for
regulatory requirements. While some of be faced with significant reporting IFIs to remain competitive with their
these take into account the nature of dilemmas. conventional counterparts, their
the industry, most are universal across financial reports need to be
entities. With the extension of IFRS Although there remain issues around comparable. This would enable IFIs to
globally, IFIs are increasingly reporting measurement and recognition that compete for the same sources of
through such standards. need further research and insights, finance, and would enable analysts to
concerns around disclosure and benchmark and rate them against
The joint ACCA and KPMG roundtable therefore transparency as to how conventional financial institutions and
discussions have clearly revealed Islamic finance transactions were against other IFIs in different
widespread support for the use of IFRS recorded were the overwhelming jurisdictions.
as the most applicable globally priority from a corporate reporting
accepted set of accounting standards. perspective. For example, many IFIs Although specific financial reporting
Nonetheless, panellists were equally in reporting under IFRS recognise standards such as those propagated by
agreement that additional guidance in unrestricted investment accounts as AAOIFI can address unique features of
relation to disclosure requirements for liabilities, and there is little information Islamic finance, it is crucial for the future
IFIs would be particularly beneficial. to enable users of financial statements growth of Islamic finance that
Islamic finance transactions need to distinguish these Sharia’a-compliant confidence is garnered across all
careful consideration in terms of how deposit accounts from their stakeholders through the consistent
they are accounted for within an conventional counterparts. Hence, the application of IFRS.

2. The Asian-Oceanian standard-setter Group

(AOSSG), http://www.aossg.org/docs/
Publications/AOSSG_Survey_Report_2011_
FINAL_CLEAN_29_12_2011.pdf

18
6. Recommendations

RECOMMENDATIONS FROM THE RECOMMENDATIONS FROM THE

ROUNDTABLES TO THE IASB ROUNDTABLES TO THE ISLAMIC
FINANCE INDUSTRY
The IASB should consider the issuance
of guidance on the application of IFRS Advisory group linked to IASB
when accounting for certain Islamic In the view of many of the roundtable
financial products, in order to achieve participants it is essential that that the
greater harmonisation of financial Islamic finance industry offers
reporting for Islamic financial products immediate support to the IASB by
and services, both by Islamic financial forming an expert advisory group,
institutions and conventional banks crucially including scholars, from various
offering Islamic finance ‘windows’. Given jurisdictions, if Islamic finance is to be
the importance of global standards part of the IASB agenda. in this space.
most participants in the roundtables The group could contribute to the due
preferred to retain a single set of such process for new standards and help
standards, consistently applied by all with the overall review and, or
entities, regardless of their being IFIs. alternatively, provide advice on ad hoc
basis.
Secondly, the IASB should also consider
the issuance of guidance on additional Education
disclosures that could be made for the Recognising the need for greater
benefit of stakeholders seeking transparency and understanding,
information on the entity’s Sharia’a- especially for the investor community,
compliant operations. further outreach and education by the
Islamic finance industry needs to be
Thirdly, the IASB should work with conducted and maintained. Providers of
organisations such as AAOIFI and other professional qualifications should look
leading Islamic finance bodies to into the relevance of Islamic finance to
facilitate gap analysis between IFRS their syllabuses and their members.
and prevalent Islamic accounting
standards, including the overarching The regulators
frameworks and assessment of user Most participants felt that the industry
needs. This should also include a review needed to engage more with local
of terminology/nomenclature within regulators to understand their
IFRS, and consider whether sensitive expectations of financial reporting and
terms such as ‘interest’ can be the disclosure of Islamic financial
amended or added to. instruments.

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 19

Appendix 1: The panellists

KUALA LUMPUR, 6 OCTOBER 2010 DUBAI, 5 MAY 2011 LONDON, 5 MARCH 2012

The meeting was chaired by Mr Aziz The meeting was chaired by Mr Aziz The meeting was chaired by Mr Aziz
Tayyebi, head of international Tayyebi, head of international Tayyebi, head of international
development, ACCA, and Mr Samer development, ACCA, and Mr Phil development, ACCA, and Mr Samer
Hijazi, director, Financial Services, Knowles, partner, Financial Services, Hijazi, director, Financial Services,
KPMG in the UK. KPMG in the UAE. KPMG in the UK.

Zaiton Hassan Khairul Nizam Richard Martin, ACCA

ACCA Malaysia Advisory Committee AOIFI
Ian Welch, ACCA
Malkit Singh Shahid Amin
Mansur Mannan
Bank Islam Malaysia Al Hilal bank
Dar Capital
Faizal Jaffar Thomas Joe
Dr Mehmet Asutay
Bank Negara Malaysia Al Hilal bank
Durham University
Azril Azmi Hisham Al Mannai
Mohammad Memon
ECS Solutions Sdn Bhd Central Bank of Qatar
Europe Arab Bank
Wayne Upton Alaa El Ghazaly
Sam Perera
International Accounting Standards Central Bank of Qatar
European Islamic Investment Bank
Board
Ahmed Fayed Al-Gebali
Arshad Ur-Rahman
Dr Shahul Hameed bin M. Ibrahim Dubai Islamic Bank
Financial Services Authority
International Centre for Education in
Mohammed Shamim
Islamic Finance (InCEIF) Brandon Davies
Dubai Islamic Bank
Gatehouse Bank
Abdulwahab Ahmadnasri
Noman Ali
KPMG in Malaysia Simon Archer
HSBC Bank Middle East Limited
Independent Islamic finance academic
Adrian Lee
Muzzafar Ahmed
KPMG in Malaysia Mushtak Parker
Islamic Development Bank
Independent Islamic finance journalist
Mohammad Faiz Azmi
Neil Miller
Chairman, Malaysian Accounting Wayne Upton
KPMG in the UAE
Standards Board International Accounting Standards
Muhammad Tariq Board
Mas Sukmawati Abu Bakar
KPMG in the UAE
Malaysian Accounting Standards Board Iain Crawford
Faisal Anwar Islamic Bank of Britain
Zulfa Abdul Rahman
KPMG in the UAE
Malaysian Institute of Accountants Andrew Vials
Abdullah Akbar KPMG in the UK
Ronnie Royston Fernandiz
KPMG in Saudi Arabia
Maybank Berhad Colin Martin
Khalid Howladar KPMG in the UK
Ng Kean Kok
Moodys
University Tunku Abdul Rahman Rukaiya Rashida
Raza Rashid KPMG in the UK
Noor Islamic Bank
Zimran Fazal
Standard Chartered Bank
David Loweth
UK Accounting Standards Board
Peter Casey
Dubai Financial Services Authority
20
Appendix 2: Arabic terms used in this report

Ijara a lease contract

Ijara muntahia bittamleek a lease contract where the lessee has the option to acquire ownership of the asset at
any time

Ijara wa iqtina a lease contract where the lessee has the option to acquire ownership of the asset at
end of lease period

Istisna’a contract to manufacture, where the delivery is deferred – the sale price may be
payable at spot or deferred

Mudaraba partnership agreement where one partner (Rab al maal) provides the capital and the
other (Mudarib) provides the work/management

Murabaha sale of goods at an agreed mark-up

Musharaka partnership arrangement

Riba literally excess, referring to unfair gain: usually synonymous with interest

Salam a contract where advance payment is made for defined goods to be delivered later at
a fixed date

Shari’a (or Shariah) the rules and underlying principles of Islamic law

GLOBAL ALIGNMENT: BRINGING CONSISTENCY TO REPORTING OF ISLAMIC FINANCE THROUGH IFRS 21

 INVITATION TO COMMENT

This report highlights a number of important avenues for determining the future direction of financial reporting of
Islamic finance.

ACCA and KPMG are keen to hear from all stakeholders interested in this subject. If you would like to comment on any of
the issues raised in this report please contact either Mr Aziz Tayyebi or Mr Samer Hijazi, who are leading this project for
ACCA and KPMG respectively.

Samer Hijazi
Samer is a director in KPMG’s Financial Services Audit practice. Samer is currently director on the
Standard Chartered Bank audit team responsible for the audit of the Wholesale Bank and Islamic
finance. He also works with a number of Islamic retail and investment banking entities in the UK
where he has provided accounting and advisory services for the past six years. Samer has also
provided accounting and quality assurance advice on Islamic financial products and operations to
several leading conventional global financial institutions with Islamic windows in London.
[email protected]

AzIz Tayyebi
Aziz is head of international development at ACCA, responsible for developing and supporting key
growth markets for ACCA. Aziz has been at the forefront of extending ACCA’s reputation in the
field of corporate reporting and in particular IFRS, and he leads ACCA’s work in the field of Islamic
finance, contributing articles and discussion papers on the subject. Aziz has represented ACCA on
a number of key international forums such as Jetco’s Indo-UK taskforce on accounting, the
Federation of European Accountants (FEE) and the CityUK Islamic finance group, as well as addressing
conferences internationally on key issues affecting business and the accountancy profession.
[email protected]

22
POL-AFB-GABC

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