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What is AAOIFI’s Proper Accounting Standards Role?


9 February 2011

The item below was originally published in the magazine Islamic Finance News, and is reproduced here with the concurrence of the editor.

When most of the world accounts under IFRS, what should be AAOIFI’s role with regard to accounting standards?

At Islamic finance events, participants often ask whether Islamic financial institutions should account under International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB) or under the Financial Accounting Standards issued by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). While this question is common, a more fundamental question is “What is the proper role of AAOIFI with regard to accounting standards?”

AAOIFI was established after an agreement signed by various Islamic financial institutions on 26 February 1990 and was registered in Bahrain as an international autonomous non-profit making corporate body on 27 March 1991. At that time local country accounting standards were not well established in the Middle East and a need was clearly felt for the establishment of accounting standards for Islamic financial institutions that would be harmonised across countries. AAOIFI has also established a Shariah Board which is highly respected, and is probably the leading global setter of Islamic finance Shariah standards. However the organisation’s name clearly indicates that it regards its main focus as being accounting and auditing standards setting.

AAOIFI’s limited geographical reach

The 2010 edition of AAOIFI’s “Accounting, Auditing and Governance Standards for Islamic Financial Institutions” shows that AAOIFI’s Accounting and Auditing Standards Board is heavily dominated by the Middle East. The 15 members (ignoring the secretary general) come from only the following countries: Kuwait (1), Bahrain (5), Saudi Arabia (2), Lebanon (1), UAE (2), Jordan (1) and Qatar (1) with only Malaysia (2) from outside the Middle East.

A review of AAOIFI’s membership list published in the same volume shows that it has many member Islamic financial institutions drawn from outside the Middle East. For example both Kenyan Islamic banks (First Community Bank and Gulf African Bank Ltd) are members, and so are two (European Islamic Investment Bank and Gatehouse Bank) of the five Islamic banks established in the United Kingdom. However it is striking that the other three UK Islamic banks do not feel any need to join AAOIFI.

Unlike the situation in 1990, by 2011 IFRS have become almost universally accepted in Europe, Asia, Oceania, Africa, Latin America and the Caribbean. The only significant country that still clings to its domestic accounting standards is the USA, but the US accounting standards setter, the Financial Accounting Standards Board (FASB) has signed a memorandum of understanding with the IASB with the purpose of converging FASB standards and IFRS. The goal of convergence is that well before the end of this decade US companies should account under IFRS.

Islamic financial institutions are required to use the system of accounting standards which is mandated by the financial services regulator of the country in which they are based. Accordingly, Islamic financial institutions based in the USA must use FASB accounting standards, while almost everywhere else they account under IFRS, although limited time and the variable quality of English language information disclosure makes exhaustive verification of this impractical. However it is practical to review the position in the countries closest to AAOIFI’s base, namely the countries of the Gulf Cooperation Council (GCC). A review of published accounts for 2009 shows the following:



Islamic financial institution reviewed

Accounting standards used


Kuwait Finance House KSC



Al Salam Bank-Bahrain BSC



Qatar Islamic Bank SAQ


Saudi Arabia

Al Rajhi Banking and Investment Corporation


UAE (Dubai)

Dubai Islamic Bank PJSC


UAE (Abu Dhabi)

Abu Dhabi Islamic Bank PJSC


The writer understands that Oman does not have any Islamic banks (none are members of AAOIFI) although some websites list certain entities as offering Islamic financial services. The accounts of one Omani bank, Oman Arab Bank SAOC, were reviewed. It accounts under IFRS although there is no indication from the accounts that it is an Islamic Financial Institution.

Accordingly, even within the GCC AAOIFI accounting standards are used by only two countries, Bahrain, the country where AAOIFI is established, and its neighbour Qatar. All other GCC countries use IFRS. While both Bahrain and Qatar are important countries for Islamic finance, they only represent a small minority of the global Islamic financial services industry.

The purpose of accounting

Before drawing any conclusions from the almost universal non-use of AAOIFI’s accounting standards, it is helpful to consider the purpose of accounting. Both standard setting organisations have set out their views.

AAOIFI’s "Statement of Financial Accounting No. 1: Objectives of Financial Accounting for Islamic Banks and Financial Institutions" was published in 1993. The introduction to that statement says: "Financial accounting in Islam should be focused on the fair reporting of the entity's financial position and results of its operations, in a manner that would reveal what is halal (permissible) and haram (forbidden).

Section 6/2 of the standard sets out the objectives of financial reports in six paragraphs of which the first is "6/2(a) Information about the Islamic bank’s compliance with the Islamic Shari’a and its objectives and to establish such compliance; and information establishing the separation of prohibited earnings and expenditures, if any, which occurred, and of the manner in which these were disposed of."

In 2001 the IASB adopted its "Framework for the Preparation and Presentation of Financial Statements." Paragraph 12 states: "The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions.”

These quotations demonstrate that the two standard-setting organisations have entirely different priorities.

In the writer’s opinion, a key criterion for accounting is comparability; two organisations that carry out transactions which have identical economic effects should account for the transactions in the same way. Comparability breaks down when AAOIFI requires transactions to be accounted for differently from IFRS standards.

One simple example is leasing in cases where the asset is to be transferred to the lessee by a gift, Ijarah Muntahia Bittamleek, covered in AAOIFI’s FAS No. 8 paragraph 2/2(a). AAOIFI requires the leased asset to be held on the lessor’s balance sheet and depreciated. IFRS would clearly regard such a transaction as a finance lease, removing the asset from the lessor’s balance sheet and instead accounting only for a finance lease receivable.

What should AAOIFI be doing with regard to accounting?

It is pointless AAOIFI continuing to issue accounting standards in competition with the IASB, when those standards are going to be ignored outside a few countries. This represents a waste of limited resources, and also reduces the comparability of Islamic financial institutions’ accounts since AAOIFI accounts are not directly comparable with IFRS accounts.

AAOIFI’s accounting resources would be more usefully directed to collaborating with the IASB. The following goals come to mind immediately, although as the collaboration developed other goals would also most likely emerge:

  1. Islamic banks accounting under IFRS will of course show the same numbers in their financial statements and balance sheets as would conventional banks undertaking identical transactions. However Islamic investors need additional information which is not mandated by IFRS, for example the amount on which they should pay zakah in respect of their shares. In most cases Islamic financial institutions accounting under IFRS are likely to provide this information voluntarily; for example in its 2009 accounts the UK’s European Islamic Investment Bank provided a figure computed using AAOIFI’s standards. It would be desirable to have IFRS mandate a standard method of calculation for IFRS accounting entities that wished to make such a disclosure.
  2. Muslims represent a growing proportion of the investor base of conventional non-financial companies that account under IFRS. It would be desirable for such companies to give a voluntary disclosure in their accounting notes regarding the amount of their dividends that arise from sources that are regarded as impure by Shariah scholars, computed in a standardised way.

To conclude, while it may appear radical for AAOIFI to cease issuing accounting standards, this would enable it to become globally relevant by partnering with the IASB.


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