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Most of the time we operate on "autopilot" without thinking about our basic assumptions.

That makes sense most of the time. Life would be impossible if you had to think consciously all the time about how to walk! However it helps to occasionally step back and think about the basics.

Exactly why does Islamic finance need accounting standards, and is there any need for specific "Islamic accounting standards"? I decided to tackle this in my July column for the magazine "Islamic Finance News".

Why Islamic finance needs accounting standards

The apparently obvious should occasionally be questioned. Why does Islamic finance need accounting standards and Shariah standards? These are distinct questions meriting separate columns.

The accounting profession began to develop modern accounting standards during the 19th century, driven by the multiplication of joint stock companies with publicly traded shares. Gradually the accounts of different companies within the same country became more standardised. The pressure to standardise increased each time there was a major scandal involving distorted accounting.

International comparability came much more slowly.

As recently as 1991, in Geneva, I gave participants on an international course the accounts of four giant bulk chemicals companies to review; one each from the USA, UK, Germany and Japan. Despite being very similar businesses, their accounts were dramatically different because accounting standards differed so much between their countries. That is why we needed international standardisation!

Today, Islamic financial institutions (IFI’s) account on a planet divided into four parts:

• The USA which ignores the rest of the world and uses its own Financial Accounting Standards (FAS) as promulgated by the Financial Accounting Standards Board. As the world’s largest economy, this separatism by the USA matters, but with every year that passes the USA is a slightly smaller part of the global economy.
• Almost all of the rest of the world uses International Financial Reporting Standards (IFRS) promulgated by the International Accounting Standards Board (IASB).
• A tiny number of countries (when I last checked only Bahrain and Qatar) which require IFI’s to account using Financial Accounting Standards promulgated by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI).
• A few isolated countries such as Iran where IFI’s account using local country accounting standards.

The IASB has an “Islamic Finance Consultative Group” to ensure that it takes account of Islamic finance. However, the most recent meeting I could trace was as long ago as 27 March 2018, chaired by PwC partner Mohammad Faiz Azmi of Malaysia.

Overall, I would say that users of IFI’s accounts have basically the same needs as the users of accounts prepared by other financial institutions. They want to assess the profitability of the entity, and its viability and exposure to risks.

However, they also have some additional needs. For example:

• Has the entity received any religiously prohibited income? The shareholder may wish to donate to charity dividends arising from such income rather than retaining the money.
• Has the entity paid zakat on behalf of the shareholder? If not, what is the amount on which shareholders should pay zakat?

However, apart from religious needs like those above, the remaining needs of accounts users are the same, regardless of whether the financial institution is Islamic or not.

The commonality of needs and the near-universal adoption of IFRS are the reasons why my 9 February 2011 Islamic Finance News article “AAOIFI’s Proper Accounting Standards Role” recommended that AAOIFI should stop issuing accounting standards and instead partner with the IASB to ensure that IFRS mandated disclosures which would help IFI’s’ shareholders address religious needs like those illustrated above.

In my contribution “Accounting and Tax Developments” in the Islamic Finance News 2015 Annual Guide, I noted that AAOIFI had agreed to participate in the IASB’s “Consultative Group on Shariah Compliant Instruments and Transactions.” [The former name of the Islamic Finance Consultative Group] However, my search of the IASB and AAOIFI websites indicates that this participation appears not to have continued.

Mohammed Amin is an Islamic finance consultant and former tax partner at PwC in the UK.