1. Introduction
Accounting policies are principles, rules and procedures selected, and consistently followed, by the management of an organization (the accounting entity) in preparing and reporting the financial statements. There is no single list of accounting policies which are applicable to all circumstances. The differing circumstances in which enterprises operate in a situation of diverse and complex economic activity make alternative accounting principles and methods of applying those principles acceptable. The choice of the appropriate accounting principles and the methods of applying those principles in the specific circumstances of each enterprise calls for considerable judgement by the management of the enterprise.
Accounting policies is deferred from society to another according to its social choice process such as political. In other words, to have effective accounting policies, these policies must consonance with our national heritage (May and Sundem, 1976). However, many of developing countries adopted accounting standards and policies which contradict with environmental dynamic for instance, Indonesia adopts American standards. On the other hand, some countries have adopted the international accounting standards (IAS called IFRS now) along with their own accounting standards for the aforesaid reasons such as Gulf Cooperation Council (GCC) and Malaysia.
In 1991, Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was formed as a private sector standard-setting body in Bahrain with the aim of producing international accounting standards based on the Shari’ah precepts for Islamic banks and financial institutions.
This paper aims to analysis the financial statements for two Islamic banks in gulf countries UAE (Emirates Islamic Bank) and Bahrain (Bahrain Islamic Bank), both are adopted AAOIFI standards. The organization of the paper is as follows .
2. Background
As mention above GCC countries adopted IAS (IFRS) standards along with their own standers. Despite this countries have cooperation in many areas but, this cooperation is neglected in terms of accounting. In other words, there is a difference in accounting practice between them. This part will focus on bank accounting standards in UAE and Bahrain as well as the AAOIFI standards.
2.1 Bahrain
2.1.1 Regulatory environment
The Bahrain Monetary Agency (BMA) was established under Law 23 in 1973 and, inter alia, is authorized to specify the form and manner in which banks operating in the country should make public the balance sheet and the profit and loss statement of all operations carried out during the year. The Law decrees that an (independent) auditor must certify the accounts. The Law also specifies that the financial year should coincide with the calendar year. Exceptions are made for some Islamic banks, including Bahrain Islamic Bank, which us
2.1.2 Accounting principles and practiceszUntil 1992, there was no legislation prescribing accounting policies to be followed nor was there a prescribed minimum level of disclosure. Management and the auditor had considerable discretion in determining the accounting policies that were to be followed. As a result auditors’ reports are at variance making reference to proper books of account, international accounting guidelines, generally accepted auditing standards and generally accepted accounting principles.
Since 1992 financial year-end, the BMA required all banks to produce statements in accordance with IAS and, without exception auditors’ reports. Thereafter, they referred to International Standards on auditing and IAS. Further, locally incorporated and publicly quoted banks have been required to publish financial statements on a quarterly basis. These statements need not be audited, but should be reviewed by external auditors and published within eight weeks of the end of the quarter. The following significant accounting principles have been applied:
Accounting convention, Financial statements are prepared under the historical cost convention, modified in the case of some banks by the revaluation of premises and equipment in respect of certain subsidiaries.
Income and expenses, These are generally recognized on an accrual basis.
Foreign currency, These transactions are translated to the currency of the bank’s balance sheet at rates prevailing on transaction dates. Assets and liabilities denominated in foreign currencies are translated at rates prevailing at year-end and any resulting gains or losses are taken to income.
Trading securitie, These are generally stated at market value at the balance sheet date, although some banks show the lower of cost or market value.
Investment securities, These are stated at cost, with provision being made for any permanent decline in value.
Loans and advances, These are stated net of accumulated provisions. They are placed on non performing status as soon as payments of interest or repayments of principal are 90 days past due.
Provision for bad and doubtful debts, Specific and general provisions for loan losses are made on the basis of a continuous appraisal of the lending portfolio, taking into account the bank’s previous experience and current economic conditions. The general provision covers doubtful debts which are likely to be present in any portfolio of bank advances but which have not yet been specifically identified.
Depreciation, Freehold land is not depreciated. The cost of leasehold improvements is depreciated by equal annual instalments over the period of the lease. The cost of other fixed assets is depreciated by equal annual instalments over their estimated useful lives.
Revenue recognition, Interest income is generally accounted for on an accrual basis. Loan interest that is 90 days or more overdue is excluded from income until received in cash. Dividend income, fees and commissions are normally accounted for as and when received.
Taxatio,. There is no tax on corporate income in Bahrain. Taxation on foreign operations is provided at the rates applicable in each location.
Employees’ terminal benefits, Provision is made for amounts payable under Bahraini law applicable to employees’ accumulated periods of service at the balance sheet date.
Fiduciary assets, These are held in trust or in a fiduciary capacity are not included in financial statements.
2.2 United Arab Emirates
2.2.1 Regulatory environment
The banking system comprises 18 locally incorporated commercial banks, two Islamic banks, 27 foreign commercial banks, 36 representative offices of foreign banks and one restricted licensed bank. The banks are supervised by the central bank of the UAE. The central bank also regulates the activities of licensed brokers dealing in shares, bonds, commodities and money market transactions, money exchange houses, investment companies and investment consultants. The Emirates Securities and Commodities Market Authority, which is to be established soon, will regulate share brokers and other participants in the capital markets in the future. The Shar’ia and Supervisory Board of the Ministry of Religious Endowments regulate the central bank and the Islamic banks (Capital Intelligence, 1999-2000).
2.2.2 Accounting policies and practices
The central bank has made it mandatory for all commercial banks in the UAE to prepare their accounts to IAS from 1999 onwards. A few banks began to use IAS well before it was required to do so.
Income recognition, Interest receivable is recognised on a time proportion basis, taking account of the principal outstanding and the rate applicable. Other fees receivable are recognised when due. Loan interest accruing on doubtful accounts is recognised on a cash basis. While all banks provide interest income and expense details, most do not provide information on dividend, investment and commission income, or on gains and losses from securities trading and foreign exchange dealings.
Foreign currency translation, Assets and liabilities denominated in foreign currencies are translated into UAE dirhams at rates prevailing on balance sheet date, whereas foreign exchange transactions are translated at rates prevailing on transaction dates. Gains or losses arising from normal banking activities are charged or credited accordingly in the profit and loss. Forward exchange contracts are valued at forward rates prevailing at year-end and the resulting gains or losses are transferred to income. Exchange differences arising from the retranslation of the opening net investments in overseas operations are taken directly to reserves.
Investments, There is no standardised accounting treatment for investments. Emirates Bank International (EBI), National Bank of Abu Dhabi (NBAD), Abu Dhabi Commercial Bank (ADCB) and Mashreq Bank value trading account securities at market price, while investment securities held with the intention of being retained until maturity are stated at cost adjusted for any premiums and discounts amortised from the date of purchase to the date of maturity on a straight-line basis. Commercial Bank of Dubai (CBD) considers its entire securities portfolio as a long-term investment, which has therefore been stated at cost. EBI values “funds under management” at market price. Many banks now state the market value of their securities. UAE Law 10 bars banks from investing more than 25 per cent of depositors’ funds in stocks and bonds.
Loans and advances, Loans and advances are stated net of reserves for bad and doubtful debts and net of interest in suspense.
Provision for bad and doubtful debt, Specific provisions must be maintained by all banks according to the classification of loans and advances. Loans are generally classified when they are deemed “substandard” (high risk and past due for 180 days), “doubtful” (likelihood of loss), and “bad” (irrecoverable). Bad loans must be fully provided for, whereas substandard and doubtful loans must be partly provided for, according to the bank’s experience and the amount of loan that is likely to be defaulted. Interest relating to all accounts that have been classified and provided for must be suspended. Any payment applied towards the recovery of such interest may be taken to the profit and loss, provided that full repayment of the remaining outstanding balance is no longer subject to doubt.
Subsidiaries, Investments in companies not exceeding 20 per cent of their paid-up capital are stated at the lower of cost or fair value, as determined by the banks’ executive committees, whereas investments in companies of over 20 per cent and below 50 per cent of their paid-up capital are accounted by applying the equity method. The accounts of companies in which a bank directly owns more than 50 per cent of paid-up capital are consolidated with those of the parent. Goodwill arising on consolidation is charged against profit over 25 years or, alternatively, written off at the time of acquisition.
Fixed assets, Fixed assets are depreciated using the straight-line method and are stated at cost less accumulated depreciation. Buildings are depreciated over a period of 20 to 30 years, whereas other fixed assets are depreciated over a period of three to six years or are full expensed upon acquisition. Freehold land is not depreciated.
3. AAOIFI accounting standards
3.1 concept of Islamic bank
AAOIFI attempts to come up with a conceptual framework for Islamic accounting or accounting for Islamic financial institutions under SFA2 which considers mixed bag consisting of quality characteristics, elements of financial statements and concepts rolled into one statement, much like the IASB’s framework. The question here how does SFA2 standards look like and how does it work?
As mention above the adoption of accounting standards depends on the function of business where should that standreds applied. In Islamic banking there are four functions which are: investment management, investment, financial services, and social services. Based on these function, AAOIFI design its standards which consist along Shari’ah perspectives as well.
Investment Management is a function performs by banks based on either a Mudaraba contract or an agency contract. According to the Mudaraba contract, the bank receives a percentage of the returns only in case of profit. However, in case of loss the bank receives no reward for its effort and the provider of funds is allocated the losses. When Islamic bank invest funds (its own fund or holders funds) to conduct Murabaha contracts, leasing, joint ventures, Mudaraba contracts, Salam or Istisna’ contracts, formation of enterprises or the acquisition of controlling or other interests in existing enterprises, trading products, and investment or trading in publicly traded shares or real estate. These transactions report in balance sheet in assets side.
Another important function is investment which includes unrestricted and restricted mudaraba, both unrestricted and restricted mudaraba are represented in assets side too in balance sheet. Beside that Islamic banks offer financial services based on an agency contract or a rental by using fee base such as, letter of guarantee, wire transfers. Finally, Islamic bank also offer social services for instance, Qurd, Zakah, charity fund.
3.2 Financial Statements
Conventional banks use four statements which are: balance sheet, income statement, cash flow, and statement of changes in owners’ equity. SFA2 adds three statements to the conventional back statements, these statements are: Statement of changes in restricted investments, statement of sources and uses of funds in the zakah and charity fund, and Statement of Sources and uses of funds in the qard fund.
The discussion here will focus on the elements of SFA2’s three statements, balance sheet as well as income statement from AAOIFI point view to compare it with what has been practice in Islamic banks around us.
3.2.1 Balance Sheet
This statement should include the Islamic bank’s assets, liabilities, equity of unrestricted investment account holders and its equivalents, and its owners’ equity. Separate totals for assets, liabilities, unrestricted investment accounts and their equivalents, and owners’ equity must be provided.
Assets:
An assert is any measurable thing that is capable to generate cash flows or other economic benefits in the future, individually or in combination with other assets, of which the Islamic bank has acquired the right to hold, use or dispose of, as a result of past transactions or events. For instance, Cash and cash equivalent, Receivables ( Murabaha, Salam, Istisnaa), Investment securities, Mudarabah investment, Musharakah investment, Investment in other entities, Inventories, Investment in real estate, Assets acquired for leasing, Other investments (disclosure of their types), Fixed assets (disclosure of depreciation for significant asset types ),and Other assets (disclosure of significant types).
Liabilities:
A liability is any measurable present bank’s obligation to another party to transfer assets, extend the use of an asset, or provide services to that party in the future as a result of past transactions or events. The Islamic obligation must not be a reciprocal to an obligation of the other party to the bank. The balance sheet for Islamic bank must note these labiliteies, Current accounts, saving accounts and other accounts with separate disclosure of each category, Deposits of other banks, Salam Payable, Istisnaa Payable, Declared but undistributed profits, Zakah and taxes payable, and other accounts payable.
Equity of unrestricted investment account holders and their equivalents:
It refers to the amount of original funds received minus withdrawals or transfers to other accounts plus/minus shares in profits/losses. Unrestricted investment accounts and their equivalents are treated as elements of the financial position. This account is not considered a liability since there is no obligation on the bank to guarantee original principals except in cases of proven neglect, nor ownership equity because they do no enjoy voting right or entitlement to profits generated from the use of the bank’s current accounts. Here, the unrestricted investment account holders and their equivalents should be disclosed, whether the bank acts as Mudarib or agent as well as separately disclosure of of assets jointly financed by the Islamic bank and unrestricted investment account holders and those exclusively financed by the bank should be provided in supplementary notes.
Owners’ Equity:
It is the amount remaining at the date of the statement of financial position, from the Islamic bank’s assets after deducting the bank’s liabilities, equity of unrestricted investments and their equivalents and prohibited earnings if any.
3.2.2 Income Statement
Income statement must include separate disclosures of investment revenues, expenses, gains and losses jointly financed by the bank and unrestricted investment account holders and their equivalents.
Revenues:
Presented by increases in assets or decreases in liabilities due to investment by, or distribution to owners, deposits or withdrawals by unrestricted account holders or their equivalents, deposits or withdrawals by current or non-investment account holders or the acquisition of assets. This revenue should be recognized when it takes place, there are three conditions to recognize the revenue which are: the bank should have earned the right to receive revenue through a completely consummated process, an obligation must fall on another party to a remit a fixed or a determinable amount to the bank, and amount should be known and collectible.
Expenses:
It is gross decreases in assets or increases in liabilities resulting from the same sources as defined for expenses.
Gain and losses:
A gain is a net increase in net assets or from incidental legitimate reciprocal (e.g sale of assets not acquired for sale) or no-reciprocal transfers (donations), except for non-reciprocal transfers with equity owners or holders of unrestricted investment accounts or their equivalents. A loss is a net decease in net assets or from incidental legitimate reciprocal and non-reciprocal transfers (e.g. penalties by Central Bank), except for nonreciprocal transfers with equity holders or holders of unrestricted investment accounts or their transfers. Gain and losses are recognized either when completion of a reciprocal or non-reciprocal transfer resulting in gain or loss, or sufficient evidence indicating reasonably measurable appreciation or depreciation in values of recorded assets or liabilities.
Return on unrestricted investment accounts:
It is the share allocated to the holders of these accounts out of investment profits/losses as a result of their joint participation with the Islamic bank with the financing of investment transactions during the period covered by the income statement – not an expense (in case of profit) or revenue (in case of loss).
Net income (net loss):
It is the net increase (decrease) in owners’ equity resulting from revenues, expenses, gains, losses, after allocating the return on unrestricted investment accounts and their equivalents, for the period. All legitimate changes in equity are included except those resulting from investment by owners and distributions to owners.
3.2.3 Statement of changes in restricted investment and their equivalent:
Restricted investment accounts and their equivalents are based on restricted Mudarabah which are not assets for bank; therefore, it should be reported in annual report off-balance sheet. The statement must show deposits and withdrawals by holders of restricted investments and their equivalent as of a given date. With regards of disclosure, the statement should include: first, balance of restricted accounts at the beginning of the period, with separate disclosure for the part of the balance which results from revaluation of restricted investment accounts to their cash equivalents where applicable. Second, number of investment units in each of the investment portfolios and the value per unit at the beginning of the period. Third, deposits received or investment units issued during the period. Forth, withdrawals or repurchase of units during the period. Fifth, Bank’s share in investment profit as Mudarib or fixed fee as investment agent. Sixth, allocated overhead expense, if any. Seventh, Restricted investment accounts profits/losses during the period with separate disclosure of the part resulting from revaluation to cash equivalents where applicable. Ninth, number of investment units in each of the investment portfolios at the end of the period and the value per unit.
3.2.4 Statement of sources and uses of funds in the Zakah and Charity Fund:
3.2.5 Statement of sources and uses of funds in the Qard Fund:
4. Discussion: Bahrain Islamic Bank vs. Emirates Islamic Bank
Since these UAE and Bahrain adopting IAS (IFRS) standards, the following discussion will compare their adopting (differences if any) of AAOIFI standards through Bahrain Islamic Bank (BIB) and Emirates Islamic Bank (EIB).
The consolidated financial statements of the BIB and its Subsidiary have been prepared in accordance with the (AAOIFI) Financial Accounting Standards, the Sharia’a rules and principles as determined by the Sharia’a Supervisory Board of the Bank, the Bahrain Commercial Companies Law, CBB and the Financial Institutional Law.
The consolidated financial statements of EIB have been prepared in accordance with IFRS, Sharia’a rules and principles as approved by the Bank’s Fatwa and Sharia’a Supervisory Board, and the requirements of Federal Law number 6 (of 1985) regarding Islamic Banks, Financial Institutions and Investment companies.
Balance sheet :
First, EIB is not well disclose with regards of Islamic financial instruments such as Murabah, Ijarah, and Istisnaa which classified under financing receivable element in its balance sheet. Unlike, with BIB which are classified clearly by their name in assets side in the balance sheet.
Second, unrestricted investment account is disclosed clearly in BIB in the balance sheet as a liability according to AAOIFI standards. In contrast, EIB disclosed it together with its liabilities (IFRS standards).
In EIB’s balance sheet especially in assets side, there is none Islamic product “Loans and receivables” this type of product suppose not be exist in Islamic banks. But there is note says “These products have been discontinued since the Bank transformed to the Islamic Banking system”.
