Question

 

There is no doubt that Islamic financial system has a difference characteristic compared to interest based conventional system. The Islamic alternative system promotes an equity stake into economy (e.g. Mudharabah, Musharakah) by sharing their profit and risk into economy. This system will bring a justice and stability into economy which is promoted the balancing between the growth and stability, between efficiency and equity, and between profitability and welfare. Unlike, interested-bearing system is failure to achieve this objective and created instability and crisis.

As per its own website, AAOIFI, established in 1991 and based in Bahrain, is the leading international not-for-profit organization primarily responsible for the development and issuance of standards for the global Islamic finance industry. It has so far issued a total of 100 standards in the areas of Shariah, accounting and auditing for use in Islamic financing transactions. It is supported by a number of institutional members, including central banks and regulatory authorities, Islamic commercial banks and financial institutions, accounting and auditing firms and legal firms from over 45 countries. Its standards are currently followed by all the leading Islamic financial institutions across the world and have introduced a progressive degree of harmonization of international Islamic finance practices.

1. The nature of the relationship between the clients and Islamic bank is different from the conventional practices. Do you agree with this statement? Explain.                

2. Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) plays a vital role in regulating the Islamic Banking industry. What are the objectives of AAOIFI? and explain its role in regulating Islamic Banking Industry.                              
3. In Murabaha car financing contract, total cost price for the bank is R.O. 100,000. The bank sells it to the customer 5% profit per annum on a 5 year terms. Down Payment is R.O 20000. Assume for simplicity, it is paid back on yearly basis. Calculate the annual installment?

Answer 1

AAOIFI, within the Islamic Shari’ah rules and principles, has the following objectives:

1. to Develop accounting, auditing, governance and ethical thought relating to the activities of Islamic financial institutions taking into consideration the international standards and practices which comply  with Islamic Shari’ah rules;
2. to Disseminate the accounting, auditing, governance and ethical thought relating to the activities of Islamic financial institutions and its application through training seminars, publication of periodical newsletters, preparation of reports, research and through other means;
3. (A) Harmonize the accounting policies and procedures adopted by Islamic financial institutions through the preparation and issuance of accounting standards and the interpretations of the same to the said institutions.

(B) Improve the quality and uniformity of auditing and governance practices relating to Islamic financial institutions through the preparation and issuance of auditing and governance standards and the interpretation of the same to the said institutions.

(C) Promote good ethical practices relating to Islamic financial institutions through the preparation and issuance of codes of ethics to these institutions.

4. Achieve conformity or similarity -to the extent possible- in concepts and applications among the Shari’ah supervisory boards of Islamic financial institutions to avoid contradiction and inconsistency between the fatwas and the applications by these institutions, with a view to activate the role of the Shari’ah supervisory boards of Islamic financial institutions and central banks through the preparation, issuance and interpretations of Shari’ah standards and Shari’ah rules for investment, financing and insurance.

5. To approach the concerned regulatory bodies, Islamic financial institutions, other financial institutions that offer Islamic financial services, and accounting and auditing firms in order to implement the standards, as well as the statements and guidelines that are published by AAOIFI.

6. To offer educational and training programs, including professional development programs on accounting, auditing, ethics, governance, Shari’ah, and other related areas, so as to promote knowledge on, and to encourage greater professionalism in, Islamic banking and finance. Training, examination and certification shall be carried out by AAOIFI itself and/or in coordination with other institutions.

7. To carry out other activities, including certification of compliance of AAOIFI’s standards, so as to gain wider awareness and acceptance of AAOIFI’s standards on accounting, auditing, ethics, governance, and Shari’ah.

AAOIFI carries out these objectives in accordance with the precepts of Islamic Shari’ah which represents a comprehensive system for all aspects of life, in conformity with the environment in which Islamic financial institutions have developed. This activity is intended both to enhance the confidence of users of the financial statements of Islamic financial institutions in the information that is produced about these institutions, and to encourage these users to invest or deposit their funds in Islamic financial institutions and to use their services.

Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI) is an independent industry body dedicated to the development of international standards applicable for Islamic financial institutions. The Bahrain-based organisation started producing standards as early as 1993.

AAOIFI standards have been developed in consultation with leading Sharia scholars, with several counties adopting them. Although AAOIFI standards are not binding on members, over the last few years the organisation has made significant progress in encouraging the widespread adoption of the standards.

Countries where AAOIFI standards are either mandatory or recommended include: Bahrain, Malaysia, UAE, Saudi Arabia, Lebanon, Syria, Sudan and Jordan. Prior to implementation of AAOIFI standards many financial institutions in these countries were operating under a “semi-regulated market” (Al Baluchi, 2006), where accounting policies were determined with the assistance of the bank’s Sharia Supervisory Board (SSB). In addition, over this period, International Accounting Standards (IAS) or respective national accounting standards were followed by Islamic banks. Hence, the unique requirements of Islamic financial institutions were not being met. To give two examples:

1. Fiduciary risk: the Mudaraba contract places liability of the loss on the mudarib.
2. Displaced commercial risk: where Islamic banks “smooth” the returns Investment Account Holders (IAH) by varying the percentage of profit taken as Mudarib share.

As a result, with the support of banking authorities, AAOIFI standards were created. In an industry that is often quite fragmented, it is hoped that the development of AAOIFI standards will go a long way in promoting convergence in Sharia standards and leading to further growth in this nascent market.    

The bank will charge flat fee of 5% for five year, Fee amount = 100000*5%*5= 25,000. Cost of car = 100000+25000= 125000. Down payment= 20000 Monthly installment for car = 105000/5  = 21000.

In tabular form:-

Cost Price- 100000

+Flat fee(Profit)- 25000

125000

-Down payment 20000

________________

105000

________________

Monthly Installment on a yeaarly basis= 105000/5=21000