Differences between Conventional and Islamic Accounting

THE DIFFERENCES BETWEEN CONVENTIONAL AND ISLAMIC ACCOUNTING

ABSTRACT

The concern of this project paper is to explore the differences between Islamic accounting and its conventional counterpart. The distinctions need to be addressed as both accounting is presently thought of many people as synonymous. There is danger for such kind of perception because the basic building blocks for respective accounting are worlds apart. As for professional accountants who have been taught on the idea for accounting to be ‘objective’ and value-free, the idea for attaching a religion may seems to be embarrassing and unprofessional. However, with the resurgence of Islam globally, the awareness for the need of Islamic accounting arises. Islamic accounting as a whole is able to serve the whole gamut of stakeholders. Its principles do not serve the interest of any particular group, but to the society as a whole which can make corporations accountable for their actions and ensure they comply with Shariah principles.

1.0 1.0 Introduction

It is widely accepted that the primary objective of accounting is to provide useful information to assist users in making economic decisions. Thus, it can be argued that accounting is therefore, a religious obligation. Hence, if accounting is a religious obligation, then the rules of accountability must be purely divine. In order to do so, appropriate accounting framework based on Shariah principles must be in place. The motivation for the development of Islamic accounting comes together with the emergence Islamic economic and Islamic resurgence for the last two to three decades. The awareness for the need for Islamic accounting is due to basic building blocks of conventional accounting itself since the International Financial Reporting Standards (IFRS) are based on interest-based elements. Because of the interest-based requirement, the conventional accounting adopts the ‘historical cost and conservatism concept’ in order to ensure whether the capital and interest are repaid. This is one of the elements embedded in the conventional accounting which is already violating the requirements of Shariah. As an alternative accounting system, Islamic accounting is gaining more recognition, especially by Islamic countries. It is necessary to have Islamic accounting to be in place rather than conventional accounting in order to provide information on financial success in Islamic organisations. The Accounting and Auditing Organisation For Islamic Financial Institutions (AAOIFI) was formed for this reason. To this date, AAOIFI has produced a set of accounting standards that could represent a benchmark framework that draws rationales from the Shariah.

Islamic accounting can be initially defined as the “accounting process” which provides appropriate information (not necessarily limited to financial data) to stakeholders of an entity which will enable them to ensure that the entity is continuously operating within the bounds of the Islamic Shariah and delivering its socioeconomic objectives. Islamic accounting is also a tool, which enables Muslims to evaluate their own accountabilities to God (in respect of inter-human / environmental transactions). The meaning of Islamic accounting would be clearer if we compare this with the definition of ‘conventional accounting’. The conventional accounting as we know it is defined to be the identification, recording, classification, interpreting and communication of economic events to permit users to make informed decisions (AAA, 1966). From this, it can be seen that both accounting systems set out similar objective of reporting. However, the differences lie in the following;

* The objectives of providing the information;
* The type of information is identified;
* How the information is it measured, valued, recorded and communicated; and
* To whom will the information be communicated (the users).

At present, AAOIFI has no legal backing. Only few countries such as Bahrain and Sudan has made AAOIFI standards mandatory to their Islamic Financial Institutions (IFIs). In the absence of legal provisions, compliance with its standards is on voluntary basis to the extent that IFIs do not comply. In so doing, how IFIs’ financial statements are to be made comparable? And when accountants of the firms encountered difficulties in regards to complex transactions, they will eventually resort to conventional accounting treatment because of lack of knowledge in Shariah.

Therefore, this project paper intends to highlight and address the important distinctions between both conventional and Islamic accounting which is presently thought of many people as synonymous. There is danger for such kind of perception because the basic building blocks for respective accounting are worlds apart. Further, such blind acceptance and adoption of conventional accounting in Islamic organisations would lead to socio-economic behaviour inconsistent with the specific Islamic objectives, the attainment of which these institutions were set up for in the first place.

2.0 2.0 Religion, economy and accounting

When the conventional and Islamic accounting are compared, first and foremost, we have to look upon the root of modern accounting principles. Some years back, European and communist blocks adopted different set of accounting practice. In communist countries, there is lack of profit motive. Thus, profit and loss account and balance sheet doesn’t make sense in that economic system. This is why accounting profession never developed in Communist countries. Only after financial market liberalisation i.e. conversion to capitalism market, that these states trying to catch up with the West. We can conclude here, the modern accounting is in fact, capitalist accounting (Shahul Hameed, 2000). It is an offspring to capitalist economy. The adjective ‘capitalist’ is however, is not attached to the word ‘accounting’ because it would then appear not neutral. Furthermore, it has been proposed that capitalism owes its beginnings to the Protestant ethic which emphasises frugality and industry. Protestantism led by Calvin legalised the interest as opposed to Catholicism. The subsequent growth of trade aided by the formation of limited liability corporations and stock markets enabled the mobilisation and concentration of vast amounts of capital. These factors gave rise to the development of modern accounting and financial reporting practices based on ‘stewardship theory’ and later, on decision usefulness. Plainly put and in terms, conventional accounting is best described as formal rationalism of capitalist economy orientation so as to legitimise its action. On the other hand, conventional accounting is claimed by some writers to be a product of culture. It is a set of beliefs and techniques that has the ability to link actions and values so as to legitimise those actions. On contrary, Islamic accounting is a value-oriented activity, the development of which encompasses moral, spiritual, material and social aspects. It is governed by divine injunctions and does not separate the secular and religion and holistic in its reporting. Its principles do not serve the interest of any particular group, but to the society as a whole which can make corporations accountable for their actions and ensure they comply with Shariah principles.

Nevertheless, Islam is not against market system per se. Islam does not deny the market forces and market economy. Even the profit motive is acceptable to a reasonable extent. Private ownership is not totally negated. Yet, the basic difference capitalist and Islamic economy is that in secular capitalism, the profit motive or private ownership are given unbridled power to make economic decisions. Their liberty is not controlled by any divine injunctions. If there are some restrictions, they are imposed by human beings and subject to change through democratic legislation. When both accounting manifested according to the origins of its respective economic systems, the accounting treatments are totally different to each other.