As part of the comprehensive project for the revision and review of Financial Accounting Standards (FASs) initiated by AAOIFI in 2016, multiple standards were considered liable for a revisit. This included a number of key standards that had been in issue for almost two decades during which significant developments in the area of accounting have taken place, particularly in relation to insurance accounting and other specific-purpose reporting. In 2018, AAOIFI embarked on a project for Takaful standards aiming to cover accounting and financial reporting matters relating to the Takaful arrangements and to improve relevant financial reporting in accordance with enhance market practices and regulatory requirements. Another important area that witnessed new developments was the need to reconsider the AAOIFI conceptual framework (AAOIFI Conceptual Framework for Financial Reporting) and core standard (FAS 1) (FAS 1 General Presentation and Disclosures in the Financial Statements).
Other key developments that are expected to impact Islamic accounting relate to improved financial reporting for Zakat and Islamic finance windows and interim financial reporting as well as significant matters such as control, off-balance-sheet assets under management and quasi-equity that are essential to Islamic accounting and distinguish it from its conventional counterpart.
Review of 2022
In 2021, AAOIFI issued FAS 1 which followed a comprehensive revision of the AAOIFI Conceptual Framework for Financial Reporting issued in 2020 (applicable with immediate effect). The conceptual framework better defines and improves upon the existing accounting policies and treatments in line with global good practices. It also introduces the concepts and core principles underlying financial accounting and reporting by institutions and explains the relationship between these concepts, core principles and the objectives of financial reporting.
The new framework aims to help the users to obtain a better understanding of the information included in general-purpose financial statements, and consequently enhances their confidence. Overall, the revised framework promotes harmonization by providing a basis for selecting the most appropriate accounting treatment permitted by AAOIFI FASs. It also serves as a guide for the development of future AAOIFI FASs and assists in dealing with similar transactions, other events or conditions not dealt with under existing FASs. Furthermore, it serves as a guide to subjective judgments made by management while preparing financial statements and other financial reports.
This framework forms an integral part of the AAOIFI FASs, though by its own is not a standard and cannot override any specific requirement of other standards. It introduces a set of broader concepts related to quasi-equity including ‘unrestricted investment accounts’ and other transactions under similar structures and those related to ‘off-balance-sheet assets under management’ (rather than ‘restricted investment accounts’). Moreover, the concept of comprehensive income has been introduced, with the option to prepare one statement that is a combination of the statement of income and the statement of other comprehensive income, or to prepare the two statements separately.
In terms of classification, the new framework allows the use of the current and non-current distinction for assets and liabilities to make the financial statements of Islamic financial institutions comparable with similar institutions. In a nutshell, it sets out the overall requirements for the presentation of financial statements, the minimum requirements for the contents of the financial statements and a recommended structure of financial statements that facilitate faithful representation in line with Shariah principles and rules and comparability with the institution’s financial statements of previous periods and the financial statements of other institutions.
Other developments included the issuance of FAS 40 Financial Reporting for Islamic Windows, which requires that an Islamic finance window shall primarily present a complete set of financial statements in line with the requirements of the relevant AAOIFI FASs, unless otherwise required by regulators. It also excludes summarized accounting guidance for Islamic financial services offered by a conventional financial institution without having an Islamic finance window.
Preview of 2023
In 2022, AAOIFI issued a number of final standards and exposure drafts on key areas including accounting for Takaful and interim reporting. The need for an improved set of Takaful standards was highlighted by the developments in international best practices, globally accepted accounting principles and regulatory requirements with regard to conventional insurance accounting.
In consideration of the fact that such factors included developments in international best practices, globally accepted accounting principles and regulatory requirements with regard to conventional insurance accounting, gaps were identified in accounting treatments in respect of Takaful arrangements, the need to standardize the structural relationship between a Takaful institution and the different funds from the financial reporting perspective and providing accounting treatments for different transactions, balances and contracts; the different accounting requirements that were scattered in different FASs were, at times, not easy to comprehend. There is also fact that existing FASs on Takaful accounting did not address certain ancillary issues, particularly with regard to accounting for transactions and balances between different stakeholders of a Takaful institution and accounting for the investment component.
In line with the new conceptual framework, which standardizes the fundamental accounting concepts applicable to various institutions and instruments, the disclosure standard of Takaful aligns with the Shariah principles and rules relating to Takaful, whereby a Takaful institution (operator) is distinct from the participants’ funds (including participants’ Takaful fund (PTF) and participants’ investment fund (PIF), and the PTF and PIF are considered to be off-balance-sheet assets under management, therefore separate from the Takaful institution; statements for the managed PTF and PIF have been introduced, including a separate statement of financial position for the managed PTF.
Conclusion
Islamic accounting has its value proposition, particularly in terms of serving the information needs of a specific group of stakeholders driven by Shariah compliance. The new developments in the arena of Islamic accounting constitute the ever-changing reality and state of affairs at the level of the industry, and also the exhaustive efforts being exerted by AAOIFI as a standard-setter for the Islamic finance industry in the area of accounting, in reaction to market needs and especially the need to harmonize the accounting treatment, classification and measurement for multiple transactions and structures for which specific accounting treatment is always needed.
Mohammad Majd Bakir is the director of standards development at the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). He can be contacted at mbakir@aaoifi.com.