1. Chapter 4 Financial Accounting for Islamic Banking Products
Basic Principles of Accounting.
Basic Principles of Islamic Accounting.
Accrual and Cash flow Accounting Methods.
Financial Statements in Islamic Banks and Financial Institutions
Remember IRR NPV, we needed cash flows to compute them. Here we learn about these cash flow estimation
An important step in any investment to determine its return.
Take Chanel for example. When it decided to open up another store. It would start with it’s current Salhiya store sales.
There are risks: a) sale might not be at the same level. B) Cannibalize the Salhiya store. What can it do to stop that?
What we will learn here is how to estimate the cash flows and the risk of these cash flows that are used extensively in the industry

2. The Definition and the Significance of Accounting in Financial Decision-making
What is Financial Accounting?
Financial accounting is a process where business operations and their activities are measured and measurements are processed into information for these decision-makers:
  Internal decision makers include the management of the company
External decision makers are mainly investors & customers

3. The Definition and the Significance of Accounting in Financial Decision-making
What is Islamic Accounting? … is ‘the accounting process that provides appropriate information to stakeholders of an entity that will enable them to ensure that the entity is continuously operating within the bounds of the Islamic Sharī‘ah and delivering on its socioeconomic objectives’

4. Accountability in Islam
The Holy Qur’an emphasizes the need and requirement of accountability ‘حساب ’ in every human activity
Transparency and fair dealings involve a great commitment towards accountability in financial transactions
Muslim accountants have more responsibilities than non-Muslim counterparts

5. An Islamic Perspective of Accounting Concepts
The Qur’an & prophetic precedents emphasise accountability in commercial transactions
Full disclosure, social and financial accountability
Ethics for accountant entails trustworthiness and objectivity
The Islamic financial institution needs to provide relevant information on all transactions for the user. The Islamic bank needs to account for social responsibilities
The religious-spiritual element in financial transactions is as important as the element of profitability

6. The Significance of Accountability in Islam
The significance of accountability with particular reference to financial transactions is evidenced by the following Islamic concepts:
Khilafah (vicegenrency خليفة )
Taklif (responsibility تكليف )
Documentation of financial dealings
Islamic law of inheritance (مواريث )
Calculation of obligatory alms (zakat زكاة )
The underlying concept of tawhid (unity of God التوحيد )

7. International Financial Reporting Standards (IFRS)
Differences between Islamic Accounting and Conventional Accounting
Financial instruments
Accounting standards
Accounting treatment
Types of information contained in financial statements
Financial reporting
Functions of commercial/financial contracts

8. Basic Principles of Islamic Accounting
The purposes of Islamic accounting include:
Reporting of accurate income information
Promotion of efficiency and leadership
Compliance with the Sharī'ah
Commitment to justice
Reporting best practices and adapting to social change through corporate social responsibility  

9. International Financial Reporting Standards (IFRS)
IFRS and Islamic Banks and Financial Institutions
IFRS designed for conventional forms of business
Islamic banks have specific requirements e.g. transactions, reporting and disclosures
Therefore, the Islamic finance industry requires alternative sets of accounting and financial reporting standards
The establishment of the Bahrain-based Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI) in 1991

10. AAOIFI الأيوفي
Accounting & Auditing Organization for Islamic Financial Institutions
Established in Algiers in 1990 and based in Bahrain as an independent non-governmental organization based on Agreement of Association among financial institutions from different Muslim countries
AAOIFI issued the first accounting auditing, governance and Sharī'ah standards in 1991 followed by a series of relevant standards for specific Islamic finance products

11. Basic Principles of Islamic Accounting
Many countries have adopted AAOIFI accounting standards
Some countries like Bahrain, Jordan and Sudan have required Islamic financial institutions in their respective jurisdictions to abide by the AAOIFI reporting standards
Others allow such Islamic financial institutions to adopt the standards voluntarily

12. Consumers of Accounting Information for Islamic Banks
Equity holders, Holders of investment accounts & Other deposits
Current and saving account holders
Others who transact business with the Islamic bank, who are not equity or account holders
Zakah agencies (if there is no legal obligation for payment)
Regulatory agencies
(AAOIFI Statement of Financial Accounting (SFA) No. 1, para 26)

13. (SFA No. 1) Requires Information Intended For External Users
Information about the bank’s compliance with Sharī'ah and its objectives to establish such compliance
Information about the Islamic bank’s economic resources and related obligations
To assist in the determination of Zakah on the Islamic bank’s funds
To assist in estimating cash flows from dealing with the bank
To assist in evaluating the bank’s discharge of fiduciary responsibility
Information about the Islamic bank’s social responsibilities

14. Accrual and Cash flow Accounting Methods
The cash flow accounting method - based on frequency of cash flow (requires an actual exchange of cash)
The accrual accounting method - based on the occurrence of a transaction regardless of whether there is exchange of cash

15. Financial Statements in Islamic Banks & Financial Institutions
Financial statement is the formal record of the financial activities (transactions) of a business entity
Transactions are duly sorted, classified and presented in accordance with principles of bookkeeping
The transactions being recorded comprise any business transacted between the business entity and other corporate bodies, organisations or individuals
The end product of all financial transactions is the financial statement

16. Financial Statements in Islamic Banks & Financial Institutions
Comparative financial statements of a corporate entity
Gives direction of business change in at least two financial periods
Provides top management with information for decisions
Comparative financial statements analysis (Horizontal analysis)
Determines the performance of the business
Provides necessary information about sustained performance or poor performance
Islamic banks & financial institutions are required to publish comparative financial statements

17. Basic Principles of Accounting
Accounting comprises two main business activities:
Bookkeeping The detailed recording of all financial transactions in the business
The preparation of financial statements or financial accounting (periodically) Depending on the policy and the accounting standards adopted by the business

18. Four Basic Financial Statements
Balance sheets
Income statements
Cash flow statements
Statement of retained earnings or shareholders’ equity

19. Balance sheets& Income statements
Balance Sheets (also known as the Statement of Financial Position): a summary of financial balances of a company
Income Statements is a financial statement that measures the financial performance of a company over a specific period of time indicating how the revenue is transformed into net income
The income statement may also be referred to as
The Profit and Loss Statement
Statement of Operations
Statement of Income

20. Cash Flow Statements 
Also called statement of cash flow or funds flow statement
Indicates how changes in the balance sheet accounts and income statements affect cash and its equivalent
Purpose is for identification of the sources and uses of cash during the financial year in question
FAS 1, para 54 states the statement of cash flows should differentiate between cash flows from operations, from investing activities and from financing activates

21. Statement of Retained Earnings or Shareholders’ Equity
A financial statement explaining changes in retained earnings of a company over a period of time
The statement of retained earnings may also be called:
- Statement of owner’s equity (in a single proprietorship)
- Statement of partners’ equity (in a partnership)
- Statement of retained earnings & stockholders' equity (for corporations)
The owners’ equity and retained earnings may be calculated using the following formulae:
Owners’ equity = Assets – Liability

22. AAOIFI Proposed Set of Financial Statements for Islamic Banks
There are three major categories
The first category comprises the financial statements that are meant to reflect the position of the Islamic bank as an investor, such as:
Statement of Financial Position
Statement of Income
Statement of Cash Flows
Statement of Retained Earnings or Statement of Changes in Owners’ Equity

23. AAOIFI Proposed Set of Financial Statements for Islamic Banks
The second category focuses on the financial reporting of restricted investments managed by the Islamic bank for the benefit of others. Such a statement will be referred to as “Statement of Changes in Restricted Investments”
The third category includes financial statements reflecting the Islamic bank’s role as a fiduciary of funds made available for social services
Statement of Sources and Uses of Funds in the Zakah & Charity Fund
Statement of Sources and Uses of Funds in the Qard Fund