Transcript Optimal Sharing Contracts - Islamic Development Bank

7th DISTANCE LEARNING PROGRAM
ISLAMIC DEVELOPMENT BANK , JEDDAH
·
Al-Hujurat (The Dwellings) [49:6]
O ye who believe! If a wicked person comes to you with any news, ascertain the truth
lest ye harm people un wittingly, and afterwards become full of repentance for what ye have done.
SHARI’AH AUDITIng: beTween THe
ideals and realities
Assoc. Prof. Dr. Shahul Hameed Hj. Mohamed Ibrahim
Kulliyah of Economics and Mangement Sciences
International Islamic University Malaysia
INTRODUCTION
Shariah auditing has currently emerged as an important subject of
discussion inline with the advance development of Islamic
Financial Institutions (IFIs) . This demands the proper
governance of the Shari’ah compliance issues. As a new
emerging discipline, there are several issues which need to be
dealt . It is important that we discuss these issues and make
inputs to the development of shariah auditing.
This lecture will proceed as follows:
•
Presentation outline
Introduction and definitions
The Evolution of conventional auditing and its lessons for shariah auditing
Shariah Auditing: Definition and standards
Issues in Shariah Auditing
Perceptions from Malaysia
The Malaysian Practice
Recommendations for future development of Shariah Auditing
Types of auditing and review
Auditing and review
Financial statement auditing
Performance auditing
Tax compliance audit
Environmental Audit
Social Audit
Shariah Audit
Financial Statement Audit
International Standards on Auditing (ISA) 200, Objective and
General Principles Governing an Audit of Financial
Statements, states that:
“The objective of an audit of financial statements is to
enable the auditor to express an opinion whether the
financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting
framework”.
Audit Definition
Broader definition of audit
AAA defined auditing as:
“a systematic process of objectively obtaining and evaluating
evidence regarding assertions about economic actions and
events to ascertain the degree of correspondence between
those assertions and established criteria and communicating the
results to interested users” (Committee on Basic Auditing
Concepts [COBAC], 1972: 2)
Auditing process
Systematic
process
Collection of
evidence
Reliable and
sufficient
About subject
matter
Comparison
with criteria
Communication
of findings
Comparison between conventional and islamic auditing
Element
Conventional Audit
Islamic Auditing
3 party relationship
Entity, auditor, user
Appropriate
subject matter
Financial statement
assertions
Suitable criteria
IFRS
Sufficient
appropriate
evidence
Sufficient and
appropriate evidence
Written assurance
report
Standard audit report
prepared by auditor
Entity, auditor and
broader range of users
Processes, contracts,
personnel, systems,
performance, financial
statements
Shari’a principles and
rules, aaoifi standards
and appropriate parts
of IFRS
SSB rulings, fatwas of
international and
national fiqh boards,
plus all other
conventional evidence
A more detailed report
prepared by a shari’a
auditor
Evolution of Auditing
Financial Audit
Financial
statements
Late 1800s/1900s
Performance Audit
Economy,
effectiveness and
efficiency of resource
utilization, programs
& activities
1960s/1970s
Social &
Environmental Audit
Social contribution &
environmental
compliance
1970s
Shari’ah Audit
Every aspect of
organization’s
activities as required
by Islamic religiious
teaching
2000s
Need for shariah auditing
research
The advanced development of Islamic financial
industry necessitates for an auditing mechanism
which can fulfill the unique requirements of the
industry
Lack of research (especially empirical-based research)
in the field of auditing from Islamic perspective.
The many unresolved issues regarding the
conceptual and practical dimensions of Shari’ah audit.
Issues in shariah auditing
Shariah auditing definition
According to GSIFI 2 of AAOIFI,
Shari’a review is an examination of the extent of an IFI’s compliance, in
all its activities, with the Shari’a. This examination includes contracts,
agreements, policies, products, transactions, memorandum and articles
of association, financial statements, reports (especially internal audit
and central bank inspection), circulars, etc. The objective of a Shari’a
review is to ensure that the activities carried out by an IFI do not
contravene the Shari’a.
While the SSB is responsible for forming and expressing an opinion
on the extent of an IFI’s compliance with the Shari’a, the
responsibility for compliance therewith rests with the management of
an IFI
•
•
•
•
The AAOIFI definition is broad “in all its activities”
It uses the word “review” instead of the word audit
Review =negative assurance, lower level of assurance than audit
Perhaps in the beginning this is better than a full scale audit, however,
the scope in AAOIFI is quite broad
REVIEW AND AUDIT
ASSURANCES
REASONABLE
ASSURANCE
ENGAGEMENT (RAE) (E.g. AUDIT)
LIMITED
ASSURANCE
ENGAGEMENT (E.g. REVIEW)
(EG AUDIT)
(E.G. REVIEW)
REDUCTION IN ENGAGEMENT RISK TO AN
ACCEPTABLE LEVEL (BUT AT A HIGHER LEVEL
REDUCTION IN ENGAGEMENT RISK TO A
SUBSTANTIALLY LOW LEVEL IN THE
THAN RAE) IN THE CIRCUMSTANCE OF THE
ENGAGEMENT
CIRCUMSTANCE OF THE ENGAGEMENT
POSTIVE FORM OF
EXPRESSION OF THE
CONCLUSION
NEGATIVE FORM OF
EXPRESSION
The meaning of “sharia’” in sharia auditing
 Shariah compliance according to AAOIFI means “compliance
with Islamic Shari’a Rules and Principles as reflected in the
fatwas, rulings and guidelines issued by them (hereinafter, the
Shari’a)
 This seems contradictory. Unless fatwas, rulings and guidelines
covers all activities, then the “extent of shariah compliance in all
its activities cannot be reviewed.”
 In practice, as our research confirms, the SSB is mainly issuing
fatwa's related to financing products and not other activities,
hence aaofi’s definition is a bit contradictory.
 Auditing by persons based on criteria issued by the auditor
themselves poses a “self review” threat to independence.
 It does not bode well for the use of audit judgment making the
review a mechanistic procedure.
Shariah auditing standards
In the conventional accounting world, the IAASB develops
International standards on auditing and assurance services
and these are pretty established and accepted globally
In the case of shariah auditing, the Accounting and Auditing
Association for Islamic Financial Institutions (AAOIFI ) has a
set of standards both for conventional and shariah auditing of
IFIs.
The shariah auditing standards were reclassified as
Governance standards. These are :
Shari’a Supervisory Board: Appointment, Composition and Report
Shari’a Review
Internal Shari’a Review
Audit and Governance Committee for Islamic Financial Institutions
Independence of Shari’a Supervisory Board (new)
Statement on Governance Principles for Islamic Financial Institutions
(new)
Corporate Social Responsibility (under development)
Independence and qualifications of shariah
auditors (SSB)
A unique corporate governance mechanism of Islamic financial
Institutions is the shari’a supervisory board (SSB) which is theoretically
an independent external body akin to external auditors.
Consisting of at least 3 scholars in fiqh muamalat, who may be
supported by experts in Islamic banking with knowledge of fiqh
muamalat- problem may not have accounting or auditing expertise
The board is supposed to direct, supervise and review the activities of
the Islamic Financial Institution to ensure shari’a compliance in all its
activities- problemSelf interest threat to independence.
The SSB is known under various names
In Malaysia, Bank Negara calls it shari’a committee, although Bank Islam Malaysia
Bhd., uses the term Shariah Supervisory Council,
whereas Meezan Bank of Pakistan has both a Shari’a Advisor (who issued the Shari’a
Report) and a SSB,
Shamil Bank of Bahrain uses Religious Supervisory Board,
and al Baraka Bank uses the term Shari’a Board.
Confusion in SSB Nomenclature?
Bank Islam Malaysia
Bank Negara
Malaysia
Shariah supervisory
Council
Shari’a
Committee
Meezan Bank
Pakistan
Shari’a Advisor
Al Baraka
Bank Bahrain
Shamil Bank Bahrain
Shari’a Board
Religious Supervisory
Board
Duties of the SSB – A Malaysian view
GPS1 (Shariah Guideline 1 of the Central Bank of Malaysia gives what i
believe is a more thought out role of the SSB then the AAOIFI standard
i.e.







participate and actively engage in deliberating Shariah issues put before
them.
advise the BOD on Shariah matters in its business operation.
Endorse Shari’a Compliance Manuals which specify the manner in which a
submission or request for advice is to be made to the SC, the conduct of SC
meetings, and the manner of compliance with any shari’a decision.
endorse and validate relevant documentations such as contracts,
agreemnts, product manual, marketing, advertisements, sales illustrations
and brochures used to describe the product. for shari’a compliance.
To assist related parties such as the IFI’s legal counsel, auditor, or
consultant, on shari’a matters for advice upon request.
To advise on matters which have not been endorsed or resolved to the
Shariah Advisory Concil of BNM.
To provide written shari’a opinions where the IFI requests advice and on
applications for product approvales to the BNM and to assist the SAC on
reference for advice e.g by explaining shari’a issues involved and references
to jurisprudential literature. And established sources.
Shariah audit procedures
(3)
Documenting
Conclusions
& Reporting
to
shareholders
(1) Planning
Review
Procedures
SHARI’A REVIEW
CYCLE
(2) Executing
Review
Procedures &
preparing
working
papers
Planning Review Procedures
The Shari’a review procedures shall be planned so that it is completed
in an effective and efficient manner. The plan shall be adequately
developed to include a complete understanding about the IFI’s
operations in terms of products, size of operation, locations, branches,
subsidiaries and divisions. The planning shall include obtaining a list of
all fatwas, rulings and guidelines issued by the SSB.
Understanding the activities, products and management’s awareness
and attitude towards compliance with the Shari’a is essential. This will
have a direct effect on the nature, extent and timing of the Shari’a
review procedures.
The plan shall be properly documented including the sample selection
criteria and sizes, taking into consideration complexity, and frequency
of transactions.
The review procedures shall be designed based on the above input.
The review procedures shall cover all activities, products and locations.
These procedures shall ascertain whether the SSB approved
transactions and products have been undertaken and all related
conditions have been met.
Executing Review Procedures
& preparing working papers
At this stage all the planned review procedures are
executed. The SSB review procedures shall normally include:
obtaining an understanding of the management’s awareness, commitment
and compliance control procedures for adherence to the Shari’a;
reviewing of contracts, agreements, etc.;
ascertaining whether transactions entered into during the year were for
products authorised by the SSB;
reviewing other information and reports such as circulars, minutes,
operating and financial reports, policies and procedures, etc.;
consultation/co-ordination with advisors such as external auditors; and
discussing findings with an IFI’s management.
The execution of the above review procedures shall be
documented in work papers which shall be complete, neat and
cross referenced to review procedures.
Documenting Conclusions
& Reporting to shareholders
The SSB shall document their conclusions and prepare their
report to the shareholders based on the work done and
discussions held. The SSB report shall be read at the annual
general meeting of the IFI. A detailed report, when warranted,
shall also be issued to an IFI’s management.
Quality assurance
The SSB shall implement adequate quality control policies and procedures
to ensure that the review is conducted in accordance with this standard.
Quality control procedures may include review of all work papers to ensure
that review procedures were properly understood and executed. Additional
discussions may be held with the IFI’s management, if required, to ensure
that all significant matters were covered during the review.
Internal shariah review
In addition to the shari’a review, the IFI is also
required to conduct an internal shari’a review by a
special shari’a compliance unit or department or a
branch of the internal audit department depending on
the size of the bank. This is just like the internal audit
and external audit which complement each other. It is
plainly impossible for the SSB to carry out a vouching
audit to verify the shari’ah compliance of an IFI.
Therefore, it has to rely on its internal control systems,
part of which is the internal shari’a review.
Elements of internal shariah review
ELEMENTS OF
INTERNAL
SHARI’A REVIEW
CHARTER AND
OBJECTIVES
INDEPENDENCE &
OBJECTIVITY
PROFESSIONAL
PROFICIENCY
SCOPE OF WORK
STAFFING AND
SUPERVISION
COMPLIANCE
WITH CODE OF
ETHICS
KNOWLEDGE,
SKILLS AND
DISCIPLINES
CONTINUOS
EDUCATION
AND TRAINING
PERFORMANCE
DUE
PROFESSIONAL
CARE
MANAGEMENT OF
THE INTERNAL
SHARI’A REVIEW
QUALITY
ASSURANCE OF
SHARI’A REVIEW
ELEMENTS OF
EFFECTIVE
INTERNAL
SHARI’A REVEWI
CONTROL SYSTEM
PLANNING AND
DESIGN OF
INTERNAL
SHARI’A REVIEW
EMPLOYEES
EXAMINING
AND
EVALUATING
INTERNAL
SHARI’A REVIEW
INFORMATION
SEGREGATION OF
DUTIES
REPORTING
CONTROL
PROCEDUES
FOLLOW UP
Shariah audit reports
AAOIFI’S SHARIAH AUDIT REPORT
In the name of Allah, The Beneficent, The Merciful
To the Shareholders of The Example Islamic Financial Institution
Assalam Alaikum Wa Rahmat Allah Wa Barakatuh
In compliance with the letter of appointment, we are required to submit the following report:
We have reviewed the principles and the contracts relating to the transactions and applications introduced by the
Example Islamic Financial Institution during the period ended. We have also conducted our review to form an opinion
as to whether the Example Islamic Financial Institution has complied with Shari’a Rules and Principles and also with
the specific fatwas, rulings and guidelines issued by us.
The Example Islamic Financial Institution’s management is responsible for ensuring that the financial institution
conducts its business in accordance with Islamic Shari’a Rules and Principles. It is our responsibility to form an
independent opinion, based on our review of the operations of the Example Islamic Financial Institution, and to report
to you.
We conducted our review which included examining, on a test basis of each type of transaction, the relevant
documentation and procedures adopted by the Example Islamic Financial Institution
We planned and performed our review so as to obtain all the information and explanations which we considered
necessary in order to provide us with sufficient evidence to give reasonable assurance that the Example Islamic
Financial Institution has not violated Islamic Shari’a Rules and Principles.
In our opinion:
a) the contracts, transactions and dealings entered into by the Example Islamic Financial Institution during the year
ended ... that we have reviewed are in compliance with the Islamic Shari’a Rules and Principles;
b) the allocation of profit and charging of losses relating to investment accounts conform to the basis that had been
approved by us in accordance with Islamic Shari’a Rules and Principles;
(where appropriate, the opinion paragraph shall also include the following matters:)
c) all earnings that have been realized from sources or by means prohibited by Islamic Shari’a Rules and Principles
have been disposed of to charitable causes; and
d) the calculation of Zakah is in compliance with Islamic Shari’a Rules and Principles.
We beg Allah the Almighty to grant us all the success and straight-forwardness.
Wassalam Alaikum Wa Rahmat Allah Wa Barakatuh
(Names and signature of the members of the Shari’a supervisory board)
Place and Date
EXTREMES IN PRACTICE - TOO BRIEF (THE MALAYSIAN
CASE)
EXTREMES IN PRACTICE – THE GOLD STANDARD –
MEEZAN BANK OF PAKISTAN
EXTREMES IN PRACTICE – THE GOLD STANDARD – MEEZAN
BANK OF PAKISTAN
LITERATURE
REVIEW
Literature Review
The literature on auditing in the Islamic perspective is very
limited.
Among the writings which attempt to explore the conceptual
framework of auditing from Islamic perspective are for e.g.
Khan, 1985; Briston & El Ashker, 1986; Harahap; 2002.
The writings which highlight the auditing issues in Islamic banks
(Al Abji, 1989; Janahi, 2000; Simpson & Willing, 2000)
The studies on the role, functions, responsibility and
independence of Shari’ah advisors (for example Abu Mouamer,
1989; Abdallah, 1990; Abdul Rahman et al., 2004; Shafei,
2005).
Gap of the Literature on Shari’ah Audit
There are also studies that compare the different models of the
roles of Shari’ah Supervisory Board (SSB) and external auditors in
Islamic banks (Banaga, 1994), the notion of independence
between SSB and external auditors (Karim, 1990) and possible
interaction between the two parties (Hood & Bucheery, 1999).
The relevance of Islamic auditing to the public audit institutions
has been explored by Khan (2001)
who analyzes the role of
Supreme Audit Institutions (SAIs) in the Islamic economy.
The latest study which is more comprehensive in identifying the
issues and challenges of Shari’ah compliance process in the IFIs is
a paper by Grais & Pellegrini (2006). Their study has explored the
limitations in relying the Shari’ah compliance assurance to the
internal party (i.e. SSB) and proposed an effective framework to
monitor and assess Shari’ah compliance.
summary
RESEARCH OBJECTIVE
& METHODOLOGY
Research Objective
To explore the perceptions of accounting
academicians, audit practitioners and
Shari’ah scholars in Malaysia with regards
to the issues of Shari’ah auditing.
Research Questions
1.
Is it important to develop the discipline of Shari’ah audit and what
should be the definition of Shari’ah audit? This question examines
the awareness of respondents of the term Shari’ah audit and their
perception on the importance to establish the discipline of Shari’ah
audit and its definition.
2.
What are qualification requirements for Shari’ah auditors and
who should appoint Shari’ah auditors? This question seeks to
identify who are supposed to perform Shari’ah audit, what should be
the qualification requirements for Shari’ah auditors, and who should
appoint the Shari’ah auditors.
3.
What should be the scope of Shari’ah audit? This question
encompasses the investigation on the business areas to be audited
under Shari’ah audit
4.
To what extent should Shari’ah audit be performed? This question
aims to explore the extent of and when Shari’ah audit should be
performed.
Question of definition
Review or audit?
Review is defined as “is a service where the auditor’s
objective is to provide a moderate level of assurance,
being a lower level of assurance than that provided by an
audit” (CPA Australia, 2006)
Review has also been defined as “a formal assessment of
an activity with the intention of suggesting or
implementing changes” or a review “implies an audit type
investigation that does not meet the full requirements of
Generally Accepted Auditing Standards (GAAS)”
(O’Regan, 2004)
GSIFI No.2 on Shari’ah review states that “Shari’ah
review is an examination of the extent of an IFI’s
compliance in all its activities with the Shari’ah” (AAOIFI,
2002)
Shariah reports indicate an audit not a review
Who should Conduct Shari’ah Audit?
New
Professionals
called
Shari’ah
auditors??
Islamic
Jurists
(Ulama)?
External
Financial
auditors??
Shari’ah
Supervisory
Board??
Internal
auditors
under
supervision
of SSB??
Qualification & Competence Requirements
Degree/Professional
qualification in accounting
and specialized certification
in Shari’ah audit??
?
Degree/Professional
qualification in
accounting & Fiqh
(Islamic Law)??
Trax Associates, Sept 2003
Degree/Professional
qualification in
accounting??
Scope of Shari’ah Audit
Human
resource
Management??
Business
Policies??
Scope of
Shari’ah
Audit
Marketing &
advertising??
Processes &
Procedures??
Zakat calculation
& payment??
Contracts &
agreements??
Social
contribution??
Environmental
impact of
operation??
To What Extent & When Should Shari’ah
Audit be Performed?
To what extent?
Every single activity?
To the extent deemed
satisfactory by the
auditors?
Using sampling
method?
When?
Throughout financial
year?
During new product
application?
At the end of financial
year?
Respondents’ Background
1. Muslim accounting academicians
Muslim lecturers teaching at the Accounting Program in
public universities in peninsular Malaysia
2. Muslim audit practitioners
Muslim audit practitioners in peninsular Malaysia
3. Shari’ah scholars
Members of the Shari’ah Committee or Shari’ah Supervisory
Board (SSB) of the Islamic commercial banks (ICB) and
Islamic subsidiaries of commercial banks (ISCB) in Malaysia
FINDINGS & ANALYSIS
Response Rate
Total
Distributed
No.
1.
Total
Received
Response
Rate (%)
Total
Used
Respondents
No
%
No
%
No
%
187
52.1
62
62
60
61.2
33.2
126
35.1
27
27
27
27.6
21.4
46
12.8
11
11
11
11.2
23.9
359
100
100
100
98
100
27.9
Accounting lectures
2.
Auditors
3.
Shari’ah Committee
Total
Research Question No.1
Awareness of the term “Shari’ah Audit”
No
.
1.
Statement
Awareness of the term “Shari’ah
Audit”:
Yes
Not Sure
No
Missing
Acctg.
Lecturers
Auditors
Shari'ah
scholars
Overall
N
%
N
%
N
%
N
%
28
9
22
1
46.7
15
36.6
1.7
7
5
14
1
26
18.5
51.8
3.7
7
3
1
63.6
27.3
9.1
42
14
39
3
42.8
14.3
39.8
3.1
60
100
27
100
11
100
98
100
Research Question No.1
The Importance of Developing the Discipline of “Shari’ah
Audit”
Research Question No.2
Who should perform Shari’ah audit for IFIs
Research Question No.2
Competence and Qualification Requirements of Shari’ah
Auditors
Acctg.
Lecturers
N
o
6.
7.
Shari'ah
scholars
Auditors
KruskalWallis
Test
(Asymp.
Sig.)
Overall
Statement
It is important for a body to set
up qualification and
competence requirements for
Shari’ah auditors
Minimum qualification of the
Shari’ah auditor:
a)Degree/Professional in
accounting
b)Degree/Professional in
accounting & Fiqh (Islamic
Law)
c)Degree/Professional
qualification in accounting and
specialized certification in
Shari’ah audit
N
M
e
a
n
M
e
d
i
a
n
N
M
e
a
n
M
e
d
i
a
n
59
4.68
38
N
M
e
a
n
M
e
d
i
a
n
5
27
4.48
3.76
4
21
43
4.42
5
54
4.54
5
N
M
e
a
n
M
e
d
i
a
n
5
9
5
5
95
4.65
5
.023
4.29
4
4
3.75
4
63
3.94
4
.193
24
4.08
4
6
4.50
4.5
73
4.31
4
.094
24
4.37
4.5
10
4.90
5
88
4.53
5
.076
Research Question No.2
Who should appoint Shari’ah auditors for IFIs
Acctg Lecturers
No
5a.
5b.
5c.
5d.
Auditors
Statement
Shareholders of the respective IFI through its
AGM
Yes
No
Bank Negara of Malaysia
Yes
No
Islamic Financial Service Board (IFSB)
Yes
No
A newly established regulatory and
supervisory body dedicated to oversee the
practice of Shari’ah audit
Yes
No
Shari'ah
scholars
Total
N
%
N
%
N
%
N
%
6
54
10
90
7
20
25.9
74.1
3
8
27.3
72.7
16
82
16.3
83.7
60
100
27
100
11
100
98
100
5
55
8.3
91.7
4
23
14.8
85.2
2
9
18.2
81.8
11
87
11.2
88.8
60
100
27
100
11
100
23
37
38.3
61.7
16
11
59.3
40.7
1
10
9.1
90.9
60
100
27
100
11
100
46
14
76.7
23.3
14
13
51.9
48.1
5
6
45.5
54.5
60
100
27
100
11
100
98
40
58
98
65
33
98
100
40.8
59.2
100
66.3
33.7
100
Research Question No.3
Areas to be audited under Shari’ah audit
Research Question No.4
To what extent Shari’ah Audit should be performed?
No
Statement
9a.
Every single activity
9b.
As assumed
auditors
9b.
Using sampling method
satisfactory
by
the
Acctg.
Lecturers
Auditors
N
%
N
%
N
%
N
%
20
33.9
5
18.5
4
44.4
29
30.5
19
32.2
6
22.2
2
22.2
27
28.4
20
33.9
16
59.3
3
33.3
39
41.1
59
100
27
100
9
100
95
100
Shari'ah scholars
Overall
Research Question No.4
When Should Shari’ah Audit be Performed?
No
Statement
10a.
Throughout financial year
10b.
During new product application
10c.
At the end of financial year
Acctg.
Lecturers
Auditors
Shari'ah
scholars
Overall
N
%
N
%
N
%
N
%
32
53.3
15
57.7
3
33.3
50
52.6
-
-
3
11.5
1
9.1
4
4.2
28
46.7
8
30.8
5
55.6
41
43.1
60
100
26
100
9
100
95
100
CONCLUSION
Conclusion – Research Question No.1
While the subject of Shari’ah audit is gradually attracting
the attentions from relevant parties such as scholars in
the field of Islamic finance, however generally it has yet to
become a popular subject to the academic individuals in
the accounting field and to the audit professionals
especially.
Despite the respondents’ varying degree of awareness, it
is very encouraging to discover that the respondents
highly regarded the importance to develop the discipline
of Shari’ah audit.
While many of the respondents tend to agree towards
defining the term Shari’ah audit based on the definition of
Shari’ah review by AAOIFI, several other respondents
have instead see the inappropriateness of such
association.
Conclusion – Research Question No.2
Shari’ah audit should be performed by new professionals
called “Shari’ah auditors” who are specifically certified in
Shari’ah audit
Shari’ah auditors must be appointed by a new
independent body dedicated to oversee the practice of
Shari’ah audit
It is seen strongly important to establish and standardize
the qualification and competence requirements for
Shari’ah auditors who are supposed to have minimum
degree/professional qualification in accounting and
specialized certification in Shari’ah audit
Conclusion – Research Question No.3
Among the areas of the business activities that are
perceived as mostly important in Shari’ah audit work are;
Zakat calculation and payment, contracts and agreements,
processes and procedures, financial system & reporting,
and business policies.
Conclusion – Research Question No.4
Since the term “Shari’ah compliance” implies a broader
understanding, responsibility and accountability (i.e. in
this world and hereafter), there could be a dilemma of
whether the audit to attest such compliance is sufficient
by relying on the sampling method or the extent deemed
satisfactory by the auditors, or we should go beyond
those assumptions by checking and assuring every single
activity of the IFIs are in compliant with the Shari’ah
precepts and conducting the Shari’ah audit throughout
financial year.
Literature Review – Khan (2001)
Discussed the role of Supreme Audit Institutions (SAI) in the Islamic
countries.
The scope of Supreme Audit Institutions (SAIs) in the Islamic countries
need to be expanded to play an effective role in realizing the objectives of
an Islamic economy which stands for freedom, justice, fairness, protection
of public interest and elimination of and corruption.
Illustrated the newer expectations of the SAI which covers 15 areas,
namely accountability, transparency, corruption and fraud, performance
auditing, evaluation of policies, audit of expenditure management
systems, audit of privatization, evaluation of regulators, audit of public
debt, environmental audits, leadership role in reforming government
accounting, audit of social services and public administration, and lastly
the framework for realizing Shariah goals through the SAI.
Among the element of framework for realizing Shari’ah goals through
Supreme Audit Institution is to train the auditors.
The SAI (perhaps to apply to the regulator of Shari’ah audit practice in
general) would need to determine the knowledge and skill requirements of
its staff for the expanded role outlined in his study.
back
Literature Review – Karim (1990)
Provided analysis on the factors affecting the notion of the independence of SSB
versus the external auditors
It is necessary that both SSB and the external auditors are perceived
independence to ensure the credibility of financial statements
The perceived independence of the SSB is very much influenced by moral values
while that of external auditors is largely affected by economic factors.
Another incentive for SSB’s independence is due to the belief that a rational
management would be very keen to adhere to religious precepts since the cost it
would bear for a reported breach would be more than the cost it can impose on
the SSB.
He opines that ideally both SSB and external auditors should be from one
organizational body since Islam does not recognize any separation between
business and religion.
suggested that accounting principles compatible with Islamic law must be
developed as guidance for those who conduct the financial audit for Islamic
financial institutions or Islamic enterprise and be familiar with the various
religious rulings which have a bearing on the financial matters of the bank.
back
Literature Review – Simpson & Willing (2000)
Shari’ah compliance is essential for the Islamic banks given
the impact that their products may no longer be acceptable
if they fail to comply.
Emphasized that one of the relevance of the Islamic
banking industry’s infancy is highlighted by the continued
lack of an internationally accepted framework of uniform
and comprehensive accounting standards or auditing
guidelines.
Argued that the role of external auditors in the Islamic
banks is seen to be complex due largely to the lack of
experience of most external auditors on the Shari’ah
principles
Believed that establishment of rules and regulations would
enhance the effectiveness of the banks and ensure its
compliance to the Shari’ah.
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Literature Review – Harahap (2002)
Wrote a book in Indonesian language on Auditing from the
Islamic Perspective
Provided discussion on the development of accounting and
auditing in the Islamic sphere and urged for the Muslim
Intellectuals to develop the discipline of Islamic auditing as
it is inline with the development of Islamic Financial
System.
Stressed the importance of formulating a philosophical
foundation of the auditing theory from Islamic perspective
as he elaborated that the absence of a philosophical
foundation would lead to the variation and lack of focus in
the development of Islamic auditing as a discipline and in
practice.
Among other future initiatives to be taken with regards to
Islamic auditing are: 1) to transform the social system into
Shari’ah based system where currently Muslim society are
very much tied to the Western ideology and civilization, and
2) to harmonize the practice among all the Muslims.
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The Malaysian Practice
The following is the result of interviews conducted by my
student Sister Nawal Kassim who is undertaking a PhD in
Accounting under my supervision.

22 respondents comprising external auditors, Sharia supervisory
board members and staff of shariah compliance units/internal
auditors of 9 IFIs and 6 Islamic branches of conventional banks in
Malaysia.
Interviews covered:





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definition and responsibility,
organization of the shariah compliance function
Reporting structures of shariah compliance units
scope of audit,
audit procedures,
independence, qualifications and authority of SSBs.
Malaysian Practice- Definition
Preference for shariah review as opposed to audit (in line with
aaoifi definition.)
One respondent (head of Islamic bank audit dept of local
Islamic branch) consider no need for separate audit unit as
“procedures and processess are the same as conventional
auditing” – minority view
Another respondent (shariah compliance unit) said that the
responsibility for the shariah audit is the responsibility of the
Shariah supervsory board or in Malaysia known as the Shariah
Committee
Another respondent (external auditor) is of the view that
shariah compliance audit is an internal matter nothing to do
with external auditor because:
Not required by law
Lack of expertise
Will increase audit cost
Practice- Organization of the shariah
compliance function
Many different structures as illustrated below:
Reporting structures of Shariah compliance
units
The shariah departments or units reports to various
persons in different IFIs. This includes
Reporting to CEO/MD (3/22 )
Reporting to SSB (10/22)
Reporting to Risk manager (4/22)
Product development manager (3/22)
Problems of independence can be seen. Perhaps
should report to audit committee of the BOD
All products/findings are endorsed by SSB
No direct contact with Scompliance personnel but
through shariah division head or shariah co-ordinator
who attends the SSB meetings.
Malaysian Practice- Audit Scope
Most IFIs audit compliance of products only.
Cost consideration of extending scope
Newcomers and therefore need to compete by developing new
products
• (discuss Implication on audit report on activities and
operations)
Education of staff needed before scope expansion
Perceived to be difficult
Other scope under research stage
Extension of scope in agenda
Discussion on going on staff compliance with sharia dress codes
and marketing of products
Not in favour of social and environmental or performance audit
as considered not within scope and lack of public awareness
Fear workload increase without adequate resources
Capitalist mentality- shariah audit is a business unit to make profits.
Malaysian Practice- Audit Procedures
Begins at proposal stage
Use of checklist with non-compliance parameters
development by shariah division and endorsed by
SSB
Key Risk indicators
Use shariah policy, guidelines, circulars and fatwas.
Non compliance reported to SSB on a monthly basis
Ex post audit
Documents reviewed include
Concept papers, structure and terms sheet
Documentation examined include agreements, letters of
offer, policies and procedures, corporate
advertisements/brochures and pamphlets
The above documents are compared with
Fatwas
Central bank regulations
Company’s shariah compliance audit manual
Non compliance are noted as comments and queries
and post audit monitoring is carried out.
Observation: lack of audit judgment, very mechanical
process is evidence.
Authority , Independence and Qualifications issues
Internal audit teams who conduct shariah audits are
not Muslims nor shariah qualified except in a very
few cases.
However, they claim to be exposed to
concepts/policies and ethics of Islam
They work with shariah qualified officers in the
shariah department or compliance unit
Use shariah compliance checklist handed down from
HeadQuarters but modified for Malaysian
environment
SSB is dominant in the process as they must endorse
the work of the SC units
Authority , Independence and Qualifications issues
However, there seems to be overdependence on the
organizational units to carry out most of the audit
work due to:
SSB members are part time
Mostly academics who are busy
Therefore their Independence and reliability of the
evidence on which their report is based is put into
question.
SSB meetings discuss Shariah compliance matters in
addition to product development approvals
Recommendations for future development of
Shariah Auditing
There is need for integrated education of shariah auditors and
accountants to produced competent shariah accountants and
auditors
Accountants can be certified in shariah audit (short term)
Shariah/madrasah/hafiz students with a strong grounding in Arabic and
islamic studies should follow an integrated curriculum in both Arabic and
English with accounting, auditing, business, fiqh muamalat and usulul fiqh
subjects as well as Islamic economics, finance, accounting etc
Shariah auditing needs to evolve to cover marketing, personnel, systems,
processes, social and environmental areas
SSB functions should be decomposed into advising and directing and the review
function should be split to an independent outside professional group known as
shariah public accountants and auditors who are independent of the company
and the SSB.
AAOIFI needs to update its GSIFI standards to differentiate review from audit as
well as broadening the scope of shariah audit and develop standards on related
audit procedure and better audit report standard.
There needs to be a professional body for Shariah accountants and auditors.
The End
wASSAlAmU’AlAIkUm
Thank You!