Exploring Auditing In Islamic Financial Institutions Accounting Essay


A proper standard framework for Shariah Compliance Audit is essential to ensure the harmonization of Shariah practice in Islamic Financial Institutions. The development of Shariah audit programme is also important as to ensure the procedures (Maqasid Shariah) of each product in IFI are being followed. Thus, this study is aimed to develop Shariah Compliance Audit Framework and Audit Programme development for Islamic Financial Institutions specifically in Islamic Banking and Takaful institutions. Shariah Compliance Audit Framework and Audit Programs for the products of IFIs will be able to mitigate the Shariah non-compliance risk as it recognizes the operational issues in

the IFIs that complies to the Shariah and other sources of attestation or otherwise. Shariah compliance is critical to IFIs operations and such compliance requirements must permeate throughout the Organization and their products and activities. As a majority of the fund providers use Shariah-Compliant operation as a matter of principle, their perception regarding IFIs compliance with Shariah rules and principles is of great importance to sustainability of IFIs. In this regard, Shariah compliance is considered as falling within a higher priority category in relation to other identified risks.

Basic principle for audit under shariah

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Principle 1- Islamic Financial Institution (IFI) should have a comprehensive risk management and reporting process in place. The process should consider appropriate steps to comply with Shariah rules and principles and to ensure the adequacy of relevant risk reporting to the supervisory authority.

Principle 2- IFI should have a strategy for financing. The instruments used must be in compliance with Shariah, whereby it recognizes the potential credit exposures that may arise at different stages of the various financing agreements.

Principle 3- IFI shall carry out a due diligence review in respect of counterparties prior to deciding on the choice of an appropriate Islamic financing instrument.

Principle 4- IFI should have appropriate methodologies for measuring and reporting the credit risk exposures arising under each Islamic financing instrument.

Principle 5- IFI shall have in place Shariah-compliant credit risk mitigating techniques appropriate for each Islamic financing instrument.

IAS And AAOIFI Standards


The first IAS was published in 1975 by the IASC, which was formed in 1973

IASB is to develop an internationally acceptable set of high quality financial reporting standards. To achieve this goal, the IASC and IASB have issued Principles-based standards, and taken steps to remove allowable accounting alternatives and to require accounting measurements that better reflect a firm's economic position and performance (IASC, 1989). Limiting alternatives can increase accounting quality because doing so limits management's opportunistic discretion in determining accounting amounts (Ashbaugh andPincus, 2001). Accounting amounts that better reflect a firm's underlying economics, either

resulting from principles-based standards or required accounting measurements, can increase accounting quality because doing so provides investors with information to aid them in making investment decisions. These two sources of higher accounting quality are related in that, all else equal, limiting opportunistic discretion by managers increases the extent to which the accounting amounts reflect a firm's underlying economics. Consistent with this line of reasoning, Ewert and Wagenhofer (2005) develops a rational expectations model that shows accounting standards that


AAOIFI was established in 1990 in Algiers under an Agreement of Association between a number of Islamic financial institutions (IFIs). Now it is based in Bahrain. Its objectives primarily include development of accounting, auditing, governance and Shariah standards for Islamic financial institutions. Accounting, Auditing and Governance Standards (AAGS) are issued by AAOIFI's Accounting and Auditing Standards Board whereas the Shariah Standards Board issues the Shariah Standards.

Audit and Governance Committee

The importance of the AGC for an IFI emanates from its role in:

achieving the fundamental objectives of an IFI, by enhancing greater transparency and disclosure in financial reporting; and enhancing the public's confidence of the IFI as genuine in its application of Shari'a rules and principles.

Responsibilities of the Auditor

As described in SAP 2, "Objective and Scope of the Audit of Financial Statements", the objective of an audit of financial statements, prepared within a framework of recognized accounting policies and practices and relevant statutory requirements, if any, is to enable an auditor to express an opinion on such financial statements. An audit conducted in accordance with SAPs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be held responsible for the prevention of fraud and error.

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The fact that an audit is carried out may act as a deterrent, but the auditor is not and can not be held responsible for prevention of fraud and error, however, the auditor shall be held responsible for negligence and misconduct.