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Review of Islamic Economics, Vo1.3, No.2, (1994),pp. 1-18

ACCOUNTING POSTULATES AND PRINCIPLES FROM ANISLAMIC PERSPECTIVE

ELTEGANI ABUDLGADER AHMED*National Management Consultancy CentreJeddah. Saudi Arabia

AbstractThis paper reviews and scrutinizes accounting postulates and principles from an

Islamic Perspective. It coiicludes that accounting postulates are generally acceptableand can be used as the basis of accounting in Islamic banks and Islamic financialinstitutions. Accounting principles are also largely acceptable. However, some ofthese do not comply with fairness accounting; they are subject to considerable deb ateand criticism, even from a conventional point of view. Accounting for Islamicinstitutions should be based on justice and fairness, to ensure all parties' rights anddues . All principles which help achieve the objective of justice are acceptable anddesirable. Compromises, however, are inevitable in some cases, even though theyshould be within the general framework of Islam and should maintain welfare. Inother wor ds, realisation of major objectives might justify some com prom ise onprinciples of less priority. Although Islam ic banking has abandoned interest, that doesnot necessarily mean different accounting. How ever, some accounting principles andconcepts are more desirable than others.

Introduction

This research e xam ines the compatibility of accounting postulates and principleswith Islamic Law and principles. It provides a general review of accounting po stulatesand principles, and considers in the light of Islamic Law whether they are acceptableto furnish a basis for accou nting in Islamic financial institutions. Mor e general as pectsof accounting from an Islamic perspective are also discussed.* The author would like to thank the two referees for their valuable comments and remarks. Needless to saythe author solely remains responsible for any shortcomings.

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Review of Islamic Economics, Vo1.3, No.2Naturally, accounting postulates and principles are indispensable for Islamic

financial institutions, thus making it imperative to assess their compatibility withIslamic law and principles. Also accounting postulates and principles merit specialconsideration in the face of an Islamic opinion which believes that they do notconform to Islamic principles and teachings1.

As a m atter of fact, theory evolves ov er time whereby errors in the prescription ofexisting theories are examined and the theories modified - and accounting is not anexception. Accounting theory has progressed through a long evolutionary process,being affected by logic, policy-making, gove rnm ent regulations and develop men ts infinance, which itself evolved from economics.2 Norms and societal beliefs also playan important role in the evolution of theories.

Accounting principles emerge from and express the values and essentialcliaracteristics of a society. They are rooted in the value system of the society in whichthey operate, and are hence socially determined. Value judgments are applied to theinterpretation an d justification of econo mic an d social events. Th e subjective n atureof these values implies that there is ample opportunity for controversy as to howevents should be measured and for whom such measurements are intended.Accordingly, accounting developments reflect a response to changing socialneeds.3Contemporary concepts of accounting evolved with the growth of accountingtheory in the Western world, in relation to developments in economic life and thechanging needs of different groups for accounting information. This is clearlyexplained by C atlett4, wh o indicates that accounting w as created and developed toaccomplish various desired objectives and , therefore, it is not based on fundamentallaws or absolute precepts. Since accounting has evolved ov er many years through trialand error, it should be co ntinually improved to give a better final product t o satisfy therequirements of end-users who utilize financial statements.

Eve n more critically, there is no unanimity amo ng accounting authors in definingpostulates. Som e authors refer to assum ptions, while others use the term "concepts" or" c ~ n v e n t i o n s " . ~aton himself uses m any term s,h including postulates, assum ptions,and concepts. However, we shall stick to the definition that postulates are basicassumptions or fundamental propositions concerning the economic, political andsociological environment in which accounting operates. They serve as a foundationfor the logical derivation of furthe r propositions, and they m ust be generally acceptedby accountants.' A short review and definitions of some key accounting postulatesand principles, and their acceptability from Islamic Law point of view, nowfollows.

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Accounting Postulates a nd Principles from an Islam ic Perspec tive1.Accounting Postulates

1.1Accounting EntityAn acco unting entity is "Any econom ic unit which has been selected as the subject

to be accounted for ( that is, as the accounting entity) is to be viewed, in the accoun tingprocess, as a real entity, existing in its own right, separate and distinct from otherentities which have dealings with it."s

Th is postulate enables the acc ountant to differentiate between the person or personswho own the enterprise and the enterprise itself. It also enables the accountant tosegm ent the enterprise into smaller accounting entities for measuring performance orcontrol. It states that financial accounting information relates to the activities of abusiness entity only , and not to the activities of its ow ners, given that the enterprise issomething separate and distinct from those who provide its capital. The businessentity or unit owns the resources of the company and is liable to the claims of theproviders of capital and to those of the creditors. Accordingly the accounting equ ationis:Assets = Liabilities + Stockholders' Equity.91.2 Accounting Entity From the Islamic Point of View

As w e hav e already seen, under the entity theory, transactions are recorded from theviewpoint of the firm rather than those of its ow ners, and incom e and expen diture aredefined from the viewpo int of the enterprise. As a result, entity theory en ables us toconsider:1. the firm as a separate and distinct entity from the owners and other firms;2. the firm as a real thing responsible for itself;3. that the firm owns the resources;4. that the accoun tant is to report the transa ctions of the firm rather than those of its

owners.These points are now considered from the viewpoint of Islamic principles and

rules, in o rder to see whether o r not the accounting entity theory co ntradicts them. T heprinciples and rules which govern financial contracts in Islam, as sum marized by Ibna1 A'rabi, are:11- Proh ibition of interest and legitimacy of trade. Although trad e is allow ed, there

are restrictions on the conditions and practices of trade.2- Proh ibition of 'un justified' enrichment (Akl Amwdl al-N ds Bi al-Bdtil); "do not

eat up your property among yourselves for vanities" (Qur'an, IV:29).3- Prohibition of 'dubious circumstances' and uncertainty in trade contracts (Ba i'

al- G ha ra r), that is, a sale which involves fraud or unfair exchange.4- Giving consideration to intentions and aims ( al -M aq d~ id ) nd to welfare(al-M asdlih). Consideration of aims indicates that the intentions of dealers must

conform with Islamic teachings. Therefore, it is not permitted to comm it anillegitimate act through a trick. For exam ple, a person m ay approach a trader to

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Review of Islamic Econom ics, Vo1.3, No.2buy from him a commo dity for 1 10 units on a deferred basis on condition thatthe trader should rebuy it from him at 100 units immediately and in cash.Although this transaction consists of two permitted transactions, it is notlegitimate as the intention of the buy er is to obtain a loan of 100 units which hewill repay in the future w ith an incremen t of 10 units. In effect,the transaction isa loan with interest.

Th e accounting entity theory does not conflict with any of these four rules; indeed itis com patible with I sl an ~i c rinciples for the following reasons:1- The entity postulate makes matters easier for the clients of the enterprise;

instead of dealing with many owners the clients are dealing with only onenominal person. It is also easier for the accountant to prepare the financialstatements of this nominal person. This helps to maintain the rights of allparties who are dealing with the entity.2- Th e entity postulate en ables the establishment of huge joint-stock com panies,in which a large number of people are shareholders. This can lead to thedistribution of wealth am ong a large numb er of people, while the possibility ofconcentration of wealth in few hands is reduced.

3- Th e entity postulate m akes it easier for the court to deal with a nominal personin case of disputes.4- Th e postulate is acce pted, because in Islam everything is permitted and lawfulexcept that which is explicity prohibited in the Holy Qur'an or in the Sunnah.

5- Muslim jurisprudence (Fiqh) is familiar with the idea of entity or nominalpersonality as it is the case for endow men t ( W a d , reasury (Baitul Ma l) andg ~ v e r n m e n t . ' ~his sho ws that the concept of an institution as a distinct entityis acceptable in Islamic thought.

1.3The Going Concern PostulateThe going concern, or continuity, postulate holds that the business entity will

continue its operations long enough to realise its projects, commitments, andon-going activities. As most economic units are organized for operation over anindefinite period of time, it is frequently argued that the entity should logically beviewed as remaining in operation indefinitely under normal circumstances. Thepostulate assumes either that the entity is not expected to be liquidated in theforeseeable future or that it will continue for an indefinite period of time. Such ahypothesis of stability reflects the expectations of all parties interested in the entity.Th us, the financial statements provide a tentative view of the financial situation of thefirm and are only part of a series of continuous reports.12

Newm an and M ellman13 define the continuity concept as follows: "unless and untilthe entity has entered into a state of liquidation, it is to be viewed as having anindefinite life."From the valuation14 point of view, the going co ncern postulate is conside red veryimportant: many assets derive their value from their employment in the firm, and

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Accounting Postulates a nd Principles from an Islamic Perspectiveshould the firm ce ase to operate, the value which co uld be obtained for these assets ona closing-dow n sale would probably be mu ch less than their book-value. T hat is thereason why the valuation of assets used in a business is based on the assum ption thatthe business is continuing, and not on the verge of cessation.This postulate however, has come under attack from many accountants. Sterlingdescribes it as an unreasonable and absurd assum ption. He argues that the high rate ofbusiness failures makes it difficult to build an evidential case for a projection ofcontinuity15. Fremgen16 also attacks the going co ncern assum ption, arguing that it "isnot a scientific fact or even a completely rational assumption."1.4The Going-Concern Postulate from an Islamic PerspectiveThe continuity postulate assumes that the entity is a going-concern or is remaining inoperation in the absen ce of evidence to the contrary. Th is assumption d oes not seem tocontrad ict any of the Islamic principles. In Islamic jurisprudence there is a principlesimilar to this postulate, that is, the principle of "retaining" or "accompanimen t"( I s t i ~ h a h ) . ~ ~his principle m eans retaining any eve nt or verdict experienced in thepast, until evidence is found that this event o r verdict has chan ged . Hence if a person isknown to exist, his existence is not denied till an evidence to the contrary.l8

How ever, although the co ntinuity postulate does not co ntradict Islamic principles,the significant ideas which underlie this postulate and their consequences arequestionable from the Islamic point of view. T hese include the recording of assets atthe lower of co st or market value which is know n as the con servatism principle.I9 Oneof the most q uestionable conseque nces of the continuity postulate from the Islamicpoint of view is the so-called conservatism principle. It holds that when choosingamon g two or more acceptable accounting techniques, some preference is shown forthe option that has the least favourable impact on the stockholders' equity.20

Newman aml Mellman,2I argued that conservatism may be expressed as anecessary cond ition for the fair presen tation of accoun ting data. They argue that thisconcept come s into play bec ause eve nts or activities which m ust be reflected in theaccounting process are characterised by uncertainty. The conservatism concept isused to avoid risk in terms of accoun ting results and is equ ivalent to taking a cautiou sor prudent approach to valuation.Hindmarch justifies this concept on grounds tliat uncertainty prevails in theeconom ic environm ent. He argue s that, "if it is possible to measure with accuracy thenconse rvatism has little impact, but there are many situations where accuracy cannot beachieved and in such situations this concept should prevent optimism."22Many authors criticise the principle of conservatism. Sterling points out that "theFinney and Miller texts, which m irror the mainstrea m of acco unting thought, referredto conservatism as a 'principle of accounting' through four editions. In the fifthedit ion, however, they complain about the ' fet ish of con~ervatisrn' .~~inney andM illerz4 argue that, in the early day s of the deve lopm ent of accounting, publicaccountants' records were required mainly for the preparation of reports for bankers

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Reliew of' 1,tlamic Economics, Vo1.3, No.2and guarantors of short-term credit, who w ere primarily interested in the m argin ofsecurity. When the interest of bankers and other short-term creditors changed,accountants, who were influenced by their attitudes, changed their emphasis. Thusconservatism was a mo re highly esteem ed virtue in the past than it is today. As statedby Belkaoui: "The present view of conservatism as an accounting principle is boundto disappear."2"terling26 arg ues that "conse rvatism yields, not only zero inform a-tion, but also, misinformation", becaus e historical costs, when they are used, arethemselves conservative. H ence, he conclude d, historical costs are justified if andonly if conservatism is justified. Thus historical costs also yield misinformation.

As a result of the conservatism principle, profits may be shifted from on e year toanother. Furthermore, valuation of inventories under this principle m inimises the basefor Zukah, which should be paid annually. For these reasons the conservatismprinciple is not compatible with Islamic principles and rules.1.5 Accounting Period Postulate

The life of an entity is currently regarded as consisting of a chain of periodicalsegments. The final statements which report on the activities for a year and thecondition of the entity as at the clos e of that year, are based on w hat is referred to bymany writers as the 'accounting period co nv en ~i on '~ 7. elkaoui28 claims that,although the continuity postulate assum es that the entity w ill exist fo r an indefiniteperiod of time, users require a variety of inform ation abo ut the financial situation a ndperformance of an enterprise to make short-term decisions. In response to thisconstraint, the accounting period assumption holds that financial reports showingchanges in the wealth of an enterprise should be published periodically.

Pa ton 2k on sid ers this postulate as one of the important conventions of accounting.For the purpose of comparisons between revenues and applicable costs related to afiscal year, the accounting period postulate enables accountants to analyse andrearrange original accounting data to reflect im me diate administrative decisions andprovides administratively useful data for future use.30By requ iring an enterprise to provide p eriodic, short-term financial rep orts, the periodconvention thus im plies the accrual basis of accounting. "This entails the assignmentof revenue to the period in which it was earned (rather than when received)."" Sa lesof assets will be considered as revenue during the year in which sales took placeregardless of when payment is received.

How ever, the accounting period p ostulate, besides helping in investment decisions,assists in the prediction of bankruptcies and risk and, hence, is useful in makingloans.321.6The Accounting Period Postulate from an Islamic PerspectiveThe accounting period postulate does not contradict any Islamic principle, and isdesirable rather than questionable, for it helps in paying Zakuh. This concept wasknown to Muslims before it has been suggested recently as an accounting concept.

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Accounting Postulates and Principles from an Islamic PerspectiveDepicting the financial situation of an en terprise periodically helps the en terprise toknow how much it should pay as Zakah. However, accrual accounting entails theassignment of revenu e to the fiscal year in which it was earned rather than received.This could cause firms to pay Zakah for revenues not yet received, and according tothe al-Madhah al-Maliki, (Maliki school of thought), loans are exempted fromZa ka h.3 W ow ev er, this constraint is not a sufficient justification to reject the accrualbasis of accounting, for revenues which are not yet received can be dedu cted from thewealth which is subject to Zakah, Furthermore, it is not universally agreed amongreligious scholars, that loans are exempted from Zakah.1.7 The Unit-of-Measure Postulate

The unit-of-measure postulate holds that accounting is a process of m easurem entand comm unication of the activities of the firm that are measurable in monetary term s.This assum ption implies that the purchasing power of the m onetary unit is stable overtime." T o express accounting information in terms of mon ey alone may excludefactors such as quality of the product. Ano ther disadv antage of this assum ption is thatit ignores chan ges in the purch asing power.3s "Even actual cost," a s expressed byPaton, "is only a tentative figure. Accounting deals largely with judgements andestimates, not with certainties. Values are always more or less conjectural andunstable. But an exhibit of cost is in itself a significant statistical record; it gives afairly reasonab le starting p oint, at least."36 He argue s that it is important for theaccountant to as sum e that cost indicates actual value for purpo ses of initial statement,for cost is the only definite fact available when an asset is purchased. It is thereforereasonable to charge the appropriate asset account with the amount of thisIt is believed" that using mo netary terms to measure financial position at a givenmoment in time is the most objective and least biased method.

Despite changes in the purchasing power of mon ey, acco unting has been unwillingto introduce into the accounts m odifications of values in order to reflect ch anges in thevalue of the monetary standard. Therefore, "values in accounting are expressed interms of money as a fixed and constant ~ tandard ."~g

Paton and Littleton40do not agree that accounting qualitative mea suremen ts shouldbe designed to interpret and influence business conduct. T o do so, in their opinion,overstates the purpose and subject matter of accounting. They argue that the term"measured consideration" is more appropriate than the word "value" to indicate thetype of information which makes up the subject matter of accounting. If the valuewhich expresses the mutual valuation of the buyer and seller as of the moment ofexchange, ch anges, the recorded price-aggrega te is still the best mean s available forrepresenting varied transactions in homogeneous terms.

How ever, the unit-of-measure postulate assumes that the purchasing power of themonetary unit is stable over time. If it changes, this change is insignificant. Thisassumption is not always correct, especially in the current world-wide inflationarye n ~ i r o n m e n t . ~ '

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Review of Islamic Eco nom ics, Vo1.3, No.2Recently, however, accounting information resulting from the application of thehistorical cost concept has been questioned4* by various financial-statement user

groups. It is argued that the use of historical cost information frequently results inincome not being recogn ized during the period in which it occurs , and also results inoverstating income in periods of inflation. Changes in prices create two accountingproblems: ( i) valuation; the value of individu al assets change s in relation to all otherassets in the economy, irrespective of any change in the general level of price; (ii)measurement unit; the value of the measurement unit changes because prices ingeneral change.Tw o different viewpoints as to how to present financial information to account forthe effect of changing prices and values oil an enterprise, to overcome thedisadvantages of historical cost information. One school of thought advocatesstatements prepared on the basis of current value to address the valuation problem.The other proposes "price-level-adjusted financial statements", that is, adjustment ofhistorical cost information to account for the effect of the overall change in prices.This viewpoint addresses the measurement unit problem.1.8 The Unit-of-Measure Postulate From an Islamic Perspective

Money as a unit-of-measure is accepted from the viewpoint of Islam,4 3 s generallyaccepted currency having the attributes of gold and silver and serving as a store ofvalue. Thus the sam e rules concerning usury in gold and silver apply: Money m ust notbe sold against itself unless like for like, equal for equal and hand-to-hand. H owever,if the denominations of money differ, it is allowed to exchange them againstthemselves hand-to-hand, provided the sale and transfer of the two quantities of thedifferent currencies take place on the spot.Money as a unit of measure can be accepted in Islam under a stable monetarysystem, where stability in the value of money is maintained, because of theunequivocal stress of Islam upon honesty and justice in all measures of value:44

Give measure and weight with (full) justice (6:152).Give just mea sure and weight, nor withhold from the people the things that aretheir du e (7:85).45 (Transla tion).

However, in an inflationary environment the role of money as a unit of measurebecomes questionable from the Islamic viewpoint, as it fails to serve as a just andhonest unit of account. It makes money an unfair standard of deferred payments andan untrustworthy store of value, whereas some people become unjust towards others,albeit unknowingly. T his contradicts Islamic principles, such as "do not eat up yourproperty among yourselves for vanities" (Qur'an 4:29). Inflation does injustice tothe Riba-free lender by eroding the real value of (Qard hassan), a loan extendedwithout either interest or profit-sharingS46 t has been suggested that the effect ofinflation can be minimized by indexation, or monetary correction, of all monetaryassets and incomes, but indexation has not yet been accepted by any school of Islamic

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Accounting Postulates and Principles from an Islamic Perspectiveju r i~prudence .~ 'Others suggest the use of replacement or present value to valueassets.48 How ever, this is not so easy .

It seems, however, that the alternative which conforms to Islamic principles is tomaintain stability in prices and value of money. Indexation, replacement price orcurrent value are merely temporary palliatives, not a permanent solution to theproblem of inflation.

The measurement convention, which limits the recognition of activities to thosewhich c an be expressed in monetary terms 0n ly ,4 ~ hough practical in registeringfinancial transactions, doe s not cover all aspects. However, the F inancial Accoun tingOrganization for Islamic B anks and Financial Institutions (FA OIBFI) assum es, foraccounting purposes for Islamic Banking, that the purchasing power of money isstable.50

2. The Accounting Principles from an Islamic PerspectiveDefinition and discussion of some accounting principles and how they are fit into

Islamic framework to furnish an accounting system and procedures for Islamicfinancial institutions, will be considered here. Th e plan to study accoun ting principlesfrom an Islamic perspective is to review these principles from the viewpoint of themajor Islamic principles which gov ern financial dealings and co ntracts, as mentionedin the Qur'an. These are:

1- Realisation of fairness and justice.2- Preservation of the rights and dues of all parties'.3- Paying Zakah (that necessitates having accu rate and just financial statemen tswhich represent accurately and truly the financial position of the entity).Th e first two Islamic principles are emphasized by the Holy Q ur'an. It is instructed

that measure and weight should be given with justice and without withholding frompeople what is theirs (Qur'an, 6:152, 7:29, 11:85, 17:35, 55:9, 57:25). Muslims alsoare ask ed, when dealing in financial transactions involving further obligation (debt),to write down faithfully and precisely this obligation (Qur'an, 2:282). Therefore,accounting which helps to keep and record the rights and dues of all parties' isrequired in Islam. It represents an integrated part of the just system which Islamrequires. Therefore accounting principles in a Muslim Community should beformulated so a s to provide fair and just information (i.e. fairness accounting)

On the other hand Zakah is one of the five pillars of Islam. Qur'an requires Muslimswith a specified minimum wealth (Niscib) to pay Zakah (12:41, 78; 24: 56; 33: 33 ; 58:13). The rate of Zakah varies according to the type of wealth. Zakah revenue isearmarked to be spend on certain items detailed in the Qur'an (9:60).2.1 The Objectivity Principle

The usefulness of financial information depends heavily on the reliability of themeasurement procedure used. Because ensuring maximum reliability is difficult,

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Review of Islamic Economics, Vo1.3, No.2accountants have e mployed the objectivity principle to justify the choic e of ameasurem ent procedure. Financ ial reporting is considered useful if it provides usefulinformation to present to potential investors, creditors and o ther users, on w hich tobase rational investmen t, credit and similar decisions. The principle of objectivity hasbeen subject to different interpretations51 as below:1- An ob jective me asurement is a verifiable measurem ent in the sense that it isbased on evidence.

2- An objective measurement is an impersonal measure and free from thepersonal bias of the measurers.Th e development of new ways and means for realizing objectivity is particularly

needed in the present situation of inflation. Although historical cost, for example,realizes ob jectivity for record ing values of different items at their acquisition, it doesnot maintain the same if used as the basis for valuation. Therefore, it is essential todifferentiate between measurement objectivity and valuation objectivity.The objectivity principle, from an Islamic point of view, is a desired principle forfairness accounting, especially when recording different transactions, i.e. assets,goods and services at the price prevailing d uring the d ate of acqu isition (historicalcost). Howeve r, objectivity turns out to be anything but objective when valuation istaken according to historical cost in an inflationary environment. Therefore, theobjec tivity realised by using cost price at acqu isition date is not necessa rily achievedwhen valuation is mad e at a later date. As a result, it is believed that objec tivity can beaccepted fo r recording transactions at the prices of the date of acquisition in Islamicfinancial institutions. However, in certain circumstances it yields non-objectiveinformation. Therefore, other methods of valuation, e.g., current value, should beadopted. Difficulties embodied w ith alternatives should not prevent the acc eptance ofthe need for change. Indeed, it is believed that difficulties involved with othermethods can be solved through practice.2.2 The Matching Principle

Th e matching principle (or convention) holds that expenses should be recognizedin the sam e period as associated revenue. H ence, the matching principle links revenuewith their relevant expenses. This means identifying the gains resulting fromtransactions and setting them off against those expenses which are related to thoset r an~ac t i ons .5~On e of the conseq uences of the co nventional matching p rinciple is that it relegatesthe balance sheet to a secondary position.Three matching principles are employed by accountants: associating cause andeffect, systematic and rational allocations, and immediate recognition. Applyingthese principles involves a great deal of judgmen t. T he acc ountant should determinewhether a cost pertains to future revenues and hen ce should be deferred; whether acost is related t o past revenues and therefore sho uld be written against prior income; o rwhether a cost, although not yet paid, is related to current revenues and therefore

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Accounting Postulates and Principles from an Islamic Perspectiveshould be accrued. In making these decisions, official pronouncements byauthoritative bodies, conservatism and expendiency play an important role. Somerules are very specific, others are vague, s uch as recording a loss if it is probable that aliability has been incurred.

On e of the most desirable and acceptable principles for fairness accounting from a nIslamic perspective is the matching principle. The matching principle as it allocatesexpenses to their related revenues, provides fairness and justice simultaneously toshareholders and depos itors in Islamic ban ks. Indeed it is of paramount importance inthe allocation of profits in case of Islamic investm ent accounts where a large pool ofinvestible funds with different maturities is formed.2.3 The Consistency Principle

It is held that similar economic events should be recorded and reported in aconsistent manner from period to period. The principle implies that the sameaccounting procedures will be applied to similar items over time. Ap plication of theconsistency principle ma kes financial statements more com parab le and more useful,especially within the same firm.

Com paring the accounts of different con~ pa nie ss more difficult and the accountingmethods of individual firms are not always the same. There is no uniformity ofaccounting methods which w ould provide the consistency of treatment of informationnecessary for the com parison of the accounts of different companies. Th erefore, theneeds of investors for greater comparability of information between companies isundermined by accounting conventions w hich accept internal consistency, but allowdifferent methods of measurement and treatment which cannot yield comparableresults. Therefore, it is recommended that accounting standards committees arecharged w ith the task of finding a way to secure agreement o n appropriate accountingmethods which ensure a higher degree of comparability of accounting informa-tion.53

The consistency principle is desirable from the Islamic point of view , as it helps toprovide more useful information and more accurate and fair financial statement.Failure to maintain consistency might lead to unrealistic profit with obviousimplications for Zakah and distribution of profit to investm ent depositors in IslamicBanking.2.4 The Uniformity and Comparability Principle

This r e f e d 4 to the use of the sam e procedures by different firms. The desiredobjective is to achieve comparability of financial statements by reducing the diversitycreated by the use of different accounting procedures by different firms. Th e principalarguments for uniformity are that it would:1- Reduce the diverse use of accounting procedures and the inadequacies of

accounting practices.

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Review of Islamic Econom ics, Vo1.3, No .22- Allow comparisons of the accounts of different firms.3- Lead to governmental regulation of accounting practices.Showing similar and comparable financial statements help users to take right

decisions, which is indeed desirable from an Islamic viewpoint.2.5 The Materiality Principle

Materiality serves as an im plicit guide for the accountant in terms of w hat shou ld bedisclosed in the financial reports, enabling the accountant to decide what is notimportant or what d oes not m atter on the basis of record-keeping cost, accuracy offinancial statements, and relevance to the user. An item should be considered asmaterial if there is reason to believe that knowledge of it would influence the decision sof an investor or a user. M ateriality is primarily related t o relevance. If an item is notma terial, then it is not relevan t. Materiality really m atters because financia l reportingis only concerned with s ignif icant i n f o r m a t i ~ n . ~ ~

The materiality principle, however, lacks an operational definition. Mostdefinitions of materiality stress the accou ntant's role in interpreting what is and whatis not material. That may introduce an eleme nt of subjectivity, as accountants vary intheir considerations of what is, or is not, material. However, it is indicated that theratio of an income item to current income is a popular guide for materiality judgme nt.It has been suggested that accounting standards comm ittees m ay furnish quantitativeguidelines on materiality to achieve uniformity of practice.56

The importance of the materiality principle relates to the simple fact thataccounting and audit depend to a large extent on samp ling. Since it is impractical andsometimes impossible to show all and every detail of the firm's transactions, theaccountant is given the right to decide what is relevant and what is not. We believe thatthis principle does not violate Islamic financial principles, provided safeguardsagainst its misuse are adopted.2.6 The Cost Principle

This principle holds that the acquisition cost, or historical cost is the appropriatevaluation basis for recognition of the acqu isition of all goods and se rvices, expensescosts and equities. It implies that an item is valued at the exchange price at the date ofacquisition and is recorded in the financial statements at that value or an amortizedposition of that value. The historical cost may be justified in terms of its objectivityand the going concern postulate.57How ever, because of chan ges in price levels and purchasing po wer, the actual costbasis has been subject to much criticism. It is argued58 that although money c an be anadequate com mon denom inator am ong diverse activities, it is a less than satisfactorycommon denominator between different periods of time. Historical cost valuationmay produce unrealistic figures if changes in the values of assets over time areignored. Due to the perceived deficiencies of historical cost accounting, manyalternatives have bee n suggested to replace historical cost.

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Accounting Postulates and Principles from an Islamic PerspectiveRecently many books on Inflation Accounting have been published; inflation

accounting as defined by T wee die and Whittington, is "eclectic, including all forms ofaccounting which seek to reflect the consequences of price changes, whether bymeans of general prices indices or by reporling the market price of specificcommodities". In recent history, accounting for changing prices, (i.e. a form ofcurrent cost accounting) has been adopted in the USA as has been the case in the restof the English-speaking world.59 As the objective of financial statements is to reportecon om ic events and the econ om ic status of an enterprise as realistically a s possibleand to provide useful information for managers to help them in decision-making, ithas been argued that under inflation financial statements should be adjusted or currentcost acc ounting used to fulfill that role. It is argued60 that adjusted financial stateme ntsare essential for efficient managem ent and it is in the interest of shareholders that theyshould be provided with that adjusted information.One of the questionable principles from the Islamic point of view is the costprinciple. It conflicts with justice and fairness if valuation is based on it in aninflationary environment. Furthermore, financial information based on it willpassively affect depositors who withdraw from investment in Islamic banks. Inadditio n, unrealistic inform ation a s a result of inflation tends to reduce the Zakah base.However, ways of solving these problems need a separate research.2.7 Realisation Principle

Revenue cannot be recorded except when it is evidenced by cash receipts or anexchange has actually occurred. Therefore, according to the dom inant view , revenueis recognised only when realised.6'

It has been argued that a clear distinction should be drawn between earned andrealised revenue; earnin g should not be identified with realisation." Rev enue isearned w hen the final product is delivered. On the othe r hand, it is fully realised wh enit is represented by cash receipts or when it is converted into cash or receivables.Revenue, therefore, will not be recognised with respect to a transaction that isincomplete at the close of an accounting period.63It has been pointed out that the main reasons for deferring profit realisation untilreceipt of cash, are the risk of not collecting the amount du e in full and the possibilityof incurring additional expen~es.6~hus it sou nds as if the justification of therealisation principle is certainty.

Although the realisation co nvention is the domin ant current practice in acco unting, ithas been the subject of much criticism . Som e writer@ have sugge sted that a valuationsystem should be established for inventories. It is argued that it is not fair to postpon ethe valuation of inventories until realisation takes place. Other@ argue that although itis accepted to value in ventories of most businesses at cost of acquisition, except wherethe "lower of cost or market value" rule calls for departure from historical co st, there aresome cases where inventory measurement at net realisable value is acceptable. Inpractice, net realisable value (i.e. current selling price less expected costs of realisation)is applied to some products such as cotton, raw sugar and crude oil.

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Review of ls lam ic Economics, Vo1.3, No.2Accounting Associations have considered the deficiencies of accounting reportsusing historical co sts (if realisation does not take p lace the "lower cost or m arket value"

rule will be adopted). The Am erican Acco unting Association argues for the reporting ofboth current and historical costs on the assum ption that a periodic comp arison betweencurrent costs and historical costs will be relevant to investors'needs.67

The realisation principle is considered acceptable from the Islamic viewpoint as faras recording of transactions are concerned. It is prudent to recognize revenue onlywhen it is realised. But this convention might harm transitional investors whowithdraw from investment. Depositors in some Islamic banks have the right towithdraw their funds at any time. Thus if some of them withdraw before the fullliquidation of the project in which their funds or part of them have actuallyparticipated, they may lose all or part of the profit that might be realised in thefuture.Investment accounts, M udar ahah accounts in so me Islamic banks are entitled to apart of the realised profits for the accounting period. S ince these profits d o includeprofits (positive or negative) of projects which are not yet liquidated, investors whowithdraw at this stage may well not share in the profits of some of the projects inwhich their moneys have actually participated. Hence it may be argued that thisconflicts with the requirement of justice and fairness.

To tackle this problem it is necessary to get a useful insight from the Islamicjurisprudence. In Islamic jurisprudence, a small degree of uncertainty (Gharar) intrade is accepted. Thus it is likely that a degree of "unfairness" which m ay affect thebank or its investors, may be considered acceptable, especially if it results in theelimination of interest.

Even if a holder of equity in a corpora tion, decides to withdraw by selling some orall of his shares, the price which h e may obtain for each s hare is uncertain, although itreflects the financial situation of the comp any. Th e value of a sha re depend s, to a largeextent, upon dividends payable ov er the life of the comp any. He nce, valuation of theshare depends on these dividends. However, it is difficult to know in advance thelikely grow th in dividends, and the m arket price in the sha res at the predicted date ofsale. Moreover, share prices in the stock exchange market are not always fair, andoften fluctuate in response to speculative forces.2.8 The Disclosure P r i n ~ i p l e ~ ~

There is a general consensus in accounting that there should be fair and adeq uatedisclosure of accounting data. Fair accounting presentation necessitates the adequatedisclosure of material information. Adequate disclosure requires that financialstatements be designed and prepared to portray accurately the econ omic eve nts thathave affected the firm for the period and to contain sufficient information to mak ethem useful and not misleading to users and average investors.In general, it is expected that any matter of significance, such as majorcom mitme nts, will be disclosed if knowledge of it w o i~ ld ffect the decision of an

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Accounting Postulates and Principles from an lslam ic Perspectiveave rage investor. T he term, "disclosure", doe s not mean that any and all inform ationis to be included in the accounting statements. It implies adequate disclosure ofinformation which is of material interest to different users.

Adequate disclosure, however, leaves several questions open to interpretation;what is meant by fair and adequate disclosure? Adequate co nnotes a minimum set ofinformation to be disclosed; fair implies an ethical constraint dictating an equitabletreatment of users; and complete and comprehensive presentation of information.

Adequate disclosure, from an Islamic perspective is also one of the desiredprinciples for fair accounting. It provides the public with the needed infornlation forsound financial decisions. Zakah base value and its distribution can also be attained a sa result of this principle. It has been pointed out that disclosure is minimal in someIslamic ban kshy, as there is no strong pressure from the public nor from theshareholders. Although depositors generally feel that their money is safe, yetusefulness of information is realised in Islamic financial institutions if the accountingprinciples are m aintained. O ne aspect of this usefulness is the possible provision of anaccurate financial position. Accuracy, in a sense, involves an aspect of fairness. Thatmay explain why it is felt that most accounting principles are acceptable from anIslamic perspective. Therefore, it can be concluded that accounting principles in aMuslim commun ity should be formulated so as to provide fair and just information(i.e. fairness accounting). In recognition to this fact the Financial AccountingOrganization for Islamic Ban ks and F inancial Institutions su ggests that the financialstatements of Islamic Banks and Financial Institutions include information aboutsources and uses of Zukah an d Qar.~!Hassan funds.70

3. ConclusionTo su m up , accounting p rinciples, are generally accepted for fairness accounting in

Islamic banks. Although Islamic banks operate in a different way from conventionalbanks, that does not mean that they are totally different financial institutions whichneed entirely different accounting. Like their traditional coun terpa rts, they also aim togenerate profit which involve them in credit and debt transactions, which must berecorded in such a way as to produce useful, accurate and fair financial statements.Differences in aims and objectives among different groups of financial institutionsfocus on different accounting principles. As a result, priority can be given to certainaccounting principles, policies and procedures. Hence, all principles and procedureswhich maintain fairness and justice are accepted in accounting for lslalnic banks.

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Review of Islamic E conomics, Vo1.3, No.2

Notes and References1-a) K.A. al-Abiji, al-Itcir al- 'Il mi wa al-Muhrisahi w al-D arib i lil-Ma ~cir if al-Islcimiyah (Sc ientifi c,

Accounting and Taxation Framew ork for Islamic Ba nk s), Ph.D. Thesis, University of Cairo, Cairo,198 1, pp. 42-63 .b) A. Abdullah, a l- Sh a kh ~ iy a h l - ' l t b r i r i y a h , ~ l - ~ i ~ h/-Islrimi (Nom inal Entity in Islamic Jurisprud-

ence) (Arabic), Al-Dar Al-SudBniah lil Kutub, Khartoum, no year of publication.How ever the author accep ts the concep t of Entity but does not agree to its consequen ce, i.e., LimitedLiability.

2-a) R.L. Watts & J.L. Zimmerm an, Positi~.e ccounting Theor y,Prentice-H all, Inc., Englewood Cliffs,New Jersey, 1986, pp. 4.-7, 14.

b) K.S. Most, Accounting The ory , Grid Publishing, Inc., Columbu s, Ohio, 1982, pp. 4-16, 52.3- M.W .E. Glautier & B. Underdown, Accounting Theory and Practice, Pitman Publishing, London,

1986, Reprinted 1987 , 1988, pp. 9, 114- G.R . Catlett, "Factors that Influence Accounting Principles", in: W.T.Baxter and S.Dav idson (eds.),Studies in Accounting Theory, Sweet & Maxwell Ltd., London, 1962, p. 381.5- R.R. Sterling, "Conservatism: the Fundamental Principles of Valuation in Traditional Accounting",

in: S.A. Zeff and T. F. Keller (eds.), FinuncialAccounting Theory, Mc Graw -Hill, Inc., N.Y., 1973 , p.536.

b) W.A. Paton and A.C. Littleton, An Introduction to Corporate Accounting Standards, EdwardsBrothers, Inc., USA, 1967, p. 7.

c) W .A. Paton, "The Postulates of Accounting", in: M . M oonitz and A.C. Littleton (eds.) , Si~ni f icantAccounting Essays, Prentice-Hall, Inc., Englewood Cliffs 1965, p. 64.

d) Ahmed Belkaoui, Accounting Theory,2nd edition, Harcourt Brace Jovanovic h, Inc., N.Y ., Lond on,1985, p. 220.

e) C.P. Mill, "Protecting the Standard-Setting Process", in: M.J.R. Gaffikin (ed.), ContemporaryAccounting Thought, Prenlice-Hall of Australia Pty. Ltd., Sydney, 1984, pp. 323-4, 345.6- a) W.A. Paton, "The Postulates of Accounting", op cit., pp. 64, 69.

b) W.A. Paton and A.C. Littleton, An Introduction to Corporate Accounting Stan dard s, op cit., p.7.

7- E.S. Hendriksen, Accounting Theory, Richard D. Irwin, Inc., Hom ewoo d, Illinois, 1982, p.61.8- B. Newman and M. Mellman, Accounting Theory: A CP A Review, John Wiley & Sons , Inc., N.Y.,

1967, p.7.9- a ) M.W .E. Glautier & B. Underdow n, op cit., 1986, pp. 53-5.

b) A. Belkaoui, op cit., 1985, p. 220.10- S.M . al-Darir, AI-Gharar wa Atharuhufi al-'Oqo od,fial-F iqh al-Islcimi (Un certa inty and its Effect

on Contracts in Islamic Jurisprudenc,e), Dar Nashr wal-Thaqafa, Cairo, 1967, p. 1.1 I -a) M.A. Zarqa, al-Madkhulal-Fiqhi a l- am (General Introduction to Islamic Jurisprudence), volumeNo. 3, Alif Ba Press, Damascus, 1968, pp. 256-58.

b) A.A . Khayatt, El-Sharikah ,fi al-Sha ri'ah al-Islrimiya (Comp anies in Islamic Law ), Ministry ofEndowment, Amman, volume No.2, 197 1 , pp. 2 1 1-21.

C) A.A. Sayed, al-Hissu hil-'Amal huyn al-F iqh al-Islcimi wa al-Qa noon al-W ad'i (Share According toWo rk in Islamic Jurisprudence & Traditional Law ), Higher C ouncil for Islamic Affairs, C airo, Noyear of publication, pp. 49-56.

12-a) A. Belkaoui, op cit., 1985, p. 221.b) E.S. Hendriksen, op cit., 1982, p. 64.C ) B. Underdown & P.J. Taylor, Ac,counting Theory and Policy Making, Heinemann Professional

Publishing Ltd., Lond on, 1985, Reprinted 1987,p.33.13- B. Newm an and M . Mellman, op (,it . , 1967, p. 35.14- M.W .E. Glautier & B. Underdown, op cit., 1986, Reprinted 1987, 1988, pp. 57-8.15- R.R. Sterling, "Conservatism", op cit., p. 536.

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Accounting Postulates and Principles from an Islamic Perspective16- J.M. Fremgen, "The Going Concern Assum ption: A Critical Appraisal", The Accounting Review,

volume X LIII, October 1968, pp. 649-56.17- A. Khallaf, Masadiral Tashri' al-Islami (Sources of Islamic Law ), Dar al-Qalam, Kuw ait, 1978, p.

151.18- A. Khallaf, 'Ilm Uslil Al-Fiqh (Islamic Jurisprudence Principles), DBr Al-Qalam, Al-Kuwait,l978,p. 90.19- B. Newman and M. Mellman, op cit., 1967, p. 35.20- A. Belkaoui, op cit., 1985, p. 239 .21- B. Newman and M. Mellman, op cit., 1967, p. 37.22 - A. Hindmarch et a[ ,Accounting: an Introducfion, the Macm illan Press Ltd., London, 1977, p.

23 .23 - R.R. Sterling, "Conservatism: the Fundam ental Principles of Valuation in Traditional Acco unting",

op cit., p. 52 124- H.A. Finney and H.E. Miller, Principles of Accounting, Intermediate, 5th edition, Prentice-Hall,

Inc., Englewood Cliffs, New Jersey, 1960, p.169-70.25 - A. Belkaoui, op cit., 1985, p.240.26 - R.R. Sterling, "Conservatism", op cit., p. 542.27- B. Newman and M. Mellman, op cit., 1967, p. 33.28 - A. Belkaoui, op cit., 1985, p.22329- W.A . Paton and A.C. Littleton, op cit., 1967, p. 22.30 - A.C. Littleton, Structure of Accounting Th eory , American Accounting A ssociation, 19 70, p. 63.3 1- M. Backer, "Determination and Measurement of Business Income by Accountants", in: M. Backer

(ed.), Handbook of Modern Accounting Theory, Prenlice-Hall, Inc., Englewood Cliffs, 1959,p.214.

32 - R.L. Watts & J.L. Zimmerman, Positive Accounting Theo ry, Prentice-Hall, Inc., Englewo od C liffs,New Jersey, 1986, pp. 11 1-28.

33 - Malik ibn Anas, Al-Muwatta' , 3rd edition, Dar al-Afaq al-Hadithah, Beirut, 1985, p. 204.Maliki School (al-Madhabal-Mciliki), s one of the four m ain schools of religious thoug ht, and hasmany follow ers in the Islamic world. According to this schoo l, one does not have to pay Zakah onmoney paid as a loan to another; when it is repaid. Zakah must be p aid on it. Howeve r, other juristsargue that loans are subject to Zakah.

34- A. Belkaoui, op cit., 1985, pp. 222, 223.35 - A. Hindmarch et al., op cit., p. 24.36 - W.A. Paton, Accounting Theory, Scholars Book Co ., Kansas, 1973, p. 293.37 - Ibid., p. 488.38 - R.G. Schroeder et al , Accounfing Theory, John Wiley & Son s, Inc., New Y ork, 1 987, pp. 199,

640.39- B. Newman and M. Mellman, op cif . , 1967, pp. 25, 26.40- W.A . Paton and A.C. Littleton, op cit., 1967, pp. 11-13.41-a) F.L. Clarke, "Price Variation Accounting: the Insouciance of Professional Prescription", in: M.J.R.

Gaffikin (ed.), op cit., 1984, p. 81.b) B. Underdown & P.J. Taylor, op cit., 1985, pp. 165-8.

42 - R.G. Schroeder et al, op cit., 1987, pp. 6 40-1.43- A. Ibn Man iea', al-Waraq al-Naqdi (Bank No fe) ,2nd edition, Farazdaq Commercial Press, Riyadh,

1984, pp. 113-14.44- M.U . Chapra, Towards a Just Monetary System, the Islamic Foundation, Leicester, 1985, p. 37.45- A.Y. Ali, The Meaning of the Glorious Qur'a n, 2nd edition, Nadim & Co., London, 1983, pp. 194,

212.46 - M.U. Chapra, op cif., 1985, pp. 37, 38.47 - Ibid., pp. 39-40.48 - M.A. Salam, al-Muhasabahfil-Islam (Accounting in Islam), D2r al-Bayan al-A'rabi, Jeddah, 1982,p. 48.

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b, p & M I ,&j gjsdJr ~ W IJ U I , -1 CTJ*j$ ji ~ L * l l JU I3 >,if1 + iJ ! y ~ y ~Z+- t;ilb + U Y ~ gut ~L;II, ~ L Y I AIL*L '9s~ i31, , J W l J! 3 3 3 1 , j& I &k41 (FairnessAccounting) il W 1 & M I;oL?I pr!Jds +Y \ ~ Y Y ~ U IA pg r ~$ q b J19i'L L+?!--l J u 9 1 j+ i.+ JL.i J , 4 b IL+4& , ~ LU I+ A JAIi y, .a ~ g'94 1 -MI A J ~i LLL ji-- MI ji.QUI aL;II PLj %41ip