Shariah Audit: Evidence & Methodology in Islamic Finance
Achene
Lahsasna, Shahul Hameed Haji Mohamed Ibrahim & Datuk Syed Othman Alhabshi
hasan@inceif.org INCEIF
Abstract:
The growth of Islamic finance industry has attracted the
attention of many around the globe. Both practitioners and academicians are
looking into the mechanism and structure of this nascent field. This attention
has gained momentum after the global financial crisis. One may observe that
this growth is accompanied by a parallel growth in the related field of Islamic accounting as well as Islamic or
Shariah audit. However, whereas studies in Islamic accounting are being
conducted at a greater speed, Shariah audit has remained an untouched area of
research so far. The current study is, therefore, an attempt to touch upon
different aspect of Shariah audit, starting from its definition, its Islamic
foundations, the current state of affairs and challenges, as well as its
evidence and methodology, consisting of three phases including planning,
examination and documentation. Conclusions and recommendations for different
stakeholders of Islamic finance industry have been given at the end of the
paper. Thus, this paper contributes to the scant literature on Shariah audit by
touching both its theoretical aspects as well as some practical aspects that
can assist those involved in carrying out the duty of Sharaih audit.
Key Words: Audit, Shariah Audit,
Hisbah,
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1 This paper is funded by the BNP Paribas – INCEIF Centre for Islamic
Wealth Management (CIWM)
1. Introduction:
The present research paper is focusing on Shariah audit
evidences and methodology in Islamic finance. The paper is an attempt to
deliberate some related aspects and issues pertaining Shariah audit which is
still regarded as emerging field of knowledge in Islamic finance.
2. The Nature of Accountability in Islamic finance
Accountability for all actions and even intentions of
the human beings appears a recurrent theme in the Holy Quran. To begin with,
the question of how human accountability will take place, a verse in Quran
explains that, “while (appointed) over you there are watchers, who are noble,
writers (of the deeds), who know whatever you do.” (Al-Infitaar: 82/11-
13) Broadening the scope of responsibility to include
even intentions, another verse contains that, “To Allah belongs what is in the
heavens and what is in the earth. If you disclose what is in your hearts or
conceal it, Allah shall hold you accountable
for it; then He will forgive whom He wills and punish whom He wills. Allah is
powerful over everything.” (Al-Baqarah: 2/284) Perhaps the most glaring example
of how deep and encompassing this accountability by God is: “He knows the
treachery of the eyes and whatever is concealed by hearts.” (Al-Momin: 40/19). In a nutshell, this vast accountability is
the direct outcome of the concept of Tauheed (the confession of the omnipotent
authority of God), as has been beautifully expressed in verses like: “Allah
takes careful account of all things.” (Al-Nisa: 4/86). “Then shall anyone
who has done an atom’s weight of good, see it! And anyone who has done
an atom’s weight of evil, shall see it!! (Al-Qariah: 99/7-8).
Apart from a general sense of accountability for
everything, Quran also touches upon one important aspect of accountability; the
financial accountability. More interestingly, it is easier to find some indications
in Quran for its specific focus on financial accountability. It is because
human beings love wealth and are materialistic by nature: “and in his love for
wealth, he is very intense.” (Al-Aadiat: 100/8). Another verse also throws
light on the greedy nature of humans in detail: “It has been made attractive
for people to love the desired things; that is, women, children, hoarded heaps
of gold and silver, branded horses,
cattle and tillage. That is an enjoyment of the worldly
life; but with Allah lays the beauty
of the final resort. …” (Aal-Imran: 3/14) Therefore, it is the demand of this
natural lust for wealth and material that human beings should be repeatedly
reminded not to forget that they are “trustees” and that any violation in what
they have been entrusted with might result in unpleasant consequences for them.
In this regard, some of the verses
which stress upon fulfilling financial “trust” and avoiding financial distrust
include: “Whoever misappropriates shall bring forth, on Doomsday, what he
misappropriated. Then, everybody shall be paid, in full, for what he has
earned, and they shall not be wronged.” (Aal-Imran: 3/161) “Do not eat up each
other‘s property by false means, nor approach with it the authorities to eat up
a portion of the property of the people sinfully, while you know (that you are
unjust in doing so). (Al-Bakara:188) “Give the measure and weight in full, and
do not make people short of their things, and do not make mischief on the earth
after it has been set in order. That is good for you, if you are believers.”
(Al- Aaraf: 85) “Give full measure when ye measure,
and weigh with a balance that is straight.” (Al-Israa: 17/35) “Woe to the
curtailers who, when they measure something to receive from people, take it in
full, and when they measure or weigh something to give it to them, give less
than due. (Al-Motaffifin: 83/1-31). Thus it can be seen that Quran elaborates
on the issue of both general and financial accountability to a great extent.
The above mentioned Quranic injunctions and emphasis on
accountability were practically implemented in the early Islamic period by the
Prophet peace be upon him. Numerous instances can be quoted in this regard. For
instance, the Prophet peace be upon him stressed “individual” accountability in
these words: “Beware that every one of you is a shepherd and everyone is
answerable with regard to his folk. The caliph is a shepherd over the people
and shall be questioned about them. A woman is a guardian over the house hold
of her husband and his children and has to be questioned about them. A slave is
a shepherd over the property of his master and shall be questioned about it”.
Then the Prophet, may peace be upon him, added: “beware that every one of you
is a guardian and every one of you shall be questioned with regard to his
trust”. The words of this hadith explicitly
make each individual responsible for his/her subordinates. Thus, it is a
manifestation of both individual and “institutional” or “organizational”
accountability in
which those in charge of some task or some persons are
responsible for their duties towards them accordingly. Dost 2 argues
that the institution of “hisbah” that
is to be found in the later Islamic era was inspired by the practice of the Prophet
peace be upon him, as he used to visit the market personally and check on the
accuracy of measures. He also assigned specific places to different mongers and
prohibited different market practices like meeting the producer-farmer at the
entrance of the city before they reached the market, fearing they may sell at
lower price. The Prophet peace be upon him was also opposed to price fixation
at the time of scarcity when he replied those who complained high prices and
requested to fix it: “the seller and the buyer, the one who provides and who
fixes the prices are nobody but the God. I don’t wish to die whilst people
having demands of life and property from me”. 3 On one such
occasion, the Prophet peace be upon him observed that a person was selling some
food stuff in the market. He put his hand in the pile and saw that it was wet
from inside, while it seemed fine apparently. The Prophet peace be upon him
rebuked the seller by saying that why he did not put the wet stuff on the top
of pile so that the people could see it? He further added: “The person who
cheats is not amongst us.” At another occasion, the Prophet peace be upon him
did “audit” of one of his appointees of zakah
collection. When the person arrived after collecting zakah, he presented one part of the collected stuff to the Prophet
peace be upon him and kept one part for himself saying that it has been gifted
to him. The Prophet peace be upon him rebuked the person in a very polite
manner and asked if he would receive such gifts if he were sitting in him home?
4 Indeed, these and other kinds of instances reveal to us how the
Prophet peace be upon him was seriously concerned with the financial
accountability of his appointees as well as the accountability of the market
practitioners.
3. The Institution of Hisbah
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2 Dost .S (undated): The Idea of Free Market in Early Islam. Source: http://atlasnetwork.org/wp- content/uploads/2009/03/suleyman-dost-essay_new.pdf. Retrieved on: 21-8-2013
3 Dost . S (undated): The Idea
of Free Market in Early Islam. Source: http://atlasnetwork.org/wp- content/uploads/2009/03/suleyman-dost-essay_new.pdf. Retrieved on: 21-8-2013
4 S. H. H (1999). Hurmat al-Maal al-Aam fi Zoai Shariah
al-Islamiyya. Page: 58, Dar un Nashar lil Jamiat,
Egypt
Keeping in view the aforementioned examples from the
life of the Prophet himself, a separate institution for market supervision
called hisbah was established. This
institution was formed based on the Islamic concept of “al amr bil maroof wal nahyu anil munkar”
i.e. (the task of) enjoining what is right and
forbidding what is evil. This is an essential feature of a given Islamic
society and Quran stresses upon the establishment of this institution, either
by the state or by the community members themselves. In its strict financial and business sense, the duty of muhtasib or the person in charge of hisbah was “to ensure that the daily
business transactions are done in a manner that is not harming the society.” 5
The major responsibility of muhtasib was
to ensure that the business practices prevalent in the market are in accordance
with Islamic injunctions and each party is getting its due rights as well as
performing its duties. It is not an
exaggeration to state that the current day “auditor” has the same task to
perform as was done by the classical muhtasib,
although the auditor’s role is restricted to the extent of monitoring that
everything in the financial “papers” is according to the regulations whereas muhtasib concentrated on the physical
inspection of the market. This change is the direct outcome of the changes that
have taken place in the business structure during the course of the centuries.
The classical Muslim writer, Al-Mawardi, has elaborated
the duties of muhtasib in his famous
book al-Ahkam al-Sultaniyya. 6
In fact he has devoted a full chapter of his book for this purpose which he
titled as al-hisbah.
The accountability in general and financial
accountability in particular has held great importance in both Islamic
literature and the practice of Islamic state at the time of its inception and
later on. Whereas the two major sources of Islamic Shariah, namely Quran and
Sunnah, provided a general framework as well as theoretical foundation for
financial accountability, it was practically demonstrated by the Prophet peace
be upon him and his followers since the early Islamic era. Both these steps led
to the establishment of the
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5 Rahim et al (2012). A New Breed Of Islamic Accountants And Their Role
In Islamic Institutions. Advances in Natural and Applied Sciences
6 Al-Mawardi (450 AH): Al-Ahkam al-Sultaniya wa al-Wilaya
al-Diniyya. (“The Laws of Islamic Governance”, Translated by Asadullah
Yate. Ta-Ha Publishers Limited, London)
institution of hisbah
or market supervision in the later years. The rulings about hisbah and the duties of muhtasib, the market supervisor, were
elaborated by Muslim jurists and scholars such as Al-Mawardi as an example of
it. This shows the deep concern of Islam with what can be termed in today’s
world as “audit”. However, we have also observed that the audit or
accountability in Islamic terminology is wider than its meaning in conventional
term; the former encompassing one’s actions, thoughts, and even intentions.
4. Definition of Shariah Audit:
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The growth of Islamic finance industry has lead to the parallel emergence of related fields of study. On the one hand, accounting has been looked and researched from an Islamic perspective. On the other hand, it is audit which is viewed from the same angle. However, the emergence of Islamic accounting is substantially advanced as compared to that of Shariah audit. Nevertheless, both these are getting momentum as the industry is expanding at a fast speed. Since the research about Shariah audit is at the embryonic stage, some basic issues and concepts of it have not yet been resolved. For instance, any field of study needs a proper definition before one can dig deep into its different aspects. However, there has not been any unanimous and clear cut definition of the term Shariah audit yet. In its simplest sense, Shariah audit has been defined as an audit attestation for Shariah compliance (Yahya and Mahzan, 2012) 7 However, the term is not so easy to be explained by such a simple expression and the writers confess this fact by pointing towards different issues that might arise as a result of this definition. On the other hand, AAOIFI’s Governance Standard for IFIs no. 3 elaborate the objective of Shariah audit as “the primary objective of the internal Shariah review (carried out by independent division or part of internal audit department) is to ensure that the management of an IFI discharge their responsibilities in relation to the implementation of the Shariah rules and principles as determined by the IFI’s Shariah Supervisory Board (SSB)”. 8 It is visible in this statement that Shariah audit aims at Shariah compliance and it has been taken as an internal matter of an IFI which is the responsibility of an independent division or a
7 Yahya, Y and Mahzan, N. (2012) The Role of
Internal Auditing in Ensuring Governance in Islamic Financial Institutions
(IFI). 3rd International Conference on Business and Economic
Research (3rd ICBR 2012)
8 AAOIFI (2010) Accounting, Auditing and Governance
Standards for Islamic Financial Institutions. Manama, Bahrain: Accounting
and Auditing Organization for Islamic Financial Institutions.
branch of internal audit department. We find a more
comprehensive definition of the term given by Haniffa (2010) which states that
Shariah audit is: “a systematic process
of objectively obtaining and evaluating evidence regarding assertions about
religious and socioeconomic actions and events in order to ascertain the degree
of correspondence between those assertions and those of the applicable
financial reporting framework, including the criteria specified based on
Shariah principles as recommended by the Shariah Supervisory Board (SSB) and
communicating the results to all interested parties”. 9 This
definition catches the broad scope of Shariah audit by adding the socioeconomic
aspect into it apart from the religious obligations. An operational definition
of the term has also been provided which states that: “Shariah audit is the examination of an IFIs compliance with the
Shariah, in all of its activities, particularly the financial statements and
other operational components of the IFIs that are subjected to the risk of
compliance including but not limited to products, technology supporting the
operations, operational processes, the people involved in the key areas of
risk, documentations and contracts, policies and procedures and other
activities that require adherence to Shariah principles” (Haniffa, 2010;
Sultan, 2007, as quoted in Yaacob, 2012; & Akram Laldin, 2009, as quoted in
Mohiuddin, 2012). 10 Although the socioeconomic aspects of the
earlier definition are missing here, we can see that almost all the operational
aspects, including technology, processes, and procedures etc are included in
this definition. Whereas Rahman (2008) defines Shariah audit as “the accumulation and evaluation of evidence
to determine and report on the degree of correspondence between information and
established criteria for shari’ah compliance purposes”, 11
Hameed (2008) has defined it as “a
systematic process of objectively obtaining and evaluating evidence regarding
assertions about socio- economic, religious and environmental actions and
events in order to ascertain the degree of correspondence between those
assertions and Shariah (Islamic Law), and communicating the results to
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9 Haniffa, R. (2010) Auditing Islamic Financial Institutions. Islamic
Finance: Instruments and Market. QFinance
10 Mohiuddin, G. M. (2012)
Auditing: Conventional and Divine Perspective, Research Journal of Finance and Accounting
11 Rahman, A. R. A. (2008) Shari’ah
audit for Islamic financial services: the needs and challenges. ISRA
Islamic Finance
Seminar, Kuala Lumpur, Malaysia.
users.” 12 This definition is broader in the
sense that it captures the environmental aspects into considerations too, apart
from socioeconomic and religious assertions.
Keeping in view the above definitions, Shariah audit is
defined according to AAOIFI as an examination of the extent of an IFI’s
compliance, in all its activities, with the Shariah. 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. (AAOIFI. Governance
standards 2). Hence is it a very comprehensive and complete process to ensure
the Shariah compliance status of the IFI.
5. Objectives and Scope of Shariah Audit
It is evident from the definitions given above that the
logic for Shariah audit is to ensure the compliance of IFI with Shariah in all
possible respects. Indeed this is the core objective of Shariah audit. It has also been explicitly asserted by
what AAOIFI published in 2010 about the objectives of auditing. According to
this, the audit of an IFI aims to enable the auditor to express an opinion
about the financial statements of the organization, as to whether they are
prepared in all material respect in accordance with the fatwas, rulings and
guidelines issued by the Shariah supervisory board of the said IFI, the
accounting standards of AAOIFI itself, the national accounting standards and
practices, as well as the relevant rules
and regulations of the country where the IFI operates. The auditors conducting
this audit should also cater for the Code of Ethics for Professional Accountant
and should be dressed with righteousness, integrity, trustworthiness, fairness,
honesty, independence, objectivity, professional competence, due care,
confidentiality, professional behavior and technical standards. 13
The definition and objective of Shariah audit makes it easier to comprehend the
scope of Shariah audit. It is broader than conventional audit in the sense that
it comprises of an extra attribute of making sure that an IFI must comply
with Shariah. It does not, in any sense, mean that Shariah
audit
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12 Hameed, S. (2008) The Case for Islamic Auditing. International Accountant. Source: http://www.kantakji.com/fiqh/Files/Accountancy/v181.pdf
13 Yaacob, H. (2012) Issues and
challenges of shari’ah audit in Islamic financial institutions: a contemporary view. 3rd International Conference on Business
and Economics Research,
Bandung,
Indonesia.
would ignore the financial aspects of the transactions.
As argued by Rahman (2008) 14 the first scope of Shariah audit would
be the audit of financial statements of the concerned IFI. It would review and
ensure that all the financial transactions are recognized, measured, and
reportedly accurately and they precisely reflect the rights and obligations
arising from different contracts. Furthermore, it would also ensure that there
is an adherence to the relevant standards, like the rules and regulations of
Bank Negara or those of AAOIFI etc. However, it is worth mentioning here that
Shariah is a very broad term and it encompasses all aspects of life including
business transactions. Hence, Hameed (2008) laments that the Shariah
Supervisory Boards (SSB) currently take a narrow view of Shariah and confine
adherence to it in the form of technical compliance of the financial contracts
to the fatwas (opinions) of the SSB
regarding what is permissible or otherwise. Therefore, he asserts that a
broader and holistic approach needs to be adopted which should take into
consideration the “business policies, processes and procedures, contracts and
agreements, financial systems and reporting, human resource management, social
activities and contributions, marketing and advertising, reports and circulars,
zakat calculation and payment, and IT
systems.” 15 Yaacob and Dongla (2012) also assert that auditing is
important for guaranteeing corporate accountability and enhancing the
stakeholders’ faith in the company. However, unlike the conventional audit
which focuses on the compliance of financial statements to be in accordance
with GAAP and other relevant standards, “the
auditing of Islamic Financial Institution (IFI) cover a wide range of scope.
This is because auditors/Shariah auditors must attest that the management has complied not only with
relevant standards but also the Shariah framework in all of the transactions to
achieve the maqasid as shari’ah.” 16 The broader scope of
Islamic auditing has also been reiterated by Yahya and Mahzan 17 who
mention that in contrast
to conventional audit where the auditor is liable to the owner
of the
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14 Rahman, A. R. A. (2008) Shari’ah audit for Islamic financial services:
the needs and challenges. ISRA Islamic
Finance Seminar, Kuala Lumpur, Malaysia.
15 Hameed, S. (2008) The Case for Islamic Auditing. International Accountant. Source: http://www.kantakji.com/fiqh/Files/Accountancy/v181.pdf
16 Yaacob, H. and Donglah, N.
K. (2012) Shari‟ah audit in Islamic financial institutions: The postgraduates‟
perspective, International Journal of
Economic and Finance
17 Yahya, Y. and Mahzan, N.
(2012) The Role of Internal Auditing in Ensuring Governance in Islamic
Financial Institutions (IFI). 3rd International Conference on
Business and Economic Research (3rd ICBR
2012)
business and is not guided by religious principles, the
Shariah auditor is: “In light of Islamic teaching, the role of auditor would
assimilate some different approach and objective i.e. upholding shariah principles.” This broader scope
is also pointed by Khan (as quoted in Yahya and Mahzan, 2012) who states that: “The scope of auditing in Islamic framework
is much larger as compared to the scope of traditional auditing. From the
traditional concept of attest and authority it would expand to report on various social and economic aspects of
business organization. This is due to the reason that auditing in Islam has
been derived from the basic values of Islamic societies and shariah principles”.18
6. Issues in Shariah Audit
As stated earlier, Shariah audit is an emerging field
with most part of it yet to be explored academically. Therefore, it is rather
natural to find many unresolved issues in it. To begin with, the most important
issue is Shariah audit is that of the independence of Shariah auditors.
Independence is a fundamental concept in audit, be it conventional or Islamic.
But members of Shariah Supervisory Board, who are involved in audit as is the
practiced by some IFI, are paid by the same institution whose audit they
conduct. In other words, they also audit their own work which raises the issue
of independence as well as conflict of interest. In this regard, Kassim (2009)
argues that although SSB members follow the Shariah rules, there is no
professional code followed by them. AAOIFI does have a code of ethics for them
to follow, but there is no framework developed for them that they can perform
their task with19 Secondly, Hameed (2008) raises the issue of the
competence of SSB members when it comes to the performance of conducting
Shariah audit. He argues that although the members of SSB are well qualified in
the task of issuing fatwas about the
permissibility or otherwise of any financial product, they can not stand as
qualified auditors because they do not have the necessary qualification and
training. Besides, their dual role of advising at the product development stage
and auditing at the later stage
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18 ibid
19 Kassim, N. (2009) Dynamics
of Shariah Auditing in Islamic Financial Institutions: A Study of The Malaysian
Islamic Financial Sector. Unpublished PhD thesis
creates “self review threat” as per the IFAC’s code of
ethics. 20 However it should be noted that in many jurisdictions
including Malaysia the Shariah board members do not involved in the Shariah
audit exercise because it is not within their scope and job description, but
there is an interaction between them to clarify some outstanding issues faced
by the auditors. Thirdly, Rahman (2008) pinpoints some issues in the reports
produced by SSC which reflect complete conformity of the operations of Islamic
banks with Shariah principles. On the contrary, the role of SSC is very limited
and it is not even responsible to conduct audit in a way done by financial
auditors. What they are responsible for is only the approval of products and
services. The writer further elaborates that financial auditors are well
educated, qualified, trained and experienced in their profession. They are free
to perform their duty as auditors and perform their task impartially for which
they are paid. On the contrary, although SSC members are well qualified Shariah
scholars, they have not been exposed to proper training or qualification about
how to conduct Shariah audit. 21 Likewise, there is also the issue
of the responsibility of SSB members. Their main duty is to “advise” the bank
as how to conduct their business in Shariah compliant way. Ironically, the
report they present shows that they are responsible for the “assurance” of
Shariah compliance. 22 This situation leads to an interesting fifth
point, i.e. the liability of the SSB in case of non Shariah compliance. This
issue has been raised by Muneeza and Hassan (2011) who argue that the current
legal position is silent about the consequence of malpractice liability of the
members of SSC. It makes these
members immune to any legal action in the eyes of the masses and, therefore, it
is needed to explain whether Shariah scholars could be sued by their customers
in case of negligence or not? 23 One might argue here that this
issue has been addressed by IFSA 2013. However, the writers raise another
interesting point by stating that if clients are allowed to sue these members of Shariah Board, they would be
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20 Hameed, S. (2008) The Case for Islamic Auditing. International Accountant. Source: http://www.kantakji.com/fiqh/Files/Accountancy/v181.pdf
21 Rahman, A. R. A. (2008)
Shari’ah audit for Islamic financial services: the needs and challenges. ISRA Islamic Finance Seminar, Kuala
Lumpur, Malaysia.
22 Rahman, A. R. A. (2008)
Shari’ah audit for Islamic financial services: the needs and challenges. ISRA Islamic Finance Seminar, Kuala
Lumpur, Malaysia.
23 Muneeza, A. and Hassan, R.
(2011) The Legal Obstacles in Shari'ah Corporate Governance of Islamic
Financial Institutions in Malaysia. Paper presented in the Asia Pacific
Business Research Conference,
Malaysia
reluctant to sit on these boards/committees which can
hamper the industry already faced with the shortage of experts. Therefore, it
is more reasonable to stipulate that Shariah scholars can only be sued in
serious and extreme cases (Hodgins, 2010, as quoted in Muneera and Hassan,
2011). 24 In short, there are some fundamental issues that still
need to be addressed and solved in the context of Shariah audit.
7. Shariah Audit Evidence
7.1.
Definition
of Audit Evidence and its Main Features
Audit is the systematic process of collecting and
evaluating evidence to form an opinion about an entity’s status. Audit evidence
is the foundation on which the whole decision or opinion making process is
based on. Audit evidence stands for the information that is used by the auditor
to arrive at a conclusion and form an opinion. Evidence is a piece of
information collected and used to providing a factual basis for developing
observations and arriving at some conclusion regarding audit objectives. It provides the basis for believing that a
particular assumption is true or not by providing persuasive support for a fact
or a point under consideration. 25 Audit evidence is persuasive in
nature and, thus, stands in contrast to legal evidence. The auditor gets reasonable
assurance after it and that is all his decision is based on. Absolute certainty
is rarely possible with the help of audit evidence. Legal evidence on the other
hand is a type of rigorous proof which is beyond audit evidence in its
certainty and assurance. 26 Substantially good audit evidence should
have the following features: 27
(1)
Sufficiency:
Sufficiency does not mean that the hundred percent audit evidence should be
availed. It means that the quantity of the evidence should be adequate enough
for the auditor to form an opinion.
(2)
Appropriateness:
As against sufficiency which considers audit evidence in terms of its quantity,
appropriateness measures the quality of the audit evidence. In other words, it
measures whether audit evidence helps in detecting any
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24 ibid
25 Audit Manual (2005). Public Service Commission of Canada. Available at:
www.psc-cfp.gc.ca. Retrieved on: 20-12-2013
26 Hayes, R et al (2005):
Principles of Auditing. Pearson Education Limited, UK
27 Fundamentals of Accounting
and Auditing (2012). ICSI, New Delhi
misstatements and breach of compliance; whether it is both reliable
and relevant or not?
(3)
Reliability:
The audit evidence needs to be reliable in order for the auditor to base his
assessment upon. Once again, one hundred percent reliability is not possible
logically. Hence the evidence should be persuasive rather than conclusive.
(4)
Relevance:
The type of evidence should also match the matter being investigated. For
instance, if it is aimed to check the balance stock, the physical verification
is the most relevant evidence.
(5)
Persuasiveness:
Audit evidence does not need to be conclusive as is the case with legal
evidence. It is enough if the auditor finds the evidence to be persuasive. Only
a small is usually used in order to arrive at some conclusion. Persuasiveness
of evidence is increased if there is harmony among evidence obtained from
different sources. 28
In addition to the above, following are a few rules of
thumb that are helpful in judging the soundness of audit evidence: 29
Firstly, documentary evidence is preferred over testimonial evidence. Secondly,
evidence obtained from different sources or of a different nature is preferred.
Thirdly, original papers are better than their photocopies. Fourthly, evidence
collected from a third party is better than the evidence collected from within
the organization. Lastly, direct evidence obtained by the auditor through
personal observation, inspection etc is better than the evidence gathered
indirectly.
7.2. Sources and Techniques of Audit Evidence
The information which constitutes audit evidence can be
obtained from two main sources: primary and secondary. 30
·
Primary
Evidence: This is the information gathered by auditors personally. The
information can be gathered by auditors themselves by using different
techniques like interviews, surveys, observation and inspection. What is
essential in selecting
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28 Hayes, R et al (2005):
Principles of Auditing. Pearson Education Limited, UK
29 Fundamentals of Accounting
and Auditing (2012). ICSI, New Delhi
one or more of these techniques to gather information is that the
auditor should possess the skills and expertise required in applying these methods.
·
Secondary
Evidence: Secondary evidence can be categorized into two types; information
gathered by audited entity and information gathered by third parties. Since
every business entity keeps records of its daily transactions, it produces
ample amount of information that can be used is audit. Similarly, outside
authorities like regulators etc also have substantial information about the
entity which can constitute evidence that can be utilized in audit.
An auditor has the following options as techniques of collecting
audit evidence:
·
Inquiry
·
Observation
·
Inspection
·
Recalculation
·
Confirmation and
·
Analytical procedures
7.3. Documentation of Audit Evidence
Evidence documentation usually contains the evidence
itself. However, neither every document examined is to be copied and filed, nor
the detailed information obtained from these documents is to be listed in it.
For example, if the evidence consists of an entity’s financial record, it
should suffice record which document was examined and how that specific
document can be identified and located. Similarly, the working papers which
contain the evidence should be structured in a logical manner and should be easily
accessible. These papers should have either the evidence itself or the
description of the evidence examined so as to enable the viewers to arrive at
the same conclusions as those of the auditor himself. Once again, the
professional judgment and experience of auditor will play the most important
role in evidence documentation. 31
8. Shariah Audit Methodology
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8.1.
Planning Phase
Shariah audit is a “systematic process” which means that
it should have a proper design from the very beginning. It should be properly “planned” and be according to the design
drawn by the auditor. After proper planning, the second phase namely
“examination” should follow. The third phase in implementing Shariah audit is
the reporting phase which comes as a logical end of the first two phases.
Finally, there should be the reporting phase of Shariah audit in the form of
producing an audit report which is the ultimate objective of this whole
process. Following are some essential elements of Shariah audit planning phase:
8.2. Understanding the Business of IFI
Not all the financial institutions and their respective
businesses are the same. While some indulge in retail business providing small
and basic facilities to their customers, others are broader in their scope and
activities and serve both the individual customers as well as corporations and
may provide funding to huge projects of the governments and other entities.
Therefore, a Shariah auditor needs to understand first what kind of activities
and businesses are the focus of an IFI. An Islamic financial institution may be
serving the individual customers with retail banking as its main operation.
Such an IFI will possibly be providing credit card facilities as well as home
financing, and other personal financing facilities. If a Shariah auditor is
entrusted with the task of auditing such an IFI, with retail banking as its
core business, any audit plan consisting of techniques and procedures that are
suitable for the audit of project financing. Hence, the Shariah auditor must
first understand the business of the IFI before moving forward.
8.2. Understanding the Contracts Appropriate for the Business
Generally speaking, the nature of IFIs and the
businesses that they do are different from the nature and business of
conventional financial institutions. Whereas conventional financial
institutions, especially conventional banks, primarily deal in lending and
borrowing, the operations of Islamic financial institutions are trade based.
That is to say, IFIs indulge in buying from and selling to their customers and
not borrowing and lending. This is mostly true in the case of retail Islamic
banks for instance. Consequently, a
Shariah auditor may find that the most proper and widely
used underlying contract for personal financing and retail banking is murabaha.
On the other hand, equity financing is usually done through the contract of
musharakah and mudharabah whereas salam, istisna, and ijarah contracts are
utilized for project financing. Therefore, it would be illogical, as stated before,
to prepare an audit plan focusing on murabaha transaction when the IFI is
conducting project financing as its main business activity. On the other hand,
a focus on salam and istisna when the IFI serves retail customers will be an
inappropriate audit technique.
8.3. Identifying the Appropriate Evidence Gathering Techniques
Once the nature and objectives of the IFI business have
been understood and the essence and sequence of the relevant contracts utilized
by the IFI to obtain these objectives have been realized, the next step in
planning Shariah audit is to identify the most suitable techniques that can be
used to gather evidence in order to form an opinion about the Shariah
compliance status of the IFI. Since the nature of business and the contracts
utilized by IFIs are different, as stated earlier, it should come as a logical
conclusion that some audit techniques would be more appropriate than others for
this purpose. As an illustration, since buying and selling and not lending and
borrowing is the main business of Islamic banks, for instance, such techniques
would be needed that can cater for buying and selling aspect of the business.
For instance, in case of project financing, a visit to the site, if felt
necessary by the auditor, might be more handy than other techniques.
8.4. Developing Proper Audit Plan
After understanding the IFI business and deciding on the
relevant techniques for collecting evidence, it is important that a proper and
audit plan is prepared in the light of these decisions. An audit plan is the
sketch of the key activities to be undertaken by the auditor in the process of
auditing. 32 It elaborates the objectives of each of the activities
that are a part of this process. Similarly, it also outlines the respective
techniques which
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32 Sultan,S, A, M (2007). A Mini Guide to Shariah Audit for Islamic
Financial Institutions- A Primer. Cert Publications, Kuala Lumpur
will be employed to attain these objectives. In short,
audit plan is first important step that lays the foundation of what is to be
achieved through the whole process of audit.
8.5. Shariah Audit Methodology: Examination, Reporting and Documentation Phase
8.5.1. Examination Phase:
Examination or the actual field work is a very important
decision in the audit methodology. Examination is the implementation of the
initial audit plan and this is what will make the entire procedure a successful
one. The most important decision/action at the examination step is the
selection of an appropriate technique that can be deployed for gathering audit
evidence. There are a number of techniques available with the auditor to select
one or more tools. Usually, a Shariah auditor can select among the following
list of techniques: 33
·
Examination of Papers
·
Interviewing
·
Direct Observation
·
Benchmarking
·
Surveys
·
Case Studies
·
Flow Charting
·
Statistical Analysis
·
Walkthrough, and
·
Questionnaires.
There are many factors that will lead to the selection
and/or priority of one or more of these tools over others. For instance, the
objective of the audit will be the first factor to determine this. Similarly,
the nature of the business of IFI will also prefer some techniques over the
others. Likewise, the availability of some of these techniques and the absence
of others, as well as the superiority of some techniques like direct
observation will also affect this decision.
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33 ibid
8.5.1. Reporting Phase (Nature of the audit report)
An audit report usually consists of a few lines and is,
therefore, very brief. Since the audit report is very brief and to the point,
the elements that it comprises of are to the point too, avoiding any details or
elements that are unwanted and unnecessary. The presentation of the report is
depending on the approach of each auditor, hence the presentation of the report
may vary, however the most important listed items in the Shariah audit report
are:
Part 1: executive summary
·
Introduction
·
Overview
·
Audit objectives and scope
·
Risk profile
·
Rectification of previous finding
·
Audit assessment
·
Management discussion
·
Conclusion
Part 2: Details finding
·
Current audit finding
·
Status of previous audit finding
Part 3:
·
organization chart
·
Photograph Appendices
8.5.2. Audit Documentation Phase
Audit
documentation is the main record which forms the basis for the conclusions
drawn by the auditor and supports his report. It also provides a review of the
quality and
standard of the work by providing written evidence that
support the conclusions of the auditor. Audit documentation is also referred to
as working papers or work papers. These are the papers that record the overall
activities of the auditor during the auditing process and the results and
conclusions drawn by him from the audit evidence. This can either be in the
form of papers or in an electronic form. 34
Working papers perform different functions including:
·
These help
in the planning and performance of the audit. If the audit is to be planed and
performed well, the required reference information and detail should be present
in the form of these papers.
·
Working
papers also serve as proof that the audit evidence which supports the opinion
of auditor is valid and in accordance with the concerned regulatory
requirements.
·
These
papers also validate and confirm the very process of audit too. It helps the supervisory authorities
confirm whether the whole audit process was efficient and is reliable or not.
·
It can also
serve different parties for their own purposes like the tax regulators,
government bodies and others. 35
The question of what content should or should not be
included in the working papers depends on the professional judgment of the
auditor. Whereas it is not possible to include each and every point in it, it
is also not plausible to skip any points that are supposed to be in these
papers. As a general rule, the auditor should add anything that would be needed
to provide another auditor with no past experience and knowledge of the entity
to understand the performed audit work. They should provide the ground for the
decision that has been made. 36
9. Challenges and Recommendations
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There are no two opinions that Shariah compliance is the essence of Islamic finance. It is the very foundation and the primary objective for the inception of the entire industry. Shariah audit, a newly emerging field of study, is one of the important tools to achieve
34 Hayes,
R et al (2005): Principles of Auditing. (Second Edition) Pearson Education
Limited, UK 35 Hayes,
R et al (2005): Principles of Auditing. (Second Edition) Pearson Education
Limited, UK 36 Ibid
this objective of ensuring Shariah compliance. The
current study attempted to add to the current scant literature on Shariah
audit. The objective was to explore the current status of Shariah audit, identify the gaps, attempt
to fill some of these gaps and suggest some future directions for further research.
9.1. Challenges
While undertaking this study on Shariah audit evidence
and methodology, the following problems were detected which need to be
addressed:
9.1.1. Lack of Literature
Islamic finance saw some tremendous development only
during the last decade or so. It is
also during this time period that attention started to be paid to it as a
discipline and it different areas are now being researched. However, it is also
a fact that Shariah audit has not been given proper attention so far by the
regulators as well as the practitioners and academicians. As a result of this
situation, one faces difficulty at the outset while trying to search and
explore the relevant literature for Shariah audit. Whereas the literature available
on say, Islamic banking, is quite sufficient to conduct a further research
study or know the existing status and level of the discipline, this is not the
case of Shariah audit. This lack of literature makes any attempt to further
enhance the field through academic research more problematic and difficult.
9.1.2. Lack of Experts
Since Shariah audit has not yet received its due
importance from all the respective stakeholders including academia and industry
players, there is a scarce number of experts, if any, belonging to this
discipline. This is a natural outcome of the lack of literature as well as the
lack audit practice by the industry as mentioned above.
9.1.3. Lack of Research
General observation tells us that although Islamic
banking and takaful etc have received recognition as essential parts of Islamic
finance industry and these have been taught to a certain extent, this is not
true in the case of Shariah audit. Even worse, the discipline that
needs to be established before Shariah audit, i.e.
Islamic accounting, has not yet developed fully to the extent that Islamic
banking or takaful have developed. It is logical to expect that Shariah audit
will get attention of the researchers once Islamic accounting makes further
advancement as a research discipline. However, once again the common
observation and experience tells the other story. This creates difficulty for
anyone trying to do quality research on Shariah audit.
9.1.4. Non Recognition by the Relevant Parties
Unlike accounting, audit has not yet been accepted by
the stakeholders of Islamic finance industry as an essential pillar needed for
the development and uplift of the industry. This is visible from the current
situation wherein the major stakeholders, like IFIs, practitioners,
academicians and researchers have not yet put Shariah audit in their priority
list. It is very essential for the development of this discipline as well as
the industry as a whole that Shariah audit be recognized as an integral part of
the Islamic finance industry by all. We should record here with appreciation
the effort of the Bank Negara Malaysia towards providing Shariah audit
framework for the industry which is still on-going project. Beside that very
important aspects of Shariah audit have been highlighted in the Shariah
governance framework that was issued by Bank Negara Malaysia. In the light of
our discussion so far, this study would recommend the following for a robust
growth of the discipline of Shariah audit.
9.2. Recommendations
9.2.1.
Recommendations
for IFIs
Shariah compliance is the hallmark that differentiates
Islamic financial institutions from their conventional counterparts. Shariah
audit is the mechanism or “stamp” that ensures this compliance. Therefore, if
compliance with Shariah is the soul of Islamic finance industry, Shariah audit
is the trade mark for this compliance. Hence, these institutions should join
hands for its implementation and should welcome any efforts by the regulators
in this direction. Even if there is delay from regulators’ side in the
implementation of Shariah audit, these institutions should take voluntary steps
in this direction.
9.2.2. Recommendations for Academia
The role of academia in the development and growth of
any discipline needs no explanation. In order
for Shariah audit to develop further and achieve it due place and importance,
academia has to wake up. Carrying out individual research projects by learned academicians,
as well as their facilitating and encouraging both graduate and post graduate
students to conduct research in this area can result in the much needed growth
of literature on the subject. It will also give Shariah audit the status of a
well developed and properly recognized academic discipline that will pave the
way for its acceptance as an essential pillar of the Islamic finance industry
by the rest of the stakeholders, including the regulatory authorities, and
industry players.
9.2.3. Recommendations for Regulators
The implementation of Shariah audit in the Islamic
finance industry greatly depends on the role of regulators. It is suggested
that the central authorities and regulatory bodies make the practice and
conduct of Shariah audit mandatory for the Islamic financial institutions by
introducing new laws for this purpose or properly amending the existing
regulations. This will certainly be the starting point for the flight of
Shariah audit and the industry as a whole in the right direction.
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