Accounting Treatment of Zakah: Additional Evidence from AAOIFI

Accounting Treatment of Zakah: Additional Evidence from AAOIFI

 Dr. Adel Mohammed Sarea

           The most important results of the previous studies are confirmed that, Zakah can eliminate poverty in Muslim countries and achieve the desired justice in the distribution of income and wealth (Abdelbaki, 2013). Zakah is essential as a social welfare levy imposed to Islamic society’s wealthier members and more prosperous businesses and thus helps to close the gap between the poor and the rich (Awang&Abdul Rahman, 2003).

                 However, Zakah has been identified as an important source to the economy of the Muslim community and give an impact on socio-economy development of nation (Ibrahim et al., 2013). According to Shari’ah principles, Zakah is an obligation in respect of funds paid for a specified type of purpose and for specified categories. It is a specified amount prescribed by Allah the Almighty for those who are entitled toZakah as specified in the Qur’an. The word Zakah is also used to indicate the amount paid from the funds that are subjected to Zakah (AAOIFI, 2010).

                Furthermore, Zakah also is fundamental to every Muslim as well as Zakah is the Islamic contribution to social justice (Dahr and Akhan, 2010). However, Zakah is an obligation, prescribed by Allah S.W.T with the ultimate goal as a form of social security, to develop balanced economic growth through redistribution of wealth in society (Abdul Aziz and Abdullah, 2013). Historically, although in early Islamic states, Zakah funds were collected and managed by the state (Hassan, 2010). Zakah management has gone through historical challenges after the extinction of early Islamic states. 

            After the colonial era, a few Muslim countries such as Yemen, Saudi Arabia, Libya, Sudan, Pakistan, and Malaysia have opted for mandatory Zakah management through government (Hassan, 2010). Other countries such as Egypt, Jordan, Kuwait, Iran, Bangladesh, Bahrain and Iraq, have formed specialized state institutions but participation of public is made voluntary (Hassan, 2010).

    Due to the absence of authorities to implement accounting standards for Islamic financial institutions, IFIs are currently applying different accounting standards in their financial reporting (Sarea& Hanefah, 2013). In addition, Due to the current different regulatory requirements and legislations, the relevance and comparability of financial statements are the foundations upon which accounting standards are predicated. Thus, diversities exist in terms of their class structure, political systems, legal systems, financial systems, educational systems, and the very nature of conducting business and business ownership (Choi and Meek, 2005).

        In related study, Lovett (2002) documented that, with financial statements prepared under different accounting standards a problem may exist in: 

      Comparability of financial statements prepared globally, Reliability and creditability. Islamic financial institutions prepare their financial statements using a number of accounting standards either international accounting standards or local accounting standards, the problem may exist in the practices and the level of understanding among accountants and the level of compliance (Report, KPMG and ACCA, 2010).

       Accordingly, the need for accounting standards for Islamic financial institutions may possibly be the right way to resolve these issues. In this regard, according to Sarea& Hanefah (2013) as quoted from Maali and Napier (2010) due to unique transactions of Islamic financial institutions, conventional accounting rules such as the International Financial Reporting Standards are not compatible to Islamic banks. Thus, the need to develop and apply the accounting standards related to Zakah may reduce any differences in the methods of treatment applied by IFIs. 

         Therefore, the researcher reviewing many of the previous studies in order to discuss these issues, many initiatives have been taken to facilitate Zakah collection and distributions. For instance, the AAOIFI organizations has been recognized and mandated to develop accounting, auditing, governance and ethics standards in order to promote comparable and reliable accounting information. The formulation and adoption of AAOIFI standards in any country is intended to increase foreign investment as well as investor’s confidence. These standards are set up to produce financial statements that are transparent in their preparation and easily interpretable by users (Sarea & Hanefah (2013) as quoted from (Karim, 2001).

                        The objective of this study is to determine the accounting treatment of Zakah according to the requirements of AAOIFI FAS 9. The importance of Zakah as a source of financing to payout the eight categorizes as mentioned in the Quran. Allah S.W.T says,“Take sadaqah (obligatory alms) out of their wealth through which you may cleanse and purify them" [al-Tawbah: 103]. However, the researcher reviewsthe requirements of AAOIFI FAS 9 in terms of three elements: 1. Recognitions: to discuss the basic principles that determines the timing of revenue, expense, gain and loss. 2. Measurements: to discuss the principles that determine the amount at which assets, liabilities, owners equity are recognized 3. Disclosures: all information should be available for all users.

Accordingly, data were collected from AAOIFI FAS 9 (recognitions, measurements and disclosures) and literature review in order to answer the research question.

         The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI), a private standard setting body, was established by the Islamic banks and other interested parties to prepare and promulgate accounting, auditing and governance standards based on the Shari’ah precepts for Islamic financial institutions (Sarea & Hanefah, 2013) as quoted from(Karim, 2001). Background of the standard: The standard for Zakah was adopted by the Accounting and Auditing Standards Board in its meeting No. 15 held on 27-28 Safar, 1419H corresponding to 21-22 June, 1998 and shall be effective for financial statements for fiscal periods beginning 1 Muharram 1420 H or 1 January 1999. This standard aims to set out accounting rules for the treatments related to the determination of the Zakah base. Thus, it is expected that the standardization in the methods applied would help to provide useful information to the users of the financial reports, The AAOIFI FAS 9 covers the accounting treatments related to zakah base and disclosure of zakah (AAOIFI, 2010). AAOIFI FAS No.9 consist of 21 paragraphs that describe measurements, recognition, and disclosure requirements, as well as setting out accounting rules for the treatments related to the determination of the Zakah base and measurement of items included in the Zakah base and disclosure of Zakah in the financial statements of the Islamic banks and financial Institutions (AAOIFI, 2008). 

In reference to the AAOIFI FAS 9 (Para 9, 10 & 11), there are two scenarios to explain the payment of Zakah. The first scenario in case the Islamic bank is obliged to pay zakah and the second scenario in case the Islamic bank is not obliged to pay zakah: 4.1.1: The First Scenario In any of the following cases, zakah shall be treated as a (non-operating) expense of the Islamic bank and shall be included in the determination of net income in the income statement: (a) When the law requires the Islamic bank to satisfy the zakah obligation. (b) When the Islamic bank is required by its charter or by-laws to satisfy the zakah obligation. (c) When the general assembly of shareholders has passed a resolution requiring the Islamic bank to satisfy the zakah obligation. In para (9), unpaid zakah shall be treated as a liability and presented in the liabilities section in the statement of financial position of the Islamic bank (AAOIFI, 2008). 4.1.2: The Second Scenario (a) In case some or all of the shareholders ask the Islamic bank to act as agent in meeting the zakah obligation relating to their investment in the Islamic bank from their share of distributable profits, the zakah shall be deducted from the shareholders’ share of distributable profits (para 10). (b) In case some or all the shareholders ask the Islamic bank to act as agent in meeting their zakah obligation and the Islamic bank agrees to do so even if there are insufficient distributable profits to meet the shareholders’ obligations, the amount paid by the Islamic banks shall be recorded as a receivable due from these shareholders (para 11).

                This research attempts to discuss the accounting treatment of zakah by focusing on the recognitions, measurements and disclosures of zakahaccording to the AAOIFI (FAS No.9). This research may be considered as additional evidence to determine the accounting treatment of zakah.Therefore, this research contributes to a better understanding of zakahconcept and willing to deal with the requirements of recognitions, measurements and disclosures of financial reporting and become a useful tool to meet the various needs of IFIs. The findings seem to demonstrate that, the accounting treatment of zakahaccording to AAOIFI (FAS No. 9)could contribute to have more transparency of financial reporting. In other words, the financial statements will be more transparent and easily comparable. This paper concludes with some recommendations in order to improve the quality of transparency of financial reporting as well as to example of main differences between domestic accounting standards and the AAOIFI accounting standards.