This is especially so given that globalization of Islamic finance offers huge potential for greater intermediation of cross border financial flows, especially surplus funds, between economies from different parts of the world, thus presenting new opportunities for the industry.

Indeed, recently Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the central bank, urged global standard-setting bodies such as the International Accounting Standards Board (IASB), to engage “in this process (of examining the technical issues in financial reporting of Islamic finance) to complement, and to leverage on the current global efforts to converge international accounting frameworks.”

Zeti was speaking at the 18th World Congress of Accountants (WCOA) 2010 which was convened in Kuala Lumpur in November 2010 and organized by the Malaysian Institute of Accountants (MIA) and the International Federation of Accountants (IFAC).

She commended the work done by the Bahrain-based Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in enhancing cross-border comparability of Islamic financial transactions. At the same time, the newly-established regional Asian-Oceanian Standard-setters Group (OSG) is examining the technical issues in financial reporting of Islamic finance.

“The efforts by AAOIFI and OSG represent important contributions to current efforts to evolve an accounting framework that is appropriate and that will support further the global development of Islamic finance. As we enter this new phase of globalization, the cumulative efforts of the standard setters, the regulators and the industry will raise the potential to address the many challenges before us. We need to leverage on the respective areas of strengths and address the weaknesses with unrelenting perseverance,” she declared.

Robert L. Bunting, the president of IFAC, echoed the fact that the global financial crisis highlighted the interconnectedness of the global economy — which once again underscores the need for global standards. “While national standards should reflect the local mores and business practices,” he added, “they should be based on international standards, which help foster high quality financial information, which in turn increases financial comparability, clarity and transparency. As a result, stability fosters confidence in the markets of emerging nations, which in turn increases international investment; facilitates regional and international economic integration; and, by stimulating economic growth, produces a wealth of social benefits, including poverty reduction and a mitigation of corruption.”

In a global financial environment that is faced with extraordinary challenges of regulatory reforms and uncertainties, Islamic finance, with estimated funds under management totaling $1 trillion, is proving to be a positive force. Shariah principles require that financial transactions in Islamic finance be accompanied by an underlying productive economic activity that will generate legitimate income and wealth. As such this connects the sector to the real economy.

Its profit and risk sharing requires the appropriate due diligence, disclosure and transparency, and emphasis the importance of governance and risk management. The Shariah Board in the respective individual financial institutions is an extra layer of oversight. Not surprisingly, explained Zeti, despite the turmoil and uncertainties in the global financial system, Islamic finance has demonstrated its resilience and its continued global expansion during this period, expanding at an average annual rate of 20 percent and representing one of the fastest growing segments in the financial industry.

On financial reporting, Governor Zeti observed that applying the existing accounting frameworks and conventions to Islamic financial institutions may prove to be more challenging given the unique features of Islamic financial transactions such as the equity based and profit sharing contracts. Given the risk sharing features of these contracts, it may raise the case for a higher level of transparency for users to better understand and be better positioned to assess the underlying risks and their likely financial impact.

Similarly, there are different views on how conventional accounting concepts, such as reporting based on substance over form, and cash flow discounting principles, can be applied to Islamic financial transactions. As such, she advised greater understanding on these issues to further evolve solutions that would improve the value of financial reporting.

Abdul Rahim Abdul Hamid, the president of MIA, in a recent interview with Epicentre, the newsletter of the Malaysia International Islamic Financial Centre (MIFC), acknowledged that the conventional and Islamic financial systems are separate systems but in terms of value there shouldn’t be any difference and that good accounting practices always contribute to a better set of reporting.

He does not think there is a need to have a separate accounting standards regime for Islamic finance.

“Accounting is done for business transactions. Some of the Islamic finance products are less than standard. Therefore, they require a certain accounting treatment. However, a trade is a trade and a sale is a sale. Any jurisdiction should have a basic accounting standard, which may take into account the differences that may happen from time to time,” he added.

In Malaysia, the default standard is the international financial reporting standard. The basic concepts underlying the preparation and presentation of financial statements should not be different for any transaction and event, be it Islamic or non-Islamic. “Using a common framework to report on Islamic and conventional transactions,” maintained Abdul Rahim, “would enhance the transparency and international comparability of financial reporting for Islamic finance. The international accounting standards focus on the economic substance of the transaction rather than its legal form. The principles-based nature makes it possible to recognize, measure and disclose the economic substance of Islamic finance without compromising Shariah principles. Provided the framework is sensibly applied, and supported by appropriate explanatory disclosures, the existing international standards regime suffices. The MASB issues statement of principles and technical release that complements the existing international standards. These are also applied to Islamic transactions. Unless there is a clear Shariah prohibition, which to our knowledge has not been encountered to date, the existing international standards are applicable.”

MASB accounting standards carry the force of law in Malaysia, where The Financial Reporting Act 1997 (FRA) requires financial statements to be prepared or lodged under any law administered by the Securities Commission, the Central Bank or the Registrar of Companies, in accordance with the approved accounting standards of the Malaysian Accounting Standards Board (MASB). As such, these standards take precedence in Malaysia, which is why Malaysia has not adopted the standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in relation to Islamic financial reporting. However, the MASB has been keeping abreast of AAOIFI’s developments to understand the relevance of any views that may impact on Malaysian Islamic finance transactions.