Book Review for Islamic Financing: Shift from Debt to Equity: An Anaylsis of Business Framework (2011) by Dr. Muhammad Hanif, Associate Professor (Islamabad)
By: Camille Paldi
This brief but brilliant book takes the reader on a fascinating voyage through the financial reporting and accounting world of the conventional and Islamic finance industries and examines the methods currently being utilized and cross-utilized by the conventional and Islamic finance systems. In addition, the author diligently points out the strengths, weaknesses, and loopholes of the current international accounting and reporting framework and makes suggestions for the improvement of the system with the aim of improving the conventional system and preserving the intention of Islamic finance and the Islamic finance industry.
This highly intellectual and thought-provoking book begins with Chapter One: Introduction, which includes a precise explanation of riba (interest), Islamic banking, Why and how the Islamic financial system was developed, and the different modes of Islamic finance. The author reveals that as of December 2008, there were approximately 280 Islamic finance institutions in more than 50 countries managing funds of US$951 Billion Dollars. Under Shari’ah compliant instruments, return of the financier is pre-determined and fixed. Risk of return is minimized, while under Shari’ah based transactions, return is linked with outcome. Dr. Hanif points out that the conventional accounting standards and laws have failed in elimination of accounts manipulation; hence, calculation of true profit and loss could not be achieved. It is clear that the share of the financier in return is linked with the outcome of the project under Shari’ah based modes of financing. The outcome of the business project is neither certain nor pre -determined. The share of the financier in Islamic finance also affects the way that financial results are reported. Due to the use of inconsistent and conventional accounting and reporting standards with a few optional Islamic standards in the Islamic finance industry, financial reports of Islamic firms are not transparent, do not reflect true profit calculation, are often manipulated, and often do not depict economic reality nor shed light on the true financial health of an IFI. A serious adverse effect resulting from the use of conflicting standards across the Islamic finance industry, includes non-comparability of financial statements, which implies that differences in financial statements are the result of different financial accounting treatments.
In Chapter Two, Financial Reporting Framework, Dr. Hanif provides a thorough academic and technical overview of the objectives of financial reporting, the uses of financial reporting and their needs, the conceptual framework for financial reporting, financial reporting principles, and the issues and concerns in financial reporting. The author includes various tables, which illuminate these topics including the following: The general objectives of financial statements, Summary of the particular objectives of financial reporting as per APBS-4, Summary of the qualitative objectives of financial reporting as per APBS-4, Summary of the users (and their needs) of financial reports, Summary of accounting principles, and Summary of transactions structuring (tools of manipulation). After reading this chapter along with examining the various tables, it became quite clear what is the function of financial reporting, who needs financial statements and why, the theory, objectives, principles, and concepts behind the statements, and how the statements are produced in reality with the resulting impact on the conventional and Islamic financial systems.
In Chapter Three, Dr. Hanif discusses the definition of earnings management, motives behind earnings management, measuring methods of earnings management, earning manipulation tools, factors assisting in managing earnings, controlling tools, and consequences of earnings management. Earnings are managed to hide weaknesses of management. When management fails in meeting targets then the last option is to manipulate accounting numbers keeping in view the pressure of stakeholders’ expectations. This has already occurred in the conventional world on a large scale with ENRON and there is room for a similar scandal in the Islamic financial world, due to the number of loopholes created by the use of conventional and inconsistent standards for accounting and reporting across the Islamic finance industry. The whole contract of Shari’ah based financing is based on the principle of sharing outcome, which is depicted through the profit and loss account. According to Dr. Hanif, if accounting figures are manipulated, the true outcome is not displayed. Dr. Hanif explains that earnings management is not affecting the conventional system as the IFI’s return is fixed. However, in contrast, the author reveals that earnings management impacts Islamic IFI’s greatly as the whole business depends upon the result communicated through financial reports. Dr. Hanif says that through regulation, capacity building of auditing professionals, compensating management through stock ownership, creating an environment of job security for managers, and producing a financially literate board of directors’, earnings management can be minimized.
In Chapter Four, Dr. Hanif includes an Opinion Survey, which sheds light upon ‘Why the Musharakah mode of financing is not as popular as other modes used by IFIs according to different market players’; and ‘How the share of Shari’ah based financing can be increased in comparison with Shari’ah compliant financings by IFIs.’ Chapter Five concludes with “What are the aims and findings of this research?,” “What is the practical application of these findings?,” “What were the limitations of this study?,” and “What are the areas identified for future research?”
Dr. Hanif makes several key recommendations for improvement including that AAOIFI, an accounting standard setting body in Bahrain, should examine these issues and prepare guidelines for businesses dealing with Islamic financial institutions under Musharakah and Mudharabah financing for the purpose of preparing a special set of accounts and earnings calculations to determine the share of Islamic banks and that these guidelines might become binding rather than just optional.
Overall, this book is a comprehensive academic exercise for comprehensively and comparatively learning about all of the different accounting methods and principles around the world in existence today, the purpose of financial reporting in theory, objective, and practice, and the impact of the current methods and practices on the conventional and Islamic finance industries. In addition, it is quite a useful exercise in earnings management. This is a must-read for anyone working in the conventional or Islamic finance space, academic, or accounting, finance, or business student!