Emerging Issues on Accounting & Reporting of Zakat: A Personal Reflection

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Prof. Dr. Abdul Rahim Abdul RahmanKuala Lumpur Metropolitan University College (KLMUC)

(abdulrahim.iium@gmail.com)

Meanings of Zakat

General Meaning

“a compulsory levy imposed on the Muslims so as to take

surplus money or wealth from the comparatively well-to

do members of the Muslim Society and give it to the

destitute and needy”.destitute and needy”.

Literal Meaning (Arabic word)

1. ‘Growth’ or ‘Increase”

� Giving Zakat will increase in prosperity in this world and religious merit in the hereafter.

2. ‘Purity’

� Purifies from sins (“take from their property (sadaqah) in order to purify them (tuzakkihim)” Al-Qur’an 9:104.

Note: Both meanings have spiritual connotations.

Issue 1:What could be the generally accepted

accounting principles on Zakat? accounting principles on Zakat?

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Principles of Zakat Accounting

1. Individual Right of Ownership

� Wealth belongs to government, community or Waqf is not subjected to Zakat

2. The valuation of assets should be based on current or market value.

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market value.

� show the most accurate and relevant value of the assets

� measure the net worth of the individual/company

3. Yearly principle

� assets should be owned for one full year (Haul).

� Zakat charged only once a year (except for agriculture produce)

Principles of Zakat Accounting

4. Ability to Pay� The aim of Nisab (minimum requirement) is to ensure

Zakatable wealth is in excess of normal requirements.5. Full Disclosure� Zakat computation must be true and fair

Zakat payers need to truthfully disclosed all his/her

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� Zakat payers need to truthfully disclosed all his/her financial facts.� In the case of companies, is the audited financial

statement a reliable financial fact? 6. Objectivity (True and Fair View)� Measurement must be objective and quantifiable � Justice to both Zakat payers (who hold the financial

obligation) and Zakat beneficiaries (who are the rightful recipients of Zakat).

Issue 2:What is the most appropriate basis of asset

valuation for Zakat purposes? valuation for Zakat purposes?

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Basis of Asset Valuation: An Islamic Perspective

� Ibn Rushd: Historical Costs

� Jabir Ibn Ziyad: Sale (Market) Value on the day Zakat is determined

� Prof. Monzer Kahf: Lower of Cost or Market Value

� Prof. Shehatah: Current Price/Selling Price/Market

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� Prof. Shehatah: Current Price/Selling Price/Market Price (expected or estimated)

� AAOIFI FAS 9: Cash Equivalent Value

Fair Value Accounting

� Fair value is the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction� Fair value has been introduced in IFRS as� Fair value has been introduced in IFRS as

� A means of putting a value on an incomplete transaction

� A measurement attribute for subsequent measurement in a number of significant standards

Fair Value Measurement

� Fair value is a market-based measurement and as such not affected by factors specific to a particular company� If available, an observable market price in an active

market is the best evidence of fair valuemarket is the best evidence of fair value� But what if:� a) there is more than one market price� b) the market is illiquid� c) there are no recent prices� d) there is no market for the specific item to be

measured � Reliability and objectivity concerns

Financial instruments

� Financial instruments include cash, receivables, payables, equity and debt instruments as well as derivatives and some commodity contracts � FRS 139 Financial Instruments: Recognition and

Measurement establishes principles for recognizing Measurement establishes principles for recognizing and measuring financial instruments

Fair Value Framework - Measurement

� Fair value hierarchy� Prioritizes inputs to the valuation technique used to

measure fair value� Level 1 – quoted prices (unadjusted) in active � Level 1 – quoted prices (unadjusted) in active

markets for identical assets and liabilities� Level 2 – inputs and other quoted prices included in

Level 1 that are observable either directly or indirectly

� Level 3 – unobservable inputs reflecting the reporting entity’s own assumptions about market participant assumptions

Fair Value Framework - Measurement

� Valuation techniques consistent with market, income and/or cost approaches shall be used to measure FV� Market Approach – Uses observable prices and other relevant

information generated by market transactions involving identical or comparable assets or liabilities� Income Approach – Converts cash flow or earnings to a single � Income Approach – Converts cash flow or earnings to a single

present amount (discounted) . Value indicated by current market expectation about future amounts� Cost Approach – Amount that would currently be required to

replace the service capacity of an asset (current replacement cost)

� Use valuation techniques that are appropriate in the circumstances and for which sufficient data are available

Fair Value Accounting - Issues

� The Problem – Reliability of measures� Different parties could get inconsistent measures� Possible for management to influence measures

� Financial statement users still prefer fair value while � Financial statement users still prefer fair value while many do not believe the “market” is always the most accurate reflection of a transaction/account

Cash Equivalent Value or Fair Value?

� AAOIFI FAS 9 for Zakat prefers Cash Equivalent Value (CEV)� IFRS prefers Fair Value (FV) especially for financial

assets.� However, CEV is not FV!� However, CEV is not FV!� Do we still remember Realisation Principle i.e.

recognise when realised?� How to realise the value based on fair value and

current cash equivalent without selling the asset or objectives measurement techniques?� Thus, if failed realisation test, then no recognition.� How about prudence concept? Does FV violates

prudence principle?

Is Fair Value, really fair?

� Is FV really reflects true value?� Fair to whom? Preparers (IFIs) or Users (investors,

shareholders etc.) or both?� Shari’ah issue: Is quoted market price even if

available reflect true value? Will FV leads to Gharar?available reflect true value? Will FV leads to Gharar?� How about the speculative value of financial assets?

How about changes in economic situation (booming vs. recession) that affect value?� Since many IFIs will be adopting FRS 139, the

challenge for accountants in IFIs to account, measure and report objectively.

Method of Assets Valuation for Zakat

� AAOIFI FAS 9: Market Value (market selling price or cash equivalent value) whenever possible

Reasons:

� Zakah base should include the historical cost and any holding gains (or losses)

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holding gains (or losses)

� To reflect the true value of the assets and the current financial position of the entity

� However, trade liabilities, long term liabilities, equity, and fixed assets are permissible to be valued at book value

� Differences in valuation will affect the assessment and adjustment of the differences in the valuation need to be provided

AAOIFI FAS 9

AAOIFI: Cash Equivalent Value (most preferred in the case of Zakat valuation if the following are available):� availability of objective indicator;� relevant information;� logical and relevant valuation� logical and relevant valuation� consistency of valuation methods� experts valuation� conservatism in the valuation process

Issue 3:What should be the most appropriate method of

Zakat measurement for financial assets?Zakat measurement for financial assets?

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Zakat Accounting for Shares and Sukuk

If shareholders or investors acquired the shares for long-term investment or as a way to gain control over the company’s capital (Held to Maturity), or as a participation (stake) in the company’s capital, the shares are considered as fixed assets. Thus, only its income generated (i.e. dividend) will be

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Thus, only its income generated (i.e. dividend) will be subjected to Zakat at 10% (as for agriculture produce).

If shareholders acquired the shares for trading activity, it is considered current assets, and its value and income is subject to Zakat. Thus, Zakat on Shares = (Market Value of Shares x Quantity) x 2.5%.

Zakat Accounting for Shares and Sukuk

� Zakat on Sukuk has been argued should be charged as a form of valuable trading commodity. � Thus, Zakat for Sukuk = (Current Market Value x

Quantity) x 2.5% � Is quoted market price of shares and sukuk at the end of

the zakat year is the best valuation for Zakat purposes?

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the zakat year is the best valuation for Zakat purposes? What option do we have?� How about the haul requirement?� Why don’t we average out i.e. Average Daily Net Asset

Value of the shares and sukuk throughout the year? If shares are traded in the open market then it is possible.

Issue 4:Why do we have difficulties to comply with

AAOIFI FAS 9 on Zakat for IFIs? AAOIFI FAS 9 on Zakat for IFIs?

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AAOIFI Financial Accounting Standard No. 9

Why do we need Accounting Standard for Zakat?

� Consistency

� Comparability

� Compliance

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� Compliance

Scope of the Standard:

(1) The determination of Zakah base (methods of assessment)

(2) The measurement of items included in the Zakah base (methods of valuation)

(3) Disclosure requirements in the Financial Statement

AAOIFI FAS 9

� Effective beginning 1 Muharam 1420H or 1 January 1999

� However, in many Muslim countries the standards served only as guidelines which they are not supposed to be complied with

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supposed to be complied with

� This is due to the required compliance with the respective countries Central Bank guidelines and by-laws

AAOIFI FAS 9: Reporting Requirements

� Methods used for determining Zakah base and items included in the base

� The ruling of the Syari’ah Board of the Islamic Bank on issues related to Zakah that are not included in the standard

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standard

� Statement on whether or not the Islamic Bank as a holding company pays its share of Zakat obligation of its subsidiaries

� In the case the Islamic Bank does not pay Zakah, the amount of Zakah due should also be disclosed

AAOIFI FAS 9: Reporting Requirements

� Whether or not the Islamic bank collects and pay Zakah on behalf of the holders of the investment accounts and other accounts

� Restrictions imposed by the Syari’ah Supervisory Board of the Islamic Bank in determining Zakah base

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of the Islamic Bank in determining Zakah base

� The disclosure requirements of FAS 1: General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions shall be observed

Issue 5:Is conventional accounting and reporting

standards address the needs of zakat standards address the needs of zakat accounting and reporting?

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Fairness in Accounting

� Fairness = Neutrality of the accountant in the preparation of annual reports� Scott (1941) “Accounting rules, procedures and

techniques should be fair, unbiased and impartial. They should not serve a special interest” (Is it possible?)possible?)� Fairness = Conservatism (Prudence) = Objective� Lee (1976) “Accounting must be based on firm,

verifiable evidence (whenever possible), and it must not be such as to tend to benefit a particular user (or group of users) to the relative detriment of others” (Is it possible?)

True and Fair View?

� True = “accounting information contained in the financial statements has been quantified and communicated in such a way as to correspond to the economic events, activities and transactions it is intended to describe” (Lee, 1971) � Fair = “accounting information has been measured and � Fair = “accounting information has been measured and

disclosed in such a manner which is objective and without prejudice to nay particular sectional interests in the company” (Lee, 1971) � What does it means by faithful representation? Do we

have objective measure? What are the guiding principles?

Questions to ponder

1. Is accounting a value-free and neutral scientific knowledge just like computer science, physics, chemistry etc.?

2. Since accountants are human beings, do you think accounting is an objective and scientific knowledge or accounting is an objective and scientific knowledge or a subjective and social science kind of knowledge?

3. How `true’ and `fair’ is conventional accounting for zakat purposes?

4. Would the accountants belief-system or ideology affect accountants and accounting?

5. Would the different economic and financial system lead to different accounting system?

Islamic Worldview & Accounting

� Transcendental accountability to Allah SWT (Hablumminallah)� Social accountability to the society (Hablumminan-nass)� Individuals as trustees or Khalifah (vicegerents)� Success in this world and in the hereafter (Falah)� Success in this world and in the hereafter (Falah)� Economic goals beyond purely wealth maximization and

include Tazkiyah (purification of self and wealth i.e. Zakat)� Personal accountability (Taklif) � Justice (Adalah) in relationships, contracts, and activities� Maslahah i.e. public interest is more important than

personal interest.