Islamic banking: A gross accounting misnomer
it is virtually attributed to Islam and | Friday, 8 April 2011
it is virtually attributed to Islam and
knowledge-base of the people concerned, Afzalul Haq Now-a-days accountancy has become an important academic and professional discipline. It does no more remain a mere tool but has now been recognised as a very sophisticated and highly systematic discipline. Accounting deals with, among many other things, recognition, measurement and fair recording of transactions, reporting of the organisation's operational results and finally true and fair presentation of the state of affairs thereof. Although accounting is not a language of mass people, by this time some of the accounting knowledge has become the part of general knowledge, at least a common business language. For example, study or observation of Annual Report of any company is a matter of common interest for any stakeholder from any discipline. Keeping the above scenario in mind we would now focus on typical recording of a transaction commonly conducted in the realm of Islamic banking of the country. In any recognised standard of accounting, it is beyond controversy that all payables denote a liability and as such recorded as a credit (liability) item. Correspondingly, all receivables denote an asset and hence recorded as debit (asset). It is surprising to observe an entry in the accounting books of many an Islamic bank in our country of 'profit receivable' as a liability item. This goes against the basic accounting principle of any standard, recognised in any country of the world. It's also a gross violation of Golden Rule of Double Entry System, well established doctrine of accounting. Study, as well as observation of different operation manuals and above all practical records of some Islamic banks demonstrates a gross contradiction. Islamic banks extend investment (Credit/ Loans & Advances) under different modes. Under trading modes they can sell commodities on credit to its clients at a profit over cost price. Our topic would be to talk about their recording procedure thereon. As usual, a sale in the book of bank is recorded in the name of the purchaser in the form of respective investment account, say, Murabaha (Muajjal) for the sale price. Bank records it to the debit of the concerned investment account with corresponding 2 entries, separately for cost price and the profit (say Tk.100+Tk.6 respectively). For example, Fact of the above entry reveals that total sales price receivable amount is recorded as a debit entry for the consolidated amount of Tk.106 (Tk.100 for purchase/cost and Tk.6 for profit). Correspondingly Tk.100 is credited to neutralise purchase or the cost price and Tk.6 is credited as profit/mark-up over cost. No problem arises if it is as simple as that. Had this Tk.6 been recorded as final profit of the venture (investment income), there would remain no controversy. But problem arises when this profit amount is recorded to the credit under the nomenclature of 'Profit Receivable'. As already stated 'Receivable' is supposed to be a debit entry as an asset item. In accounting, a profit is receivable and treated as asset when falls due but not received/collected. As such it is profit earned but not yet realised from the counter party. On the other hand, profit may be recorded as a liability when it remains payable to the counter party until it is paid. It is rather a profit of the counter party and obviously an incurred cost not paid off by the bank. Ours is the former case. For clarification it is worth mentioning that in banking practice, the sale is usually made on credit say for 6 months. Recognition of the whole amount of profit on execution of sales would not as usual create any problem in accounting of profit. But in practice what the bank does is that, it spreads that profit/income over the whole period, as noted 6 months in this case. Let us see how this spreading is conducted. Islamic bank transfers profit of taka one each month for the sake of uniform distribution of the same over the concerned period. As such Tk.6 is distributed @ Tk. 1/- per month. A gross misnomer takes place in many an Islamic bank of the country when profit is instantly credited to the Profit Receivable Account and reversed proportionately throughout the whole period by crediting to Investment Income Account at the end of each month. Practice of spreading the income or profit amount over the total period concerned makes good sense; but problem is to name the profit suffixing the wrong term 'Receivable' and its posting to the credit. In fact this expected profit is duly awaited for its monthly recognition over period i.e, total Tk.6 is not recognized as profit instantly. Rather it is recognition of the total due (cost + expected profit) amount from the purchaser/investment client. But as profit, it is recognized later on, gradually to the credit of Investment Income Account. Profit expected or asked for is, therefore, treated as a corresponding liability to be transferred to actual income on accrual or realization or any other basis according to the policy of the organisation. This process of spreading the expected profit throughout the period concerned is fair enough. But the nomenclature of the liability account (against the expected profit amount included in the sales price) must commensurate with the connotation of liability/credit. This connotation mismatches the term Profit Receivable. The word receivable, therefore, must be replaced by an appropriate term that denotes liability and not to be a misnomer of asset. In other words, we are talking about an expected profit which is yet to be spread over or apportioned. This profit is to be taken into the books of income later on. Then it indicates a liability like unearned or unexpired income. According to nature of treatment it should have a nomenclature indicating liability rather than asset. As we like to record it as a component of other liabilities, it is better to choose a word unearned/unexpired/unapportioned or the like to suffix or prefix the term Profit; but must not denote misnomer of asset instead of liability. As such, the right form of the full term may be 'Unapportioned Profit' instead of 'Profit Receivable'. A period of 28 years is enough for making such an accounting entry alright in the realm of Islamic banking of the country. To the best of our knowledge, some of the Islamic Banks have recruited professional accounting people in their Accounts and Finance Department. Moreover, it is mandatory to have the accounts of a bank duly audited by one or more CA firms. How this fundamental thing can remain beyond their sight for about three decades? We cannot afford to have any gross conceptual misgivings in the Islamic banking because it is virtually attributed to Islam and the Muslims. This demonstrates the poor knowledge-base of the people concerned. To err is human. Correction always deserves appreciation. We should bring our accounting practice within the purview of Generally Accepted Accounting Principles (GAAP). Writer is the First Vice President of Bank Asia Limited. He can be reached through e-mail: [email protected] .Opinions expressed in the article are of the writer's own and not necessarily of the organization he is working for
knowledge-base of the people concerned, Afzalul Haq Now-a-days accountancy has become an important academic and professional discipline. It does no more remain a mere tool but has now been recognised as a very sophisticated and highly systematic discipline. Accounting deals with, among many other things, recognition, measurement and fair recording of transactions, reporting of the organisation's operational results and finally true and fair presentation of the state of affairs thereof. Although accounting is not a language of mass people, by this time some of the accounting knowledge has become the part of general knowledge, at least a common business language. For example, study or observation of Annual Report of any company is a matter of common interest for any stakeholder from any discipline. Keeping the above scenario in mind we would now focus on typical recording of a transaction commonly conducted in the realm of Islamic banking of the country. In any recognised standard of accounting, it is beyond controversy that all payables denote a liability and as such recorded as a credit (liability) item. Correspondingly, all receivables denote an asset and hence recorded as debit (asset). It is surprising to observe an entry in the accounting books of many an Islamic bank in our country of 'profit receivable' as a liability item. This goes against the basic accounting principle of any standard, recognised in any country of the world. It's also a gross violation of Golden Rule of Double Entry System, well established doctrine of accounting. Study, as well as observation of different operation manuals and above all practical records of some Islamic banks demonstrates a gross contradiction. Islamic banks extend investment (Credit/ Loans & Advances) under different modes. Under trading modes they can sell commodities on credit to its clients at a profit over cost price. Our topic would be to talk about their recording procedure thereon. As usual, a sale in the book of bank is recorded in the name of the purchaser in the form of respective investment account, say, Murabaha (Muajjal) for the sale price. Bank records it to the debit of the concerned investment account with corresponding 2 entries, separately for cost price and the profit (say Tk.100+Tk.6 respectively). For example, Fact of the above entry reveals that total sales price receivable amount is recorded as a debit entry for the consolidated amount of Tk.106 (Tk.100 for purchase/cost and Tk.6 for profit). Correspondingly Tk.100 is credited to neutralise purchase or the cost price and Tk.6 is credited as profit/mark-up over cost. No problem arises if it is as simple as that. Had this Tk.6 been recorded as final profit of the venture (investment income), there would remain no controversy. But problem arises when this profit amount is recorded to the credit under the nomenclature of 'Profit Receivable'. As already stated 'Receivable' is supposed to be a debit entry as an asset item. In accounting, a profit is receivable and treated as asset when falls due but not received/collected. As such it is profit earned but not yet realised from the counter party. On the other hand, profit may be recorded as a liability when it remains payable to the counter party until it is paid. It is rather a profit of the counter party and obviously an incurred cost not paid off by the bank. Ours is the former case. For clarification it is worth mentioning that in banking practice, the sale is usually made on credit say for 6 months. Recognition of the whole amount of profit on execution of sales would not as usual create any problem in accounting of profit. But in practice what the bank does is that, it spreads that profit/income over the whole period, as noted 6 months in this case. Let us see how this spreading is conducted. Islamic bank transfers profit of taka one each month for the sake of uniform distribution of the same over the concerned period. As such Tk.6 is distributed @ Tk. 1/- per month. A gross misnomer takes place in many an Islamic bank of the country when profit is instantly credited to the Profit Receivable Account and reversed proportionately throughout the whole period by crediting to Investment Income Account at the end of each month. Practice of spreading the income or profit amount over the total period concerned makes good sense; but problem is to name the profit suffixing the wrong term 'Receivable' and its posting to the credit. In fact this expected profit is duly awaited for its monthly recognition over period i.e, total Tk.6 is not recognized as profit instantly. Rather it is recognition of the total due (cost + expected profit) amount from the purchaser/investment client. But as profit, it is recognized later on, gradually to the credit of Investment Income Account. Profit expected or asked for is, therefore, treated as a corresponding liability to be transferred to actual income on accrual or realization or any other basis according to the policy of the organisation. This process of spreading the expected profit throughout the period concerned is fair enough. But the nomenclature of the liability account (against the expected profit amount included in the sales price) must commensurate with the connotation of liability/credit. This connotation mismatches the term Profit Receivable. The word receivable, therefore, must be replaced by an appropriate term that denotes liability and not to be a misnomer of asset. In other words, we are talking about an expected profit which is yet to be spread over or apportioned. This profit is to be taken into the books of income later on. Then it indicates a liability like unearned or unexpired income. According to nature of treatment it should have a nomenclature indicating liability rather than asset. As we like to record it as a component of other liabilities, it is better to choose a word unearned/unexpired/unapportioned or the like to suffix or prefix the term Profit; but must not denote misnomer of asset instead of liability. As such, the right form of the full term may be 'Unapportioned Profit' instead of 'Profit Receivable'. A period of 28 years is enough for making such an accounting entry alright in the realm of Islamic banking of the country. To the best of our knowledge, some of the Islamic Banks have recruited professional accounting people in their Accounts and Finance Department. Moreover, it is mandatory to have the accounts of a bank duly audited by one or more CA firms. How this fundamental thing can remain beyond their sight for about three decades? We cannot afford to have any gross conceptual misgivings in the Islamic banking because it is virtually attributed to Islam and the Muslims. This demonstrates the poor knowledge-base of the people concerned. To err is human. Correction always deserves appreciation. We should bring our accounting practice within the purview of Generally Accepted Accounting Principles (GAAP). Writer is the First Vice President of Bank Asia Limited. He can be reached through e-mail: [email protected] .Opinions expressed in the article are of the writer's own and not necessarily of the organization he is working for