Is accounting a mere technical matter or is there any question of ideology or value judgment? In other words, is an accounting system followed by the conventional bank compatible to Islamic Shariah or is it necessary for Islamic banks to design their own accounting system? As we know Islam is a way of life where ends does not justify means rather both ends and means should be justified. Islam has its own objectives and the ways and means to achieve those objectives. Like all others spheres of life in the banking sector Islamic scholars have developed their own banking system that differs from conventional banking system both in terms of philosophy and operational mechanism. Undoubtedly the accounting system is a very technical matter but not without any principle or philosophy. So, the principles and philosophy of the accounting system of an interest-free bank should not be as that of a conventional bank. 

1. Objectives of Financial Accounting for Islamic Banks

              There are two approaches in developing objectives and concepts of financial accounting for Islamic banks:

a)      The first approach is to deduce such objectives and concepts from the Shariah. In this way we can establish the objectives of Islamic accounting based on the principles of Islam and then consider these established objectives in relation to contemporary accounting thought.

b)      The second approach is to start with objectives established in contemporary accounting thought, test them against Islamic Shariah, accept those that are consistent with the Shariah and reject those objected by the Shariah. 

From among these two mutually exclusive alternative approaches of establishing objectives for Accounting and Auditing Organization for Islamic Financial Institutions have decided to adopt the second approach.

Although there is a large degree of similarity between the proposed objectives for financial accounting for Islamic banks and those developed by Western accounting professional bodies, the former require the provision of additional information regarding the compliance of Islamic banks and financial institutions with the Shariah doctrines in their business transactions.  Furthermore, it is proposed that financial accounting for Islamic banks should provide information to assist in separating prohibited earnings which occur advertently or inadvertently, if any, and to verify that such earnings have been utilized for charitable causes.

The objectives of financial accounting for Islamic banks may be described as follows:

a)      To determine the rights and obligations of all interested parties, including those rights and obligations resulting from incomplete transactions and other events, in accordance with the principles of the Islamic Shariah and its concepts of fairness, charity and compliance with Islamic business values;

b)      To contribute to the safeguarding of the Islamic bank's assets, its rights and the rights of others in an adequate manner;

c)       To contribute to the enhancement of the managerial and productive capabilities of the Islamic bank, encourage compliance with its established goals and policies and, above all, compliance with Islamic Shariah in all transactions and events; and

d)      To provide, through financial reports, useful information to users of these reports, to enable them to make legitimate decisions in their dealings with Islamic banks. 

2. INFORMATION FROM financial reports

Financial reports, which are directed mainly to external users, should provide the following types of information:

a) Information about the Islamic bank's compliance with the Islamic Shari'ah and its objectives, and to establish such compliance; and information establishing the separation of prohibited earnings and expenditures, if any, which occurred, and of the manner in which these were disposed of;

b) Information about the Islamic bank's economic resources and related obligations (the obligations of the Islamic bank to transfer economic resources to satisfy the rights of its owners or the rights of others), and the effect of transactions, other events and circumstances on the entity's economic resources and related obligations. This information should be directed principally at assisting the user in evaluating the adequacy of the Islamic bank's capital to absorb losses and business risks; assessing the risk inherent in its investments and; evaluating the degree of liquidity of its assets and the liquidity requirements for meeting its other obligations;

c) Information to assist the concerned party in the determination of Zakah on the Islamic bank's funds and the purpose for which it will be disbursed;

d) Information to assist in estimating cash flows that might be realized from dealing with Islamic bank, the timing of those flows and the risk associated with their realization. This information should be directed principally at assisting the user in evaluating the Islamic bank's ability to generate income and to convert it into cash flows and the adequacy of those cash flows for distributing profits to equity and investment account holders;

e) Information to assist in the evaluating the Islamic bank's discharge of its fiduciary responsibility to safeguard funds and to invest them at reasonable rates of return, and information about investment rates of returns on the bank's investments and the rate of return accruing to equity and investment account holders; and

(f) Information about the Islamic bank's discharge of its social responsibilities. 

3. VARIOUS CONCEPTS OF ISLAMIC Accounting 

3.1 The Accounting Unit

The Islamic Fiqh states that Waqf (trust foundation), mosque and Dar -al-maal (treasury) are units of accountability. The recent Fiqh thinkers extend the application of this concept to companies including an Islamic bank. It requires the identification of those economic activities that are associated with the Islamic bank and can be expressed as the bank's assets, liabilities, revenues, expenses, gains and losses. In other words there will be a separation of entity between Islamic banks and owners in terms of assets and liabilities as resolved by the Council of the Islamic Fiqh Academy. "There is no objection in Shariah to setting up a company whose liability is limited to its capital for that is known to the company clientele and such awareness on their part precludes deception." However, some activities with which the Islamic bank is associated are the activities of other accounting units.  

3.2 The Going Concern

The Mudaraba and Musharaka contracts are for specific periods. However, these are assumed to continue until and unless one or all of the parties to the contract decide to terminate the contract. Islamic banks are based on the Mudaraba contract and are, therefore, assumed to continue unless there is evidence to the contrary. Wealth is deviled by Islamic Fuqaha into money and goods. Again goods are deviled into two categories, those that are available for sale and those that are not available for sale. Examples of the second category of goods are equipment and building, which are used for longer periods implying that the entity would continue in operation. Financial accounting assumes the continuation of such an entity as a going concern. This means that in preparing the entity's financial statements it is assumed that there is no intention or necessity to liquidate the entity. The major implication of this concept is that the Islamic bank's activities, under this assumption, are assumed to represent continuous streams and the task of financial accounting is to make the most significant measurements possible of the continuous flow of the entity activities.

The going concern concept has special implications for an Islamic bank. Assumptions are made about the continuity of the bank's activities in the future, including its investment activities. However, the relationship between the bank and owners of investment accounts may not continue until the liquidation of investments, when their actual results become known. It may, therefore, be appropriate to measure investments during the life of such investments at their cash equivalent values in order to achieve equity in determining the rights of the holders of investment accounts who wish to withdraw their funds before the actual liquidation of investments. 

3.3 The Periodicity

The periodicity concept means that the life of the Islamic bank should be broken into reporting periods to prepare financial reports that provide interested parties with information or directions by which they can evaluate the performances of the accounting units.

Islam assigns certain rights to money and wealth and associates those rights with periods of time to assure that those rights are fulfilled on a timely basis. Zakat is an example of this periodicity. Because, according to Islamic Shariah, Zakat is payable on money and wealth after one year of its reaching the 'Nisab'. As prophet (peace be upon him) has said, "No Zakah on wealth until a year passes" (Daraqutni, Baihaqui). Keeping this concept in mind it is believed that there is an obligation on Islamic banks to present periodic reports reflecting their financial positions as of a given date and the results of their operations during a specific period so that rights and obligations of Islamic banks and those of interested parties could be focused. 

3.4 The Stability of the Purchasing Power of the Monetary Unit

As we know financial accounting has to use the monetary unit of a particular currency to facilitate the expression of the basic elements of financial statements. The use of a monetary unit as a means of expressing the basic elements of the financial statements is a prerequisite for measuring the financial position, results of operations and other changes in the financial position of an accounting entity during a specific period. But as we know the value of money is not stable rather it has a tendency to be changed. A persistent increase in the general price level, which is otherwise called inflation, decreases the value (purchasing power of monetary units) and vice versa. In this context economists often question the use of monetary unit as a measuring rod.

There are two schools of thought in Islamic Fiqh with respect to the effect of changes in the purchasing power of money on financial rights and obligations. One school of thought believes that changes in the purchasing power of money should be taken into account when setting financial rights and obligations. The other school of thought believes that they should be ignored. For the purpose of financial accounting, the stability of the purchasing power of the monetary unit is assumed. Regarding the opinion of the first school of thought it can be said that if the changes in the purchasing power of money are taken into account during the setting of financial rights and obligations, then it is nothing but to subscribe the concept of Riba. The Islamic Fiqh Academy reviewed this issue in its meeting held in Kuwait in December 1988 and concluded that debt should be satisfied by an equivalent number of monetary units regardless of the changes, if any, in the purchasing power of the monetary unit to avoid any implications of payment of Riba. 

4.  Accounting Practices 

4.1 Cash Accounting vs Accrual Accounting

There are two types of accounting, namely the cash method and the accrual method. Conventional banks follow the accrual method of accounting. The cash accounting implies that only the incomes and expenditure items that involves inflows and outflows of cash will be given consideration. Accrual accounting, on the other hand implies any income or expenditure accrued will be accounted for accordingly. One example may help to understand the concept. In our country, conventional banks show in their income statement all the interest accrued on their total investment as their income. Experience indicates that only a part of the interest accrued is realized. In this context one can easily raise the question of whether or not it is a misrepresentation on the part of a conventional bank to treat the interest accrued as income knowing fully well that only a part of it could be realized in the end. Is it not fair to show only the part of the interest accrued as income that could be realized? Islam is against any kind of misrepresentation of fact, which is called window dressing in modern accounting. So, Islamic jurists are in favor of cash accounting rather than accrual accounting. But as a matter of fact Islamic banks all over the world do not follow the same accounting system. Even one single bank practices both cash and accrual accounting for different purposes, which is apparently contradictory. Islamic banks use different profit recognition methods for the investment mechanisms, which they use in their application of funds. For example, some Islamic banks recognize the profit generated from Murabaha transactions as soon as the deals are concluded, while other Islamic banks only recognize it either when the installment is due or received in cash or when the full amount due is paid. This suggests that some Islamic banks use cash accounting while others use accrual accounting for the same type of transaction. 

4.2 Treatment of Investment Accounts

The treatment of investment accounts (and fund under management) is another issue on which Islamic banks differ. Some banks treat these accounts as an on-balance-sheet item.  The classification of investment accounts as a liability reveals the contractual relationship of these accounts with the bank. Given that these accounts are based on Mudaraba contracts and, hence, bear their own risk in the event of loss, it is incorrect to classify them as a liability. Rather, each of these accounts should be classified as a separate category by itself on the balance sheet, as will be explained below.

There is no uniformity among those Islamic banks that treat investment accounts as an on-balance-sheet item. Some treat the returns on investment accounts as an expense deducted from the bank's reserves, while in other Islamic banks they are treated as an appropriation of income. 

4.3 Reporting of Social Services

Islamic banks are also divided on the manner of reporting their social services. Some banks issue a statement of the Qard fund (for good faith loans) and /or a statement of the zakah fund showing the amounts that the bank allocated to, or received from, the public to be spent on social services and how these funds were utilized. Other Islamic banks disclose in their annual report a lump sum that they have allocated to these activities, while others do not disclose information on these activities at all.

On the other hand, not all the accounting policies used by some Islamic banks in the preparation of their financial reports match with those advocated by generally accepted Western accounting principles. For example, the Statement of Financial Accounting Standards No. 115, Accounting for Certain Investment in Debt and Equity Securities issued by the Financial Accounting Standards Board in the USA (May, 1993) requires that equity securities classified as trading securities should be reported at fair value, with unrealized gains and losses included in earnings. Islamic banks tend to measure financial assets at cost or the lower of cost or market value and ignore unrealized gains. This is because if unrealized gains are included in earnings, unrestricted investment accounts would be entitled to receive their share in these gains when earnings from mixed investments are distributed between owners of these accounts and shareholders. Furthermore, while financial accounting and reporting in the West is based mainly on accrual accounting, the accounting practices of some Islamic banks tend to rely mainly on a cash basis. 

5. Accounting System of Islamic Banks

In regard to the accounting system of the Islamic bank, it is worth pointing out that the articles which govern this system, as stated in the Bank's Law, are explained and /or detailed by the bank's Board and Management, and that these explanations are subject to the approval of the bank's Shariah Consultant, who must, in turn, elaborate the Shariah standpoint on these explanations.  Some contracts from the bank's law are stated below: 

5.1 Profits Realized From Investments

a)   Profits and losses relating to financing and joint investment activities shall be separated in the accounts from the other income and expenditure relating to other activities and services offered by the bank. The same applies to the income and expenditure of investments for specific purposes, in respect of which a separate account must be kept for each particular project.

b)   In regards to the profit income connected with its financing and investment activities, the bank may not adopt a method of accounting which takes into account estimated or expected profits, but it must confine itself to the profits realized in accordance with the nature of the operations which the bank finances, and in accordance with the following rules:

i)  In the case of individual Mudaraba, the profits shall be realized on the basis of a final settlement of accounts carried out between the bank and the party utilizing the funds, such settlement should be based on actual receipt of the cash and realization of the income and should be duly approved and accepted. The profits of each year shall be entered in the accounts of the year in which such settlement is carried out, whether in respect of the complete project or a part of it.

ii)  In the case of decreasing participation, the profit or income shall be realized on the basis of the net income derived from the project concerned until the end of the financial year, even if such income is not in fact received in cash, as in such event, the income realized shall be treated as money due but not received.

iii) In the case of purchasing for others on a pre-agreed profit basis, the profit shall be realized upon the conclusion of the subsequent contract and on the basis of the difference between the actual cost and the price agreed upon with the party who ordered the purchase.

iv)     The various financing operations shall be charged with all the direct expenses and costs arising there from, and should not be charged with any part of the general overhead expenses of the bank.  

5.2 Apportionment of Joint Investments

a)    In order to replenish the special account for meeting investment risks, the bank shall deduct annually deducts an amount equal to 10% of the net profits realized from various investment operations during that year.

b)    The amounts so deducted annually are kept in a special account to meet any losses exceeding the total profits derived from investment in that year.

c)     The deduction of such percentage should be stopped as soon as the accumulative balance of this account reaches twice the paid-up capital of the Bank.  

5.3 Distribution of Profit Between Shareholders and Investment Account Holders

There are two differing aspects regarding the distribution of profits and losses between shareholders and investment account holders of an Islamic bank:

            a)   Should investment accounts share in all types of revenues and expenses of the bank, or

         b)   Should they only participate in the revenues and expenses pertaining to their investments? 

The latter expenses do not include the administrative expenses of the bank, the external auditor fees or the remuneration of the Board of Directors. Islamic banks tend to differ on the revenues and expenses that determine the return of investment accounts. These include, among other items, gains from foreign currency transactions, provisions for bad and doubtful debts and depreciation charges.  

5.4 Distribution of Profits between the Bank and the Investors

a)   The Board shall announce by public notice the general percentage of profit to be allocated to the general funds participating in joint investments. This announcement is to be made at the beginning of the same financial year and not later than the end of the first month of each year.

b)   The bank, as joint investor, is entitled to the remaining percentage after the deduction of the amount allocated to the investors. The bank shall also be entitled to participate in the profits of joint investments in proportion to the amount of its own funds or the funds, which it is authorized to risk in joint investments.

c)   In determining the funds participating in joint investment, priority shall be given to joint investment deposits and to the holders of Joint Muqarada bonds. The bank may not consider itself as a participant in financing from its own funds in excess of the amounts utilized in financing over the total balances of the investors.

The bank, as a joint investor, shall bear any losses resulting from any cause for which it is legally liable, including any cases where authority is exceeded or insufficient care or caution is exercised by the members of the Board of Directors, the managers, employees or workers of the bank. Insufficient exercise of care for which the bank is answerable shall include any cases of fraud, a4buse of trust, collusion and similar forms of misconduct which fall short of the standards of honesty expected in the management of a joint venture operated by the bank.

Losses incurred which are not attributable to misconduct involving the exceeding of authority or failure to exercise care or caution shall be deducted from the total profits realized for the year in which such losses are incurred. Any excess of losses over the profits that were actually realized during that year shall be deducted from the reserve account opened for covering the risks of investment.

If the total profits realized in the year, together with the reserves accumulated from the previous year are not sufficient to cover the losses incurred, the bank must carry out a comprehensive assessment of expected profits and losses, based on market rates, from operations which are financed by venture funds, which have not reached the stage of final settlement by the end of the financial year. If the result of such assessment indicates that the estimated profits are sufficient to cover the excess loss, the bank must carry forward the excess loss so that it may be covered from the proceeds of the expected profits when they are realized from the operations include in the comprehensive assessment.

If, on the other hand, the estimated profits are less than the excess loss, the bank may treat it as a loss carried forward, provided that the amounts withdrawn from the joint investment deposits and the joint Mudarada bonds shall be charged with a pro-rata of the excess loss, depending on the type of the account in each case.

The Islamic legal consultant who is appointed in accordance with the provisions of this law shall ascertain the existence of a legal doctrinal (Fiqhi) basis to support the charging of any loss resulting from joint investment operations to the bank.

In case of liquidation of the bank, the depositors' rights shall be dealt with as follows:

a)   The rights of depositors in trust deposit accounts, and other deposited funds, which are not intended for investment and participation in investment profits, shall be settled first.

b)   Next the rights of depositors in joint investment accounts shall be settled in accordance with the special conditions applicable to such accounts, as well as shall the rights of the holders of joint Mudarada bonds, who shall receive the same percentage as the depositors in joint investment accounts.

c)   The rights of depositors in specific investment accounts, and of the holders of specific Mudarada bonds, shall be linked to the projects specified for each investment, and they shall bear the risk of such specific investment.

d)   The rights of shareholders shall be settled on the basis of a distribution among them of the remaining fund, in proportion to the shares held by each of them.

e)   The balance of the reserve account for covering investment risks shall be transferred, upon the liquidation of the bank, to the account of the charity (Zakah) fund to be spent for the purposes prescribed under the special law of the aforesaid fund.  

5.5 Final Accounts, Balance Sheet, Profit & Loss Accounts

            The accounts of the Bank are maintained in accordance with banking accountancy methods. The Final accounts shall be closed annually on the thirty-first day of December of every year.

The auditors who are elected in accordance with the provisions of the Articles of Association audit the Annual balance Sheet and Profit-and-Loss Accounts annually, prior to their presentation to the general meeting.

The Investment profits are distributed to investment depositors and holders of Muqarada bonds during the month of January of the following financial year.

The net profits accruing to the bank which are not realized until the end of the financing year shall be apportioned as follows:

a)   10% to the compulsory reserve account, until the balance accumulated in this account becomes equal to the capital of the Bank.

b)   5% to the remuneration of the members of the Board of Directors accounts, to be distributed among them in proportion to the number of meetings attended within the limit prescribed in the Company's Law.

c)   Any percentage the Board may deem necessary to provide a suitable reserve to meet the various liabilities, within a maximum limit of twenty percent of the net profits of that year.

d)   The balance of the profits is distributed to the shareholders in proportion to the number of shares which each of them holds.  

6. ACCOUNTING TREATMENT OF SOME SELECTED ISLAMIC MODES

6.1 Murabaha and Murabaha to the Purchase Order

Measurement of asset value at accosting by the Islamic bank: Concepts of Financial Accounting for Islamic Banks and Financial Institutions stipulates that historical cost shall be the basis used in measuring and recording the assets at the time of acquisition. Therefore, the assets possessed by the Islamic bank for the purpose of selling them on the basis of Murabaha purchase order shall be measured at the time of their acquisition on an historical cost basis. In the cases where the asset value declines below cost whether due to damage, destruction or from other unfavorable circumstances, such decline shall be reflected in the valuation of the asset at the end of each financial period. 

In the case of Murabaha to the purchase ordered who is not obliged to fulfill his promise: If the Islamic bank finds that there is an indication of possible non-recovery of the costs of goods available for sale on the basis of Murabaha to the purchase order who is not obliged to fulfill his promise, the asset shall be measured at the cash equivalent (i.e. net realizable) value. This shall be achieved by creating a provision for a decline in the asset value to reflect the difference between acquisition cost and the cash equivalent value.

Potential Discount to be Obtained After Acquisition of the Asset

(a)         In cases where the Islamic bank is likely, at the time of concluding the contract with the client, to obtain a discount on the asset available for sale on the basis of Murabaha or Murabaha to the purchase order, and the discount is in fact received subsequently, such discount shall not be considered as revenue for the Islamic bank; instead, the cost of the relevant goods shall be reduced by the amount of the discount. Consideration should be given to the impact this will have on both the profits of the current period and future deferred profits.

(b)         The discount may, however, be treated as revenue for the Islamic bank if this is decided by the Shariah supervisory board of the Islamic bank. Such revenue shall be recognized in the income statement.

Murabaha Receivables

Short-term or long-term Murabaha receivables shall be recorded at the time of occurrence at their face value. Murabaha receivables are measured at the end of the financial period at their cash equivalent value. Thus, receivables are valued at the amount of debt due from the customers at the end of the financial period less any provision for doubtful debts.

Profits Recognition

Profits of Murabaha or Murabaha to the purchase order are recognized at the time of contracting if the sale is for cash or on credit not exceeding the current financial period.

Profits of a credit salewhich will be paid for either by means of one payment due after the current financial period or by installments over several future financial periods shall be recognized by using one of the following two methods:

(a)      Proportionate allocation of profits over the period of the credit whereby each financial period shall carry its portion of profits irrespective of whether or not cash is received. This is the preferred method.

(b)      As and when the installments are received. This method shall be used based on a decision by the Shariah supervisory board of the Islamic bank or, if it is required, by the Supervisory authorities. (In both 2/4/1 and 2/4/2 above, revenues and costs of goods sold shall be recognized at the time of concluding the sale contract, subject to the deferral of profits in 2/4/2.)

 Deferred Profits

Deferred profits shall be offset against Murabaha receivables in the statement of financial position.

Early settlement with deduction of part of profit

Deduction of part of profit at the time of settlement: If a client accelerates his payment of one or more installments prior to the date specified for such payment, the Islamic bank may deduct part of the profit to be agreed upon between the Islamic bank and the client at the time of settlement. The deducted amount shall be credited to the Murabaha receivable account and excluded from the profit recognized in respect of the installments. 

Deduction of part of the profit after settlement

The same accounting treatment in 2/6/1 applies if the client accelerates his payments one or more installments prior to the time specified for such payment and the Islamic bank did not allow the client a deduction of part of the profit but asked the client to pay the full amount and thereafter the Islamic bank reimbursed the client with part of the profit. 

Procrastination in payment by, or insolvency of, the client

Procrastination: If the client is delinquent in paying his debt installments, then any additional amount received by the Islamic bank from the client as a penalty (either by mutual agreement or by court ruling) shall be treated according to what the Shariah supervisory board of the Islamic bank deems appropriate either as:

            a) Revenue to the Islamic bank; or

            b) An allocation to a charity fund.

Insolvency: If it becomes evident that the client's non-payment was due to insolvency, then the Islamic bank cannot ask the client to pay any additional amount by way of penalty.       

6.2 MUDARABA

Recognition of Mudaraba capital at time of contracting

Mudaraba financing capital (cash or kind) is recognized when it is paid to the Mudarib or placed under his disposition.

If it is agreed that the capital of a Mudaraba is to be paid in installments, than each installment is to be recognized at the time of its payment.

If the conclusion of a Mudaraba contract is contingent on the occurrence of an event in the future or is delayed to a future time, and the payment of the Mudaraba capital is conditional upon the occurrence of that event, then the Mudaraba capital is to be recognized only when it is paid to the Mudarib.

Mudaraba financing transactions are to be presented in the Islamic bank's financial statements under the heading of": Mudaraba financing." Mudaraba capital provided in the form of non-monetary assets is to be reported as "non-monetary Mudaraba assets." 

Measurement of Mudaraba capital at the time of contracting

Mudaraba capital provided in cash by the Islamic bank is to be measured by the amount paid or the amount placed under the disposition of the Mudarib.

Mudaraba capital provided by the Islamic bank in kind (trading assets or non-monetary assets for use in the venture) is to be measured at the fair value of the assets (the value agreed between the Islamic bank and the client), and if the valuation of the asset results in a difference between fair value and book value, such difference is to be recognized as profit or loss to the Islamic bank itself.

Expenses of the contracting procedures incurred by one or both parties (e.g., expenses of feasibility studies and other similar expenses) are not considered as part of the Mudaraba capital unless otherwise agreed by both parties. 

Measurement of Mudaraba capital after contracting at the end of a financial period

Mudaraba capital is to be measured at the time that the assets are provided to the Mudarib. However, any repayment of the Mudaraba capital is to be deducted from the Mudaraba capital.

If a portion of the Mudaraba capital is lost prior to the inception of work because of damage or other causes without any misconduct or negligence on the part of the Mudarib, then such loss is to be deducted from the Mudaraba capital and is treated as a loss to the Islamic bank. However, if the loss occurs after inception of work, it shall not affect the measurement of Mudaraba capital.

If the whole Mudaraba capital is lost without any misconduct or negligence on the part of the Mudarib, the Mudaraba is terminated and the account is to be settled with the loss being treated as a loss to the Islamic bank.

Recognition of the Islamic bank's share in Mudaraba profits or losses

Profits or losses in respect of the Islamic bank's share in Mudaraba financing transactions that commence and end during a single financial period shall be recognized at the time of liquidation. In the case of Mudaraba financing that continues for more than one financial period, the Islamic bank's share of profits for any period, resulting from partial or final settlement between the Islamic bank and the Mudarib, shall be recognized in its accounts for that period to the extent that the profits are being distributed; the Islamic bank's share of losses for any period shall be recognized in its account for that period to the extent that such losses are being deducted from the Mudaraba capital.

If the Mudarib does not pay the Islamic bank its due share of profits after liquidation or settlement of account is made, the due share of profits shall be recognized as a receivable due from the Mudarib.

Losses resulting from liquidation shall be recognized at the time of liquidation by reducing the Mudaraba capital.

The Mudarib shall bear the losses incurred due to misconduct or negligence on his part. Such loss shall be recognized as a receivable due from the Mudarib. 

6.3  MUSHARAKA 

Recognition of the Islamic Bank's Share in Musharaka Capital at the Time of Contracting

The Islamic bank's share in Musharaka capital (cash or kind) is to be recognized when it is paid to the partner or made available to him on account of the Musharka. This share shall be presented in the Islamic bank's book under a Musharaka financing account with (in the name of the client) and it should be included in the financial statement under the heading "Musharka financing". 

Measurement of Islamic Bank's Share in Musharaka Capital at the Time of Contracting 

a)         The Islamic bank's share in the Musharaka capital provided in cash is to be measured by the amount paid or made available to the partner on account of Musharaka. 

b)         The Islamic bank's share in Musharaka Capital provided in kind (trading assets or non-monetary assets for use in the venture) is measured at the fair value of the assets (value agreed between the partners), and if the valuation of the assets result in a difference between fair value and book value, such difference shall be recognized as profit or loss to the Islamic bank itself.

c)         Expenses of the contracting procedures incurred by one or both parties (e.g., expenses of feasibility studies and other similar expenses) should not be considered part of the Musharaka capital unless otherwise agreed by both parties. 

Measurement of the Islamic Bank's Share in Musharaka Capital  After Contracting at the End of a Financial Period 

a)          The Islamic bank's share in the constant Musharaka capital is to be measured at the end of the financial period at historical cost (the amount which was paid or at which the asset was valued at the time of contracting)

b)          The Islamic bank's share in the diminishing Musharaka is to be measured at the end of a financial period at historical cost after deducting the historical cost of any share transferred to the partner (such transfer being by means of a sale at fair value). The difference between historical cost and fair value shall be recognized as profit or loss in the Islamic bank's income statement.

c)          If the diminishing Musharaka is liquidated before complete transfer is made to the partner, the amount recovered in respect to the Islamic bank's share shall be credited to the Islamic bank's Musharaka financing account and any resulting profit or loss, namely the difference between the book value and the recovered amount, Is to be recognized in the Islamic bank's income statement.

d)          If the Musharaka is terminated or liquidated and the Islamic bank's due share of the Musharaka capital (taking account of any profits or losses) remains unpaid when a settlement of account is finalized, the Islamic bank's share shall be recognized as a receivable due from the partner.  

Recognition of the Islamic Bank's Share in Musharaka Profits or Losses

a)         Profits or losses in respect of the Islamic bank's share in Musharaka financing transactions that commence and end during a financial period is to be recognized in the Islamic bank's accounts at the time of liquidation.

b)         In the case of a constant Musharaka that continues for more than one financial period, the Islamic bank's share of profits for any period, resulting from partial or final settlement between the Islamic bank and the partner, is to be recognized in its accounts for the period in which the profits are distributed.  On the other hand, the Islamic bank's share of losses for any period is to be recognized in its accounts for that period to the extent that such losses are being deducted from its share of the Musharaka capital.

c)         Item 4(b) also applies to a diminishing Musharaka, which continues for more than one financial period, after taking into consideration the decline in the Islamic bank's share in Musharaka capital and its profits or losses.

d)         As implied by item 3(d) above, if the partner does not pay the Islamic bank its due share of profits after liquidation or settlement of account is make, the due share of profit is to be recognized as a receivable due from the partner.

e)         If losses are incurred in a Musharaka due to the partner's misconduct or negligence, the partner shall bear the Islamic bank's share of such losses. Such losses are to be recognized as a receivable due from the partner.

f)          The Islamic Bank's unpaid share of the proceeds as mentioned above in items 3(d) and 4(d), is to be recorded in a Musharaka receivables account. A provision is to be made for these receivables if they are doubtful.   

7. THE MIS SYSTEM AND THE ELECTRONIC BANKING  

Banking services are probably the fastest growing services of the modern world. The industrial revolution was a milestone for the development of the banking industry. With the acceleration of the pace of industrialization throughout the world the growing need for financial intermediation was a reality. However, until World War-II there was no real development in this sector. After the World War was over, the banking industry played a vital role to rebuild the war-damaged countries. Japan, in particular became a unique example in this regard. The banking industry in Japan took the initiative to erect the modern industrialized Japan. But still no significant innovation was found until 1960. By February 1961, a key banking innovation occurred - the introduction of the first effective negotiable certificate of deposit (CD). The instrument was introduced by First National City Bank of New York (the present day Citicorp). The term "Liability Management" came into the banking arena after this innovation, because it permitted banks to purchase funds and thereby manage their liabilities. Since then, numerous financial and technological innovations have been introduced on an ongoing basis. While the 1960s and 1970s were a time of growth in the banking industry, the greatest number of innovations and changes (e.g. mergers, consolidations and failures) occurred over the past two decades.

7.1 Innovations of Financial Services and Emergence of Electronic Banking

Technological innovation in the banking sector has been manifested primarily in the form of electronic funds transfer system (EFTS or EFT systems). The basic components of EFTS are automated teller machine (ATMs), point of sale (POS) terminals and the automated clearinghouse (ACHs). Less visible than EFT, but more important to a bank's ability to operate efficiently is the bank's "back office technology" (i.e. its computer operating systems). Banking has come a long way from the times of barter trading. Modern banking uses three forms of transferring value: physical currency, checks, and in an age of technology, electronic fund transfers. However, checks are by far a dominant means of payment, but that may change in the years ahead.  

7.2 Structures and Classification of Electronic Banking

The concept of electronic banking system is a computer-based technology for rendering banking services. Electronic banking systems can be broadly divided into two categories, namely back-office electronic banking and front-office electronic banking services. Since inception of electronic banking, it has gone through a comprehensive evolution process. The evolution of electronic banking, both front and back office systems can be grouped into three categories; first, second and third generation electronic banking.

First Generation electronic banking rendered back office services like ledger keeping, cash management and so called Management Information Systems. The front office services were cash dispensers or ATMs.

The Second Generation of electronic banking got some extended back-office services like transaction, processing (off-line), ACHs, record keeping and fund transfer systems. The front-office services that evolved during this phase were telephone bill payment, point-of-sale (POS) systems, check verification, ATMs and authorization.

The present status of the electronic banking system could be termed The Third Generation of electronic banking. This era of electronic banking enjoys back office services like on-line transaction processing, centralized processing at country level, internet banking, and inter bank transaction processing to name a few. The front-office services of this era are automatic fund transfer, on-line banking, electronic home banking, and direct deposit, check truncation, lock box check truncation, electronic fund transfer electronic check representation and internet banking

Banks to provide higher quality financial services to their customers are using information technology.    

7.3 Status of Electronic Technology in the Banking Sector of Bangladesh

Bangladesh Bank, the "Central Bank" of Bangladesh, has installed computerized MIS (Management Information Systems) very recently to ensure the efficient flow of information among its different locations throughout the country. However, it should be noted that it has yet to get its MIS fully automated to get the desired performance. The MIS, within the bank, is mainly performed by the Computer Department. Data which are collected from different banks and primary sources are stored in the bank's database. This data bank is used for the following purposes:

i)   to conduct research on various issues relating to banking and finance;

ii)  to determine trends in different aspects of banking operations;

iii) to publish articles in journals, monthly bulletins, annual reports and other information;

iv) to disclose all types of information to the top management of the bank; and

v) to supply the Government with necessary information to facilitate the formulation of policy regarding  money and capital markets.

In Bangladesh nationalized, private and foreign commercial banks are engaged in business. Most of the local banks have limited computer systems. All the banks have their own computer department in the main office location and have added the highest volume branches to the network. Unfortunately, most of the banks are not serious about the utilization of high information technology for collecting information, processing, analyzing and implementing. The use of computer technology in the local banks is still in an infant stage. In a limited sphere they are installing modern technology. Network system between the Bangladesh Bank and various banks' head offices have not yet been developed. In most of the local banks personal computers are used on a stand-alone basis.  Due to lack of inter-branch communication, customers are not receiving the quality service that they deserve. Foreign banks are already using computerized banking systems. In fact, some of the foreign banks have already introduced 24-hour withdrawal facilities to their customers.

There is a positive attitude among the top management of the local nationalized and private commercial banks towards the modernization of their information systems, but the success is not yet realized as most of the data is being collected on the basis of a batch processing system. Sonali Bank is making an effort to develop an integrated computerized system through creating networks with their 68 zonal offices and 7 GM offices (outside Dhaka). Currently, information is provided to management from the research and planning department, central accounts department, international division, audit and inspection department, branches department, and various other parts of the bank. However, the research and planning department, on a monthly basis, submits statistical information about Sonali Bank to the top-level management, which is mostly collected through disks or in a prescribed format. Similarly, the computer division of Agrani Bank collects information on a prescribed format to submit to their management. The Agrani Bank tried to link a branch on a test basis in Dhaka City through a network system from Head office, but the experience was not a success due to a disruption in the telecommunication system. Currently Agrani Bank has created a MIS cell as a means of utilizing technology.

The MIS department of Janata bank collects information from 64 regional offices and other departments and divisions through disk. It has also made continuous efforts to strengthen its MIS by creating a network system. Rupali bank has its own MIS department, but is not very effective and efficient in utilizing high information technology. Uttara bank has established the MIS and computer department but it is still using a blend of manual and computer based systems.  Development banks and financial institutions like BKB, BSB and BSRS are still lagging behind the utilization of modern technology based information management.

Most of the foreign banks are trying to use computerized systems in order to take advantage of the superior technology available to provide quality customer service better information to management. Foreign banks, through the successful use of a global network, have increased the timeliness and accuracy of information, benefiting its customers, its employees and also its management. Hongkong Bank, ANZ Grindlays Bank and Standard Chartered Bank are using more or less an integrated network. They are collecting information through on-line systems and providing network links to their valued customers. American Express Bank is also using a proprietary network system. Citicorp, uses technology to gather relevant information about the bank's operations at month end, organizes the data and sends it to it's home office via electronic media. Finally, Habib Bank Ltd. has only one branch that collects information and sends reports to its Head Office on monthly basis.   

7.4 Need for Using Modern Technology and Appliance by an Islamic Bank

In today's advanced society it is obvious that technology is needed to render better service to bank customers. Islamic banking is no exception. Like any other bank an Islamic bank can also enjoy the following advantages by introducing modern machines and appliances in its accounting and other systems. 

a)      By introducing a modern system in accounting, Islamic banks can improve their customer service. In a traditional accounting system a manager has to apply a time consuming process, which involves a number of employees to supply the required information to a valued customer. In contrast, the same customer could be served with a modern system simply with the touch of a button Cashing a check would be an easier transaction for customers of the bank.

b)      By introducing an electronic banking system an Islamic bank can be more competitive. It should not be forgotten that this is the age of electronic service. In this context, the sooner the Islamic banks adopt modern technology, the better for the sustainability and development of Islamic banking as an alternative banking system.

c)       Presence of a well-designed MIS with fully electronic banking system will enrich the research department of Islamic banks. Research information on various banking operations will be much easier to generate.

d)      A well-constructed MIS will be able to provide management with updated information on a timelier basis. Top management will be in a position to evaluate the performance of the bank both at micro and macro level without depending on the manual systems.

e)      Electronic banking will save time for both bank management and the clients. Initially it may increase the transaction cost but with the passage of time the cost of transaction will go down.

f)        A full MIS supported by electronic banking will uphold the image of Islamic banks. The bank will be more attractive to the modern clients.