SHARI

1
SHARIAH AUDITing between theideals and
realities
7th DISTANCE LEARNING PROGRAM ISLAMIC DEVELOPMENT
BANK , JEDDAH
Al-Hujurat (The Dwellings) 496 O ye
who believe! If a wicked person comes to you with
any news, ascertain the truth lest ye harm people
un wittingly, and afterwards become full of
repentance for what ye have done.
Assoc. Prof. Dr. Shahul Hameed Hj. Mohamed
Ibrahim Kulliyah of Economics and Mangement
Sciences International Islamic University Malaysia
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INTRODUCTION

• Shariah auditing has currently emerged as an
  important subject of discussion inline with the
  advance development of Islamic Financial
  Institutions (IFIs) . This demands the proper
  governance of the Shariah compliance issues. As
  a new emerging discipline, there are several
  issues which need to be dealt . It is important
  that we discuss these issues and make inputs to
  the development of shariah auditing.
• This lecture will proceed as follows

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Presentation outline
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Types of auditing and review
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Financial Statement Audit

• International Standards on Auditing (ISA) 200,
  Objective and General Principles Governing an
  Audit of Financial Statements, states that
• The objective of an audit of financial
  statements is to enable the auditor to express an
  opinion whether the financial statements are
  prepared, in all material respects, in accordance
  with an applicable financial reporting
  framework.

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Audit Definition

• Broader definition of audit
• AAA defined auditing as
• a systematic process of objectively obtaining
  and evaluating evidence regarding assertions
  about economic actions and events to ascertain
  the degree of correspondence between those
  assertions and established criteria and
  communicating the results to interested users
  (Committee on Basic Auditing Concepts COBAC,
  1972 2)

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Auditing process
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Comparison between conventional and islamic
auditing
Element Conventional Audit Islamic Auditing
3 party relationship Entity, auditor, user Entity, auditor and broader range of users
Appropriate subject matter Financial statement assertions Processes, contracts, personnel, systems, performance, financial statements
Suitable criteria IFRS Sharia principles and rules, aaoifi standards and appropriate parts of IFRS
Sufficient appropriate evidence Sufficient and appropriate evidence SSB rulings, fatwas of international and national fiqh boards, plus all other conventional evidence
Written assurance report Standard audit report prepared by auditor A more detailed report prepared by a sharia auditor
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Evolution of Auditing
Social Environmental Audit
Financial Audit
Performance Audit
Shariah Audit
Every aspect of organizations activities as
required by Islamic religiious teaching
Economy, effectiveness and efficiency of resource
utilization, programs activities
Social contribution environmental compliance
Financial statements
Late 1800s/1900s
1960s/1970s
1970s
2000s
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Need for shariah auditing research

• The advanced development of Islamic financial
  industry necessitates for an auditing mechanism
  which can fulfill the unique requirements of the
  industry
• Lack of research (especially empirical-based
  research) in the field of auditing from Islamic
  perspective.
• The many unresolved issues regarding the
  conceptual and practical dimensions of Shariah
  audit.

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Issues in shariah auditing
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Shariah auditing definition

• According to GSIFI 2 of AAOIFI,
• Sharia review is an examination of the extent of
  an IFIs compliance, in all its activities, with
  the Sharia. This examination includes contracts,
  agreements, policies, products, transactions,
  memorandum and articles of association, financial
  statements, reports (especially internal audit
  and central bank inspection), circulars, etc. The
  objective of a Sharia review is to ensure that
  the activities carried out by an IFI do not
  contravene the Sharia.
• While the SSB is responsible for forming and
  expressing an opinion on the extent of an IFIs
  compliance with the Sharia, the responsibility
  for compliance therewith rests with the
  management of an IFI
• The AAOIFI definition is broad in all its
  activities
• It uses the word review instead of the word
  audit
• Review negative assurance, lower level of
  assurance than audit
• Perhaps in the beginning this is better than a
  full scale audit, however, the scope in AAOIFI is
  quite broad

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REVIEW AND AUDIT
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The meaning of sharia in sharia auditing

• Shariah compliance according to AAOIFI means
  compliance with Islamic Sharia Rules and
  Principles as reflected in the fatwas, rulings
  and guidelines issued by them (hereinafter, the
  Sharia)
• This seems contradictory. Unless fatwas, rulings
  and guidelines covers all activities, then the
  extent of shariah compliance in all its
  activities cannot be reviewed.
• In practice, as our research confirms, the SSB is
  mainly issuing fatwa's related to financing
  products and not other activities, hence aaofis
  definition is a bit contradictory.
• Auditing by persons based on criteria issued by
  the auditor themselves poses a self review
  threat to independence.
• It does not bode well for the use of audit
  judgment making the review a mechanistic
  procedure.

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Shariah auditing standards

• In the conventional accounting world, the IAASB
  develops International standards on auditing and
  assurance services and these are pretty
  established and accepted globally
• In the case of shariah auditing, the Accounting
  and Auditing Association for Islamic Financial
  Institutions (AAOIFI ) has a set of standards
  both for conventional and shariah auditing of
  IFIs.
• The shariah auditing standards were reclassified
  as Governance standards. These are
• Sharia Supervisory Board Appointment,
  Composition and Report
• Sharia Review
• Internal Sharia Review
• Audit and Governance Committee for Islamic
  Financial Institutions
• Independence of Sharia Supervisory Board (new)
• Statement on Governance Principles for Islamic
  Financial Institutions (new)
• Corporate Social Responsibility (under
  development)

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Independence and qualifications of shariah
auditors (SSB)

•  A unique corporate governance mechanism of
  Islamic financial Institutions is the sharia
  supervisory board (SSB) which is theoretically an
  independent external body akin to external
  auditors.
• Consisting of at least 3 scholars in fiqh
  muamalat, who may be supported by experts in
  Islamic banking with knowledge of fiqh muamalat-
  problem may not have accounting or auditing
  expertise
• The board is supposed to direct, supervise and
  review the activities of the Islamic Financial
  Institution to ensure sharia compliance in all
  its activities- problemSelf interest threat to
  independence.
• The SSB is known under various names
• In Malaysia, Bank Negara calls it sharia
  committee, although Bank Islam Malaysia Bhd.,
  uses the term Shariah Supervisory Council,
• whereas Meezan Bank of Pakistan has both a
  Sharia Advisor (who issued the Sharia Report)
  and a SSB,
• Shamil Bank of Bahrain uses Religious Supervisory
  Board,
• and al Baraka Bank uses the term Sharia Board.

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Confusion in SSB Nomenclature?
Bank Negara Malaysia Sharia Committee
Bank Islam Malaysia Shariah supervisory Council
Meezan Bank Pakistan Sharia Advisor
Al Baraka Bank Bahrain Sharia Board
Shamil Bank Bahrain Religious Supervisory Board
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Duties of the SSB A Malaysian view

• GPS1 (Shariah Guideline 1 of the Central Bank of
  Malaysia gives what i believe is a more thought
  out role of the SSB then the AAOIFI standard i.e.
• participate and actively engage in deliberating
  Shariah issues put before them.
• advise the BOD on Shariah matters in its business
  operation.
• Endorse Sharia Compliance Manuals which specify
  the manner in which a submission or request for
  advice is to be made to the SC, the conduct of SC
  meetings, and the manner of compliance with any
  sharia decision.
• endorse and validate relevant documentations such
  as contracts, agreemnts, product manual,
  marketing, advertisements, sales illustrations
  and brochures used to describe the product. for
  sharia compliance.
• To assist related parties such as the IFIs legal
  counsel, auditor, or consultant, on sharia
  matters for advice upon request.
• To advise on matters which have not been endorsed
  or resolved to the Shariah Advisory Concil of
  BNM.
• To provide written sharia opinions where the IFI
  requests advice and on applications for product
  approvales to the BNM and to assist the SAC on
  reference for advice e.g by explaining sharia
  issues involved and references to jurisprudential
  literature. And established sources.

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Shariah audit procedures
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Planning Review Procedures

• The Sharia review procedures shall be planned so
  that it is completed in an effective and
  efficient manner. The plan shall be adequately
  developed to include a complete understanding
  about the IFIs operations in terms of products,
  size of operation, locations, branches,
  subsidiaries and divisions. The planning shall
  include obtaining a list of all fatwas, rulings
  and guidelines issued by the SSB.
• Understanding the activities, products and
  managements awareness and attitude towards
  compliance with the Sharia is essential. This
  will have a direct effect on the nature, extent
  and timing of the Sharia review procedures.
• The plan shall be properly documented including
  the sample selection criteria and sizes, taking
  into consideration complexity, and frequency of
  transactions.
• The review procedures shall be designed based on
  the above input. The review procedures shall
  cover all activities, products and locations.
  These procedures shall ascertain whether the SSB
  approved transactions and products have been
  undertaken and all related conditions have been
  met.

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Executing Review Procedures preparing working
papers

• At this stage all the planned review procedures
  are executed. The SSB review procedures shall
  normally include
• obtaining an understanding of the managements
  awareness, commitment and compliance control
  procedures for adherence to the Sharia
• reviewing of contracts, agreements, etc.
• ascertaining whether transactions entered into
  during the year were for products authorised by
  the SSB
• reviewing other information and reports such as
  circulars, minutes, operating and financial
  reports, policies and procedures, etc.
• consultation/co-ordination with advisors such as
  external auditors and
• discussing findings with an IFIs management.
• The execution of the above review procedures
  shall be documented in work papers which shall be
  complete, neat and cross referenced to review
  procedures.

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Documenting Conclusions Reporting to
shareholders

• The SSB shall document their conclusions and
  prepare their report to the shareholders based on
  the work done and discussions held. The SSB
  report shall be read at the annual general
  meeting of the IFI. A detailed report, when
  warranted, shall also be issued to an IFIs
  management.
• Quality assurance
• The SSB shall implement adequate quality control
  policies and procedures to ensure that the review
  is conducted in accordance with this standard.
• Quality control procedures may include review of
  all work papers to ensure that review procedures
  were properly understood and executed. Additional
  discussions may be held with the IFIs
  management, if required, to ensure that all
  significant matters were covered during the
  review.

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Internal shariah review
In addition to the sharia review, the IFI is
also required to conduct an internal sharia
review by a special sharia compliance unit or
department or a branch of the internal audit
department depending on the size of the bank.
This is just like the internal audit and external
audit which complement each other. It is plainly
impossible for the SSB to carry out a vouching
audit to verify the shariah compliance of an
IFI. Therefore, it has to rely on its internal
control systems, part of which is the internal
sharia review.
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Elements of internal shariah review
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Shariah audit reports
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AAOIFIS SHARIAH AUDIT REPORT
In the name of Allah, The Beneficent, The
Merciful To the Shareholders of The Example
Islamic Financial Institution Assalam Alaikum
Wa Rahmat Allah Wa Barakatuh In compliance with
the letter of appointment, we are required to
submit the following report We have reviewed
the principles and the contracts relating to the
transactions and applications introduced by the
Example Islamic Financial Institution during the
period ended. We have also conducted our review
to form an opinion as to whether the Example
Islamic Financial Institution has complied with
Sharia Rules and Principles and also with the
specific fatwas, rulings and guidelines issued by
us. The Example Islamic Financial Institutions
management is responsible for ensuring that the
financial institution conducts its business in
accordance with Islamic Sharia Rules and
Principles. It is our responsibility to form an
independent opinion, based on our review of the
operations of the Example Islamic Financial
Institution, and to report to you. We conducted
our review which included examining, on a test
basis of each type of transaction, the relevant
documentation and procedures adopted by the
Example Islamic Financial Institution We planned
and performed our review so as to obtain all the
information and explanations which we considered
necessary in order to provide us with sufficient
evidence to give reasonable assurance that the
Example Islamic Financial Institution has not
violated Islamic Sharia Rules and Principles.
In our opinion a) the contracts, transactions
and dealings entered into by the Example Islamic
Financial Institution during the year ended ...
that we have reviewed are in compliance with the
Islamic Sharia Rules and Principles b) the
allocation of profit and charging of losses
relating to investment accounts conform to the
basis that had been approved by us in accordance
with Islamic Sharia Rules and Principles
(where appropriate, the opinion paragraph shall
also include the following matters) c) all
earnings that have been realized from sources or
by means prohibited by Islamic Sharia Rules and
Principles have been disposed of to charitable
causes and d) the calculation of Zakah is in
compliance with Islamic Sharia Rules and
Principles. We beg Allah the Almighty to grant
us all the success and straight-forwardness.
Wassalam Alaikum Wa Rahmat Allah Wa Barakatuh
(Names and signature of the members of the
Sharia supervisory board) Place and Date
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EXTREMES IN PRACTICE - TOO BRIEF (THE MALAYSIAN
CASE)
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EXTREMES IN PRACTICE THE GOLD STANDARD MEEZAN
BANK OF PAKISTAN
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EXTREMES IN PRACTICE THE GOLD STANDARD MEEZAN
BANK OF PAKISTAN
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• LITERATURE REVIEW

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Literature Review

• The literature on auditing in the Islamic
  perspective is very limited.
• Among the writings which attempt to explore the
  conceptual framework of auditing from Islamic
  perspective are for e.g. Khan, 1985 Briston El
  Ashker, 1986 Harahap 2002.
• The writings which highlight the auditing issues
  in Islamic banks (Al Abji, 1989 Janahi, 2000
  Simpson Willing, 2000)
• The studies on the role, functions,
  responsibility and independence of Shariah
  advisors (for example Abu Mouamer, 1989
  Abdallah, 1990 Abdul Rahman et al., 2004
  Shafei, 2005).

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Gap of the Literature on Shariah Audit

• There are also studies that compare the different
  models of the roles of Shariah Supervisory Board
  (SSB) and external auditors in Islamic banks
  (Banaga, 1994), the notion of independence
  between SSB and external auditors (Karim, 1990)
  and possible interaction between the two parties
  (Hood Bucheery, 1999).
• The relevance of Islamic auditing to the public
  audit institutions has been explored by Khan
  (2001) who analyzes the role of Supreme Audit
  Institutions (SAIs) in the Islamic economy.
• The latest study which is more comprehensive in
  identifying the issues and challenges of Shariah
  compliance process in the IFIs is a paper by
  Grais Pellegrini (2006). Their study has
  explored the limitations in relying the Shariah
  compliance assurance to the internal party (i.e.
  SSB) and proposed an effective framework to
  monitor and assess Shariah compliance.
• summary

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• RESEARCH OBJECTIVE
• METHODOLOGY

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Research Objective

• To explore the perceptions of accounting
  academicians, audit practitioners and Shariah
  scholars in Malaysia with regards to the issues
  of Shariah auditing.

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Research Questions

1. Is it important to develop the discipline of
   Shariah audit and what should be the definition
   of Shariah audit? This question examines the
   awareness of respondents of the term Shariah
   audit and their perception on the importance to
   establish the discipline of Shariah audit and
   its definition.
2. What are qualification requirements for Shariah
   auditors and who should appoint Shariah
   auditors? This question seeks to identify who are
   supposed to perform Shariah audit, what should
   be the qualification requirements for Shariah
   auditors, and who should appoint the Shariah
   auditors.
3. What should be the scope of Shariah audit? This
   question encompasses the investigation on the
   business areas to be audited under Shariah audit
4. To what extent should Shariah audit be
   performed? This question aims to explore the
   extent of and when Shariah audit should be
   performed.

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Question of definition

• Review or audit?
• Review is defined as is a service where the
  auditors objective is to provide a moderate
  level of assurance, being a lower level of
  assurance than that provided by an audit (CPA
  Australia, 2006)
• Review has also been defined as a formal
  assessment of an activity with the intention of
  suggesting or implementing changes or a review
  implies an audit type investigation that does
  not meet the full requirements of Generally
  Accepted Auditing Standards (GAAS) (ORegan,
  2004)
• GSIFI No.2 on Shariah review states that
  Shariah review is an examination of the extent
  of an IFIs compliance in all its activities with
  the Shariah (AAOIFI, 2002)
• Shariah reports indicate an audit not a review

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Who should Conduct Shariah Audit?
New Professionals called Shariah auditors??
Internal auditors under supervision of SSB??
Shariah Supervisory Board??
External Financial auditors??
Islamic Jurists (Ulama)?
38
Qualification Competence Requirements
Degree/Professional qualification in accounting
and specialized certification in Shariah
audit??
?
Degree/Professional qualification in accounting
Fiqh (Islamic Law)??
Degree/Professional qualification in accounting??
Trax Associates, Sept 2003
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Scope of Shariah Audit
Business Policies??
Processes Procedures??
Human resource Management??
Zakat calculation payment??
Scope of Shariah Audit
Marketing advertising??
Contracts agreements??
Social contribution??
Environmental impact of operation??
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To What Extent When Should Shariah Audit be
Performed?
To what extent?
When?

• Every single activity?
• To the extent deemed satisfactory by the
  auditors?
• Using sampling method?

• Throughout financial year?
• During new product application?
• At the end of financial year?

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Respondents Background

• 1. Muslim accounting academicians
• Muslim lecturers teaching at the Accounting
  Program in public universities in peninsular
  Malaysia
• 2. Muslim audit practitioners
• Muslim audit practitioners in peninsular Malaysia
• Shariah scholars
• Members of the Shariah Committee or Shariah
  Supervisory Board (SSB) of the Islamic commercial
  banks (ICB) and Islamic subsidiaries of
  commercial banks (ISCB) in Malaysia

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• FINDINGS ANALYSIS

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Response Rate
No. Respondents Total Distributed Total Distributed Total Received Total Received Total Used Total Used Response Rate ()
No. Respondents No No No Response Rate ()
1. Accounting lectures 187 52.1 62 62 60 61.2 33.2
2. Auditors 126 35.1 27 27 27 27.6 21.4
3. Shariah Committee 46 12.8 11 11 11 11.2 23.9
Total Total 359 100 100 100 98 100 27.9
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Research Question No.1

• Awareness of the term Shariah Audit

No. Statement Acctg. Lecturers Acctg. Lecturers Auditors Auditors Shari'ah scholars Shari'ah scholars Overall Overall
No. Statement N N N N
1. Awareness of the term Shariah Audit Yes Not Sure No Missing 28 9 22 1 46.7 15 36.6 1.7 7 5 14 1 26 18.5 51.8 3.7 7 - 3 1 63.6 - 27.3 9.1 42 14 39 3 42.8 14.3 39.8 3.1
60 100 27 100 11 100 98 100
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Research Question No.1

• The Importance of Developing the Discipline of
  Shariah Audit

46
Research Question No.2

• Who should perform Shariah audit for IFIs

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Research Question No.2

• Competence and Qualification Requirements of
  Shariah Auditors

No Statement Acctg. Lecturers Acctg. Lecturers Acctg. Lecturers Auditors Auditors Auditors Shari'ah scholars Shari'ah scholars Shari'ah scholars Overall Overall Overall Kruskal-Wallis Test (Asymp. Sig.)
No Statement N M e a n Me d i a n N M e a n Me d i a n N M e a n Me d i a n N M e a n Me d i a n
6. It is important for a body to set up qualification and competence requirements for Shariah auditors 59 4.68 5 27 4.48 5 9 5 5 95 4.65 5 .023
7. Minimum qualification of the Shariah auditor Degree/Professional in accounting Degree/Professional in accounting Fiqh (Islamic Law) Degree/Professional qualification in accounting and specialized certification in Shariah audit 38 43 54 3.76 4.42 4.54 4 5 5 21 24 24 4.29 4.08 4.37 4 4 4.5 4 6 10 3.75 4.50 4.90 4 4.5 5 63 73 88 3.94 4.31 4.53 4 4 5 .193 .094 .076

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Research Question No.2

• Who should appoint Shariah auditors for IFIs

No Statement Acctg Lecturers Acctg Lecturers Auditors Auditors Shari'ah scholars Shari'ah scholars Total Total
No Statement N N N N
5a. Shareholders of the respective IFI through its AGM Yes No 6 54 10 90 7 20 25.9 74.1 3 8 27.3 72.7 16 82 16.3 83.7
60 100 27 100 11 100 98 100
5b. Bank Negara of Malaysia Yes No 5 55 8.3 91.7 4 23 14.8 85.2 2 9 18.2 81.8 11 87 11.2 88.8
60 100 27 100 11 100 98 100
5c. Islamic Financial Service Board (IFSB) Yes No 23 37 38.3 61.7 16 11 59.3 40.7 1 10 9.1 90.9 40 58 40.8 59.2
60 100 27 100 11 100 98 100
5d. A newly established regulatory and supervisory body dedicated to oversee the practice of Shariah audit Yes No 46 14 76.7 23.3 14 13 51.9 48.1 5 6 45.5 54.5 65 33 66.3 33.7
60 100 27 100 11 100 98 100
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Research Question No.3

• Areas to be audited under Shariah audit

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Research Question No.4

• To what extent Shariah Audit should be
  performed?

No Statement Acctg. Lecturers Acctg. Lecturers Auditors Auditors Shari'ah scholars Shari'ah scholars Overall Overall
No Statement N N N N
9a. Every single activity 20 33.9 5 18.5 4 44.4 29 30.5
9b. As assumed satisfactory by the auditors 19 32.2 6 22.2 2 22.2 27 28.4
9b. Using sampling method 20 33.9 16 59.3 3 33.3 39 41.1
59 100 27 100 9 100 95 100

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Research Question No.4

• When Should Shariah Audit be Performed?

No Statement Acctg. Lecturers Acctg. Lecturers Auditors Auditors Shari'ah scholars Shari'ah scholars Overall Overall
No Statement N N N N
10a. Throughout financial year 32 53.3 15 57.7 3 33.3 50 52.6
10b. During new product application - - 3 11.5 1 9.1 4 4.2
10c. At the end of financial year 28 46.7 8 30.8 5 55.6 41 43.1
60 100 26 100 9 100 95 100

52

• CONCLUSION

53
Conclusion Research Question No.1

• While the subject of Shariah audit is gradually
  attracting the attentions from relevant parties
  such as scholars in the field of Islamic finance,
  however generally it has yet to become a popular
  subject to the academic individuals in the
  accounting field and to the audit professionals
  especially.
• Despite the respondents varying degree of
  awareness, it is very encouraging to discover
  that the respondents highly regarded the
  importance to develop the discipline of Shariah
  audit.
• While many of the respondents tend to agree
  towards defining the term Shariah audit based on
  the definition of Shariah review by AAOIFI,
  several other respondents have instead see the
  inappropriateness of such association.

54
Conclusion Research Question No.2

• Shariah audit should be performed by new
  professionals called Shariah auditors who are
  specifically certified in Shariah audit
• Shariah auditors must be appointed by a new
  independent body dedicated to oversee the
  practice of Shariah audit
• It is seen strongly important to establish and
  standardize the qualification and competence
  requirements for Shariah auditors who are
  supposed to have minimum degree/professional
  qualification in accounting and specialized
  certification in Shariah audit

55
Conclusion Research Question No.3

• Among the areas of the business activities that
  are perceived as mostly important in Shariah
  audit work are Zakat calculation and payment,
  contracts and agreements, processes and
  procedures, financial system reporting, and
  business policies.

56
Conclusion Research Question No.4

• Since the term Shariah compliance implies a
  broader understanding, responsibility and
  accountability (i.e. in this world and
  hereafter), there could be a dilemma of whether
  the audit to attest such compliance is sufficient
  by relying on the sampling method or the extent
  deemed satisfactory by the auditors, or we should
  go beyond those assumptions by checking and
  assuring every single activity of the IFIs are in
  compliant with the Shariah precepts and
  conducting the Shariah audit throughout
  financial year.

57
Literature Review Khan (2001)

• Discussed the role of Supreme Audit Institutions
  (SAI) in the Islamic countries.
• The scope of Supreme Audit Institutions (SAIs) in
  the Islamic countries need to be expanded to play
  an effective role in realizing the objectives of
  an Islamic economy which stands for freedom,
  justice, fairness, protection of public interest
  and elimination of and corruption.
• Illustrated the newer expectations of the SAI
  which covers 15 areas, namely accountability,
  transparency, corruption and fraud, performance
  auditing, evaluation of policies, audit of
  expenditure management systems, audit of
  privatization, evaluation of regulators, audit of
  public debt, environmental audits, leadership
  role in reforming government accounting, audit of
  social services and public administration, and
  lastly the framework for realizing Shariah goals
  through the SAI.
• Among the element of framework for realizing
  Shariah goals through Supreme Audit Institution
  is to train the auditors.
• The SAI (perhaps to apply to the regulator of
  Shariah audit practice in general) would need to
  determine the knowledge and skill requirements of
  its staff for the expanded role outlined in his
  study.
• back

58
Literature Review Karim (1990)

• Provided analysis on the factors affecting the
  notion of the independence of SSB versus the
  external auditors
• It is necessary that both SSB and the external
  auditors are perceived independence to ensure the
  credibility of financial statements
• The perceived independence of the SSB is very
  much influenced by moral values while that of
  external auditors is largely affected by economic
  factors.
• Another incentive for SSBs independence is due
  to the belief that a rational management would be
  very keen to adhere to religious precepts since
  the cost it would bear for a reported breach
  would be more than the cost it can impose on the
  SSB.
• He opines that ideally both SSB and external
  auditors should be from one organizational body
  since Islam does not recognize any separation
  between business and religion.
• suggested that accounting principles compatible
  with Islamic law must be developed as guidance
  for those who conduct the financial audit for
  Islamic financial institutions or Islamic
  enterprise and be familiar with the various
  religious rulings which have a bearing on the
  financial matters of the bank.
• back

59
Literature Review Simpson Willing (2000)

• Shariah compliance is essential for the Islamic
  banks given the impact that their products may no
  longer be acceptable if they fail to comply.
• Emphasized that one of the relevance of the
  Islamic banking industrys infancy is highlighted
  by the continued lack of an internationally
  accepted framework of uniform and comprehensive
  accounting standards or auditing guidelines.
• Argued that the role of external auditors in the
  Islamic banks is seen to be complex due largely
  to the lack of experience of most external
  auditors on the Shariah principles
• Believed that establishment of rules and
  regulations would enhance the effectiveness of
  the banks and ensure its compliance to the
  Shariah.
• back

60
Literature Review Harahap (2002)

• Wrote a book in Indonesian language on Auditing
  from the Islamic Perspective
• Provided discussion on the development of
  accounting and auditing in the Islamic sphere and
  urged for the Muslim Intellectuals to develop the
  discipline of Islamic auditing as it is inline
  with the development of Islamic Financial System.
• Stressed the importance of formulating a
  philosophical foundation of the auditing theory
  from Islamic perspective as he elaborated that
  the absence of a philosophical foundation would
  lead to the variation and lack of focus in the
  development of Islamic auditing as a discipline
  and in practice.
• Among other future initiatives to be taken with
  regards to Islamic auditing are 1) to transform
  the social system into Shariah based system
  where currently Muslim society are very much tied
  to the Western ideology and civilization, and 2)
  to harmonize the practice among all the Muslims.
• back

61
The Malaysian Practice

• The following is the result of interviews
  conducted by my student Sister Nawal Kassim who
  is undertaking a PhD in Accounting under my
  supervision.
• 22 respondents comprising external auditors,
  Sharia supervisory board members and staff of
  shariah compliance units/internal auditors of 9
  IFIs and 6 Islamic branches of conventional banks
  in Malaysia.
• Interviews covered
• definition and responsibility,
• organization of the shariah compliance function
• Reporting structures of shariah compliance units
• scope of audit,
• audit procedures,
• independence, qualifications and authority of
  SSBs.

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Malaysian Practice- Definition

• Preference for shariah review as opposed to audit
  (in line with aaoifi definition.)
• One respondent (head of Islamic bank audit dept
  of local Islamic branch) consider no need for
  separate audit unit as procedures and processess
  are the same as conventional auditing minority
  view
• Another respondent (shariah compliance unit) said
  that the responsibility for the shariah audit is
  the responsibility of the Shariah supervsory
  board or in Malaysia known as the Shariah
  Committee
• Another respondent (external auditor) is of the
  view that shariah compliance audit is an internal
  matter nothing to do with external auditor
  because
• Not required by law
• Lack of expertise
• Will increase audit cost

63
Practice- Organization of the shariah compliance
function
Many different structures as illustrated below
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Reporting structures of Shariah compliance units

• The shariah departments or units reports to
  various persons in different IFIs. This includes
• Reporting to CEO/MD (3/22 )
• Reporting to SSB (10/22)
• Reporting to Risk manager (4/22)
• Product development manager (3/22)
• Problems of independence can be seen. Perhaps
  should report to audit committee of the BOD
• All products/findings are endorsed by SSB
• No direct contact with Scompliance personnel but
  through shariah division head or shariah
  co-ordinator who attends the SSB meetings.

65
Malaysian Practice- Audit Scope

• Most IFIs audit compliance of products only.
• Cost consideration of extending scope
• Newcomers and therefore need to compete by
  developing new products
• (discuss Implication on audit report on
  activities and operations)
• Education of staff needed before scope expansion
• Perceived to be difficult
• Other scope under research stage
• Extension of scope in agenda
• Discussion on going on staff compliance with
  sharia dress codes and marketing of products
• Not in favour of social and environmental or
  performance audit as considered not within scope
  and lack of public awareness
• Fear workload increase without adequate resources
• Capitalist mentality- shariah audit is a business
  unit to make profits.

66
Malaysian Practice- Audit Procedures

• Begins at proposal stage
• Use of checklist with non-compliance parameters
  development by shariah division and endorsed by
  SSB
• Key Risk indicators
• Use shariah policy, guidelines, circulars and
  fatwas.
• Non compliance reported to SSB on a monthly basis

67
Ex post audit

• Documents reviewed include
• Concept papers, structure and terms sheet
• Documentation examined include agreements,
  letters of offer, policies and procedures,
  corporate advertisements/brochures and pamphlets
• The above documents are compared with
• Fatwas
• Central bank regulations
• Companys shariah compliance audit manual
• Non compliance are noted as comments and queries
  and post audit monitoring is carried out.
• Observation lack of audit judgment, very
  mechanical process is evidence.

68
Authority , Independence and Qualifications
issues

• Internal audit teams who conduct shariah audits
  are not Muslims nor shariah qualified except in a
  very few cases.
• However, they claim to be exposed to
  concepts/policies and ethics of Islam
• They work with shariah qualified officers in the
  shariah department or compliance unit
• Use shariah compliance checklist handed down from
  HeadQuarters but modified for Malaysian
  environment
• SSB is dominant in the process as they must
  endorse the work of the SC units

69
Authority , Independence and Qualifications issues

• However, there seems to be overdependence on the
  organizational units to carry out most of the
  audit work due to
• SSB members are part time
• Mostly academics who are busy
• Therefore their Independence and reliability of
  the evidence on which their report is based is
  put into question.
• SSB meetings discuss Shariah compliance matters
  in addition to product development approvals

70
Recommendations for future development of Shariah
Auditing

• There is need for integrated education of shariah
  auditors and accountants to produced competent
  shariah accountants and auditors
• Accountants can be certified in shariah audit
  (short term)
• Shariah/madrasah/hafiz students with a strong
  grounding in Arabic and islamic studies should
  follow an integrated curriculum in both Arabic
  and English with accounting, auditing, business,
  fiqh muamalat and usulul fiqh subjects as well as
  Islamic economics, finance, accounting etc
• Shariah auditing needs to evolve to cover
  marketing, personnel, systems, processes, social
  and environmental areas
• SSB functions should be decomposed into advising
  and directing and the review function should be
  split to an independent outside professional
  group known as shariah public accountants and
  auditors who are independent of the company and
  the SSB.
• AAOIFI needs to update its GSIFI standards to
  differentiate review from audit as well as
  broadening the scope of shariah audit and develop
  standards on related audit procedure and better
  audit report standard.
• There needs to be a professional body for Shariah
  accountants and auditors.

71
WassalamualaikumThank You!
The End