ACC 6810 Lesson 2

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5/14/2013 ACC6810 Islamic Accounting andFinance SH

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Lesson 2 - The Need for IslamicAccounting-Push Factors

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IntroductionTopics in Lesson 1

The problems of conventional accounting in

detail

Problems with the decision-usefulness frameworkof Conventional Accounting (CA) -object ive

Problems with concepts of CA -bui ld ing blo cks of

measurement and valuation and disc lo sure rules.

Macro Implications of C.A.- externalit ies Micro behavioural consequences

Islamic Perspective of Critique

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The Problems with Decision Usefulness

Objective of CA.

Definition

The objective of accounting is to provide

information to enable users (shareholderscreditors and others) to permit informed

decisions which in turn enables the scarce

resources in the economy to be efficiently

allocated resulting in social welfare (AAA

1975)

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Decision Usefulness- Problems.

A change from stewardship to decision usefulness

frameworkAICPAs study group on Objectives of

Accounting (Lehman,1992)

Not superfluous but calculated to reinforce the role of

accounting being crucial to the efficient allocation of

resources by individuals,enterprises and government.

Dominant paradigm of successive accounting

frameworks (eg. IASC 1989, ASB 1992, AAOIFI1996?)

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1. the economic-environmental context in which it was

developed and therefore the environment under

which it may be appropriate;

2. the economic assumptions underlying decision-

usefulness, the under-specification and achievability

of social welfare;

3. the decision-users who are targeted; and

4. the societal assumptions underlying decision-

usefulness.

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Decision Usefulness- Problems. Inappropriate economic-

environmental context

DU paradigm born in the US where the underlying economicenvironment is very different (advanced exchange economies

with a developed capital market) from that which operates in

Muslim countries

Thus

The US is a highly developed exchange economy where large amounts of

capital is required for maintain ing the complex production processes which

result in the production and exchange of goods and services. These

processes requi re economic resour ces, whi ch is allocated by the market

mechanism. The eff ectiveness of individuals (through buying, sel l ing or

holding shares & bonds) and enterprises, markets and government inallocating scarce resources among competing uses is enhanced (.i.e.

allocated to enterprises that use them efficiently) if those who make

economic decisions have information regarding the standing and

performance ofbusiness. (FASB, 1978, p 5-8).

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BUT economic realities in Muslim countries are different ,

Many Muslim countries do not have established or developed stock

exchanges.

Many industries are government owned (although privatisation has

started in earnest in Malaysia, Pakistan, Turkey and Egypt). A large section of the economy is non-monetised and most people

are involved in agriculture which do not produce huge financial

surpluses.

therefore

a decision-usefulness form of accounting oriented towards marketparticipants does not make a great deal of social or economic sense

except as a tool for overseas capitalists interested in appropriating

the wealth of these countr ies (see Tinker, 1985).

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In Muslim countries where stock exchanges are

fairly developed (such as Malaysia), the

decision-usefulness orientation serves thesame role as in the West with the same

undesirable consequences of financial

hyperreality (McGoun, 1997) ; these

consequences are not desirable from anIslamic perspective.

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The Ceteris Paribus of Decision Usefulness.

Better Economic Decisions

Social Welfare

Accounting

Information Efficiency

Efficient Allocation of Resources

Accounting route to social welfare

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Link between welfare and du is

tenacious (bertahan) The links between individual self-interest

(greed as manifested in conventional

economic, finance and accounting literature)and social welfare cannot be demonstrated. It

is vaguely possible that such a link exists-

and in very specific circumstances might

actually do so but it cannot be show to holdfor everyday western economics. (Gray

et al., 1996, p 20)

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The Ceteris Paribus of Decision Usefulness.

(i)The breakdown of the assumption about perfect competition leads to

inconsistencies and problematic implications for the role of accounting.

Does accounting leads to efficient allocation of resources or whether

markets are efficient in spite of accounting regulation.

(ii) The generalisation of individual preferences to collective

preferences by aggregating individual utilities of shareholders who have

heterogeneous interests, to obtain societys collective preferences is

questionable. This has resulted in the recognition by Beaver & Demski

(1974) that choice among reporting alternatives has social

consequences that affect non-users and users of accounting

information in terms of the distribution of wealth. Hence, ethical

judgements must be made as to whose well being should be enhanced

and whose should be diminished.

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The Ceteris Paribus of Decision Usefulness. (iii) The separation of social and economic spheres of analysis is

problematic. For example, Lehman (1992) contends these two spherescannot be separated. He questions the maxim that it is inappropriate foraccounting to consider the distribution of resources of income andwealth while at the same time insisting that it leads to social welfare bymaximising wealth. It is not logically possible to develop productionconditions independent of distribution conditions. The neo-classical

economic model (marginal productivity theory), by seeking to ignoreincome and wealth distribution becomes a tautology as whendetermining the optimal vector of factor input prices, one needs toassume a given distribution of income, which in turn is what the modeltries to explain.

Problem of too many ifs. Thus:

Ifall agents were equal, and i fmarkets were information efficientand i f , ,this led to allocative efficiency and i f, this led in turn toeconomic growth and i f, this ensured maximum social welfareand i f, maximum social welfare is the aim of the society thenaccounting is morally, economically and socially justifiable.

(Gray et al., 1996, p 17).

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The Meaning of Social Welfare

welfare and goodness again dependon the value system of the community.

Despite universal values, Islamic valuesare different. Falah (success includeshereafter) material welfare does notsuffice. Efficiency cannot undermineequity.

Problems with concentration of wealth

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The Societal Assumptions of Decision-usefulness

Pristine Liberal Economic Democracy Provides normative justification for accountants acting in

under this conception of society thus:

Decision usefulness has li t t le posit iv e value ...(as)..the research

l i terature (indicates).. . . that current f inancial statements do not

represent the informat ion that investors most desire. . . ( therefore) . .

. . . there is no just i f icat ion for the normat ive posi t ion of decis ion

usefulness. .. .i f i t is to be useful , why sho uld i t be on ly us eful to

investors? .. ..we can only jus t i fy such an assum pt ion in a pr ist ine

l iberal econom icworld. ( ib id ., p 74-75).

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Accounting Principles- Problems

Historical cost and realisation concepts

May Cause inequitable distribution of wealth

zakat and investors Entity concept ignores externalities

harusnya proprietory theory (khan, 1994)

Monetary measurement concepts- leaves out

important events and transactions

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Macro Implications of Acc

Causes social and environmental disasters (Lovecanal Tinker, 1985, Falconbridge, Buhr 1988,)

Insider trading and fraud and scandals(Briloff 1990)

Unemployment (Arnold and Cooper 1999)

Rationalise privatisation when non exists (Shaoul,1988)

Transfer wealth from developing to developed

countries (Hove, Tinker, 1985) Promote gender discrimination (Reiter, 1997)

Promotes social conflict (Lehman 1992)

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Neg. Implications of Acc

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Micro behavioural consequences

Behavioural problems of budgeting and

performance evaluation Padding,

tensions, ketegangan domination,

manipulation,

fault finding,

inter-dept strife, perselisihan

unhappiness.

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Islamic Perspectives

The substitution of selfishness (egois) for caring, confrontationforco-operation, a short term you only live once paradigm for along-term spiritual dual world-view to is both socially andreligiously unacceptable from an Islamic viewpoint.

The concern becomes more acute (hangat) if these individualsare charged with the altruistic Islamic mission of guiding Islamicorganisations which are specifically established to achieveIslamic socioeconomic objectives. This will certainly lead to goalincongruence between Islamic organisations and the Muslims orother employees who work for these organisations, theconsequences of which, are not only economic but social andmoral. Islamic organisations will certainly be unable to achievetheir objectives while Muslim organisations will become thebreeding ground of un-Islamic misfits.

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Summary The objectives of conventional accounting based on decision

usefulness may not be acceptable from an Islamic point of viewbecause it seeks to concentrate and accumulate wealth tocertain sections of society i.e. shareholders and creditors.

Neither the assumptions of pristine liberal economic democracynor the developed exchange economy with a developed stockmarket is valid for many Muslim countries.

The accounting principles on which conventional accountingreports are prepared may be unsuitable for the direct andindirect equitable distribution of wealth and the calculation ofZakat which is the one of the most important objective of Islamic

accounting. The problem with historic cost income models becomes more

problematic in a Muslim environment where profit is the mainmeans of ascertaining divisible returns to finance providers asinterest is prohibited.

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ACC 6810 Lesson 2