Difference of Accounting System between Islamic Banking and Conventional Banking

Difference of Accounting System between Islamic Banking and Conventional Banking

Difference of Accounting System between Islamic Banking and Conventional Banking:1.00 Islamic Banking:- Banking run on Islamic Principle

The Organization of Islamic Conference (OIC) defined an Islamic Bank as “ a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations.”

2.00 “Allah has permitted trade and forbidden usury”– Sura–Al-
Baqarah-Ayet No. 275.

3.00 The basic Accounting Principle (Golden Rule) in determining Debit or Credit for Accounting Entries:

The basic Accounting Principle (Golden Rule) in determining Debit or Credit for Accounting Entries is universally accepted. In Banking transactions the Golden Rule is also accepted. In Islamic Banking the Golden Rule is also accepted.

The Golden rule is as under:

Assets : An increase – Debit
A decrease – Credit

Liabilities : An increase – Credit
A decrease – Debit

Capital : An increase – Credit
A decrease – Debit

Income : An increase – Credit
A decrease – Debit

Expenditure: An increase – Debit
A decrease – Credit

In Islamic Banking accounting the main difference with conventional Banking is that Islamic Banks can not deal with interest transactions and also can not deal with Haram items/business.

4.00 Point wise difference in Accounting issues between conventional Banks and Islamic Banks are summarized below:

Islamic Banking Conventional Banking
i) Islamic Banks are to follow Quran, Sunnah, Ijma and Kiyas i.e. Shariah, in all the business transactions including Accounting Entries. i) Conventional Banking follows the man made practice and rules.

ii) They can not engage in any interest transactions.
ii) They conduct their transactions on interest basis.
iii) If any interest is included / entered in the operations of the banks, that should be excluded from the regular income of the Bank.
iii) Interest is their main income.

iv) If any income is earned violating Shariah Principles that can not be included in the distributable income of the Bank.
iv) They do not follow shariah rules & regulations.

v) In Musharaka, Mudaraba, Bai-Salam modes of Investment, Income can not be accounted for on accrual basis. v) In Conventional Banking there is no practice of Musharaka, Mudaraba, Bai-Salam modes of Investment and most of their income are recognized on accrual basis.
vi) For delay of Payment of Investment by the clients, in case of Bai-Murabaha and Bai-Muazzal etc. Investment further amount of profit can not be charged. vi) No such Bai- Muraba and Bai Muazzal Investment in conventional Banks. They Charge interest/ penal interest for delay in payment/ repayment.

vii) In case of overdue Investment compensation may be charged if an independent committee like Review Committee decides to impose the Compensation. vii) They charge interest/ penal interest on overdue Investment (Loans and Advances).

viii) Islamic Bank is to pay Zakat 2.50%/ 2.58% on its reserves. viii) They do not pay any Zakat on reserves.
ix) Islamic Banks are to pay a certain minimum percentage of Investment Income to the Mudaraba Depositors. ix) They do not pay a certain amount to the depositors from their Investment income, rather they pay fixed rate of interest irrespective of any amount of Investment Income.
x) Mudaraba Depositors are to share the loss, if any, incurred out of Investment made from Mudaraba Deposits. x) Their depositors neither share any profit nor bear any loss.

xi) Islamic Banks are to follow Accounting, Auditing and Shariah Standards developed by Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) in addition to International Financial Reporting Standards (IFRS) developed by International Federation of Accountants, Bangladesh Bank guidelines, The rules of the Income Tax , The rules of the companies Act, The rules of the Securities & Exchange Commission (SEC). xi) They only follow International Financial Reporting Standards (IFRS),Bangladesh Bank guidelines, The rules of the Income Tax , The rules of the companies Act, The rules of the Securities & Exchange Commission (SEC).

Principles of Collecting Deposit, Determining & Distributing of Profit for Shari’ah Based Banks & Financial Institutions;

Principles of Collecting Deposit:

Deposit is the “life-blood” of a Bank. Bank has given utmost importance in mobilization of deposits. Islamic Banks mobilizes deposit by two principles whereas conventional banks mobilize deposits on the basis of interest. The principles of deposit mobilization of Islamic banks are ‘Al-wadeeah’ and ‘Mudaraba’ principle.

Al-Wadeeah Principle:

Meaning of Al-wadeeah: The word “Al-wadeeah” derived from the Arabic word “Wadeeah” means “Amanat.” The term Al-wadeeah means deposit of money allowing some body to allow to use/mix the amount with other fund.
# In case of “Al-wadeeah” deposit, there must have prior permission from the owner of the fund to use / invest/mix the same fund in their business with other funds.

The depositors understand that the bank may earn a profit from its investment activity with the use of such funds/deposits but any losses from this investment activity are totally borne by the bank. The depositor is not liable for any losses incurred from these investment activities. As the depositors do not take risk of losses with “Al-wadeeah” accounts, they are not entitled to any profit from use of their deposits by investors. Bank bears all the risk & as such entitled to get all the profit.

Mudaraba Principle:

Meaning of Mudaraba: The term “Mudaraba” has been derived from one of the meanings of Arabic word “Darb/Darbun” which means “Travel, Enterprise, etc.” Thus the word Mudaraba means Travel for undertaking business.

Mudaraba is a partnership in profit whereby one party provides ‘Capital/Fund’ and the other party provides ‘Skill & Labour’. The provider of capital is called “Sahib al Maal/Rabbul Maal”(owner of the fund) while the provider of skill and labour is called “Al Mudarib” (Organizer/Manager). So, Mudaraba may be defined as a contract of partnership where the “Sahib al Maal” provides capital to the Mudarib for investing it in a commercial enterprise by applying his labour and endeavor.

Both the parties share the profit as per agreed ratio and the losses, if any, is wholly borne by the Sahib al Maal, except if it is due to breach of trust i.e. misconduct, negligence or violation of the conditions agreed upon and the Mudarib becomes liable for that. The Mudarib is in the nature of trustee as well as an agent of the business.

In Islamic banking, the Depositor (owner of the fund) is the “Sahib al Maal” and the Bank (organizer / user / investor / Manager) is the “Mudarib” The Bank is authorized to invest the Mudaraba funds at the risk of the Depositor i.e. “Sahib al Maal”

The Bank arranges proper deployment of the fund and the Depositor has got no say in management of business. Total profit resulting from such investments is distributed between ‘the Bank’ and ‘the Depositor’ as per agreed ratio. Any loss incurred is to be wholly borne by the Depositors.

Deposits Products:

Without multidimensional and diversified products, any financial institution specially Banks cannot prosper and compete with other banks effectively. With this idea, Islamic Banks in Bangladesh so far introduced the following deposit products:

A. Al-Wadeeah Principle:

Al Wadeeah Current Account

B. Mudaraba Principle:

1. Mudaraba Hajj Savings Account (1 Year to 25 Years)
2. Mudaraba Waqf Cash Deposit Account
3. Mudaraba Special Savings (Pension) Account (5 Years and 10 Years)
4. Mudaraba Muhor Savings Account (5 Years and 10 Years)
5. Mudaraba Savings Bond (5 Years and 8 Years)
6. Mudaraba Monthly Profit Deposits Scheme Account (3 Years and 5 Years)
7. Mudaraba Term Deposits Account (3 Months, 6 Months, 12 Months, 24 months and 36 Months)
8. Mudaraba Savings Deposits Account
9. Mudaraba Special Notice Deposits Account
10. Mudaraba Education Deposit
11. Mudaraba Monthly Profit Deposit
12. Mudaraba Bashsthan Savings Deposit
13. Mudaraba Marriage Savings Deposit etc.
14. Mudaraba Foreign Currency Deposit (Savings) Account
15. Mudaraba NRB Savings Bond (MNSB).
16. Students Mudaraba Savings Account (SMSA) etc.

Determination of Profit:

a) Musharaka:
Investment Income is accounted for on realised (Cash) basis (i.e. accrual basis of income recognition is not permissible).

b) Bai-Murabaha:
Investment Income is accounted for on Accrual basis (cash basis income recognition is also allowed).In case of early payment, rebate can be allowed. In case of delay in payment, no extra/ additional profit can be charged, if any compensation / penalty is charged that must go to charity. Buying and selling of goods must be ensured.

c) Bai-Muajjal:
Investment Income is accounted for on Accrual basis (cash basis income recognition is also allowed). In case of early payment, rebate can be allowed. In case of delay in payment, no extra/ additional profit can be charged, if any compensation / penalty is charged that must go to charity. Buying and selling of goods must be ensured.

d) Hire-Purchase under Shirkatul Melk:
Investment Income is accounted for on Accrual (due) basis, etc.

Distribution of Profit:

There are 2 (two) types of Deposits-

i) Al-Wadeeah Deposits and

ii) Mudaraba Deposits.

Al-Wadeeah Depositors do not share any income of the Bank.

Mudaraba Depositors are entitled to get minimum (Say 65%) of the Investment Income earned through deployment of Mudaraba Fund.

For the purpose, ratio of Mudaraba Deposits and Non Mudaraba Deposits (Cost Free Fund including Bank’s Equity) to total Investment of the Bank is ascertained. In this connection Credit balance of Profit Receivable A/c., Un-earned Income A/c and Profit/ Rent / Compensation Suspense A/c. (i.e. the amount which are not real deployment of fund but included in the investment amount) are deducted from total outstanding Investment.

Related Liquidity Reserve (CRR) which are required to be kept separate from making Investment are deducted from Mudaraba Deposits. This may be seen in the Profit Calculation Format- 1.

Amount of minimum (Say 65% which may vary from Bank to Bank) of Investment income earned through deployment of Mudaraba Fund is calculated as per Profit Calculation Format- 2.

It may be mentioned here that Bank covers the entire cost of managing the Investment Port Folio and also make necessary provision for Classified, Unclassified Investment and Off Balance Sheet items, by the amount of share of Investment Income pertaining to Non Mudaraba Deposit and Non-investment income of the bank.

It may further be mentioned here that Mudaraba Depositors do not share any portion of Non-investment Income because to earn the same no involvement of fund is required.

There after the minimum (Say, 65% or the higher amount/ percentage as decided by the Competent Authority of the Bank) is allocated among the Mudaraba Depositors for which total yearly product (the product is calculated as per rules and manner of deposit & withdrawal restriction/rules of each type of Mudaraba Deposits) of each type of Mudaraba Deposits is multiplied by the related weightage and thus weighted product is arrived, there after share of distributable profit of each type of Mudaraba Deposits is ascertained, which is again divided by total yearly product of individual Mudaraba Deposits and thus rate of profit per annum is arrived against individual Mudaraba Deposits, which may be seen from Profit Calculation Format- 3.

Calculation/Fixing of weightage:

Different weightages are assigned to various Mudaraba Depositors considering the following factors in connection with distribution of profit:-

a) Period of Deposits:

The longer period of Deposit, the greater the risk they bear with regard to fluctuation of the rates of profit and erosion of the value of deposit due to inflation. Some depositors shall have to forgo full or part of profit if there is premature encashment Some depositors shall have to forgo some profit in case of default of scheduled installment of deposits.

b) Banking Facilities:

Some depositors do not enjoy any banking facility such as, operating accounts by cheques, collection of cheques and other instruments, executing standing instructions through their accounts and so on and so forth. On the other hand, the Mudaraba Savings Depositors have freedom to get the above services through their accounts. Mudaraba Special Notice Depositors enjoy still greater facilities in regard to making deposits in and withdrawal from their accounts.

c) The pattern of Rates of Return:

The pattern of Rates of Return on various types of cost bearing deposits of the other Islamic Banks, as well as other traditional/conventional Banks have also an important bearing on allocation of weightage at different rates.

In consideration of the above factors, highest weightage has been assigned to Mudaraba Hajj Savings Account of more than 10 years Term and Mudaraba Waqf Cash Deposit Accounts and lowest Weightage has been given to Mudaraba Special Notice Deposits.

Difference of Accounting System between Islamic Banking and Conventional Banking

Difference of Accounting System between Islamic Banking and Conventional Banking

Difference of Accounting System between Islamic Banking and Conventional Banking

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