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Auditing Best Practice

Auditing Islamic Financial Institutions

by Roszaini Haniffa

Executive Summary

  • Auditing Islamic financial institutions (IFIs) covers a wider scope than statutory financial statement auditing.

  • External auditors of IFIs not only conduct financial audits, but also conduct tests on the shariah compliance of IFIs, according to fatawa (religious opinions) and guidelines set by the Shariah Supervisory Board (SSB).

  • Shariah review is unique to IFIs, due to the requirement to ensure that all business activities and operations of IFIs adhere to shariah precepts.

  • Scope of audit of IFIs needs to be comprehensive in order to achieve maqasid al-shariah (wider objectives of the shariah).

  • Challenges in auditing of IFIs include lack of standardized shariah guidelines, lack of independence of SSB, and lack of competence of external auditors to conduct comprehensive shariah audit.

Introduction

The purpose of the statutory or financial statement audit is to enhance the degree of confidence of intended users of the financial statements as to whether the financial statements are prepared in accordance with an applicable financial reporting framework. The most widely accepted and adopted auditing standards are those issued by the International Federation of Accountants (IFAC).

Following the emergence and phenomenal growth of Islamic financial institutions (IFIs) in recent years in various parts of the world, the scope of conventional statutory financial audit is inadequate to fulfill the needs of the stakeholders of IFIs. Because IFIs need to adhere to shariah principles in all their business transactions and operations, a new dimension in auditing, as well as auditing standards which can cope with such principles, is needed. Recognizing the limitations of the International Standards of Auditing (ISA) in addressing issues related to religious compliance, the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) has taken steps in producing a number of auditing standards and audit methodologies specifically for IFIs.

Objective of Auditing IFIs

Auditing forms an important element in the process of securing corporate accountability and in enhancing stakeholder faith in management’s stewardship. According to AAOIFI’s Auditing Standard for Islamic Financial Institutions No. 1 (ASIFI 1), the objective of an audit of financial statements of IFIs “… is to enable the auditor to express an opinion as to whether the financial statements are prepared, in all material respects, in accordance with the Shari’ah Rules and Principles, the accounting standards of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and relevant national accounting standards and practices in the country in which the financial institution operates.”

Unlike conventional statutory financial audit, which requires auditors to express a true and fair view that the financial statements have been prepared according to relevant auditing standards, the audit of IFIs covers a wider scope. This is because auditors must also attest that management has complied not only with the shariah precepts, but also with the wider objective of shariah (maqasid al-shariah), which is to protect and improve the condition of human life in all dimensions. In other words, auditing of IFIs is not only confined to the statutory financial audit but also to what is known as the shariah review, which is the raison d’être for IFIs.

Hence, auditing of IFIs can be defined as a systematic process of objectively obtaining and evaluating evidence regarding assertions about religious and socioeconomic actions and events, in order to ascertain the degree of correspondence between those assertions and the applicable financial reporting framework, including the criteria specified based on shariah principles as recommended by the Shariah Supervisory Board (SSB), and communicating the results to all interested parties. Noncompliance with shariah principles is an area of risk for IFIs that could translate into legal, image, and reputational risks, which would have far-reaching consequences not only for the individual IFI but also for the entire Islamic financial system.

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Further reading

Books:

  • El-Gamal, M. Islamic Finance: Law, Economics and Practice. Cambridge, UK: Cambridge University Press, 2006.
  • Sultan, S. A. M. A Mini Guide to Shari’ah Audit for Islamic Financial Institutions: A Primer. Kuala Lumpur, Malaysia: CERT Publications, 2007.

Article:

  • Haniffa, R., and M. Hudaib. “A theoretical framework for the development of the Islamic perspective of accounting.” Accounting, Commerce and Finance: The Islamic Perspective Journal 6:2 (2002): 1–71.

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