Shariah Audit for Islamic Finance Industry in

Revolution Industry 4.0: A Part of Religious Confession

Abdurrahman Raden Aji Haqqi

Faculty of Shariah and Law, University Islam Sultan Sharif Ali (UNISSA), Brunei Darussalam

Keywords: Revolution Industry 4.0, Islamic Financial Industry, Shariah Audit, Confession.

Abstract: A key component of Revolution Industry 4.0 is the internet which is characterized by connected devices.

Not only does this help internal operations, but through the use of the cloud environment where data is

stored, equipment and operations can be optimized by leveraging the insights of others using the same

equipment or to allow smaller enterprises access to technology they wouldn’t be able to on their own.

Shariah auditing has a key importance as there is a growing awareness among Islamic institutions that every

such institution should contribute towards achieving Maq’asid Al-Shariah or the objectives of the Islamic

law. It is suggested that there is a need to have regular independent Shariah audits in IFIs as people are now

experiencing a movement along a continuum from a society that trusts everything and audits nothing to a

society that trusts nothing and audits everything. The concept of Shariah Auditing should be extended to the

activities relating to among others, the system, the products, the employees, the environment and the

society. Confession is a specific form of testimony, involving oneself and it is used as a form of proof in

judicial matters. Confession has been recognized as a source of conclusive proof of a right and a crime by

Islamic textual sources. There are accusations that Islamic financial industry doesn’t Shariah-compliance.

By the existence of Shariah audit in the industry it will prove the industry that it is in the real track of

Islamic teaching. The paper uses qualitative approach, desk-research study in which it uses the existing

literature. At the end, the research found that the industry still minimizes the Shariah auditing role though it

is a confession proof as required in Islamic teachings. Among the objectives and aims of this paper are: (1)

To understand the importance of Shariah compliance and Shariah governance in Islamic banking and

comprehend Shariah audit, (2) To analyze the Shariah audit area in facing Revolution Industry 4.0, (3) To

relate the importance of Shariah audit in Islamic Financial Institutions to admission as proof that IFIs are

Shariah-compliance. The methodology followed in this study is mainly of library work, basically it was

based on related literatures written in conventional and Islamic perspective. Some information is taken from

the practitioners’ of many organizations through a primary data collection. The paper found that Shariah

audit is considered as a confession to defense the allegation that IFIs are not in accordance with Islamic

teachings.

1 INTRODUCTION

Abdul Karim Zaidan as quoted by Kamali (1996,

p. 17) said: “In its capacity as the vicegerent of God,

the Muslim community is entrusted with the

authority to implement the Shariah, to administer

justice and to take all necessary measures in the

interest of good government. The sovereignty of the

people, if the use of the word 'sovereignty' is at all

appropriate, is a delegated, or executive sovereignty

(sultan tanfidhi) only.

Theoretically one can argue that there cannot be

any financial institution like banks in Islamic

economics paradigm as the real sense of existing

banking practice contradict with the fundamental

Islamic finance principles. The debate on whether

Islamic banks ever be Islamic has been going on

since the inception of the first Islamic bank in Egypt,

Mit Ghamr. So, what's the current position among

academics and practitioners after 5 decades of

tremendous development in Islamic finance

industry.

Shariah compliance and review is the third

important pillar of the Shariah Governance Model.

Shariah review and assessment of adequacy of

internal controls is a regular feature of the Shariah

compliance. For this purpose, an internal Shariah

audit department, under the internal audit committee

of any Islamic financial industry, is to be established

with the objectives to ensure compliance and to

Haqqi, A.

Shariah Audit for Islamic Finance Industry in Revolution Industry 4.0: A Part of Religious Confession.

DOI: 10.5220/0010115300002898

In Proceedings of the 7th ASEAN Universities International Conference on Islamic Finance (7th AICIF 2019) - Revival of Islamic Social Finance to Strengthen Economic Development Towards

a Global Industrial Revolution, pages 90-101

ISBN: 978-989-758-473-2

develop a Shariah non-compliance risk awareness

culture in the organization.

However, due to various reasons, the internal

audit is not considered a sufficient and reliable tool

by the external users. Therefore, to give greater

confidence to stakeholders of IFIs, an independent

external Shariah audit is to be conducted by the

statutory auditors, for which they are required to

build up their capacity by engaging qualified Shariah

auditors in their teams.

Till the time the audit firms develop a reliable

Shariah audit system, Shariah review of the

operations and transactions of IFIs may be

conducted by their in-house Shariah board or

Advisor on periodical basis (Haqqi, 2014).

Yaacob (2012) wrote: “Modern Islamic banking

and financial institutions (IFIs) have been in

existence for more than forty years. The first

recorded institution was the Mit Ghamr Savings

Bank in Egypt which was led by one Ahmad

Elnaggar, established in the year of 1962. The bank

was later absorbed by the Nasr Social Bank in 1972

(El-Hawary, Grais and Iqbal, 2004). Then the

Pilgrims’ Savings Fund Board was formed in

Malaysia in 1963. It still exists until today (Haniffa

and Hudaib, 2010). Haniffa and Hudaib (2010)

provide an interesting analysis of the stages in the

modern Islamic finance history from the 1940s to

present time. They argued that somehow the sacred

intentions became “perplexed with the secular goals

of modernity” Although it is argued that the

establishment of IFIs had started as early as the

development of Islam in Makkah and Madinah

(Haron and Azmi, 2009).

The Islamic financial industry instantly expanded

over the past few decades and in 2011, Dubai

Islamic Bank argues that Islamic banking and

finance is one of the fastest growing economics

sectors of the world today. However, compared to

conventional banking and finance, Islamic banking

and finance system is still in its very early stage. The

conventional banking and finance system was first

started in the 16th century when the merchants in

Venice established the Banco Della Pizza at Rialto

in Venice, Italy (Haron and Azmi, 2009, pp.43-44)

This paper discusses the importance of Shariah

audit in Islamic financial institutions and it is

regarded as a confession by the institutions that all

its operational activities are in accordance with

Islamic teachings. This is importance to keep the

institutions are accountable and trustworthy in the

eyes of public as stakeholders.

2 LITERATURE REVIEW

In “Emerging issues for auditing in Islamic Financial

Institutions: Empirical evidence from Malaysia”,

(2013) the authors examine the perspective of

practitioners who are involved directly and/or

indirectly with the process of Shariah

compliance/auditing from Islamic financial

institutions (IFIs) in Malaysia on the issues of

standards for Shariah auditing, auditor qualifications

and independence. They examine 77 self-developed

questionnaires applicable to the main issues focused

by this study. The survey questionnaires are

distributed by mail or delivered in person to 85

respondents in 21 Malaysian Islamic financial

institutions. They found that Malaysian IFIs are in

need of properly guided Shariah standards for

Shariah auditing practices.

This paper discusses the relation between

Shariah audit and the way to prove a fact or deny it

before the court in order to highlight that Shariah

audit in IFIs is needed to prove that IFIs are Shariah

complince.

Nor Fadilah and Nuzul Akhtar (2016) in

“Shariah Governance Framework: The Roles of

Shariah Review and Shariah Auditing” highlight the

roles of Shariah Review and Shariah Auditing and

discuss on the issues and challenges related to

Shariah review and Shariah Audit in Islamic

Financial Institution (IFIs). They said that the

growth of the Islamic finance industry around the

world is due to the unique features of Islamic

Financial institutions (IFIs) that emphasize on the

fairness and justice in their operations. Al Quran and

As-sunnah be the main rules to be followed. The

IFIs are responsible to ensure they comply with the

Shariah principles in its products, instruments,

operations, practices, management, etc. As for that

reason, Shariah governance is another component

that is peculiar exclusively to IFIs.

This paper relates the need to Shariah audit by

IFIs to admission as one of method to prove the fact

before Shariah courts.

Nawal, Shahul and Maliah in “Shariah Auditing

in Islamic financial institutions: Exploring the gap

between the “desired” and the “actual” discuss

“what ought to be” Shariah auditing and the current

practice of Shariah audit in IFIs in Malaysia. Their

paper aims to explore empirically the gap between

“the desired” and “the actual” practice of Shariah

auditing in IFIs in Malaysia. They found that there

exists a gap between the two concepts in terms of

certain issues discussed in this study.

Shariah Audit for Islamic Finance Industry in Revolution Industry 4.0: A Part of Religious Confession

This paper does not touch the desire and the

actual practice of Shariah auditing but only discuss

the relation between Shariah audit and confession in

Islamic law of evidence.

A paper titled “Post Implementation of Shariah

Governance Framework: The Impact of Shariah

Audit Function Towards the Role of Shariah

Committee” written by Zurina Shafii, Ahmad Zainal

Abidin, Supiah Salleh, Kamaruzaman Jusoff and

Nawal Kasim (2013) states that recent issuance of

Shariah Governance Framework by Bank Negara

Malaysia has shown a significant impact towards

the establishment of the Shariah audit and

consequently, towards the role of the Shariah

Committee. Hence the paper studies on the impact of

the Shariah audit function towards the role of

Shariah Committee with regards to the post

implementation of the Shariah Governance

Framework and found that from in depth interviews

reveal that the Shariah audit function has an added

value in ensuring the compliance towards the

Shariah principles.

This study elaborates the importance of Shariah

audit in IFIs and its connection with admission in

Shariah court for proving the fact.

Nor Aishah and Zurina (2014) claim in “The

Undergraduates’ Perspective on Shariah Audit in

Islamic Banks: An Insight to the Future Shariah

Auditor Labour Market in Malaysia” that despite the

importance of Shariah audit, there is little

understanding on how to implement an effective and

efficient Shariah audit from the human capital

perspective, particularly in terms of Shariah audit

education. This study purports to explore the

perception of the undergraduates on Shariah audit in

the Islamic Banks in Malaysia using questionnaire

survey in Malaysia. It found that there is significant

difference between students who are exposed to

Shariah audit course and those who are not.

This paper discusses the proof of confession is

practiced by IFIs through their Shariah auditing

institutions.

On the other side, Lutz Sommer (2015) in

“Industrial Revolution - Industry 4.0: Are German

Manufacturing SMEs the First Victims of this

Revolution?” writes that industry 4.0 represents a

special challenge for businesses in general and for

SMEs in particular. The study at hand will examine

companies´ awareness, readiness and capability to

meet this challenge taking into account the special

role of SMEs.

This paper confirms the importance of Shariah

auditing in IFIs as its admission of Shariah-

compliance in this challenging era of Revolution

Industry 4.0.

A Othman (1996) in An Introduction to Islamic

Law of Evidence said: “Iqrar [admission] is

therefore a form of admission for the purpose of

proving a fact in order to establish a right or interest

of another person against the maker of the admission

himself”. The book is about Islamic law of evidence

as a discipline of knowledge.

This paper aims at proving that Shariah audit is

considered as confession that IFIs are on the tract of

fulfilling the need to prove that they are in

accordance with Shariah rules.

3 DISCUSSION

3.1 Shariah Audit Defined

Shariah audit consists two words ‘shariah’ and

‘audit’. Shariah, also spelled Sharia, the fundamental

religious concept of Islam—namely, its law. The

religious law of Islam is seen as the expression of

God’s command for Muslims and, in application,

constitutes a system of duties that are incumbent

upon all Muslims by virtue of their religious belief.

Known as the Sharīʿah (literally, “the path leading to

the watering place”), the law represents a divinely

ordained path of conduct that guides Muslims

toward a practical expression of religious conviction

in this world and the goal of divine favour in the

world to come (Ahmed El Shamsy, N.J Coulson,

Britannica).

On the other hand, audit is the examination or

inspection of various books of accounts by an

auditor followed by physical checking of inventory

to make sure that all departments are following

documented system of recording transactions. It is

done to ascertain the accuracy of financial

statements provided by the organization.

Audit can be done internally by employees or

heads of a particular department and externally by

an outside firm or an independent auditor. The idea

is to check and verify the accounts by an

independent authority to ensure that all books of

accounts are done in a fair manner and there is no

misrepresentation or fraud that is being conducted.

Auditing is “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)

7th AICIF 2019 - ASEAN Universities Conference on Islamic Finance

Having discussed the two words i.e ‘shariah’ and

‘audit’ above, then Shariah audit refers to the

periodical assessment conducted from time to time.

This is to provide an independent assessment and

objective assurance designed to add and improve the

degree of compliance in relation to the Islamic

financial institution IFI’s business operation, with

the main objective of ensuring a sound and effective

internal control system for Shariah compliance. In

other words, it is to prevent instances of Shariah

non-compliance which is a peculiar risk to all

institutions operating under an Islamic worldview

domain (Rauf, n.d).

AOIFI's Governance Standard No. 2 states:

“Shariah review is an examination of the extent of

an IFI's compliance, in all its activities, with the

Shariah. This examination includes contracts,

agreements, policies, products, transactions,

memorandum and articles of association, financial

statements, reports (especially internal and central

bank inspection), circulars, etc.” (AAOIFI, 2004).

Kamaruddin and Hanifah (2017) “Currently,

there is no standardized definition of Shariah audit

issued by the regulated bodies as the IFIs industry is

still growing. However, there are few descriptions

regarding Shariah audit that can be used in

identifying Shariah audit. For instance, Bank Negara

Malaysia (BNM) in Shariah Governance Framework

(SGF) refers Shariah audit as: “The periodical

assessment conducted from time to time, to provide

an independent assessment and objective assurance

designed to add value and improve the degree of

compliance in relation to the IFI’s operations, with

the main objective of ensuring a sound and effective

internal control system for Shariah compliance.

(BNM, 2010, p. 10)

Before the issuance of SGF in 2010, several

scholars have defined Shariah audit based on their

understanding and experience. This includes a

definition of Shariah audit by Prof Dr Abdul Rahim

Abdul Rahman which is: “the accumulation and

evaluation of evidence to determine and report on

the degree of correspondence between information

and established criteria for Shariah compliance

purposes” (Abdul Rahman, 2008, p. 9).

Another Shariah audit definition by Associate

Prof Dr Nawal Kasim is as follows: “a systematic

process of obtaining sufficient and appropriate

evidence to form an opinion as to whether the

subject matter correspondence with Shariah rules

and principles in broadly accepted by stakeholders

and society at large” (Kasim, Ibrahim, & Sulaiman,

2009, p. 1).

The above Shariah audit definitions are also in

line with the scope for internal Shariah review by

Accounting and Auditing Organization for Islamic

Financial Institutions Governance Standard

(AAOIFI, 2010) for IFIs (GSIFI-3) No. 3 which is to

ensure that the management of an IFI discharge their

responsibilities in relation to the implementation of

the Shariah rules and principles as determined by the

IFI’s Shariah Supervisory Board (SSB).

Another related description regarding internal

Shariah audit is put forward by Dr Asyraf Wajdi

Dusuki in defining Shariah audit as: A systematic

process of obtaining and evaluating, sufficient and

reliable evidence by an internal Shariah auditor, as a

basis to form an opinion, as to whether the

operations and activities of the entity being audited

is incompliance with established Shariah criteria and

reporting the opinion hereon to the appropriate

authority. (Dusuki, 2011, p. 3)

Last but not least, the latest Shariah Governance

Exposure Draft issued by BNM on November 2,

2017 also re-defines the Shariah audit as: “a function

that provides an independent assessment on the

quality and effectiveness of the IFIs internal control,

risk management systems, governance processes as

well as the overall compliance of the IFIs operations,

business, affairs and activities with Shariah” (BNM,

2017, p. 18).

Based on all above definitions regarding Shariah

audit, it can be said in general that Shariah audit is

considered as tools or procedures to give assurance

to the stakeholders that an organization’s operations

are in accordance with Shariah laws and principles.

Although there are a lot of descriptions regarding

Shariah audit, yet it still lacks in terms of detailing

the scope of Shariah audit itself. As a result, Shariah

audit practices by each IFI currently are different

each other.”

3.2 Revolution Industry 4.0

To some, it will seem too soon to talk about the next

industrial revolution, i.e., the fourth industrial

revolution, but the adoption of digital technology

has reached a point where we are ready for another

radical change, the digital transformation of the

industry or what we call industry 4.0.

The change is based on the adoption of new

technologies for the progressive automation of the

production process. It is about innovative

technologies whose application to the industry will

be developed day by day

Bernard Marr, “We’re in the midst of a

significant transformation regarding the way we

Shariah Audit for Islamic Finance Industry in Revolution Industry 4.0: A Part of Religious Confession

produce products thanks to the digitization of

manufacturing. This transition is so compelling that

it is being called Industry 4.0 to represent the fourth

revolution that has occurred in manufacturing. From

the first industrial revolution (mechanization through

water and steam power) to the mass production and

assembly lines using electricity in the second, the

fourth industrial revolution will take what was

started in the third with the adoption of computers

and automation and enhance it with smart and

autonomous systems fueled by data and machine

learning.

3.3 Allegation against Islamic Financial

Institutions

Understanding the underlying wisdom of the origin

of Muamalat could clear some misconceptions

towards Islamic banks in Malaysia. These

misconceptions arise when we talk about

transformation from conventional bank to Islamic

bank. The development process of Islamic banking

and the services offered by Islamic banks may be

similar to those of conventional banks with some

exception that include general banking principles

(Eddy Yusuf, 2008).

Nawal and Sanusi (2013) wrote: “New

regulations have been imposed to restore confidence

in the corporate governance system and the

oversight role in this system. The effect on the

presence of a code of ethics for instance, appears to

have an impact on the quality of auditors‟ judgments

[8]. Hence, the introduction of Islamic laws into

Islamic financial institutions has resulted in great

changes; especially in the way the institutions do

their business. This has also affected the audit of

these institutions. Accordingly, the normal audit

objective has been changed to agree with the Islamic

law even though the normal conventional auditing is

unable to cater for the values of shariah Islamiah.

Conventional auditing is based on a system which is

value-free and does not take into consideration the

moral and ethical values laid down by Islam, despite

the fact that standard setters believe that the ethical

environment is an important factor in improving

audit quality.”

Yasoa, Wan Abdullah and Endut observed “On

the contrary, if the Islamic banks fail to monitor the

internal control and strengthen the lines of defense

in the organisation, the probability of Shariah non-

compliance activities or events to occur is very high.

The existence of the Shariah non-compliance

activities can damage the Islamic banks’ reputation

and may reduce the confidence of depositors,

shareholders, customers, and other stakeholders

towards the institutions. Hence, any income earned

from non-compliant transactions should be

channelled to charitable organisations and should

not be recorded as normal income from operation.”

Siddiqui (2018) “Fatwas given are according to

Islamic principles which are not followed by bankers

working in Islamic banks. Ulama are on board in

advisory capacity only while those involve in

execution are bankers. Many learned scholars who

are in favor of Islamic banking have also shown

their concerns over what was prescribed by them

and what is in actual in practise Islamic banks are

following.

In March 2009, Sheikh Muhammad Taqi Usmani

of the Accounting and Auditing Organization for

Islamic Finance Institutions (AAOIFI), a Bahrain-

based regulatory institution that sets standards for

the global Islamic Banking industry, declared that

85% of Sukuk, or Islamic bonds, were "un-Islamic".

Usmani has been called "the granddaddy of modern-

day Islamic finance".

According to another veteran of Islamic

economics, Muhammad Akram Khan, criticizes

Islamic banking as professing to have "put its

business on a basis other than interest" but in

practice devising "a whole host of ruses and

subterfuges to conceal interest."

Mahmoud Amin El-Gamal, a professor of

economics at Rice University (United States), has

described modern Islamic finance as “Sharia

arbitrage” -- i.e. what is prohibited in conventional

finance becomes permissible when deemed “Shari’a

compliant” despite having similar, if not the same,

economic substance

Islamic economist Muhammad Akram Khan said

Islamic banking has evolved toward convergence

with conventional banking "imitating conventional

banks in product development" rather than

establishing "a different type of banking which was

aligned to fairness, equitable income distribution,

and ethical modes of investment."

The above allegations shall be faced by IFIs in

order to keep themselves as Shariah compliance

industry in all their concept, activities, procedures

and management.

3.4 The Need to Shariah Audit

The Guidelines on Internal Syariah Audit

Framework of Brunei Darussalam are intended to

provide guidance on the Notice No. IFAU/N/2/2018.

These Guidelines are designed to meet the following

objectives:

7th AICIF 2019 - ASEAN Universities Conference on Islamic Finance

(i) To set out the expectations of the Authority on

the Financial Institutions and Banks to establish

institutional arrangements and recommendations

to facilitate the effective implementation of

internal Syariah audit as an integral component

of the Syariah Governance Framework; and

(ii) To provide guidance for the Financial

Institutions and Banks in specifying the scope of

internal Syariah audit, internal Syariah audit

objectives, internal Syariah audit governance,

internal Syariah audit charter, competency of

internal Syariah auditors, internal Syariah audit

process and reporting for internal Syariah audit.

Shariah audit system must be in place to

forensically examine the institution’s performance

on a regular basis and identify incidences of

incorrect or incomplete transactional flows, with the

aim of rectifying and improving performance in a

continual and sustainable manner, and following the

necessary Shariah, governance, and ethical, financial

and regulatory standards.

The shariah audit shares similar functions to the

company audit but they focused more on the

compliance of IFIs to shariah precepts and

requirement (Sultan, 2007). Haniffa (2010, p.45)

stresses that”the conventional financial audit is

inadequate to fulfill the needs of the stakeholders of

IFIs”. This is true as the International Standards on

Auditing (ISAs) did not take into accounts the

shariah aspects. The International Auditing and

Assurance Standard Board (IAASB) only sets the

international standards for auditing, quality control,

review and other assurance and related services that

serves mostly the shareholders interest. Sometimes

the ISAs are catered for specific country or

environment needs. Only recently we can see the

growing awareness of IFIs to implement shariah

audit which is one the core key elements of good

corporate and shariah governance to achieve the

objectives of the shariah (Kasim, Ibrahim and

Sulaiman, 2009).

Shariah audit is the examination of an IFIs

compliance with the shariah, in all of its activities,

particularly the financial statements and other

operational components of the IFIs that are subjected

to the risk of compliance including but not limited to

products, technology supporting the operations,

operational processes, the people involved in the key

areas of risk, documentations and contracts, policies

and procedures and other activities that require

adherence to sharia principles” (Haniffa, 2010). The

shariah audit should ensure that the IFIs have sound

and effective internal control systems to comply

with the shariah.

3.5 Confession a Proof of

Accountability

Under Islamic law, disputes are mediated before a

judge or Qadi. Similar to common law principles,

the burden of proof is on the plaintiff or accuser who

must present clear and convincing evidence to

support his claim. A defendant has the presumption

of innocence and any doubts in the dispute are

resolved in his favor. A judge's decision, which is

final and binding on the parties, must be consistent

with both the evidence presented and Islamic law.

Generally, only the oral testimony of a witness is

permitted as evidence. A witness is required to

testify that he had direct and personal knowledge of

the act and is certain that his testimony is true. A

witness who testifies untruthfully is subject to

punishment. Documentary or circumstantial

evidence may be permitted only if its reliability is

proven. Both the plaintiff and the defendant are

allowed to present evidence at trial.

Confession is regarded as useful evidence in a

dispute. A confession occurs when a defendant

swears that they are guilty prior to trial. Confession

must be done according to specific procedures

before it can be regarded as admissible. A

confession, for example, must be done without

coercion before a notary. Once admissible, a judge

may use either as proof of a defendant's innocence or

guilt.

Confession is a specific form of testimony,

involving oneself and it is used as a form of proof in

judicial matters. This aspect concerning moral guilt

has been carried on in various legislative codes in

which a criminal is considered worse if he does not

confess to his crimes. Al-Iqrar is the Arabic word

for confession. It literally refers to an admission or

confession.

However, under Islamic law, admission or

confession is one of the ways in which cases are

proof. A confession as a statement oral or written

made by a person accused of an offence, stating that

he has committed that offence. Confession has been

recognized as a source of conclusive proof of a right

and a crime by the Holy Quran and the Sunnah of

the prophet (PHUH) and he implemented Hadd

(offences with prescribed punishment) merely on the

confession of the accused.

However, a confession must be clear and devoid

of ambiguity. It must be subject to one and same

interpretations at all times and were an admission

(its wording and context) is clear; it is binding on the

court to act upon it. On the other hand, confession

could be described as admitting liability in the issue

Shariah Audit for Islamic Finance Industry in Revolution Industry 4.0: A Part of Religious Confession

or issues before a court of law. It could be oral or

written. It is a trite law that a confession of crime by

a sane, adult, which is made freely without any

element of compulsion, binds the maker.

Allegations against the operation of Islamic

financial institutions as mentioned in the previous

point must be solved including by means of

confession by the industry in order to maintain the

confident of the customers of the industry.

3.6 Shariah Audit: A Solution

Helal Uddin, Md. Musharof Hossain (2013)

Auditing standards are the norms of auditing policies

and practices issued by the authority for the

guidance of their members regarding the

examination of the items and making the audit report

for satisfaction of the intended users. The

International Standard of Auditing which is

currently practiced was developed interest based

western socio-economic culture and environment.

But Islamic organizations established and operated

based on Islamic Shariah to achieve legitimate

objectives, work in different environment using

different financial instruments and perform some

transactions which are unknown to the western

world. Hence, The Accounting and Auditing

organization for Islamic financial institutions

(AAOIFI) is an Islamic International autonomous

not-for-profit corporate body that was established in

Bahrain to prepare accounting, auditing, governance,

ethics and shariah standards for Islamic financial

institutions and the industry on 26th February, 1990

to attain the following objectives:

1) to develop accounting and auditing thoughts

relevant to Islamic financial institutions;

2) to broadcast accounting and auditing thoughts

relevant to Islamic financial institutions and its

applications through training, seminars,

publications of periodical newsletters, carrying

out and commissioning of research and other

means;

3) to prepare, promulgate and interpret accounting

and auditing standards for Islamic financial

institutions; and

4) to review and amend accounting and auditing

standards for Islamic financial institutions.

Islamic financial institutions need Shariah

auditing because the Shariah has basic principles to

be observed in any operation. Such basic principles

are:

a. Integrity

b. Objectivity

c. Confidentiality

d. Neutrality

e. Competency

f. Continuity

g. Disclosure

h. Giddiness

i. Orienting

j. Planning

k. Legality

l. Committed to Ethics, and

m. Committed to Religion.

In addition, Audit engagement indicates, to do

the audit work in a particular time, according to

Islamic auditing view point the engagement will

occur among the parties by considering following

standards:

a. Believable standards,

b. Moral standards,

Behavioral standards,

d. Educational standards,

e. Practical Standards.

According to Helal Uddin, Md. Musharof

Hossain. (2013), Role of Auditor in Islamic Auditing

are:

a) Auditor’s liability towards Outside financiers:

The auditor’s liability to outside financiers in

the Islamic framework is enhanced by specific

institutional setup of the economy. In the

Islamic economy interest- bearing finance is

not available to the business. All finance is risk

capital in the form of equity capital or

mudarabah capital for different maturities. The

outside financiers who provide capital on

mudarabah on the basis of profit loss sharing

will need an extended assurance from an

independent agency that the profit (or loss)

declared by the management is true or correct.

In the absence of such an assurance, the outside

finance shall be extremely bashful. It would

simply make the operation of interest-free

financing impossible. In these circumstances

who could be looked up for reliance other that

the auditor? In the capitalist framework the

interest of outside financiers is protected by

predetermined interest charge. The auditor

makes sure that the final figure of profit (or

loss) is arrived at after providing for interest on

all loans and financial obligations. With the

absence of interest, the determination of true

profit (or loss) becomes crucial for the outside

financiers as well. It is to them that the auditor

will owe a responsibility. Determination of

7th AICIF 2019 - ASEAN Universities Conference on Islamic Finance

profit or loss is a subjective and value-laden

area in a business organization. The ultimate

figure of profit depends on a number of

decisions such as rates of depreciation on

different assets, valuation policies of stocks,

amortization of intangible assets, charging to

deferred payments to current operational

income, apportionment of profit into reserves

and dividends, etc. In the capitalist framework

these questions are decided by the management

and the auditor reports compliance on them.

But in the Islamic framework standards may

have to be devised for the determination of

profit or loss for different categories of trade

and industry. Due care would be taken to arrive

at a judicious and consistent figure of profit (or

loss) so that interest of outside financier are

also protected. In the absence of fixed

predetermined rate of interest, the financiers

may be left at the mercy of the management to

declare a profit (or loss) in the manner they

like. The prevalent standards of morality and

integrity in Muslim countries suggest that the

auditor would have to operate in an extended

field to verify an accurate figure of profit (or

loss), which may not be a strict compliance of

the management policies. It would be an

outsider’s view-a third party opinion on the

operations of the business organization. If the

Islamic framework does not provide for such a

role of the auditor, it would not fetch necessary

confidence and support of the masses.

b) Assessment of management practices: As

stated above the business firms would acquire

outside finance on the basis of shirkah or

mudarabah. The financiers would also require

an assurance that the firms acquiring these

funds would manage them with due regard for

economy, efficiency and effectiveness. In the

absence of such an assurance the financiers

may not be willing to provide capital for fear of

gross mismanagement. The funds provided on

the basis of shirkah or mudarabah do not have

any predetermined cost in the form of interest.

As a result the likelihood of miss utilization of

these resources increases. Part of which the

financiers can have proper management of

these resources will come through an

independent examination of the business

processes and practices. Such an independent

examination will be made by the auditor. It is,

therefore important that the auditor in the

framework would extend his examination to

the management of resources as well. The audit

criteria for such an examination would be

derived from the generally accepted

management practices. Of course, in the

Islamic economy these practices would also

undergo certain change in the light of Shariah

law and values.

As a corollary, it is implied that such an

examination would require exposition of

standards for business management in the

Islamic framework. These standards would be

utilized by the auditor for his examination. As

stated earlier, traditionally it is not part of the

statutory responsibility of the auditor to

examine and report on the management of

resources. Only recently, various shades of

‘value for money’ auditing have emerged,

which have expanded the scope of auditing

considerably. The expansion in the scope of

auditing is taking place in the capitalist

framework as well. In the Islamic economy the

basic framework would undergo a change

although the concept of expansion in the scope

may be similar to the one being evolved in the

capitalist framework. It may be added that the

‘value for money’ auditing is being applied,

mainly to public sector organizations where the

ownership of resources is impersonal as

compared to business firms where the owners

exercise direct control on the management. But

in the Islamic framework, the outside

financiers of business firms would have direct

control over management. Therefore, they

would require an independent examination of

the management processes and practices to

satisfy themselves that their funds are not being

squandered away willfully or handled

negligently. Thus, the auditor’s role in the

Islamic economy would expand to include

assessment of resource management even in

the private sector.

c) Bakhs: The auditor would be required to report

on the extent of bakhs practiced by the auditee.

Bakhs literally means to decrease; to diminish;

to reduce. But the Qur’an has used this term to

indicate any voluntary effort to diminish or

decrease the value of the product being sold.

The Qur’an has admonished the people of the

Prophet Shu’aibAlaihissalam for

bakhs since

they caused a loss to the buyer by reducing the

value of the merchandise (Surah al-A’raf: 85).

Bakhs would, therefore, include adulterations

in food, changes in specifications of ingredient

and raw-material or modification in the

Shariah Audit for Islamic Finance Industry in Revolution Industry 4.0: A Part of Religious Confession

production formulate that may result into

decrease in the quality of the product.

d) Tatfif: The auditor would investigate into the

extent of tatfif exercised by the clients. Tatfif is

Qur’anic term which stands for causing

damage to the other party in weight and

measures (Surah al-Mutaffifin: 1-2). It suggests

taking-in an excess measure and giving –out a

short measure. They would report on the extent

the organization adhered to the Shariah

injunction of ‘awful mikyalwalmizan (give a

full measure and weight). He would check the

accuracy of the weights and measures and in

case of packed material would testify, to as far

an extent as possible, that these package weigh

and measure the quantity stated on them.

e) Uqud: The auditor would investigate into the

extent the business firm kept to its uqud

(contracts). Keeping of contracts has been

emphasized in the Qur’an at a number of places

(Surah al-Maidah: 1). The auditor would look

into various contractual commitments of the

clients towards customers, suppliers, debtors,

creditors and the state. His report would point

out areas of neglect and non-fulfillment of

obligations.

f) Ihtikar: The auditor would check the extent of

ihtikar (hoarding) practiced by an organization.

Hoarding of foodstuffs has been prohibited by

prophet (peace be upon him), explicitly. By

analogy to foodstuffs, hoarding of other article

with the intension of causing scarcity and

bidding up prices artificially may also be

treated as ihtikar. The auditor would express

his opinion on the extent an organization

practiced ihtikar.

g) Khiyanah: The auditor would point out area of

khiyanah in the affairs of the organization. It

does not include merely embezzlement of

funds but also falsification of accounts, bogus

insurance claim, tax evasions, window

dressings, and miss-statement of accounts.

h) Israf: another area of auditor’s investigation

would be the extent of israf (extravagance)

which an organization practiced. Israf has been

condemned by the Qur’an as an undesirable

behavior for individuals (Surah al-Maidah: 41).

This can be extended to cover the behavior of

firms as well. Israf is a socially determinate

concept.

The state and other institutions (such as

chamber of commerce and industry) may lay

down desirable scales of office furnishing,

business banquets and social functions. These

would be guidelines for the auditor to comment

on the propriety of expenditure by an

organization.

i) Speculation: While auditing the accounts of

financial institutions, the auditor would report

on the extent of credit extended by these

organizations for speculative purposes. He

would also examine and report on disguised

riba. He would try to unveil all such

malpractices which the shariah has banned in

the bai’alsarf (exchange of money for money).

Determination and payment of zakat: Payment

of Zakat is an obligation on those who own

wealth beyond the exemption limit (nisab).

Thus, the obligation of Zakat on the rich is

because of their wealth. On the basis of this

general rule it is agreed that business firms are

also subject to Zakat, although the exact

method of its calculation needs reconsideration.

It will be one of the responsibilities of the

auditor in the Islamic economy to report that

Zakat has been calculated correctly and paid

into the public Zakat fund or spent properly on

one of the eight heads of account specified in

the Holy Qur’an (Surah al-Taubah: 60).Thus

the auditor would watch the interest of the poor

people in the society. Knowledge requirement

for a Muslim auditor: The auditor would have

to play an extended role in the Islamic

economy. He would be operating in the wider

social orbit advising management on

efficiency, helping state in Amar

bilma’rufwanahy’anil’ munkar and protecting

the interests of third parties such as customers

and suppliers.

k) The Auditor’s report: Socio – economic values

of the Islamic economy include ihsan. Ihsan in

turn, is a cluster of various values such as

amanah (honesty), ithar (sacrifice), ta’awun

(cooperation), sabr (patience), shukr (thanks

giving), tawakkul (trust), infaq (spending), and

silaturrahm (joining of kinship ties), etc.

Business organization undertakes philanthropic

and socio-cultural activities even in capitalist

economies. In an Islamic economy, the

adoption and promotion of ihsan is one of the

requirements of the shariah. Auditor in the

Islamic framework would report on the extent

an organization adhered to these concepts and

propagated them over and above its principal

operations. Following subject matter must

consider for formulating final report,

o The scope of the report,

o The auditing standards are committed,

7th AICIF 2019 - ASEAN Universities Conference on Islamic Finance

o The shariah rules be committed,

o The main remarks and Errors,

o The main recommendations,

o The date of the report,

o The signature of the Auditor.

4 CONCLUSION

Shariah compliance is the backbone of Islamic

finance institutions (IFI) in which they operate.

Therefore, ensuring Shariah compliant aspect is

paramount to maintain the confident level and public

at large. Inadequate attention to the whole process of

Shariah compliant aspect triggers negative

repercussion to the IFIs, such as massive withdrawal

and financial loss. In this regard it is essential to

have a comprehensive, robust and well-functioning

Shariah control mechanism to ensure the beginning-

to-end Shariah compliant in the day-to-day business

operations. As such, a sound Shariah audit and

review have to be in place to assess the level of

Shariah compliance aspect on a regular basis, to

identify any potential Shariah compliant incidences

as to provide with the proper rectification

mechanism.

The findings basically reveal that the Shariah

audit function has an added value towards the

Shariah compliance of the operation of the IFIs,

particularly on the implementation process of the

product in the organization and the internal control

that should be imposed. In addition, the function

facilitates IFIs to identify possible Shariah breach of

contracts (if any), prior as well as after the

implementation of the product. This is vital for IFIs

to provide preventive and corrective measures

before greater issues really happen.

4.1 Recommendation

Compliance to Shariah is vital to enhance the

confidence of the stakeholders of IFIs. This is one of

the reasons for any regulatory body in a jurisdiction

to issue the Shariah Governance Framework for

implementation by the IFIs. It is the objective of this

paper to examine the impact of the Shariah audit

function as a confession to extract confidence from

stakeholders of the industry.

Hence, Shariah auditing is a must in the industry

because it’s a proof that the industry runs its

operations in accordance to Shariah compliance.

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