Association of Islamic Banking Institutions, Malaysia

 

Shariah Audit Conference on the 10th May 2011.

 

Shari’a Audit Findings in determining Types Shari’a Auditors’ Reports

Prepared by
Dr. Abdulbari Mashal
Manager General-RAQABA for Islamic Financial Consultations
Leeds-Britain

 

Private Company Registered under No. (06405981) Leeds- Britain

 

 

Association of Islamic Banking Institutions, Malaysia
Shari’ah Audit Conference on the 10th May 2011.

 

Shari’a Audit Findings in determining Types Shari’a Auditors’ Reports

Praise be to Allah, the Lord of the worlds and all prayers and blessings of Allah be upon our master, the most noble Prophet and Messenger Muhammad, his family, companions, followers, and those who follow them righteously till the Day of Judgment.
I’d like to thank the colleagues in the Association of Islamic Banking Institutions, Malaysia for giving me the chance to take part in Shari’a Audit Conference held on the 10th May 2011 in Malaysia.  I will tackle in the paper the effect of Shari’a audits findings in determining types of Shari’a auditors’ reports.
This subject is tackled through the following:

Point (1): Shari’a Notes
Point (2): Shari’a Auditors’ Reports
Point (3): Reports Competence

 

Point (1): Shari’a Notes
First, Types of Shari’a Notes
Secondly, Treatment of Shari’a Notes
Thirdly, Disclosure of Shari’a Notes

 

First, Types of Shari’a Notes
Through induction and practice, the Shari’a notes resulting from Shari’a audit might be classified into the following types:

Type (A): breach of the accredited Shari’a procedures such as:

• Usurious borrowing and lending.
• If the subject matter of the contract is haram such as wines and prohibited benefits and services.
• If the subject matter of the deferred payment sale contract, or salam contract, or istisna’ contract is gold or silver and the price is in cash.
• If the price and the appraised (cash or goods) are usurious in the futures, or salam, or istisna’ contracts.
• If the customer financed has previously concluded a contract on the purpose of finance.
• Sale before owning the specified goods in musawamah and murabahah contracts.
• Sale before acquiring the specified commodity in musawamah and murabahah contracts.
• Sale of as-salam or the manufactured before its acquisition.
• Paying the capital of as-salam later than the date of contract.
•  Paying interests in case of disclosing the bank accounts at the correspondent banks.
•  Paying interests in case of delay in paying any dues.
• Receiving the fines and the delay interests from the debtors to the bank.

Type (B): breach in models

• Using contracts or models which are not accredited by Shari’a.
• Using contracts or models which are not fully compliant with the forms accredited by Sharia’a in some items.
• Not stating the dates, or the goods description, or the price, or the customer name, or the signatures in the contract.

Secondly: Treatment of Shari’a Notes:

• Removing the breach causes if possible such as terminating the contract or repaying the interests and the fines, etc.
• Completing the missing data in the contract or model in a non-contradictory way with the proven data.
• Allotting the received interests and fines for charity.
• Allotting the profits of the void contracts for charity.
• Avoiding repetitions in case of the lack of financial effect due allotment.

At any rate, the Shari’a treatments must be based on the standards accredited by Sharia’a. There must be sufficient Sharia’a standards to cover the Sharia’ treatments of the all possible Sharia’ breaches.

 

Thirdly, Disclosure of Shari’a breaches

• The essential Shari’a breach in addition to the correctional procedure taken by the institution administration must be disclosed either if there is a haram financial effect or not such as:
• Usurious borrowing: the breach and the board’s situation concerning it are stated. Note that there is no illegal financial effect on the company’s revenues.
• Entering in non-Shari’a contracts: the report states that these contracts are void according to the board.  Moreover, the haram revenues resulting from them must be allotted and the institution must be truly committed to allotment.
• The allotment of the haram revenues resulting from illegal sources which are received on the basis of a Shari’a opinion such as the interests of the correspondents’ accounts and the haram amount of the mixed companies’ revenues must be disclosed.
• Non -essential notes according to Shari’a view shall not be disclosed. It is enough to treat them internally by the bank or the institution administration.

At any rate, the disclosure of the essential Shari’a breaches is a professional requirement and hiding the inessential breaches requires treating them internally between the board and the institution. This disclosure has a great effect on the form of the opinion paragraph in the auditor’s report as shown in point (2).

Point (2): Shari’a Auditors’ Reports
The external Shari’a auditor’s report (Shari’a censorship boards reports) concerning to what extent the institution is committed to the rulings of Islamic Sharia’a is the focal interest for those who are affected by the Islamic financial institutions including owners, employees, supervisory agencies, customers, and the masses. Three types of reports are distinguished:

• Administration Letter: It is a report to the institution administration to point out its main weak points in the internal Shari’a censorship system that must be avoided to improve the system through internal work team or external consultations.
• Initial Report: It is a detailed report with the Shari’a notes resulting from auditing the commitment. This report includes a summary of the audit process and its results. It also includes the notes on the institution’s activities in a full way and the institution’s opinion about each note, and then the Shari’a auditor’s opinion (the board) about each note in the light of the institution’s opinion about its effect on keeping or removing the note.
• Final report: It is a short form report including the external Shari’a auditor’s opinion (Shari’a Censorship Board) to show to what extent the institution administration is committed to the Islamic Shari’a rulings.  This report is the final target of the external Shari’a auditor (Shari’a Censorship Boards) and is presented to the General Assembly.  This is the focal interest for those who are affected by the institution such as the shareholders and the supervisory agencies. Therefore, the Board’s opinion about the commitment range must be explicitly expressed.  This report is our focal point in this paragraph.

This subject is tackled through the following points:

First: Contents of the reports
Secondly: Types of the reports
Thirdly: Models of the reports

 

First: Contents of the reports
The Shari’a auditor’s report (Shari’a Censorship Board) must include a suitable documentation as follows:

• Putting a title to the report such as The External Shari’a Auditor’s Report/The Shari’a Censorship Board’s Report.
• Fixing to whom the report is addressed such as the institution’s shareholders.
• Putting the signatures of the members of the Shari’a Censorship Board.
• Writing the date of the report preparation and the fiscal period it covers.

The body of the report includes two main paragraphs as follows:

 

ــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــــ
The terms used for the Shari auditing reports are basically taken from the external financial auditor’s reports with the regards to the setting standard issued by the AAIOFI.

 

Paragraph One: Business range
This paragraph includes the following:

• Stating the purpose of the audit, and that the administration is responsible for the execution while the auditor is responsible for illustrating his opinion.
• Depicting the nature of the task performed by the auditor.  The inspection or audit is done according to the conventional standards of audit and on the basis of sampling. The task performed by the auditor (Shari’a Board) presents a reasonable but not an unquestionable confirmation and provides a sufficient basis to illustrate opinion.

Paragraph Two: Opinion Paragraph
This paragraph shows the results reached through the audit. It represents the auditor’s opinion and judgment issued after evaluating their evidences and confirmations. The Shari’a auditor’s report aims at showing the opinion of the Shari’a auditor (Shari’a Censorship Board) concerning to what extent the institution is committed to Islamic Shari’ rulings as in the accredited standards.

Secondly: Types of reports:
Shari’a auditors’ reports/opinions concerning the Shari’a commitment range differ according to:

• The range of the institution’s deviation from commitment to the Islamic Shari’a rulings. The deviation could be basic or non-basic.
• The range of restrictions imposed by the institution on executing the task of the Shari’a audit.
• The range of obtaining sufficient evidences.

Generally, four types of the auditors’ opinions/reports are distinguished accordingly as follows:

 

Unqualified report or opinion

Adverse report or opinion

Disclaimer of opinion

Qualified report or opinion

 

In the light of the disclosure policy of Shari’a breaches as stated in item 3 inPoint 1, the causes of using each type of report/opinion are determined in accordance with the three aforementioned issues as follows:

 

1. Unqualified report or opinion (1) Contracts and transactions concluded are compliant with Shari’ah Confirming that the calculation of Zakat is in accordance with the bases legally accredited Confirming that the profits of investment accounts are distributed according to the bases legally accredited	Lack of any basic or non-basic deviation   Lack of restrictions on executing the task   Sufficiency of evidences The existence of a non-basic deviation It is essential to show the auditor’s supervision upon the calculation of Zakat. While Paying Zakat depends on the agreement between the shareholders and the administration and the disclosure is done accordingly. As for the banks which have investment deposits, it is necessary that the dividends are in accordance with Shari’ah.
1. Unqualified report or opinion (2)   The disclosure of receiving the interests of the correspondents’ accounts and delay fines and allotting them for charity	The existence of received interests on the correspondents’ accounts   The existence of delay fines on the debtors for charity
2. Disclaimer of opinion	Insufficiency of evidences  The existence of restrictions upon executing the task
3. Adverse report or opinion Contracts and transactions concluded are non-compliant with Shari’ah.	The existence of a whole basic deviation.
4. Qualified report or opinion Unqualified except for…….etc	The existence of a partial basic deviation which does not lead to an illustration of an adverse opinion

 

6- Four types are differentiated in the external auditor’s reports according to the opinion type: Unqualified report or opinion, qualified report or opinion, adverse report or opinion, and disclaimer of opinion (The Encyclopedia of Audit Standards, Vol 3, p.96). This paper attempts to tackle some aspects which could be relied on in classifying the reports of ٍٍShari’a boards according to the commitment level.

 

Thirdly: Models of reports

 

1. Unqualified Report Model (1)

 

In the name of Allah, most Gracious, most Merciful Shari’a Censorship Board Report To the Islamic financial institution’s shareholders May Allah`s peace , mercy, and blessing be upon you According to the assignment letter, we audit the contracts and transactions executed by the institution during the fiscal year ended on / / to illustrate our opinion about the institution’s commitment range to the Islamic Shari’ah rulings as stated previously. The institution’s administration shall be responsible for executing the contracts and transactions according to the Islamic Shari’ah rulings. However, we shall be responsible for illustrating an independent opinion about the institution’s commitment range accordingly on the basis of our audit and presenting you a report. Our audit is done according to the control standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions. This requires us to plan and execute the audit procedures to get all essential information, interpretations, confirmations, and statements to provide us with sufficient evidences to give a reasonable confirmation that the institution is committed to the Islamic Shari’ah rulings. Our audit is done on the basis of checking samples of each type of the contracts and transactions executed during the period. We think our audit activities provide a suitable base to illustrate our opinion. In our opinion:

The contracts and transactions concluded by the institution during the fiscal year ended on / / are executed according to the Islamic Shari’ah rulings. Distributing profits and charging the loss upon the investment accounts are according to the base accredited by us. Calculation of Zakat is according to the principles accredited by us.

The Shari Censorship Board (Names and signatures of the board members) (Report date)

 

2. Unqualified Report Model (2)

 

In case of adding an explanatory paragraph that does not affect the unqualified opinion, but being essential for the Shari auditor, this paragraph could be added subsequent to the opinion paragraph.

This is represented if there are usurious interests on the institution’s account balance at foreign usurious banks (The institution’s accounts at others) and the institution could not arrange another legal substitute to deal with those banks on the basis of Islamic Shari’ah rulings. These interests are automatically directed to the institution’s charity account for the charitable aspects. They are not included in the institution’s business income in accordance with the accredited Shari instructions.

Hence, the interests are not due to a breach by the institution but rather an accredited Shari instruction. This is for the need that requires such accounts. Accordingly, these usurious interests do not affect evaluating the institution’s commitment to the Islamic Shari’ah rulings. The controller of this situation is the prohibition of business according to the public Shar’iah rules. Yet, the company undertakes this business in the light of the accredited Shari instruction in recognition of the need.
The same case is applied to the delay fines imposed on the basis of the commitment to the donation to a third party.

The named explanatory paragraph could be added subsequent to the opinion paragraph in the first unqualified report as follows:

All the delay fines/usurious interests received according to an accredited Shari’ instruction is expended for charitable purposes. (Model -1) All the delay fines/usurious interests received according to an accredited Shari instruction are kept in the charity account in order to be expended for the charitable purposes. (Model -2)

 

3. Adverse Report Model

The need for illustrating an adverse opinion requires achieving the auditor’s satisfaction with illustrating an unqualified opinion, in case there are basic Shari’a breaches which do not suffice the institution’s confirmations. This case is depicted when there is a full gap between the Islamic Shari’a rulings and the institution’s state since the audit results show that the Islamic Shari’a rulings have not come into execution in the institution’s state. This is called the whole basic deviation.

The adverse opinion could be formed as follows:

 

In our opinion:  Contracts and transactions concluded by the institution during the fiscal year ended on../…/ do not comply with the Islamic Shari’a rulings.