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TOPIC 9

Zakat Accounting for Islamic Financial Institutions

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Meanings of Zakat

General Meaning“a compulsory levy imposed on the Muslims so as to take surplus money or wealth from the comparatively well-to-do members of the Muslim society and give it to the destitute and needed”.

Literal Meaning (Arabic word)1. “Growth or increase”

• Giving Zakat will increase in prosperity in the world and religious merit in the hereafter.

2. “Purity”• Purifies from sins (“take from their property

(sadaqah) in order to purify them (tuzakkhihim)” Al-Qur’an 9:104.

Note: Both meanings have spiritual connotations.

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The Role of Zakat• Maududi: “To ensure a decent living for the people and fulfill

their basic needs is in the nature al-amru bil maaruf wa nahy an al-munkar (enjoining good and forbidding evil)”

• Surah al-Maarij, verse 25: basic right for the poor in the wealth of the affluent

• Surah Al-Insan, verse 8: Allah SWT promises with distinction those who “feed for the love of God the indigent, orphan and the capitve (slave)”

• State’s responsibility: Ar-Rasul SAW declined the request of her daughter Fatimah who married Ali RA, to provide a servant

“By Allah I shall not grant this while Ahlu Suffah (a group of poor immigrants who slept in the mosque for lack of shelter) suffer from hunger and I do not find enough to feed them”(Imam Ahmad Ibnu Hanbal Al-Musnad)

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Wealth Subjected to Zakat (Traditional Wealth)

Gold and Silver (including jewellery and money)• Surah At-Taubah verse 35

Agriculture Produce (dates, wheat, etc.)• Surah Al-An’am verse 141

Minerals (gold and silver)• Surah al-Baqarah verse 267

Trade Assets• Surah Al-Baqarah verse 267

Animals (camels, sheep, etc.)• Surah An-nahl verses 5 – 7)

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Wealth Subjected to Zakat (Modern Wealth)

Based on Ijma’, Qiyas and Ijtihad of Contemporary Ulama’

• Income (e.g., salaries and wages)

• Financial Securities (e.g., shares and bonds)

• Islamic Financial Institutions (e.g., banks, insurances)

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Principles of Zakat Accounting

1. Individual Right Ownership• Wealth belongs to government or community or

Waqf is not subjected to zakat

2. The valuation of Assets based on current or market value• Show the most accurate and relevant value of

assets• Measure the net worth of the individual/company

3. Yearly principle• Assets should be owned for one full year (haul)• Zakat charged only once a year (except for

agriculture produce)

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Principles of Zakat Accounting

4. Ability to pay• The aim of Nisab (minimum requirement) is to ensure

Zakatable wealth is in excess of normal requirements.

5. Full Disclosure• Zakat computation must be true and fair• Zakat payers need to truthfully discloses all his/her

financial facts• In the case of companies, is the audited financial

statement a reliable financial fact?

6. Objectivity (True and Fair View)• Measurement must be objective and quantifiable• Justice to both Zakat payers (who hold financial

obligation) and Zakat beneficiaries (who are the rightful recipients of Zakat)

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Zakat on Trade Wealth

“O you who believe! Give away some of the good things you have earned and some of what the earth produces”(Al-Quran, Chapter 2 verse 267)

Abu Dawud reports from Samura ibn Jundub;“The Prophet SAW used to order us to pay Sadaqa (Zakat) from what we have for sale”

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AAOIFI Financial Accounting Standard No. 9 (Zakah)

Why do we need Accounting Standard for Zakat?

• Consistency• Comparability• Compliance

Scope of the Standard:

1. The determination of Zakah base (methods of assessment)

2. The measurement of items included in the Zakah base (methods of valuation)

3. Disclosure requirements in the Financial Statement

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AAOIFI FAS 9

• Effective beginning 1 Muharram 1420H or 1 January 1999

• However, in many Muslim countries the standards served only as guidelines which they are not supposed to be complied with

• This is due to the required compliance with the respective countries Central Bank guidelines and by-laws.

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Determination of Zakah Base

Calendar Year

• 2.5% (Lunar of Hijrah)• 2.5775 (Solar or Masihi)

Methods of Assessment

• Net Assets Method• Net Invested Funds Methods

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Difference between Masihi and Hijrah years

Jan – 31 Feb – 28 March – 31 April – 30 May – 31 June – 30 July – 31 Aug – 31 Sept – 30 Oct – 31 Nov – 30 Dec – 31 Total = 365

Muharram – 30 Safar – 29 Rabiul Awwal – 30 Rabiul Akhir – 29 Jamadil Awal – 29 Jamadil Akhir – 30 Rejab – 29 Syaaban – 30 Ramadhan – 30 Syawal – 29 Zulkaedah – 30 Zulhijjah – 29 Total = 354

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Method of Zakat Measurement: Net Assets Method

• Assumptions:Urudh At-Tijarah or Net Trade (Current) Assets (Hanafi, Syafie Mazhab)

• Zakah Base:(Trade Assets/Current Assets) less (or minus)(Trade Liabilities/Current or Short-Term Liabilities)

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Assets subjected to Zakat

• Assets acquired for trading (e.g., marketable securities, i.e., dealing and investment)

• Financing Assets (e.g., Mudarabah, Musharakah, Salam, etc.)

• Cash and cash equivalents

• Receivables (net of provision for doubtful debts)

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Liabilities to be deducted

• Current or short term liabilities (payables or creditors, etc.)

• Equity of unrestricted investment accounts

• Equity owned by the government

• Equity owned by endowment funds (Waqf)

• Equity owned by charities

• Equity owned by non-profit organisations

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Method of Zakat Measurement: Net Invested Funds Method

Zakah Base• Net Equity (Invested Funds) minus (less) Fixed or Long Term Assets

(Hanbali Mazhab)

Equity• Paid-up capital• Reserves• Retained Earnings• Net Income (profit for the year)• Long Term Liabilities (due more than a year)

Fixed Assets • Net Fixed Assets after depreciation (e.g., Land, Buildings, etc.)• Long Term Investment• Losses (if there is any)

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Method of Assets Valuation for Zakat

• AAOIFI FAS 9: Market Value (market selling price or cash equivalent value) whenever possible

Reasons:• Zakat base should include the historical cost and any

holding gains (or losses)• To reflect the true value of the assets and the current

financial position of the entity• However, trade liabilities, long term liabilities, equity,

and fixed assets are permissible to be valued at book value

• Differences in valuation will affect the assessment and adjustment of the differences in the valuation need to be provided

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AAOIFI FAS 9: Disclosure Requirements

• Methods used for determining Zakat base and items included in the base

• The ruling of the Shari’ah Board of the Islamic Bank on issues related to Zakat that are not included in the standard

• Statement on whether or not the Islamic Bank as a holding company pays its share of Zakat obligation of its subsidiaries

• In the case the Islamic Bank does not pay Zakat, the amount of Zakat due should also be disclosed.

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AAOIFI FAS 9: Disclosure Requirements

• Whether or not the Islamic bank collects and pay Zakat on behalf of the holders of the investment accounts and other accounts.

• Restrictions imposed by the Shari’ah Supervisory Board of the Islamic Bank in determining Zakat base.

• The disclosure requirements of FAS 1: General Presentation and Disclosure in the Financial Statements of Islamic Banks and Financial Institutions shall be observed.

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Emerging Issues of Zakat on Trade Wealth

• Is a company or an IFI a legal entity to pay zakat?

• Incentive to pay? No tax rebate for corporate zakat

• Mixed ownership i.e. Muslim and Non-Muslim shareholders?

Thus, (% shares ownership X Net Current Assets at year end)

• Is a conventional audited financial statement relevant for zakat measurement?

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Zakat Obligations for Islamic Financial Institutions

• Obligations to pay should be charged directly to the shareholders and depositors

• Shareholders authorising the Islamic Banks to do so on their behalf

• Islamic Fiqh Academy recognised Zakat due to be paid by the enterprise as a corporate entity

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Zakat Obligations for Islamic Financial Institutions

• Islamic Banks must pay Zakah when:

- the law requires them to pay- required by its Charter or by-laws, and- when the general assembly (AGM) and shareholders has passed resolution require them to pay

• If the Islamic bank pay Zakah then the shareholders and depositors do not have to pay

MASB Technical Release i - 1

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The amount of zakat assessed shall be recognised as an expense and included in the income statement for the period in which it is incurred

Assessment – one haul Zakat on business = zakat rate x zakat base The rate of zakat on business, as determined by

National Fatwa Council, is 2.5% of zakat base Zakat base – net adjusted amount of zakat assets

and liabilities from the business activities Adjusted working capital method Adjusted growth method

Disclosure under MASB–Tr i-1

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Method used in the determination of zakat base

Its responsibility towards payment of zakat on business; and

Major components of zakatCurrent zakat expenseZakat paymentZakat liabilityAny adjustments recognised in the period for

zakat of prior periods

MASB Tr-i 1 vs AAOIFI’s FAS 9

MASB Tr-i 1MASB Tr-i 1 AAOIFI’s FAS 9AAOIFI’s FAS 9

ApplicableApplicable Business that pay zakatBusiness that pay zakat Islamic banksIslamic banks

MeasurementMeasurement Same measurement bases Same measurement bases used in the preparation of used in the preparation of financial statements – book financial statements – book valuevalue

Cash equivalent value Cash equivalent value – assets– assets

Book value – liabilities Book value – liabilities and equitiesand equities

Zakat rateZakat rate 2.5%2.5% 2.5% - Hijriah year2.5% - Hijriah year

2.5775% - Masehi year2.5775% - Masehi year

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