Paper Sample in Finance: IFRS and Accounting and Auditing Organization for Islamic Financial Institutions

International Financial Reporting Standards refer to the rules set for accounting to ensure that there is a common language in the business fair. This is important since it ensures that accounting records for a company is understandable and comparable internationally. The main advantage of having comparable accounting records is that it opens up more business opportunities for your business. Your business will have the ability to collaborate with international companies and increase profits. There are rules which govern this. This system is commonly used in Europe and the Middle East. However, United States has not adopted the system yet. Brazil is the only country from American region which has adopted the system. In the near future, private companies in the United States might see the need to join this system. Although there are many companies which use the system as well, the best example is Banque de France. Like other companies, Banque de France has compiled to the IFRS rules and can trade with the others internationally with ease. However, the Islamic affiliated companies use another accounting system known as Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

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Accounting and Auditing Organization for Islamic Financial Institutions is a body which helps Islamic financial institutions with auditing, accounting and Sharia laws among other things. This institution was created since the Islamic companies were not comfortable with the International Financial Reporting Standards regulations. Although it does the same work as IFRS, it they have several differences. Just like IFRS, the companies under this institution can compare their accounts with others internationally. This is important as well since they can trade and increase profits. The companies under IFRS will find it hard to trade with those under AAOIFI since they believe in different rules. For example, under the AAOIFI the lessor is responsible for all the risks while under IFRS both the lessor and the lessee share the risks. Qatar Islamic Bank is an example of the institution which uses AAOIFI. The accounting rules under AAOIFI tend to be much harsh when compared to those under IFRS.

This paper analyses the differences between International Financial Reporting Standards and Accounting and Auditing Organization for Islamic Financial Institutions.

The Constitution of the Financial Lease when you are using International Financial Reporting Standards and the Tests Applied

Before you receive a financial lease from the institutions under the IFRS, there are certain qualifications that you must have and the rules which you must agree with. As noted before, one of the companies under this system is Banque de France.

Firstly, the transfer of the asset to the lessee is done at the end of the period they agreed to lease. This implies that when the leaser gives out the asset to the lessee, they still remain the owners of the asset. The lease has no right to sell the asset since they are not the owners. The only thing they can achieve with the asset is by making a profit (Godfrey & Chalmers 2007 ). Moreover, the leaser can make any decision regarding the asset. The leaser can decide when to repair the asset or can even terminate the lease period. Secondly, the lease must have the bargain option for the lease.Grais & Pellegrini (2006 ) agree that the lessee has a right of buying the asset at a lower value compared to the one in the market. This is an important policy to ensure that the leaser does not exploit the lessee. Normally, there are those leasers who tend to overprice the assets leasing. This is the reason for creating this policy. However, the lessee can only bargain to reasonable measures. There is a limit too in which the asset cannot be leased. This is to ensure that the leasers too are protected and gain profits.

Thirdly, the lessee has a chance to use the leased asset by themselves alone. Normally, the leased asset is made important for use by the person who has leased it. This denotes that no other person can use the asset (Greuning & Iqbal 2008 ). The leaser has no right to lease the asset within the period agreed with the previous lessee. In case they have to terminate the period and give it to another person, then they will also have to refund the lessee. However, in case the leaser wants to modify the assets in between the period, they can make an agreement. Too much modification should not be done on the asset, though. Additionally, the lease term is when the asset gains economic value. It is during this period that the leaser and the lease manage to benefit from the asset. The lease uses the asset to trade and gain profit. In return, he pays the leaser an agreed amount.

Apart from those, the leaser also carries out some tests before leasing out an asset. Firstly, he must know the financial potential of the lessee. A lessee must show that they have the potential to pay back for the asset before earning the lease. Moreover, the lessee proves to the owner of the assets that they are loyal. This proved from previous records of leasing. This is an important consideration since there are other lessees who might go missing with the asset.

How the AAOIFI Institutions will deal with Financial Lease Based on their Standards

Firstly, the lessee has the responsibility to handle all the risks that affect the asset. After leasing out the asset, the leaser is still the owner, but the lessee is responsible for any damage. The lessee must ensure that they take good care of the asset (Boje, 2015 ). However, sometimes there are accidents which might lead to damage or write-off. Incase such incidences occur, the one who has rented should make sure that they take the whole responsibility. This agreement is usually provided before the lease. If they fail to meet the terms and conditions of the agreement, then they will have to face the law. Secondly, the leaser is still the owner of the asset even after the lease. During the lease term, the lessee only takes care and has the responsibility of the asset. However, the leaser is still the owner. This implies that the leaser can make decisions regarding the asset. Just like the IFRS, the leaser can terminate the contract when they want. They might decide to sell the assets within the term. However, before they take such actions, they have to provide the lessee with a notice. This will help them prepare on how they will adjust after they hand over the asset.

Thirdly, the leaser is the one who finances the asset. According to this rule, the owner of the asset is the one who should take care of the assets before presenting it to the lessee. The asset should be in good condition during the presentation. It is also the responsibility of the lessee to ensure that they take the asset when it is still in good condition so that they do not bare the leasers responsibilities (Hassan & Lewis 2014 ). Moreover, despite the fact that the lessee takes the whole loss responsibility when it comes to profits they share with the leaser. When the asset brings in profit during the lease term, they have to share with the leaser. Relatively, just like the IFRS system, this one too has the test which the lessee must pass. The lessee must prove to the leaser that they have the potential to pay for the asset. In some occasions, the lessee takes the asset but fail to make profits (Knapp, Contemporary Auditing 2014 ). This normally results to bad debts between the leaser and lessee. Due to that, it is just important to be sure with the financial status of the lessee. This will enable them only to lease their assets to those who have potential. Apart from the potential to pay back, the lessee must also have a good reputation based on loans. In case a person has had a bad reputation but seem have potential now, they will need a guarantor before they get the asset lease. According to Knapp, Contemporary Auditing (2014), the role of the guarantor is to provide trust. When the lessee fails to meet the agreement of the lease, the leaser will have to look for the leaser. It is also important to notice that AAIOFI provides Sharia teachings which the lessee must be familiar with.

Accounting Treatment of AAOIFI and IFRS in the Books of the lessor and the lessee

The treatment of the accounting records is different between AAOIFI and IFRS. The following are the highlights of the treatment of the records.

Accounting for IFRS

Firstly, the lessee is not the main one who bares the responsibility for maintenance and repair. In the books of accounting, the lessee might either be responsible for the assets damage or might not be. This normally depends on with the incidence. The records will not just automatically highlight them as the ones responsible. This simply implies that both the lessee and the lessor might share the loss. When the lessor is the ones responsible for the loss, then they will be in debt in the books of account. However, when lessee is the one responsible, then the books of accounts will debt them. Secondly, the agreement in the books of account cannot be canceled. When the lessor and the lessee make an agreement, the details are recorded in their books of account (Mark.S 2009 ). This is important for future reference in case there is the rise of some issues. Notably, the books of the accounts of both of them cannot be canceled. When they make the monetary agreement, then this has to go up to the end of the term. But when there is a situation which will force one of them to terminate the contract, then they will have to refund the other party.

Accounting for AAOIFI

The books of account hold the lessee responsible for the damage. Unlike in the IFRS accounting books, the AAOIFI accounts require that the lessee pay for the damage. When there is damage or loss, the lessee is the one who is fully responsible. They are required to pay the money for the damage, or they will be held responsible. This rule is normally provided during the signing of the agreement to avoid confusion in the future. The lessor is not held responsible for any matter. Even when there is an issue of losses, the accounting books keep the lessors name clean. Moreover, the accounting books cannot cancel the agreement made between the lessee and the lessor. According to this institution, the agreed term between the lessor and the lessee must end. In case there is an issue, and they have to cancel, then the one who proposed the termination must refund the other (Mr. Inwon Song 2014). If they fail to refund, they are put in debt in the accounting books. Moreover, the lessee must provide their financial records as well before the leasing of the assets. The financial records provided by the lessee will help the lessor determine the potential of the lessee.

Time Value of Money in Account for Difference in Treatment

Time value of money provides proof for the difference in treatment between AAOIFI and IFRS. According to the time value of money principle, the money at hand has much value and is more important than the same amount of money in future. This creates the main difference between the two. In IFRS, the lessee and the lessor share the losses or damage on the asset. When they sign the agreement, they decide that they will share the damage. This is fair treatment for both parties since all of them have benefited from the asset as well (World Bank; International Monetary Fund 2005 ). Contrary to that, AAOIFI recommends that the lessee carries the whole responsibility in case of damage or loss. Although they also agree on this before signing up the agreement, this rule is quite unfair. The lessee might be involved in damage even before they make enough money which can match the repair. To make this fair, the AA...