Doing Business in Indonesia: Differences Between Islamic and Conventional Accounting
If you practise Conventional Accounting and transferring to Islamic Accounting, knowing the difference between the two can help you help sort out your confusion.
The Key Difference between Islamic and Conventional Accounting lies in different factors such as the nature and definition of their Financial Instruments, Principles of Islamic Finance, Major Differences between Conventional Financial Instruments (CFIs) and Islamic Financial Instruments (IFIs), and Forms of Financial Instruments. The discussion of this article will focus on these topics.
Differences Between Islamic and Conventional Accounting: Financial Instruments
Financial Instruments (FIs) in Islamic Accounting are contracts that increase and decrease the values of assets and liabilities. As to the one who will issue the FIs, it’s a liability or responsibility for him as he has to pay it eventually in the future. As for the one who will receive the FIs, however, it’s an asset as it creates economic benefits in the form of cash inflow.
Not only do FIs fund investments and finance the operation of a business, but they also help alleviate risks and uncertainties that a business entity might experience. If people invest in FIs, income-generating projects that are managed by the bank are secured to be funded, thus, lowering the risks.
There are 2 types of FIs in circulation. These are bank-based instruments and capital-based instruments. The former is for funding short-term projects while the latter is for medium to long-term.
Differences Between Islamic and Conventional Accounting: Principles of Islamic Finance
The Principles of Islamic Accounting and Finance are the fundamental truths about handling big money in Islam. Not like in Conventional Banking where it’s purely secular, Islamic Finance and Banking Principles are based on Qur’an. Islamic money should be utilized using the following guidelines:
The imposition of Riba or Interest in Economic Activities in Prohibited in Islamic Finance
In Conventional Finance, taxes can be imposed if products and services enter a country from another point of origin. We call it a trade tax.
Also, in the same discipline, if you make cash bank deposits, it’s guaranteed to gain the interest of a certain percentage at a certain time, let’s say after a year.
In Islamic Finance, these practices are prohibited. What’s allowed is the sharing of profit and loss. If the bank profited in a year of a certain amount, it should be shared with all its depositors. The same principle applies if the bank experiences losses.
Islamic Money Should Always be Used in Fair Dealings
Islamic Finance follows the provisions stipulated in Qur’an on to what’s allowed and what’s not. Products and Promotions should follow appropriate standards and it shouldn’t deceive customers in any way.
Islamic People are Encouraged to Donate Zakat from their Income or Profit
The amount to be paid for Zakat is 2.5% per annum. You can choose to pay either monthly or annually. It’s up to you. But this is something not compulsory by law. If you have a great amount of money in the bank, you may instruct them to process it for you, provided you pay them for the service.
Differences Between Islamic and Conventional Accounting: Major Differences between CFIs and IFIs
CFIs and IFIs have differences in certain factors. These are the following:
- The assets backing up CFIs are money based while IFIs are backed up by assets other than money. In the point of view of Islamic Banks, money is only a medium of exchange and can’t make any guarantee for Financial Instruments. Some instruments are rather used for IFIs.
- The Relationship between Investors and Issuers are also different between Conventional and Islamic Finance. In Conventional Finance, the relationship is called borrower and lender while in Islamic Finance, it’s Partnership. When an institution is issuing a bond thru the capital market, then, he will be called the borrower while the one who subscribed and acquire this bond, will be called the lender. This is the setup for Conventional Finance.
The Relationship between Investors and Issuers are called Partnership in Islamic Finance. This is to emphasize that both parties can experience profit and loss.
- Between CFIs and IFIs, the latter involves Risk Taking. In any Financial Endeavors, Risk Taking is part of IFIs. If you invest money on IFIs and it earned eventually, then, you get your share of profit. If it didn’t turn well, then, it’s also your loss.
- IFIs adheres to Divine Regulations while CFIs don’t. Financial Anomalies are forbidden in IFIs. Financial Instruments shouldn’t be used in cheating in products and prices, abnormal profiting, hoarding, and private monopoly.
- IFIs prohibits the Extent of Contractual Conditions. To presume uncertain events is prohibited in IFIs as it may lead to ambiguities and disputes eventually.
Differences Between Islamic and Conventional Accounting: Forms of Financial Instruments
IFIs are compliant with Shariah – the Islamic Law. They have their own set of Financial Instruments which include profit sharing (Mudharabah), safekeeping (Wadiah), a joint venture (Musharakah), cost plus finance (Murabahah), leasing (Liar), an international fund transfer system (Hawala), Islamic Insurance (Takaful), and Islamic Bonds (Sukuk). These are the instruments you’ll be dealing with IFIs and Islamic Accounting.
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