Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)

What Is the Accounting and Auditing Organization for Islamic Financial Institutions?

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is a not-for-profit organization established to maintain and promote Shari'ah standards for Islamic financial institutions, participants, and the overall industry. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was established in 1991 to ensure that participants conform to the regulations set out in Islamic finance.

The founding and associate members and the regulatory and supervisory authorities of the Accounting and Auditing Organization for Islamic Financial Institutions define acceptable standards for various functions. This includes areas such as accounting, governance, ethics, transactions, and investment.

Key Takeaways

  • The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) oversees Islamic banking to ensure its members follow the rules and prohibitions established by Shari'ah law.
  • In Islamic banking, the collection of interest (riba) is forbidden, and sharing profits and losses amongst the community is mandated.
  • Due to the increased role of global finance, and the importance of Arabic and Muslim regions in the world economy, the AAOIFI is constantly updating its best practices and guidelines to adjust for innovations such as hedging instruments and derivatives.

Understanding the Accounting and Auditing Organization for Islamic Financial Institutions

In Islamic finance, there are unique rules, restrictions, and requirements regarding business and investing. In order to be considered acceptable, transactions must adhere to the principles of Shariah law. The Accounting and Auditing Organization for Islamic Financial Institutions sets compliance standards for institutions wishing to access the Islamic banking market.

In Islamic finance, mudarabah is a business partership in which one party brings capital and the other brings labor or effort. The provider of capital bears any loss, but if a loss occurs then the provider of effort gets no pay. Musharaka is a contract where profits and losses are split by an agreed-upon ratio because all parties contribute capital and labor.

The AAOIFI is continually updating its scope to include the various new financial instruments entering markets around the world. For example, new hedging mechanisms would first need to be discussed and accepted by the AAOIFI before any member would offer these services.

Islamic Finance Basics

Two fundamental principles of Islamic (shari'ah) banking are the sharing of profit and loss and prohibiting the collection and payment of interest by lenders and investors. Islamic law prohibits collecting interest, known as "riba." Although Islamic finance began in the seventh century, it has been formalized gradually since the late 1960s.

Islamic banking, finance, and investing is similar to environmental, social, and governance banking, finance, and investing. Specific activities harmful to the environment, consumers, or that violate Shariah law are not allowed in Islamic finance.

To earn money without the use of charging interest, Islamic banks use equity participation systems. Equity participation means if a bank loans money to a business, the business will pay back the loan without interest but instead gives the bank a share in its profits. If the business defaults or does not earn a profit, then the bank also does not benefit.

For example, in 1963, Egyptians formed an Islamic bank in Mit Ghmar. When the bank loaned money to businesses, it did so on a profit-sharing model in which the bank would be granted a share of the profits if a company failed to make payments or defaulted on its loan.

Frequently Asked Questions

What Is the Function of AAOIFI?

The AAOIFI is similar to the International Accounting Standards Board and the Financial Accounting Standards Board because it develops accounting standards for accounting and reporting. However, it does so considering Islamic financial law.

What Is the Difference Between AAOIFI and IFSB?

AAOIFI is the body that issues standards for auditing, governance, and ethics, while the Islamic Financial Services Board publishes guidance for financial disclosure, solvency, and capital adequacy.

How Many AAOIFI Standards Are There?

The AAOIFI has issued 117 standards that address 59 Shariah, 33 accounting, eight auditing, 14 governance standards, and three codes of ethics.

The Bottom Line

The AAOIFI is an organization that works to create and publish accounting and reporting standards for businesses under Shariah law. The organization is similar to non-Islamic organizations such as the International Accounting Standards Board.

It was created in 1991 as Islamic finance practices began to expand around the globe to ensure Islamic institutions had standards to follow that complied with laws. The AAOIFI's vision is to guide Islamic financial institutions and professionals in their accounting and reporting procedures.

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