Testing a Model of Islamic Corporate Financial Report

Custom Student Mr. Teacher ENG 1001-04 11 November 2016

Testing a Model of Islamic Corporate Financial Report

1. Introduction Religion can exert a profound influence on individuals and societies. There has been a growing religious commitment during the past two decades which has led to more Muslim countries seeking to manage their economies in line with the precepts of Islam (Hassan, 1998). Central issue in Islamic accounting is weather the external financial reporting system currently adopted by Muslim countries serves the needs of Muslims. Baydoun and Willett (1994 and 2000) who argued that the influence of Islam on accounting was more likely to be in the disclosure aspect of accounting proposed a model of Islamic Corporate Financial Reports.

Their model, based on what Muslims ought to desire, need to investigate if such model is aligned with what Muslims actually regard as useful information. Maliah Sulaiman (1998) tested the model & found that the results from the survey were all non-significant, indicating no support for Baydoun and Willett’s conceptual model. Further study by (Brownell, 1995) states that non-significant results is weak due to leniency, acquiescence, halo and partitioning errors.

2. Islamic Corporate Reporting: The Model The stance of Baydoun & Willett’s (1994 & 2000) model is Western accounting system capitalist is different with teachings of Islam. Capitalistic system gives pre-eminence to the profit and loss. An Islamic economy focus for growth should lead to social justice and a more equitable distribution of power and wealth. Concepts of ownership and private property in Islam have different connotations from those prevalent in the West because for Muslims, ownership of wealth is not absolute, individuals are only trustees. Ultimate ownerships belong to Allah (SWT).

The Islamic social order is based on the principles of equality, justice and brotherhood and the concept of freedom and responsibility (al-Buraey, 1990). Two principles underlie the concept of accountability in Islam are full disclosure and social accountability. Baydoun and willett (1994 & 2000) suggested that the current value balance sheet be included as part of the reporting requirement of firms operating in an Islamic economy. An Islamic company is expected to disclose at least any prohibited transactions they made, zakat obligation they have to pay and have already paid, and social responsibility.

Social responsibilities would include charities, wages to employees, and environmental protection. This means that financial reporting in an Islamic society is likely to be more detailed than what is currently prevalent in Western societies. Its purpose should be able to direct the firm not only to provide a true picture of their firm but also encourage them to be benevolent (Ihsan) and discourage them to be unjust. Social accountability would mean that financial report should enable Muslims to determine zakat liability. For example amount payable by Muslims whose wealth exceeds a certain minimum threshold. Individuals are expected to feel socially responsible for others in community. Aim for this is to allow people to earn their living in a fair and profitable way without exploitation of others, so that the whole society will get benefits.

2.1 The current value balance sheet (CVBS) Three main theoretical arguments for this model first is Use of current values relates to the ‘justice and equity’ with regards to the payment of zakat. Second is support for the use of current values follows from practices pursued during the Prophet’s time. It may be derived from implicit common monetary used in Prophet’s time to establish nisab. Nisab is a minimum threshold of wealth above which zakat is payable. Third is Current value information allows the inclusion in the financial statements of market value based on information obtained from outside the firm’s database. Historical cost information excludes the potential relationship which accounting may have with its wider social environment (Baydoun and Willett). 2.2 The Value Added Statements

VAS shows how benefits of the efforts of an enterprise are shared amongst employees, shareholders, governments and enterprises itself. Characteristic of VAS are supports accountability in Islam. The emphasis in Islam that economic growth should lead to social justice and more equitable distribution of power and wealth. Distribution of wealth is between different sectors of society. Besides, it is an alignment with concepts of justice and mutual cooperation. It’s emphasis care and share aspects of a business in line with concepts of concepts of justice and mutual cooperation by reporting of externalities which is provide measures of success in achieving goals than just profit in term of safeguarding welfare of community.

3. In support of the experimental method Emory and Cooper (1991): four main advantages in conducting laboratory experiments. * researcher’s ability to manipulate independent variables * To control for irrelevant variables more effectively than with other designs. * Inexpensive and convenient to carry out.

* Possible to replicate experiments using different subject groups & conditions which would lead to the discovery of an average effect of the independent variable across people, situations & times (Emory and Cooper, 1991). Disadvantages:

* the artificial setting in which an experiment is carried out is for this limits the generalizability of the findings (Abdel-khalik and Ajinkya, 1979). * example: unrepresentative subjects

* hence, the more artificial setting the more precisely the one theory (Webster & Kervin, 1971) * Advantage of deliberate artificially: allow for more direct test of the theory & improve generalizability of theory.

4. Research design and hypothesis The experimental design of this study comprises both the within-subjects (repeated measures) design and the between-subjects design. In the within-subjects design, the user is provided with all the different types of financial reports under investigation in the study. That is, financial reports deemed more useful to Muslims, together with conventional (Western-based) financial statements, are given to all subjects. On the other hand, the between-subjects design requires that subjects be given either those financial reports deemed useful to Muslims or the Western based report.

One criticism leveled at the within-subjects design is that it creates a “demand effect” in that it may sensitize subjects to the nature of the study. This, it is argued, leads to subjects being induced to give “socially desirable” responses. However, if this design is adopted, one is able to utilize subjects more efficiently. In addition, the within-subjects design is said to provide a control of subject variables which may result in statistical efficiency brought about by removing the within-group variance (Brownell and Trotman, 1988).

4.1 Treatment groups Students are used as surrogates for investors. Students chosen for this study are those who had previously been exposed to financial reporting and the interpretation of accounts. It was felt that students majoring in accounting and in their final year of study would be the most knowledgeable to act as surrogates for shareholders. Subjects were randomly assigned to four treatment groups. Set 1 consisted of a historical cost profit and loss statement (PL), and a HCBS. Set 2 comprised Set 1 plus a CVBS. Set 3 comprised Set 1 plus a VAS while Set 4 was a combination of Sets 1, 2 and 3.

4.2 Measure of usefulness This study partially adopts McIntyre’s (1973) operational definition of usefulness. He defined useful information as information that produced decisions that were ‘different’ and ‘better’. ‘Different’ decisions were measured by direct comparison of investment decisions amongst treatment groups. A decision was ‘better’, if it led to a greater return on investment. However, sole emphasis on maximizing return on investment is not representative of a ‘better’ decision for Muslims. Usefulness is measured by four questions. The first question required subjects to rate on a ten-point Likert scale, the favorability of investing in a fictitious company. The second question required subjects to indicate the amount they would invest in the company given the information that they had been provided with.

This enabled the results obtained from the first question to be checked. The third question asked subjects to rate (again on a scale of ‘1’ to ‘10’), the adequacy of the information that they had been provided with, in order for them to make the investment decision. To increase the assurance that respondents had thought through the answers, they were also asked to provide the reasons for their choice. The fourth question asked subjects to choose one financial report that they deemed important, from the list provided (the list depending on which group they were in), in their investment decision-making.

4.3 Within-group differences The main objective is to investigate the differences in the usefulness of accounting information between Muslims and non-Muslims (within each financial statement treatment group) through favorability ratings, amounts invested perception of adequacy of information and choice of financial statement. Specifically, for each separate set of financial reports, the following within-group hypotheses are tested. H1o: Favorability ratings do not differ between Muslims and non-Muslims. H2o: Amounts invested do not differ between Muslims and non-Muslims. H3o: Adequacy of information does not differ between Muslims and non-Muslims. H4o: Choice of financial report does not differ between Muslims and non-Muslims.

4.4 Between group differences To examine if there are differences in the usefulness of alternative financial reports by both Muslims and non-Muslims (examined separately), a between-group analysis is undertaken. Specifically, the following between-group hypotheses are tested. H5o: Favorability ratings do not differ between alternative sets of financial reports. H6o: Amounts invested do not differ between alternative sets of financial reports. H7o: Adequacy of information does not differ between alternative sets of financial reports. H8o: Choice of financial statement does not differ between alternative sets of financial reports.


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  • University/College: University of California

  • Type of paper: Thesis/Dissertation Chapter

  • Date: 11 November 2016

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