Journal of Financial Reporting & Accounting

Adoption of AAOIFI accounting standards by Islamic banks of Bahrain

Adel Mohammed Sarea Mustafa Mohd Hanefah

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Adel Mohammed Sarea Mustafa Mohd Hanefah , (2013),"Adoption of AAOIFI accounting standards by
Islamic banks of Bahrain", Journal of Financial Reporting & Accounting, Vol. 11 Iss 2 pp. 131 - 142
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Adoption of AAOIFI accounting

standards by Islamic banks
of Bahrain
Adel Mohammed Sarea

AAOIFI
accounting
standards
131

College of Business and Finance, Ahlia University, Manama,

Kingdom of Bahrain, and

Mustafa Mohd Hanefah

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University SAINS Islam Malaysia, Nilai, Malaysia

Abstract
Purpose The objective of this paper is to determine the level of compliance with Accounting and
Auditing Organization for Islamic Financial Institutions (AAOIFI) accounting standards by Islamic
banks of Bahrain.
Design/methodology/approach The paper is based on diffusion of innovation theory whereby
the perceived relative advantage, compatibility, complexity, trialability and observability factors are
expected to influence the level of compliance with AAOIFI accounting standards.
Findings The findings indicate that Islamic banks of Bahrain are in full convergence with AAOIFI
accounting standards.
Research limitations/implications This research, just like many other studies, faces data
limitations. Sample size employed for this study contains only the accountants in Islamic banks of Bahrain.
Originality/value The results of this paper are expected to serve as a guide to the regulatory
bodies and the setter of accounting standards for Islamic financial institutions (IFIs).
Keywords Accounting, AAOIFI accounting standards, Islamic accounting, Islamic financial institutions
Paper type Research paper

1. Research overview
Financial statements for Islamic financial institutions (IFIs) are now considered more
important to Shariah scholars, researchers and users of financial statements. However,
the first study conducted by Abdel-Magid (1981) on the need of accounting for IFIs found
that there is an increasing demand among researchers to ensuring the accounting
practice is based on Shariah principles. The study has proposed a framework to prepare
financial statements based on a unique model of accounting standards for IFIs that
makes financial statements more comparable, transparent and reliable for users.
According to Hameed (2001) conventional accounting is inappropriate for Muslim users
and Islamic organizations. In another related study conducted by Karim and Tomkins
(1987) he indicates that, it is inappropriate to impose unmodified Western accounting
practices on developing countries. In addition, International Accounting Standards
(IASs) based on such techniques would create difficulties for Muslims around the world
(Shadia, 2007). Therefore, it is vital for Muslim accountants to develop accounting
standards which are specially adapted to Islamic needs and for Muslim countries
(Shadia, 2007). Thus, this paper highlights and focuses on the level of compliance with
the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI)
accounting standards by Islamic banks of Bahrain.

Journal of Financial Reporting and

Accounting
Vol. 11 No. 2, 2013
pp. 131-142
q Emerald Group Publishing Limited
1985-2517
DOI 10.1108/JFRA-07-2012-0031

JFRA
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132

2. Developments of Islamic banking in Bahrain

Cooperation Council for the Arab States of the Gulf region (Gulf Cooperation Countries
(GCC)) has a rich history of banking sector, going back to 1918 when the British first
opened a bank in Bahrain (Olson and Zoubi, 2008). Islamic banking began in Bahrain
in 1979 with the establishment of the Bahrain Islamic bank (Hussein, 2004).
The Islamic banks operating in the Kingdom of Bahrain are diversified globally in
which the GCC, EU, and North America constitute their main markets over the last ten
years.
According to Central Bank of Bahrain (CBB, 2012):
The growth of Islamic banking in particular has been remarkable, with total assets in this
segment jumping from US$1.9 billion in 2000 to US$26.3 billion by June 2009, an increase of
over 12 times. The market share of Islamic banks correspondingly increased from 1.8% of
total banking assets in 2000 to 11.1% in June 2009.

3. Importance of AAOIFI accounting standards

Due to the rise in globalization, increased competition, communication revolution, new
regulations and the strong growth in the IFIs, this paper seeks answers to the question:
to what extent Islamic banks of Bahrain comply with the AAOIFI accounting standards?
The AAOIFI formulates and issues accounting, auditing, and corporate governance
standards, as well as ethics and Shariah standards for IFIs. AAOIFI as an independent
international organization, is supported by institutional members (200 members from
45 countries) including central banks, IFIs, and other participants from the international
Islamic banking and finance industry, worldwide (AAOIFI, 2010). Currently, AAOIFI
has published 85 standards that comprises of 26 accounting standards, five auditing
standards, seven governance standards, two ethics standards, and 45 Shariah standards
(AAOIFI, 2010).
AAOIFI has been recognized and mandated to develop accounting, auditing,
governance and ethics standards that are in line with Shariah principles in order to
promote comparable, transparent and reliable accounting information for users. Thus,
the main objective of AAOIFI is to prepare and develop accounting, auditing,
governance and ethical standards relating to the activities of IFIs. In line with the
objective of this study, this paper attempts to contribute to the current framework,
body of knowledge, and also serve as a guide for IFIs.
4. The need of Shariah compliance
Issues relating to Shariah finance and compliance are limiting IFIs to promote their
products and services locally and globally. Thus, the need of Shariah compliance
becomes increasingly important to bridge the gap between theory and practice.
However, to accommodate these issues, AAOIFI has issued 45 Shariah standards as
part of the solution to be implemented by IFIs globally (AAOIFI, 2008).
Nevertheless, only a few studies have been conducted to explain the need of Shariah
compliance and standards; Fuad et al. (2011), Farook (2008) and Wahyuni (2008).
According to Farook (2008), Muslims cannot invest their money in enterprises that
engage in impermissible activities, for instance, pig farm, alcohol producing factory,
tobacco industry and debt or interest based activities. Based on that, it is necessary to
determine the need of Shariah compliance framework. Annexure (2) of IBD Circular

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No. 02 of (2008) issued by State Bank of Pakistan, documented that, the Shariah
compliance framework should include: a system of compliance having special emphasis
on Shariah aspects with relevant provisions of existing laws, rules, regulations, policies,
procedures and reviewing of issues related to Shariah compliance that should cover all
activities, products and locations of the Islamic Banking Institutions (IBIs) as approved
by Shariah advisor. In addition, access to all necessary documents/information should
be provided to Shariah compliance officials in the performance of their functions as well
as any issues related to Shariah compliance shall be properly recorded and rectified with
the approval of the Shariah advisor (State Bank of Pakistan, 2008).
In this context, to demonstrate full Shariah compliance, Shariah compliance
should also cover all financial activities. Study conducted by Fuad et al. (2011)
examined that, the original contract used in premium savings certificate (PSC) violates
the conditions of deposit account (Wadiah contract), as in Wadiah, the bank is not
allowed to spend the money for investment, but in practice, the National Savings Bank
of Malaysia (Bank Simpanan Nasional (BSN)) Malaysia uses the money for investment,
hence the scholars had unanimously declared that giving any kind of benefit like prizes
to the creditor is riba (usury). In another study related to Shariah auditing, Wahyuni
(2008) indicates that, lack of a supervisory board and low demand for audited financial
statements provide little incentive for managers of Islamic microfinance institutions in
Indonesia (Baitul Maal wat Tamweel (BMT)) to get their financial statements audited
by independent auditors.
5. Research framework
The conceptual framework for financial reporting contains objectives that are aimed at
providing meaningful information:
.
for creditors and investors to aid in making an informed decisions;
.
for the assessment of future cash flows; and
.
regarding the enterprises resources (assets) and changes in them, i.e. the users of
financial statements (Lovett, 2002).
In past literature, a number of interesting studies based on diffusion and innovation
theory have discussed the adoption of IASs by companies and banks as mandatory or as
guidelines (Lovett, 2002; Hussein, 1981). Accordingly, this research can be considered as
a first attempt to analyze the adoption of AAOIFI accounting standards in terms of
diffusion and innovation theory. Thus, this paper aims to examine to what extent Islamic
banks of Bahrain are complying with the AAOIFI accounting standards? This study
chose the diffusion and innovation theory as its main underlying theory because it is able
to explain the research problem and the extent of compliance with accounting standards
by Islamic Banks of Bahrain. Furthermore, diffusion and innovation theory may be used
to investigate the process of adopting accounting standards and the need for further
research before the theory can either be accepted or dismissed as inappropriate for
inquiry into the nature of the accounting standards setting process (Hussein, 1981). This
is because it has been found in prior research that, the acceptance of accounting
standards appears to follow the pattern of the diffusion of innovation process (Hussein,
1981). The purpose of this paper is also to determine if the attributes of the variables, as
specified by Rogers (2003) influence the adoption of AAOIFI standards by Islamic banks
of Bahrain.

AAOIFI
accounting
standards
133

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134

Rogerss theory states that the perceived attributes of an innovation, relative

advantage, compatibility, complexity, trialability, and observability influence the rate
of adoption of accounting standards. It is shown in Figure 1.
According to Rogers (2003), the innovation diffusion theory interprets the process
through which an individual passes from initial knowledge of an innovation to forming
an attitude toward the innovation, to a decision to adopt or reject, to implementation
and use of the new idea and the confirmation of this decision and how a new invention
will be successfully spread among members of a social system within the context of the
diffusion elements.
The identification of a theory is needed to serve as a basis of interpretation of the
variables influencing the adoption of the AAOIFI accounting standards. Quite a
number of researchers in the field of accounting have adopted the diffusion theory in
their studies. For instance, Hussein (1981) applied diffusion theory to the adoption of
domestic accounting standards, and measured the attitude towards the adoption of
accounting standards based on research statements pertaining to specific US generally
accepted accounting principles (GAAP), this therefore resulted in empirical evidence
that diffusion can be applied in measuring adoption of accounting standards.
Rogerss theory suggests that innovation diffusion can be applied in adopting or
rejecting any idea, which involves relative advantage, compatibility, complexity,
trialability, and observability influencing the rate of adoption of accounting standards.
Thus, Rogers model consist of five stages namely: knowledge, persuasion, decision,
implementation and confirmation. Among these five stages, the second stage which
perceives characteristics of innovation had been studied more frequently and is
generally considered the most significant in explaining the rate of adoption
(Kendall et al., 2001). Rogers (2003) identified that the rate of adoption of an innovation
is influenced by five variables namely; the perceived attributes of the innovation, the
type of innovation-decision, the communication channels, the nature of the social
system, and the extent of influence of the change agent (Figure 2).
In this research, relative advantage is described as the benefits perceived by Islamic
banks in adopting the AAOIFI accounting standards. Compatibility deals with
Stages of adoption/ compliance
Awareness

Interest

Evaluation

Trial

Figure 1.
Stages of
adoption/compliance

Adoption

Source: Rogers (2003)

Knowledge

AAOIFI
accounting
standards

Persuasion

Decision

135

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Implementation

Confirmation

Source: Rogers (2003)

Figure 2.
A paradigm of variables
determining the rate of
adoption of innovations

how well AAOIFI accounting standards will suit the current business process.
Complexity is how Islamic banks perceive AAOIFI accounting standards to be. If they
are too complex then the standards may not be adopted, and vice versa. Trialability as
applied in the current research explains the ability to engage in the AAOIFI accounting
standards without incurring cost (cost of compliance). Observability is the degree to
which the results of AAOIFI are visible to others such as users of the financial
statements (Figure 3).
Rogers model has been applied to study the adoption of innovations in many
disciplines. It has been applied in marketing to determine the acceptance of new products,
in education to determine the acceptance of new teaching techniques, in medicine to
determine the acceptance of new procedures, and in agriculture to determine the
acceptance of hybrid crops (Lovett, 2002).
The use of Rogers model in studying compliance with the AAOIFI accounting
standards by Islamic banks is rather new, especially in the case of Islamic banks of
Bahrain and more so in the field of accounting. Lovett (2002), for instance indicates that,
Relative Advantage

Compatibility

Complexity

Trialability

Observability

Source: Rogers (2003)

Figure 3.
Rogers variables
to determining the
rate of adoption

JFRA
11,2

the acceptance of accounting standards appears to follow the pattern of the diffusion of
innovation process. As a result, he found that, there is a positive relationship between the
relative advantage, compatibility, trialability and observability and adoption of general
accepted accounting standards by American companies in the state of Florida. On the
other hand, the complexity indicated negative influence on the adoption of IASs, which
means that the more complex the IASs the less likely they will be adopted.

136

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6. Research methodology
6.1 Sample selection
The population of the study consists of accountants working in Islamic banks of
Bahrain. The rule-of-thumb sample size in social science according to Sekaran (2000) is
between 30 and 500 for effective analysis based on the research questions investigated.
Therefore, a study sample rather than the entire population is more likely to produce
reliable results, which could reduce cost and time (Cooper and Schindler, 2006). A total
of 312 questionnaires were distributed to the accountants of Islamic banks of Bahrain.
Only 129 copies were returned to the researchers, approximately 41 percent which is
sufficient for statistics reliability. The sample was drawn from the total population of
accountants in Islamic banks of Bahrain (Table I).
6.2 Study hypothesis
The following hypotheses explain the relationship between independent variables as
stated by Rogers (2003) and the level of compliance with the AAOIFI accounting
standards:
H01. The more relative advantage of the AAOIFI accounting standards, the more
likely AAOIFI accounting standards will be adopted.
H02. The more compatibility of the AAOIFI accounting standards, the more likely
AAOIFI accounting standards will be adopted.
H03. The more complex AAOIFI accounting standards, the less likely they will be
adopted.
H04. The more trialability of the AAOIFI accounting standards, the more likely
AAOIFI accounting standards will be adopted.
H05. The more observability of the AAOIFI accounting standards, the more likely
AAOIFI accounting standards will be adopted (Table II).
6.3 Study model
The study model is based on Rogers (2003), which represent the relationship between
independent variables and the level of compliance with the AAOIFI accounting
standards in terms of the relative advantage, compatibility, complexity, trialability,
and observability.

Table I.
Responses to the survey
questionnaire

Total distributed
312

Islamic banks in Bahrain

Total received

Respondent rate

129

41 percent

Variable

Label

Definition and measurement

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Independent variables
Relative
ADVANT
advantage

Relative advantage is the benefits associated with the compliance of

AAOIFI accounting standards by Islamic banks
This was measured through a number of items (nine questions)
Compatibility COMPAT Compatibility is the degree to which an adoption is perceived as being
consistent with AAOIFI requirements
This variable was measured through (eight questions)
Complexity
COMPLEX Complexity has been explained in term of the degree to which an
AAOIFI is perceived as difficult to understand and use
This variable was measured through some items (six questions)
Trialability
TRIAL
Trialability involves the ability to engage in AAOIFI standards without
gaining cost (cost of compliance)
This was measured through a number of items (three questions)
Observability OBSER
The more disclose of information to adopt AAOIFI the more likely the
organizations will adopt that
This variable was measured through some items (four questions)
Dependent variable
Adoption of
AAOIFI
Adoption of AAOIFI accounting standards by Islamic banks of Bahrain
AAOIFI
This variable was measured through AAOIFI accounting standards
(17 standards)

The research model is as follows:

AAOIFI b0 b1 ADVANT b2 COMPAT b3 COMPLEX b4 TRIAL
b5 OBSER 1
where:
AAOIFI

AAOIFI accounting standards adoption.

ADVANT relative advantage.

COMPAT compatibility.
COMPLEX complexity.
TRIAL

trialability.

OBSERV

observability.

b0

is the constant.

b1, . . . , 5

is the slope of the independent variables.

random error.

7. Findings
7.1 Descriptive statistics
Table III shows the descriptive statistics of the independent variables. The variables
reflect the level of compliance with AAOIFI accounting standards. The variables also
refer to the level of understanding and acceptability of AAOIFI accounting standards

AAOIFI
accounting
standards
137

Table II.
The labels
and measurement
of the study variables

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138

to be adopted by Islamic banks of Bahrain. Overall, the mean of the variables is

positive and that reflects the high level of compliance with the AAOIFI accounting
standards. This result is in line with prior studies to reflect higher level of compliance
with the AAOIFI accounting standards.
7.2 Testing of hypotheses and discussion of findings
The hypothesis aims to test the level of compliance with the AAOIFI accounting
standards and the acceptability of these standards to be adopted by Islamic banks of
Bahrain. We hypothesis that, the more relative advantage, compatibility, trialability and
observability of the AAOIFI accounting standards, the more likely AAOIFI accounting
standards will be adopted. On the other hand, the more complex the AAOIFI accounting
standards, the less likely AAOIFI accounting standards will be adopted.
The multiple regression results are shown in Tables IV-VI.
Table IV presents the results of the regression model that examine the change in the
level of compliance with the AAOIFI accounting standards in terms of independent
variables. The model is significant with R 2 of 0.38. This means, the five independent
variables identified by Rogers (2003) influences 38 percent of the compliance level with
the AAOIFI accounting standards.
Table V shows that the independent variables are significantly related to the levels of
compliance with the AAOIFI accounting standards, F-value (5, 123) 15.4, p , 0.000.
Variable

Table III.
Descriptive statistics
for independent and
dependent variables

Independent variables
ADVANT
COMPAT
OBSERV
TRIAL
COMPLEX
Dependent variable
AAOIFI

Model
Table IV.
Regression model

Model
1

Table V.
ANOVA

Regression
Residual
Total

Minimum

Maximum

Mean

1.000
1.000
1.000
1.000
1.000

5.000
5.000
5.000
5.000
5.000

3.72
3.60
3.40
3.14
3.06
4.01

R2

SE of the estimate

0.621(a)

0.386

9.72708

Sum of squares

df

Mean square

Fa

p-value

7,319.903
11,637.787
18,957.690

5
123
128

1,463.981
94.616

15.473

0.000

Notes: aF-critical (df for denominator n 2 b 2 1 128 2 5 2 1 122), (df for numerator b 5);
and confidence level of 95 percent is 2.29

Unstandardized
coefficients
Model 1
(Constant)
Relative advantage
Compatibility
Complexity
Trialability
Observability

Standardized
coefficients

SE

ta

pvalue

9.993
1.645
1.360
21.105
21.403
0.506

13.637
0.239
0.520
0.389
0.552
0.275

0.519
0.203
20.227
20.200
0.139

0.733
6.872
2.615
2 2.843
2 2.539
1.838

0.465
0.000
0.010
0.005
0.012
0.069 *

Collinearity
statistics
B

SE

9.993
1.645
1.360
21.105
21.403
0.506

13.637
0.239
0.520
0.389
0.552
0.275

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Notes: Significant at: *10 percent level; at-critical: at df 128 2 1 127 and confidence level of
95 percent is 1.658; dependent variable adoption of the AAOIFI accounting standards

These results indicate that the accountants perceptions on the level of compliance with
the AAOIFI accounting standards influence their decision to comply with the AAOIFI
accounting standards.
The results reveal that, the level of compliance with the AAOIFI accounting
standards are affected by factors identified by Rogers. The results support the research
hypotheses that, the more relative advantage, compatibility and observability of the
AAOIFI accounting standards, the more likely the AAOIFI accounting standards will be
adopted. On the other hand, complexity variable is negatively related to the level of
compliance with the AAOIFI accounting standards, which means, the less complex the
AAOIFI accounting standards, the more likely AAOIFI accounting standards will be
adopted. Meanwhile, the trialability variable is negatively significant, which means that
Shariah principles are not for trial but must be fully adopted by all parties. Furthermore,
the AAOIFI accounting standards need to be mandated by the government in order to be
fully adopted by Islamic banks and other institutions. Bahrain has mandated that AAOIFI
accounting standards must be fully complied by all banks and financial institutions.
8. Summary, conclusion and recommendations
This paper examined the impact of relative advantage, compatibility, complexity,
trialability, and observability on the level of compliance with AAOIFI accounting
standards. The study found that, relative advantage, compatibility and observability have
positive influence with the compliance of the AAOIFI accounting standards. The more
relative advantage, compatibility and observability of the AAOIFI accounting standards,
the more likely the AAOIFI accounting standards will be adopted. On the other hand,
the complexity and trialability variables were found to have negative influence on the
compliance with AAOIFI accounting standards which means that, the less complex the
accounting standards, the more likely the AAOIFI accounting standards will be adopted. In
addition, the trialability was negatively related due to the fact that, the AAOIFI accounting
standards needs to be made mandatory in order to be adopted. The findings of the study
indicate that, Islamic banks in Bahrain comply fully with the AAOIFI accounting standards.
8.1 Implication of the study
To the best knowledge of the researchers, this research is first of its kind that
investigated the level of compliance with the AAOIFI accounting standards in terms of

AAOIFI
accounting
standards
139

Table VI.
Predictors coefficients

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140

diffusion and innovation theory as well as exploring the accountants perceptions.

Lovett (2002) investigated the adoption of IASs by American companies in Florida
state in terms of diffusion and innovation theory. The researchers used diffusion and
innovation theory as underlining theory to conduct this research and to achieve the
research objectives. Therefore, the studys findings have some theoretical implication
and policy implication. The theoretical framework is concerned with the accountants
perceptions on the level of compliance with the AAOIFI accounting standards in terms
of diffusion and innovation theory, which is the most well known model and most
appropriate in most perception studies (Lovett, 2002). The variables identified in this
study are considered important in explaining differences in the perception of
compliance with the AAOIFI accounting standards.
Based on the above discussion, this research may be considered as a first attempt to
contribute to the accounting literature in terms of the impact of the relative advantage,
compatibility, complexity, trialability, and observability on the efforts of adoption
or compliance with the AAOIFI accounting standards. The findings should also be
beneficial to the regulators and researchers to adopt and undertake further studies on
AAOIFI accounting standards.
8.2 Implications for theory and practice
The findings show significant support for the current debate regarding the level of
compliance with the AAOIFI accounting standards. However, IFIs comply with
Shariah requirements due to religious necessities in the Muslim community. Thus, the
results are expected to serve as a guide to the regulatory bodies such as CBB and
regulators of accounting standards for IFIs. Since AAOIFI standards are mandatory in
Bahrain, the high level of compliance with AAOIFI accounting standards are as
expected. High compliance to globally accepted Islamic accounting standards could
also play a significant role in attracting global investors interest to the local market,
especially in a developing Muslim country like Bahrain. Furthermore, high compliance
could support AAOIFI as an independent international organization to improve their
standards to be implemented by IFIs globally. It is highly recommended that for
Islamic banking and finance to be a success, compliance to Shariah accounting
standards like AAOIFI accounting standards must be made mandatory by all
regulators.
Due to limited research in the area of financial reporting for IFIs, this study
contributes to the literature that will be useful to other researchers.
8.3 Study limitations
This research has a number of limitations. The respondents for this study were
accountants in the Islamic banks of Bahrain. This research studied the perceptions of
the accountants rather than the banks actual adoption of the AAOIFI accounting
standards. This study too focuses only on Islamic banks, and did not include other IFIs
such as Takaful companies.
8.4 Future research
Based on the findings, suggestions for future research are as follows:
.
Perceptions of Shariah committee members and firm auditors could be
undertaken by other researchers. Future research may also consider auditing,

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governance, ethics and other Shariah standards issued by other regulators,

such as the Islamic Financial Service Board (IFSB).
Future studies could also include Islamic banks and Takaful companies in the
GCC and Organization of Islamic Countries (OIC), and compare findings with this
study.

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Corresponding author
Adel Mohammed Sarea can be contacted at: Adelsarea@yahoo.com

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