Chapter 3 Page 66

CHAPTER 3: THE PROBLEMS WITH CONVENTIONAL ACCOUNTING

AND IMPLICATIONS FOR ISLAMIC ACCOUNTING

Alternative (conventional accounting) rules may, for the individual citizen, mean the difference between
employment and unemployment, reliable products and dangerous ones, enriching experiences and oppressive
ones, stimulating work environments and dehumanising ones, care and compassion for the old and sick versus
intolerance and resentment. (Tinker, 1985, p xx)

3.0 INTRODUCTION AND CHAPTER OUTLINE:

In the previous chapter (chapter 2), the researcher outlined the world view and value system

of Islam and compared it with that of the Western worldview; he highlighted the consequent

economic implications and the accounting implications of these differences. In this chapter,

the critique of conventional accounting from the social and critical literature and behavioural

accounting literature will be reviewed. The review is undertaken through five main themes:

objectives, fundamental assumptions, characteristics, macro-consequences (effect on social

and environmental well being) and micro consequences (i.e. internal behavioural

consequences). During the course of the review, the researcher will attempt to extend this

literature through an addition of an Islamic perspective to this critique. The aim of this

chapter is to examine why the objectives, characteristics and consequences of conventional

accounting and its behavioral implications are unsuitable for an Islamic society, using the

social, critical and Islamic critique of conventional accounting.

This analysis will attempt to answer the following questions: (i) what are the objectives of

conventional accounting (based on the capitalist economic system) and are these

acceptable from an Islamic economic point of view? (ii) What are the fundamental

assumptions of conventional accounting and do these hold for the existing and desired

socioeconomic framework of Muslim and Islamic societies? (iii) What are the social and

economic consequences of conventional accounting and are these consistent with the

objectives and norms of Islamic society and organisations? (iv) Are the

measurement/valuation and disclosure principles and practices of conventional accounting

appropriate for Islamic society? (v) What are the internal and external behavioural
Chapter 3 Page 67

consequences of accounting for Muslim managers and employees, and are these are in line

with Islamic values?

The researcher argues that conventional accounting in terms of its objectives, characteristics

and consequences is a negative force from an Islamic perspective and classifies these

characteristics as the “push factors” necessitating the search for an alternative Islamic

accounting.

In the next section (3.1), an outline of the critique of conventional accounting literature is

given. Next, an examination of the critique with respect to the objectives, assumptions

(section 3.2), accounting concepts and characteristics (section 3.3) and the economic, social

and environmental consequences of conventional accounting (section 3.4) is undertaken. In

section 3.5, the management accounting and the critical accounting literatures relating to

budgeting and control systems will be used in considering the behavioural effects of

management accounting and financial reporting on employees and management. Section

3.6 adds an Islamic perspective to the traditional critique of conventional accounting

This chapter is concluded (section 3.7) with a summary of the arguments and a model of

the “push factors” depicting the need for Islamic accounting. The next two chapters

(chapters 4 and 5) will discuss the “pull factors” which express the theoretical and practical

need for Islamic accounting.

The same themes using objectives, characteristics, consequences and behavioural effects

will be used as basis to explore the issues and remedies which have been suggested in the

Islamic accounting literature, in Chapter 6. This procedure will help in identifying the

objectives and nature of Islamic accounting, which will satisfy the need of Muslim users and

organisations
Chapter 3 Page 68

3.1 AN OUTLINE OF VARIOUS ACCOUNTING CRITIQUES.

The literature, which criticises conventional accounting, draws on various perspectives:

i) Social and environmental accounting (Maunders & Burrit, 1991; Gray et al., 1996; Gray

& Bebbington, 1998),

ii) Marxist/ critical accounting (Tinker et al., 1982; Tinker, 1985; Cooper & Hopper, 1990;

Lehman, 1992a; Galhlhofer & Haslam, 1995),

iii) Feminist critiques (Cooper, 1992; Reiter, 1997) and

iv) Public interest arguments (Arrington, 1990, Briloff, 1990).

Although all of the different critique of conventional accounting point out its deficiencies from

their own perspectives, many of the issues raised are common to which Islamic academics

would have concerns. Some of the concerns about the application of conventional

accounting to Islamic societies are similar to that raised by researchers in other areas. In

spite of this, not all the concerns of Islamic societies are addressed by these critiques as

they all represent variants of the Western worldview (in both its capitalist and Marxist

forms). Therefore, the critics agree with many of the capitalist system’s core principles.

Further, they specifically exclude a religious content due to the ontological and

epistemological differences between Islam and the history of secularisation of knowledge in

Western society. The researcher attempts to highlight these differences especially when the

values or proposed solutions are not compatible with an Islamic framework.

However in all fairness, it must be said, that these different views do try to avoid or lessen

the worst excesses of modern capitalism in which conventional accounting is embedded.

Despite their common worldview at the fundamental level, the mainstream of Western

thought- itself dominated and ‘captured’ by capitalist, individualist and utilitarian ideologies-

do not allow them to be very successful. This can be seen from the fact their

recommendations are not adopted in mainstream accounting practice and do not take pride

of place in mainstream accounting research (e.g. Tinker et al., 1991; Lehman, 1992a; Lee,

1997).
Chapter 3 Page 69

There is no dearth of criticism of conventional accounting. The criticism began soon after

accounting started to grow in prominence and stature in the early part of this century: this

was especially the case in the USA and the UK where modern corporate accounting can be

said to originate. Early accounting critiques were based mainly on the problem of obtaining a

‘true income’ figure. Very few academics with the exception of writers such as MacNeal

(1970 [1939]) criticised the accounting principles and valuation methods and tried to infuse a

moral consciousness and public spirit into the profession. Writers such as Sprague (1971,

[1922]) and Scott (1931) focused on the Philosophy of accounts and the cultural

significance of accounts respectively.

Accounting has faced ever-increasing criticism since it became an important discipline and a

profession in the early part of this century. In its attempt to become a respectable discipline

akin to that of Law and Medicine, the AICPA (and their academic counterparts- the American

Accounting Association), attempted to develop a theory of accounting (AAA, 1936;1966;

1977).

However, the various schools (multiparadigm) (AAA, 1977), and various ‘images’ of

accounting (Davies et al., 1982) attracted criticisms especially on the valuation and income

determination aspects of accounting, sometimes dubbed the true income school (AAA,

1977). Until the late 1970’s, when the decision-usefulness paradigm took over conventional

accounting (ASSC, 1975; FASB 1978), the true income problem, constituted the subject of

most accounting debate.

The prominence of Accounting as a ‘social’ institution (Roslender, 1992), owes much to the

development of corporations as major business organisations in the early part of this

century. In fact, one can say, accounting achieved prominence as a profession in tandem

with the growth and diffusion of the corporate enterprise in the USA, UK and its spread in the

form of the multinational corporation. It was not too long ago that corporations were relatively

small; however, they have become very large and hold a significant amount of power and

wealth to such an extent that some have become wealthier than certain governments and
Chapter 3 Page 70

countries. The rise of “Managerial Capitalism” (Chandler, 1977), or “Investor capitalism”

(Bryer, 1993a) led to the concentration of power and wealth in the hands of a few people.

This resulted in a greater emphasis on market efficiency and shareholder value in society

with the associated environmental destruction, nihilistic consumerism, wealth appropriation

and social conflicts. This phenomenon also gave prominence to the accounting profession in

the guise of multinational audit firms especially the Big Six (now the Big four). The critique of

these excesses of the corporation started in the 1970’s when their social costs became

staggering and could not be ignored. This led to a debate regarding the moral and social

responsibility of corporations (e.g. Donaldson, 1982; Mintzberg, 1983) and extended to

corporate accounting and governance, e.g. Gray et al., (1988,1991) and Benston (1982).

The Corporate Report (ASSC, 1975) was an attempt to incorporate the social responsibility

of corporations in accounting although it adopted a ‘decision-usefulness’ framework.

The true income school and corporate social responsibility debate gave way to development

of a theoretical framework for accounting in the guise of a search for a conceptual

framework; as accountants sought a theoretical justification for ‘professional’ status akin to

medicine and law. After a series of attempts to develop statements on ‘objectives’,

conventions and postulates of accounting, for example, with the Trueblood report, (AICPA

,1973), the FASB completed its conceptual framework project resulting in the Statements of

Financial Accounting Concepts (FASB, 1985). However, this attempt according to Solomons

(1986) missed the chance to revolutionise accounting; nevertheless it established for

accounting a particular ‘decision-usefulness’ framework which emphasised the focus on

investors and creditors in the capital market. In the researcher’s opinion, it was a typical

Friedmanian approach to conceptualizing accounting as an “objective”, “neutral” tool of profit

maximizing business based on the capitalist society and world-view1.

From the late 1960’s, a capital market orientation in accounting research and theory

development arose out of criticism of armchair theorising (AAA, 1977). Instead of trying to

develop the notion of ‘true income’ or of thinking about what accounting ought to be, the
Chapter 3 Page 71

positive accounting theorists argued that accounting should study ‘what is’ and try to

investigate whether financial statements could predict future events (Watts & Zimmerman

,1979 and 1986). Capital market studies such as Ball & Brown (1968), Beaver (1981) and

Watts & Zimmerman (1979 and 1986), together with agency theory (Jensen & Meckling,

1976) which assumed that people are self-seeking zealots, led accounting away from moral

and social issues to concentrate on increasing the wealth of finance providers and market

players. This became the mainstream of accounting research and the primary focus of

practice which saw finance and financial markets develop as important disciplines in their

own right, separate from that of accounting.

This capitalistic orientation has attracted a great deal of Marxist critique of accounting

which argues that accounting is merely a tool which increases the gap between the rich and

the poor and leads to class conflicts (Tinker, 1985; Lehman, 1992a ). Marxists also

launched their attacks through the medium of critical theory (e.g. Laughlin, 1987; Cooper &

Hopper, 1990). This theoretical approach was an offspring of the Frankfurt School

expounded by Max Horkheimer (1895-1973) according to which “only a radical change in

theory and practice can cure the ills of modern society, especially unbridled technology”; in

turn it attacked Marxism itself as a “one-sided doctrine subject to criticism” (Honderich, 1995,

p290). Further critical theory contends that since theory and its concepts are products of

social processes and therefore, instead of accepting and endorsing them as they are, as

positivism and empiricism does, it should trace their origins (cf. historical materialism of

Marx)

The Critical school is also used by Feminist and Deep Green groups who have criticised

accounting (Cooper, 1992; Reiter, 1997). Radical Feminists hold that accounting promotes

male chauvinism and that a feminine perspective would give accounting much needed

balance as well as reducing male superiority (Cooper, 1992). The Deep Green perspective

on the other hand views modern society as unsustainable; their extreme proponents insist

on human depopulation to let the animals and plants reclaim their portion of world. They

1
See the emphasis and rationale of resource allocation efficiency arguments in SFAC No.1 (FASB, 1978).
Chapter 3 Page 72

view corporations and accounting as agents for the destruction and pollution of the

environment and the biosphere (Maunders & Burritt, 1991).

A Public-Interest perspective is taken by writers like Briloff (1990), who argue that

Accountants have not honoured their duties of public service by shamelessly paying littler

attention to their ethical codes and by being involved in a number of high profile scandals.

The Social and Environmental Accounting writers criticise modern accounting from

various perspectives mentioned above. However, its main advocates (e.g. Gray et al., 1996;

Matthews, 1994) favour an evolutionary approach of extending conventional accounting to

recognise, report and disclose social and environmental information leading to their

discharge of accountability to society.

Finally, a critical cultural perspective has developed which argues that accounting has

cultural relevance and should be tuned to the cultural idiosyncrasies of space and time

especially in the different cultural and economic environments of developing countries

(Perera, 1989). Writings in this area range from culturally developed accounting (Wallace,

1990a) to those which question the relevance of conventional accounting to other cultures

(Baydoun & Willet, 1995).

From a management accounting perspective, critique has focused on two main issues i.e.

the behavioural problems (Argyris, 1953 and 1990) and the of management control of the

individual and society (Miller & O’Leary, 1987).

All the above perspectives have lessons, which can be learned by Islamic accounting.

However to focus the research, this review will concentrate mainly on, the social and the

critical accounting literature, including the Marxist critique of accounting. The critical school

share similar concerns to the researcher, as the research is an attempt to look into the ills of

society and to emancipate and change it for the better. The social accounting school

provides some lessons on how the fundamental philosophies underlying conventional

accounting can be recognised and serves as an example of an evolutionary method to

change the status quo (a method favoured by Islam). The accounting ‘principles’ and ‘true

income’ debate raises some issues of concern to the content of Islamic accounting. The
Chapter 3 Page 73

public interest accounting literature being mainly concerned with the failure of the accounting

profession is not reviewed, as this research does not concern itself with this issue in any

detail. The feminist critique is not discussed except to take some lessons for Islamic

accounting from ‘enabling accounting’ (Reiter, 1997).

The discussion starts in the next section with the objectives and assumptions of

conventional accounting.

3.2 THE OBJECTIVES AND ASSUMPTIONS OF CONVENTIONAL

ACCOUNTING: SOME PROBLEMS WITH THE DECISION USEFULNESS
PARADIGM.

From the period 1977-1985, the Financial Accounting Standards Board of the United States

of America spent millions of dollars and thousands of man hours trying to develop some

theoretical basis for accounting in the form of a conceptual framework. This was supposed

to be a “ coherent system of inter-related objectives and fundamentals ...that prescribes the

nature, functions, and limits of financial accounting and reporting (FASB, 1981). Their project

resulted in six “Statements of Financial Accounting Concepts” (SFAC). SFAC No. 1

(FASB, 1978) states that:

“Financial Reporting should provide information that is useful to present and

potential investors and creditors and other users in making rational investment,
credit and similar decisions ...(through the provision of information that will help
them to assess)..... the amount, timing and uncertainty of net cash inflows to the
related enterprise”. (FASB, 1978, p16 &18)

The objective was not new (except in the importance given to cash flow) as this “decision

usefulness” objective, which has become the main paradigm of accounting, had been

emphasized before the FASB’s conceptual framework project began. (See for example,

(AAA, 1966 & 1977; ASSC 1975). In fact the American Accounting Association (AAA, 1977)

attributes Chamber’s (1955) article on the “Blueprint for a theory of accounting” as having

served as the starting point for a “decision-usefulness” theory of accounting. All the

pronouncements of AAA and the conceptual framework projects led to the dominance of this

paradigm. The main stream capital market research is an outcome of a particular variant of
Chapter 3 Page 74

this paradigm i.e. on the aggregate behaviour of decision makers (i.e. Market players) as

depicted by changes in security prices (e.g. Ball & Brown, 1968; Beaver et al.,1968).

Lehman (1992a) notes the change of emphasis from stewardship to decision usefulness or

‘decision informativeness’ from the AICPA’s Study Group report on Objectives. He contends

that the traditional stewardship role always necessitated considering management’s

effectiveness and efficiency, despite the tendency to justify this slant towards decision

usefulness as a “higher form of stewardship” (p20). The difference is not superfluous but

calculated to emphasise “the informational role of accounting being regarded as crucial to

the efficient allocation of society’s resources by individuals, enterprises and government”

(p21). Combined with agency theory and positive accounting theory, this became the

dominant paradigm of accounting in the 1990’s; adoption by the FASB’s conceptual

framework project probably added to its central role. In fact, decision-usefulness has

become the dominant paradigm of all subsequent conceptual frameworks since the FASB’s

first pronouncements on the issue (for example, IASC, 1989; ASB, 1992).

On the face of it, the term “decision-usefulness” seems rational, innocuous, and perfectly

acceptable from an Islamic perspective. However, when one examines the concept in depth,

a number of problems arise. These include (a) the economic-environmental context in which

it was developed and therefore the environment under which it may be appropriate; (b) the

economic assumptions underlying decision-usefulness, the under-specification and

achievability of social welfare; (c) the decision-users who are targeted; and (d) the societal

assumptions underlying decision-usefulness.

Each of these will be examined in turn.

3.2.1 The Economic Environment of Decision Usefulness

The decision-usefulness paradigm was born in the United States and spread to the UK as

noted above. In these countries, the underlying economic environment is very different from

that which operates in Muslim countries. The United States and the UK are advanced

exchange-based economies with developed capital markets. It is in this economic context

Chapter 3 Page 75

that the decision-usefulness paradigm was arrived at. In discussing the environmental

context of the objectives of financial reporting, the Statement of Financial Accounting

Concept 1 (FASB, 1978) notes that:

“The US is a highly developed exchange economy where large amounts of capital

is required for maintaining the complex production processes which result in the
production and exchange of goods and services. These processes require economic
resources, which is allocated by the market mechanism. The effectiveness of
individuals (through buying, selling or holding shares & bonds) and enterprises,
markets and government in allocating scarce resources among competing uses is
enhanced (.i.e. allocated to enterprises that use them efficiently) if those who make
economic decisions have information regarding the standing and performance of
business”. (FASB, 1978, p 5-8).

In this context, competitive markets are seen as a significant factor in resource allocation in

the economy (in addition to government whose intervention is frowned upon). Thus,

“decision usefulness relies heavily upon the language of self-seeking rationality, markets

and economic efficiency to describe accounting problems and interpret accounting events”

(Williams, 1987).

While, these objectives may be valid in the developed economies of the West, it may not be

suitable in economies such as those of Muslim countries where the economic realities are

different. For example, many Muslim countries do not have established or developed stock

exchanges. Many industries are government owned (although privatisation has started in

earnest in Malaysia, Pakistan, Turkey and Egypt). A large section of the economy is non-

monetised and most people are involved in agriculture which do not produce huge financial

surpluses. In such situations, a decision-usefulness form of accounting oriented towards

market participants does not make a great deal of social or economic sense except as a tool

for overseas capitalists interested in appropriating the wealth of these countries (see Tinker,

1985). In Muslim countries where stock exchanges are fairly developed (such as Malaysia),

the ‘decision-usefulness’ orientation serves the same role as in the West with the same

undesirable consequences of financial hyperreality (McGoun, 1997) ; these consequences

are not desirable from an Islamic perspective. Therefore, the basis and thrust of accounting

needs to be changed.
Chapter 3 Page 76

3.2.2 The “Ceteris Paribus” of Decision Usefulness.

The essential message of decision usefulness is that accounting provides information which

leads to the efficient allocation of resources (AAA, 1977). This is apparently through the

process of providing information, which results in information efficiency in the market, which

in turn leads to allocation efficiency. Although efficiency (the most output per unit of input)

may well be a useful goal to aim for, it cannot be the ultimate aim of human society. It is an

intervening variable which perhaps leads to a better life or more utility (perhaps at least in

the material sense). This deficiency has led a committee of the American Accounting

Association (AAA, 1975) to add “social welfare” as the ultimate aim of allocation efficiency.

Commenting on the inadequacy of a report by the Study Group on Objectives of Financial

Statements (AICPA, 1973), this committee (AAA, 1975) observed that the Study Group’s

assertion that financial statements should provide information useful for making decisions ,

“was not broad enough to lead a complete set of criteria against which accounting

alternatives should be judged” (p 42). It suggested that decision usefulness was a necessary

but not a sufficient condition. It argued that “Financial Statement alternatives should be

judged by their impact on social welfare”. Hence it is proposed that the objectives of financial

statements should be, “to provide information which is potentially useful for making

economic decisions and which if provided, will enhance the maximisation of social welfare”

(AAA, 1975, p 42).

The above discussion can be summarised in the following figure (3-1). If decision-

usefulness is adopted as the objective of accounting, then it is posited that social welfare

through the following processes:

FIGURE 3-1: ACCOUNTING ROUTE TO SOCIAL WELFARE

Accounting

Information Efficiency
Chapter 3 Page 77

Better Economic Decisions

Efficient Allocation of Resources

Social Welfare

Leaving aside the definition of “social welfare” for the moment, (discussed in section 3.2.3.),

the question arises, does conventional accounting really lead to social welfare (even in the

material sense) through the chain depicted in figure 3-1 above? In other words, does

accounting information lead to information efficiency, does this in turn lead to the right

decisions, do these decisions lead to efficient allocation of resources, and does the efficient

allocation of resources lead to social welfare? The probability that all these assumptions

hold might be dubious.

Lehman (1992a) argues that the assumption that if “accounting information is provided to

investors, the marketplace will function efficiently, ensuring maximum social welfare” (p 22)

has some limitations. He contends that there are fundamental problems with the use of neo-

classical economic model (on which conventional accounting research relies heavily), that

makes this chain dubious. These include:

(i) The breakdown of the assumption about perfect competition leads to

“inconsistencies and problematic implications for the role of accounting. Some

researchers (e.g. Benston, 1982) contend that there is no need to regulate

accounting as markets are efficient by themselves. Other researchers (e.g. Ronen,

1979 as quoted in Lehman, 1992) argue the importance of accounting in regulating

behaviour because of information asymmetry between management and investors.

Chapter 3 Page 78

The question therefore arises as to whether accounting leads to efficient allocation of

resources or whether markets are efficient in spite of accounting regulation.

(ii) The generalisation of individual preferences to collective preferences by aggregating

individual utilities of shareholders who have heterogeneous interests, to obtain

society’s collective preferences is questionable. This has been questioned by Arrow

(1971) (as quoted by Lehman, 1992), who concludes that it would take a dictator to

make social choices affecting more than one individual. This has resulted in the

recognition by Beaver & Demski (1974) that choice among reporting alternatives has

social consequences that affect non-users and users of accounting information in

terms of the distribution of wealth. Hence, ethical judgements must be made as to

whose well being should be enhanced and whose should be diminished.

(iii) The separation of social and economic spheres of analysis is another assumption,

which has been questioned. For example, Lehman (1992) contends these two

spheres cannot be separated. He questions the maxim that it is inappropriate for

accounting to consider the distribution of resources of income and wealth while at the

same time insisting that it leads to social welfare by maximising wealth. It is not

logically possible to develop production conditions independent of distribution

conditions. The neo-classical economic model (marginal productivity theory), by

seeking to ignore income and wealth distribution becomes a tautology as when

determining the optimal vector of factor input prices, one needs to assume a given

distribution of income, which in turn is what the model tries to explain.

Gray et al., (1996) put this problem as the case of ‘too many ifs”. Thus:

“If all agents were equal, and if markets were information efficient and if, ,this led
to allocative efficiency and if, this led in turn to economic growth and if , this
ensured maximum social welfare and if, maximum social welfare is the aim of the
society then accounting is morally, economically and socially justifiable”.
(Gray et al., 1996, p 17).

3.2.3 The Question of Social Welfare:

Chapter 3 Page 79

The introduction of the term “social welfare” leads to more questions than answers. Social

welfare obviously means the welfare and goodness of the community. However, “welfare”

and “goodness” again depend on the value system of the community. The differences

between the values of Western civilization and those of Islam have been discussed in

chapter 2. Although there are similarities in moral values (Kant’s – categorical imperatives),

the modernist and post-modernist trends of Western civilization are not identical with Islam

and have many differences. Hence, social welfare in Islam might mean equitable distribution

of wealth in an Islamic economy, equal distribution in the communist system, and

concentration of wealth to the ones who make use of opportunity in the capitalist system.

Another instance would be perhaps, in the West, welfare may be measured more in material

terms, while the Muslim might trade-off some return in favor of religion (El-Ashker, 1987) or

other ethical objectives. Even in the West, ethical investors may trade-off some monetary

return in favour of ethical /religious values (EIRIS, 1993). Hence, social welfare may be

culturally defined.

Even if social welfare is defined in pure economic terms, the provision of decision useful

accounting information may not lead to its achievement because of the operation of the so

called “Lipsey-Lancaster Theorem” (Laughlin & Puxty, 1981, p63). Thus:

“Social Welfare cannot be appealed to by suggesting that, if users’ needs are

satisfied, greater welfare will result, because of the operation of the Lipsey-
Lancaster Theorem" (Laughlin & Puxty, 1981, p46).

This “Lipsey-Lancaster” theorem argues that, in a non pareto-optimal world, removal of one

constraint to a pareto-optimal situation (e.g. lack of accounting information disclosure) “ may

affect welfare or efficiency either by raising it, by lowering it or by leaving it unchanged.”

(Lipsey & Lancaster, 1957, as quoted by Laughlin & Puxty, 1981). Thus, Laughlin & Puxty

(1981) argue that the direction of change in social welfare cannot be forecast simply from

the direction of change (of the constraint) itself and therefore further investigation is

necessary.
Chapter 3 Page 80

Thus increasing decision useful information may lead to an increase, decrease or no change

in social welfare, not necessarily an increase all the time. A further consideration is that

decision usefulness does not elaborate on what uses the information is put to by users.

Such disclosure can actually harm the organisation and society (at least locally). For

example, Laughlin & Puxty (1981) quote the example of (i) a self-interested union that

makes use of information to force a firm out of business by insisting on high pay and (ii) the

social consequences arising for a particular geographical area which was dependent on the

business. In this case, decision-usefulness was not useful to the local community.

In certain cases, firms may wish to restrict information disclosure i.e. in the case where a

firm exploits a gap in the market and exploits arbitrage opportunities and in the case where

they have come up with better techniques of production due to their research and

development activities. In this case, the disclosure of segmental information “useful to

users” would lead to the entry of competitors resulting in loss on the part of the firm

disclosing the segmental information. Laughlin & Puxty (1981) argue that this ability to keep

trade secrets (non-disclosure of information) is important if there is to be continuous

incentive to develop new products and services and the continued operation of businesses.

Another pertinent question to ask is who are the targeted users for whom the accounting

information is useful and is an increase in their welfare synonymous with all or even major

sections of society?

Cooper & Sherer (1984) point out that

“Focussing on informational efficiency in the capital market may contribute

towards an efficient allocation of resources from the perspective of the
shareholder class, but the resulting equilibrium may not be efficient for other
members of society”. (Cooper & Sherer, 1984, p211).

Further, Lehman (1992a) argues that the heterogeneous interests of the shareholders are

not representative of the interests of all social members but conventional accounting

assumes that it is. Thus, “maximisation of shareholder investment wealth does not

guarantee an adequate criterion for societal wealth (financial or non-financial)” (p22). This

point is particularly pertinent as, even in the case of a developed country such as the UK,
Chapter 3 Page 81

less than 30% of the public are direct investors in the share-market (Mullin, 1998). In

developing countries, especially Muslim countries, this percentage is even less. Hence this

point is particularly valid for Muslim countries who do not have developed stock markets and

who may not wish to construct “wealth-siphoning” structures in their countries.

3.2.4 The Societal Assumptions of Decision-usefulness

Accounting is normally seen as a complex set of socially neutral techniques which are value

free and objective. However, the reality is that accounting is a social construction (Hines,

1988). Gray et al. (1996) warns us that reductionism leads to artificial systems boundaries

around those parts we might choose to ignore (e.g. ethics, values, exploitation, and the

natural environment). Using the General Systems Theory framework, they assert that

accounting, ecology, society, organisations etc., are all systems, which interact. These

systems can be conceptualised and their interaction conceived of differently. They assert

that role of accounting can be better understood if the world in which it is assumed to

operate is made explicit.

They posit that accounting (in the Western developed world) operates under an assumed

“pristine liberal economic democracy” (p14). This assumed society, under which accounting

operates, is a world of equal individuals (or groups) who are free to act (liberal) and to

express choice through actions in markets (economic) and actions in the political

(democratic) arena. The role of the (small) government is to maintain their freedom and be

neutral with respect to serving particular interest groups in society. Hence an individual’s

freedom is paramount and all are equally able and free to exercise their political and

economic choices through the ballot box and in the market. The self-interested pursuit of

economic efficiency ensures that profit and economic growth is maximised making society

better off (financially). An ethic of utilitarianism is assumed which evaluates an action in

terms of its consequences or utility (measured by profits, cashflows and GNP). A profitable

action is thus a good action (Gray et al.,1996).

Chapter 3 Page 82

Gray et al. (1996) posits that decision usefulness is a normative justification for accountants

and the accounting profession acting under such a conception of society. Such a society is

beset with contradictions. In real life, people are not equally endowed financially,

intellectually and socially. It is powerful groups acting in their own interests, which make

decisions. Decision usefulness is viewed by Gray et al. (1996) has having many internal

contradictions e.g. the financial measure of societal wealth and its distribution. This

sometimes leads to anomalies where environmental degradation is counted as an increase

in GDP. The increasing gap between rich and poor is not questioned in such a society. It

has no room for environmental or ethical values other than self-interested utilitarianism.

Thus accounting which emphasises the desirability of actions by its financial consequences

(i.e. profits as a ‘good’) supports a certain moral position and encourages a certain

behaviour, which is represented as “ moral” by accounting numbers.

In questioning why a talented group such as accountants should exert so much effort to

ensure the richest and most powerful group in society become still richer and more powerful,

Gray et al. (1996) conclude that :

“The links between individual self-interest (‘greed’ as manifested in conventional

economic, finance and accounting literature) and social welfare cannot be
demonstrated. It is vaguely possible that such a link exists- and in very specific
circumstances might actually do so – but it cannot be show to hold for everyday
western economics”. (Gray et al., 1996, p 20)
and therefore

“Decision usefulness has little positive value ...(as)..the research literature

(indicates)....that current financial statements do not represent the information
that investors most desire...(therefore).. ...there is no justification for the
normative position of decision usefulness....if it is to be useful, why should it be
only useful to investors? ....we can only justify such an assumption in a pristine
liberal economic world”. ( ibid., p 74-75).

Williams (1987) asserts that, it is not proper to adopt decision-usefulness as a principle for

organising accounting practice because accountants cannot avoid making certain

judgements characterised by “fairness”. Hence, a more explicit moral language of

accountability and fairness must be added to the lexicon of accounting. He posits two

conceptual problems with decision usefulness: the asymmetry of decision usefulness and

ignoring the simultaneity of efficiency and distributive effects.

Chapter 3 Page 83

The asymmetry of decision-usefulness arises from the non-substitutability of the dual role

played by it; as a criterion for making judgements about the value of accounting data and as

an explanation of the phenomenon the accounting data represent. The consequence of this

asymmetry is that contradictions are created; for example , in the case of the FASB project

between SFAC 1, objective and the constraints imposed in SFAC2 , Qualitative

characteristics. According to Williams, there is no necessary property to explain these

constraints on the production of accounting data. Accountability on the other hand, is a more

appropriate principle as it implies constraints and possesses fairness as an inherent

property.

The second problem asserted by Williams is that the rationale of decision usefulness in the

efficient allocation of resources is problematic because it ignores issues about the

distribution of those resources. He argues that “Efficiency or allocation is but one aspect of

a two-aspect process” (p176). Although accountants seem to ignore the problem, they

implicitly make normative value judgements on distribution e.g. by using price theory (Tinker

et al., 1982). He also suggests that “reliance on the efficiency criteria and market justice only

serves to make accounting’s fairness judgement implicit not absent” (p185). Since these

interpretations of accounting’s reliance on such devices lead to the conclusion that fairness

is not assured, more explicit concern with fairness is required. This implies a moral

dimension to accounting, which in turn has consequences for the design of accounting

systems and semantic interpretations of accounting numbers. Labels such as profit,

dividends, contribution etc. take on different meanings if defined from a perspective of

fairness rather than decision-usefulness.

3.2.5 The Dysfunctional Effects of Decision Usefulness:

Laughlin & Puxty (1981) also point out that decision usefulness could lead to possible

dysfunctional policy decisions of organisations as a consequence of accounting standards

which are based on users’ needs. In this case, businessmen may be obliged to act in a way,

harmful to their firms. For example, property development companies would have had to split
Chapter 3 Page 84

up their operations into property development and property investing and pay substantially

more tax, if they had, had to adopt the provisions of SSAP 12. Although these companies

were exempted in the UK, companies in the US were not spared the negative economic and

organisational consequences of the introduction of SAS 8 on Foreign exchange

transactions.

Laughlin & Puxty (1981) blame the myopia of “decision usefulness” on the misinformed

dichotomy between external and internal accounting which ignores “ the control nature of all

accounting information and the need to take account of the reporting entity’s needs in

financial reports” (p74). They suggest an alternative framework of organisational control

which they claim can lead to social welfare (under specified conditions).

They posit that internal and external accounting should be designed in such a way so as to

meet the needs of the organisation i.e. the content should be such that it increases

organisational effectiveness in terms of goal achievement. Under this framework , the major

function of accounting would be to act as a regulator to reduce the effect of environmental

disturbances on the organisation because the disturbances make it difficult for the

organisation to achieve its objectives by changes in the controllable elements (internal

accounting). Another control model proposed is to use both accounting and systems design

to directly attempt to affect the environmental state so that the objectives might be furthered

by making the environmental constraints less damaging.

How this leads to social welfare is explained by (Laughlin & Puxty, 1981) using the

inducement-contribution theory. This theory states that an organisation continues to exists

as long as its inducements to participants is greater than the contributions it needs from

them. As long as this happens, it is contributing towards social welfare (at least that of the

participants). The authors attempt to extend this argument to the whole of society by

presuming that “a viable society in course of development, depends on the continued

viability of the enterprises which constitute it. Since viability implies control, societal welfare

depends on adapting the enterprises’ ability to control their relationship with society” (p77).
Chapter 3 Page 85

3.2.6 Conclusions on the Decision-Usefulness Objectives of Conventional Accounting.

We can therefore conclude that the decision usefulness paradigm of conventional

accounting is flawed because:

1. The theory that provision of conventional accounting information leads to efficient

allocation of resources is tenuous because there are two many ‘ifs’ in the sequence of

assumptions.

2. Even if information results in shareholder and creditor wealth maximization, this does not

mean better welfare even for themselves, much less for the wider community and society

because material wealth may not necessarily mean better quality of life and welfare.

3. Even in economic terms, decision-user based accounting may be economically harmful

to the organisation providing the information which may even result in social dislocation.

4. The economic environment hypothesised for decision useful accounting is a developed

exchange economy with a capital market focus. This implies that conventional

accounting is only relevant to countries with similar economic environments.

5. The societal assumption of “pristine liberal economic democracy” (PLED) under which

decision-usefulness makes sense (Gray et al., 1996) is not true even for some capitalist

oriented societies. According to Gray et al (1996), the actuality in these countries is neo-

liberal democracy in which there are groups of unequal power centres. The power gap

between groups have implications on the supposed sovereignty and ability of the

consumer (i.e. the user of accounting information) to make the appropriate decision to

achieve an efficient allocation of resources which might lead to social welfare.

3.3 THE CHARACTERISTICS OF CONVENTIONAL ACCOUNTING; THE

PROBLEM WITH ‘ACCOUNTING PRINCIPLES’

Financial reports under conventional accounting are prepared according to certain concepts,

which are variously referred to as postulates, principles conventions and concepts. Belkaoui

(1992, p 229) defines accounting principles as general decision rules derived from the

objectives and theoretical concepts of accounting, that govern the development of

Chapter 3 Page 86

accounting techniques. He includes the historical cost, revenue, matching, objectivity and

full-disclosure, conservatism, materiality and the uniformity and comparability concepts as

principles. Belkaoui classifies the monetary measurement and entity concepts as

postulates.

Accounting information produced in accordance to these principles is often put forward as

objective, neutral, verifiable and reliable. However, even the economic consequences

produced by the accounts prepared under these principles were shown to be wanting as

early as 1931 by MacNeal. These principles and concepts have been criticised both from the

capitalist (e.g. Edwards & Bell, 1961; Chambers, 1966; Stirling, 1970) and Islamic points of

view (Abdelgader, 1994) although the latter was at a superficial level (see Adnan & Gaffikin,

1997).

MacNeal (1970, [1939]), argued that accounting was ‘untruthful’ as it consisted of ‘unsound

accounting principles’ which he claimed was based on ‘expediency rather than the truth’ (p

vii). Financial statements prepared under this principles misled investors because it failed

to take into account current values (values in exchange) of assets and instead used

historical (original) costs and justifying them in terms of a ‘going concern’ theory. According

to him, the unwillingness of accountants to recognise unrealised profits leads the investor to

make wrong economic decisions on lending, buying and selling securities. He further

advocated that all profit and losses whether realised or otherwise should be disclosed (a

position later upheld by Edwards & Bell (1961) and the Trueblood Committee (AICPA, 1973).

MacNeal (1970) argues that the historic cost principle was relevant when businesses were

owner managed, where the function of accounting was ‘counting’ the costs of a project or

venture. As the project or venture was of short duration, historical cost sufficed to track the

cost and profits accumulated to the end of the venture as no external parties relied on this

information. The growth of bank credit perpetuated this principle because the bank required

only a conservative estimate of the value of the net assets of the borrower to guarantee the

return of loan. An under-valuation due to historic costs would be that much better and the

conservatism concept would ensure that current assets were written down in value if its cost
Chapter 3 Page 87

was higher than the prevailing market price. Thus, the accounting principles were acceptable

for this period, as the accountant could satisfy both the interest of the banker by being

conservative, and the businessman/owner would not be mislead as the latter knew the real

value of his assets independent of the accountant. The accountant, left with the question of

valuing non-marketable fixed assets invented his theory of the going concern so that he

could justify its valuation in terms of its original cost less depreciation for maintenance and

renewal.

Mergers and Acquisitions led to bigger and bigger corporations controlled by non-owner

management. This led to a situation where many small shareholders were entirely

dependent on financial statements for information to make their investment decisions. The

accounting principles led to the preparation of financial statements which ‘frequently allow

managers and directors of a company to enrich themselves at the expense of the

stockholders in a most comfortable and legal manner’.

The prudence and realisation concept is also not appropriate although a fixed asset may be

carried for a long term, investors change during this period. Hence, if investors are not given

the market values, this favours, the insider who can buy up the shares, knowing the real

values of the assets and rake in the profit at the time of realisation, thus in effect defrauding

the previous shareholder who would have sold his shares for a value less than its worth

.Although the accountancy profession has increased its standards of reporting, overall it has

followed the latter course of redefining accounting objectives. The historical cost, realisation,

going concern and prudence concepts continue to be the bedrock accounting principles, fifty

years after MacNeal wrote his book. Financial scandals continue to rock the world (Briloff,

1990) and the profession refuses to budge from its basic position with respect to recognition

and measurement conventions despite the increasing ‘audit expectation gap’.

The Trueblood Report (AICPA, 1973) tried to change the status quo by suggesting the use

of current values. It rejected the traditional emphasis on prudence and suggest the fullest

disclosure of the uncertainties involved’ (Peasnell, 1974, p38). Other proposals called for a

middle position between full current value accounting and historical accounting include those
Chapter 3 Page 88

by Lowe (1970) for “multiple-column reporting” alternate values and the proposal to report

both realised and realisable profits by Edwards & Bell (1961). The Trueblood Committee

Report was rejected because it was too revolutionary.

The monetary measurement concept also produces problems as it implies only activity,

which is measurable in terms of money, are recorded and reported. This may leave out

activities, which are termed externalities because they are too difficult to measure but which

have grave consequences to society. Further, the most important asset, the human asset is

not recorded on a balance sheet.

Besides the economic consequences on investors noted above, Accounting rules have also

social consequences, Tinker (1985) observers that:

“Accounting rules though galvanizing and adjudicating social relationships are

not supported by ‘contemplation, reflection, criticism and debate about the
nature of society and its potentialities ‘ but by ‘ expedient reasoning, ad-hoc
explanations and piecemeal rationalizations”. (Tinker, 1985, p XX)

Tinker argues that the power of accounting has been underestimated, as has the

accountant’s responsibility for the social evils “through the partisan set of accounting rules

that governs the reporting and disclosure of information about corporations” (p xix). Through

the making of accounting rules (standards, principles and concepts) accountants supply one

of the most fundamental ingredients of economic and social choices; the valuation of

alternatives’ (p xx). Accounting rules attach values to economic choices made by individuals,

groups and organisations thus affecting decision making and thereby distributing benefits

and damage between different members of the community.

The accounting principles also lead to different profit figures for similar businesses. This is

due to the differences in the methods of calculating depreciation and the quantum and timing

of income and expense recognition. For example, in the Pergamon- Leasco Affair where

Pergamon Publishing Company’s profits for the year ended 1968 was certified to be £1.503

million by its auditors. it was recalculated to a £60,000 loss by the subsequent audit of Price

Waterhouse (Lowe & Tinker, 1977). According to them:

Chapter 3 Page 89

“About half of this difference was attributable to the method of valuing stocks of
books and back issues whilst the remainder of profits on transfers between
affiliated companies”. (Lowe & Tinker, 1977, p271)

These income determination problems become more acute in an Islamic environment

because, Islam does not allow pre-arranged fixed return investments and therefore the

income calculation is the only way to ascertain returns on an Islamic investment. Hence, its

importance.

3.4 THE MACRO CONSEQUENCES OF CONVENTIONAL ACCOUNTING

Professional accountants argue that the political and social consequences of accounting

practice should not be considered because accounting strives to be objective and neutral in

social conflict. Accounting records, measures and reports the results of ‘economic activities’

of enterprises which are delineated from social activities (AAA, 1966). This separation of

social and economic spheres of activity has already been criticised from an economic

viewpoint, in section 3.2.2 above.

However, the corporation is increasingly seen as not only as a nexus of commercial

contracts but as a moral agent with social responsibilities and functions (Donaldson, 1982)

to a variety of stakeholders (Sutton & Arnold, 1999). Even if managers insist that corporate

functions are primarily economic, the consequences of their economic activities impinge on

the social in terms of their effects on the local community, consumers, employees and the

environment. The activities of Multinationals seem to attenuate these effects to a global

scale. Accounting plays a dominant role in reifying these organisations.

According to Tinker (1985), the image of the accountant as the ‘innocuous bookkeeper’,

whose trustworthiness comes from his lack of “creativity and imagination” , is in fact a mask

which shields accountants and accounting from their impact in the social and political arena

(p xv). Hence, the power of accounting has been underestimated and the accountants’

responsibility for social evils has been and continues to be systematically understated.

Tinker contends that accountants are not harmless bookkeepers but arbiters in social

conflict, architects of unequal exchanges, instruments of alienation and accomplices in the

Chapter 3 Page 90

expropriation of the life experience of others “through the partisan set of accounting rules

that governs the reporting and disclosure of information about corporations” (p xix) ,

In this context, accounting has been accused of playing changing roles in social conflicts

(Lehman, 1992a) and creating social and environmental disasters (Tinker, 1985), its

principles unsuitable in the context of providing information on ecological issues (Maunders

& Burrit ,1991). It has been accused of creating employment problems especially through

promoting privatization by demonstrating the efficiency of downsized companies using

accounting numbers (Cooper & Hopper, 1988; Arnold & Cooper, 1999). Accounting has also

been accused of directly causing social conflict by increasing the gap between rich and poor

through the wealth distribution effects inherent in the provision of conventional accounting

numbers (Tinker, 1985). Further accounting has also been accused of dehumanizing effects

arising from the construction of the “governable person” who is a more manageable and

efficient entity (Miller & O’Leary, 1987). It has also been accused of promoting gender

discrimination (Cooper, 1992; Reiter, 1997). These injurious practices of accounting have

led Briloff (1990) to charge that accountants have desecrated their covenant with society by

not practicing what they preach in the public interest (Briloff ,1990).

It is difficult to compartmentalise these negative consequences neatly into social, economic

or environmental problems, as they are often intertwined. Tinker (1985) examines

accounting’s role in perpetuating social and environmental problems by studying several

cases of multinational exploitation, stock price collapses, the dumping of toxic waste, price

gouging by public utilities and the frailties of the world banking system. These cases,

according to Tinker, illustrate accounting’s “camouflage of objective and technical expertise

and expose the discipline’s social, human and moral malaise” (ibid., p xxi). For example, the

love canal incident (discussed below) created both social (health and housing) and

economic (loss of houses which were mortgaged to banks) problems for the local

community, the company involved and the government who had to subsidise the community.

It also was a disaster for the environment as it polluted land and made it a health hazard.
Chapter 3 Page 91

The negative social consequences of accounting are emphasised by Marxist writers who

criticise accounting in the historical materialist framework of Marx. They emphasise class-

conflicts. Even within the limited insight of Marxism, the social, environmental and economic

problems caused by conventional accounting which they highlight is of concern to Muslims.

Some of these problems will be examined under the following headings; Multinational

exploitation, privatisation and loss of work and environmental problems. The dehumanising

effects of internal accounting systems are considered under the behavioural effects of

accounting in section 3.5.

3.4.1 Multinational Exploitation

Tinker (1985) examined the accounts of the Sierra Leone Development Corporation from its

inception until its dissolution over a pre and post independence period. Although the

traditional profit and loss accounts shows a profitable operation, behind these numbers lay a

very different social and economic story. He concluded that investment by Multinationals in

developing countries does not benefit the majority of host countries but perpetuated power

groups and elites and destroyed traditional accountabilities. Even in an economic sense, the

host country government and people enjoyed only 15-20% of wealth, and after

independence, this percentage was even smaller (at 11.25%). These economic and social

facts were masked by the accounts as payments to suppliers (for machinery imports,

services and expatriate management). The establishment of the company had also led to

conflict and coercion; using British troops. The local black people had been forced to leave

agriculture due to an increase in local taxes by authorities who were installed by the colonial

administration. The company also bribed local government officials to receive loans and

bailouts (Tinker, 1985).

This exploitation continues today with the use of transfer pricing and franchising fees.

Transfer pricing accounts for 30-50% of the total revenues of multinationals. The use of

transfer pricing has helped to maximise the after-tax global profits of multinationals because

they provide an opportunity to allocate profits around the world irrespective of the productive
Chapter 3 Page 92

results of the individual subsidiary (Mouritsen, 1995). For example, foreign lumber

companies operating in Papua New Guinea, sell their lumber to associated companies in

Hong Kong at a lower than world market prices in order to reduce payment of local taxes. As

in the Sierra Leone Corporation’s case, local people are paid miserably lower wages than

the expatriates who occupy the management and technical positions.

The use of franchises allows a company to milk its overseas associates through charging

advisory or franchise fees, which are based on the revenue received, and not profits. These

fees are reported as expenses and sometimes manipulated to avoid local tax. According to

Mouritsen (1995), local governments have to implement benign procedures to control

transfer pricing as they are under the constant threat of withdrawal of the foreign investment

and the ensuing loss of jobs. The establishment and adoption of International Accounting

Standards perpetuate this problem of transfer pricing by multinationals (see Hove, 1989).

3.4.2 Privatisation , Loss of work and Public Property

The Privitisation craze extended the philosophy of liberal economic democracy principles

during the Thatcher and Reagan eras. These heads of states believed that the social

democracies do not work and that welfare state had to be curtailed. There was a political

facet to this because the unions were getting too powerful (rivaling the ruling political

parties). State help to the poor was to be replaced with the equal opportunity of the market.

The free market would henceforth decide wealth creation and distribution. Henceforth state

industries which were inefficient and bureaucratic would go into private hands to increase

their efficiency (measured in accounting profitability terms). Thus, for example, in case of the

water industry, the UK government’s white paper on the privatisation of the water industry

suggested that:

“Privatization should lead to improved standards, greater efficiency, and a better

allocation of resources within the water industry. Provided that the customers are
fully protected...the water industry, their customers and the nation as a whole
should all benefit”. (Cmnd. 9734, Department of the Environment, 1986, p13).
Chapter 3 Page 93

No mention is made of the protection of workers. The social importance of the water, rail

and even health sectors (henceforth to be called industries) were to be de-emphasised. New

accounting based performance indicators were to be used to gauge their viability.

Accounting was used to prove them inefficient and non-viable, although this was contested

by the academic accountants (Hopper & Cooper, 1988).

Recent studies (e.g. Shaoul, 1997a) have shown that even the economic objectives of

efficiency and the anticipated ‘benefit for all’ have not been realised. Shaoul (1997a)

critically studied the financial performance of ten water and sewerage companies, which

were privatised in 1989. He concluded that private ownership did not increase the efficiency

of the industry and that ownership was not the most important factor in determining

performance. Further, the privatisation transferred wealth from the public at large to a

relatively few individuals and corporate entities. “Consumer found that prices rose by more

than 50%, workers lost their jobs and the nation... made a huge loss on the sale” (p 500). A

further more important social effect was that it created the conditions whereby the other

stakeholders will be disadvantaged in the future” as the privatised infrastructure was

deteriorating faster than it was being replaced. Shaoul (1997a) also quotes research

showing that in other examples of privatisation, such as that of British Telecom and British

Gas, because of the absence of substantive competition, privatisation did not result in

efficiency gains.

The moral depravity and the social problem of lost work are shown in the study of the

privatisation of Medway Ports (Arnold & Cooper, 1999). In this case, the government-owned

Medway Ports were sold in a Management and Employee Buyout in 1992 under the expert

advice of Price Waterhouse. Dockworkers and other employees bought up to 10,000 shares

valued at £1 each. Later about half the workforce were dismissed and re-employed on a

casual basis. These workers were forced, under the articles of association, to sell back their

shares to the company as they were no longer employees of the company. The shares were

valued at £2.50 by KPMG Peat Marwick. Six months later, the port was sold to Mersey Dock

and Harbor company for £37 per share which enriched the Directors and financial backers of
Chapter 3 Page 94

the company by millions of pounds. The value of the share had increased from £1 (at which

the Treasury had sold it) to £37 in 18 months. Some employees later sued KPMG Peat

Marwick for undervaluing the shares. The case was settled out of court. The industrial

tribunal found that the company has constructively dismissed the workers but also awarded

them a paltry sum of £10,000 for the loss of security and work conditions and benefits. The

same story is repeated in other cases of privatisations e.g. British Gas, British Telecom and

Water Authorities where Directors are awarded huge executive salaries and perks when the

companies were down sized to affect the “efficiency” indicators of accounting numbers.

The above cases show the role of accounting in the redistribution of wealth resulting from

privatisation, especially the social implications of accounting and accountants’ involvement

in privatisation consulting. It shows the role of major accounting firms in the neo-liberal

privatisation program. An Ernst & Whinney report claimed that the Big Six firms were the

dominant providers of privatisation advisory services (EW, 1994 as quoted by Arnold &

Cooper, 1999). According to Hanlon (1994,1996, as quoted b Arnold & Cooper, 1999), the

accounting profession has transformed itself from a semi-autonomous public service

profession to a highly commercialised service industry. Thus:

“Accountancy institutions have played a pro-active role in executing

transformations prescribed by the neo-liberal economic agenda. In particular, the
consulting divisions of the major accounting conglomerates have organised,
directed and implemented privatisation on a global scale”.
(Arnold & Cooper, 1999, p 129).

3.4.3 Environmental Problems

Ecological and environmental problems are increasingly receiving attention as it turns from a

local to a global problem (e.g. Earth Summit at Rio). Many problems, such as the green

house effect, acid rain and damage to sea-life are caused by polluting emissions of industry

and commercialised agriculture. Others result from the transport and the use of fossil fuels

such as oil which is used to drive these industries. Further the consumer culture created by

mass advertising of corporate products leads to an unsustainable life style which generates

huge amounts of non biodegradable chemicals and other rubbish which has to be disposed
Chapter 3 Page 95

off and drains non-sustainable resources (e.g. oil and other minerals). Hence business has

to play an effective part in controlling, reducing and perhaps reversing the damage to the

environment by using different energy sources, using recyclable raw and packaging

materials, using pollution control equipment, promoting a greener employment and

consumer practices.

Accounting plays an important part in disguising the environmental impact of economic

activities because it only considers financially measurable economic events. Even for these

events, it fails to take into account disposal and winding down and contingent cleaning up

costs. For example, in the case of nuclear plants, substantial expenses are incurred in

shutting down old plants because of the cost of disposing radioactive materials safely. These

deferred costs are not accrued and hence earnings are higher than they should be. Further

social and health costs are passed on to the community and government because they are

termed externalities and are not costed by the conventional accounting system unless there

is a legal liability. Hence, the community bears the social and economic costs of

environmental degradation and not the corporation which caused it.

Maunder & Burritt (1991) argue that the conventional accounting principles of going concern

(entity) , accruals, consistency , prudence and monetary measurement lead to a mismatch

between accounting information and its application to ecological issues. The principles act

to ‘exacerbate or reinforce the primary factors (such as ideologically induced attitudes

towards the desirability of economic growth) responsible for the ecological crises’. For

example, the going concern concept excludes externalities (such as pollution emitted by the

organisation) from the measurement of the entity’s performance. The prudence (historical

cost convention) induces a backwards looking approach which is less appropriate to

examining future ecological effects such as species extinction as no amount of ex-post

analysis can make these effects reversible. The accrual concept leads to the slicing up of an

entity’s life. However, as Maunders and Burritt (1991) observes “many ecological impacts

exhibit lags compared with causal events (e.g. the influence of CFC’s on the ozone layer)”

(p.11). Thus, the environmental impact of an economic activity of one period may not be
Chapter 3 Page 96

discernible until many accounting periods in the future. In these circumstances, contingent

liabilities need to be disclosed in the notes to the accounts.

An instance in point is the case of the Love Canal (Tinker, 1985). Here, the company caused

pollution by dumping toxic wastes into the Love Canal, which were covered up with earth.

Later a housing development was undertaken on the same land. The residents later noted

serious health problems including miscarriages and premature deaths. The whole area

became uninhabitable, and the residents had to move to another area losing money on their

mortgages as well as suffering health problems.

The company polluting love canal did not disclose, even as contingent liabilities, the cost

incurred in the clean up and upheaval later. Tinker rightly asserts that there are broad

implications of these costs for calculating and reporting period profits. The matter of what

additional costs and when these costs should be reported are not clear. According to Tinker

(1985), the Generally Accepted Accounting Principles under-rate long-term costs and

excludes externalities with their focus on monetary values. Tinkers asks how one can

measure the social and emotional cost of miscarriages or premature deaths (or likewise, the

environmental cost of the extinction of a species) in monetary terms? He therefore

concludes that this understatement of the social costs of corporate behaviour by

conventional accounting makes the claims of objectivity and independence by accountants

spurious.

In some instances, corporations have also used accounting (i) to legitimate their existence

and (ii) to manipulate environmental pressures such as those of anti-pollution regulation and

environmental concerns of stakeholders. One such case is that of Falconbridge (Buhr,

1998). In this case, the Falconbridge Company’s smelting process resulted in sulphur fumes

which led to acid rain. In the early part of the Century, the heap roasting method which set

logs alight to burn for 3 – 4 months, destroyed vegetation (including crops) in the whole

locality converting the surrounding areas into a barren landscape as early as 1901. In 1930,

the company put up a smelter, which ended heap roasting, but it only served to diffuse the

fumes over a wider area. The mining companies were able to stave off anti-pollution
Chapter 3 Page 97

regulation until 1969, for almost 70 years. Initially, the economic rationality of reducing costs

was used to rationalise the measures to reduce sulphur emissions. Only after legislation was

imposed, did the company set up an Environmental Improvement Project which resulted in

an improvement to its bottom line as a result of technological development. There was

tension between profits on the one hand and pollution prevention on the other, during the

1970’s, when technology did not keep pace with regulation. The environmental disclosures

in the corporate reports were scarce in the early years, as there was nothing positive to

report. Buhr (1998) posits that, by focusing on economic concerns and not on the pollution

prevention efforts, the accounting reports were used to stave off further legislation by

showing how costly it was for the company to adhere to the anti-pollution legislation.

However, from 1980 to 1984, the disclosure of improvement in pollution prevention

technology (which had a positive impact on the bottom line) offered an image of an

environmentally friendly company. Later, public opinion had swung so far over to pollution

prevention, that the company openly discussed and emphasised government regulation in

its accounting reports.

As the above case shows, a company can use accounting to (i) legitimate their existence,

trying to change the environment in their favour or (ii) react to the environment when they

are unsuccessful in changing it. Accounts are never used to assess accountability in a

socially responsible way. This is despite the extent of the damage done in the above case,

which was described in the following words:

“It will take centuries to repair the effects of logging and smelting, which left
Sudbury’s landscape looking so much like the moon that the US space agency sent
its lunar astronauts here to train”.
(Bailey, 1991, as quoted by Buhr, 1998, p 163)

Despite this, the only considerations at play were technological or financial thus:

“What has motivated the process (reduction of sulphur emissions) are the
engineers who just want to make things work better and the financial people are
behind it because it is more profitable”.
(Endicott, 1991 as quoted by Buhr, 1998, p 186)
Chapter 3 Page 98

Lehman (1995), on the other hand, argues that a moral obligation exists to provide additional

environmental information in published accounting reports. In this way, corporations would

satisfy accountability relationships as part of an administrative solution to the environmental

crisis. He argues that “through this accountability nexus, accounting would take on the role

of constraining organisational activities, particularly those that may be considered

environmentally degrading” (p396). Thus the legitimate concern for fairness (Williams, 1987)

i.e. the moral aspect should establish the need for corporations to disclose environmental

data, not technology, profit and legitimation exercises.

Lehman bases his argument on Rawl's theory of Justice and Political Liberalism. This theory

draws on the sanctity of the individual which is decided by the inter-subjectively shared

group language of the new pluralism. Although this basis may not be acceptable from the

Islamic viewpoint, the researcher supports his call.

Gray (1992) envisages a similar change in thinking and life-style in his call for a “radical

reconsideration of current attitudes, structures, beliefs and modi operandi, ” [to] “reintroduce

protection and care for the environment” (p 399). He opines that even a pragmatic approach

to survival and sustainability of current human societies forces the realisation that the roots

of Modern (especially Western) society, based on short term human and economic self-

interest, are essentially incommensurable with their continued survival. He blames

conventional economic thought of dominating the conceptualisation, language and

explanation of the world, which influence attitudes and behaviour (negative) towards the

world. He rightly asks what one could expect from the economic decisions of the rational

economic man, devoid of the traits of “loyalty, compassion, altruism, sympathy and concern

for others” except dehumanising actions and consequences.

3.5 THE MICRO CONSEQUENCES OF CONVENTIONAL ACCOUNTING -

BEHAVIOURAL PROBLEMS.
Chapter 3 Page 99

The implementation of decision-making and control techniques such as budgeting, variance

accounting and performance measurements leads to certain motivations and behaviour

within the organisation. Although these techniques are rationalist-technical in character, the

social consequences can be both positive (e.g. Roberts & Scapens, 1985) or negative

(Argyris, 1953; Richardson et al., 1996). These techniques are meant to achieve goal

congruence between the employees and the organisation, for example, by enabling

individuals to take responsibility (as in responsibility accounting) for their actions and

rewarding or disciplining those who succeed or fail according to the accounting numbers.

When the goals of the organisations are based on utilitarian and marginalist economics, they

may not be compatible for Islamic organisations, which have socioeconomic goals and

values other than profit or wealth maximisation.

Although these accounting techniques on the surface seem to make individuals responsible

for the economic consequences of their actions and decisions, it seems that a rift has arisen

between accountability and accounting which results in negative human and social

consequences. What is worrying is that accounting has been employed as a calculative

practice, as part of a wider modern apparatus of power, is used to construct individuals into

more manageable and efficient ‘governable’ persons (Miller & O’Leary, 1997). Humphrey &

Olson (1995) also view the introduction of the management accounting techniques and

philosophy into the public sector (or its privatised equivalent) as a cause of concern

because the methods being introduced are simplistic caricature of private-sector practice.

According to them, the individualistic enterprise culture, grounded in market-based

philosophy, which accompanies the introduction of these techniques, may lead to overall

reduction in effectiveness and weaken commitments to service and collegial relations.

While these practices may be beneficial for the organisation in the short-term, they have

long term social implications both for the mental attitude and social behaviour of the

individuals affected by such systems. These include an increasing selfishness and conflict,

immoral behaviour, becoming more individualistic and materialistic, becoming susceptible to

manipulations by others, and personal and family problems. Nervous breakdowns and stress
Chapter 3 Page 100

may also arise. In the long run, the effect on the individuals is reflected in the organisation

which can become “schizoid” (Richardson et al., 1996) and progress into wider social conflict

(Lehman, 1992a).

The problems associated with conventional management accounting technique of budgeting

, performance measurement and the problem of control will now be reviewed briefly as

these problems of conventional accounting techniques have implications for Muslim

employee and organisational behaviour which may make these techniques inappropriate for

Muslim users and Islamic organisations.

3.5.1 Behavioural research: human problems of budgets

The human problems with budgeting have long been recognised. In 1952, Chris Argyris

(Argyris, 1953) found that that budgets were viewed as a “pressure” device to increase

production efficiency by raising workers’ goals and increasing motivation (to produce more).

He found that budgets being written, concrete, evaluatory instruments, they were used by

supervisors as “whipping posts” in order to release their feelings about other unrelated

problems. This led to resentfulness among low-level employees (supervisors and workers)

because of the management attitude towards them as a lazy lot out to cheat the company.

This in turn led to formation of groups to counter management pressure. Further budget

pressures led to inter-departmental strife, and tension and unhappiness among supervisors.

Subsequently, budget pressures introduced a fault-finding culture, which created tensions

between line and staff functions. Supervisors could also misuse the budget to express

leadership styles that ends in hurting other people. Argyris (1953) suggested a more

participatory budgeting system. However, although Argyris noted the “narrow-minded, figure

conscious nature of accountants” he failed to question the notion of efficiency itself as a valid

objective.

In a more recent article, Argyris (1990) asserts that the use of accounting controls results in

conflicts between those who use the claim of objectivity and rigorousness to defend

accounting and those who use accounting but disbelieve the claim. The discussion of the
Chapter 3 Page 101

conflict could lead the players to feel embarrassment or threat. Using budgets to compel,

force, search out mistakes can lead to activation of organisational “defensive routines” 2,

such as gaming, smoothing, filtering, biasing, focusing, and illegal acts, that by pass the

cause of the threat and cover up the by-pass.

Hughes (1965), notes another problem with budgeting, that of padding the budget. This is

particularly problematic if managers threaten sanctions for over-spending. If each level of

management punishes the next lower level for overspending, then each level will add

contingencies to its estimates, inflating the total budget.

While accounting control techniques results in accountants becoming coercive, fault-finding

and threatening, and creates tensions and pressures on line supervisors and workers, it

also leads to dysfunctional effects (violation of system rules and procedures) on other

departmental managers as well (Jaworski & Young, 1992). In a survey of 500 marketing

managers, they found that when the individual internalizes the goals, values and beliefs of

the organisation, his actions are more likely to correspond with the activities desired by the

firm. In turn, as person-role conflict decreases, job tension decreases with a consequent

reduction in dysfunctional behaviour. Conversely, the reverse is true.

3.5.2 Management Control and Performance Measurement

A management control system has been defined as :

“A system of organisational information seeking and gathering, accountability and

feedback designed to ensure that the enterprise adapts to changes in its
substantive environment and that the work behaviour of its employees is
measured by reference to a set of operational sub-goals (which conform with
overall objectives) so that the discrepancy between the two can be reconciled”.
(Lowe, 1971, as quoted by Otley, 1995, p 47)

The limitations of an ‘accounting’ approach to control systems are recognised by Otley

(1995). In criticising Anthony’s (1965) emphasis on accounting control systems, he observes

2
Gaming refers to an action, which will achieve the most favourable outcome regardless of the action that the
superior prefers For example, salesmen can increase volume to show good personal performance at the expense
of lower profitability or increasing bad debts. Smoothing occurs when subordinate utilises the information
system to his benefit by altering the natural or pre-planned flow of data without altering the actual activities of
an organisation e.g. transferring expenses and revenues from one period to another. Filtering information occurs
when subordinates report only the more desirable elements of a set that favourably reflect on themselves.
Chapter 3 Page 102

that “a useful Management Control System cannot confine itself solely to accounting

measures of performance. It should also take into account the non-financial and technical

measures of performance and those areas of performance that cannot be measured in

precise, quantitative terms. However, the example of such areas, he quotes i.e. market

share and competitive position, are still profit oriented measures.

The cybernetic or feedback control system is the most often used model for accounting

control (e.g. Berry et al., 1995). However the effectiveness of this cybernetic model has been

found lacking in effectiveness and attributed to failure and hence in need of revision (Dermer

& Lucas 1986). Dermer & Lucas (1986) assert that managerial control is an illusion, which

fosters the belief among managers that conventional controls such as operating standards,

profit targets, and budgetary criteria accurately and validly measure and determine

behaviour. Quoting Hofstede (1978), they assert that prior social conditions

implied by cybernetic models or the social consequences of such models have not received

the attention they deserve. There is a focus on the manager as the sole causal agent,

denigrating and the degree to which non-managerial agents really influence outcomes.

Thus, they wrongly assume that the unilateral exercise of power is control- irrespective of

the effects these changes may produce.

Neimark &Tinker (1986) observe that management control systems, until then, have been

heavily influenced by neo-classical economics and organisation theory, thereby ignoring the

social origins and the social consequence of corporate control systems. Using the Marxian

dialectical approach in a case study of the internationalisation of General Motors, show that

corporate control systems are not just the consequences of exogenously determined forces

but also agents of social change. This is effected through the chain of events, which are a

consequence of the corporations’ decisions to further their own self-interests. The

consequence of the control system does not only affect other corporations but also

ultimately affect the originating entities.

Illegal acts include falsification of information where existing information is intentionally altered or fed into an
information system.
Chapter 3 Page 103

Argyris (1990) holds that managerial accounting systems can be threatening because they

evaluate performance. Further, Townley (1996) asserts that individuals have been called to

account for their performance through the “process of examination and confession” which

serve as disciplinary practices and impacts on the construction of accountability within

organisations. Townley argues that the examination form of appraisal reflects a lack of trust,

which it seeks to circumvent through compulsory visibility. The confessional form of

appraisal is more discreet but the “power-knowledge dyad and the mechanism whereby

humans are objectivised are not absent.

From the above discussion, it can be seen that management accounting tools such as

budgeting, performance evaluation and variance accounting have negative individual and

social consequences. These consequences are also not acceptable from an Islamic

perspective. This calls for alternative Islamic accounting techniques to induce more

appropriate Islamic behaviour.

3.6 CONVENTIONAL ACCOUNTING CRITIQUE: AN ISLAMIC PERSPECTIVE.

From the discussions in Chapter 2, we can see that the worldviews and philosophical

assumptions of the West and Islam are different. This gives rise to different socioeconomic

objectives, different norms and different economic systems. The implications of these

differences for accounting were discussed very briefly. This chapter has thus far undertaken

a review of the critique of conventional accounting from various ‘Western’ perspectives. This

together with the discussion in Chapter 2 leads next to an Islamic perspective of the critique

of conventional accounting. This is carried out through the same themes used in this

chapter; objectives and fundamental assumptions, characteristics, macro and micro

consequences of accounting.

3.6.1 The Inappropriateness Of Conventional Accounting Objectives And

Fundamental Assumptions From An Islamic Perspective

3.6.1.1 The unsuitability of decision-usefulness accounting from an Islamic

perspective
Chapter 3 Page 104

From an Islamic viewpoint, the pleasure of God is the ultimate aim and ‘falah’ - success in

the world and the hereafter, - the ultimate objective. Hence, social and individual welfare and

quality of life is not merely measured in material terms but both spiritual and material. Islam

has comprehensive principles and elaborate rules in the economic, social and political

arena. Hence utilitarian social welfare is not the aim of Islam and therefore should not be the

aim of a Muslim society.

From the Qur’anic abhorrence of inequity and concentration of wealth among selected

groups of people, Muslim society would certainly not to seek to enrich only shareholders and

even less creditors (because interest is forbidden). Its imposition of the halal/haram

dichotomy in transactions is meant to ensure equitable investment and earnings. With the

imposition of Zakat, Sadaqah (charity) and Infaq (any benevolent spending approved by

the Shari’ah) as wealth redistribution measures, Islam seeks to have equitable distribution

of wealth to all members of society. Thus making money and unbridled consumption is not

the objective or even an important objective in Muslim life. Thus, the shareholder/creditor

orientation and hence the ‘decision-usefulness’ objective of conventional accounting may be

unacceptable from an Islamic viewpoint, considering the size, power and the social

consequences of business organisations of today.

From a perusal of the Qur’an, Hadith and the Sharia’h, the objectives of Islamic accounting

would seem to be the avoidance of doubts and (consequently disputes) between parties by

ensuring fairness accounting (Al-Qur’an 11:84-85, 6:152). Other objectives may seen to be

the equitable transfer and distribution of property rights and wealth (Al-Qur’an 4:29),

besides ensuring an equitable base for calculating Zakat.

“O You who believe!, when you contract a debt for a fixed period, write it down. Let
a scribe (accountant?) write it down in justice between you.....Let him who incur
the liability dictate...And get two witnesses out of your own men.....You should not
become weary to write it down whether it be big or small....that is more just with
Allah, more solid as evidence and more convenient to prevent doubts among
yourselves, save when it is a present trade which you carry on , on the spot among
yourselves, then there is no sin on you if do not write it down”.(Al-Qur’an, 2:282).
Chapter 3 Page 105

Although, the above verse apparently refers to writing of debt contracts, it would not be too

far fetched to extend it to accounting. For example, Littleton (1966) has mentioned that

amongst the other antecedents of modern accounting, credit and writing are two important

preconditions for the emergence of systematic bookkeeping under stewardship accounting.

Investors are almost akin to creditors, their capital is akin to a loan (a liability of the business

to its owners), which has to be paid back barring losses or with the addition of the agreed

share of profit.

The inherent accountability to God in all actions point to an accountability framework such as

that of Gray et al. (1996) but modified for an Islamic setting. This will be taken up in more

detail in Chapter 6.

3.6.1.2 Accounting objectives; an Islamic framework

Other than the framework of accountability, the following objectives of accounting may be

more suitable from an Islamic point of view.

(1) To provide a fair basis for the calculation of Zakat.

(2) To avoid disputes among members of society by providing a fair basis for the sharing of

profits, wealth transfers and the full disclosure of activities and values.

(3) To promote and ensure only Islamically permitted economic activities are carried out by

the business.

(4) To ensure the quest for profits by the business does not infringe society’s rights (e.g. for

a clean environment, fair employment practices, contribution to the well being of the

community etc.)

Many writers have called for the provision of a fair Zakat base to be the most important

objective of Islamic accounting (Adnan & Gaffikin, 1997; Gambling & Karim, 1991; Baydoun

& Willet, 1998). This may seem very strange to conventional accountants many of whom

make their living by giving advice on how to avoid tax! However, under an Islamic world-

view, the pleasure of God and accountability to Him is uppermost. “This accountability has to

be manifested in the form of how one can account for his or her Zakat obligations properly”
Chapter 3 Page 106

since Muslims cannot differentiate a worship activity from a non-worship activity (Adnan

&Gaffikin, 1997). The God fearing Muslim may be more unwilling to cheat on Zakat

(although he might cheat on tax!) because unlike tax, Zakat is a religious obligation for which

He has to account for, to Allah on the Day of Judgment.

Further, the assurance that Zakat has specific recipients defined in the Qur’an itself,

motivates one to pay more rather than less because the Zakat payer knows it will be mostly

used for the poor and the destitute rather than grandiose projects of governments.

However, there is a need for greater accountability and transparency through a more

suitable accounting system than the one practiced at present to avoid irregularities.

If Zakat is made the main objective of accounting, there is a possibility that window dressing

will be reduced while fraudulent disclosure and creative accounting which are ever present

in conventional accounting might disappear. The Muslim accountants and Muslim managers

may not undertake such ventures because they would be depriving the poor and destitute of

their rights if they were to undervalue the Zakat base. In conventional firms where the

objective of the firm might be to maximise profits, Islamic accounting may not be suitable.

However, in Islamic organisations and possibly Muslim organisations, the objective may be

different. An Islamic accounting may help to achieve the social objective of Islamic

organisations and Muslim society through a Zakat oriented Islamic accounting system.

3.6.1.3 Different environment and fundamental assumptions of Muslim society

and Islamic economic system.

Further as has already been noted above, the political and economic environments of many

Muslim countries are not developed exchange economies with developed capital markets.

Most Muslim countries are not democracies but dictatorships with very inequitable and

unequal distribution of wealth and income. Since Muslim countries went through a different

historical development, the ideas of ‘pristine liberal economic democracy’ is foreign to

Muslim countries. Because Gray et al. (1996) argue that the decision usefulness route to

social welfare (figure 3-1) makes sense only in a pristine liberal economic democratic

environment, the objectives and decision-usefulness framework may not be suitable for
Chapter 3 Page 107

Muslim countries. It is even more unsuitable for those Muslim countries, which are trying to

develop an Islamic society with an Islamic economic and financial system.

Muslim society normatively has different ethical value systems with corresponding economic

codes. Even if it is argued that Muslim countries are developing along the lines of the West

and conventional accounting will be useful for developing these countries in the Western

model, there are both practical and religious reasons why these countries should not adopt

such a development model (see for example, Ahmad, 1979). Despite the pressures of

globalisation intended to create Muslim societies in the “Pristine Liberal Economic

Democracy” (PLED) image, Islamic resurgence in Muslim countries has been in some ways

going in a different direction. Some of these trends are discussed in Chapter 4 and 5.

Decision usefulness based accounting can only lead to consequences, which are not the

main aim of these societies and in the case of Islamic, organisations trying to achieve

specific Islamic objectives, could be even positively harmful.

We have also seen in section 3.2.5 that according to Laughlin & Puxty (1981), decision

usefulness based accounting may be economically harmful to the organisation providing the

information, which may even result in social dislocation. This is not acceptable from an

Islamic viewpoint because an Islamic organisation is setup to achieve the socioeconomic

objectives of a Muslim society. This is especially true of Islamic banks, fund investment

institutions and government and relief organisations. Hence, information disclosure of

Islamic organisations should be related to its control and accountability to all its

stakeholders. Instead of their ‘inducement-contribution theory’, a ‘mutual-contribution’ theory

may be more relevant. Muslims may be prepared to trade-off some material inducements for

contribution towards their values. For example, El-Ashker (1987) in his study of Egyptian

Islamic companies showed that Muslims may take a lower return from their investments in

such companies to gain what he terms '‘religious utility’. Under this framework, both the

organisation and the stakeholders contribute to the betterment of the Muslim society within

the framework of its values.

Chapter 3 Page 108

3.6.2 Characteristics of conventional accounting

3.6.2.1 The unsuitability of the historical cost and the prudence concept.

From, an Islamic point of view, the reasons given by MacNeal (1970) for the unsuitability of

the conservatism and cost concepts are particularly relevant. Since Islam bans interest, the

cost and prudence concept, which arose in relation to interest- based banking and credit,

would not be applicable under an Islamic economic system. Further, the maintenance of

equity between current, past and potential shareholders is very important in Islam’s quest for

fairness accounting in line with its concept of justice. The assessment of Zakat needs to be

based on current value as otherwise, this would lead to appropriation of wealth from the poor

to the rich in times of rising prices and values. On the other hand, current valuations of items

such as goodwill and brands may overstate the value of corporate assets because they

depend on uncertain forecasts. This has led to over-valuation of shares in the past and

ended up defrauding outsiders. Hence, fairness of values (to the extent possible) is required

in Islamic accounting to ensure that no group is deprived of its rightful share of wealth.

3.6.2.2 The calculation of income from an Islamic perspective

Profit or income is especially important in Islam, more so than in conventional accounting for

the income is the only basis on which financiers get a return on the investment of their

capital. This is so because of the ban on interest in Islam, which prohibits a predetermined

fixed return on capital.

This rule has made conventional interest-based banking, which is an important modern

economic institution, illegal in Islamic society. However, the absence of interest does not

mean the cost of capital is zero in Islamic societies. What is illegal is the predetermined

fixed rate on capital, i.e. the return on money without sharing the corresponding risk of the

borrower. Islam allows and one can say even encourages profit and loss sharing

partnerships (both active and sleeping partnerships). Islam recognises the opportunity cost

and risk involved in deferred and installment sales, and allows the deferred price to be

higher than the cash price. It also allows operational leasing and renting. However, the strict
Chapter 3 Page 109

prohibition on interest means, the main ways a capitalist can participate in business is by

partnership, equity shareholding and commenda. All these three legitimate methods require

the computation of income and asset valuations for profit distribution. Further in

conventional accounting, the investor is considered more a lender of capital than a

participant in the business. Hence, the concentration on return is geared towards interest

cover.

The search for an alternative banking institution resulted in the creation of Islamic banks and

Insurance (takaful) companies in Muslim and Western countries which finance their

customers through these allowed methods (See Chapter 5 for more details). The creation of

these Islamic financial institutions has resulted in the mobilisation of funds from Muslims and

non-Muslims (Ali, 1994) which has been estimated at US$ 137 billions (IAIB, 1997). These

funds are mobilised either based on ‘al wadia’(safe custody) with return of deposit

guaranteed but no interest is paid. However, the bank can utilise the funds while in its

custody as long as the activities financed by the bank are not against the Shari’ah (e.g.

gambling, alcoholic drinks industry). Banks are allowed to pay a part of the profit they make

to deposit holders as a ‘gift’ to the depositors provided it is not computed as a percentage of

deposits or guaranteed in advance.

Since Islamic banks are not allowed to lend on interest, they adopt Islamic financing

techniques; although they use mostly murabaha (or cost plus pricing technique) financing,

they do practice musharaka (partnership) and mudharaba (commenda) which was the

original equity-based instruments suggested in the Islamic economics literature (Chapra,

1992).

A whole series of accounting problems have arisen due to the creation of the Islamic

financing institutions. These have resulted in the setting up of accounting standards for

Islamic banks by the Auditing and Accounting Organisation for Islamic Banks and Financial

Institutions (AAOIBFI) based in Bahrain.

For example, both musharakah and mudaraba transactions require income numbers for both

the determination and distribution of profit to deposit holders. Abdelgader (1990) found
Chapter 3 Page 110

several problems in his investigation of profit determination and distribution by Islamic banks

in Sudan. These include including relating return on deposits to investments maturity

periods, pooling of various funds and in ensuring fairness among different type of depositors.

The development of Islamic institutions in banking, business, government and voluntary

sectors and their requirement for a new form of accounting to achieve their objectives

demonstrates an added urgency to the development of an alternative Islamic accounting if

these institutions are not to be submerged in the capitalist economic culture. They constitute

the ‘pull factors’ for Islamic accounting which will be discussed in chapter 5.

Further, both wealth and profits are the base on which Zakat (Islamic tax) is assessed for

individuals and organisations. Hence, the continued use of a historic cost model may result

in negative wealth transfer effects. The valuation of stocks at the lower of cost and net

realisable value is certainly not acceptable from an Islamic perspective because it leads to

lower profits (in times of rising prices) and thus Zakat being undervalued. This leads to a

reduction of the rights of Zakat beneficiaries. The non-recognition of unrealised profit may

also cause timing effects on Zakat collection but more important inequitable wealth transfers

between present and future shareholders.

This problem is especially acute in the case of term participation certificates which do not

earn interest but instead are paid dividends based on profit during the period when the

certificates are current. The return to the investor depends on a proper valuation of opening

and closing assets and income during the period. If conventional accounting is used, it is

possible to deny the short-term investors their equitable return if a historical cost model is

used in a project, which has a long incubation period. Hence, a more viable income model

for Islamic accounting may be realisable income.

3.6.3 UnIslamic Consequences of Conventional Accounting

3.6.3.1 Privatisation
From an Islamic perspective, the seemingly inexorable privatisation programs are worrying.

According to Islamic principles, energy, water and pastureland (communally important

resources such as clean air and navigational arteries) should be publicly owned and not
Chapter 3 Page 111

subject to private ownership. Unfortunately, the privatisation trend is being repeated in

Muslim countries like Pakistan and Malaysia. In view of the fact that these countries

generally do not have transparent and accountable governments, the privatisation effects

are arguably worse because they redistribute wealth to cronies of politicians as well as

increase the cost of living for its citizens. In case of Malaysia, for example, privatisation of

sewerage services has resulted in consumers and businesses being charged on their water

usage and property valuation instead of their actual use of these services. This has resulted

in windfall profits for the sewerage Company (which is a monopoly). The establishments of

toll highways, which have taken over existing public highways and forced excessive charges

on the public for tens of years, have enslaved generations of taxpayers to the new

corporations. The lack of corresponding and effective watchdog agencies which are created

in the West is also worrying; when services are privatised , these bodies are either totally

absent or are small and ineffective ‘captured’ regulatory agencies which are the skeletons of

the government bodies which have been privatised. It is conventional accounting with its

rhetoric of efficiency, which provides both the “ammunition” and “rationalization” (Burchell et

al., 1980) and lends legitimation to these privatisation exercises.

3.6.3.2 Environmental problems: Islamic perspectives

From an Islamic perspective, the environment is a trust for which man is accountable to

Allah for its use. Islam does not take a deep green position nor concedes a license to kill any

species for the benefit of corporations. It views the sentient beings as creatures of Allah

along with the environment which are to be exploited for the benefit of human beings for

their food, shelter, clothing and other legitimate requirements. Islam views all creation in the

process of celestial praise of Allah and therefore destroying any creature is akin to

destroying this celestial praise. The Prophet (pbuh) forbade the plucking of leaves wantonly

due to this. For example, In Islamic eschatology, to avoid the punishment “of the grave”,

shrubs are planted on the graves of the dead; the plants praise and remembrance of God, is

supposed to deter any punishment descending from Allah on the deceased. In one of the
Chapter 3 Page 112

Prophet’s Hadith, it is stated that a prostitute who used her shoes to get water out of a well

to give to a thirsty dog was sent to heaven, whereas the ill treatment of a cat sent an

otherwise pious woman to hell. Another Hadith states that:

“There is no Muslim who plants a tree or sows a field and a human, bird or
animals eat from it, but it shall be reckoned as charity for him”.
(Mishkat al-Masabih, Vol.1, p115, as quoted by Akhtar, 1996)

Even in times of war, Muslims soldiers cannot follow a scorched earth policy. The first Caliph

of Islam after the Prophet instructed his General to strictly observe environmental values

even in enemy territory. He wrote “Do not cut down a tree, abuse a river, do not harm crops

and animals, and always be kind and humble to Allah’s creation , even to your enemies.”

This dictum is mostly born out in Muslim history (see for example Daniel, 1993).

Chapra (1992) bases the Islamic ethical foundations for the protection of the environment

under the principal of “No injury”. Since Muslims are prevented from harming others, the

environment has to be protected.

According to Akhtar (1996), the Islamic way of life and the Islamic State makes important

contributions in maintaining and promoting an “environmental balance”. These are based on

the Islamic worldview and the ethical values developed by an Islamic way of life based on

environmental consciousness; man as custodian and trustee of Allah’s resources. Further,

simplicity, which promotes a life-style, which is anti-consumerist and pro-environment,

avoids wastage and extravagance, and promotes a fellow feeling for all creatures of Allah.

Akhtar also notes that “the present ecological crisis is an outward manifestation of a crisis of

mind and spirit” (p58). Changing beliefs and traditions (from unIslamic to Islamic) is

important so that human beings live responsibly with the rest of creation.

Thus, the importance of environmental protection from an Islamic perspective can be seen

from the above discussion. Hence, an accounting system, which encourages, promotes or

justifies environmental degradation is clearly unacceptable from an Islamic viewpoint. Thus,

an alternative Islamic accounting system would have to identify, measure and disclose on

environmental protection and damage.

Chapter 3 Page 113

3.6.3.3 Micro behavioural consequences

While the protection of individual liberty or ‘class conflict’ may be the issue of most concern

to Western writers who are researching this issue, both the individual and social

consequences of accounting are important from an Islamic perspective. The substitution of

selfishness for caring, confrontation for co-operation, a short term ‘you only live once’

paradigm for a long-term spiritual dual world-view to is both socially and religiously

unacceptable from an Islamic viewpoint. The concern becomes more acute if these

individuals are charged with the altruistic Islamic mission of guiding Islamic organisations

which are specifically established to achieve Islamic socioeconomic objectives as outlined in

chapter 2 and 5. This will certainly lead to goal incongruence between Islamic organisations

and the Muslims or other employees who work for these organisations, the consequences of

which, are not only economic but social and moral. Islamic organisations will certainly be

unable to achieve their objectives while Muslim organisations will become the breeding

ground of un-Islamic misfits. Hence, while cheating, domination, manipulation and conflict

which may result from using conventional management and financial accounting tools is

unacceptable from any religious/ethical perspective, it is more so in the case of Islamic and

Muslim organisations who try to incorporate Islamic ideals into their financing, investment

and operating decisions.

3.7 CONCLUSION

From the above review of various accounting critiques, the problems of conventional

accounting can be summarised as follows:

• The objectives of conventional accounting based on decision usefulness may not be

acceptable from an Islamic point of view because it seeks to concentrate and

accumulate wealth to certain sections of society i.e. shareholders and creditors.

• Neither the assumptions of pristine liberal economic democracy nor the developed

exchange economy with a developed stock market is valid for many Muslim countries.
Chapter 3 Page 114

• The accounting principles on which conventional accounting reports are prepared may

be unsuitable for the direct and indirect equitable distribution of wealth and the

calculation of Zakat which is the one of the most important objective of Islamic

accounting.

• The problem with historic cost income models becomes more problematic in a Muslim

environment where profit is the main means of ascertaining divisible returns to finance

providers as interest is prohibited.

• The negative economic and social consequences of conventional accounting on the

environment, society and individuals are unacceptable from an Islamic point of view.

• Conventional management accounting systems may leads to behaviour which is

dysfunctional not only in terms of organisational goal achievement but in terms of the

moral and ethical consequences of individual and group Islamic behaviour.

The researcher has grouped these factors as the “push factors” for the development of an

Islamic accounting as these factors “push out” conventional accounting from being a suitable

reporting and measurement tool for Muslims and Islamic organisations. This is depicted in

figure 3-2 on the next page.

In chapters 4 and 5, the researcher shall review the pull factors; the theoretical and practical

factors underlying the need to develop an alternative Islamic accounting system. The

researcher hopes that the discussion in the next two chapters together with the discussion in

this will demonstrate the need for Islamic accounting.

Chapter 3 Page 115

FIGURE 3-2:THE NEED FOR ISLAMIC ACCOUNTING: PUSH FACTORS

CONSEQUENCES:
OBJECTIVES: CHARACTERISTICS
MEASUREMENT
DECISION-
VALUATION
USEFULNESS INCOME MODELS
PRINCIPLES/CONVENTIONS MACRO MICRO

• DIFFERENT ECONOMIC • HISTORICAL COST • MULTINATIONAL • FRAUD AND CHEATING

ENVIRONMENT • MONETARY MEASUREMENT EXPLOITATION • SELFISHNESS &

• WRONG ASSUMPTIONS • CONSERVATISM • INEQUITABLE WEALTH MATERIALISM

• DIFFERENT WELFARE • INCOME MODELS TRANSFERS • CONFLICT

CONCEPT • DISCLOSURES • LOSS OF WORK & PUBLIC • LOSS OF ULTIMATE

• DIFFERENT SOCIETY AND PROPERTY MISSION & WORLDVIEW

VALUES • ENVIRONMENTAL • MANIPULATION &

PROBLEMS HAGEMONEY

• UNISLAMIC EFFECTS

UNSUITABILITY OF CONVENTIONAL ACCOUNTING