Financial Reporting and Analysis

#### **Chapter 1**

## Financial Reporting and Analysis of Tesla Green Technology in the United States Market

*Nizar Mohammad Alsharari*

#### **Abstract**

This study aims to discuss and analyze the financial position and performance of the US Tesla green technology company in the United States. This study uses a case study approach, financial data, and website methodologies to collect and analyze the research data. The case study is Tesla, Inc., which is a US electric vehicle and clean energy company based in Austin, Texas. Tesla is a green technology company that produces and designs electric cars, battery energy storage from home to grid-scale, solar roof tiles and solar panels, and related products and services. Tesla is growing fastly by introducing new green products, and it is now one of the world's most valuable enterprises. It has a high market capitalization of almost US\$1 trillion to become the world's most valuable automaker. This study concludes that Tesla has changed their strategy to become the most worldwide sales of purely battery electric vehicles, capturing 23% of the market and 16% of the plug-in electric battery in the market for 2020. It has also developed a significant installer of photovoltaic systems through its subsidiary Tesla Energy in the United States. One of the largest global battery energy-storage systems suppliers is Tesla Energy, with 3.99 gigawatt-hours installed in 2021.

**Keywords:** financial reporting, financial analysis, tesla, manufacturing company, United States

#### **1. Introduction**

Global business has become more competitive than before. The technology and dynamic life increase the opportunities and risks for several firms. Accordingly, financial statements and financial analysis must be developed to assess the company's performance relative to its past performance or relative to its industrial competitors [1–6]. The financial statements are annual reports containing essential information about the firm, including income, cash flows, and current financial condition, illustrating the assets, liabilities, and owners' equity. However, if the financial information is not analyzed well, it will not help the company's success and management decision-making. In addition, a firm should be prepared for the uncertainties and opportunities in the future; therefore, the financial analysis can support oversight of the future business [3, 7, 8].

The financial analysis uses financial statements to evaluate the firm's overall performance, assess the equity securities, value opportunities, and risk, grow company earnings, and increase the cash flow. This study discusses financial statements, the difference and similarities between US GAAP and IFRS, financial data collection, research methodology, and analysis. In addition, a case study of one of the recent international companies, which is Tesla Motors, will be explained, and financial analysis and results will be applied to it [9, 10].

The used financial analysis method is financial ratios analysis. In this research, the profitability ratio, liquidity ratio, leverage ratio, and activity ratio will be applied to the financial statement of Tesla Motors. This study aims to evaluate the financial position of Tesla Motors through ratios and formulas to analyze the efficiency and business risk of the enterprise.

#### **2. Literature review**

#### **2.1 Financial statements overview**

A financial statement consists three main statements that provide essential details and information about the company's performance—income statements, balance sheets, and cash flow statements. The statements are analyzed annually using financial analysis techniques to continuously compare the firm effectiveness with previous years and compare it with the competitors from the same industry [11–13].

#### *2.1.1 Income statement*

The income statement is defined as the profit and loss statements representing the cost of sales, total operating expenses, net profit to the net sales over a certain period, and earnings per share. The cost of sales contains the cost of merchandise, production, materials purchase expenses, research and development costs, and total operating expenses, including administrative and distribution expenses. To increase the net profit of the firm, expenses must be decreased, and sales have to be increased. The return of investment, financial flexibility, operating capabilities, and risk are essential information gathered from the income statement. The firm's overall performance is measured by the return of investment, where the enterprise's ability to adapt to consequences and opportunities is defined as financial flexibility. Moreover, the ability to maintain operations at the desired level is considered the operating capability, and risk is defined as the uncertainty related to the firm's future. In summary, an Income statement supports the stakeholders and managers in evaluating the past performance, predicting future performance, and reducing the risk and uncertainty in achieving future cash flows [14].

#### *2.1.2 Balance sheet*

The balance sheet statement is referred to as the statement of financial position. The primary role of the balance sheet is to report the firm's assets, "economic resources," liabilities, "economic obligations," and equity over a particular period where total assets should be equal to total liabilities and equity "residual claims of owners." The assets are shown concerning its cash liquidity, and the liabilities are related to its maturity date. The balance sheet can be measured by several values based

#### *Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

on the relevance and reliability of desired attributes—a one-time cost, present cost, present market value, net realizable value, and the current value of future cash flows. At a specific balance sheet date, the current or present cost is the cash required to attain the asset, whereas the current market value is the amount of cash gained from selling the asset. In addition, the net realizable value is represented as the cash obtained from the sale of a future asset. The benefit of the balance sheet is to gather information and data about obligations, resources, and net resources equity. As well as it supports predicting the time, cost amounts, potential, and uncertainty of future cash flows [14].

#### *2.1.3 Statement of cash flow*

The cash flow statement is a classification of cash payments and cash receipts issued by financing, operating, and investing activities. Each firm prepares the cash flow statement annually and compares the current year with previous years to evaluate the overall performance and plan the organization's expenditures. The information and details provided by the cash flow statement report to stakeholders, lenders, and investors are cash that comes from or is used in operating and financing activities and the change of cash, whether increasing or decreasing in a particular period. In addition, the statement of cash flow support making economic decisions about the firm. The financing activities related to a firm are treasury stock, which describes the reacquisition of earlier issued shares, stock issuance, dividends payment to stakeholders, debt financing, and debt repayment. Investing activities contain fixed assets, debt sale or purchase, and equity securities of entities. Additionally, the operating activities are related to manufacturing companies and the sale of goods [14].

The above three statements can be prepared in accordance with two types of the conceptual framework, which are The International Financial Reporting Standards (IFRS), which is used the worldwide, and the United States Generally Accepted Accounting Principles (US GAAP), which was used in the US but recently it has been used by some firms in the UK and India. Both representations have similarities and differences in finance and account aspects. Some differences and similarities in financial aspects are illustrated in the table below (Similarities and Differences A comparison of IFRS, US GAAP, and UK GAAP\*, 2005) (see **Table 1**).

#### **2.2 Financial analysis techniques**

To evaluate firm performance, it is complimentary to analyze the presented data and compare it with historical data or/and other competitors from the same industry. Thus, the basis and elements of comparison must be clarified to ensure an entity's excellent performance and effectiveness. Analytical techniques can assess the firm's capabilities to generate and grow the cash flow and earnings. Additionally, it supports identifying the cash flow and earnings risks for current and future times.

For example, one of the main aspects of comparison is the firm profitability compared with other companies. In most cases, there will be differences between the companies in the firm size, presenting financial information or/and the currency of financial data. Therefore, comparing the firms based on the net income will provide the right and valuable results. An alternative methodology was created, a ratio analysis


#### **Table 1.**

*IFRS and US GAAP conceptual frameworks: Similarities and differences in financial statements preparation.*

technique that expresses one value concerning another value that enables more sufficient and accurate comparison and results. Furthermore, performing the standard size of financial statements eliminate the size factor, which provides improper results.

Regarding the issue of currency differences that appear from comparing international companies, an alternative method rather than using ratio analysis is using global exchange rates and unifying the currency in financial status at the end of a particular period. In addition to that, the enterprise compares its performance over time. Using the ratio analysis, which is horizontal financial statements that compare the current year to a based year and implement the results as a graph, shows the significant changes in the firm's effectiveness and performance [14].

The primary objectives of using ratio analysis are as follows:


Types of ratio Analysis:

1.**Profitability ratio.** It concentrates on the enterprise's effectiveness in using resources and operating processes to earn and increase income.

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*


#### **3. Case study: financial analysis of tesla motors**

#### **3.1 Automobile industry overview**

The automobile industry is the producer of electric, hybrid, and gasoline-powered vehicles and one of the largest industries that affect the economy and culture of the world. Moreover, it opened a broader market area for many businesses and commerce by using vehicles in transporting people and goods. Based on the worldwide statistics, the leading countries for the production of passenger cars in 2018 are represented in the figure below. The total global sales of passenger cars reached 62 million vehicles in 2018, and the United States produced around 2.8 million vehicles. Accordingly, the US is considered one of the largest automobile markets in production and sales.

The most produced and selling brands of vehicles in the US automobile industry are Ford, Volkswagen, Toyota, Hyundai, and Chevrolet. All mentioned models are fuel-based vehicles where a new generation of alternative energy resources was developed in the US to produce and sell hybrid and electric vehicles. One of the leading global producers of electric cars is Tesla Motors. This research discusses an overview of Tesla Motors, methodology, and analysis of Tesla's financial statements (see **Figure 1**) [16].

#### **3.2 Company background: tesla motors**

Tesla Motors is an international manufacturing automotive and energy company founded in 2003 and based in California, US. The company is founded by Martin Eberhard, Marc Tarpenning, Elon Musk, J. B. Straubel, and Ian Wright. The organization aims to establish a sustainable energy eco-system by creating affordable vehicles and building unique energy solutions like solar roofs, power walls, and power packs. Tesla's automotive and energy solution enables the consumers to manage the generation, consumption, and storage of renewable energy. Tesla Motors achieved a financial turnover of around 21.5 billion US dollars in the fiscal year of 2018 and 45,000 employees in 30 worldwide branches.

Due to the massive competition in the automotive industry, the global economy affecting the business, and the competitive prices, Tesla Motors added a unique value to its customers by alternating fuel-based vehicles with electric vehicles. Although Tesla avoids the risk of increasing the oil prices, technological and political environments significantly impact Tesla vehicle prices. Therefore, the financial and

**Figure 1.** *Leading countries for the production of cars in 2018 [15].*

non-financial performance of Tesla should be analyzed carefully to support in making critical decisions and to determine the future risk and potential of the company [17].

#### **4. Research methodology**

The historical financial information and data of Tesla Motors provide a better understanding of its financial position and cash flow forecast. Moreover, by comparing the annual financial reports, the created value of Tesla and performance relative to peers can be examined. The financial information contains annual reports of Tesla's income statement, balance sheet, and cash flow. Those financial details are authenticated and published by Tesla Motors company. In this research, the financial data duration will be analyzed, including the years from 2015 to 2018. A copy of detailed Tesla financial statements is attached in appendix A. Furthermore, the model used to evaluate Tesla's financial performance is described in (**Figure 2**).

The financial technique used in this research is the ratios analysis technique, which provides financial measurements and results to indicate the performance of Tesla Motors. The main four ratios for financial data analysis are liquidity ratios, assets management ratios, profitability ratios, and debt management ratios (Appendix B). Each ratio contains various formulas that describe an essential principle of finance and account, represented in the table below (see **Table 2**).

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

**Figure 2.** *The research methodology.*


**Table 2.**

*Financial ratios analysis.*

#### **5. Financial analysis and results**

#### **5.1 Liquidity ratios**

The liquidity ratio indicates the strong ability to use its asset to cover its short-term debts. The three liquidity ratios used in this research are current ratio, quick ratio, acid test, and cash ratio.

#### *5.1.1 Current ratio*

The current ratio formula is performed by dividing the current assets by the current liabilities for the same year. The current asset consists of cash and cash equivalents, restricted cash, net accounts receivable, inventory, prepaid expenses, and other current assets, where current liability includes Accounts payable, accrued liabilities, deferred revenue, resale value guarantee, customer deposits, current portion of long-term debt and capital leases (see **Table 3** and **Figure 3**).

**Analysis**: As observed from the above table and graph, the current ratio exceeded only in 2016, when the firm used its assets correctly and paid the creditor back. On the other hand, for 2017 and 2018, the current ratio decreased, indicating that the firm could not meet its short-term obligations. The liquidity position of General Motors has been reducing negatively for the past two years. Accordingly, the firm can increase its current liabilities compared to its current assets by increasing inventory sales, resulting in increasing the cash. Moreover, the average current ratio of the automobile industry is 1.01 for 2018, which means that General Motors is less than the average current ratio of 17.69%.

#### *Banking and Accounting Issues*


**Table 3.**

*Current ratio analysis.*

#### *5.1.2 Acid test ratio*

The acid test or quick ratio is calculated by eliminating the inventories from current assets and dividing them by current liabilities (see **Table 4** and **Figure 4**).

**Analysis:** it is obtained that General Motors has poor liquidity since its liquid assets are low and cannot pay off and cover its entire current liability.


#### **Table 4.**

*Acid test ratio.*

**Figure 4.** *Acid test ratio graph.*

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

#### *5.1.3 Cash ratio*

A cash ratio is a type of measurement, which evaluates the strong ability to cover its current liability by only its cash and cash equivalent (see **Table 5** and **Figure 5**).

**Analysis:** Although the cash and cash equivalent increased from the year 2015 to 2018 except between 2016 and 2017, there was a slight reduction, but the company failed to cover its liabilities. Thus, it should increase its investments to increase its cash and cover the current liabilities.


#### **Table 5.**

*Cash ratio.*

**Figure 5.** *Cash ratio graph.*

#### **5.2 Asset management ratios**

The most important financial ratios for the manufacturing company are asset management because it effectively measures the enterprise usage and control of its assets. It consists many ratios, but in this research, the accounts receivable turnover, inventory turnover, accounts Payable turnover, and total asset turnover will be implemented on General Motors' financial statements.

#### *5.2.1 Accounts receivable turnover ratio*

The accounts receivable turnover measures the number of cash collection times during a particular period, and it is calculated by dividing the sales by the average account receivable (see **Table 6** and **Figure 6**).


**Table 6.** *Accounts receivable turnover ratio.*

**Figure 6.** *Accounts receivable turnover ratio graph.*

**Analysis:** Based on collected data, the accounts receivable turnover ratio decreased at the end of 2016 and increased in 2017 and 2018. The graph indicates that Tesla Motors is doing well in collecting its cash annually.

#### *5.2.2 Inventory turnover ratio*

This ratio is calculated several times inventories are sold and restocked yearly. All manufacturers have Inventories to keep unsold stocks which cost them significant value until the materials are sold out. It is measured by dividing the cost of goods sold over the average inventories (see **Table 7** and **Figure 7**).

**Analysis:** The inventory turnover ratio indicates that Tesla Motors has improved over four years, wherein in 2018, the firm renewed its total inventory about 6.48 times a year.


#### **Table 7.**

*Inventory turnover ratio.*

**Figure 7.** *Inventory turnover ratio graph.*

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

#### *5.2.3 Accounts payable turnover ratio*

Since raw materials are considered the main expenses of manufacturing firms, the accounts payable turnover measures the speed of paying the purchasing of raw materials or inventories on the account. The account payable turnover is calculated by dividing the purchases over average accounts payable. The below formula calculates the value of the purchase (see **Table 8** and **Figure 8**).


#### **Table 8.**

*Accounts payable turnover ratio.*

#### **Figure 8.**

*Accounts payable turnover ratio graph.*

Purchases = Cost of goods sold + [(Ending inventory) – (Beginning inventory)]. **Analysis:** It has been observed that Tesla Motors can pay its purchases on time 5.366 times in 2018, which is improved compared to previous years.

#### **5.3 Profitability ratios**

The company's overall efficiency and performance are evaluated by the profitability ratio, where it concentrates on measuring the assets and controlling the expenses to generate a reasonable rate of return. In addition, it analyses the firm current operational performance compared to previous years. The net profit margin, gross profit margin ratio, and operating profit margin ratio will be performed on the financial statements of Tesla Motors.

#### *5.3.1 Net profit margin*

The net profit margin is calculated by dividing the net profit after tax over the net sales. For any automotive company, the higher the net profit margin, the better the performance (see **Table 9** and **Figure 9**).


#### **Table 9.**

*Net profit margin.*

#### **Figure 9.**

*Net profit margin graph.*

**Analysis:** As observed from previous data, the net profit margin significantly decreased in 2018 compared to previous years, where the most profitable year is 2015 and the second most profitable year is 2017.

#### *5.3.2 Gross profit margin ratio*

A gross profit margin serves as the source of paying additional expenses and savings for the future to assess financial health. The gross profit margin ratio is calculated by dividing the gross profit over sales (see **Table 10** and **Figure 10**).


#### **Table 10.**

*Gross profit margin ratio.*

**Figure 10.** *Gross profit margin ratio graph.*

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

**Analysis:** From 2015 to 2018, the gross profit margins are positive, which indicates that the firm is profitable.

#### *5.3.3 Operating profit margin ratio*

This ratio is calculated by dividing the operating profits over sales (see **Table 11** and **Figure 11**).

**Analysis:** The operating margin of Tesla Motors is dramatically decreased in 2018 compared to previous years, which indicates that the firm is earning less per dollar of sales. The low operating profit margin is due to high fixed production costs or high sales volume.


#### **Table 11.**

*Operating profit margin ratio.*

**Figure 11.** *Operating profit margin ratio figure.*

#### **5.4 Debt management ratios**

The degree of safety afforded to creditors is financial leverage or debt financing. There are two methods to obtain the enterprise debt by determining the borrowed funds used to finance assets on the balance sheet. The other is by obtaining the fixed charges covered by the operating profits in the income statement.

#### *5.4.1 Debt ratio*

The debt ratio is calculated by dividing total debt over total assets, where total debt contains current liabilities and long-term debt (see **Table 12** and **Figure 12**).

**Analysis:** The debt ratio is less than one, which indicates that a higher amount of the firm's assets is financed by its equity, not by its liability.

#### *Banking and Accounting Issues*


**Table 12.**

*Debt ratio.*

**Figure 12.** *Debt ratio graph.*

#### *5.4.2 Time interest earned ratio*

The time interest earned is measured by dividing the earnings "EBIT" before interest tax by the interest charged. The ratio indicates the enterprise's ability to meet the interest payment (see **Table 13** and **Figure 13**).

**Analysis:** As observed, the company can pay for the interest. The higher the ratio is, the better since it indicates that the firm covers the interest from its earnings.


#### **Table 13.**

*Time interest earned ratio.*

**Figure 13.** *Time interest earned graph.*

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

#### **6. The conclusions**

An overview of financial statements, financial presentation methods, and financial analysis was discussed. A real-life case study on Tesla Motors was implemented to perform the financial analysis and concluded the results of its financial statements and analyses to evaluate its performance.

This study concludes that Tesla Motors continuously suffers from losses. Tesla Motors has a high value of assets since they concentrate on adding value to the customers and inventing unique electric vehicles. In addition, the automobile industry is too competitive where vehicle manufacturers compete to drive the attention of various stakeholders in the market. Furthermore, the new idea of shifting from fuelbased vehicles to electric-based vehicles needs significant duration to convince stakeholders to purchase the developed electric cars. However, this research proves that Tesla Motors made low gross profits where it decreased from 21.642% in 2015 to 4.682% in 2018. The decrement is due to high maintenance costs, research and development cost, selling expenses, and administrative expenses. Furthermore, the interest percentage is too high where Tesla Motors is accumulating the losses, which leads to increasing the interest expenses of the current year. The financial ratios support Tesla Motors to highlight the current firm position and provide the potential threats and opportunities in the future.

This study concludes that Tesla has changed their strategy to become the most worldwide sales of purely battery electric vehicles, capturing 23% of the market and 16% of the plug-in electric battery in the market for 2020. It has also developed a significant installer of photovoltaic systems through its subsidiary Tesla Energy in the United States. One of the largest global battery energy-storage systems suppliers is Tesla Energy, with 3.99 gigawatt-hours (GWh) installed in 2021.

This study also concludes that Tesla has changed its production strategy over time. It started to produce its first car model, the Roadster sports car, in 2009, which was followed by the Model S sedan in 2012, the Model X SUV in 2015, the Model 3 sedan in 2017, and the Model Y crossover in 2020. However, the Model 3 is the best-selling plug-in electric car in the global market, and, in the mid of 2021, it became the first electric car sale with 1 million units globally. The sale strategy thus has been developed. The global sales of Tesla increased to 936,222 cars in 2021, with an 87% increase over the previous year, and cumulative sales for all years totaled 2.3 million cars at the end of 2021. By the end of 2021, The market capitalization of Tesla reached \$1 trillion to hold the rank 6 in US market history.

### **Appendix A**

#### • The year 2017–2018




#### • The year 2017–2016



#### • The year 2016–2015



*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

#### **Appendix B**




*Banking and Accounting Issues*

### **Author details**

Nizar Mohammad Alsharari Department of Accounting, Finance, and Entrepreneurship, Jackson State University, College of Business, United States

\*Address all correspondence to: nizaralsharari@gmail.com

© 2022 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

*Financial Reporting and Analysis of Tesla Green Technology in the United States Market DOI: http://dx.doi.org/10.5772/intechopen.105065*

### **References**

[1] Alsharari NM. Management accounting and organizational change: Alternative perspectives. International Journal of Organizational Analysis. 2019a (Accepted Manuscript)

[2] Alsharari NM. A comparative analysis of taxation and revenue trends in the Middle East and North Africa (MENA) region. Pacific Accounting Review. 2019b (just-accepted)

[3] Alsharari NM. Accounting changes and beyond budgeting principles (BBP) in the public sector. International Journal of Public Sector Management. 2019c (just-accepted)

[4] Alsharari NM. Internationalization market and higher education field: Institutional perspectives. International Journal of Educational Management. 2019d (just-accepted)

[5] Alsharari NM. Institutional change of cloud ERP implementation in the public sector. International Journal of Disruptive Innovation in Government. 2021

[6] Alsharari NM, Al-Shboul M, Alteneiji S. Implementation of cloud ERP in the SME: Evidence from UAE. Journal of Small Business and Enterprise Development. 2020

[7] Alsharari NM. Results based costing (RBC) system: Questioning the unit of analysis in ABC. Corporate Ownership and Control. 2016a;**13**(2):587-603

[8] Alsharari NM. The diffusion of accounting innovations in the new public sector as influenced by IMF reforms: Actor-network theory. International Journal of Actor-Network Theory and Technological Innovation (IJANTTI). 2016b;**8**(4):26-51

[9] Alsharari NM. The development of accounting education and practice in an environment of socio-economic transformation in the Middle East: The case of Jordan. International Journal of Educational Management. 2017a;**31**(6): 736-751

[10] Alsharari NM. Institutional logics and ERP implementation in public sector agency. The Journal of Developing Areas. 2017b;**51**(2):417-425

[11] Alsharari, N. M. Management accounting relevance: Practice, variance and current research agenda. UOS Journal for Humanities and Social Sciences, University of Sharjah. 2016

[12] Alsharari NM. Internationalization of the higher education system: An interpretive analysis. International Journal of Educational Management. 2018a;**32**(3):359-381

[13] Alsharari NM. Multilevel institutional analysis of accounting change in public management. International Journal of Organizational Analysis. 2018b;**26**(1):91-106

[14] White G, Sondhi A, Fried D. The Analysis and Use of Financial Statements. Hoboken, NJ: Wiley; 2003

[15] Rejeb A. Financial Analysis of Automotive Industry: Evidence from General Motors and Honda Motor, LTD. 2015

[16] Statista. (2019). Passenger Car Production by Country 2018 | Statista. [online] Available at: https://www.sta tista.com/statistics/226032/light-vehic le-producing-countries/ [Accessed August 25, 2019].

[17] Sehested P. Valuation of Tesla Motors Inc. Master Thesis. Copenhagen Business School; 2014

Section 2

## Islamic Accounting and Islamic Banking

### **Chapter 2**

## The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases)

*Lucky Nugroho*

#### **Abstract**

This chapter aims to explain the implementation of accounting in Islamic banks industries. Moreover, the research question will include the following: (i) What are the principles of Islamic banking? (ii) How is the implementation of Islamic accounting in Islamic banks? (iii) What is meant by Islamic ethical principles? (iv) What is meant by Islamic financial transactions? (v) What is meant by Islamic financial statements?. Furthermore, based on the formulation of the problem, this chapter aims to understand the implementation of understanding the accounting process for Islamic banking institutions according to Islamic Accounting Standards. In addition, the implication of this chapter is to provide a scientific repertoire in the field of Islamic accounting, especially related to the Islamic banking industry.

**Keywords:** Islamic bank, accounting, Islamic accounting, Islamic principles, Islamic financial transactions

#### **1. Introduction**

The historical background of establishing Islamic banks in various countries has differences in the year of establishment and the motivation for establishing Islamic banks in these countries. Moreover, the background and motivation for the establishment of Islamic banks in several countries are as follows:


Bank is to mobilize funds from the public in Egypt by applying Islamic principles to provide customers with a halal income. The objectives of establishing the Mith-Ghamr Islamic savings bank are as follows: (i) as an institution that mobilizes funds in rural Egyptian communities so that people who have excess funds can be appropriately allocated to people who need capital; (ii) as an educational center to manage the finances of the Egyptian people so that people have the habit of saving and saving to improve their welfare; (iii) helping to mobilize idle funds in Egyptian rural communities so that idle funds in the community can be used as capital for productive activities. The development of this bank was quite successful and was accepted by the people in Egypt. However, after the Mith-Ghamr Islamic Savings Bank developed quite widely in the community for approximately 3 years, this bank was closed in 1967 by the government due to political reasons [3, 4].


Referring to the statement from [9, 10], the economic and financial crises that occurred in the world were caused by greed from humans, so they took action that maximizes profits without paying attention to environmental sustainability, social problems, and the next generation. Furthermore, the country's economic growth also depends on the financial sector, which functions to drive the real sector in the form

#### *The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases) DOI: http://dx.doi.org/10.5772/intechopen.103140*

of business activities such as production, processing, manufacturing, and so on that contribute directly to the economy as the locomotive of the financial sector in the banking industry [11, 12]. Therefore, if the banking industry experiences a shock or disturbance, it will impact the economic crisis. For example, this happened in the period 2007–2008 where banks in America failed to distribute housing loan products, which resulted in the bankruptcy of several of these financial institutions [13, 14]. The impact of the shock on the financial sector impacts is increasing unemployment and increasing inflation, which leads to a crisis in the country [15, 16]. Therefore, according to better function of the financial sector, one of which is the banking industry as the locomotive of the financial sector, it will have implications for economic growth, which will also get better [17, 18].

In addition, according to [19, 20], the development of the number of Islamic financial institutions in the Middle East and Indonesia is as follows:

Based on **Table 1**, it is known that the number of Islamic financial institutions in Middle Eastern countries is 248. However, the number of Islamic banks is 52, and Islamic window banking is 32. Therefore, there is a potential for 84 Islamic bank financial institutions that will use Islamic banking accounting in Middle Eastern countries. In addition, according to **Table 2**, there are also 34 Islamic banks and 168 Islamic rural banks in Indonesia, so there is a potential for 202 Islamic banking financial institutions to use Islamic banking accounting. Thus the existence of Islamic accounting for banking institutions becomes a necessity.

Therefore, based on the phenomenon of the existence of Islamic banks and the urgency of the existence of Islamic banks to improve welfare for the community, it is necessary to apply an Islamic accounting system to record, acknowledge, and disclose


#### **Table 1.**

*Islamic financial institution development in Middle East countries.*


#### **Table 2.**

*Islamic financial institution development in Indonesia.*

transactions based on Islamic principles. Thus, the formulation of the problems that will be discussed in this chapter of this book includes the following:


Furthermore, based on the formulation of the problem, this chapter aims to understand the accounting process for Islamic banking institutions under Islamic Accounting Standards. In addition, the implication of this chapter is to provide scientific references in the field of Islamic accounting, especially related to the Islamic banking industry.

#### **2. Discussion**

Furthermore, before we discuss what Islamic accounting means, we must understand the concept of Islamic finance. The theory presented by a () states that the company's activities running its business must understand that it must be based on the Tawhid String Relationship (TSR). Where TSR is a theory that states that all human activities, including earning a living, must be based on the Qur'an and Hadith, and other Islamic laws; however, according to [19, 20], the application of Islamic laws must also be accompanied by knowledge, so that science in Islam has an important role, therefore, in maqasid sharia (sharia goals) reason must be maintained. Sharia maqasid, according to [21–23] includes the following: *hifdz al-din* (religion protection), *hifdz al-nafs* (protection of the soul), *hifdz al-'aql* (protection of the intellect), *hifdz al-nasl* (hereditary/family protection), and *hifdz al-maal* (property ownership protection). Furthermore, the sharia maqasid is implemented in daily human life in meeting basic needs (daruriyyat), secondary needs (hajiyyat), and tertiary needs (tahsiniyyat). Thus, Islamic banking as a bank that applies sharia principles should apply Islamic accounting in every transaction.

#### **2.1 Islamic accounting**

The Islamic banking industry in the world has such rapid growth that an accounting system following Islamic principles must support it. According to [24], the definition of Islamic accounting based on etymology (origin of the word) comes from the Arabic language, namely *Muhasabah* (*mashdar hassaba-yuhasibu*), which means to count, measure, or add up based on Islamic principles. In addition, according to [25], *Muhasabah* is closely related to *Hisab* where *Hisab* is one of the processes of calculating charity during human life in the world by Allah. Therefore, for every action and activity in *muamalah* (human social activity), such as trade transactions, then every Muslim must always be in a state of trust, honesty and have a high commitment to keep his promises. The development of the word *Hisab* in Arabic refers to the word *Al-Hisbah*. This public institution has existed in Islamic society since the beginning of the Islamic period until the period of Western occupation that conducts inspections

#### *The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases) DOI: http://dx.doi.org/10.5772/intechopen.103140*

of trade activities. The person conducting the inspection is called the *Muhtasib*, whose function is to carry out the following tasks:


Furthermore, referring to the definition of Islamic accounting, according to [26], the purpose of Islamic accounting is to provide benefits for humanity. This is because the legal basis for implementing Islamic accounting comes from the Qur'an and Hadith, as well as other sources of Islamic law such as *Ijma*, *Qiyas*, and *Ijtihad*. Some references to verses of the Qur'an that make the legal basis of Islamic accounting are as follows:

• Al Baqarah verse 282, which means:

*O you who have believed, when you contract (i.e. when you have or contract a debt) a debt one upon another for a stated term, then write it down. And let a writer write it down between you with justice, and let not any writer refuse to write it down, as Allah has taught him. So let him write and let the one upon whom is the truthful duty of payment (i.e. the debtor) dictate, and let him be pious to Allah his Lord and not depreciate anything therein. So, in case the one upon whom is the truthful duty is foolish, or weak, or unable to dictate himself, then let his patron dictate with justice. And call in to witness two witnesses of your men; yet, in case the two are not two men, then one man and two women from among the witnesses you are satisfied with, so that (in case) one of the two women should err, then either of the two should remind the other, and let the witnesses not refuse whenever they are called (upon). And be not too loath to write it down, (whether) it is small or great, with (Literally: to is term) its term. That is more equitable in the Providence of Allah, and more upright for testimony, and likelier that you will not be suspicious. Except (when) it is commerce present that you transact among yourselves, then it shall be no fault in you if you do not write it down. And take witnesses when you sell one to another, and let not either writer or witness be harmed, and in case you perform (that), then that is evident immorality in you. And be pious to Allah, and Allah teaches you; and Allah is Ever-Knowing of everything.*

Therefore, related to the verse above, Muslims have instructions to record or write related to debt and receivable transactions. Furthermore, if the parties making the debts and receivables cannot record, they can use a third party to be a witness to carry out the transaction reasonably. Thus, if interpreted from the perspective of Islamic

#### *Banking and Accounting Issues*

accounting, the implementation of Islamic accounting must be based on the principles of justice.

#### **2.2 Islamic ethical principles**

According to [27–29], Muslim activities must refer to the concept of the Tawhid String Relationship (TSR), where all activities and activities in the lives of Muslims must follow and obey the sources of Islamic law, namely Al-Qur'an, hadith, and other legal sources that apply. Therefore, referring to the legal basis of Islamic accounting, namely QS, Al Baqarah verse 282, then there are important things that include:


The implementation of Islamic accounting must be under the objectives and based on Islamic laws (shari'ah). Therefore, the application or implementation of Islamic accounting must meet the principles of Islamic ethics, which include:

1.Accountability, the essence of accountability, is related to trust, where trust is a responsibility in human transactions with Allah SWT. The purpose of humans being created on this earth is as a caliph where later they will be held account*The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases) DOI: http://dx.doi.org/10.5772/intechopen.103140*

able. Therefore, if implemented in accounting, it can be realized in accounting reporting;


#### **2.3 Islamic financial transactions**

The transaction is an activity carried out by someone that causes changes to the assets or finances owned, whether it is increased or decreased—for example, selling property, buying goods, paying debts, and paying the various expenses to meet the

necessities of life [30, 31]. In the transaction, there is transaction administration. As for what is meant by the administration here, it is an activity to record changes in the finances of a person or organization, which is carried out carefully and using specific methods. Whereas in an economic system based on Islamic principles, transactions must always be based on the rules of Islamic law (shari'ah), because transactions are a manifestation of human charity that has the value of worship before Allah SWT, so that in Islamic accounting transactions can be grouped into two: (i) halal transactions; (ii) illegal transactions (*haram*) [31].

Furthermore, the transaction involves a contract (*akad*). *Akad* is a written agreement between the parties that contains the rights and obligations of each party, the agreed terms, and conditions under the provisions of shari'ah and applicable law. Furthermore, when viewed from a language perspective, the pronunciation of the contract comes from the Arabic pronunciation of al-acid, which means the engagement, agreement, or consensus all-ittifaq. In fiqh terminology, the contract is defined as the ties of *ijab* (statement by making a bond) and qabul (statement of accepting a bond) by the will of the Shari'ah, which affects the object of the engagement. So, the contract is an engagement, an agreement marked by a statement of binding (*ijab*), and a statement of accepting a bond (qabul) following Islamic shari'ah, which affects the object that the engagement factor binds. From this understanding, in the contract, at least two parties will carry out the engagement, then the object of the engagement and accompanied by consent and qabul for the implementation of the engagement.

In the Islamic economic system, contracts are generally divided into the *tabarru'* contract and the *tijarah* contract. *Tabarru's* contract is an agreement/contract that does not seek material gain. So, it is pure virtue and only hopes for a reward from Allah SWT, while the tijarah contract is an agreement/contract whose purpose is to seek business profits. The following is an explanation of the two types of contracts. In essence, the *tabarru'* contract is a contract of doing good that expects a reply from Allah SWT alone. That is why this contract is not intended to seek commercial gain. The logical consequence is that if the *tabarru'* contract is carried out by taking commercial profits, it is no longer a tabarru' contract. Instead, it will be a tijarah contract. If he wants to remain a tabarru' contract, he may not take advantage (commercial profits) from the tabarru' contract. Of course, he is not obliged to bear the costs of implementing the *tabarru'* contract. That is, he may ask for a replacement for the costs incurred in carrying out the *tabarru'* contract. Furthermore, the difference between tabarru' and tijarah contracts is shown in **Table 3** below:


### **Table 3.**

*Difference between Tabaru' and Tijarah.*

*The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases) DOI: http://dx.doi.org/10.5772/intechopen.103140*

#### **Figure 1.**

*The contracts on Islamic bank. Sumber: [11].*

Therefore, transactions in Islamic banks must be based on contracts that are tailored to the needs and objectives, as shown in **Figure 1** as follows:

Referring to **Figure 1** above, Islamic banks have different contracts tailored to each transaction's purpose. Therefore, the products at Islamic banks are divided into 3 (three), namely (i) funding, (ii) financing, and (iii) services. Funding contracts (giro, savings, and time deposits) are divided into:


Financing products are divided into 2 (two) principles, namely buying and selling, which generate margin and cooperation based on the principle of profit sharing. The distribution of sale and purchase financing contracts at Islamic banks includes:


Meanwhile, the financing contract based on the principle of cooperation includes:

• Mudharabah is a cooperation agreement in which the bank owns capital. The customer is the owner of the skills or expertise, divided based on the agreed ratio. • Musyarakah is a cooperation agreement in which the bank participates in part of the capital so that both parties, both the bank and the customer, contribute funds or capital.

Furthermore, other contracts at Islamic banks include:


#### **2.4 Islamic bank financial statements**

Furthermore, Islamic financial reports consist of financial statements for commercial activities and financial reports for social activities consisting of:

	- a.Report on the source and use of zakat funds;

b.Report on sources and uses of social funds.

In addition, financial reports have two functions, namely as a recording tool and as a tool for analyzing. Therefore, in principle, the financial statements are the same for small and giant businesses. The only difference is the nominal in it and the number of activities or activities covered by the entity. Users need financial reports at any time because financial statements can provide information regarding the following matters:


Islamic banks are financial institutions with an intermediary function in the community, collecting and distributing them back to the community following Islamic principles. Referring to **Figure 1** above, the sources of funds from Islamic banks consist of:


*The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases) DOI: http://dx.doi.org/10.5772/intechopen.103140*


Furthermore, the sources of funds are channeled by Islamic banks with the following financing contracts:


The results of the distribution of financing to the community generate income, which includes:


In addition, the financial statements of Islamic banks that are prepared and responsible for the management have a purpose for the users and stakeholders of Islamic banks. In more detail, the objectives of the Islamic bank financial statements include the following:


Furthermore, the components of the financial statements of Islamic banks that differentiate them from conventional banks include:


### **3. Conclusions**

The development of Islamic banking financial institutions in the world is a necessity. Therefore, there is great potential for using Islamic accounting in these institutions. Furthermore, based on this, in the implementation of Islamic accounting in banking, several things need to be considered, which include::


### **Author details**

Lucky Nugroho Mercu Buana University, Jakarta, Indonesia

\*Address all correspondence to: lucky.nugroho@mercubuana.ac.id

© 2022 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

*The Concept of Accounting in Islamic Bank (Indonesia Empirical Cases) DOI: http://dx.doi.org/10.5772/intechopen.103140*

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#### **Chapter 3**

## Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development

*Mahfud Sholihin and Dian Andari*

#### **Abstract**

Islamic banks (IBs) have distinctive characteristics compared with the conventional ones. IBs only perform permissible (*halal*) financial transactions viewed from Islamic perspective and avoid usury (*riba*) and overspeculation (*gharar*). Consequently, IBs require special accounting to accommodate their nature. In terms of accounting, Indonesia is unique, as it has two accounting (for business organizations) standard setters: Financial Accounting Standard Board (*Dewan Standar Akuntansi Keuangan*-DSAK) and Sharia Financial Accounting Standard Board (*Dewan Standar Akuntansi Keuangan Syariah*-DSAS). This chapter discusses the development of IBs in Indonesia, a country with majority of its citizens being Muslim. Further, it explains the development of Islamic Financial Accounting Standards (IFAS) including how the standards are developed (the due processes). Finally, this chapter describes whether Islamic financial accounting standards developed in Indonesia has sufficiently fulfilled the accounting standards needed by Islamic banks in Indonesia.

**Keywords:** Dewan Standar Akuntansi Syariah (DSAS),

Institute of Indonesia Chartered Accountants (IAI), Indonesia, Islamic accounting, Islamic banking

#### **1. Introduction**

This chapter discusses Islamic banking and Islamic accounting development and implementation in Indonesia. The first part of this chapter elaborates on the emergence and development of Islamic banks (IBs) in Indonesia. Then, the next part discusses the history and role of Islamic accounting in Indonesia. The chapter intended to develop understanding related to Indonesia Islamic banking and accounting as a unique case of Islamic finance state of the art.

As the most Muslim populous country in the world, the development of Islamic banking in Indonesia is not without challenges. The emergence of Islamic banks in Indonesia was triggered by internal and external factors. The growth of demand in permissible (*halal*) financial services started in the Middle East encouraged Indonesia to join the opportunity to pave its way in the banking sector after the formation of Islamic financial institutions at the grassroot level [1–3]. PT. Bank Muamalat

Indonesia (BMI) was the first Islamic bank in Indonesia established in 1990 in Jakarta, Indonesia. The stagnant development in its first years led to the enactment of the Indonesian Law No. 21 of 2008 about Islamic banking (or Sharia Banking) that set the definition and legal foundation for Islamic banks to grow in Indonesia.

Upon the establishment, the development of Islamic banks became more steady and apparent over time. In 2020 itself, the growth of Islamic banking (yoy) had double-digit increment for 13.11 percent (yoy). Even though the Islamic banking industry growth is increasing, the inferior competitive advantage only contributes to less than 10 percent of national banking assets [4]. Hence, in 2021, the ministry of state-owned enterprise combined three state-owned Islamic banks (PT. Bank Syariah Mandiri, PT. Bank Negara Indonesia Syariah, and PT. Bank Rakyat Indonesia Syariah) into PT. Bank Syariah Indonesia (BSI) through merger. This merger resulted in the improvement of the competitive advantage of BSI to its conventional counterparts [4]. This momentum marked the commitment of the government and stakeholders to boost the development of Islamic banking in Indonesia.

Accountability is important to ensure the relevance and reliability of information in Islamic banks. It can be said that the development of Islamic accounting in Indonesia is driven by the growth of Islamic banking and finance [5]. There is a demand to accommodate accounting standards for Islamic transactions; hence, reliable information can be used by users for making a sound decision. *Dewan Standar Akuntansi Syariah Ikatan Akuntan Indonesia* or Sharia Financial Accounting Standard Board of the Institute of Indonesia Chartered Accountants (DSAS IAI) was formed to review, to study, and to issue accounting standards for Islamic financial transactions. The standard must be embedded with Islamic values and norms; hence, the process also demands knowledge in Islamic law, accounting, and business.

Until today, the Islamic or Sharia accounting in Indonesia has developed to myriad activities and transactions performed by Islamic banks (i.e. *mudarabah* (investment), *murabaha* (cost-plus), and *ijarah* (leases),). Islamic-based transactions also encompass social or charitable activities that need guidance and standard to operate accountably. Accounting standards for Islamic social or charitable activities such as zakah (Islamic compulsory alms), sadaqah, and waqf (charity) were set to allow both nonprofit and profit organizations to perform a systematic financial reporting. Indeed, these activities are also committed by Islamic banks and other Islamic profitoriented organizations as manifestations of their Islamic ethical identity. Therefore, it is expected that Islamic accounting is able to fulfill its goal to assist Islamic Banks to be accountable to their stakeholders and God by being fair and transparent in business.

#### **2. Islamic banks (IBs) in Indonesia**

#### **2.1 Islamic banking emergence in Indonesia**

The history of Islamic banks in Indonesia cannot be detached from the Islamic banking as a global phenomenon. The early concept of Islamic financial institutions was established by the idea of a bank with a profit-sharing system [1, 2]. In the 1940s, a Pakistan bank specifically set up to manage Hajj (pilgrimage) funds was founded but failed to prevail. The establishment of Mit Ghamr Local Saving Bank in Egypt marked as a breakthrough of modern Islamic banking in 1963. By 1967, the National Bank of Egypt and the Central Bank of Egypt took over Mit Ghamr operation due to declining performance during political turmoil. With this acquisition, Mit Ghamr's

#### *Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development DOI: http://dx.doi.org/10.5772/intechopen.103654*

interest-free principle has been abandoned, and banks are once again functioning on an interest basis. In 1971, the concept of interest-free was finally reinvented during the Sadat administration with the establishment of the Nacelle Social Bank. The purpose of the bank is to continue its business according to the concepts practiced by Mit Ghamr. The growth of economy also drove more Muslim countries to facilitate Islamic principle-based banks. Dubai Islamic Bank in 1971, the first bank initiated by private institutions, indicated growing interest in the Islamic financial facilities. In 1975, Faysal Islamic Bank started to operate in Sudan and Egypt, and at the same time, the Kuwait government established Kuwait Finance House. Finally, the Islamic Development Bank (IsDB) was formed in October 1975, which consisted of 22 founding Islamic countries. IsDB provides financial assistance for the development of its member countries, helping them to establish Islamic banks in their respective countries and playing an important role in research in Islamic economics, banking, and finance. Now, IsDB, based in Jeddah-Saudi Arabia, continues to operate with more than 56 member countries. Subsequently, the efforts to establish Islamic banks began to spread in many countries. Some countries such as Pakistan, Iran, and Sudan decided to change their financial system by adopting an interest-free system. In other Islamic and Muslim majority countries such as Malaysia and Indonesia, interest-free banks operate side by side with conventional banks.

Despite the grassroot Islamic microfinance in Indonesia already prevailing, the contemporary Islamic banking development was marked in the 1980s. Expecting efficiency and economic strengthening, the Indonesian government implemented deregulation allowing banks to set interest rates in 1983 [3, 4]. "Pakto 88," a monetary policy package as part of deregulation, was promulgated to support liberalization of Indonesia banking system encouraging the emergence of banks. Along with, grassroot developing Islamic financial institutions, named BMT Salman ITB in Bandung and Koperasi Ridho Gusti in Jakarta, paved a way to be a pilot model for Islamic banks in Indonesia. In 1990, the Indonesia Ulema Council (Majelis Ulama Indonesia a.k.a. MUI) formed a task force to establish the first Islamic bank in Indonesia, PT. Bank Muamalat Indonesia (BMI). Initially, the bank received less recognition from the public due to lack of legal foundation to operate. The legal basis for banking under the Sharia system was only in one of the paragraphs of "banks with a profit-sharing system" in Law no. 7 of 1992, without details on the basis of Sharia law and the types of businesses that are allowed. In 1998, Law No. 7/1992 became Law No. 10 of 1998, clearly stating that there are two banking systems (dual-banking system) in the country, the conventional banking system and the Islamic banking system. This law encouraged the establishment of several other Islamic banks or Islamic windows, namely Bank IFI, Bank Syariah Mandiri, Bank Niaga, Bank BTN, Bank Mega, Bank BRI, Bank Bukopin, BPD Jabar, and BPD Aceh.

#### **2.2 Islamic banking in Indonesia: Theory and practice**

The dual-banking system in Indonesia allows conventional banks and Islamic banks to operate. The operationalization of both banking in parallel is called the dualbanking system. According to Indonesian Law No. 21 of 2008 about Islamic banking (or Sharia Banking) [5],

*"Islamic Banks are banks that carry out business activities based on Islamic law (Sharia) principles, or Islamic legal principles regulated in the Islamic legal opinion (fatwa) of the Indonesian Ulema Council (Indonesian: Majelis Ulama Indonesia a.k.a. MUI) such as* 

*the principles of justice and balance ('adl wa tawazun), benefit (maslahah), universalism (alamiyah), and does not involve excessive speculation (gharar), gambling (maysir), usury (riba), exploitation (zalim) and unlawful (haram) objects." (translated)*

In addition, the law also mandates Islamic banks to perform social functions by facilitating collection of Islamic alms and charities and distributing it through Islamic charitable institutions. There are three categories of Islamic bank entities operating in Indonesia: Islamic commercial banks, Islamic-windowed banks, and Islamic rural banks. Islamic commercial banks are full-fledged Islamic banks that offer only Islamic financial products and operate under Islamic principles. Islamic-windowed banks, however, are business units or divisions of a conventional commercial bank (CCB). This business unit offers Islamic financial products. Meanwhile, Islamic rural banks are banks that operate in certain regions and only offer a more limited type of product compared with Islamic commercial and Islamic-windowed banks. Usually, the size of Islamic rural banks is significantly smaller than Islamic commercial banks. All these banks must comply with Islamic banking regulation.

Substantially, Islamic banks must nurture their identity as value-based institutions. Islamic bank's ethical identity explains how Islamic value is followed by the institution to stakeholders as a distinguishing characteristic from conventional banking practices [1–3]. There are five main traits of Islamic banks identity, namely: underlying philosophy and values; provision of interest-free products and services; restriction to Islamically acceptable deals; focus on developmental and social goals; and subjection to additional reviews by the Sharia Supervisory Board (SSB) [6]. The traits are broken down into several indices such as commitment to Sharia, existence of SSB, contribution to alms and charity (zakat and shadaqah), commitment to employees, and so on. While Belal et al. [7] conducted a longitudinal study to Islami Bank Bangladesh Limited (IBBL), a panel study of Islamic Identity Index measurement that was conducted by Zaki et al. [8] compares communicated and ideal ethical identities similar to those in Haniffa and Hudaib [9] but targeted Islamic banks in Asia. The result shows that three out of seven banks show value above the average, while the remaining have wide disparity. It indicates that not all Islamic banks in Asia have shared identity as Islamic banks. From the research, it is interesting that Indonesia Islamic bank's ethical identity index outperforms other Islamic banks in Asia even compared with Middle Eastern banks. It suggests that there is more consideration in the institutionalization of Islamic banks in Indonesia so that it can represent the Islamic norms and values in the banking industry.

The implementation of the regulatory and supervisory functions of Islamic banking from the aspect of implementing prudential principles and good governance is carried out by the Financial Services Authority (Indonesian: Otoritas Jasa Keuangan a.k.a. OJK) as is the case with conventional banking, but with a regulation and supervision system that is adjusted to the peculiarities of the Islamic banking operational system. The problem of fulfilling Sharia principles is unique for Islamic banks, because essentially Islamic banks are banks that offer products that comply with Islamic principles.

As prudential institutions, banks bear responsibility to manage its risk accordingly. As the distinction between conventional and Islamic banks, all stakeholders demand Islamic compliance as the foundational value of Islamic banks. The uniqueness of Islamic Banks (IB) entails consequence on risk exposing the bank [4]. Salem [5] argues that credit risk in IBs is higher than that in Conventional Banks (CBs) due to potential

#### *Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development DOI: http://dx.doi.org/10.5772/intechopen.103654*

moral hazard triggered by asymmetric information embedded in Profit-Loss Sharing (PLS) contracts. However, deliberate negligence or misconduct committed by the *mudharib* or *musyarakah*'s management partner is proven, IBs can switch the contract to debt-like financing and impose penalties to the violating party [6, 9, 10]. IBs are claimed to have higher liquidity risk compared with conventional counterparts. The lack of liquid Sharia-compliant instruments causes inflexibility in securitization and diversification [11–13]. Accessibility to the capital market is impeded as there is less or even none of the interbank market for IBs [7, 8, 14]. Moreover, unlike conventional banking, the "last resort for lender" function happened to be complicated due to the injunction of usury, which is naturally prohibited by Shari'ah [11]. Sharia compliance, legal and fiduciary risk. Sharia noncompliance risk arises when IB violates Sharia law principles [15]. Failure in complying to Sharia can disturb or even fail the completion of contract, contributing to fiduciary risk due to poor due diligence and misconduct by IB [16]. The Islamic values and norms must be manifested and hence followed in Islamic banks, contributing complexity in Islamic banks that is unique compared to conventional banking.

Systems to ensure sharia compliance are important in Islamic banking. Therefore, the existence of Sharia Supervisory Board (SSB) in Indonesia Islamic Banking is mandatory. According to Law No. 21 of 2008 about Sharia Banking, the National Sharia Board of Indonesian Ulema Council (Indonesian: Dewan Standar Nasional Majelis Ulama Indonesia a.k.a. DSN MUI) issues Islamic legal guidance (fatwa) on lawfulness of Islamic bank's products and then SSBs guard its implementation in IBs. Additionally, OJK stipulates that all Islamic banking products may only be offered to the public after the bank has received a fatwa from the DSN-MUI and obtained permission from the OJK. At the operational level, each Islamic bank is also required to have a Sharia Supervisory Board (SSB), which has two functions, the first is the sharia supervisory function and the second is an advisory function when banks are faced with questions about whether an activity is sharia-compliant or not, as well as in the process of developing a product that will be submitted to DSN to obtain a fatwa. In addition to these functions, Sharia Banking is also directed to have an internal audit function that focuses on monitoring sharia compliance to assist DPS, and in carrying out external audits used by sharia banks are auditors who have qualifications and competencies in Islamic law subjects.

#### **2.3 Recent development of Islamic banking in Indonesia**

OJK categorizes institutions in Islamic financial industry into three subsectors, namely Islamic banks, Islamic non-banking financial institutions (Islamic NBFI), and Islamic capital market with a total capitalization of assets for IDR 1801.40 trillion or USD 127,71 billion (excluding Islamic stocks) in 2020 [17]. Islamic capital market contributes the largest proportion for IDR 1076.22, then Islamic banking for IDR 608.90, and the least, Islamic financial non-banking institutions for IDR 116.28 trillion (USD 1 = IDR 14,050). Since its establishment, the growth of Islamic financial industry in Indonesia has been growing. Regardless of its contribution to national market share that only counts for 9.95 percent in 2020, the growth of Islamic financial assets recorded 22.71 percent (yoy) consisting of the growth of Islamic capital market, Islamic banks, and Islamic NBFI for 30.58, 13.11, and 10.15, in sequence. From the banking industry, Sharia commercial banks dominate the growth proportion followed by Sharia business units and Sharia rural banks (**Figures 1** and **2**).

#### **Figure 1.**

*The growth of Islamic finance and banking assets in Indonesia from 2016 to 2020. Source: Financial service authority (OJK), 2021.*

#### **Figure 2.**

*Islamic banks' main indicators and performance in 2020. Source: Financial service authority (OJK), 2021.*

The future of Islamic banking in Indonesia is promising if stakeholders, especially the government, commit to the development of the industry. The dual-banking system put Islamic banking in a competition with conventional banking. As a "newcomer" in the financial industry, Islamic banking market capitalization is far below conventional banking. The size of Islamic banks is significantly low compared with its counterparts, leading to the low capacity of lending. Nationally, the market share of the banking industry in terms of assets shows the dominance of several banks in BUKU 41 , while most banks still have a small business scale and market share, including Islamic banks. Structurally, both conventional commercial banks (CCBs) and Sharia commercial banks (SCBs), the majority of banks are in BUKU 2 with 58 BUK (*Bank Umum Konvensional*, Conventional General Bank) and 7 BUS (*Bank Umum Syariah*, Sharia General Bank), respectively. In terms of BUK, there are already seven banks that are in BUKU 4, while there is not one BUS that is included in BUKU 4 and only a small part is included in BUKU 3 (**Figures 3** and **4**).

The Financial Services Authority (OJK) encourages banking consolidation policies and strengthens bank capital in Indonesia as stated in POJK No. 12/POJK.03/2020 concerning Commercial Bank Consolidation. In 2021, the Ministry of State-Owned

<sup>1</sup> BUKU is categorization of banks in Indonesia. Bank BUKU 4 is the biggest bank in Indonesia with capital more than IDR30 billions.

*Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development DOI: http://dx.doi.org/10.5772/intechopen.103654*

#### **Figure 3.**

*Classification of commercial banks based on business activity in Indonesia in 2020. Source: Financial service authority (OJK), 2020.*

#### **Figure 4.**

*Bank's rank based on assets in Indonesian, 2020. Sources: Financial service authority (OJK), 2020.*

Company of Indonesia finalized the merger of three state-owned Islamic banks. PT. Bank Syariah Mandiri, PT. Bank Negara Indonesia Syariah, and PT. Bank Rakyat Indonesia Syariah were merged into PT. Bank Syariah Indonesia. By the end of 2021, there are 12 operating Sharia commercial banks in Indonesia from [16] the prior of the merger (**Table 1**) [12]. This merger has brought three largest Sharia commercial banks, which were previously excluded from the top 10 of the biggest operating commercial banks nationally, up the ranks to the seventh position with 2.7 percent of the


#### **Table 1.**

*The number of Islamic banks in Indonesia according to classification.*

national market share of the banking industry. The Islamic bank merger is an important consolidation momentum for Islamic banking to be able to present Islamic Banks that are strong in capital and able to compete in the national banking industry. In addition, the "new" bank, Bank Syariah Indonesia, has the opportunity to join BUKU 4 by increasing the scale of the economy so that it can contribute significantly to the national economy. This merger manifested as the commitment of the Indonesian government to support Islamic bank's development.

#### **2.4 Indonesia Islamic banking way forward**

The growth of Islamic banking in Indonesia is promising. During the 2020 pandemic, Islamic banks still maintained their growth and robustness through the crisis. The bank should keep innovating to capture larger market share. If Indonesian Islamic banks fail to capture the potential benefit from Muslim demography, the industry might not develop [1]. Islamic banks must maintain their identity by balancing the social function and communicating its value to the users. Reputational risks remain the vital issue in Islamic banks. Muslim community is diverse, many interpret Islamic law differently according to schools or teachings. Sharia governance may offer solutions for a systematic Sharia compliance guarantor that bridge different opinions among Sharia scholars and build public trust to the permissibility *(halal*) value in Islamic banking. At the implementation level, the government must take the Sharia audit into account as there are loopholes in the process. It must be understood that Sharia audit differs from audit for Sharia/Islamic financial institutions. This leads to the human capital issue. It is understandable that due to the small size of institutions, the labor market for Islamic banking is not as strong as the conventional counterparts.

A recent opportunity to be captured by Islamic banks is the digitalization of banking services. Young adults in their productive age dominate Indonesia populations. This generation has high literature in digital technology, especially the internet. Financial technology has emerged as the institution offers digital-based financial services. The easy, timeless, and reliable platform has captured the young generation to use financial services from start-up companies. Albeit becoming a new competitor for conventional banking, this institution may not replace the role of conventional banking later in the future due to the fundamental role and robustness of banking institutions that are supported by other supporting prudential institutions. The

#### *Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development DOI: http://dx.doi.org/10.5772/intechopen.103654*

Islamic banks must capture the momentum to invest in technology. First, branding is important to capture the new market by making Islamic financial transactions userfriendly and easy to access. This branding also involves the strategy to increase awareness and literacy on Islamic banking that has been lacking in the society. Second, the bank should maintain its security as the number of cyberattacks increases, ranging from identity theft, skimming, to phishing, and banks must mitigate this risk appropriately to protect the customers.

#### **3. Islamic accounting in Indonesia**

#### **3.1 History**

As previously mentioned, the development of Islamic accounting in Indonesia cannot be separated from the establishment of the first Islamic Bank in Indonesia, namely Bank Muamalat Indonesia (BMI) in 1991 and the existence of Law No. 7 of 1992 concerning banking, which is further detailed in Government Regulation 72 of 1992, Law no. 10 of 1998 and Law no. 23 of 1999. After BMI was established, there was a problem because BMI was an Islamic Bank but the financial statements made were not based on Sharia accounting. In addition, the existence of this Islamic bank also requires supervision and auditing of Islamic bank products. These factors encourage the importance of developing Islamic accounting.

In 2002, IAI through the Financial Accounting Standards Board (DSAK) ratified PSAK No. 59, Islamic Banking Accounting, which became effective in January 2003. Another thing that contributed to the development of Islamic accounting was the emergence of the IAI Sharia Accounting Committee in 2005. In 2010, IAI decided to transform the institution by establishing a Sharia Financial Accounting Standards Board (DSAS), which is authorized to formulate Islamic Financial Accounting Standards (IFAS). Islamic accounting, in Indonesia is often called as Sharia accounting, is accounting based on an Islamic (teachings) paradigm. It is an instrument or subsystem to implement Islamic teachings, especially in business. Therefore, the objectives of Islamic accounting must be consistent with the objectives of Islamic teachings (*maqaasid shari'ah*), namely to achieve happiness of human beings, both materially and spiritually.

To achieve the above objectives, Islamic accounting relies on various principles: (1) brotherhood (*ukhuwah*), which upholds the value of togetherness in obtaining benefits (sharing economy); (2) justice (*'adalah*), which does not tolerate usury, injustice, gambling and speculation (*maysir*), excessive uncertainty (*gharar*), and does not perform unacceptable (*haram*) goods or services; (3) beneficial (*maslahah*) in an effort to protect the objectives of sharia (protecting faith, reason, descent, life, and property); (4) balance (*tawazun*) of material and spiritual aspects, private and public, financial and real sectors, and utilization and conservation (for example, natural resources); and (5) universalism (*syumuliyah*), which considers various stakeholders to realize the welfare of the universe (*rahmatan lil alamin*). Thus, the benefits of Islamic accounting are not only for Muslims, but also for all mankind, even for the universe [18].

In general, the model or approach to develope Islamic accounting can look like **Figure 5**. From **Figure 5**, there are two approaches in developing Islamic accounting [19]. The first approach is often called the "ideal" approach. In this approach, the development of Islamic accounting begins with the search for sharia sources and then

#### **Figure 5.** *Approaches in Islamic accounting development. Source: Sholihin [19].*

is derived into Sharia accounting standards. The second approach is often referred to as the "pragmatic" approach. This approach starts from conventional accounting, then the purification process is carried out. Conventional accounting that is not in accordance with sharia is abandoned and which is not contrary to sharia remains. Islamic Financial Accounting Standard Board (*Dewan Standar Akuntansi Syariah*-DSAS) of the Institute of Indonesia Chartered Accountants (IAI) uses the second approach. In this case, to assess the compliance with Sharia, DSAS IAI relies on the fatwas of the National Sharia Council of the Indonesian Ulema Council (DSN MUI). Even in the DSAS membership, there are representatives/ex-officio of DSN MUI.

In developing Islamic Financial Accounting Standards (IFAS), DSAS IAI is very careful and follows a very strict due process. The due process adopted in the preparation of Islamic financial accounting standards are: (1) identifying the issues (and consulting with the Consultative Board of IAI if necessary), (2) conducting research related to the issues that have been identified, (3) discussing the material, (4) ratifying and publishing the exposure draft, (5) conducting public hearings and if necessary conducting limited hearings, (6) discussing public input, and (7) ratifying standards. In the discussion, the first thing to discuss is the aspect of transaction clarity from a sharia perspective. Even though during the discussion, there were already members of DSAS IAI from DSN MUI who became members, institutionally DSAS IAI again proposed the standards that had been ratified to DSN MUI to be checked/reviewed again for compliance with Sharia. So, Sharia accounting standards in Indonesia are developed by starting from the clarity of sharia aspects and ending with checking again the conformity of the standards with sharia. This procedure is intended to achieve the blessing of the ratified Islamic accounting standards and not to conflict with sharia.

#### **3.2 Recent development**

To date (December 2021), several Statements of Islamic Financial Accounting Standards (SIFAS) have been published by DSAS. In addition to PSAK 59 (Islamic Banking Accounting), DSAS have published SIFAS 101 (Sharia

*Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development DOI: http://dx.doi.org/10.5772/intechopen.103654*

#### **Figure 6.**

*Mapping between transactions in Islamic Bank (in blue) and the accounting standard (in gray). Source: Hendarsyah [20].*

Financial Statement Presentation), SIFAS 102 (Accounting for *Murabaha*), SIFAS 103 (Accounting for *Salam*), SIFAS 104 (Accounting for *Istishna'*), SIFAS 105 (Accounting for *Mudharabah*), SIFAS 106 (Accounting for *Musyarakah*), SIFAS 107 (Accounting for *Ijarah*), SIFAS 108 (Accounting for Sharia Insurance Transactions), SIFAS 109 (Accounting for Zakat and Infaq/Alms), SIFAS 110 (Accounting for *Sukuk*), SIFAS 111 (Accounting for *Wa'd*), and the last is SIFAS 112 (Accounting for Waqf). In addition, DSAS has also issued Interpretation of Financial Accounting Standards (ISAK) 101 concerning Recognition of Deferred *Murabaha* Revenues Without Significant Risk Related to Inventory Ownership and ISAK 102 about Impairment of *Murabaha* Receivables has also been issued.

Until now, DSAS continues to work to develop various accounting standards to support the development of Islamic economics and finance. DSAS IAI in developing standards uses a transaction-based approach, not an accounting approach for certain institutions, even though the first Islamic accounting standard that appears is Islamic Banking Accounting (PSAK 59).

From the SIFAS above, it can be seen that the DSAS IAI does not only focus on accounting standards for commercial activities. However, DSAS IAI also pays great attention to the aspects of social finance (Social Islamic Finance), namely the issuance of SIFAS 109 and SIFAS 112. SIFAS 109 is currently being reviewed due to the development of various programs and social activities in the distribution of zakat, infaq, and alms for community empowerment.

The mapping of transactions used by Islamic banking and how the match between those transactions and the IFAS can be seen in **Figure 6** [20].

#### **4. Conslusion**

This chapter discusses the development of IBs in Indonesia and explains the development of Islamic financial accounting standards including how the standards are developed (the due processes). This chapter also describes whether Islamic financial accounting standards developed in Indonesia have sufficiently fulfilled the accounting standards needed by Islamic banks in Indonesia.

Islamic banks (IBs) have distinctive characteristics compared to the conventional ones. IBs only perform permissible (*halal*) financial transactions viewed from Islamic perspective and avoid usury (riba) and overspeculation (*gharar*). The growth of demand in permissible (*halal*) financial services started in the Middle East encouraged Indonesia to join the opportunity to pave its way in the banking sector after the formation of Islamic financial institutions at the grassroot level. PT. Bank Muamalat Indonesia (BMI) was the first Islamic bank in Indonesia established in 1990 in Jakarta, Indonesia.

Upon the establishment, the development of Islamic banks became more steady and apparent over time. Hence, in 2021, the ministry of state-owned enterprise combined three state-owned Islamic banks (PT. Bank Syariah Mandiri, PT. Bank Negara Indonesia Syariah, and PT. Bank Rakyat Indonesia Syariah) into PT. Bank Syariah Indonesia (BSI) through merger. This merger resulted in the improvement of the competitive advantage of BSI to its conventional counterparts. This momentum marked the commitment of the government and stakeholders to boost the development of Islamic banking in Indonesia.

Accountability is important to ensure the relevance and reliability of information in Islamic banks. Consequently, there is a demand to accommodate accounting standards for Islamic transactions to provide reliable information for users for making a sound decision. *Dewan Standar Akuntansi Syariah Ikatan Akuntan Indonesia* or Sharia Financial Accounting Standard Board of the Institute of Indonesia Chartered Accountants (DSAS IAI) was formed to review, to study, and to issue accounting standards for Islamic financial transactions. The standard must be embedded with Islamic values and norms; hence, the process also demands knowledge in Islamic law, accounting, and business, and it is called as Sharia Financial Accounting Standard.

Until December 2021, several Statements of Islamic Financial Accounting Standards (SIFAS) have been published by DSAS IAI. In addition to PSAK 59 (Islamic Banking Accounting), DSAS have published SIFAS 101 (Sharia Financial Statement Presentation), SIFAS 102 (Accounting for *Murabaha*), SIFAS 103 (Accounting for *Salam*), SIFAS 104 (Accounting for *Istishna'*), SIFAS 105 (Accounting for *Mudharabah*), SIFAS 106 (Accounting for *Musyarakah*), SIFAS 107 (Accounting for *Ijarah*), SIFAS 108 (Accounting for Sharia Insurance Transactions), SIFAS 109 (Accounting for Zakat and Infaq/Alms), SIFAS 110 (Accounting for *Sukuk*), SIFAS 111 (Accounting for *Wa'd*), and the last is SIFAS 112 (Accounting for Waqf). In addition, DSAS has also issued Interpretation of Financial Accounting Standards (ISAK) 101 concerning Recognition of Deferred *Murabaha* Revenues Without Significant Risk Related to Inventory Ownership and ISAK 102 about Impairment of *Murabaha* Receivables has also been issued. It is expected that Islamic accounting is able to fulfill its goal to assist Islamic Banks to be accountable to their stakeholders and God by being fair and transparent in business.

*Islamic Banking and Islamic Accounting in Indonesia: History and Recent Development DOI: http://dx.doi.org/10.5772/intechopen.103654*

### **Author details**

Mahfud Sholihin\* and Dian Andari Department of Accounting, Gadjah Mada University, Yogyakarta, Indonesia

\*Address all correspondence to: mahfud@ugm.ac.id

© 2022 The Author(s). Licensee IntechOpen. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

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Section 3
