THOROUGH ANALYSIS ON INVESTMENT IN SECURITIES

The coverage of the analysis is made with the reference to the comparison between
Alliance Islamic Bank Berhad (Malaysia) and Al Barakah Banking Group (Bahrain). An in-
depth study has been undertaken to analyse the accounting treatments and disclosure on
investment in securities in these two banks and it is meant to look for the similarities,
differences and the critical issues underlying given findings. The method of the findings is to
search for possible investment in securities related items and disclosure in financial
statements including the notes as well.

ALLIANCE ISLAMIC BANK BERHAD

The bank don’t apply FRS 132(Presentation & Disclosure of Financial Instrument)
and yet to apply FRS 139(Recognition & Measurement of Financial Instrument) in their
financial statement but follow guideline set by Financial Reporting for Licensed Institutions
(BNM/GP8) issued by Bank Negara Malaysia, The revised BNM/GP8 dated 1 April 2008 has
resulted in significant changes in the accounting policies of the bank pertaining to the
treatment of financial instruments. It is to be stated that, the treatment of securities and
derivatives under the revised BNM/GP8 is generally consistent with FRS 139 based on
certain principles in connection with the recognition, derecognition and measurement of
financial instruments which are similar to those prescribed by FRS 139 have been adopted by
the Bank. We also noted that FRS 132 is not applicable in the financial statement preparation.
However, Alliance stated that FRS 7 which is the latest guideline on financial instrument
disclosure together with FRS 139 only will be adopted by the bank starting financial year
2010.

AL BARAKA BANKING GROUP

For disclosure and recognition guidelines for investment in securities related item, Al
Baraka adopted AAOIFI’s Financial Accounting Standard No. 17 (FAS 17) which is a
standard for investment. In addition, they stated that for parts where AAOIFI remain silent,
IFRS is applicable. So, FAS 17 of AAOIFI’s standards and relevant IFRS might be the basis
of preparation for Al Baraka Financial Statement.

To evaluate the actual disclosure or recognition of investment in securities of these

two banks, we will start with income statement items, balance sheet items, statement of
changes in equity together with notes to financial statement wherever applicable.
INCOME STATEMENT DISCLOSURE

In Alliance Islamic Bank Berhad income statement, there are few items related to
investment in securities. Income from investments is divided into different source of funds
which is depositor and shareholder fund. These items have been disclosed in details further in
notes to financial statements. The details illustrate the different type of funds and income
generated from different source of investment or financing (i.e. income from different
investment type or financing contract). In BNM/GP8 guideline, it is stated that income
statement should reflect income and expenses grouped by nature, quantifying the principal
types of income and expenses1. Thus, Alliance followed the guideline set up by BNM/GP8
and presented the income items accordingly in the income statement (below is the note to
financial statement). In addition, this disclosure is also consistent with the requirement set by
MASB Tri-3 Guideline, which require income to be separated by showing income from
investment of depositor’s fund, income derived from investment of shareholder’s fund and
other income2.

a) In Income Statement

b) Notes to Financial Statement

1
(GP8 Guidelines on Financial Reporting for Licensed Islamic Banks (Revised Edition),
2008)
2
(Technical Release i-3 (TRi-3), 2009)
 Above attachment is a disclosure of details item for income from depositor’s fund. The
same type of disclosure has been applied for income from shareholder’s fund. This part has
been explained in the earlier part of this assignment.

In Al Barakah, the income is directly segregated according to the portion of profit. It is

allocated for the bank or for the depositors. Clearly stated in FAS 17, income from all types
of investments shall be presented in the income statement under “Income from investments”
taking into consideration the split between the portion related to owner’s equity and the
portion related to unrestricted investment account holders (URIA)3.The further disclosure in
the notes will specify which income comes from which component or type of investment.
This is also the requirement of Para 21(5/2) FAS 17, AAOIFI.

For allowances for losses and financing advances item in income statement of
Alliance Islamic, no further details beside below disclosure are available in the notes.
BNM/GP8 requires the bank to disclose further details only if the company apply
“BNM/GP3: Guidelines on Classification and Impairment Provisions for Loans/Financing”
guideline4. Based from our findings, Alliance Islamic’s financial statement do not show other
details than what is shown below( specific, general and bad debts) in its notes to financial
statement. This is the BNM/GP8 requirement.

3
(Financial Accounting Standard No. 17 (FAS 17), 2003)
4
(GP8 Guidelines on Financial Reporting for Licensed Islamic Banks (Revised Edition),
2008)
 Such provision made by Al Baraka is not included in computation for profit before
distribution to URIA. The provision only recognized or deducted only for Group profit and it
will affect the profit distribution for group. This is to ensure that such provision don’t affect
the profit of URIA.

Further in notes to financial statement, the breakdown of provision of Al Baraka was

made accordingly to their products and financing contracts. The breakdown consists of the
movement during the year and it is more precise in details compared to Alliance Islamic
provision disclosure. In addition, the provisions of the disclosure also include the provisions
made by geographical area.

In Alliance Islamic financial statement, expenses directly attributable to the

investment of the depositors and shareholder's funds are included in the computation of profit
to be distributed. In Al Baraka, expense directly attributable can’t be identified directly, only
staff and other operating expenses are identifiable which is not included in the computation
before distribution. The expenses are deducted from Mudarib’s portion of total profit.

OVERALL ANALYSIS AND ISSUES

I. Income Classification & Notes Disclosure

AAOIFI FAS 17 and BNM/GP8-i has totally different methods of classifying the
income and details provided in the notes. While FAS 17 classified the income while
separating the portion of ownership of the income whether it belong to equity owner or
depositor of URIA, BNM/GP8-i only separated the income according to sources of fund
used. It is noted that Alliance Islamic disclosure is consistent with MASB Tri-3 guideline.
Notes accompanying both type of disclosure vary significantly which has seen AAOIFI
disclosure through its FAS 17 shown component of income in details by product or
financing contracts type while BNM/GP8-i only disclosed the investment types and
financing products generally.

II. Presentation of Allowances or Provisions

As stated above, Alliance Islamic accounted provision in the calculation for profit
before distribution while Al Baraka accounted provision after the profit apportionment
but before the taxation part .This indicates one thing, that the depositor fund of Alliance
 Islamic has to bear the loss from the allowance unlike Al Baraka, where only the Mudarib
(the Bank)’s profit is affected by the provisions made. For notes of the provisions, we
concluded that disclosure in Al Baraka is more detailed and informative compared to
provision made in Alliance Islamic which followed MASB Tri-3 Para 27.

III. Expenses Attributed To The Investment.

In Alliance Islamic, the expenses attributed to the investment are the combination of
depositor’s and shareholder’s fund investment. This raised the issue of gharar
(uncertainty) of what is the actual amount of expenses attributed to depositor’s and
shareholder’s investment. This indicates that expenses should not be mixed as the issue of
unfair allocation of expenses will arise. Al Baraka only shown the expenses deducted
from Mudarib’s profit only. This will lead to another issue of who is actually should be
responsible to the administrative expenses.

This has been explained by Napier, C. (2007) that there are two methods of profit
allocation, the pooling method and the separation investment method. The pooling
method suggests that revenues and expenses are shared by shareholders and investors and
separation method where bank separates the revenues and expenses of investment
operation from other banking services and the issue whether which method is the most
fairness depend on the bank judgement5.

In our opinion, Alliance Islamic disclosure is a separate account investment method

as it is also stated in their financial statement. The argument is here, whether it is fair to
mix investment expenses with different sources of fund is still in ongoing discussions.
While some argue that if the investment operation type is the same, it is not wrong to mix
the expenses, but others don’t agree with it. Karim (2001) pointed out that majority
Islamic banks that commingle investment fund and their investment activities resulted in
the state where investment accounts funds are not ‘ring fenced’ from the bank’s funds6.
The issue would be whether the fairness of profit and expenses allocation can be justified
through these two methods is still not well addressed by scholars. The effect from this
situation will be discussed in the next point.

Another issue arising from expenses section is the limited or no disclosure of the
information breakdown associated with expenses directly attributed to the investment
5
(Napier, 2007)
6
(Karim, 2001)
 disclosed in Alliance Islamic’s income statement. The main concern is how much is the
actual expenses for investment activities should be allocated to depositor fund and
shareholders fund. This possibly can lead to uncertainty (gharar) as wrong amount of
expenses might be imposed on depositor’s portion of profit.

IV. Profit Distribution Computation

The result of the conflict of how should Alliance and Al Baraka allocate their profit
and expenses will result in actual profit distribution allocated to depositor and shareholder
fund. This analysis will focus on Alliance Islamic’s disclosure as Al Barakah has
appropriately and fairly shown the income distribution because it follows AAOIFI’s
standards. In Alliance, it is noted tha before the distribution, the profit percentage is
shown as below,

Income Derived Amount Percentage Portion

Depositor’s Fund & Etc RM 181,512 181,512/201,714 : 89.98%

Shareholder’s Fund RM 20,202 20,202/201,714 : 10.02%

Total RM 201,714 100 %

However, after accounted the allowance and expenses attributable to the investment,
the portion of income is calculated below,

Income Derived Amount Percentage Portion

Depositor’s Fund & Etc RM 65,460 39.97 %

Shareholder’s Fund RM 98,298 60.03 %

Total RM 163,758 100 %

Given the significant decrease in portion of income, it might have already taken the
portion of bank’s profit based on agreed Profit Sharing Ration (PSR), however the
methods of mingling the income and expenses together and its presentation before the
distribution still raised the issue whether this presentation and method of allocation really
reflect a fair and justice distribution. Unlike AAOIFI’s disclosure based on FAS 1,
group’s profit as mudarib has been shown clearly and the depositor fund’s income is not
mixed and thus, has reduced the uncertainty of profit allocation.

BALANCE SHEET DISCLOSURE

 It is obvious in the balance sheet that the presentation of investments in securities item
varies between Alliance Islamic and Al Barakah. The main item shown in Alliance Islamic
mainly covers the scope of FRS 139 (as BNM/GP-i resembles FRS 139) which is the primary
instruments and derivatives7. Thus, the presentation in Alliance’s balance sheet generally
follows MASB Tri-3 guideline and rules prescribed in BNM/GP8-i. Items shown below are
considered financial instruments based on standards and guidelines applied by Alliance
Islamic: In Income Statement

In notes to financial statement :

In note no. 6, the value are shown at amortised cost, however, a further disclosure of
market value (whenever applicable) are shown for securities held to maturity but it is stated
in FRS 139 that held to maturity need to be recorded at cost unless certain impairment
identified. For securities available for sale, FRS 139 concurrent with BNM/GP-i require
disclosure of securities available for sale at market value with further disclosure of detailed
items. BNM/GP-i(Para 7.7) also requires the disclosure of procedure establishment
determining the fair value. This has been shown accordingly in the notes as well.

7
(Jane Lazar, 2008)
 On the other hand, Al Baraka used AAOIFI FAS 17 for investment in securities
disclosure. Para 20 suggests that only an “investment” item in shown in balance sheet and
their significant components of type of investment should be disclosed in the notes to
financial statement. As per shown below,

For investment in trading securities and investment available for sale, AAOIFI FAS
17 are in the opinion of valuing mentioned types at fair value (Abdul Rahman, 2010, p.
162)8.This also applies to investment in real estate. For held to maturity investment ad
investment in shares, value are recorded at cost. Para 24 of FAS 17 also suggests that notes to
financial statements shall indicate the movement (beginning balance, changes & ending
balance) of the investments. Another interesting disclosure is Para 34 which implies that
investment in shares shall be made of the entities whose shares invested, percentage and
nature of investment activities. This can be seen in the notes (see example attachment below):

8
(Rahman, 2010)
 Another disclosure to look is at the deposited amount from customer in given IFIs. In
Alliance, MASB Tri-3 outlined that the bank should disclosed its deposits based on
Mudarabah & Non-Mudarabah deposit based on para 16.In addition, BNM/GP-i also require
explanation notes to show that deposits from customers with a breakdown by types of
deposits , types of customers and its maturity structures of term deposits. This can be seen in
notes number

However, in Al Baraka, no details are available in the liability side showing type of
customer accounts as the only item is “customer and other deposits”. Thus, this can’t show
type of deposit accounts available.

Last but not least, the last item related to investment shown in the balance sheet would
be the fair value reserve account. Please note that FRS 139 and AAOIFI FAS 17 have
different recognition and disclosure of its fair value reserve. In Alliance Islamic, its
presentation of fair value reserve account is combined together with other reserves and
constitute as one item in the balance sheet. Below is further disclosure in the notes to
financial statements:
 In Al Baraka, the fair value reserve is shown as its own item in the balance sheet.
Although FAS 17 para 26 use “Investment Fair Value Reserve” account as the name, Al
Baraka use a different name called “Cumulative changes in fair value reserve”.

OVERALL ANALYSIS AND ISSUES

I. Classification Of Investment

Basically, it is noted that FRS 139 and FAS 17 have their own classification of
investment. FAS 17 classified investment into 3 types, for trading purposes, available for sale
and held to maturity. Surprisingly, FRS 139 also has available for sale and held to maturity as
investment types but do not include investment for trading purposes. The main item in FRS
139 is the type of investment called financial assets at fair value through loss and profit.
Abdul Rahman (2004) said the problem in classifying the above investments is to objectively
determine the intention of the investors and intention may also subject to change overtime
due to the changes in economic climate9. Thus, to say which classification is better and more
accurate depends on the intention of the investors and other uncontrollable factors.

II. Fair Value Measurement

It is also found that the guideline on measuring fair values provided in FRS 139 is
more extensive and comprehensive as compared to AAOIFI FAS 17 (Ani Salwani, 2005)10.
FRS 139 stand on the measurement by referring to “price agreed by willing buyer and seller
in arm’s length transaction”. For actively traded stocks, one might want to refer to the quoted
price (or known as bid price).Some of the alternatives method would be discounted cash flow
analysis, option pricing model or refer to similar items market price. This however raised the
issue of uncertainties lie under the value of the instruments (Abdul Rahman, 2004) presented
in the balance sheet.

9
(Rahim, 2004)
10
(Pa, 2005)
 III. Fair Value Reserve Account
Both financial statements do have fair value reserve account to recognize the
differences in fair value amount and both also disclosed the amount in the statement of
changes in equity. AAOIFI FAS 17 suggests that disclosure shall be made of the
“Investments fair value reserve” indicating the balance at the beginning of the financial
period, changes during the period and the balance at the end of the financial period. (para 37).
This has been applied by Al Baraka in the statement of changes in equity.

In addition, Al Baraka which follows AAOIFI FAS 17, do proportioned the

unrealised gain into the income in financial statement. This is to ensure that depositor do
benefit from the fair value revaluation. This will be stated as unrealised gain. In Alliance,
lack of transparency of how fair value will affect the income proportion and income
statement wholly is severe, as only balance sheet reflected the changes in fair value. In our
opinion, this indicates that FAS 17 treatment of changes in fair value is more transparent, and
fulfil Shariah requirement of ensuring just and fair profit sharing distribution between
depositor and shareholder (Abdul Rahman, 2010)11

IV. Derecognition

Besides fair value accounting, FRS 139 provides additional provision for
derecognition of financial assets. According to the standard, an entity shall derecognize a
financial asset when the contractual rights to the cash flows from the financial asset expire or
it transfers the financial asset together with its risk and rewards. This provision is crucial as
failure to recognize a financial asset will result in understatement of an entity's assets while
failure to derecognize a financial asset will result in overstatement of an entity's assets and
both situations will affect company's value as well as shareholders' wealth (Ani Salwani,
2005). This guideline is also inserted into BNM/GP-I requirement. Such disclosure however
is not found in AAOIFI FAS 17 and not applicable to Al Baraka. This shown that FRS 139 is
more detail and transparent in derecognizing the financial instruments.

11
(Rahman, Accounting For Investment In Islamic Securities, 2010)
OTHER ANALYSIS AND ISSUES

I. Non Disclosure of Restricted Investment Accounts

It is stated that some bank chose not to disclose investment account on the face of the
balance sheet (Napier, 2007). However, after analysing Alliance Islamic and Al Baraka
financial statement, it is noted that all investment accounts are presented and disclosed
accordingly, even for restricted investment account; Al Baraka presented the whole details
and movement of restricted investment account activities in the “Consolidated Statement of
Changes in Restricted Investment Accounts”. For the case of Alliance Bank, they don’t
follow AAOIFI standard, thus, no classification of unrestricted and restricted investment
accounts are available in the presentation.

II. Report & Disclosure of the Shariah Advisory Board/ Committee

It is required in BNM/GP8-I that there should be a report from Shariah Advisory

Board in the financial statement. The report is available in Alliance financial statement
stating the responsibility and assurance towards income and the activities conducted by the
bank. However, by comparing the Alliance Islamic’s Shariah Board report with Al Baraka’s,
we found that details prescribed in AAOIFI’s guided financial statement is more
comprehensive and include additional statement of comprehensive zakat computation as well.
We are in the opinion that Al Baraka Shariah Board presentation is better and transparent
thus reflecting their fulfilment of obligation towards Shariah goals.

III. Risk Management & Corporate Governance Disclosure

As some of the measurement require fair value measurement, BNM/GP8-I require a

more definitive risk management policies and procedures and together with the soundness of
good corporate governance to ensure more reliable fair value measurement. However, we
couldn’t found any statement on corporate governance in Alliance’s Islamic financial
statement. In Al Baraka, there is a statement of corporate governance responsibility to ensure
more reliable internal management. Thus, we believed that a better disclosure of corporate
governance can ensure a better risk management practised in the company. This also can
build the trust among the investors and shareholders.

On the other hand, we believed that FRS 139 provide a better disclosure of risk
management policies. (Ani Salwani, 2005) stated that as long as risk management policies is
concerned, FRS 139 provides detailed discussion on the requirement, which was not part of
AAOIFI FAS 17. This is true based from our analysis on Alliance Islamic and Al Baraka
financial statements. So we concluded that FAS 17 coverage on risk management is not in
existence and not as extensive as FRS 139.