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CHAPTER 3: THE PROBLEMS WITH CONVENTIONAL ACCOUNTING AND IMPLICATIONS FOR ISLAMIC ACCOUNTING  Alternative (conventional accounting) rules may, for the individual citizen, mean the difference between employment and unemployment, reliable products and dangerous ones, enriching experiences and oppressive ones, stimulating work environments and dehumanising ones, care and compassion for the old and an d sick versus intolerance and resentment. (Tinker, 1985, p xx)

3.0

INTRODUCTION AND CHAPTER OUTLINE:

In the previous chapter (chapter 2), the researcher outlined the world view and value system of Islam and compared it with that of the Western worldview; he highlighted the consequent economic implications and the accounting implications of these differences. In this chapter, the critique of conventional accounting from the social and critical literature and behavioural accounting literature will be reviewed. The review is undertaken through five main themes: objectives, fundamental assumptions, characteristics, macro-consequences macro-consequences (effect on social

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consequences of accounting for Muslim managers and employees, and are these are in line with Islamic values? The researcher argues that conventional accounting accounting in terms of its objectives, characteristics and consequences is a negative force from an Islamic perspective and classifies these characteristics as the “push factors” necessitating the search for an alternative Islamic accounting. In the next section (3.1), an outline of the critique of conventional accounting literature is given. Next, an examination of the critique with respect to the objectives, assumptions (section 3.2), accounting concepts and characteristics (section 3.3) and the economic, social and environmental consequences of conventional accounting (section 3.4) is undertaken. In section 3.5, the management accounting and the critical accounting literatures relating to budgeting and control systems will be used in considering the behavioural effects of management accounting accounting and financial financial reporting on employees employees and management. Section

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AN OUTLINE OF VARIOUS ACCOUNTING CRITIQUES.

The literature, which criticises conventional accounting, draws on various perspectives: i) Social and and environmental environmental accounting accounting (Maunders (Maunders & Burrit, 1991; 1991; Gray et et al., 1996; 1996; Gray & Bebbington, 1998), ii) Marxist/ critical accounting (Tinker et al., 1982; Tinker, 1985; 1985; Cooper Cooper & Hopper, Hopper, 1990; 1990; Lehman, 1992a; Galhlhofer & Haslam, 1995), iii)

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

iv) Public interest arguments (Arrington, 1990, Briloff, 1990). Although all of the different critique of conventional accounting point out its deficiencies from their own perspectives, many of the issues raised are common to which Islamic academics would have concerns. Some of the concerns about the application of conventional accounting to Islamic Islamic societies are similar similar to that raised by by researchers in in other areas. In spite of this, not all the concerns of Islamic societies are addressed by these critiques as

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There is no dearth of criticism of conventional accounting. The criticism began soon after accounting started to grow in prominence and stature in the early part of this century: this was especially the case in the USA and the UK where modern corporate accounting can be said to originate. Early accounting critiques were based mainly on the problem of obtaining a ‘true income’ figure. Very few academics with the exception of writers such as MacNeal (1970 [1939]) criticised the accounting principles and valuation methods and tried to infuse a moral consciousness consciousness and public spirit spirit into the profession. profession. Writers such as Sprague Sprague (1971, [1922]) and Scott

(1931) focused focused on the Philosophy Philosophy of accounts and and the cultural

significance of accounts respectively. Accounting has faced ever-increasing criticism since it became an important discipline and a profession in the early part of this century. In its attempt to become a respectable discipline akin to that of Law and Medicine, the AICPA (and their academic counterparts- the American Accounting Association), attempted to develop a theory of accounting (AAA, 1936;1966;

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countries. The rise of “Managerial Capitalism” (Chandler, 1977), or “Investor capitalism” (Bryer, 1993a) led to the concentration of power and wealth in the hands of a few people. This resulted in a greater emphasis on market efficiency and shareholder value in society with the associated environmental destruction, nihilistic consumerism, wealth appropriation and social conflicts. This phenomenon also gave prominence to the accounting profession in the guise of multinational audit firms especially the Big Six (now the Big four). The critique of these excesses of the corporation started in the 1970’s when their social costs became staggering and could not be ignored. This led to a debate regarding the moral and social responsibility of corporations (e.g. Donaldson, 1982; Mintzberg, 1983) and extended to corporate accounting and governance, e.g. Gray et al., (1988,1991) and Benston (1982). The Corporate Report (ASSC, 1975) was an attempt to incorporate the social responsibility of corporations in accounting although it adopted a ‘decision-usefulness’ ‘decision-usefulness’ framework. The true income school and corporate social responsibility debate gave way to development

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positive accounting theorists argued that accounting should study ‘what is’ and try to investigate whether financial statements could predict future events (Watts & Zimmerman ,1979 and 1986). Capital market studies such as Ball & Brown (1968), Beaver (1981) and Watts & Zimmerman (1979 and 1986), together with agency theory (Jensen & Meckling, 1976) which assumed that people are self-seeking zealots, led accounting away from moral and social issues to concentrate on increasing the wealth of finance providers and market players. This became the mainstream of accounting research and and the primary primary focus of practice which saw finance and financial markets develop as important disciplines in their own right, separate from that of accounting. This capitalistic orientation has attracted a great deal of Marxist critique of accounting which argues that accounting is merely a tool which increases the gap between the rich and the poor and leads to class class conflicts (Tinker, (Tinker, 1985; Lehman, Lehman, 1992a ).

Marxists also

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

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view corporations and accounting as agents for the destruction and pollution of the environment and the biosphere (Maunders & Burritt, 1991). A Public-Interest perspective is taken by writers like Briloff (1990), who argue that Accountants have not honoured their duties of public service by shamelessly paying littler attention to their ethical codes and by being involved in a number of high profile scandals. The Social and Environmental Accounting writers criticise modern accounting from various perspectives mentioned above. However, its main advocates (e.g. Gray et al., 1996; Matthews, 1994) favour an evolutionary approach of extending conventional accounting to recognise, report and disclose social and environmental information leading to their discharge of accountability to society. Finally, a critical cultural perspective has developed which argues that accounting has cultural relevance and should be tuned to the cultural idiosyncrasies of space and time especially in the different cultural and economic environments of developing countries

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public interest accounting literature being mainly concerned with the failure of the accounting profession is not reviewed, as this research does not concern itself with this issue in any detail. The feminist critique is not discussed except to take some lessons for Islamic accounting from ‘enabling accounting’ (Reiter, 1997). The discussion starts in the next section with the objectives and assumptions of conventional accounting.

3.2

THE OBJECTIVES AND ASSUMPTIONS OF CONVENTIONAL ACCOUNTING: SOME PROBLEMS WITH THE DECISION USEFULNESS PARADIGM.

From the period 1977-1985, the Financial Accounting Standards Board of the United States of America spent millions of dollars and thousands of man hours trying to develop some theoretical basis for accounting in the form of a conceptual framework. This was supposed to be a “ coherent system of inter-related objectives and fundamentals ...that prescribes the nature, functions, and limits of financial accounting and reporting (FASB, 1981). Their project

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this paradigm i.e. on the aggregate behaviour of decision makers (i.e. Market players) as depicted by changes in security prices (e.g. Ball & Brown, 1968; Beaver et al.,1968). Lehman (1992a) notes the change of emphasis from stewardship to decision usefulness or ‘decision informativeness’ informativeness’ from the AICPA’s Study Group report report on Objectives. He contends that the traditional stewardship role always necessitated considering management’s effectiveness and efficiency, despite the tendency to justify this slant towards decision usefulness as a “higher form of stewardship” (p20). The difference is not superfluous but calculated to emphasise emphasise “the informational informational role of accounting being regarded regarded as crucial to the efficient allocation of society’s resources by individuals, enterprises and government” (p21). Combined with agency theory and positive accounting theory, this became the dominant paradigm of accounting in the 1990’s; adoption by the FASB’s conceptual framework project probably added to its central role. In fact, decision-usefulness has become the dominant paradigm of all subsequent conceptual frameworks since the FASB’s

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that the decision-usefulness paradigm was arrived at. In discussing the environmental context of the the objectives objectives of financial financial reporting, reporting,

the Statement Statement of Financial Financial Accounting Accounting

Concept 1 (FASB, 1978) 1978) notes that: “The US is a highly developed exchange economy where large amounts of capital is required for maintaining the complex production processes which result in the production and exchange of goods and services. These processes require economic resources, which is allocated by the market mechanism. The effectiveness of  individuals (through buying, selling selling or holding shares & bonds) and enterprises, markets and government in allocating scarce resources among competing uses is enhanced (.i.e. allocated to enterprises that use them efficiently) if those who make economic decisions have information regarding the standing and performance of  business”. (FASB, 1978, p 5-8).

In this context, competitive markets are seen as a significant factor in resource allocation in the economy (in addition to government whose intervention is frowned upon). Thus, “decision usefulness relies heavily upon the language of self-seeking rationality, markets and economic efficiency to describe accounting problems and interpret accounting events” (Williams, 1987).

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The “Ceteris Paribus” of Decision Usef ulness.

The essential message of decision usefulness is that accounting provides information which leads to the efficient efficient allocation of resources (AAA, 1977). This This is apparently apparently through the process of providing information, which results in information efficiency in the market, which in turn leads to allocation allocation efficiency. Although Although efficiency (the most most output per unit unit of input) may well be a useful goal to aim for, it cannot be the ultimate aim of human society. It is an intervening variable which perhaps leads to a better life or more utility (perhaps at least in the material sense). sense).

This deficiency deficiency has led a committee of the American Accounting Accounting

Association (AAA, 1975) to add “social welfare” as the ultimate aim of allocation efficiency. Commenting on the inadequacy of a report by the Study Group on Objectives of Financial Statements (AICPA, 1973), this committee (AAA, 1975) observed that the Study Group’s assertion that financial statements should provide information useful for making decisions , “was not broad enough to lead a complete set of criteria against which accounting

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Better Economic Decisions

Efficient Allocation of Resources

Social Welfare

Leaving aside the definition of “social welfare” for the moment, (discussed in section 3.2.3.), the question arises, does conventional conventional accounting really really lead to social welfare (even (even in the material sense) through the chain depicted in figure 3-1 above? In other words, does

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The question therefore arises as to whether accounting leads to efficient allocation of resources or whether markets are efficient in spite of accounting regulation.

(ii)

The generalisation of individual preferences to collective preferences by aggregating individual utilities of shareholders who have heterogeneous interests, to obtain society’s collective preferences is questionable. This has been questioned by Arrow (1971) (as quoted by Lehman, 1992), who concludes that it would take a dictator to make social choices affecting more than one individual. This has resulted in the recognition by Beaver & Demski (1974) that choice among reporting alternatives has social consequences that affect non-users and users of accounting information in terms of the distribution of wealth. wealth. Hence, ethical judgements judgements must be made made as to whose well being should be enhanced and whose should be diminished.

(iii)

The separation of social and economic spheres of analysis is another assumption, which has been questioned. For example, Lehman (1992) contends these two

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The introduction of the term “social welfare” leads to more questions than answers. Social welfare obviously obviously means the welfare and and goodness of the community. community. However, “welfare” “welfare” and “goodness” again depend on the value system of the community. The differences between the values of Western civilization and those of Islam have been discussed in chapter 2. Although there are similarities in moral values (Kant’s – categorical imperatives), the modernist and post-modernist trends of Western civilization are not identical with Islam and have many differences. Hence, social welfare in Islam might mean equitable distribution of wealth in an Islamic economy, equal distribution in the communist system, and concentration of wealth to the ones who make use of opportunity in the capitalist system. Another instance would be perhaps, in the West, welfare may be measured more in material terms, while the Muslim might trade-off some return in favor of religion (El-Ashker, 1987) or other ethical objectives. Even in the West, ethical investors may trade-off some monetary return in favour of ethical /religious values (EIRIS, 1993). Hence, social welfare may be

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Thus increasing decision useful information may lead to an increase, decrease or no change in social welfare, welfare, not necessarily necessarily an increase all all the time. A further consideration consideration is that decision usefulness does not elaborate on what uses the information is put to by users. Such disclosure can actually harm the organisation and society (at least locally). For example, Laughlin Laughlin & Puxty Puxty (1981) quote quote the example example of (i) a self-interested self-interested union that makes use of information to force a firm out of business by insisting on high pay and (ii) the social consequences arising for a particular geographical area which was dependent on the business. In this case, decision-usefulness decision-usefulness was not useful to the local community. In certain cases, firms may wish to restrict information disclosure i.e. in the case where a firm exploits a gap in the market and exploits arbitrage opportunities and in the case where they have come up with better techniques of production due to their research and development activities. In this this case, case, the disclosure of segmental segmental information “useful to users” would lead to the entry of competitors competitors resulting in loss on the part of the firm

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less than 30% of the public are direct investors in the share-market (Mullin, 1998). In developing countries, especially Muslim countries, this percentage is even less. Hence this point is particularly valid for Muslim countries who do not have developed stock markets and who may not wish to construct “wealth-siphoning” structures in their countries. 3.2.4

The Societal Assumptions of Decision-usef ulness

Accounting is normally seen as a complex set of socially neutral techniques which are value free and objective. However, the reality is that accounting is a social construction (Hines, 1988). Gray et al. (1996) warns us that reductionism leads to artificial systems boundaries around those parts we might choose to ignore (e.g. ethics, values, exploitation, and the natural environment). Using the General Systems Theory framework, they assert that accounting, ecology, ecology, society, organisations organisations etc., are all all systems, which which interact. interact.

These

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

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Gray et al. (1996) posits that decision usefulness is a normative justification for accountants and the accounting profession acting under such a conception of society. Such a society is beset with contradictions. In real life, people are not equally endowed financially, intellectually and socially. It is powerful groups acting in their own interests, which make decisions. Decision usefulness is viewed by Gray et al. (1996) has having many internal contradictions e.g. the financial financial measure of societal wealth and and its distribution. distribution.

This

sometimes leads to anomalies where environmental degradation is counted as an increase in GDP. The increasing increasing gap between rich rich and poor is not questioned questioned in such a society. It has no room for environmental environmental or ethical values other than self-interested utilitarianism. utilitarianism. Thus accounting which emphasises the desirability of actions by its financial consequences (i.e. profits as a ‘good’) supports a certain moral position and encourages a certain behaviour, which is represented as “ moral” by accounting numbers. In questioning why a talented group such as accountants should exert so much effort to

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The asymmetry of decision-usefulness decision-usefulness arises arises from the non-substitutability non-substitutability of the dual role played by it; as a criterion for making judgements about the value of accounting data and as an explanation of the phenomenon the accounting data represent. The consequence of this asymmetry is that contradictions are created; for example , in the case of the FASB project between SFAC 1, objective and the constraints imposed in SFAC2 , Qualitative characteristics. According to Williams, there is no necessary property to explain these constraints on the production of accounting data. Accountability on the other hand, is a more appropriate principle as it implies constraints and possesses fairness as an inherent property. The second problem asserted by Williams is that the rationale of decision usefulness in the efficient allocation of resources is problematic because it ignores issues about the distribution of those resources. resources. He argues that that “Efficiency or allocation allocation is but one aspect aspect of a two-aspect process” (p176). Although accountants seem to ignore the problem, they

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up their operations into property development and property investing and pay substantially more tax, if they had, had to adopt the provisions of SSAP 12. Although these companies were exempted in the UK, companies in the US were not spared the negative economic and organisational consequences of the introduction of SAS 8 on Foreign exchange transactions. Laughlin & Puxty (1981) blame the myopia of “decision usefulness” on the misinformed dichotomy between external and internal accounting which ignores “ the control nature of all accounting information and the need to take account of the reporting entity’s needs in financial reports” (p74). They suggest an alternative framework of organisational control which they claim can lead to social welfare (under specified conditions). They posit that internal internal and external accounting accounting should be designed in such such a way so as to meet the needs of the organisation i.e. the content should be such that it increases organisational organisational effectiveness in terms of goal achievement. achievement. Under this framework framework , the major

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Conclusions on the Decision-Usef ulness Ob jectives of Conventional Accounting.

We can therefore conclude that the decision usefulness paradigm of conventional accounting is flawed because: 1. The theory that provision of conventional conventional accounting information information leads to efficient allocation of resources is tenuous because there are two many ‘ifs’ in the sequence of assumptions. 2. Even if information information results in shareholder shareholder and creditor wealth maximization, maximization, this does does not mean better welfare even for themselves, much less for the wider community and society because material wealth may not necessarily mean better quality of life and welfare. 3. Even in economic economic terms, decision-user decision-user based accounting accounting may be economically economically harmful to the organisation providing the information which may even result in social dislocation. 4. The economic environment environment hypothesised hypothesised for decision decision useful accounting accounting is a developed developed exchange economy with a capital market focus. This implies that conventional

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accounting techniques. He includes the historical cost, revenue, matching, objectivity and full-disclosure, conservatism, materiality and the uniformity and comparability concepts as principles.

Belkaoui classifies

the monetary measurement and entity concepts as

postulates. Accounting information produced in accordance to these principles is often put forward as objective, neutral, verifiable and reliable. However, even the economic consequences produced by the accounts prepared under these principles were shown to be wanting as early as 1931 by MacNeal. These principles and concepts have been criticised both from the capitalist (e.g. Edwards & Bell, 1961; Chambers, 1966; Stirling, 1970) and Islamic points of view (Abdelgader, 1994) although the latter was at a superficial level (see Adnan & Gaffikin, 1997). MacNeal (1970, [1939]), argued that accounting was ‘untruthful’ as it consisted of ‘unsound accounting principles’ which he claimed was based on ‘expediency rather than the truth’ (p

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was higher than the prevailing market price. Thus, the accounting principles principles were acceptable for this period, as the accountant could satisfy both the interest of the banker by being conservative, and the businessman/owner would not be mislead as the latter knew the real value of his assets independent of the accountant. The accountant, left with the question of valuing non-marketable fixed assets invented his theory of the going concern so that he could justify its valuation in terms of its original cost less depreciation for maintenance and renewal. Mergers and Acquisitions led to bigger and bigger corporations controlled by non-owner management. This led to a situation where many small shareholders were entirely dependent on financial statements for information to make their investment decisions. The accounting principles led to the preparation of financial statements which ‘frequently allow managers and directors of a company to enrich themselves at the expense of the stockholders in a most comfortable and legal manner’.

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by Lowe (1970) for “multiple-column reporting” alternate values and the proposal to report both realised and realisable profits by Edwards & Bell (1961). The Trueblood Committee Report was rejected because it was too revolutionary. The monetary measurement concept also produces problems as it implies only activity, which is measurable in terms of money, are recorded and reported. This may leave out activities, which are termed externalities because they are too difficult to measure but which have grave consequences to society. Further, the most important asset, the human asset is not recorded on a balance sheet. Besides the economic consequences on investors noted above, Accounting rules have also social consequences, Tinker (1985) observers that: “Accounting rules though galvanizing and adjudicating social relationships are not supported supported by ‘contemplation, ‘contemplation, reflection, reflection, criticism and debate debate about the nature of society and its potentialities ‘ but by ‘ expedient reasoning, ad-hoc explanations and piecemeal rationalizations”. (Tinker, 1985, p XX)

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

These income determination problems become more acute in an Islamic environment because, Islam does not allow pre-arranged fixed return investments and therefore the income calculation is the only way to ascertain returns on an Islamic investment. Hence, its importance.

3.4

THE MACRO CONSEQUENCES OF CONVENTIONAL ACCOUNTING

Professional accountants argue that the political and social consequences of accounting practice should not be be considered because because accounting accounting strives to be objective and and neutral in social conflict. Accounting records, measures and reports the results of ‘economic activities’ of enterprises which are delineated from social activities (AAA, 1966). This separation of social and economic spheres of activity has already been criticised from an economic viewpoint, in section 3.2.2 above.

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expropriation of the life experience of others “through the partisan set of accounting rules that governs the reporting and disclosure of information about corporations” corporations” (p xix) , In this context, accounting has been accused of playing changing roles in social conflicts (Lehman, 1992a) and creating social and environmental disasters (Tinker, 1985), its principles unsuitable in the context of providing information on ecological issues (Maunders & Burrit ,1991). It has been accused of creating employment employment problems problems especially especially through promoting privatization by demonstrating the efficiency of downsized companies using accounting numbers (Cooper & Hopper, 1988; Arnold & Cooper, 1999). Accounting has also been accused of directly causing social conflict by increasing the gap between rich and poor through the wealth distribution effects inherent in the provision of conventional accounting numbers (Tinker, 1985). 1985). Further accounting has has also been accused accused of dehumanizing dehumanizing effects arising from the construction of the “governable person” who is a more manageable and efficient entity (Miller & O’Leary, 1987). It has also been accused of promoting gender

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The negative social consequences of accounting are emphasised by Marxist writers who criticise accounting in the historical materialist framework of Marx. They emphasise classconflicts. Even within the limited insight of Marxism, the social, environmental and economic problems caused by conventional accounting which they highlight is of concern to Muslims. Some of these problems will be examined under the following headings; Multinational exploitation, privatisation and loss of work and environmental problems. The dehumanising effects of internal accounting systems are considered under the behavioural effects of accounting in section 3.5. 3.4.1

Multinational Exploitation

Tinker (1985) examined the accounts accounts of the Sierra Leone Development Development Corporation from its inception until its dissolution over a pre and post independence period. Although the traditional profit and loss accounts shows a profitable operation, behind these numbers lay a very different social and economic story. He concluded that investment by Multinationals in

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results of the individual individual subsidiary (Mouritsen, 1995).

For example, example, foreign foreign lumber lumber

companies operating in Papua New Guinea, sell their lumber to associated companies in Hong Kong at a lower than world market prices in order to reduce payment of local taxes. As in the Sierra Leone Corporation’s case, local people are paid miserably lower wages than the expatriates who occupy the management and technical positions. The use of franchises allows a company to milk its overseas associates through charging advisory or franchise fees, fees, which are based on the revenue revenue received, received, and not profits. These fees are reported as expenses and sometimes manipulated to avoid local tax. According to Mouritsen (1995), local governments have to implement benign procedures to control transfer pricing as they are under the constant threat of withdrawal of the foreign investment and the ensuing loss of jobs. The establishment and adoption of International Accounting Standards perpetuate this problem of transfer pricing by multinationals multinationals (see Hove, 1989). 342

Privatisation

Loss of work and Public Property

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No mention is made made of the protection of workers. The social social importance of of the water, rail and even health sectors (henceforth to be called industries) were to be de-emphasised. de-emphasised. New accounting based performance indicators were to be used to gauge their viability. Accounting was used to prove them inefficient and non-viable, although this was contested by the academic accountants (Hopper & Cooper, 1988). Recent studies (e.g. Shaoul, 1997a) have shown that even the economic objectives of efficiency and the anticipated anticipated ‘benefit for all’ have not not been realised. realised.

Shaoul (1997a) (1997a)

critically studied the financial performance of ten water and sewerage companies, which were privatised in 1989. He concluded that private ownership did not increase the efficiency of the industry and that ownership was not the most important factor in determining performance. Further, the privatisation transferred wealth from the public at large to a relatively few individuals and corporate entities. “Consumer found that prices rose by more than 50%, workers lost their jobs and the nation... made a huge loss on the sale” (p 500). A

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the company by millions of pounds. The value of the share had increased from £1 (at which the Treasury had sold it) to £37 in 18 months. Some employees later sued KPMG Peat Marwick for undervaluing the shares. The case was settled out of court. The industrial tribunal found that the company has constructively dismissed the workers but also awarded them a paltry sum of £10,000 for the loss of security and work conditions and benefits. The same story is repeated in other cases of privatisations e.g. British Gas, British Telecom and Water Authorities where Directors are awarded huge executive salaries and perks when the companies were down sized to affect the “efficiency” indicators of accounting numbers. The above cases show the role of accounting in the redistribution of wealth resulting from privatisation, especially the social implications of accounting and accountants’ involvement in privatisation consulting. It shows the role of major accounting firms in the neo-liberal privatisation program. program. An Ernst & Whinney Whinney report claimed claimed that the Big Six firms were the the dominant providers of privatisation advisory services (EW, 1994 as quoted by Arnold &

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off and drains non-sustainable resources (e.g. oil and other minerals). Hence business has to play an effective part in controlling, reducing and perhaps reversing the damage to the environment by using different energy sources, using recyclable raw and packaging materials, using pollution control equipment, promoting a greener employment and consumer practices. Accounting plays an important part in disguising the environmental impact of economic activities because it only considers financially measurable economic events. Even for these events, it fails to take into account disposal and winding down and contingent cleaning up costs. For example, in the case of nuclear plants, substantial expenses are incurred in shutting down old plants because of the cost of disposing radioactive radioactive materials safely. These deferred costs are not accrued and hence earnings are higher than they should be. Further social and health costs are passed on to the community and government because they are termed externalities and are not costed by the conventional accounting system unless there

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discernible until many accounting periods in the future. In these circumstances, contingent liabilities need to be disclosed in the notes to the accounts. An instance in point is the case of the Love Canal (Tinker, 1985). Here, the company caused pollution by dumping toxic wastes into the Love Canal, which were covered up with earth. Later a housing development was undertaken on the same land. The residents later noted serious health problems including miscarriages and premature deaths. The whole area became uninhabitable, and the residents had to move to another area losing money on their mortgages as well as suffering health problems. The company polluting love canal did not disclose, even as contingent liabilities, the cost incurred in the clean up and upheaval later. Tinker rightly asserts that there are broad implications of these these costs for calculating and and reporting period period profits. The matter matter of what additional costs and when these costs should be reported are not clear. According to Tinker (1985), the Generally Accepted Accounting Principles under-rate long-term costs and

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regulation until 1969, 1969, for almost 70 years. Initially, the economic rationality rationality of reducing costs was used to rationalise the measures to reduce sulphur emissions. emissions. Only after legislation was imposed, did the company set up an Environmental Improvement Project which resulted in an improvement to its bottom line as a result of technological development. There was tension between profits on the one hand and pollution prevention on the other, during the 1970’s, when technology did not keep pace with regulation. The environmental disclosures in the corporate reports were scarce in the early years, as there was nothing positive to report. Buhr (1998) posits that, by focusing on economic economic concerns and and not on the pollution prevention efforts, the accounting reports were used to stave off further legislation by showing how costly it was for the company to adhere to the anti-pollution legislation. However, from 1980 to 1984, the disclosure of improvement in pollution prevention technology (which had a positive impact on the bottom line) offered an image of an environmentally friendly company. Later, public opinion had swung so far over to pollution

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Lehman (1995), on the other hand, argues that a moral obligation exists to provide additional additional environmental information information in published published accounting reports. reports. In this way, corporations corporations would satisfy accountability relationships as part of an administrative solution to the environmental crisis. He argues that “through this accountability nexus, accounting would take on the role of constraining organisational activities, particularly those that may be considered environmentally environmentally degrading” (p396). Thus the legitimate concern for fairness (Williams, 1987) i.e. the moral aspect should establish the need for corporations to disclose environmental data, not technology, profit and legitimation exercises. Lehman bases his argument on Rawl's theory of Justice and Political Liberalism. This theory draws on the sanctity sanctity of the individual individual which is decided by the inter-subjectively inter-subjectively shared group language of the new pluralism. Although this basis may not be acceptable from the Islamic viewpoint, the researcher supports his call. Gray (1992) envisages a similar change in thinking and life-style in his call for a “radical

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The implementation of decision-making and control techniques such as budgeting, variance accounting and performance measurements leads to certain motivations and behaviour within the organisation. Although these techniques are rationalist-technical in character, the social consequences can be both positive (e.g. Roberts & Scapens, 1985) or negative (Argyris, 1953; Richardson et al., 1996). These techniques are meant to achieve goal congruence between the employees and the organisation, for example, by enabling individuals to take responsibility (as in responsibility accounting) for their actions and rewarding or disciplining disciplining those who succeed or fail according according to the accounting accounting numbers. numbers. When the goals of the organisations are based on utilitarian and marginalist economics, they may not be compatible for Islamic organisations, which have socioeconomic goals and values other than profit or wealth maximisation. Although these accounting techniques on the surface seem to make individuals responsible for the economic consequences of their actions and decisions, it seems that a rift has arisen

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may also arise. In the long run, the effect on the individuals is reflected in the organisation which can become “schizoid” (Richardson et al., 1996) and progress into wider social conflict (Lehman, 1992a). The problems associated with conventional management accounting technique of budgeting , performance performance measurement measurement and and the problem of control will will now be reviewed briefly as as these problems of conventional accounting techniques have implications for Muslim employee and organisational organisational behaviour which which may make these techniques inappropriate inappropriate for Muslim users and Islamic organisations. 3.5.1

Behavioural research: human problems of budgets

The human problems with budgeting have long been recognised. In 1952, Chris Argyris (Argyris, 1953) found that that budgets were viewed as a “pressure” device to increase production efficiency by raising workers’ goals and increasing motivation (to produce more). He found that budgets being written, concrete, evaluatory instruments, they were used by

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conflict could lead the players players to feel embarrassment embarrassment or threat. Using budgets to compel, compel, force, search out mistakes can lead to activation of organisational “defensive routines” 2, such as gaming, smoothing, filtering, biasing, focusing, and illegal acts, that by pass the cause of the threat and cover up the by-pass. Hughes (1965), notes another problem with budgeting, that of padding the budget. This is particularly problematic problematic if managers managers threaten sanctions sanctions for over-spending. over-spending. If each level of management punishes the next lower level for overspending, then each level will add contingencies to its estimates, inflating the total budget. While accounting control techniques results in accountants becoming coercive, fault-finding and threatening, and creates tensions and and pressures on line supervisors supervisors and workers, workers, it also leads to dysfunctional effects (violation of system rules and procedures) on other departmental managers managers as well (Jaworski & Young, 1992). 1992). In a survey of 500 marketing managers, they found that when the individual internalizes the goals, values and beliefs of

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that “a useful Management Control System cannot confine itself solely to accounting measures of performance. It should also take into account the non-financial and technical measures of performance and those areas of performance that cannot be measured in precise, quantitative terms. However, the example of such areas, he quotes i.e. market share and competitive position, are still profit oriented measures. The cybernetic or feedback control system is the most often used model for accounting control (e.g. Berry et al., 1995). However the effectiveness of this cybernetic model has been found lacking in effectiveness and attributed to failure and hence in need of revision (Dermer & Lucas 1986). Dermer & Lucas (1986) assert that managerial control is an illusion, which fosters the belief among managers that conventional controls such as operating standards, profit targets, and budgetary criteria accurately and validly measure and determine behaviour. Quoting Hofstede (1978), they assert that prior social conditions implied by cybernetic models or the social consequences of such models have not received

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Argyris (1990) holds that managerial accounting systems can be threatening because they evaluate performance. Further, Townley (1996) asserts that individuals have been called to account for their performance through the “process of examination and confession” which serve as disciplinary practices and impacts on the construction of accountability within organisations. organisations. Townley argues that that the examination form of appraisal appraisal reflects a lack of trust, which it seeks to circumvent through compulsory visibility. The confessional form of appraisal is more discreet but the “power-knowledge dyad and the mechanism whereby humans are objectivised are not absent. From the above discussion, it can be seen that management accounting tools such as budgeting, performance evaluation and variance accounting have negative individual and social consequences. These consequences are also not acceptable from an Islamic perspective. This calls for alternative Islamic accounting techniques to induce more appropriate Islamic behaviour.

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From an Islamic viewpoint, the pleasure of God is the ultimate aim and ‘falah’ - success in the world and the hereafter, - the ultimate objective. Hence, social and individual welfare and quality of life is not merely measured in material terms but both spiritual and material. Islam has comprehensive principles and elaborate rules in the economic, social and political arena. Hence utilitarian social welfare is not the aim of Islam and therefore should not be the aim of a Muslim society. From the Qur’anic abhorrence of inequity and concentration of wealth among selected groups of people, Muslim society would certainly not to seek to enrich only shareholders and even less creditors (because interest is forbidden). Its imposition of the halal/haram dichotomy in transactions is meant to ensure equitable investment and earnings. With the imposition of Zakat, Sadaqah  (charity) and Infaq  (any benevolent spending approved by the Shari’ah) as wealth redistribution redistribution measures, Islam seeks seeks to have equitable equitable distribution of wealth to all members of society. Thus making money and and unbridled consumption consumption is not

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Although, the above verse apparently refers to writing of debt contracts, it would not be too far fetched to extend it to accounting. For example, Littleton (1966) has mentioned that amongst the other antecedents of modern accounting, credit and writing are two important preconditions for the emergence of systematic bookkeeping under stewardship accounting. Investors are almost akin to creditors, their capital is akin to a loan (a liability of the business to its owners), which has to be paid back barring losses or with the addition of the agreed share of profit. The inherent accountability to God in all actions point to an accountability framework framework such as that of Gray et al. (1996) but modified for an Islamic Islamic setting. This will be taken up in more detail in Chapter 6.

3.6.1.2 Accounting objectives; an Islamic framework Other than the framework of accountability, the following objectives of accounting may be more suitable from an Islamic point of view.

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since Muslims cannot differentiate a worship activity from a non-worship activity (Adnan &Gaffikin, 1997). 1997). The God fearing Muslim Muslim may be be more unwilling unwilling to cheat

on Zakat

(although he might cheat on tax!) because unlike tax, Zakat is a religious obligation obligation for which He has to account account for, to Allah on the Day Day of Judgment. Further, the assurance that Zakat has specific recipients defined in the Qur’an itself, motivates one to pay more rather than less because the Zakat payer knows it will be mostly used for the poor and the destitute rather than grandiose projects of governments. However, there is a need for greater accountability and transparency through a more suitable accounting system than the one practiced at present to avoid irregularities. If Zakat is made the main objective of accounting, there is a possibility that window dressing will be reduced while fraudulent disclosure and creative accounting which are ever present in conventional accounting might disappear. The Muslim accountants and Muslim managers may not undertake such ventures because they would be depriving the poor and destitute of

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Muslim countries. It is even more unsuitable for those Muslim countries, which are trying to develop an Islamic society with an Islamic economic and financial system. Muslim society normatively has different ethical value systems with corresponding economic codes. Even if it is argued that Muslim countries are developing along the lines of the West and conventional accounting will be useful for developing these countries in the Western model, there are both practical and religious reasons why these countries should not adopt such a development model (see for example, Ahmad, 1979). Despite the pressures of globalisation intended to create Muslim societies in the “Pristine Liberal Economic Democracy” (PLED) image, Islamic resurgence in Muslim countries has been in some ways going in a different direction. Some of these trends are discussed in Chapter 4 and 5. Decision usefulness based accounting can only lead to consequences, which are not the main aim of these societies societies and in the case of Islamic, Islamic, organisations trying trying to achieve specific Islamic objectives, could be even positively harmful.

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Characteristics of conventional accounting

3.6.2.1 The unsuitability of the historical cost and and the prudence concept. From, an Islamic point of view, the reasons given by MacNeal (1970) for the unsuitability of the conservatism and and cost concepts are particularly particularly relevant. relevant. Since Islam bans interest, the cost and prudence concept, which arose in relation to interest- based banking and credit, would not be applicable under an Islamic economic system. Further, the maintenance of equity between current, past and potential shareholders shareholders is very important in Islam’s quest for fairness accounting in line with its concept of justice. The assessment of Zakat needs to be based on current value as otherwise, this would lead to appropriation of wealth from the poor to the rich in times of rising prices and values. On the other hand, current valuations of items such as goodwill and brands may overstate the value of corporate assets because they depend on uncertain forecasts. This has led to over-valuation of shares in the past and ended up defrauding outsiders. Hence, fairness of values (to the extent possible) is required

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prohibition on interest means, the main ways a capitalist can participate in business is by partnership, equity shareholding shareholding and commenda. commenda. All these three legitimate methods methods require the computation computation of of income and asset asset valuations valuations for profit distribution.

Further in in

conventional accounting, the investor is considered more a lender of capital than a participant in the business. Hence, the concentration on return is geared towards interest cover. The search for an alternative banking institution resulted in the creation of Islamic banks and Insurance ( takaful ) companies in Muslim and Western countries which finance their customers through these allowed methods (See Chapter 5 for more details). The creation of these Islamic financial institutions has resulted in the mobilisation of funds from Muslims and non-Muslims (Ali, 1994) 1994) which has been estimated at at US$ 137 billions (IAIB, 1997). These funds are mobilised either based on ‘al wadia’ (safe (safe custody) with return of deposit guaranteed but no interest is paid. However, the bank can utilise the funds while in its

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several problems in his investigation of profit determination and distribution by Islamic banks in Sudan.

These include including relating return on deposits to investments maturity

periods, pooling of various funds and in ensuring fairness among different type of depositors. The development of Islamic institutions in banking, business, government and voluntary sectors and their requirement for a new form of accounting to achieve their objectives demonstrates an added urgency to the development of an alternative Islamic accounting if these institutions are not to be submerged in the capitalist economic culture. They constitute the ‘pull factors’ for Islamic accounting which will be discussed in chapter 5. Further, both wealth wealth and profits profits are the base on which Zakat (Islamic tax) is assessed for individuals and organisations. Hence, the continued use of a historic cost model may result in negative wealth transfer effects. The valuation of stocks at the lower of cost and net realisable value is certainly not acceptable from an Islamic perspective because it leads to lower profits (in times of of rising prices) and thus thus Zakat being undervalued. undervalued. This leads to a

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subject to private private ownership. ownership.

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Unfortunately, the the privatisation privatisation trend is being repeated repeated in

Muslim countries like Pakistan and Malaysia. In view of the fact that these countries generally do not have transparent and accountable governments, the privatisation effects are arguably worse because they redistribute wealth to cronies of politicians as well as increase the cost of living for its citizens. In case of Malaysia, for example, privatisation of sewerage services has resulted in consumers and businesses being charged on their water usage and property valuation valuation instead of their actual use of these services. This has resulted resulted in windfall profits for the sewerage Company (which is a monopoly). The establishments of toll highways, which have taken over existing public highways and forced excessive charges on the public for tens of years, have enslaved generations of taxpayers to the new corporations. The lack of corresponding and effective watchdog agencies which are created in the West is also worrying; worrying; when services are privatised privatised , these bodies bodies are either totally absent or are small and ineffective ‘captured’ regulatory agencies which are the skeletons of

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Prophet’s Hadith, it is stated that a prostitute who used her shoes to get water out of a well to give to a thirsty dog was sent to heaven, whereas the ill treatment of a cat sent an otherwise pious woman to hell. Another Hadith states that: “There is no Muslim who plants a tree or sows a field and a human, bird or animals eat from it, but it shall be reckoned as charity for him”. (Mishkat al-Masabih, Vol.1, p115, as quoted by Akhtar, 1996)

Even in times of war, Muslims soldiers cannot follow a scorched earth policy. The first Caliph of Islam after the Prophet instructed his General to strictly observe environmental values even in enemy territory. He wrote “Do not cut down a tree, abuse a river, do not harm crops and animals, and always be kind and humble to Allah’s creation , even to your enemies.” This dictum is mostly born out in Muslim history (see for example Daniel, 1993). Chapra (1992) bases the Islamic ethical foundations for the protection of the environment under the principal of “No injury”. Since Muslims are prevented from harming others, the environment has to be protected.

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3.6.3.3 Micro behavioural consequences While the protection of individual liberty or ‘class conflict’ may be the issue of most concern to Western writers who are researching this issue, both the individual and social consequences of accounting are important from an Islamic perspective. The substitution of selfishness for caring, confrontation for co-operation, a short term ‘you only live once’ paradigm for a long-term spiritual dual world-view to is both socially and religiously unacceptable from an Islamic viewpoint. The concern becomes more acute if these individuals are charged with the altruistic Islamic mission of guiding Islamic organisations which are specifically established to achieve Islamic socioeconomic objectives as outlined in chapter 2 and 5. This will certainly lead to goal incongruence between Islamic organisations and the Muslims or other employees who work for these organisations, organisations, the consequences of which, are not only economic but social and moral. Islamic organisations will certainly be unable to achieve their objectives while Muslim organisations will become the breeding

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The accounting principles on which conventional accounting reports are prepared may be unsuitable for the direct and indirect equitable distribution of wealth and the calculation of Zakat which is the one of the most important objective of Islamic accounting.

•

The problem with historic cost income models becomes more problematic in a Muslim environment environment where profit is the main means of ascertaining divisible returns to finance providers as interest is prohibited.

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The negative economic and social consequences of conventional accounting on the environment, environment, society and individuals are unacceptable unacceptable from an Islamic point of view.

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Conventional management accounting systems may leads to behaviour which is dysfunctional not only in terms of organisational goal achievement but in terms of the moral and ethical consequences of individual and group Islamic behaviour.

The researcher has grouped these factors as the “push factors” for the development of an

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FIGURE 3-2:THE NEED FOR ISLAMIC ACCOUNTING: PUSH FACTORS

OBJECTIVES:

CHARACTERISTICS

DECISION-

MEASUREMENT

CONSEQUENCES:

VALUATION

USEFULNESS

INCOME MODELS

DIFFERENT ECONOMIC

•

HISTORICAL COST

ENVIRONMENT

•

MONETARY MEASUREMENT

•

WRONG ASSUMPTIONS

•

CONSERVATISM

•

DIFFERENT WELFARE

•

INCOME MODELS

CONCEPT

•

DISCLOSURES

•

•

•

•

•

MULTINATIONAL

•

FRAUD AND CHEATING

EXPLOITATION

•

SELFISHNESS & MATERIALISM

INEQUITABLE WEALTH TRANSFERS

•

CONFLICT

LOSS OF WORK & PUBLIC

•

LOSS OF ULTIMATE

PROPERTY

DIFFERENT SOCIETY AND VALUES

MICRO

MACRO

PRINCIPLES / CONVENTIONS

•

ENVIRONMENTAL PROBLEMS

•

UNISLAMIC EFFECTS

MISSION & WORLDVIEW •

MANIPULATION MANIPULATION & HAGEMONEY