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THE CRITICAL ASPECT ON FAIR VALUE ACCOUNTING AND 
ITS IMPLICATION TO ISLAMIC FINANCIAL INSTITUTIONS

Jamaluddin Majid & Safri Haliding1

Abstract: The Critical Aspect on Fair Value Accounting And Its Implication 
To Islamic Financial Institutions. Fair value accounting (FVA) paradigm 
replaced the historical cost accounting (HCA) in the development of 
accounting standards that FVA is more relevant that HCA probably did not 
provide the real financial and income information. This paper tries to explore 
critical aspects of the fair value accounting and its implications to Islamic 
Financial Institutions implications. This study concludes that that fair value 
accounting measurement provides many critical aspects to be implemented 
to Islamic Financial Institutions (IFIs). AAOIFI proposed cash equivalent 
value as respond to fair value measurement  that cash equivalent value when 
the attribute condition are present such as the relevance, reliability and 
understandability of the resulting information.  

Keywords: Fair Value Accounting, Islamic Financial Institutions, IFRS, 
AAOIFI

Abstrak: Tinjauan Kritis Terhadap Nilai Wajar Akuntansi Serta 
Implikasinya Terhadap Institusi Keuangan Islam. Paradigma nilai wajar 
akuntansi telah menggantikan penilaian histori akuntansi dalam pengembangan 
standar akuntansi dimana nilai wajar akuntansi lebih relevan daripada nilai 
histori akuntansi yang tidak memberikan pembaharuan informasi keuangan 
dan pendapatan. Penelitian ini mencoba mendalami aspek kritik pada 
nilai wajar akuntansi dan bagaimana implikasinya pada lembaga keuangan 
Islam. Penelitian ini menyimpulkan bahwa pengukuran nilai wajar memiliki 
kekurangan apabila digunakan pada lembaga keuangan Islam. AAOIFI telah 
menyediakan cash equivalent value (CEV) untuk merespon pengukuran nilai 
wajar, dimana cash equivalent value lebih memberikan informasi yang relevan, 
lebih dapat dipercaya dan lebih mudah dipahami. 

Kata Kunci: Nilai Wajar Akuntansi, Institusi Keuangan Islam, IFRS, AAOIFI

 1 Diterima: 12 April 2014, direvisi: 25 Mei 2014, disetujui: 3 Juni 2014
JamaluddinMajid is an accounting lecturer at Universitas Islam Negeri (UIN) Alauddin, Makassar, 
email: jamal_majid55@yahoo.com 
Safri Haliding, lecturer at Faculty of Economics, Muhammadiyah University of Makassar, Indonesia 
and part time lecturer at UIN Alauddin Makassar and doing his master in accounting at International 
Islamic University Malaysia (IIUM). Email: safrihaliding@yahoo.com and safrihaliding@gmail.com



Al-Iqtishad: Vol. VI No. 2, Juli 2014 284

INTRODUCTION 

Recently, the fair value measurement and its implication in accounting 
standards have been increasing (Ramanna, 2006). In around the world, including 
the United States, the United Kingdom, Australia, and the European Union, many 
jurisdictions of accounting standards have issued standards that fair value is primary 
recognition of balance sheet and income (Landsman,2006).

One of the important aspects of financial reporting is measurement (Barth, 
2007). Barlev and Haddad (2003) state that the fair value accounting (FVA) 
paradigm replaced the historical cost accounting (HCA) in the development of 
accounting standards that FVA is more value relevant that HCA probably did not 
provide the real financial information and income. Therefore, Barlev and Haddad 
(2003) argue that the measurement of financial reporting should be relevance in 
regard to some issues in financial reporting such as the stewardship function, agency 
costs, managementefficiency, and relevant information to stakeholders and workers 
in terms of social conflict.

However, previously studies mention that fair value accounting suffers from 
some serious limitations and disadvantages such as issues in market approach, income 
approach, and cost approach, (for instance: Ball, 2006; Barth, 2007; Deans, 2007; 
Penman, 2007; Benston, 2008;Ramanna, 2008; Barth and Taylor, 2009;  Holban 
(Oncioiu),and Oncioiu, 2009; So and Smith, 2009; Xia and  Monroe, 2010; Jr, 
2011).Therefore, Penman (2007) is questioning that whether fair value accounting 
is really measuring the economic value and market value of businesses activities. 

In addition, Al-Yassen and Al-Khadash (2011) argue that accounting 
standard setters such as the International Accounting Standards Board (IASB) UK 
and the Financial Accounting Standards Board (FASB) U.S as well as other national 
accounting standard setters provide high attention and long-term ambition to use 
fair value accounting as full measurement in all financial instruments.However, 
regarding to Islamic Financial Institutions (IFIs) that have different objectives and 
principles as well as have different financial products with conventional financial 
institution. Therefore, Abdul Rahman (2012) argues that fully adopting International 
Financial Reporting Standards (IFRS) issued by IFRS-IASB probably there will 
no specific standards for unique functions of Islamic Financial Institutions. This 
argument supports previous paper that Ibrahim (2007) states that Islamic Financial 
Institutions cannot fully comply with IFRS in their financial reporting because 
Islamic Financial Institutions have some unique requirement.

This paper tries to explore critical aspects of the fair value accounting and its 
implications to Islamic Financial Institutions implications. The paper is organized 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  285

into four sections. The first section provides the information on fair value accounting 
and the primary drives of International accounting standard setters. The second 
section highlights the pros and cons on fair value accounting. This section discusses 
the critical aspect on fair value accounting. Additionally, this section reviews 
some implication to financial institutions. The third section reviews the fair value 
accounting implication to Islamic Financial Institutions. This section also highlights 
the Islamic Accounting Standards namely Accounting and Auditing Organizations 
for Islamic Financial Institutions (AAOIFI) and some related issues with regard to 
Islamic finance products. The next section will focus on the conclusion remarks. 

OVERVIEW OF FAIR VALUE ACCOUNTING

The development of fair value paradigm may take many steps and a number 
of avenues by accounting profession and the standard setting bodies that probably 
using a sociological approach and an economic viewpoint regarding to the demand 
and supply of accounting principles(Berlev and Haddad, 2003).

Therefore, when regulatory bodies adopts a financial reporting paradigm 
that it becomes the guiding principle for regulation in accounting standards (Hitz, 
2007). In terms of the definition of fair value that both US GAAP and IFRS have 
own explanation with regard to term of fair value accounting.The definitions of fair 
value based on accounting standard setters’ view areas follows:
US GAAP Fair Value Accounting Perspective

Bragg (2010) published a book that “GAAP 2011, interpretation and 
application Generally Accepted Accounting Principles”. Bragg (2010) highlights 
the overview of FVA under GAAP. Moreover, the definition of fair value according 
to GAAP,ASC 820 that 

“the price that would be received to sell an assets or paid to transfer a liability in an 
orderly transaction between market participants at the measurement date”.
In this definition also mentioned that “although GAAP literature has primarily 

focused on fair value in the context assets and liabilities, the definition also applies 
to instruments classified in equity” (Bragg, 2010).Regarding to this definition Chea 
(2011) argues that fair value is market based that in fair value also takes consideration 
with other market participants for pricing an asset and liability.

In order to understand the concept of fair value that Bragg (2010) highlights 
the measurement principles and process under ASC 820 into series of steps. The key 
measurement steps can be listed as follows: 
1.  Identify the item to be valued and unit account.



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 “Specifically identify the asset or liabilities, including the unit of account to be 
used for the measurement”.

2.  Determine the principle or most advantageous market and the relevant market 
participants.

 “From the reporting entity’s perspective, determine the principle market in which 
it would sell the assets or transfer the liabilities”.

3.  Select the valuation premise to be used for asset measurements.
 “If the item being measured is an asset, determine the valuation premise to 

be used by evaluating whether the market place participants would judge the 
highest and best use of the asset utilizing an “in-use” valuation premise or an 
“in-exchange” valuation premise”.

4.  Consider the risk assumptions applicable to liability measurements.
 “If the item being measured is a liability, identify the assumptions that market 

participants would make regarding nonperformance risk including”. 
5.  Identify available inputs.
 “Identify the key assumptions that market participants would use in pricing the 

asset or liabilities, including assumptions about risk”.
6.  Select the appropriate valuation technique(s).
 “Based on the nature assets or liability being valued, the types and and reliability of 

inputs available, determine the appropriate valuation technique or combination 
of technique to use in valuing the asset or liability”.

7.  Make the measurement.
 “Measure the asset or liability”.
8.  Determine amounts to be recognized and information to be disclosed.
 “Determine the amounts and information to be recorded, classified, and disclosed 

in intern and annual financial statements”.
According to Shaffer (2011) describes that there are several rules under 

GAAP that applying fair value accounting. For instance, investment securities and 
derivative contracts on Statement Financial Accounting Standards (SFAS) no. 115 
and SFAS No. 133. Moreover, Shaffer (2011) mentions that the expansion of fair 
value such as SFAS 195 on hybrid instruments and SFAS 156 on servicing rights in 
2006; and fair value option (SFAS 159), business acquisitions (SFAS 141R), and no 
controlling interests (SFAS 160) in 2007.

In addition, regarding to the purpose of fair value measurement that Bragg 
(2010) mentions that inputs are the indicators of assumptions, in pricing asset or 
liabilities is used the market participant as well as assumption with regard to the risk. 
The inputs are described in hierarchy as follow:
1.  Level I Inputs (Directly observable): Quoted prices in active markets for identical 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  287

assets or liabilities that the reporting entity has the  ability to access at the 
measurement date. Such prices are not adjusted for the effects, if any, of the 
reporting entity holding a large block relative to the overall trading volume 
(referred to as a “blockage factor”).

2.  Level II Inputs (Indirectly observable): Directly or indirectly observable prices in 
active markets for similar assets or liabilities; quoted pricesfor identical or similar 
items in markets that are notactive; inputs other than quoted prices (e.g., interest 
rates, yield curves, credit risks, volatilities); or “marketcorroborated inputs.

3. Level III inputs (unobservable):  Inputs that are unobservable; that reflect 
management’s own assumptions about the assumptions market participants 
would make.

IFRS Fair Value Accounting Perspective

IFRS is one of accounting standard issued by the International Accounting 
Standards Board as independent organization based in London, UK.  
Regarding to definition fair value that based on IFRS (2010) fair value is “the amount 
for which an asset could be exchanged, or a liability settled, between knowledgeable, 
willing parties in an arm’s length transaction.

Regarding to the definition of fair value that Cairns (2006) criticizes IFRS 
fair value that there are inconsistency in understanding of the definition and what is 
and what is not fair value with regard to uncertainties about the application IFRS’s 
fair value definition. For instance, IFRS are entry price or exit price of an asset, 
liability and equity instrument. It is not clear to determine IFRS. Therefore, Cairns’ 
study (2006) suggests that when the fair value is used to determine the cost and exit 
price and impairment purpose, entry price should be used.

Ball (2006) states that both IASB and FASB increased over the time the list of 
implementation of fair value accounting. Moreover, Cairns (2006) indicate that in 
order to use the fair value, IFRS allow in four steps. The steps as follows:
1. For the measurement of transactions (and the resulting assets, liabilities and 

equity items) at initial recognition in the financial statements;
2. For the allocation of the initial amount at which a transaction is recognized 

among its constituent parts;
3.  For the subsequent measurement of assets and liabilities; and
4.  In the determination of the recoverable amount of assets.

According to Cairns (2006) that it is important to recognize these steps which 
for the first, second and fourth uses are essential even in the financial statement and 
for the three uses it is not necessary for using the fair value at the subsequent sheet 
date. Additionally, Cairns (2006) argues that for all assets, liabilities, and equity 



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instruments irrespective, IFRS use the fair value as a generic term whether those are 
trade on active  market or quoted. Therefore, fair value is a subset market value that 
in active market, it is fair value as determined (Cairns, 2006).

However, regarding to the asset, liabilities, or equity which are not traded 
in active markets, Cairns (2006) argues that it is likely very difficult, possibly and 
unreliable to be implemented fair value. Indeed, Cairns (2006) highlights that there 
is a flexibility in using fair value under IFRS, if the circumstance is less reliable 
fair value in the initial measurement of an asset or liabilities that IFRS-standards 
prohibit to use fair value in unreliable circumstance (see: IAS 38 intangible assets 
and IAS 39 equity instrument).

Recently, Standard setters accounting both US GAAP and IFRS are 
continuing to develop for expanding the use of fair value (Shaffer, 2011). 
Interestingly, International Accounting Standard Board (IASB) releases the proposal 
on accounting for financial instrument that this proposal uses the approach of fair 
value by mixing the measurement of U.S GAAP and IFRS that IASB and FASB 
tried to provide the new fair value as mixed measurement between US GAAP-FASB 
and IFRS-IASB (Shaffer, 2011).

In addition, the new development of fair value between FASB and IASB 
takes many attentions and responses among practitioners, investors, academics and 
regulator. Therefore, the FASB and IASB continue their proposals to re-deliberate as 
response from feedback and reconcile the differences between fair value under IASB 
and FASB (Shaffer, 2011).

Penman (2007) argues that since both IASB and FASB standards provide 
fair value as mandatory for measure the assets and liabilities, the issues in fair value 
probably are when and how should be applied that  fair value is far from resolved.

Shaffer’ study (2011) finds that in the approach of FASB closely mirrors the 
IASB’s proposed measurement model. For instance, firms are allowed to amortized 
cost to measure the instruments principally of cash flowwhich being held for 
collection or payment such as loans, deposits and debt).

THE DEBATING IN FAIR VALUE ACCOUNTING

This section discusses the critical aspect on fair value accounting both US 
GAAP and IFRS. Additionally, this section reviews some implication to financial 
institutions. 

Regarding to the issues in fair value that Penman (2007) indicates some 
preliminaries with regard to what is fair value? And fair value to whom? Regarding 
to fair value to whom that Penman identifies some notions in fair value.The notions 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  289

of what is fair value as follows (Penman S.H, 2007):
1.  Fair value variously applied in a ‘mixed attribute model’: fair value is used 

alternatively with historical cost for the same asset and liability but at different 
time.

2.  Fair value continually applied as entry value: asset are revalued at their replacement 
cost, with current costs then recorded in the income statements, with unrealized 
(holding) gains and losses also recognized.

3.  Fair value continually applied as exit value: asset and liability are remarked each 
period to current exit price, with unrealized gains and losses from remarking 
recorded a part of income.

In this light, Penman (2007) argues that for the notions 1 and  2 in application 
could be debated due to both are really modified cost accounting, standard revenue 
recognition and applying exit price on actual exit of the product to the market, 
however, notion 3 applies exit prices values  but with-out actual exit (realization).

In addition to fair value to whom,Penman (2007) indicates that the demand 
probably plays important that different users may different demand for accounting 
report. For instance, in the case of a creditworthiness deteriorates the shareholder 
probably use the value a fall in the market value in order to recognize the gain, 
but not the creditor that the bank may use the bank deposits at fair value, not the 
deposits (Penman, 2007). 

Moreover, in bank regulator perspective that if the reporting affected the 
depositors’ confidence in the banking system, the bank regulator may use the value 
is less than face value while investor uses the fair value information with regard to 
volatility, not so a central banker focuses on feedback effects on systematic risk that 
during the speculative times the  a bank regulator focuses on marking up banks’ 
capital (Penman, 2007). Therefore, fair value provides different demand with 
different perspective depend on its perspective of users.
Fair Value under SFAS 157 US GAAP

Regarding to fair value definition under US GAAP, Benston (2008) identifies 
that the new definition of fair value as stated in 5 of SFAS 157 provides two issues: 
firstly, fair value is the exit value of asset and liability, secondly, fair value is often 
not based on actual market transactions. Similarly, Penman (2007) states that there 
are two questions with regard to the FASB and IASB fair value: firstly, whether exit 
value measures value to shareholders and at the level aggregate whether fair value is 
applicable.

Regarding to the shortcoming of SFAS 157 fair value measurement that 
Benston (2008) highlights the shortcomings of US GAAP fair value. The following 



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shortcomings are:  
1.  Fair values not based on actual market prices are costly to determine and verify.
2.  Value in use and entrance value are used, contrary to SFAS 157-specifieds exit 

values.
3.  Transaction costs are used, contrary to SFAS 157.
4.  Fair value for inventories and fixed assets that may be included in business 

combinations present problems that are not recognized.
5.  Fair value other than level 1 could be readily manipulated and difficult to 

verify.
Therefore, based on the above shortcomings of SFAS 157 Benston (2008) 

asserts that there are some problems and cost of constructing, recording, and 
presenting the required numbers in implementing the guideline SFAS 157 US 
GAAP fair value measurement. Moreover, Benston (2008) concludes that FASB uses 
the fair value in order to make the relevance of the numbers presented in financial 
statements to satisfy the users. This is supported in the statement of SFAS 157 
that‘‘should provide users of financial statements (present and potentialinvestors, 
creditors and others) with information that is useful in making investment,credit, 
and similar decisions” (Benston, 2008).

SFAS 157 provides the hierarchy inputs in order to measure from the most 
to least reliable into fair value measurement (Ryan, 2008). In addition to the level 
inputs that Penman (2007) identifies the pluses and minuses regarding to the 
implementation of inputs lever 1, 2, and level 3.The pluses and minuses of level 
inputs as follows:
Pluses and minuses of level 1 fair value measurement

Penman (2007) argues that there is a subjective estimate of fair value of asset 
and liability for shareholders with regard to the idea of accounting information 
probably is based on the objective, reliable evidence. Therefore, Penman provides 
the plus and minus with regard to level 1:
The Plus: “fair (market) values are a plus when value to shareholders is determined 
solely by exposure to market price; that is, shareholder value is one-to-one with market 
prices”. 
The Minus: “fair (market) values are a minus when the firm arbitrages market prices 
that is, fair value is not appropriate when the firm adds value (for shareholders) by 
buying at (input) market prices and  selling at (output) market prices”.
Pluses and minuses of level 2 and 3 fair value measurement

Level 2 and 3 provide the estimates of hypothetical market price which 
there is a subjective estimate in this objectivity of those levels (Penman, 2007). 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  291

For this level 2 and 3 Penman highlights how important the integrity of managers 
with regard to the potential their subjective biases in using this levels as well as 
the effectiveness of the control is very important such as the independence and 
competence of monitors-auditors, assessor and corporate boards.

With regard to the estimated fair value that Penman (2007) provides that 
plus and minuses of level 2 and 3 fair value measurement. Those are as follows:
1. Fair value accounting applies only when shareholder value is solely determined 

by exposure to market prices means that, in most cases, there will be an active 
market where Level 1 measurements are available.

2.  One must question whether Level 3 really enforces a discipline in estimating 
market prices.

3.  Fair value estimation errors introduce error into the balance sheet but also the 
income statement (which reports the change in fair value).

4.  Historical cost involves estimates and estimated fair values are nodifferent.
5.  Historical cost estimates true up against the actual transaction record, and usually 

fairly quickly.
6.  An analyst will have difficulty in carrying out a quality analysis on fair value 

accounting.
7.  The observed market behavior is instructive.
8.  The informative of fair values declines as estimates are introduced.

To sum up, based on the discussion,  my opinion to fair value implications 
that fair value accounting provide pros and cons among researchers that the main 
weakness of the fair value is not indicating as the value of the measurement date at 
large that measurement probably could be manipulate due to subjective estimates. 
Therefore, it provides the bad implication to economics decision regarding to 
substantial uncertainty in fair value measurement. 
Fair Value Accounting IFRS

Regarding to fair value accounting that IASB provides conceptual framework 
as guidance. However, Barth (2007) states that with regard to accounting 
measurement,  IASB’s framework is not providing much guidance such as historical 
cost and settlement value, measurement technique, such as present value that  there 
is no properly guidance to choose among.

In terms of the objective of financial reporting that Barth (2007) quoted 
from IASB in 2006, Para. OB2 as ‘to provide information that is useful to present 
and potential investors and creditors and others in making investment, credit, and 
similar resource allocation decisions’.

In this light, Barth (2007) argues that the objective of financial reporting as 



Al-Iqtishad: Vol. VI No. 2, Juli 2014 292

provided in IASB seems focus on investors or investing decision  that the terms of 
‘investor’ in objective of financial reporting refers to present and potential equity 
holders and their advisers,  the term ‘creditor’ refers to present and potential  lenders 
and their advisers.

The implementation of IASB seems providing some misunderstandings with 
regard to decision due to accounting measurement in the real-world economic 
phenomena do not specify how to measure the real economics. For instance, not all 
expected inflow and outflows are assets and liabilities in real economics for financial 
statements purposes (Barth, 2007). Therefore, Barth highlights some common 
misunderstandings about the IASB approach. The misunderstandings as follows 
(Barth, 2007):
1.  The Framework does not identify conservatism as a qualitative characteristic of 

decision-useful financial information.
 “Conservative amounts are not neutral, which is a qualitative characteristic that 

neutralitymeans freedom from bias. Conservatism implies a negative bias for 
assets and income and a positive bias for liabilities and expenses”

2.  Matching is not a separate concept in the Framework.
 “Matching is not an objective of accounting recognition or measurement that the 

Framework is based on the notion that if assets and liabilities are appropriately 
recognized and measured, profit or loss will be too, which obviates the need for a 
separate concept of matching. However, the application of the matching concept 
under this Framework does notallow the recognition of items in the balance sheet 
which do not meet the definition of assets or liabilities”.

3.  The term reliability as used in the current Framework is neither limited to 
verifiability, as some interpret it, nor does it mean precision.

 “This common misunderstanding is why the preliminary views document 
(IASB, 2006a) uses the term ‘faithful representation’ rather than ‘reliability’ 
and explains that just because an amount can be calculated precisely, it is not 
necessarily a faithful representation of the real-world economic phenomenon it 
purports to represent. Faithful representation implies neither absolute precision 
in theestimate nor certainty about the outcome” 

4. The objective of financial reporting does not include providing accounting 
information for

 management to use in managing the business or for contracting parties to include 
in contracts.

 “This is because these users can directly specify the information they want and 
need. IASB standards are designed for general purpose financial reports, whose 
objective stems from the information needs of external users who lack the ability 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  293

to prescribe all the financial information they need from the entity”.
5.  The Framework focuses on defining financial position elements, i.e., assets and 

liabilities, not because financial position is more important than profit or loss.
 ”It is because profit or loss is important. Defining financial position elements 

is the only way standard setters have been able to determine how to measure 
revenues and expenses, which comprise profit or loss”.

6.  The IASB does not have an objective to measure all assets and liabilities at fair 
value.

 “As explained in Section 3, there are reasons why fair value is a candidate 
measurement basis in many situations, and the IASB and FASB have a stated 
long-term objective to measure all financial assets and liabilities at fair value”.

The Advantages Fair Value Accountingof IFRS for Investors

With regard to advantages fair value to investors that Ball (2006) highlights 
the potential advantages. These are as follows:
1. IFRS promise more accurate, comprehensive and timely financial statement 

information, relativeto the national standards they replace for public financial 
reporting in mo.st of the countries adopting them.

 “Financial statementinformation is not known from other sources,this should 
lead to more-informed valuation in the equity markets and hence lower risk to 
investors”.

2.  Small investors are less likely than investment professionals to be able to anticipate 
financial

 statement information from other sources.
 “Improving financial reporting quality allows them to compete better with 

professionals, andhence reduces the risk they are trading with a better-informed 
professional (known as ‘adverse selection’)”.

3.  By eliminating many international differencesin accounting standards, and 
standardizing reportingformats, IFRS eliminate many of the adjustments analysts 
historically have made in

 order to make companies” financials morecomparable internationally.
 “IFRS adoption therefore could reduce the cost to investors of processing 

financial information. The gainwould be greatest for institutions that create 
large, standardised-format financial databases”

4.  A bonus is that reducing the cost of processing financial information most likely 
increases the efficiency with which the stock market incorporates it in prices.

 “Most investors can be expected to gain from increased market efficiency”.
5.  Reducing international differences in accounting standards assists to some 

degree in removing barriers to cross-border acquisitions and divestitures, which 



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in theory will reward investors with increased takeover premiums.
The Disadvantages Fair Value Accountingof  IFRS for Investors

 Regarding to the potential problems of fair value to investors that Ball 
(2006) highlights the potential problems.These are as follows:
1. Market liquidity is a potentially important issue in practice. Spreads can be large 

enough to
 cause substantial uncertainty about fair valueand hence introduce noise in the 

financial statements.
2. In illiquid markets, trading by managers can influencetraded as well as quoted 

prices, and
 hence allows them to manipulate fair value estimates.
3. Worse, companies tend to have positively correlatedpositions in commodities and 

financial
 instruments, and cannot all cash out simultaneouslyat the bid price, let alone at 

the ask. Fair value accounting has not yet been tested by amajor financial crisis, 
when lenders in particularly could discover that ‘fair value’ means ‘fairweather 
value”.

4. When liquid market prices are not available,fair value accounting becomes ‘mark 
to model’accounting

5. If liquid market prices are available, fair valueaccounting reduces opportunities 
for self-interestedmanagers to influence the financial statementsby exercising 
their discretion overrealizing gains and losses through the timing ofasset sales. 

 To summary, based on the above discussion, my opinion to fair value 
implications that fair value with regard to IFRS that may bring accurate to business 
decision with more attention and advantages to investor as supported in objective 
of IASB. However, fair value of IFRS fails to fully acknowledge the significance 
between liquid and illiquid marker similarly to US GAAP fair value that provides 
uncertainty (gharar) and leading to subjective estimates as well.

ISLAMIC PERPECTIVE OF ACCOUNTING MEASUREMENT

Since, Islamic Financial Institutions (IFIs) established that have different 
objectives and principles as well as have different financial products with 
conventional financial institution. Therefore, Abdul Rahman (2012) argues that 
fully adopting International Financial Reporting Standards (IFRS) issued by IFRS-
IASB probably there will no specific standards for unique functions of Islamic 
Financial Institutions. Indeed, in 1992, the Accounting and Auditing Organization 
for Islamic Bank and Financial Institution (AAO-IBFI) now called Accounting and 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  295

Auditing Organization for Islamic Financial Institution (AAOIFI) was established 
as respond to the establishment of Islamic banks and Islamic Financial Institutions 
(Karim, 1995).

First of all, AAOIFI developed the objective of financial reporting. The 
objective is different compared to the accounting standard-setting bodies such FASB- 
US GAAP and IASB-IFRS. Based on the AAOFI (2010) one of main objectives as 
follows:

 “To determine the rights and obligations of all  interested parties, including those 
rights and obligations resulting from incomplete transactions and other events, in 
accordance with the principles of Islamic Shariah its concepts of fairness, charity 
and compliance with Islamic business values”

And one of main objectives with regard to financial reports
“information about Islamic bank’s compliance with the Islamic Shariah and 
its objectives and to establish such compliance and information establishing the 
separation of prohibited earning and expenditures, if any which occurred, and of 
the manner in which these were disposed of ”

Regarding to objective of IFIs, Rasid, Abdul Rahman and Ismail (2011) point 
out that the main differences between IFIs and conventional financial institutions 
is the principles as objectives which need to be compliance based on shariah 
(jurisprudence and Islamic ethics). The Principles such as 1.Prohibition of riba, 
2.Application of al-bay (trade and commerce), 3.Avoidance of gharar (ambiguities) 
in contractual agreements, prohibition of maisir (gambling), 4.Prohibition of 
conducting business involving prohibition commodities.

Since, Islamic Financial Institutions have differences objectives and principles 
as compared to conventional counterpart. Therefore, IFIs come up with specifically 
accounting for Islamic Institutions. For instance, accounting for Islamic Banks 
with regard to Zakat, murabahah, mudahrabah, ijarah and other Islamic banking 
contracts. However, Yaya (2004) argues that in terms of Islamic Accounting’s 
objectives of The AAOIFI, the contents and goals are likely the same with currently 
conventional accounting that focus on providing information system for users.

Abdul Rahman (2003) argues that accounting on Islamic perspective in 
Muslim society, in way of accountant to provide the financial information to user 
is not only as service to the users and public at large, but information is provided 
to society must take consideration to accountability in order to follow the God’s 
commandments.Lewis (2001) argues that Islamic accounting may follow the 
shariah law in terms of theaccounting principles and postulates in order to develop 
the proper accounting theory.

In my point of view that fair value accounting provides benefit to economic 



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decision for shareholders. However, in essence to Islamic Financial Institutions those 
economics decisions is not the main objective to Islamic Financial Institutions, 
compliance to shariah and bringmaslahah to society need to notice before making 
economic decisions.

Therefore,Islamic principles are crucial issues in Islamic financial Institutions.
Regarding to accounting principles from Islamic perspective, Ahmed (1994) states 
that accounting in Islamic principles should govern with financial dealing and 
contracts based on Islamic objective such as realization of fairness and justice, 
preservation of the rights and dues of all parties, paying Zakat (that necessitates 
having accurate and just financial statements which represent accurately and truly 
the financial position of the entity).  

In this light, AAOIFI (2010) under SFA no. 2 with regard to the concepts 
of Financial Accounting for Islamic Banks and Financial Institutions states that 
“concepts of accounting measurement in measurement attributes refer to the 
attributes of assets and liabilities that should be measured for financial accounting 
purposes”. In addition to measurement attributes that AAOIFI indicates to “the 
cash equivalent value expected to be realized is the number of monetary units that 
would be realized if an asset was sold for cash in the normal course of business as 
of the current date” (AAOIFI,2010,para. 89). However,SFA no. 2 AAOIFI (2010, 
para.89) refers to cash equivalent value when the attribute condition are present such 
as the relevance, reliability and understandability of the resulting information.

In this regard, SFA, no. 2 AAOIFI (2010, para.89) states that cash equivalent 
value specifically would be suitable as basis for accounting measurement for an 
Islamic banks as the condition for Islamic banks’ products such as mudarabah and 
investment accounts. In addition to cash equivalent value that FAS no. 2 AAOIFI 
(2010) argues that reliable and comparable information are very important to unsure 
the measurement of  cash equivalent value. Therefore, SFA no. 2 AAOIFI (2010) 
indicates some principlesduring the revaluation assets, liabilities and restricted 
investments. The principles are as follows:
a.  To the extent available, outside indicators (such as market prices) should be 

used.
b.  All relevant information whether positive or negative should be utilized.
c.  Logical and relevant valuation method methods should be utilized.
d.  Consistency in the use of valuation methods should be adhered to.
e.  To the extent appropriate, experts in valuation should be utilized. 
f.  Conservatism in the valuation process by adhering to objectivity and neutrality 

in the choice of value (SFA no.2. AAOIFI, para. 95).



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  297

In light this, Al-Sadah (2000, p.42) points out as quoted in Napier (2007)
that “the majority of Islamic banks represented on the AAOIFI accounting standards 
board strongly rejected adopting the cash equivalent value approach, since this 
accounting treatment would exert pressure on the banks to pay out a higher level of profits 
to shareholders and investment account holders if the bank recognized the unrealized 
gains”.

However, AAOIFI provides historical cost as a recommendation to alternative 
measurement attribute to the cash equivalent value. Particularly, AAOIFI refers to 
its fair value at the date of its acquisition including amounts incurred to make it 
usable or ready for disposition (SFA no. 2. AAOIFI para.98; Abdul Rahman, 2010.
Page. 31).
The Implication to Islamic Financial Institutions

Islamic financial institutions (IFIs) and Islamic Banking (IB) have special 
characteristics. For instance, Islamic banks are not using interest on lending and 
borrowing money(Karim, 2001). Moreover, Napier (2007) indicates that Islamic 
Banks provides profit-loss sharing instruments such mudarabahah and musharakah 
and mark-up instruments such as murabahah, ijarah and salam. Since, the Islamic 
banks and IFIs have different characteristic to counterpart of conventional banks. 
Therefore, probably IFIs and (IB) have different consequence to accounting 
principles and regulation to govern the financial transaction based on the Islamic 
objectives and principles.
Issues in Gharar in Fair Value 

As noted on previously discussion to fair value accounting problems. Ball 
(2006) points out that “Market liquidity is a potentially important issue in practice. 
Spreads can be large enough to cause substantial UNCERTAINTY about fair value 
and hence introduce noise in the financial statements”.

In Islamic perspective, uncertainty means as a gharar that one of the principles 
of Islamic Financial Institutions is to avoid of gharar (ambiguities) in contractual 
agreements or no gharar involve business transactions(Rasid et al 2011). Lewis 
(2001) argues that in business terms, gharar means “to undertake a venture blindly 
without sufficient knowledge or to undertake an excessively risky transaction”. 
Additionally, gharar transaction provides a potential speculation in business terms. 
For instance, investment trading for futures on stock markets (Lewis, 2001).

In addition, Malia, Casson and Napier (2006) note that unlawful transaction 
in Islamic Financial Institutions violates Islamic principles such hedging or optional 
transaction which contains excessive risk (gharar). Therefore, Malia et al (2006) 



Al-Iqtishad: Vol. VI No. 2, Juli 2014 298

suggest that Islamic banks should not enter into unlawful transaction in order to 
compliance to shariah and follow Islamic principles.

According to AlQuran Al Baqarah 2:282 “O ye who believe! When ye deal with 
each other, in transactions involving future obligations in a fixed period of time, reduce 
them to writing; let a scribe write down faithfully as between the parties…”. Based on 
this verses that all muslims transaction must be recorded as to show the importance 
of fulfill rights and obligationsin order to reduce the doubt and uncertainty (gharar) 
in inter-personal arrangements(Napier, 2007).

Based on above discussion regarding to gharar in fair value. Therefore, my 
argument that when fair value provides uncertainty or gharar in measuring the 
asset and liabilities in certainty conditions. For instance, level 2 and level 3 of fair 
value which provides subjective estimates (see, Penman, 2007) that violate Islamic 
principles, meaning that fair value is not shariah compliance at certain circumstance. 
Therefore, Islamic banks or Islamic Financial Institutions need to reduce in adopting 
fully fair value. Otherwise, cash equivalent value is the best choice for Islamic banks 
as recommended by AAOIFI. 
Issues in Zakat 

Many studies argue that the implication of accounting measurement to 
Islamic Financial Institutions refers to Zakat valuation (for instance:Ahmed, 
1994; Adnan and Graffikin, 1997;Mirza and Baydoun, 2000;lewis, 2001; Abdul 
Rahman, 2003;Yaya, 2004;Lewis, 2006). Moreover, Yaya (2004) argue that Islamic 
accountability in accounting is crucial and Zakat as a primary objective in Islamic 
accounting and accountability. His argument supported by such as Adnan and 
Graffikin(1997); Lewis (2006) and Abdul Rahman (2007;2010).

In this regard, Mirza and Baydoun (2000) argue that the measurement of 
assets with regard to Zakat is important issue from Islamic perspective. Hence, 
according to Mirza and Baydoun (2000) in order to measure the amount of Zakat, 
need to use the contemporary time not in historical cost.Mirza and Baydoun (2000) 
suggest that re-value the assets regularly is needed and Islamic accounting system 
probably uses both historical and market selling prices with regard to enable firms 
to accommodate contracts and to discharge with social responsibility.

In addition, Adnan and Gaffikin (1997) argue as quoted in Yaya (2004) that 
there is no room in Islamic financial institutions to use the concept of historical cost 
and conservatism due to the issues in misleading and quality of justice and honesty 
of financial information.

Abdul Rahman (2007) argues that fair measurement of Zakat paid by 



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  299

corporation is one important issue as Zakat for business wealth. In addition, Abdul 
Rahman (2007) mentions that business wealth should pay the Zakat including in 
business activities which involves such as trade goods (or stock on trade), cash in 
hand or at bank, debt or credit extended to customers or others.

Regarding to Zakat, AbdulRahman’s study (2007) found that in case of Zakat 
in the Malaysia context, IFIs should reports: 1. The amount of Zakat due or paid; 
2. The method of Zakat measurement used; 3. The ruling of Shariah supervisory 
board in matters to pertaining Zakat; and 4. The obligation on Zakat due from 
the subsidiaries, the equity investment account, and other investment account (in 
case of Islamic banks). Moreover, Abdul Rahman (2007) points out with regard to 
Zakat practices that there is a lack of information provided to the users of the annual 
reports.

Regarding to Zakat that AAOIFI provides in FAS no.9 that discussing issues in 
standard accounting treatment of Zakat base and disclosure requirement.Regarding 
to determination of Zakat AAOIFI FAS no. 9. Para.2 states that “the Zakat base 
shall be determined by using 2.5% for a lunar calendar year and 2.5775% for a 
solar calendar year based on either of the following two methods: Net Assets, Net 
Invested Funds”. Moreover, Zakat should be measured at cash equivalent value as 
recommend by AAOIFI FAS no.9. para. 5. However, AbdulRahman (2007)asserts 
that AAOIFI under FAS no.9 did not provide the specific regarding to charge the 
net receivables.

In addition, in terms of the treatment of Zakat in financial statements FAS 
no.9.para. 9 AAOIFI: case in which the Islamic bank is obligated to pay Zakat:

“In any of the following cases, Zakat shall be treated as a (non-operating) 
expense of the Islamic bank and shall be included in the determination of the 
income statement:
(a).  When the law requires the Islamic bank to satisfy the Zakat obligation.
(b).  When the Islamic bank is required by its charter or by-law to satisfy the Zakat 

obligation.
(c). When the general assembly of shareholders has passed a resolution requiring 

the Islamic bank to satisfy the Zakat obligation.
Abdul Rahman (2007) states that issues in fairness in Zakat are very important 

such as providing justice to both Zakat payer and Zakat recipient respectively. 
Wahab and Abdul Rahman (2011) indicate that due to distribution of Zakat fund 
that there are many shortcomings that influence significantly payment to Zakat 
institutions.  Therefore, Islamic accountability on accounting is important as well as 



Al-Iqtishad: Vol. VI No. 2, Juli 2014 300

transparency in Islamic financial Institutions.Additionally, Abdul Rahman (2007) 
indicates that in Islamic perspective the preparation of financial information need 
to take consideration to Zakat purpose.
IFRS vs. AAOIFI:  The Competition of accounting standards?

Abdul Rahman (2012) argues that fully adopting International Financial 
Reporting Standards (IFRS) issued by IFRS-IASB probably there will no specific 
standards for unique functions of Islamic Financial Institutions2. This argument 
supports previous paper that Ibrahim (2007) states that Islamic Financial Institutions 
cannot fully comply with IFRS in their financial reporting because Islamic Financial 
Institutions have some unique requirement.

Karim (2001) points out that there is increasing interest to provide the 
harmonization of accounting and financial reporting by banks. For instance, 
international Accounting Standards Committee (IASC) to issue international 
accounting standard (IAS), Basle Committee and United Nation regarding to issues 
in transparency and comparability.

In terms of banking regulation of Islamic banks that Karim (2001) argues 
that the implication of the unique characteristic of Islamic banks seems that did not 
get higher support from the supervisory bodies in the countries in which Islamic 
banks operated. For instance, due banking system, the system is same both Islamic 
and conventional banks that there is no particular standard or regulation to apply to 
Islamic banks (Karim, 2001).

With regard to IFRS that many countries as well as Muslim countries in 
which Islamic banks operated seem to be consistent to adopt the IFRS. For instance 
Indonesia, Malaysia use IFRS as a future core accounting standards. Concerning to 
issues in IFRS vs. AAOIFI,Ibrahim (2007) claims that there are many issues relate to 
conflict in convergence with the global International Reporting Standards that may 
not appropriate with the spirit of global accounting standards convergence.

Additionally, Ibrahim (2007) indicates that the issues currently move to 
seriously debate on convergence of accounting standards from harmonization to 
hegemonic tone of standardization. Ibrahim argues that IFRS seems to be arrogant 
as Ibrahim states “the preface to the recent International Financial Reporting Standards 
which states that financial statements cannot state that they comply with international 

 2  This argument is taken from slides in class for subject Islamic accounting and finance (ACC 
6810) on subtopic Islamic accounting Practice-Accounting for Islamic Finance prepared by Professor 
Dr.Abdul Rahim Abdul Rahman in 2012, Professor accounting at International Islamic University 
Malaysia (IIUM).



Jamaluddin Majid: The Critical Aspect on Fair Value Accounting  301

financial reporting standards unless they comply with all the applicable standards and 
not some of them. Hence, IFRS permits no exceptions and is Busherian in tone, “either 
you are with me or are against me!”

 In light this, AAOIFI provides promulgate accounting, auditing and 
governance standards that there are 14 accounting standards as well as the statements 
which provide a conceptual framework that guides the preparation standards 
(Karim, 2001). However, AAOIFI’s standards seems tobe failin implementing in 
which Islamic banks operated that there is lack of appreciation by agencies (Karim, 
2001). Probably, many issues involved with regard to accounting standard-setting. 

Karim (2001) indicates that the acceptance for AAOIFI for worldwide may 
tend to challenge the adherence to IASs to achieve international harmonization 
in financial reporting regardless of cultural differences that probably there is no 
collaborative productively among regulatory bodies.

In terms of the growth of Islamic finance that KPMC-audit firm (member 
of big 4) and the Association of Chartered Certified Accountants (ACCA) (2010) 
report for potential development of harmonizing financial reporting of Islamic 
finance that the report provides possible approaches. The approaches as follows:
1. IFRSby default
 “IFRS could be used as the default reporting framework, although guidance 

based on existing Islamic financial reporting models would need to be used to 
supplement the standards for those IF transactions that do not fit simply into the 
framework”.

2. Islamic accounting standards by default
 “Alternatively, a set of globally recognized Islamic accounting standards could be 

used by IFIs. Where possible these would be based on IFRS, but would include 
specific recognition, measurement, presentation and disclosure requirements 
relevant to Islamic finance products and transactions”.

To sum up, my personal opinion that probably, the collaboration productively 
among regulatory bodies is the best way to produce harmonizing financial reporting 
of Islamic finance and implication to Islamic Financial Institutions because the 
successfully of harmonizing Islamic finance’s financial reporting needs supports from 
international bodies such as business organizations and professional organizations as 
well as governments that IFRS has been proved how to get international recognition. 
Therefore, AAOIFI may need to learn from IFRS’ experiences as accounting 
standards-setting.



Al-Iqtishad: Vol. VI No. 2, Juli 2014 302

CONCLUSION

The paper indicates that fair value accounting measurement provides many 
critical aspects to be implemented to Islamic Financial Institutions (IFIs) that Islamic 
bank do not provide interest on business transaction that considered as unique 
characteristics with profit loss sharing schemes. Additionally, AAOIFI proposed 
cash equivalent value as respond to fair value measurement  that cash equivalent 
value when the attribute condition are present such as the relevance, reliability and 
understandability of the resulting information.

Regarding to AAOIFI’s standards that Karim (2001) argues AAOIFI’s 
standards seems to be fail in implementing in which Islamic banks operated that 
there is lack of appreciation by agencies. Therefore, Abdul Rahman (2012) argues 
that fully adopting International Financial Reporting Standards (IFRS) issued by 
IFRS-IASB probably there will no specific standards for unique functions of Islamic 
Financial Institutions. In addition, the paper may be recommended to work together 
among Muslim countries to unity the potential harmonizing one set accounting 
standards for Islamic Financial Institutions. For instance, AAOIFI’s standards.

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