Lecture 6

Accounting , reporting and governance of

Takaful activities
Mohd Khairy Kamarudin

Nature of Takaful and its effects on

accounting & reporting
The most important factor that distinguishes a

takaful scheme from its conventional

counterpart is the donation feature.

Nature of donation
Donation in takaful contract is a mutual act of good

deeds and righteousness among policyholders.

It may tied to a particular condition for its type or
amount.
If indemnity does not exceed the fund, a surplus
arises and the benefit is to the policyholders.
If indemnity exceeds the fund, a loan can be
granted by the operator with the understanding
that such loan to be recovered from any surplus of
subsequent years.

Donation versus
Participation
principle of donation for the policyholders
principle of participation for the shareholders.
Participation involves the contract of investment.
The Islamic jurists viewed that the takaful operator

should present and disclose all information relating

to the process to the policyholders.
This disclosure will make them aware that the
Takaful activities are done in a legitimate
cooperative manner and free from gharar or any
elements of riba, maysir, and other prohibitions
that render the contract void or voidable.
That is their right since the insured pays
contributions that are wholly or partially donated to

Reporting framework and relevant

accounting standards
Takaful operator is responsible to disclose all information on its

processes to the policyholder.

The disclosure requirements have to meet the objective of
Statement of Financial Accounting No. 1 & 2 of AAOIFI by providing
the following information:
Shariah compliance of operations of Islamic Insurance Company (IIC).
To assist in separating prohibited earnings and expenditures.
Responsibility (and method) of determination of zakah.
Treatment of deficit and business risk.
Assessment of inherent risk in insurance and reinsurance.
Estimation of cash flows.
To evaluate IICs capability to generate reasonable rates of return

from investment of funds.

To evaluate role in fulfilling social responsibility.

Important Shariah contractual

conditions and accounting principles
Before a contract is signed between the

participants and the operator, there are some

conditions which must be followed:
Existence (recognition)
Lawful (recognition)
Measurable (measurement)
Deliverable (recognition & measurement)
Equitable (distribution)
Accountability (disclosure & presentation)

Existence (Recognition)
The existence of a valid contract is necessary
before a transaction can be recognized.
When the contract is duly concluded and
signed, all contractual conditions must be
followed to render the transaction valid and
existing.
Lawful(Recognition)
The recognition process would also take into
consideration the lawfulness of the economic
activities.
Revenue is not recognized if the activity is

Measurable (measurement)
Precise measurement is an essential condition
to avoid unlawful transactions.
Hence the scale and basis of measurement
should be reflective of the real economic
condition.
Deliverable (Recognition & measurement)
Deliverable goods are also an essential
condition to avoid gharar and timing of
recognition and ability to measure will also take
into account this condition.

Equitable (Distribution)
Equitable in dealings between the contracting
parties include the manner of distribution
between the Takaful operators and participants.
It involves the determination of reasonable
rates of returns from the contracted profit
sharing ratio.
Accountability (Disclosure & Presentation)
An essential mechanism to attain accountability
is through proper and adequate disclosure and
reporting to the other party/ies involved in the
transaction.

Complete set of financial statements

for Islamic insurance/ takaful company
Statement of Financial Position
Statement of Policyholders revenue and expenses
Income Statement
Statement of Cash Flows
Statement of Changes in Owners Equity
Statement of Policyholders Surplus (Deficit)
Statement of Sources & the use of Zakat and

Charity Funds.
Notes to Financial Statements

Specific Disclosures
Unusual supervisory restrictions
Earnings or expenditure prohibited by Shariah.
Concentration of Asset Risks (Segment).
Amounts recoverable related to claims from

insurance and reinsurance activities.

Contingencies
Outstanding Financial Commitments
Accounting Changes
Any effect of changes in policy, estimates or error
correction on income statement as well as effects
on policyholders surplus or deficit.

Presentation of Statement of
Financial Position
Assets

Cash & cash equivalents

Investments
Contributions receivables
Fixed assets (net)
Development cost

Liabilities + Policyholders
equity + owners equity

Outstanding claims
Unearned contributions
Reinsurance balances
Dividends payable
Other liabilities
Capital
Reserves

Presentation of Policyholders
revenue & Expenses
Insurance revenue
Earned contributions
Gross contributions (less) reinsurers shares
Net retained contributions
(less) changes in unearned contributions
Reinsurance commissions
Insurance expenses
(paid claims recovered claims) +
(outstanding claims recovered claims) +
Remuneration of owners equity [fees]
Net surplus from insurance operations
Net investment income
Surplus or Revenue (over) expenses

Statement of policyholders
surplus(deficit)
Add (less)

Less

Beginning balance

Xxxxxxxx

Surplus (deficit)for
the year

Xxxxxxxxx

Available surplus for

year

Xxxxxxxxx

Distribution to
policyholders

(xxxxxxxxx)

Ending residual
balance

Xxxxxxxxx

Allocation models for insurance

surplus or deficit
All
policyholders

Policyholders
that have not
claimed

Surplu
s

Policyholders
that do not
claim or
claimless
than their
contribution

Policyholders
and
shareholders

Reserves of
polycyholders

borrow from
shareholders
funds or
other funds

Defici
t

increase
future
premium
contribution
of
policyholders
on pro-rata
basis

Requests
policyholders
to meet
deficit prorata

Disclosure bases for determining

and allocating surplus or deficit
In Takaful, there is a need to disclose the allocation of

surplus or deficit due to the need to determine the

relationship between the policyholders and shareholders.
Segregation of their assets, obligations and result of

operations.

There is a need to allocate surplus in a fair manner

among policyholders.
This disclosure of varying allocation bases functions to
assist in decision making and fair reporting.
Any failure to disclose the process of the allocation may
cause other problems among the policyholders and
shareholders in the future.

Corporate and Shariah Governance

for Islamic Financial Activities
The need for Shariah governance (Shariah

review or audit) became more apparent with

the development of Islamic financial
institutions and increasing corporate
involvement in Islamic financial activities.
There is an increased realization for the need
of such governance if the business and
economic activities are to achieve the goals of
Shariah, sound implementation of its
principles and compliance to the rules and
requirements.

Nature of the Shariah Supervisory

Board
A shariah supervisory board is appointed to ensure

Shariah compliance of the company.

Board is an independent body of specialised jurists
in fiqh al-muamalat (Islamic commercial law) that is
entrusted with the duty of directing, reviewing and
supervising the activities of Islamic financial
institution in order to ensure that they are in
compliance with Islamic rules.

Governance Standards and Code of

Ethics
Governance standards and code of ethics of the

Shariah Supervisory Board that must be adhered by

the Islamic financial institutions
Governances standards
Shariah supervisory board
Shariah review
Internal Shariah review
Audit and Governance Committee
Ethics

Code of Ethics for Accounting and Auditors of Islamic financial

Institutions
Code of Ethics for the employees of Islamic financial
Institutions

Impact of disclosure on governance

Disclosure benefits:
Provide confidence to investors and policyholders on the
Shariah compliance of the transactions and activities.
Safeguards the interest of both shareholders and
policyholders.
Allow clear distinction between donation and investment
activities and their related contracts.
Provides useful information on treatment of surplus for
takaful operations and surplus for investments.
Enhance reporting accountability and performance
measure of takaful operator cum fund manager.
Allows comparability of accounting information from varied
takaful practices.