Management accounting systems in

Islamic and conventional

Financial institutions in Malaysia

1. Introduction
Management accounting systems (MAS) refers to the systematic use of management
accounting techniques to achieve organizational goals. The International Federation of
Accountants (IFAC, 1998) defines management accounting as the process of
identification, measurement, accumulation, analysis, preparation, interpretation, and
communication of information (financial and operational) used for the planning, control
and effective use of resources by an institution
s management. Thus, management
accounting becomes an integral part of the management process in an organization
providing information essential for:

Controlling the current activities of an organization;

Planning its future strategies, tactics and operations;
Optimizing the use of its resources;
Measuring and evaluating performance;
Reducing subjectivity in the decision-making process; and
Improving internal and external communication (IFAC, 1998).

The Malaysian financial system is based on the dual banking system in which the
conventional financial system operates alongside the Islamic financial system. The
development of the Islamic Financial Institutions (IFIs) has contributed to the
strengthening of Malaysia as an International Islamic Financial Centre (MIFC). MAS for
IFIs has received limited attention as most prior literature on accounting for IFIs focuses
mainly on financial accounting related to measurement and reporting issues, the purpose
of this paper is to explore whether there is any difference in the MAS of conventional and
IFIs in Malaysia. The current study is intended to fill the void in the literature on
management accounting in IFIs.

The remainder of the paper is structured as follows. The next section reviews the
relevant literature and develops the hypotheses, followed by the research method in
Section 3. Results and discussion are presented in Section 4 and finally, Section 5
presents the conclusions

2. Literature review
A well-designed MAS will assist managers to be more effective in decision-making.
Traditionally, management accounting information has been delineated in financial terms,
but recently it has been expanded to include non-financial (operational or physical)
information, including quality and process times. Besides fulfilling the traditional
function of providing quantitative and financial information, MAS have expanded to
include information relevant for innovation, marketing and organizational design.
The challenge faced by financial institutions is in sustaining their competitive edge by
being cost efficient without compromising the quality of their services. The key to
survival is to have an internal management reporting system that can signal problem areas
and allow management to react swiftly and assuredly. Following the deregulation of the
financial sector and the rapid advances in technology, information on pricing, product
mix and market share strategies have become more important to the financial services
sector. MAS in a financial institution can play an important role by providing information
on the effectiveness of a sales promotion programmer, revenue by business units, product
lines and customer category. The management of financial institutions depends on
concise and relevant information to help them carry out their daily duties. Well-managed
firms should have good information structures and MAS can be seen as a tool for
managing resources, measuring performance, warning of risks, aiding decisions, and
providing data for planning, specifically argues that a good MAS does the following:

Tells the cost and profitability of doing business by organization, product, and
major customers;
Avoids surprises;
Allows all managers to explain their performance as it is reported;
Allows everyone to participate in planning via plan-to-actual reporting used as a
management tool;
Provides timely, accurate, relevant, and understandable reporting;
Ensures that only one set of numbers is circulating within the organization; and
Reduces or eliminates complaints about information non-availability.

Some financial institutions have turned to activity-based costing (ABC) as a way to

measure accurately the consumption of shared resources by a particular customer or

product. In fact, the application of ABC in the financial services sector today identifies
new and unique ways to leverage cost and profitability information, including:

Activity-based pricing, particularly for business-to-business services;

Linking ABC information to performance management scorecards and processes;
Providing information on a process view of costs, both to support cost
improvement needs and to enable ongoing accountability for management by the
business process; and
Information on the profitability of discrete customer relationships.

2.1 Relevance of MAS to IFIs

The management of IFIs needs management accounting information as an organizational
control mechanism. Since all IFIs activities should comply with the norms of Shari
ah and
Islamic ethics, they need more management information for decision-making, planning
and control activities to meet both business and religious objectives. The need of MAS
can also be argued from the sources of funds perspective. Unlike conventional banking
systems where customers are entitled a guaranteed return, the return on investment for
Islamic bank investment holders is uncertain since they share the profit or loss incurred
by the bank.

The implications of the Shari

ah compliance framework on the use of MAS information

need to be explored. The research on this issue is still scant; with the only study available
to date being one by Islam studied the information adequacy of MAS in the banks in
Bangladesh. They argue that the adoption of a profit-sharing system of mudarabah and
musharakah by Islamic banks in their financing activities requires a different set of MAS
information in terms of scope and integration.
The results that managers of Islamic banks, in contrast to those in non-Islamic banks,
believe that they have better designed MAS in terms of scope and integration. Their
findings support the argument that profit-sharing systems in the financing activities of
mudarabah and musharakah in Islamic banks require broad scoped and integrated MAS
information.
2.2 Development of hypotheses
The scope of an information system consists of three sub-dimensions, which are focus,
quantification and time horizon. The main difference between IFIs and conventional
financial institutions is that their objectives and operations, as well as principles and
practices, must conform to the principles of Islamic Shari
ah (Jurisprudence) and Islamic
ethics as enunciated by Shari
ah. The principles are:

(1) Prohibition of riba(interest);

(2) Application of al-bay (trade and commerce);
(3) Avoidance of gharar (ambiguities) in contractual agreements; prohibition of
maisir (gambling); and
(4) Prohibition of conducting business involving prohibited commodities.
Transactions in IFIs involve different Islamic contractual relationships in which various
underlying Shari
ah principles have been used. In the Islamic banking sector for example,
the relationship between investment account holders and the banks and the relationship
between the banks and their customers (borrowers) are different from conventional
banking systems. In conventional banking system, all deposits are treated as liabilities.
In Islamic banks, savings are categorized into A l-Wadi
ah (safe custody) and A lMudarabah (profit sharing) saving accounts. Although equity-based financing
(mudarabah and musharakah) is not widely used at the moment, some arguments related
to MAS information may still be considered. Equity-based financing is risky since there
is no fixed assured return to the banks.
H1. There is a significant difference regarding the scope of MAS between IFIs and
conventional financial institutions.

Timeliness of information refers to the provision of information on request and the

frequency of reporting collected information. Timeliness influences the managersability
in responding quickly to events. MAS, together with timely information, is able to report
upon the most recent events and provide rapid feedback on decisions. In Islamic banks,
the profit rates for their financing are fixed. However, the return on the deposits fluctuates
depending on market conditions. Therefore, to prevent mismatch between assets and
liabilities, timely information is required by IFIs in calculating their profit distribution.
H2. There is a significant difference in the use of timely MAS between IFIs and
conventional financial institutions.

Coordination of the various segments within a sub-unit is an important aspect of

organizational control. Integrated MAS characteristics that may assist coordination
include information about the activities of other departments within the firm and
information on the impact that decisions in one department have on the performance of
another. In the Islamic banking system, different products require different contracts,
which lead to different kinds of relationship. For example, unlike financing in
conventional banking where the bank is the lender and the customer is the borrower, in
murabahah (deferred sale) financing, the customer is the buyer and the bank is the agent
who buys and sells the product to the buyer.
H3. There is a significant difference in the use of integrated MAS between IFIs and
conventional financial institutions.

Information aggregation deals with a variety of ways to collect and summarize the data
within periods of time or area of interest, such as responsibility centers or functional areas.
Aggregate information represents summarized information that covers periods of time or
diverse management area while disaggregated information represents excessively detailed
information that may include only one period or one functional area.
H4. There is a significant difference in the use of aggregated MAS between IFIs and
conventional financial institutions.

3. Results and discussion

Since IFIs have to meet both business and religious objectives, they are expected to have
a broader scope, more timely, highly integrated and highly aggregated MAS information
than conventional FIs.

3.1 Scope
The empirical evidence from this study suggests that in order to be Shari
ah compliant,
IFIs use a broader scope of MAS information than conventional FIs. Besides looking at
business operations, other aspects of the organization also have to be Shari
ah compliant.
The findings from the survey is that managers of Islamic banks need a relatively broader
scope of information about their business operations and the prospects of their clients.
IFIs require more non-financial information especially those related to the issue of Shari
ah compliance. As managers of customer funds, IFIs have to make sure that the funds are
managed in accordance with the principles of Shari
ah. Hence, more non-financial
information related to Shari
ah compliance is required by them.
In addition, in conventional commercial banking systems, there is a lender and borrower
relationship where each transaction is subjected to interest payments. However, in the
Islamic banking system, a different relationship exists depending on the nature of the
product. Various underlying Shari
ah principles are used. This again requires a huge

amount of non-financial information related to Shari

ah issues. IFIs have to go through
more processes than conventional in order to get approval for product introduction. In
equity-based financing, Islamic banks need to be selective in choosing their clients, as the
returns are not guaranteed.
Furthermore, in musharakah financing, once a partnership has been established with the
client, Islamic banks have to participate directly in the business. Aside from the constant
monitoring conducted to ensure that business activities are in accordance with Shari
ah,
IFIs must ensure that the business activities provide the expected return to both parties.
As for the Islamic insurance business, management has to monitor funds collected from
customers and certify that they are invested in Shari
ah compliant businesses. Thus, more
external and future information is required to ensure that operation and day-to-day
activities of the IFIs are in accordance with Shari
ah.
3.2 Timeliness
The empirical findings from the survey reveal that IFIs use more timely information than
their conventional counterparts. A possible explanation for this is quite possibly that IFIs
take a partnership position. Furthermore, in Islamic banks, deposits are not based on
guaranteed return but based on profit sharing, with a fixed amount on the asset side and a
varied amount on the liability side. If profits are overly distributed, then banks may have
insufficient funds to meet their obligations. Thus, calculation on profit distribution has to
be prepared and submitted monthly to the Central Bank.
With timely information, decisions on profit distribution can be made effectively and the
possible mismatch of assets and liabilities can be monitored closely. Another possible
reason for this is the size of the IFIs themselves. The IFIs in this study are mostly smaller
than conventional FIs and in smaller organizations; bureaucracy can be expected to be
lower. With advances in information technology, information can be stored and retrieved
quite efficiently.
3.3 Integration
The findings of this study suggest that IFIs use more integrated information than
conventional IFIs. IFIs use information about the activities of the various departments
within the firm alongside information on the impact of decisions on them. The issue of
Shari
ah compliance in product innovation gives a possible explanation for these findings.
Product innovation requires the integrated effort of various departments; including the
SSB, product development, legal, marketing and finance. IFIs have to make sure that the
contracts associated with the new products conform to Shari
ah. The need for more
integrated MAS in IFIs is increased because all transactions are monitored by SSB to
ensure Shari
ah compliance.

3.4 Aggregation
The findings of this study also suggest that IFIs use more aggregated information than
conventional FIs. The aggregation of information by product is required by IFIs in
calculating their capital charge for risk management. Under the capital adequacy ratio
(CAR) requirements, IFIs have to identify the Shari
ah concept of each product because
the weight ratio for each product varies according to whether the products have collateral
or not.
The empirical findings from the survey was supported in the interviews, which revealed
that in order to be Shari
ah compliant, IFIs rely on a broader scope of information in
addition to the traditional financial and quantitative nature of accounting information.
The empirical findings from both the survey and the interviews also reveal that IFIs use
more integrated and aggregated information than conventional FIs. In addition, IFIs are
expected to be more transparent in reporting and consequently require more integrated
and aggregated information that covers a wider scope of information.

5. Conclusion
The aim of this study has been to determine whether there is any difference between the
MAS of conventional and IFIs. A survey on financial institutions in Malaysia was
conducted and semi-structured interviews were carried out to gain further insights into the
survey findings. The study shows that IFIs use MAS information that is broader in scope,
more timely, more integrated and more aggregated than conventional financial
institutions. In order to meet both religious and business objectives, IFIs require
sophisticated MAS information, which is available through the use of strategic
management accounting (SMA) tools and techniques such as the BSC and ABC. The use
of these techniques brings a competitive advantage to IFIs, as SMA places customer
needs at its top of priority. The study has illustrated that IFIs normally develop and adopt
an integrated accounting and overall enterprise system. With this comprehensive
enterprise system, the management accounting function is integrated with other functions
in the organization.
This study covers only financial institutions in Malaysia, thus the findings cannot be
generalized to other enterprises or to other countries. As for the respondents, this study
involved top management as the sole respondents and representatives of their respective
organizations. Nonetheless, the information sought is not beyond their knowledge as top
management are normally well-versed in the diverse aspects of the organization. Future
research can consider collecting data from individuals at various levels of the
organization.
This study has provided an avenue for further investigation on issues of MAS for IFIs. A

future focus might be on how MAS helps in strategic and operational decision making
by considering the need for Shari
ah compliance. Researchers might also focus on the
role of MAS in promoting transparency and accountability in IFIs. A case study approach
would be able to provide a deeper and richer understanding of this issue. In addition,
future studies might examine the significance of supporting activities (departments) in the
delivery of Islamic financial products. It is also worth including for further study the need
to explore value chain components in IFIs, and how they help contribute to the value of
the products they offer.