This essay discusses the universally recognized accounting concepts and principles, known as GAAPs. These guidelines were created by accountants and professional accounting organizations worldwide to regulate how businesses should manage their daily accounting tasks. While businesses are allowed to create their own accounting methods, they must provide valid reasons for any deviations from the commonly accepted practices.
In light of this, I will now strive to comprehend the viewpoints of Islamic scholars and jurists on the compatibility of the conventional ‘Separate Business Entity Concept’ with Islamic principles. However, prior to exploring this matter further, it is crucial to clarify certain points. There are two misconceptions that frequently arise among students and individuals lacking accounting knowledge in relation to this concept. It is imperative for me to address these two misconceptions as I also experienced confusion regarding both.
I will begin by explaining the fundamental understanding of the concept. It states that owners and their businesses are separate entities, so Mr J and J Enterprise cannot be considered as one single entity. This concept also suggests that Mr J and J Enterprise have a relationship similar to that of a debtor and a creditor. In other words, Mr J initially invested his personal funds, known as the capital, into J Enterprise to establish the business. As a result, J Enterprise should perceive itself as indebted to Mr J.
During an accounting period, Mr J is entitled to take cash or physical items from J Enterprises, which is referred to as drawings. J Enterprise can acquire personal assets and lands, have liabilities, sue and be sued by others, have contracts with other businesses, pay taxes to the government, hold properties under its name, and may be declared bankrupt like any other individual.
This concept applies to all types of businesses, including sole traders, partnerships, and companies. For the purpose of this discussion, let’s consider J Enterprise becoming a limited company named J Ltd in the future. In a limited company, a group of individuals, known as shareholders, buy shares of J Ltd. By doing so, they become partial owners of J Ltd. Collectively, these shareholders constitute the ownership of the company.
J Ltd and its shareholders are separate entities. If J Ltd makes a profit, the shareholders will receive dividends proportional to their initial investment. Conversely, if J Ltd incurs losses or undergoes liquidation, the shareholders are only responsible for settling debts up to their initial investment.
The creditors of J Ltd. are limited in their ability to seek remedies from the shareholders of J Ltd. They cannot demand more than the initial investment made by the shareholders. These two paragraphs address the previously mentioned ambiguities. The first ambiguity is that in all forms of business, including sole traders and complex public limited companies, there is a clear distinction between the owners and the business itself. Any transactions between the owners and the business should be properly documented, as with any other business transactions.
The second point is that, if a business should incur a loss for that period, as mentioned before, the shareholders of a company will not be held responsible for settling the company’s debt. The shareholders have ‘limited liability’ over the company. As Mufti Taqi Uthmani wrote in this issue, “’The limited liability’ in the modern economic and legal terminology is a condition under which a partner or a shareholder of a business secures himself from bearing a loss greater than the amount he has invested in a company or partnership with limited liability”.
According to the Companies Act 1965 (Act 125) Section 16(5), a company is considered a body corporate with the ability to perform all the functions of an incorporated company, as stated in both English and Malaysian Law. However, this legal status does not apply to sole traders, who are personally responsible for all business debts. Creditors have the right to claim a sole trader’s personal assets to settle these debts. In summary, there are two key distinctions: 1) Separate Entities – applies to all business types including sole traders, and 2) Separate Legal Entities – does not apply to sole traders. Scholars and jurists primarily focus on the latter point, specifically the separation of legal entity between shareholders and the company.
Mufti Taqi Uthmani has expressed his view on the issue of syari’ah compliance, particularly in situations where a company faces financial loss and is unable to compensate its creditors. He emphasizes that although the concept of ‘limited liability’ benefits shareholders, it can also have negative consequences for creditors.
If a limited company has more liabilities than assets, it becomes insolvent and is subsequently liquidated. As a result, the creditors may experience substantial losses as they are only entitled to receive the value of the company’s liquidated assets. They are unable to demand payment from shareholders for any remaining amount owed. Furthermore, even the directors of the company cannot be held responsible for satisfying the creditors’ demands in this unfortunate situation.
If a limited company has larger liabilities compared to its assets, it becomes insolvent and undergoes liquidation. Consequently, creditors might face significant losses since they can only receive compensation equal to the worth of the company’s liquidated assets. Seeking payment from shareholders for any remaining debts is not possible for them. Additionally, even the directors hold no responsibility in fulfilling creditors’ requests during such an unfortunate scenario.
The requirement for extensive discussion and research among Muslim ulama and from the Syari’ah perspective is the main reason why the concept must be addressed. Mufti Taqi Uthmani argues that the concept should be accepted within the Syari’ah due to certain factors that will be discussed later. Additionally, two lecturers from University Kelantan Malaysia have written a paper expressing their opinion that the concept is not in compliance with Syari’ah law.
Mutfi Taqi Uthmani argues that in order to address this issue, it is crucial to assess the conformity of the concept of ‘juridical person’ with syari’ah. According to Mufti Taqi, if we acknowledge the validity of ‘juridical person’ and its ability to be treated similarly to a natural person regarding legal consequences for transactions conducted on its behalf, then we must also accept the concept of ‘limited liability,’ which naturally emerges from this notion.
According to Oxford University Press, a juridical person refers to an individual, company, or entity with legal rights and obligations. Therefore, if we acknowledge that a company can be considered as a juridical person like a human being in terms of the law, this principle also applies when a company encounters bankruptcy.
Mufti Taqi Uthmani supports the acceptance of the concept of ‘juridical person’ in shariah. This viewpoint is further supported by historical examples, such as our ancestors who participated in comparable transactions and engagements. An illustration of this can be found in the term ‘Waqf’ in Arabic, which denotes a legal and religious establishment where individuals dedicate their property for charitable or religious intentions.
When a person declares something to be a waqf, they relinquish ownership of it. However, neither the person who accepts the waqf nor the beneficiaries become its owners. The beneficiaries may receive certain benefits from the waqf, but they do not possess full ownership rights. The true owner remains God Almighty alone. Consequently, older Muslim Jurists have regarded waqf as an independent legal entity and have assigned it certain qualities resembling those of a human being.
The Fuqaha’ (Muslim jurists) have issued two rulings regarding a waqf that contribute to a better understanding. Initially, if the income from a waqf is used to purchase a property, the purchased property does not automatically become part of the waqf. Rather, the jurists assert that the purchased property should be considered as separate property owned by the waqf. This indicates that a waqf, similar to an individual, has the ability to possess property. In addition, Ahmad Al-Dardir, an esteemed Maliki jurist, supports an inheritance request made by a mosque and justifies this by stating that mosques can possess properties.
The Muslim jurists have recognized that a Waqf, such as an inn or a bridge, can own properties. Despite being a non-human entity, the jurists have treated it as a human being in terms of ownership. Once its ownership is established, it can engage in selling, purchasing, being a debtor or creditor, and participating in legal actions, attributing it with the characteristics of a ‘juridical person’. Additionally, there is the concept of the Bait al-Mal in Islamic States, which is the exchequer. While every citizen has some beneficial rights over the Bait al-Mal, full ownership cannot be claimed by anyone. However, the Bait al-Mal does have specific rights and obligations unique to it.
Imam al-Sarakhsi, a renowned Hanafi Jurist, asserts in his work ‘Al – Mabsut’ that the Baitul-mal may have certain rights and obligations which are yet to be determined. He further states in the same work that if the leader of an Islamic state requires funds to pay salaries to the army, but there are no funds available in the Kharaj department of the Baitul-mal (which is generally used for salary payments), he can utilize funds from the sadaqah (Zakah) department. However, the amount taken from the sadaqah department will be considered as a debt on the Kharaj department.
The Bait al-Mal, as a whole and its different departments, have the capability to loan and advance funds to each other. The repayment of these loans is not the responsibility of the Head of State, but rather falls under the department involved. This signifies that each department of Baitul-mal operates as a distinct entity, with the ability to lend and borrow money. Additionally, it can be considered a debtor or creditor, and can both initiate and defend legal actions like a juridical person. Thus, the Islamic scholars have acknowledged the existence of a juridical person in relation to Baitul-mal. Mufti Taqi’s third argument is rooted in the example found in Imam As-Syafi’i’s Fiqh, which closely resembles the concept of a Joint Stock.
According to a principle in the school of As-Syafi’i, if partners contribute assets to a business and the assets are mixed together, each partner is individually obligated to pay Zakah. However, the Zakah is collected on the collective joint stock as a whole. This means that even if one partner’s portion of asset is below the nisab amount, Zakah is still payable on the entire joint stock including that partner’s shares. If Zakah was based on individual proportions of each partner’s assets, that partner would not have to pay Zakah.The principle of ‘Khultah-al-Shuyu’ is applied to the levy of Zakah on livestock. This principle sometimes requires individuals to pay more Zakah than their individual liability, and sometimes less. The Prophet advised against combining separate assets or separating joint assets to reduce the amount of Zakah. The Maliki and Hanbali schools accept this principle to some extent with variations in details, and it incorporates key concepts of a juridical person.
The concept of zakah is that it is not imposed on individual partners or owners, but rather on the collective joint stock. This means that the joint stock is treated as a separate entity from the owners or partners, and the obligation of zakah focuses on the joint stock. This concept is similar to the idea of a juridical person. Mufti Taqi’s fourth argument on this matter can be summarized as the inheritance left by a deceased person whose debts exceed the value of all their property, also known as the ‘Inheritance Under Debts’ concept.
According to Muslim jurists and scholars, the specific type of property mentioned in this text is considered unowned by both the deceased individual who lacked life and their heirs. This is because the debts owed by the deceased take precedence over the rights of the heirs. The creditors also do not own this property as the settlement has not yet occurred. While creditors may have claims on these debts, such claims do not confer ownership unless the property is divided among them. Therefore, inheritance under debt exists as a separate legal entity that cannot be claimed by anyone. The heir of the deceased can manage this property but never attains ownership.
If there are expenses involved in settling the debt, those expenses will be applied to the property itself. Therefore, this situation of inheriting debt creates its own separate entity, capable of buying and selling, becoming both debtor and creditor, similar to a legal person. In addition, the liability of this “legal person” is limited to its current assets. If the assets are not enough to cover all the debts, the creditors have no recourse to sue anyone, including the deceased’s heirs, for the remaining claims. In conclusion, Mufti Taqi’s fifth argument aligns with the common practice of slavery in classical Arab society.
The subject matter being discussed pertains to the idea of slavery. Acquiring a slave involves a monetary transaction where the prospective owner invests in purchasing them. The funds used for this acquisition are initially solely owned by the purchaser. Any earnings made by the slave are entirely directed towards their owner. Additionally, if the slave is tasked with assisting their owner’s business endeavors and incurs debts as a result, those obligations will be settled utilizing the finances and possessions possessed by the slave.
If the creditors find those measures insufficient, they can sell the slave to another buyer in order to recover their debts. If the creditors’ demands remain unmet, the slave will perish while still in debt. It is important to note that the creditors cannot seek repayment from the original master of the slave. The master, who owned the entire enterprise, utilized the slave as a tool for business transactions and held full ownership of the business. However, the master’s responsibility was limited to their invested capital, which includes the value of the slave. After the death of the slave, creditors were unable to make claims on any personal assets belonging to the master.
According to Mufti Taqi Uthmani, the concept of limited liability can be justified in Islamic Fiqh. He argues that this concept is similar to examples found in Islamic Fiqh and does not go against any injunctions of Islam. However, he emphasizes that limited liability should not be used to deceive or avoid natural liabilities that come with profitable trade.
He further emphasized that restrictions should be placed on partnerships and private companies. He argues that each shareholder and partner in these types of businesses can easily acquire knowledge of the day-to-day affairs and should be held responsible for all liabilities. However, he believes that these arguments are valid for public companies with thousands of shareholders. One argument made by two lectures from University Kelantan Malaysia in a paper titled ‘Islamic Accounting and Business Practices: A Conceptual Framework’ supports this viewpoint. They initiated a study that compares conventional accounting and business practices using arguments from the Holy Quran and Authenticated Hadiths to determine their approval in the syari’ah.
According to the argument, the discussed concept does not have approval within Syari’ah because “the owners are not responsible for the company’s debt during bankruptcy but still have rights to residual profits, which is considered unlawful and similar to gambling.” They also argue that in Islamic Accounting, “if the owners go bankrupt, the liabilities may be distributed to their successors or legal inheritors, which would be better for the owners because they will be held accountable for it in the hereafter [Al-Qur’an, 23:115].” Additionally, they mention that according to other opinions, some have accepted the concept as Syari’ah compliant, citing “the early age of Islamic State when there were Mosques or Baitul-Mal with separate financial status” [Abdul-Rahman, 1996 and AAOIFI, 1999].
In my humble opinion, I believe that this discussion should not be concluded. As students, including myself, who are inclined towards careers in business and accountancy, we are unaware of the differing opinions on these subjects that may exist. Despite proclaiming Islam as our way of life, we still lack knowledge in these areas. Currently, I am not capable of deciding which options align with syari’ah or selecting which materials to study due to external decisions. Therefore, it is essential to develop self-awareness to distinguish wisdom from ignorance, truth from deception, success from failure, and the blessings of The Most High from His Wrath. With this perspective, I end this essay. Wallahu a’lam.
