Summary
The Middle Eastern countries and Islam do not believe in interest -money is not an asset and cannot have a cost (interest). It can only be traded in relation to some commodity. The present crisis has shown that if a cost is not attributed to money then the result is a crisis. In this analysis I look at the effects of the Dubai debt crisis in relation to accounting rules.
Analysis
1. The Dubai debt problem is an implosion of ongoing activity in that emirate for several years based on borrowed funds - without considering the cost of funds.
2. Interest is the easiest and simplest method of calculating the cost of money.
3. Islamic rules do not consider interest and all borrowing and lending has to be without interest. The cost of money is therefore built into the borrowing in some other hidden form.
4. It is obvious that the cost of borrowing was not calculated properly in the case of Dubai world. Exposure by various entities was taken based on financial statements in which interest played no role.
5. Economics and accounting both require that the lender of money should get a fair return on his investment and the proper way to measure the same is in the form of interest.
6. Islamic finance requires that complex financial products be developed by people with a great amount of religious as well as financial knowledge.
7. The knowledge of islamic finance in the accounting world is limited. This therefore makes for complex and difficult to read financial statements in the case of those entities which rely on borrowed funds.
8. Accounting rules would be difficult to apply and therefore the we have the present situation where suddenly the entity has failed. What is required is a body of knowledge for non interest based finance where fair value and disclosure is properly tabulated and understood by preparers as well as users of financial statements.
