The purpose of this study is twofold. First, it explores the impact of the Financial Accounting Standards (FAS) issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) on real earnings management (REM) through commission and fee (CF) income of Islamic banks in the Middle East and North Africa (MENA) region. Second, it investigates whether this impact depends on the adoption status: mandatory or voluntary.
The authors test two hypotheses using the dynamic generalized method of moments (GMM) and the system GMM estimator.
The findings show that Islamic banks adopting AAOIFI-FAS generate more abnormal CF income than non-adopters, indicating a higher level of REM. Based on the substitution relationship between REM tools and accrual-based earnings management (AEM), we can infer that banks resort to managing activities that yield CF income to address the limitations of AEM resulting from AAOIFI-FAS. This study also shows that compared to non-adopters, mandatory adopters of AAOIFI-FAS use REM practices more strongly, while voluntary adopters do not reveal significant differences.
From an academic perspective, the results suggest that researchers should investigate emergent strategies for earnings management and explore how regulators can design effective incentive mechanisms to foster compliance with AAOIFI-FAS. Additionally, educational institutions teaching Islamic finance should integrate subjects dealing with REM strategies in Islamic banks and the AAOIFI accounting framework into their curricula.
From a practical standpoint, authorities should enhance bank supervision practices and establish stricter regulations on the recognition of CF income. This approach would contribute to improved income reporting quality. They should also strengthen compliance with AAOIFI-FAS by showing their societal virtues, implementing more stringent control mechanisms and providing captivating incentives. These measures would encourage voluntary adopters to take these standards seriously and motivate non-adopters to switch to them.
This paper offers new insights by analysing the impact of AAOIFI-FAS on REM via abnormal CF income in Islamic banks across the MENA region. It uniquely explores REM in Islamic banks using abnormal CF income, filling gaps left by previous studies focused on AEM.
