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Dubai’s Accounting Questioned in Wake of Debt Crisis

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November 30, 2009

Dubai World stunned investors late last week when the government-controlled company announced that it needed to restructure $26 billion in debt, but some of the problems may be related to its accounting.

An analysis by Indian accountant and consultant Nitish Grover noted that many Middle Eastern countries do not believe in charging interest on loans as the concept goes against Islamic belief. “Islamic rules do not consider interest, and all borrowing and lending has to be without interest,” he noted. “The cost of money is therefore built into the borrowing in some other hidden form.”

Grover believes that the cost of borrowing was thus improperly calculated on Dubai World’s debt, and investors misinterpreted the company’s financial statements. “The knowledge of Islamic finance in the accounting world is limited,” he added. “This therefore makes for complex and difficult-to-read financial statements in the case of those entities which rely on borrowed funds.”

Grover believes that preparers and users of financial statements need to have a greater understanding of non-interest-based finance in which fair value and disclosure can be properly tabulated.

Back in April, one of the members of the International Accounting Standards Board, Robert Garnett, gave a talk in Dubai in which he discussed plans to converge International Financial Reporting Standards and Islamic accounting standards (see IFRS to Converge with Islamic Accounting Standards). The Dubai World debt issue may make that effort even more urgent now.

However, the IASB and the U.S. Financial Accounting Standards Board are now accelerating their own convergence efforts, agreeing recently to meet on a monthly basis with the goal of melding U.S. GAAP with IFRS by June 2011, so convergence efforts with Islamic accounting standards are probably going to stay on the back burner for a while.

Investors and financial statement users will likely need to be extra cautious in evaluating the true cost of debt and the value of loans in Middle Eastern countries in the wake of the Dubai episode. It seems fair value accounting isn't an issue only in the U.S. and Europe now.

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