AAOIFI standards and income smoothing behavior: evidence from Islamic financial institutions in the MENA region

Purpose Our study investigates whether the adoption of Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) accounting and auditing standards influences income smoothing behavior in Islamic Financial Institutions (IFIs) operating in the Middle East and North African (MENA) region. In particular, we examine whether Financial Accounting Standards (FASs) affect earnings behavior differently from International Financial Reporting Standards (IFRS) and whether institutions jointly applying AAOIFI accounting and auditing standards exhibit different income smoothing behavior from institutions not applying AAOIFI auditing standards. Design/methodology/approach Using a sample of IFIs from 2013–2018, we employ a multi-method approach combining earnings variability, benchmark-beating tests, and a classification of income smoothing into artificial, real, and natural categories. Findings Our results indicate that IFIs applying AAOIFI FASs exhibit a higher likelihood of income smoothing and lower earnings volatility compared to IFRS-adopting institutions. Institutions jointly applying AAOIFI accounting and auditing standards also exhibit a positive association with income smoothing. However, this association is weaker and less robust across alternative specifications than that observed for FASs. Practical implications Our findings indicate that regulators, auditors and Sharia governance bodies should require transparent, comparable disclosure of reserve movements and other stabilization mechanisms. Such disclosure can help investors and investment account holders distinguish sustainable performance from reporting-induced stability. Originality/value This study provides novel cross-country evidence on AAOIFI standards and income smoothing in IFIs. By separately examining FASs and the joint application of AAOIFI accounting and auditing standards, we extend the Islamic finance and emerging-market accounting literature.