International Journal of Business and Social Science Vol. 10 • No. 2 • February 2019 doi:10.30845/ijbss.v10n2p7 55 Impacts of Zakat Avoidance on the Market Performance of Banks in Saudi Arabia Dr. Salah Oraby Assistant Professor Accounting Department College of Administrative and Financial Sciences Saudi Electronic University Ammar Abdullah Alhajjaj (MBA) Ph.D. Candidate Al-Imam Mohammad ibn Saud Islamic University Abstract This study aims at investigating whether investors in Saudi capital market are aware of the behavior of banks in the field of zakat avoidance especially that zakat dues are treated as a component of equity in balance sheet rather than as an item of income statement and that treatment may give a room to management to manipulate the calculation of the book value per share that is of value relevance. To test research hypotheses two regression models are developed: the first assumes that investors are not aware of zakat avoidance by banks whereas the declared book value per share as the independent variable is regressed on the market value per share as the dependent variable, the second model assumes that investors are aware of zakat avoidance by banks, whereas the adjusted book value per share as the independent variable is regressed on the market value per share as the dependent variable. The two models gave similar results indicating that both book values are of value relevance explaining about 51 % of changes in the market value per share. It can be said that investors are not aware of zakat avoidance by banks and are using the declared book value as the predictor of the market value per share rather than using the adjusted book value. The results of research may be due to the lack of sufficient disclosures by external auditors in some cases and due to the complete absence of disclosures by external auditors in most cases. Keywords: value relevance, book value per share, adjusted book value per share, zakat avoidance. 1. Research Problem The accounting treatment of Zakat expense for financial institutions, including banks, in KSA is different than other entities. The IAS 12.77 states that “the amount of tax expense (or income) related to profit or loss is required to be presented in the statement(s) of profit or loss and other comprehensive income” (IFRS Foundation, 2002, p. A983). The KSA’s accounting standards that issued by the Saudi Organization for Certified Public Accountants (SOCPA), also, states that “the Zakat provision shall be presented in separate item in income statement after the exceptional profit/loose items and before the net income item” (SOCPA, 1999, p. 1712). Therefore, all entities shall recognize the Zakat expense in the income statement before the net income item. However, financial institutions (banks, finance company, and insurance) are supervised by the Saudi Arabian Monetary Authority (SAMA),where SAMA requests financial institutions, in its circular number (381000074519) on Apr. 11, 2017, to prepare their financial statements using IFRS standard except IAS 12 that it is related to accounting of Zakat. The circular addresses how to present Zakat in the financial statements as follows: the total amount of Zakat shall be disclosed in the financial statements under the Statement of changes in shareholders’ equity and present Zakat for the current year and Zakat for the prior year(s) in separate items. Indeed, to comprehend the reflection of this difference in treatment of Zakat amount, we will take example for both treatments. If company make one million as an earning before Zakat (EBZ) and two hundred thousand as a Zakat amount, the net income using the treatment that banks use in KSA is one million. Whereas, the net income for company that following International Financial Reporting Standards (IFRS) or SOCPA will be only eight hundred thousand netting of tax expense. Consequently, this difference in accounting treatment may misleading investment decisions for investors who do not aware about it. As a result of SAMA abovementioned circular, the banks’ net profit will not be affected by either Zakat provisions or Zakatpaid. Therefore, Zakat avoidance in KSA banks under current accounting treatment, will affect the equity in the bank’s balance sheet. Moreover, there is variation in calculating Zakat base between the General Authority of Zakat and Tax (GAZT) and the banks that subject to Zakat in KSA.