ACCOUNTING TREATMENT

FOR ISLAMIC BANKING

PRODUCTS
 Creditor Debtor

Deposit ($) Loans ($)

Interest paid ($) Interest charged ($)

 Deposit ($) Financing ($)

AQAD / CONTRACT AQAD / CONTRACT

Wadiah Musharakah
Mudharabah Mudharabah
Murabahah Murabahah
Qard* Ijarah
Istisna’a
Salaam

Profit paid (except Profit Sharing

for Qard) Profit Charged
 Accounting Recognition

Recognition
Define the basic principles that determine the timing of
revenue, expense, gain and loss

Measurement
Define the broad principles that determine the amount at
which assets, liabilities, owners equity etc. are
recognised
 Islamic Accounting Recognition

Revenue Recognition
Recognized when realised
The right to receive not necessarily when the payment is received
(i.e. accrual basis – MASBi-1 para 22; AAOIFI) e.g. when a bank
delivers the service
Shariah Requirement: the amount of revenue should be known
and collectible

Expense Recognition
Realisation either because the expense relates to the earning of
revenue (e.g. transportation cost for services), or because it relates
to the period of income statement
 Types of Shariah Contracts

SALE-BASED PARTNERSHIP-BASED LEASE-BASED

Murabahah (Cost-Plus) Mudharabah (Profit Sharing) Ijarah (Leasing)

Istisna (Construction) Musharakah (Profit & Loss Ijarah Thumma Bai (Leasing
Salam (Deferred Delivery) Sharing) Followed by Sale)
Bai Bithaman Ajil (Deferred
Installment)
Bai Inah (Sell & Buy Back)

FEE-BASED OTHERS

Wadiah (Safekeeping) Kafalah (Guarantee)

Wakalah (Agency) Hibah (Gift)
Ibra (Rebate)
Qard
 Some Commonly Used Contracts
There are various Principles that can be applied in Islamic finance. The four main
Principles commonly used are ……
Refers to agreement made between a capital provider (Rabbi Al-Mal) &
another party who acts as the entrepreneur (Mudarib). Profits are
The Mudharabah distributed based on pre agreed ratio and losses are borne solely by the
(Profit Sharing) Capital provider.
Example - Investments, Depository products etc

Refers to a partnership or joint venture for a specific business.

The Musharakah Distribution of profits are apportioned based on agreed ratio. Losses are
(Profit & Loss Sharing shared based on respective equity participation.
Joint Venture) Example - Project financing, Asset financing, Depository products.

Refers to a sale of goods at a price which includes a profit margin as

The Murabahah (Cost agreed by both parties. The price, other costs and profit margin of the
Plus) seller are stated at the time of the agreement of sale.
Example - Asset financing

Refers to an arrangement under which the lessor leases equipment,

building or other facilities to a client at an agreed rental or charges as
The Ijarah (Leasing) agreed by both parties.
Example - Equipment/Asset financing
 Key Differences from Conventional

Products Conventional Islamic Concepts Major Differences

Concepts
Hire Purchase Interest based lending  Aitab (Leasing ending with purchase) Asset-backing
 Bai Bithaman Ajil(deferred payment sale)

Home Mortgage Interest based lending  Bai Bithaman Ajil (deferred payment sale)  Asset-backing
 Musharakah (partnership)  Ownership of Assets
Credit Card Interest based lending  Bai Inah (sell & buy back) , Ujrah (fee)  Selling & buying of assets /
fee based
Personal Loan Interest based lending  Bai Inah (sell & buy back)  Selling & buying of assets
 Tawaruk (Commodity Murabahah)
Savings / Current Interest earning  Al Wadiah (Savings with guarantee)  Profit determination upon
Accounts savings  Mudharabah (profit sharing) maturity
Fixed / Term Interest earning  Mudharabah (profit sharing)  Profit sharing upon
Deposit savings maturity
Bonds (SUKUK) Interest earning  Musharakah (partnership)  Asset-backing transactions
investments  Ijarah (leasing)
 Istisna (Sale by order)
…for Islamic finance, the need for external financing can be met by Equity Financing & Debt Financing.
Within each respective domain, different types of contracts, securities and institutions usually evolve.

Hence, 2 distinct interrelated markets exist side

by side in the banking & financial system

Human Need for External Financing

EQUITY FINANCING DEBT FINANCING

Involves Mudharabah
Musharakah (partnership) or joint
venture for a specific business,
whereby the distribution of
profits will be apportioned
according to an agreed ratio. In
the event of losses, it is shared on
the basis of their equity
participation
Shariah Based Products
EQUITY MARKET
& Involves mainly contracts which
allows one party to provide
capital / funds to customers for
the purchase of goods or
entrepreneurship. 3 commonly
used principles are Murabahah
(cost plus) & Ijarah (Leasing) & Al
Bai Bithaman Ajil (Deferred
Payment Sale)
Shariah Compliant Products
DEBT MARKET
TYPES OF DEPOSITS/
FINANCING
Wadi’ah Deposit
 Wadi’ah Deposit
 One of the most commonly used principles in the Islamic
banks
 Acceptance of deposits in the saving and current accounts
 Jurists of all schools of Islamic law (mazahib) agree that
Wadi’ah is a form of trust
 The Islamic bank as trustee is responsible to safely keep the
deposited monies in his custody. The Islamic bank must
return the deposited monies at any time upon the request of
the depositors
 In both current and saving accounts, the depositors grant
permission to the Islamic bank to mobilize the funds but at
the same time guarantee their deposits (Wadi’ah
Yadhamanah)
 Deposits will be treated as liabilities – guaranteed custody
account
 Wadiah Deposit – Journal Entries

No. Transactions/Events Dr Cr

1 Deposit received from depositor Cash Wadiah Deposit

2 Deposit paid to depositor Wadiah Deposit Cash

3 Hibah disbursed to depositors Profit and Loss Cash

Qard Deposit
 Qard Deposit
 This is a savings account offered to the customers of the bank
that serves to support as basic banking requirement of the
customers and to allow the bank solicit deposits from the
customer.

 The product applies the concept of qard which means loan.

 If qard principle is followed, the customer would be the

lender and the bank would be the borrower (a creditor and
debtor relationship). Still, there’ll be no return on the money
deposited by client. No profit can be agreed on the loan.

 Deposits will be treated as liabilities – guaranteed custody

account
 Qard Deposit – Journal Entries

No. Transactions/Events Dr Cr

1 Deposit received from depositor Cash Qard Deposit

2 Deposit paid to depositor Qard Deposit Cash

Mudharabah/ Profit Sharing
Investment Accounts
Mudharabah/ Profit Sharing Investment Accounts
 Under the mudharabah contract, depositors (hereinafter
known as investment account holders or IAH) agree to
participate in the financial activities undertaken by the
Islamic banking institutions (as mudharib) and share the
profit generated from financing and/or investment activities
based on an agreed profit-sharing ratio.

 The IAH shall bear the losses arising from the assets funded
under the mudharabah contract or commonly known as
profit-sharing investment account (PSIA), except in the case
of misconduct, negligence or breach of contracted terms by
the Islamic banking institutions.
Mudharabah/ Profit Sharing Investment Accounts

 In Malaysia, Islamic banking institutions generally offer two

types of PSIA namely, the General Investment Account (GIA)
and the Specific Investment Account (SIA).

 In managing the GIA and SIA, Islamic banks have full

discretion to utilize the funds from GIA (also known as
unrestricted investment account) for the provision of finance
and/or investments, while the financing and/or investment
activities funded by SIA (or restricted investment account) are
confined to the investment mandate agreed between the
Islamic banking institutions and the IAH.
 AAOIFI FAS 5: Profit Allocation
Required Disclosures for Unrestricted Investment Account Holders
 AAOIFI FAS 5: Profit Allocation
Required Disclosures for Restricted Investment Account Holders
 AAOIFI FAS 6: Equity of Investment Account
Holders and Their Equivalent
 Accounting treatment of equity of investment account holders

 Unrestricted investment accounts

 Recognized when received unless condition that funds will not be

invested before certain date (to be recorded in current accounts till
date of investment).
 Profits on jointly financed investments to be allocated according to
capital contribution.
 Losses should be deducted from any undistributed profits on the
investment, unutilised provisions and respective equity share, in
that order.
 Any loss due to negligence/misconduct (as interpreted by the SSB)
will be charged to the Islamic bank.
 AAOIFI FAS 6: Equity of Investment Account
Holders and Their Equivalent

 Accounting treatment of equity of investment account holders

 Restricted investment accounts

 Assets and liabilities to be treated off-balance sheet.

 Recognized when received unless condition that funds will not be
invested before certain date (to be recorded in current accounts till
date of investment).
 Each type of investment account shall be recognized separately.
 Equity of RIAH’s shall be measured at amount received or clients’
purchase price of units/shares.
 If the Islamic bank has funds invested in RIAs, the Islamic bank shall
share in the profits earned on such funds as provider of funds.
 AAOIFI FAS 6: Equity of Investment Account
Holders and Their Equivalent

 Presentation and Disclosure

 Significant accounts.

 Percentage of UIAHs funds the Islamic bank has agreed to invest.

 Equity of UIAHs shall be presented as an independent category

between liabilities and owners’ equity.

 Information on RIAHs should be presented in the Statement of

Changes in Restricted Investments or at the foot of the balance sheet
 Mudharabah - Journal Entries

No. Transactions/Events Dr Cr

Equity of
Deposit received from capital Unrestricted
1 provider/ rab al-mal Cash Mudharabah
Investment

Equity of
2 Deposit paid to capital provider/ rab Unrestricted Cash
al-mal Mudharabah
Investment

3 Profit disbursed to depositors Profit and Loss Cash

Mudharabah Financing
 Mudharabah Financing

 The capital provider or the Islamic bank (rab al-mal) and the
small entrepreneur (mudharib) become a partner

 The profits from the project are shared between capital

provider and entrepreneur, but financial loss will be borne
entirely by the capital provider

 Mudharib will not be liable for losses except in cases of

misconduct
 Mudharabah Financing

The distinguishing feature of any Mudharabah is that:

i.The profit sharing ratio between the rab al mal and the
mudharib is agreed upfront

ii.Any losses, other than those incurred due to negligence or

mismanagement of the mudharib is borne by the rab al mal
 Mudharabah - Journal Entries

No. Transactions/Events Dr Cr

Mudharabah financing Mudharabah

1 provided to mudharib Financing Cash

Repayment of Mudharabah Mudharabah

2 Cash
capital repaid by mudharib Financing

3 Profit received from mudharib Cash Profit and Loss

Set-off Mudharabah loss borne Mudharabah

4 by rab al-mal Profit and Loss Financing
 FAS 3: Mudaraba Financing
Accounting treatment of Mudaraba financing

• Mudaraba capital (cash or in kind) recognized when paid to the

mudarib. If in installments, then when each installment is paid.
• Present in financial statements under ‘Mudaraba Financing’ or ‘non-
monetary Mudaraba assets’ if not paid in cash.
• If Mudaraba capital is paid in kind, it should be measured at fair market
value. If valuation is different from book value, then the difference
should be recognised in the books of the Islamic bank as
income/expense.
• Expenses incurred by either party is not considered as Mudaraba capital
unless agreed upon by both parties.
• Any repayment of Mudaraba capital shall be deducted from Mudaraba
capital.
• Any loss (other than due to mudarib negligence) of capital suffered prior
to inception shall be borne by the Islamic bank.
 FAS 3: Mudaraba Financing
Accounting treatment of Mudaraba financing
• If loss occurs after inception, Mudaraba capital is not affected.
• If all Mudaraba capital is lost, the Mudaraba will be terminated, account
settled and loss recognized by the Islamic bank.
• When a Mudaraba is terminated/liquidated, the Mudaraba capital will
be recognized as a receivable due from the mudarib.
• Profits shall be recognized when distributed by the mudarib.
• Losses shall be deducted from the Mudaraba capital.
• Mudarib shall bear the losses incurred due to misconduct or negligence
(receivable due from the mudarib)
• Disclosure should be made in the notes to the financial statements of
any provisions made for decline in value of Mudaraba assets.
Murabaha to the Purchase
Orderer
 Murabahah transaction

 Arrangement where the customer, who wish to purchase

certain goods or assets, requests the bank to purchase the
items and sell the goods/ assets to the customer at cost plus
a declared profit

 Cost price of the commodity will be specified

 Another relate mode of murabahah financing are bai’

bithaman ajil and bai’ al-muajjal (deferred payment sale)
 Basic Shariah rules related to Murabahah

The subject of the sale must be in existence at the time of sale

The subject of the sale must be owned by the seller
The subject of the sale must be possessed by the seller
The sale must be instant and absolute
The subject of the sale must be an asset of value
The subject of the sale should be a thing which is permissible
The subject of the sale must be specifically known and identified to the
customer
The delivery of the asset must be certain
The sale must be unconditional

 The key characteristic of Murabahah is that the seller discloses the actual cost
he has incurred in acquiring the asset and then adds some profit thereon
 The profit may be in lump sum or on a percentage
 The payment can be on spot or on deferred payment
 Murabahah transaction

1 2

1) The bank buys the goods for murabahah sale from the vendor and pays
for it.
2) The bank enters into a murabahah contract with a customer and delivers
the goods.
3) The customer pays the bank in installments over the contract period.
 Murabaha to the Purchase Orderer
transaction

3
2
4

1) The customer orders the bank to purchase goods, which it promises

(this may be binding or non-binding) to buy from the bank giving it
some profit.
2) The bank buys and pays for the goods from the vendor.
3) The bank executes a murabaha contract of sale to the customer and
delivers the goods.
4) The customer pays for the goods on an installment basis to the bank.
FAS 2: Murabaha & Murabaha to the Purchase Orderer

Income recognition of Murabaha financing

• Profits are recognized at time of contracting for cash or credit

transaction not exceeding the current financial period.
• If credit period exceeds one financial period, the recognition
methods are:
• Accrual basis method, or
• Cash basis method
• Accrual basis method recognizes income based on a proportionate
allocation of profits whether cash is received or otherwise.
• Cash basis method recognizes income as and when the installment
are received and requires approval of the Sharia Supervisory Board.
• Deferred profits (unearned) shall be offset against Murabaha
receivables on the face of the financial statement.
• Settlement amount is based on outstanding financial amount
(accrual basis)
FAS 2: Murabaha & Murabaha to the Purchase Orderer

Income recognition of Murabaha financing

• Penalty charges from procrastinating customers (non-
insolvent) can be treated according to what the SSB
decides, either as revenue or as allocation to charity
fund.
• Binding promise – the amount of actual loss should be
deducted or balance recovered from customer
• Disclosure should be made in the notes as to whether
promises to purchase are binding or non-binding.
• Disclosure according to FAS 1.
 Murabahah - Journal Entries

No. Transactions/Events Dr Cr

1 Purchase of Asset by Bank Asset Cash/Creditors

2 Murabahah sale Murabahah Financing Asset at cost

(cost+profit) Deferred profit with
profit
3 Installment received Cash Murabahah Financing

4 Installment due Receivable Murabahah Financing

5 Recognition of profit as each Deferred profit Profit and Loss

installment is received

6 Rebate for early payment Deferred profit Murabahah financing

Musharaka Financing
 Musharakah Financing

 Islamic bank enters into a partnership with entrepreneur(s) to

invest in a feasible business project

 If there is a profit, it will be shared based on pre-agreed ratio,

and if there is a loss, it will be shared according to capital
contribution ratio

 Musharakah mutanaqisah – capital is not permanent and

every payment of capital by the entrepreneur will diminish
the total capital ratio for the entrepreneur until the
entrepreneur becomes the sole proprietor for the business
 Musharaka – Journal Entries

No. Transactions/Events Dr Cr

Financing for Customers and

1 Musharaka Financing Cash
Partners provided

Termination or repayment of
2 Cash Musharaka Financing
capital by partner

3 Profit received from Musharaka Cash Profit and Loss

4 Loss on Musharaka Profit and Loss Musharaka Financing

5 Amount outstanding from partner Receivable Musharaka Financing

at settlement
 FAS 4: Musharaka Financing

Recognition of the Islamic bank’s share in Musharaka capital at the time of

contracting

The accounting rules for recognition and measurement for Musharaka capital is
similar to those of Mudaraba except for losses. The following are some of the rules.

1)The Islamic bank’s share in Musharaka capital (cash or kind) is recognized when it
is handed over to the partner or made available to the partnership under the title
“Musharaka financing” in the balance sheet.

2)If the bank’s share is in the form of trading or non-monetary assets, it should be
valued at fair value and any difference between the carrying amount of the assets
in the bank’s books and the fair value, is recognized as profit and loss in the income
statement.

3)Normally, contracting expenses (e.g. feasibility studies, legal expenses) are not
recognized as part of the capital unless agreed by both parties.
Measurement of the Islamic bank’s share in Musharaka capital after contracting at
the end of a financial period

4)In the case of constant Musharaka the Islamic bank’s share in the constant
Musharaka capital should be measured at the end of the financial period at historical
cost (the amount which was paid or at which the assets was valued at the time of
contracting).
5)However, if the Musharaka is a diminishing (musharaka mutanaqqisa), then the
Islamic bank’s share in the diminishing Musharaka should be measured at the end of
a financial period at historical cost after deducting the historical cost of any share
transferred to the partner (such transfer being by means of a sale at fair value). Any
difference between historical cost and fair value of the portion of share sold should
be recognized as profit or loss in the Islamic bank’s income statement.
6)If the diminishing Musharaka is liquidated before complete transfer is made to the
partner, the amount recovered in respect of the Islamic bank’s share shall be
credited to the Islamic bank’s Musharaka financing account and any resulting profit
or loss, namely the difference between the book value and the recovered amount,
shall be recognized in the Islamic bank’s income statement.
7)If the Musharaka is terminated or liquidated and the Islamic bank’s due share of
the Musharaka capital (taking account of any profits or losses) remains unpaid when
a settlement of account is made, the Islamic bank’s share shall be recognized as a
receivable due from the partner.
 FAS 4: Musharaka Financing
Recognition of the Islamic bank’s share in Musharaka profits or losses

8)Profits or losses in respect of the Islamic bank’s share in Musharaka financing transactions that
commence and end during a financial period shall be recognized in the Islamic bank’s accounts at
the time of liquidation.
9)In the case of a constant Musharaka that continues for more than one financial period, the
Islamic bank’s share of profits for any period, resulting from partial or final settlement between the
Islamic bank and the partner, shall be recognized in its accounts for that period when the profits
are distributed; the Islamic bank’s share of losses for any period shall be recognized in its accounts
for that period to the extent that such losses are being deducted from its share of the Musharaka
capital.
10)The same as in (9) above applies to a diminishing Musharaka which continues for more than
one financial period, after taking into consideration the decline in the Islamic bank’s share in
Musharaka capital and its profits or losses.
11)If the partner does not pay the Islamic bank its due share of profits after liquidation or
settlement of account is made, the due share of profits shall be recognized as a receivable due
from the partner.
12)If losses are incurred in a Musharaka due to the partner’s misconduct or negligence, the partner
shall bear the Islamic bank’s share of such losses. Such losses shall be recognized as a receivable
due from the partner.
13)The Islamic bank’s unpaid share of the proceeds as mentioned above shall be recorded in a
Musharaka receivables account. A provision shall be made for these receivables if the are doubtful.
 FAS 4: Musharaka Financing

Disclosure requirements

FAS 4, requires disclosure in the notes to the

financial statements if the Islamic bank has
made during that period a provision for a loss of
its capital in Musharaka financing transactions.
In practise, however, the banks provides for this
in the balance sheet itself and this is more in line
with international standards on asset
impairment.
Ijarah and Ijarah Muntahia
Bittamleek
 Ijarah Financing

 Where one party is given the right to use the services of a

person or of a given asset from another party for a
consideration
 Operating ijarah – not involved transfer of ownership
 Financing the acquisition of assets, whereby, the bank
acquires the assets and subsequently leases the asset to the
customer for a fixed period on a lease rental basis
 Asset remains the property of the Islamic bank
 Well recognised concept used for vehicle and equipment
financing
 Ijarah muntahia bittamleek – lies pre-existence of that
promise whereby a lease concludes with the legal title
passing to the lessee
Different types of Ijarah
Different types of Ijarah Muntahia Bittamleek
 Ijarah – Journal Entries

No. Transactions/Events Dr Cr

1 Purchase of Ijarah asset Ijarah Assets Cash

Depreciation Accumulated
2 Depreciation of Ijarah assets
expense depreciation

3 Ijarah rental received Cash Ijarah revenue

4 Recognition of profit Ijarah revenue Profit and Loss

Cash Ijarah Assets

5 Disposal or sale of Ijarah assets Profit and Loss (if Profit and Loss (if
loss) gain)
 Ijarah – Journal Entries

No. Transactions/Events Dr Cr

Profit and Loss (if

1 Transfer of ownership – by gift Ijarah Asset
loss)

Transfer of ownership – by token Profit and Loss (if Cash

2
or pre-determine price loss) Ijarah Asset

Transfer of ownership –
3 Cash Ijarah Asset
equivalent price
 FAS 8: Ijarah and ijarah Muntahia Bittamleek
Operating Ijarah in the books of the Lessor

1) Assets acquired for Ijarah

 Assets acquired is recognized at historical cost. This

includes net purchasing price plus all expenses necessary
to bring the asset to intended use. Examples of expenses
are custom duties, taxes, freight, insurance, installation,
testing.
 If there is a permanent reduction in the estimated
residual value, this reduction is recognized as a loss in the
respective financial period.
 Leased assets is depreciated on a basis consistent with
lessor’s normal depreciation policy for similar assets.
 Leased assets are presented in the financial statements as
Investments in Ijarah assets.
 FAS 8: Ijarah and ijarah Muntahia Bittamleek
Operating Ijarah in the books of the Lessor

2) Ijarah Revenue
 Ijarah revenue should be allocated proportionately to
the financial period of the lease term. Ijarah revenue
is presented in the income statement as Ijarah
revenue.

3) Initial direct costs

 If material, should be allocated over the lease period
consistent with lease revenue pattern. If immaterial,
they should be expensed directly in the income
statement.
 FAS 8: Ijarah and ijarah Muntahia Bittamleek
Operating Ijarah in the books of the Lessor

4) Repairs of leased assets

 Repairs that are necessary for securing the service of
the leased assets shall, if immaterial, be recognized in
the financial periods in which they occur.
 If the repairs are material and differ in amount from
year to year over the lease term, then a provision for
repairs shall be established by regular charges against
income.
 If the lessee undertakes repairs of a leased asset with
the lessor’s consent and the cost of the repairs are
chargeable to the lessor, then the lessor shall
recognize these repairs as an expense in the financial
period in which they are incurred.
 FAS 8: Ijarah and ijarah Muntahia Bittamleek
Operating Ijarah in the books of the Lessor

5) At the end of the financial period

 Amortisation of initial direct cost, if material, shall be
recognized as an expense of the period.
 If a provision for repairs has been established, the cost
of repairs for the period shall be charged against the
provision.
 Leased assets shall be depreciated according to the
lessor’s normal depreciation policy for similar assets.
 Ijarah installments receivable shall be measured at their
cash equivalent value.
 FAS 8: Ijarah and ijarah Muntahia Bittamleek

 In the books of the bank as lessee

 In the books of the lessee, the Ijarah

installments are recognized as an expense
under the accrual concept over the term of the
Ijarah and presented as Ijarah expenses. Initial
direct cost, if material, may be allocated over
the lease period. If immaterial, they should be
charged directly as expense
59
Key Salient Terms & Conditions