Transcript AAOIFI’s ACCOUNTING, AUDITING AND GOVERNANCE STANDARDS

WORKSHOP ON ACCOUNTING OF
MURABAHA UNDER IFAS – 1
Presentation By:
Omar Mustafa Ansari
Partner – Islamic Financial Services
Ford Rhodes Sidat Hyder & Co.
OUTLINE
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What is Murabaha?
Difference of
treatment
Acquisition of asset
Valuation of
Inventory
Discounts
Sale to the purchase
orderer
Profit Recognition
Presentation By:
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Early settlement
Treatment of Security
Deposit
Loss in absence of
Guarantee
Customer’s Default
SBP’s Shariah
Essentials
Accounting for
Liability Side
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
What is Murabaha?
Murabaha is a cost plus profit sale, i.e. a sale in which
the seller informs the customer about his cost and the
amount of profit.
 Contemporary Murabaha transaction (referred to as
Murabaha to the Purchase Orderer by AAOIFI
Standard) is normally a deferred payment sale.
 Ba’y Murabaha, by its very nature, is a purchase-sale /
trading transaction. In other words it is not a
“financing” transaction and instead, it is a substitute to
financing transactions.
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Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Difference of Treatment
Accordingly, the IFAS - 1 issued by ICAP, as
well as, the AAOIFI standard consider it a
trading transaction and suggest the
accounting treatment like a trading
transactions with certain exceptions.
 On the other hand, the conventional banks,
as well as, Islamic banks operating in Pakistan
were accounting for Murabaha as a
financing transaction (just like an interestbearing loan) and ignoring the purchase and
sales of goods.
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Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Acquisition of Asset
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Payment made to supplier or agent for purchase
of asset is accounted for as advance.
Asset is initially measured and recorded at
historical cost, including all costs necessary to
bring the asset in its present location and
condition.
Perpetual or periodic method of accounting for
inventories / purchases may be used.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Valuation of Inventory
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IFAS requires that if inventory is lying with the Bank,
the IAS applicable to inventories shall be applied.
In case where the customer has not fulfilled his
promise to purchase the inventory, the same
needs to be brought down to Net Realizable
Value (NRV).
If he has not defaulted, then even the market
value of goods is declined, since the Bank is sure
that it is able to sell the inventory at a profit
(Murabaha price) it would not be required to
write down the inventories.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Valuation of Inventory
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AAOIFI requires that if there is an indication of
non-recovery of costs of goods, the asset shall be
measured at cash equivalent value (Net
realizable value) through a provision.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Discounts
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According to AAOIFI standard, if a discount is
received from the supplier, it shall not be
considered as revenue and instead it should
reduce the cost of goods. The discount may be
treated as revenue if this is decided by the Islamic
Bank’s Shari’a Supervisory Board.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Sale to the Purchase Orderer
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It shall be recorded at the time of occurrence at
invoiced amount i.e. gross selling price.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Profit Recognition
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Profit shall be recognized at the time of
consummation of sales, if the sale is for cash or on
credit but the term does not exceed the current
financial period.
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The profit on portion of Murabaha receivable not due for
payment should be recorded as “Unearned Murabaha
Income” with a corresponding liability on the balance sheet
called “Deferred Murabaha Income”.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Profit Recognition
As per AAOIFI Standard, profits of credit sale whose
payment due after the current financial period shall
be recognized using any of the following methods:
 Preferred method – Proportionate allocation of
profits whether or not cash is received;
 Allowed Alternative method – Profit may be
recognized as and when the amount is received.
Accrued amount of profit which is not yet received
is disclosed.
 Deferred profits shall be offset against (shown as a
deduction from) Murabaha receivables in the
statement of financial position / balance sheet.
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Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Purchase of Assets and sale to purchase
orderer
BANK
Rs. 10 M
Records
asset at full
amount of
Purchase
Price less
discount
Any decline in value
shall be reflected
at the end
of financial period
Presentation By:
Rs. 12 M
Murabaha Receivable
is recorded at Rs. 12
M including unearned
Murabaha income and
a liability of Rs. 2 M is
recorded.
Asset
Rs. 12 M
Liability
Rs. 2 M
Rs. 2 M recognized as
income over a period of
Murabaha term
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Early Settlement
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According to most of the jurists in Pakistan, no
discount can be allowed in case of early
settlement. Accordingly, in case of early
settlement, deferred Murabaha income should
be immediately recognized. However, IFAS – 1 is
silent in this respect.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Early Settlement
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According to AAOIFI Standard:
 Deduction of profit at the time of settlement
The Bank may deduct the part of the profit agreed
upon from payment of one or more installments.
This is, however, not allowed by a number of jurists,
particularly in Pakistan.
 Deduction of part of profit after settlement
The above criteria should be applied for payments
of one or more installments before the time
specified, the Islamic Bank may ask the client to
pay the full amount and thereafter reimburse with
part of profit.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Treatment of Security Deposit
(Hamish Gedayyah)
IFAS – 1 is silent regarding treatment of security deposit
may be obtained from the Purchase Orderer at the
time of initial promise to purchase. According to
AAOIFI standard, such deposit shall be treated as
liability on Islamic Bank.
 In case the customer does not fulfill his promise to
purchase the asset:
 If the promise by the Purchase Orderer is a nonbinding promise, the security deposit shall be
returned in full even if the asset is sold at lower
amount to another customer or in the market;
 If the promise is a binding promise, the amount of
actual loss shall be deducted from the security
deposit.
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Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Loss in absence of guarantee /
security deposit
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In absence of any guarantee or security deposit,
any loss incurred shall be recorded as receivable
due from the defaulter client.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Customer’s Default – Charity
IFAS – 1, does not specifically mention about the
accounting treatment for charity (in case of
customer’s default).
 However, in basic Shariah principles and features
of Murabaha, it mentions that self-imposed
penalty for charitable purpose may be included
to avoid defaults. However, such charity would
not form income of the Bank and shall be utilized
for charitable purposes only.
 Accordingly, any charity amount received should
directly be recorded as a liability.
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Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Murabaha – Customer’s Default – Charity
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According to AAOIFI Standard:
 Procrastination
The amount received as a penalty shall be treated
as revenue or an allocation to charity fund as the
Shari’a Board deems appropriate. Normally, in
Pakistan, the jurists do not allow it as revenue and
instead they say that it has to be directly paid by
the customer in the charity fund.
 Insolvency
The Islamic Bank cannot ask the client to pay any
additional amount by way of penalty.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
SBP’s Shariah Essentials – For Murabaha
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Shariah Essentials for Murabaha, as issued by the
SBP’s Shariah Board have been included as an
appendix to IFAS – 1 and are deemed to be an
integral part of the same. In addition, IFAS – 1,
itself provides basic Shariah principles and
features of Murabaha.
There is a debate, as to whether these essentials,
which otherwise are considered as “guidelines”
become “standard” (legally applicable) by virtue
of being part of this standard.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Accounting for Liability Side
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IFAS – 1 deals with the accounting as the seller in
a Murabaha transaction, which is generally the
position of Islamic financial institutions.
It does not deal with the accounting for the
purchaser in a Murabaha transaction, either for
the Islamic financial institutions or for their
customers.
Accordingly, there are a few Modarabas who
have not applied this standard on their liability
side Murabaha transactions.
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.
Accounting for Liability Side
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According to IAS – 2 and IAS – 16, the costs of
inventories and items of property, plant and
equipment (fixed assets) should not include the
additional cost representing financial charges
against deferred delivery.
Accordingly, normally the purchasers in
Murabaha transactions have to follow these
standards and to record the differential as
financial charges (except where these qualify as
borrowing costs).
Presentation By:
Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co.