Week 6

18th of August, 2009

Accounting for Asset Financing

(Murabaha & Bai Muajjal)
Nature of Asset Based Financing
Financing involving exchange of goods Financing involving exchange of
such as: services:
Murabaha or Bai Bithaman Ajil Ijarah
Salam and Parallel Salam Ijarah Al-Muntahia Bil-
Istisna and Parallel Istisna Tamleek
Al-Wakalah (Agency)

MURABAHA
There are two types of Murabaha:
Murabaha terms by AAOIFI
Murabaha to the Purchase Orderer

Murabaha Murabaha to the Purchase Orderer

A Murabaha is defined as the sale of goods at cost plus Murabaha to the Purchase Orderer involves three
mark up. parties, namely, the purchase orderer, the purchaser and
Only two parties are involved: purchaser and seller. the seller.
The purchaser should be informed of his cost of Involves intermediary due to lack of expertise or need
purchase and the profit amount (mark up). for credit facility (because purchaser doesnt have money to
buy).
MARK-UP MARK-UP
SELLER BUYER FINANCIER CUSTOMER

PRICE = COST + PRE-DETERMINED MARK-UP

CASH SALE & PURCHASE
PRICE AGREEMENT
SUPPLIER/
DEVELOPE
R

Financier (Islamic Bank) charges mark-up: because he

takes the risk and he is not actually interested in owning the
good.

Principles of Murabaha Financing

Murabaha with obligation to purchase: Murabaha without obligation to purchase:
- Customer bears risk for non-receipt of goods (delivery) Total risk born by the bank for non delivery
- Bai Bithaman Ajil (Deferred Payment Sale): murabaha to
purchase orderer & customer is obliged to purchase.
- That is even if the customer is not happy with the good,
he still have to buy from the bank who purchased on his
order.

Recognition of Murabaha Financing

Murabaha financing is asset to the bank. But: at which point should the bank recognize it legally?!
Customer Bank
1 Jan 09 15 Jan 09 22 Jan 09

Order Purchas Financin Settleme

e g nt/Dispo
sal
Indicates a Financing Sells to
transaction customer

Deposit Disbursement Receivable/ Cash/

Collateral Cash Equivalent

to developer

1. Order: 1 Jan 09
2. Purchase/Disbursement:15 Jan 09 (trade asset!)
3. Sell/financing: 22 Jan 09 (bank sells and changes financing account)
We recognize when we realize (meaning when it belongs to us) 15 Jan trade asset (form of inventory).

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But central bank doesnt allow step 2 because banks are more intermediaries and not allowed to trade. As a remedy we
execute step 2 and 3 at the same day. 2 contracts (2 in 1) this solves the problem of double tax. Since the transactions
occur at the same day trade asset will not be on the balance sheet.

Illustration of Murabaha Financing

An Islamic Financial Institution provides a financing of RM 100,000 at a constant rate of return of 10% for a period 5 years
and requires an annual installment payment of RM 30,000. Prepare an extract of the balance sheet and income statement
at the beginning and end of year 1.
Workings:
Unearned Income = 5 (RM 30,000) RM 100,000 = RM 50,000.
Unearned income is unearned mark-up. It is not called profit initially: because it is realized over a period (gradually) and
not immediately. But RM 50,000 that is already profit that will be received at the end.
Year 0, Year 1, Year 2, Year 3, Year 4, Year 5,
RM RM RM RM RM RM
Murabaha Financing (selling 150,0 120,0 90,00 60,000 30,00 0 -30,000 until it becomes
price) 00 00 0 0 zero
Unearned Income (50,00 (40,00 (30,00 (20,000 (10,00 0 -10,000 (profit)
0) 0) 0) ) 0)
Net Receivable (real cost) 100,0 80,00 60,00 40,000 20,00 0
00 0 0 0

Year 0, Year Year 2, Year Year Year 5,

RM 1, RM 3, 4, RM
RM RM RM
Murabaha Income 10,00 10,000 10,00 10,00 10,000
0 0 0

Recognition of Murabaha Financing Asset & Income

ASSETS = LIABILITIES + EQUITY
Debit Credit Debit Credit Debit Credit
+ - - + - +

Recognition of Murabaha Financing Asset Cash, Unearned Income (Deferred Profit):

Cr.: Cash/Payable
Cr.: Unearned Income (Deferred Profit)
Set-off the amount receivables Cash, Murabaha Financing:
Dr.: Cash
Cr.: Murabaha Financing (Asset)
Recognition of Murabaha Profit Unearned Income, P&L:
Dr.: Unearned Income
Cr.: P&L a/c

Income Recognition of Murabaha Financing Assets

Accrual Basis Method Cash Basis Method
Recognizes profit based on a proportionate Recognizes profit as and when the
allocation of profits whether cash is received installments are received and requires the
or otherwise approval of SSB

Policies on Expenses and Profits

Matching principle of expenses with income is applied.
Deferral profits (unearned) shall be offset against Murabaha receivables in the statement of financial
position.
Settlement amount is based on outstanding financial amount (accrual basis).

Policies on Penalty
Penalty is imposed on any failure to repay in payment (mutual agreement or court action) is a form of revenue or
allocation to charitable fund
In the case of insolvency, the bank has no authority to ask client to pay for penalty

DEFERRED PAYMENT SALE (BAI MUAJJAL) (AAOIFI FAS 20)

This standard aims at setting out the accounting rules for recognizing, measuring, presenting and disclosing.
The basis for the legitimacy of deferred payment sale is that it is covered by the rules of ordinary sale which is
mentioned in the Quranic verse: But Allah hath permitted trade.

Juristic Considerations for Deferred Payment Sale (Bai Muajjal) (FAS 20)

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 Ownership of the assets by the purchaser is already established by the contract that is concluded through offer
and acceptance of the parties to the contract.
The delivery or possession of the asset is considered as an effect of the contract.
Risks and rewards relate to ownership of the contract.

Recognition of Purchased Asset (Deferred Payment)

Asset available for deferred payment is recognized upon purchase (conclusion of contract) for full amount of
piecemeal basis at historical cost in Investment in assets available for deferred payment sale.
In case of purchase with IFI option to revoke, payments made to supplier shall be classified as advanced
payments.

Asset Measurement
Fair value measurement at balance sheet date.
Changes in value to be recorded in Investment Fair Value reserve account proportionate to investment
depositors/owners equity contribution.
Losses exciding reserve will be charged as unrealized losses in the Income Statement.

Recognition of Receivables
Receivables arising from deferred payment sale shall be recognized at the conclusion of the contract, and
measured at their face value.
At the end of financial period, receivables shall be measured at their cash equivalent value, which is the amount
of debt outstanding at the end of the financial period less any provision for doubtful debts.
Receivables presented in balance sheet to be net of deferred profits and provision of doubtful debts.

Accelerated Payment and Late Charges

Any accelerated payment by the debtor could be dealt in two ways:
Any Penalty charges for delinquent accounts to be recognized in Charity and presented in Statement of Sources
and Uses of Zakat and Charity Funds

Disclosure Requirements
Profit allocation method during the contract period
Movements of receivables on deferred payment sale including deferred profits and provisions for doubtful debts.
Finance policies on deferred payment sale as well as fair value of securities (collateral) of the sale.
Whether it has applied the option to revoke contracts in the purchase of assets available for deferred payment
sale.

COMPARATIVE DIFFERENCES
Murabaha
Predetermined mark-up
Cash/Accrual
Disclosure of cost and selling
price
Lump sum/Installment payment
Deferred Payment Sale (Bai Muajjal)
No predetermined mark-up
Accrual Basis
No disclosure of cost and selling
price
Installment Payment

CALCULATIONS PART
QUESTION 1
Bank Muamalah Berhad provides a financing facility based on the principles Murabaha to the Purchase Orderer to Barakah
Construction Sdn. Bhd. To purchase a specialized equipment to be used for their business project. The financing amounted
to RM 500,000 at a constant rate of return of 10% for a period of 5 years. The annual installment payment is RM 150,000.
Required:
Prepare journal entries for Bank Muamalah Berhad only for the first year and final year of the contract.
Present a statement showing the amount of the net receivable and murabaha income for the whole duration of
the contract.

Solution:
Cost = RM 500,000
Profit to be earned = RM 500,000 10% 5 years = RM 250,000
Total BBA Financing = RM 500,000 + RM 250,000 = RM 750,000
Profit to be earned per year = RM 250,000 / 5 years = RM 50,000
Total Repayment amount per year = RM 750,000 / 5 years = RM 150,000
-150,000 -150,000 till it turns to 0
Year 0, Year 1, Year 2, Year 3, Year 4, Year 5,
RM RM RM RM RM RM
BBA Financing 750,000 600,000 450,000 300,000 150,000 0
+50,000 +50,000 till it turns to 0

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 Unearned
-250,000 -200,000 -150,000 -100,000 -50,000 0
Income
Net Receivable 500,000 400,000 300,000 200,000 100,000 0

Year 0, Year 1, Year 2, Year 3, Year 4, Year 5,

RM RM RM RM RM RM
Murabaha
0 50,000 50,000 50,000 50,000 50,000
Income

QUESTION 2
(a) Bank Syariah Berhad provides a financing facility based on Bai Bithaman Ajil (BBA) principles to Ahmad bin Ali for
the purpose of house purchase. The financing is amounting to RM 300,000 at a constant rate of return 8% for a
period of 5 years. At the end of the contract Ahmad owes the bank amounting to RM 32,000. As part of the normal
requirements, the customers will be charged a penalty fee of 3% per month for any outstanding amount due at
the end of the contract and the amount collected is normally disbursed as charity.
Required:
I. Prepare an extract of the Balance Sheet and Income Statement of Bank Syariah Berhad from the
beginning till the end of the contract to show the amount of net receivable and Murabaha (BBA) income.
II. Prepare journal entries to record all the above transactions in the book of Bank Syariah Berhad
(including the treatment for penalty fee).

(b) Explain the similarities and the differences between Murabaha to the Purchase Orderer and Bai Bithaman Ajil
Financing.

(c) Explain the recommendations made by the Shariah Advisory Council of Securities Commission in Malaysia on
policy of charging penalty fee for default in repayment by customers and discuss the policy as currently adopted
by the Bank Syariah Berhad.

Solution:

Part (a):
Cost = RM 300,000
Profit to be earned
Total BBA Financing
Profit to be earned per year
Total Payment amount per year
= RM 300,000 8% 5 years = RM 120,000
= RM 300,000 + RM 120,000 = RM 420,000
= RM 120,000 / 5 years = RM 24,000
= RM 420,000 / 5 years = RM 84,000

Year 0, Year 1, Year 2, Year 3, Year 4, Year 5,

RM RM RM RM RM RM
252,00
Financing 420,000 336,000 168,000 84,000 32,000
0
- - -
Unearned Income -96,000 -48,000 0
120,000 72,000 24,000
180,00
Net Receivable 300,000 240,000 120,000 60,000 32,000
0

Year 0, Year 1, Year 2, Year 3, Year 4, Year 5,

RM RM RM RM RM RM
BBA Income in
0 24,000 24,000 24,000 24,000 24,000
P&L a/c

Overdue amount = RM 32,000

Penalty Fee = RM 32,000 3% = RM 960 per month

Part (b):
Murabaha to the Purchase Orderer and Bai Bithaman Ajil Financing
Similarities: Differences:
- Both are based on trade contract (bay) - MPO: mark-up must be disclosed; BBA: mark-up need not be
disclosed
- Involve 3 parties i.e. buyer, seller and - MPO: lump sum repayment or installment; BBA: deferred
bank installment only
- MPO: mostly short term; BBA: mostly long term

Part (c):
Shariah requirements on penalty fee:
- Intention to discipline customers and not to take profit out of the fee
- Must not be cumulative & fixed monthly
- The total amount of fee must not exceed the total amount due
- The rate must be minimal i.e. 1% of the overdue amount.

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QUESTION 3
(a) Bank Muamalah provides a house
financing details are as follows:
Financing Amount
Term of Financing
Rate of Return (Constant)
Penalty Fee
financing facility based on Bai Bithaman Ajil (BBA) principles to Ahmad. The
RM 300,000
8 Years (to beginning on 1st January 2007)
5% per anum
3% per month on outstanding balance

Ahmad has defaulted the terms of the facility in year 5, and having an outstanding balance of installments for the
previous 6 months. The bank has repossessed the house at the end of the year 5.

Required:
i. Prepare an extract of the Balance Sheet and Income Statement of Bank Muamalah from the beginning till
the end of the contract to show the amount of net receivable and Murabaha (BBA) income.

ii. Prepare journal entries to record the recognition of assets and income for the first and fifth year only in the
book of Bank Muamalah (including the treatment for penalty fee).

(b) Discuss the similarities and difference between Murabaha to the Purchase Orderer and Bai Bithaman Ajil
financing.

Solution:

Part (a):
Cost = RM 300,000
Profit to be earned
Total BBA Financing
Profit to be earned per year
Total Payment amount per year
= RM 300,000 5% 8 years = RM 120,000
= RM 300,000 + RM 120,000 = RM 420,000
= RM 120,000 / 8 years = RM 15,000
= RM 420,000 / 8 years = RM 52,500

By Right it should be like this:

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

Financing 420,000 367,500 315,000 262,500 210,000 157,500 105,000 52,500 0
- -
Unearned Income -90,000 -75,000 -60,000 -45,000 -30,000 -15,000 0
120,000 105,000
Net Receivable 300,000 262,500 225,000 187,500 150,000 112,500 75,000 37,500 0

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8

BBA Income in
0 15,000 15,000 15,000 15,000 15,000 15,000 15,000 15,000
P&L a/c

With the element of default: -52,500 -52,500 here he managed to pay only half
= 52,500/2 = 26,250
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
Financing 420,000 367,500 315,000 262,500 210,000 183,750
- -
Unearned Income 120,000 105,000 -90,000 -75,000 -60,000 -45,000
Net Receivable 300,000 262,500 225,000 187,500 150,000 138,750
138,750 is now a bad debt!
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8
BBA Income in
P&L a/c 0 15,000 15,000 15,000 15,000 15,000

As Ahmad is default in year 5 (having outstanding balance for 6 months of the year 5)
Overdue = RM 183,750
Fee per month = RM 183,750 0.03 = RM 5512.50
Fee for 6 months = RM 5512.50 6 = RM 33,075
Total Overdue = RM 183,750 + RM 33,075 = RM 216,825

If we would calculate compounded (how conventional bank can do it)

RM 183,750
RM 5,512.50
RM 189,262.50 0.03 = RM 5,677.88 (and like this 5 more times all together will be for 6 months)
But this way is shariah-wise (this is clear-cut ribbah)!!

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>>> ISSUE #1:
Year 6
Financing 0
Unearned
Income 0
Net Receivable 0
Overdue = RM 183,750
Penalty = RM 33,075
The question is where should we charge RM 183,750??? It is non-cash item... this is non performance financing

2 choices:
1) Reserve 2) P&L
account

However, prior to write it off from reserve we have to minus 45,000:

RM 183,750
- RM 45,000
RM 138,750 this amount must be taken from reserve

What to do with penalty? We created as receivables we have to write it off as well:

RM 138,750 (net receivables which are not collectable now)
+ RM 33,075 (penalty)
RM 171,825 profit/reserve reduction!

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>>> ISSUE #2:
What will happen with house? The bank now has to repossess the house. But the bank is not interesting in holding house
it will be sold on the auction. Lets say for RM 100,000. The question where RM 100,000 should go??? The answer:
Depends! This house is off-balance sheet item (we never created inventory of house) we keep it as off-balance sheet
item. But when we get money where does it go? we receive cash again:

2 choices again:
1) Reserve 2) P&L
account

(depends on wherefrom you wrote it off before in the issue #1!)

>>> ISSUE #3:

Penalty Fee is an issue of its own! There are two schools of thoughts on this issue:

Should NO It will attract

the Bank bad
charge customers
Penalty
Fee?
YES

Does it go PROFIT Then is the bank in the

to the business of charging
charity or penalty fee????
profit?

CHARITY

But many banks say: Charity Yes! But profit also (it is indirect income for bank).

QUESTION 4 (BBA with Ibra)

(a) Bank Mukmin provides a house financing facility based on Bai Bithaman Ajil (BBA) principles to Aminah. The
financing details are as follows:
Financing Amount RM 500,000
Term of Financing 10 Years (to beginning on 1st January 2000)
Rate of Return (Constant) 4% per anum

Aminah has paid by installments as stated in the agreement for the first 5 years and agreed to settle all the
payment outstanding in full at the beginning of year 6. The bank has agreed to give the customer a 10% rebate of
the total outstanding amount due to be paid to the bank.
Required:
i. Prepare an extract of the Balance Sheet and Income Statement of Bank Mukmin from the beginning till
the end of year 5 to show the amount of net receivable and Murabaha (BBA) income.

ii. Prepare journal entries to record the recognition of assets and income for the first, fifth and sixth year
only in the book of Bank Mukmin (including the treatment on rebate).

(b) Which accounting basis of income recognition should be adopted by Islamic banks (accrual or cash) and why?

Solution:
Part (a):

>> Unearned Income = (0.04 500,000) 10 years = RM 200,000

>> Total BBA financing = RM 500,000 + RM 200,000 = RM 700,000
>> Yearly installment = RM 700,000 10 = RM 70,000

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

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Financing 700,000 630,000 560,000 490,000 420,000 350,000 280,000
Unearned (200,000 (180,000) (160,000) (140,000) (120,000) (100,000) (80,000)
Income )
Net Receivables 500,000 450,000 400,000 350,000 300,000 250,000 200,000

>> Discount 10%: 0.10 RM 280,000 = RM 28,000

Customer pays only RM 280,000 RM 28,000 = RM 252,000
Profit & Loss account will be reduced by RM 28,000
RM 200,000 RM 28,000 = RM 172,000 will appear on balance sheet!

Part (b):
Accrual Cash

>> write an amount even if this amount
was not received in cash (recognize when
realize)
>> Is better because of the modern time
conditions: ongoing concern + different
investment times.
>> write an amount only when it is actually
received in cash
>> was used before (as the contracts mostly
were for a short term)
>> Is better for zakat purposes: as it is more
certain