Islamic Financial Accounting Standard-1

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Islamic Financial Accounting Standard-1 Murabaha
Interpretation and Implementation Effective date
January 1, 2006
Ahmed Ali Siddiqui Vice President
Manager Product Development Shariah
Compliance Meezan Bank Limited
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Scope of Presentation
The scope of this presentation comprises of two
main parts - Basic Concepts, Modalities and
Documentation of Murabaha Transaction - Process
Flow of Murabaha Transaction - Documentation
- Accounting Policies and Recording Procedure
involved in Murabaha transaction as per the
requirements and guidelines of IFAS-1 - Account
ing Policies - Recording procedure and
disclosure of Murabaha transaction as per
IFAS-1
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Introduction

• Murabaha is a kind of Sale whereby Cost as well
  as the Profit is known to the Buyer and the
  Seller.
• Payment of Murabaha price may be
• 1) At spot
• In installments
• In lump sum after a certain time
• Hence, Murabaha does not necessarily imply the
  concept of deferred payment.

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Process Flow Murabaha Financing
1. Client and the Bank sign an agreement to enter
into Murabaha through a Master Murabaha Financing
Agreement (MMFA).
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Process Flow Murabaha Financing
2. Client appointed as an agent to purchase goods
on the Banks behalf.
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Process Flow Murabaha Financing
3. Bank gives money to an agent/supplier for
purchase of goods.
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Process Flow Murabaha Financing
4. The agent takes possession of goods on the
Banks behalf.
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Process Flow Murabaha Financing
5(a). Client makes an offer to purchase the goods
from the Bank through a declaration.
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Process Flow Murabaha Financing
5(b). Bank accepts the offer and sale is
concluded / culminated.
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Process Flow Murabaha Financing
6. Client pays agreed price to the Bank according
to an agreed schedule. Usually on a deferred
payment basis (Bai Muajjal)
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Stages in Murabaha Financing

• There are two stages in Murabaha transaction
• Investment Stage (Agency to Purchase)
• Financing Stage (Declaration to payment)
• Profit Recognition in Murabaha
• The profit for the Murabaha transaction shall be
  recognized after the goods are sold by the bank
  to the customer.

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Murabaha Documentation

• There are a number of documents involved in a
  Murabaha financing transaction. The most
  essential of these documents are
• 1) Master Murabaha Financing Agreement (MMFA)
• Agency Agreement
• 3) Draw Down Notice
• Summary Payment Schedule
• Declaration
• Details of Assets

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Murabaha Documentation

• 1) Master Murabaha Agreement
• Its an agreement between the client and the Bank
  whereby the client agrees to purchase goods from
  the Bank from time to time as per the terms and
  conditions of this Agreement.
• This is an over all facility agreement under
  which various Sub-Murabahas may be executed from
  time to time.

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Murabaha Documentation

• 2) Agency Agreement
• The client is appointed by the Bank as its agent
  to purchase goods. This agreement needs to be
  signed once between the client and the bank.
• The disbursement of funds is done under this
  Agreement.
• List of assets form part of the main Agency
  Agreement which defines the assets that the
  client is authorised to by on behalf of the bank
  acting as an agent.
• 3) Draw Down Notice
• These documents are required for each
  disbursement/Murabaha tranche.
• Draw down notice must mention the amount.

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Murabaha Documentation

• 4) Summary Payment Schedule
• Summary of Payment schedule should be finalized
  prior to signing of declaration of Murabaha
  agreement.
• 5) Declaration (Offer Acceptance document)
• Declaration is to be signed by the customer
  immediately after the purchase of the goods by
  the customer.
• This document establishes the actual sale
  transaction, i.e. transfer of ownership of goods
  from the Bank to the customer.
• At this stage the specific details of the
  assets must be known i.e. quantity, quality,
  price etc.
• Proper timing of declaration is extremely
  important.

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Murabaha Documentation

• 6) List of Assets
• This forms part of the declaration whereby
  details of the goods purchased are disclosed.
• Purchase evidences to be attached with the
  details of assets as a proof of purchased by the
  client as an agent of the Bank.
• The purchase evidences may includes the
  invoices, good receiving notes, good delivery
  challans or any other suitable evidence,
  preferably in the name of the Bank or in the name
  of the client as an agent of the Bank.

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Accounting Policy for Murabaha IFAS 1 - Murabaha
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Accounting Policy for Murabaha

• Transaction Recording
• Funds disbursed for purchase of goods are
  recorded as Advance for Murabaha. On
  culmination of Murabaha i.e. sale of goods to
  customers, Murabaha financings are recorded at
  the deferred sale price net of profit.
• Previously, Murabaha financings were recorded
  at the time of disbursement of funds.
• Goods Purchased but remaining unsold at the
  balances sheet date are recorded as inventories.
• Previously these were recorded as Advance
  against Future Murabaha.
• Financing are stated net of specific and
  general Provisions against non- performing
  financings, if any, which are charged to the
  profit and loss account.

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Accounting Policy for Murabaha

• Revenue Recognition
• Profit on Murabaha Financings is recognised on
  accrual basis. Effective January 01, 2006, profit
  on Murabaha transactions for the period from the
  date of disbursement to the date of culmination
  of Murabaha is recognised immediately upon the
  later date.
• Previously, profit on Murabaha was recognised
  from the date of disbursement.

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Reason for Change in accounting Policy
Below is a brief summary of recording procedure
of the Bank for Murabaha transactions both post
and pre adoption of IFAS-1 Murabaha.
Pre-adoption 1) Murabaha Financings were recorded at the time of disbursement of funds. 2) Goods purchased but remaining unsold at the balance sheet date were recorded as Advance against future Murabaha. 3) Profit for the Murabaha transaction was recorded from the date of disbursement. Post-adoption 1) Funds disbursed for purchase of goods are recorded as Advance for Murabaha. On culmination of murabaha i.e. sale of goods to customers, Murabaha Financings are recorded at the deferred sale price net of profit payment. 2) Goods Purchased but remaining unsold at the balances sheet date are recorded as Inventories. 3) Profit for the period from the date of disbursement to the date of culmination of murabaha is recognized immediately after the date of culmination of Murabaha..
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Case Study for Murabaha
Below is the case study for the
understanding of Murabaha transactions carried
out at Meezan Bank in various scenarios
Example Amount in Rs./
Purchase price/Cost/Principal 1,000
Profit Rate 10
Tenure One year
Total profit on transaction 100
Sale price (Contract price) 1,100
Date of Disbursement to supplier/customer January 01,2007
Date of Culmination of Murabaha Transaction January 15,2007
Date of Maturity of Murabaha December 31, 2007
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Scenario-A
A-When there is bullet payment of profit and Cost
(Principal) at the end of the period 1) At
the time of payment to the client for the
purchase of goods on behalf of bank or directly
to the supplier by the bank the transaction will
be accounted for as follows January 01,
2007 Dr Advance against Murabaha (B/S Asset
side) 1,000 Cr Pay Order / Party Account (B/S
Liability side) 1,000
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Scenario-A
2) At the Culmination of Murabaha i.e. at the
time of sale of goods to the customers with
signing of Declaration by the bank and the
client following entries would be
passed January 15, 2007 Dr Murabaha Financing
1,000 Dr Unearned Murabaha Profit
Receivable 100 Cr Advance against
Murabaha 1,000 Cr Deferred Murabaha Income
100 3) Booking of Accrual of profit_at_ 10 from
the date of disbursement to the date of
culmination, the following entry would be passed.
(1000 x 10) x 15 / 365 January 15,
2007 Dr Deferred Murabaha Income
4.10 Dr Murabaha Profit Receivable 4.10 Cr Inco
me on Murabaha Financing
4.10 Cr Unearned Murabaha Profit Receivable
4.10
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Scenario-A-continued
4) Booking of Accrual of profit_at_ 10 for
remaining days of the month, the following entry
would be passed. (1000 x 10) x 16 /
365 January 31, 2007 Dr Deferred Murabaha
Income 4.39 Dr Murabaha Profit Receivable
4.39 Cr Income on Murabaha Financing
4.39 Cr Unearned Murabaha Profit
Receivable 4.39 And so on this entry will be
passed at the end of EACH month till maturity for
the accrual of profit. Disclosure in Balance
Sheet as on January 31, 2007 Murabaha
receivable-gross 1,100 Less Deferred
Murabaha Income 100- (1000x10x31/365) (91.51)
Murabaha Profit Receivable shown in other
assets (8.49) Murabaha Financing
Receivable 1,000
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Scenario-A-continued
5) On Maturity of Murabaha transaction i.e. on
December 31, 2007 and at the time of receiving of
final payment following entry would be
passed December 31, 2007 Dr Party Bank
A/c 1,100 Cr Murabaha Financing
1,000 Cr Murabaha Profit Receivable
100
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Scenario-B
B-In case Declaration is not received on January
15, 2007 and is received on February 15,
2006 1) At the time of payment to the client
for the purchase of goods on behalf of bank or
directly to the supplier by the bank the
transaction will be accounted for as
follows January 01, 2007 Dr Advance against
Murabaha 1,000 Cr Pay Order / Party
Account 1,000 On January15, 2007 No entry
would be passed At the end of First Month i.e.
January 31, 2007 No entry would be passed for
accruals of profit, as Declaration has not been
received from the customer.
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Scenario-B
2) On February 15, 2007, at the culmination
of Murabaha i.e. at the time of sale of goods to
the customers with signing of Declaration by the
bank and the client, the following entries would
be passed February 15, 2007 Dr Murabaha
Financing 1,000 Dr Unearned Murabaha Profit
Receivable 100 Cr Advance against
Murabaha 1,000 Cr Deferred Murabaha Income
100
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Scenario-B-continued
3) Booking of Accrual of profit_at_ 10 from the
date of disbursement to the date of culmination,
the following entry would be passed. (1000 x
10) x (3115)/ 365 February 15,
2007 Dr Deferred Murabaha Income
12.60 Dr Murabaha Profit Receivable
12.60 Cr Income on Murabaha Financing
12.60 Cr Unearned Murabaha Profit Receivable
12.60
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Scenario-B-continued
4) Booking of Accrual of profit_at_ 10 for
remaining days of the month, the following entry
would be passed. (1000 x 10) x 13 /
365 February 28, 2007 Dr Deferred Murabaha
Income 3.56 Dr Murabaha Profit Receivable
3.56 Cr Income on Murabaha Financing
3.56 Cr Unearned Murabaha Profit Receivable
3.56 And so on this entry will be passed at the
end of EACH month till maturity for the accrual
of profit. NOTE In case the Murabaha
declaration is NOT received on the due date, NO
Entry would be passed until the declaration is
received. Disclosure in Balance Sheet as at
February 28, 2007 Murabaha receivable-gross 1
,100 Less Deferred Murabaha Income100-
(1000x10x(3128)/365) (83.84) Murabaha
Profit Receivable shown in other
assets (16.16) Murabaha Financing
Receivable 1,000
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Scenario-B-continued
5) On Maturity of Murabaha transaction i.e.
on December 31, 2007 and at the time of receiving
of final payment following entry would be
passed December 31, 2007 Dr Party Bank
A/c 1,100 Cr Murabaha Financing
1,000 Cr Murabaha Profit Receivable
100



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Treatment for Inventory

• If goods purchased for Murabaha remain unsold on
  the reporting date they are shown as Murabaha
  Inventory in Other Assets.
• Following are possible scenario
• Bank is holding assets for future sale to its
  customers against a promise
• The Goods are imported as Banks agent and are
  not sold to the importers i.e. they are in PAD
• Any other reason due to which the goods remain
  unsold.
• 
  
  
  

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