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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Said one of the (damsels): "O my (dear) father! engage him on wages: truly the best of
men for thee to employ is the (man) who is strong and trusty".... Al-Qasas (The Narration)
[28:26]
..‫ ﻗﺎل ﻟﻮ ﺷﺌﺖ ﻟﺘﺨﺬت ﻋﻠ أﺟﺮا‬، ‫ﻓﻮﺟﺪا ﻓ ﺎ ﺟﺪارا ً ﺮ ﺪ أن ﻨﻘﺾ ﻓﺄﻗﺎﻣ‬...
They found there a wall on the point of falling down, but he set it up straight. (Moses)
said: "If thou hadst wished, surely thou couldst have exacted some recompense for it!"
Al-Kahf (The Cave) [18:77]
Chapter
10
CHAPTER LEARNING OBJECTIVES:
At the end of this chapter you will, insha Allah you will be able to:
i.
ii.
iii.
iv.
v.
Explain the meaning of ijarah and how this contract is used by Islamic
banks to finance customers
List the principles of ijarah and as well as explain the shari’a rules.
Journalize accounting entries for ijarah.
Prepare the balance sheet and income statement extracts for ijarah
transactions
Apply shari’a and accounting principles as per FAS 8 to solve
accounting problems for complex events.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
10. 1 Introduction
The word al ijarah or simply ijarah comes from the word ajr meaning
reward or wages for word done or services rendered. The technical
meaning in fiqh means a contract for hire of persons or services or
“usufruct” of a property. From the Islamic banking point of view, al ijarah
usually refers to a Islamic leasing contract of land, property or equipment
which are leased to a client for a stream of rental payments.
u·su·fruct :
the legal right to
use and enjoy the
advantages or
profits of another
person's property
There are two types (rather three) types of ijarah contacts in use:
(i) al ijarah (tashghiliyah) - operating ijarah
(ii) al ijarah muntahia bitamleek – ijarah with option to transfer ownership of asset to lessee,
and in Malaysia,
(iii) a composite contract; Al ijarah thumma al-bai’ (ijarah followed by sale) is practiced.
From a conventional banking point of view, the finance lease is preferred by banks who
want to concentrate on the financing and not on the operational complexities of leasing,
hence, they transfer substantially all the risks and rewards of ownership of the leased asset
to the client. Following the substance over form convention (on which we have noted
AAOIFI’s silence), the asset is booked in the clients books and not the banks who treat the
financing as receivable.
From a shari’a point of view, there is no such thing as a finance lease. Anything which
separates the physical transaction from its financial aspect, making the transaction a loan is
treated as ribawi and thus prohibited. Further it is normally not possible to transfer all the
risks and rewards of ownership of the asset, although some fuqaha allow this. Hence, the
leased asset should be recognized and depreciated as asset owned by the Islamic bank
and the rentals receivable treated as income. Thus, this proves to be major problem for
Islamic banks who want to follow IFRS, IAS17, which requires all financial leases to be
treated as a receivable with the principal and interest portion separated.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
10.2 Definition and financing model of Ijarah
Definitions
Ijarah
Ijarah is the transfer of ownership of a service for an agreed upon
consideration. According to fuqaha, it has three major elements:
• a form, which includes an offer and a consent.
• two parties: a lessor (the owner of the leased asset), and a lessee (the party
who reaps the services of the leased asset)
• the object of the (Ijarah) contract, which includes the rental amount and the
service (transferred to the lessee).
Operating Ijarah
Ijarah contracts that do not end up with the transfer of ownership of leased
assets to the lessee.
Ijarah Muntahia Bittamleek
Ijarah contracts that end up with the transfer of ownership of leased assets to
the lessee. Ijarah Muntahia Bittamleek may take one of the following forms:
a) Ijarah Muntahia Bittamleek that transfers the ownership of leased assets to
the lessee – if the lessee so desires – for a price represented by the rental
payments made by the lessee over the lease term. At the end of the lease
term and after the last instalment is paid, legal title of leased assets passes
automatically to the lessee on the basis of a new contract.
b) Ijarah Muntahia Bittamleek that gives the lessee the right of ownership of
leased assets at the end of the lease term on the basis of a new contract for
a specified price, which may be a token price.
c) Ijarah agreements that gives the lessee one of three options that he may
exercise at the end of the lease term:
• purchasing the leased asset for a price that is determined based on rental
payments made by the lessee,
• renewal of Ijarah for another term, or
• returning the leased asset to the lessor (owner).
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Fair value of leased assets
Fair value is the amount for which an asset could be exchanged between well informed,
willing parties (seller and buyer) in an arm’s length transaction. Useful (service) life Useful
(service) life of leased assets is (a) either the time period over which these assets are
expected to render services, or (b) the number of output units expected to be obtained from
these assets.
Residual value
Residual value of leased assets is the amount which is expected to be obtained for these
assets at the end of their useful (service) life, net of the expected cost of disposal. Residual
value of leased assets is to be estimated at the inception of the lease
1
4
2
3
Fig. 10.1 Ijarah Transaction
The above diagram shows a normal ijarah transaction. The bank (in the middle) pays
(1)the manufacturer or vendor the price of the product (in this case , a car) to be
leased. The vendor normally delivers the car ( 2 and 3)straight to the bank’s ijarah
customer. The customer then makes a series of rental payments over the term of the
ijarah contract (4). If its is ijarah muntahia bitamleek, the bank sells the car to the
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
customer at the end of the ijarah term. If not, the car is returned to the bank to be
released or disposed. Some banks such as the Kuwait Finance House, have
warehouses where they buy the cars and store them.(They are already assets on
the bank’s balance sheet). The customer goes to the warehouses and chooses a car
and the financing package. Once the legal formalities are carried out and the initial
deposits, installments are paid, the customer gets possession of the car.
However, the normal financing transaction done by the bank is ijarah muntahia bitamleek
where the ownership of the assets is subsequently transferred to the customer by
the end of the ijarah. These can be done in a number of ways according to the
shari’a. Please see the following figure (10.2).
Ijarah Muntahia
Bitt Tamleek
Gift
At the end
Of period
Token sale
consideration
At the end Of
period
Sale at
specified
amount
Sale during the
lease period for
the remaining
installments
Gradual
transfer
during lease
period
Fig 10.2 Different types of Ijarah muntahi bi tamleek
In Ijarah Muntahia bittamleek , the ownership of the asset can be transferred to the lessee
by means of:
(i) Gift at the end of the period of the ijarah. This means the ownership of the asset is
transferred to the lessee for no consideration by entering into a gift contract in fulfilment
of a prior binding promise (made at the inception of the ijarah contract), upon the
settlement of the last lease rental payment. The title can also be transferred through a gift
deed which is conditional1 on the completion of all ijarah rental payments (i.e.
installments).
1
There is a difference of opinion whether a gift contract can be conditional. Only the Maliki school and the
Abadeiyah sect.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
(ii) Sale for a token consideration at the end of the ijarah contract. In this case, initially
there is a ijarah contract and a promise to sell by the lessor if the lessee wishes at a
token consideration. The consideration can be any agreed amount between the parties.
Note: In cases (i) and (ii), in substance, the ijarah rentals would include a portion of
the capital cost of the asset which wil result in higher rentals as opposed to an
operating ijarah. In this case, if the asset is not transferred at the end of the ijarah,
and the asset is not impaired and the lessee has fulfilled his other obligations, the
fuqaha agrees that the rent should be adjusted to a fair amount and the balance
refunded to the lessee.
(iii) Sale at the end of the lease for an amount specifed in the lease. This is done through
an ijarah contract together with a promise to enter into a sale contract. The sale contract
will include the amount to be paid after the expiry of the ijarah period.
(iv)Sale of the asset at any time during the period of the lease for an amount equal to the
remaining installments. In this case, an ijarah contract is executed together with a
promise to sell the the asset to the lessee, whenever he wishes to buy the asset during
the period of the lease for a price equal to the remaining installments.. When the lessee
exercises the option to buy, the bank will execute a sale contract.
(v)Sale through gradual transfer of title. This is executed through an ijarah contract with a
promise to gradually transfer the title of the asset to the lessee until the asset is fully
transferred. In this case, the price need to be determined so that a proportionate share is
tranferred at every period. There needs to be a sale contract for each transfer and a
reduction in lease rental as the ownership of the bank decreases. In case the ijarah
contract is revoked prior to complete transfer, the property will be jointly owned by the
bank and the ex lessee.
Sale and Leaseback: This is a common practice. From a shari’a perspective, it is not
prohibited provided that the two contracts are not conditional upon on another. However,
one of the parties may make a promise to lease to or from the other.
10.3 Ijarah principles, rules and complexities
10.3.1
Elements of Ijarah
According to the majority of fuqaha, there are three general and six detailed
elements of Ijarah:
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
• The wording: This includes offer and acceptance.
• Contracting parties: This includes a lessor, the owner of the asset, and a
lessee, the party that benefits from the use of the asset.
• Subject matter of the contract: This includes the consideration (rent) and the
benefit from the use of the asset.
It should be noted that the benefit from use of the asset is the subject
matter of the contract, because it is the element to be satisfied in return
for the rent. Hence, it is the benefit of using the asset which is guaranteed
rather than the asset itself. The latter is not the subject matter of the contract,
although the Ijarah contract treats it sometimes as a subject matter and a
source of the benefit.
(2)
For example, it is commonly stated: “I hereby rent out this car to you” .
10.3.2 Execution of Ijarah
The basic rule of the Ijarah is that it should be executable. If the commencement
of the contract is not stipulated, then the Ijarah will start from the time of the contract
and will be executed as from that time.
An Ijarah contract according to which execution of the contract is deferred to a future
date is valid.. However, such a case is considered by the Hanafis as a non-binding
contract,
, it is considered permissible to enter into an Ijarah contract to lease an asset for a
second year to the same lessee as the first year before the expiry of the first year’s
(3)
contract .
Making Ijarah contingent on a future event or a condition
The majority of fuqaha have agreed that Ijarah, like sale, cannot be made
contingent on a future event or a condition. But Ibn-Taimeyah and Ibn Al-Jawzeiyah
are of the opinion that making Ijarah contingent on any future event or condition is
(4)
considered permissible .
Contracting Parties
To enter into a contract, both contracting parties should be of sound mind and
judgement. There is agreement that Ijarah cannot become valid unless the contracting
party is a competent person who is qualified to dispose of funds. For a contract to be
valid, it should have the mutual consent of both contracting parties. For the purpose of
2
al Jazaire, al Fiqh ala al Mathahib al Arba’a, Vol.2, p.98.
3
Nawawi, Manhaj at Talibeen, p.67; al Fatawa al Hindia by a number of Indian fuqaha, Vol. 4, p.410; al Dardeer, al
Sharah al Saqueer, Vol.4, p.30; al Bahwati, Kashaf al Qana’, Vol.4, p3.
Gadi Zada, Nata’ej al Afkar, Vol.7, p.210; Rejabati, Matalib Oli Annoha, Vol.3, p77; Ramli, Nehaiat al Muhtaj, Vol.5,
p.295, p.260; Ibn Rusd, Bidayat al Mujtahid, Vol. 2, p.135; Ibn Qudamah, al-Mughnee, Vol.5, p.375.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
enforceability, the contracting party to whom the offer is made should have the
authority to act in order to create a contract. This is according to both Hanafis and
Malikis who are of the opinion that the authority to act is a condition for enforceability.
Subject matter
The subject matter of Ijarah is the benefit (the use of the asset) and the rent. These
are discussed below.
Benefit: It consists of two parts
a) The contract should include the use of a benefit of a specified asset, for example,
one person says to another: “I hereby lease you this house”, or the use of a benefit of
an asset whose specification is accepted based on the lessor’s description, for
example, “I hereby lease you a house the specification of which is so and so”.
(5)
b) The contract should include a known act .
Conditions of the Benefit
Benefit should fulfil the following conditions:
a) The benefit of using the asset, not the use of it as such, should be the subject
matter of the Ijarah. This is a matter of agreement between the fuqaha.
b) The benefit should be subject to valuation and intended to be fulfilled in the
contract because no agreement can be concluded on what is considered permissible
but does not have a price. Spending money in such a way is considered profligacy.
c) The fulfillment of the benefit should be of a permissible nature.
d) Ability to fulfil the benefit should be real and in accordance with Shari’a.
e) The benefit should be identified in such a way as to remove lack of knowledge
(6)
(Jahala) which leads to dispute . Fuqaha are in agreement that lack of knowledge
(7)
which leads to dispute nullifies the contract .
Specification of the benefit
The benefit is specified by stating the subject matter or the duration. It may also be
identified by specification or physical identification.
The condition of specifying the subject of benefit has led to the division of Ijarah into
(a) Ijarah of assets whereby the benefit is fulfilled from a particular asset. In this type
5
()
6
()
7
()
al Jazaire, al Fiqh ala al Mathahib al Arba’a, Vol. 2, p.99.
Ibn Rushd, Bidayat al Mujtahid, Vol. 2, pp.180-223.
al Fatawa al Hindiyah, Vol.4, p.41; al Kasani, Badaie’ as Sanaie, Vol.4, p.180; al Mirghinani, Hidayah, Vol.3, p.232; Ibn
Rushd, Bidayat al Mujtahid, Vol.2, p.80; Sherazi, al Muhathab, Vol.1, p.398; Ibn Qudamah, Al Mughnee, Vol. 5,
pp.375-368, 1389H. edition.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
of Ijarah if the asset is impaired, then the Ijarah becomes nullified, for example, the
leasing of a particular house to live in. (b) Ijarah whose specification is accepted
based on the lessor’s description. In this type of Ijarah the benefit is fulfilled from what
is specified by description. If the benefit of the asset is impaired after it has been
specified and used for some time after the contract became effective, the lessor will
provide a replacement.
Rent
Rent is what the lessee is committed to pay as a consideration for the benefit enjoyed
by him. Everything that is suitable to be considered a price in a sale can be suitable to
be considered as a rent in an Ijarah. The majority of fuqaha have said: “the conditions
(8)
applicable to price are also applicable to rent” . Rent should be known. This is in
compliance with the saying of the Prophet, (Allah’s blessings and peace be upon him):
(9)
“he who hires a worker should inform him of his wage” . If the benefit is fulfilled and
(10)
the rent was not determined, the rent for a similar benefit should be paid .
Paying the rent in the form of services (another benefit)
The majority of fuqaha have permitted the payment of rent in the form of a benefit of
the same kind of the subject of the contract.
Flexibility in determining the rent
Rent can be determined in terms of time, place and distance. For
example, one person says to another: “if you sew me this dress on this day, its charge
will be one dirham and if you sew it tomorrow, the charge will be half dirham, and if
you live in this house as a blacksmith you will be charged ten and if you live as a
(11)
perfumer, you will be charged five, and so on” .
Entitlement of the rent and its due time
The Hanafis and Malikis are of the opinion that entitlement to the rent does not
become a right as per the contract itself. Rather, entitlement to the rent becomes a
right by fulfilling the condition in the contract or by fulfilling the subject matter of the
contract. The Hanafis added the condition of accelerating the actual payment of the
rent by the lessee.
8
al Dardeer, as Sharh as Sagheer, Vol. 4, p.59; Ramli, Nehaiat al Muhtaj, Vol. 5, p.322, Ibn Qudamah, Al Mughni, Vol.
5, p.327; al Fatawa al Hindiyah, Vol. 4, p.42; AlMusali; Al Ekhtiar, Vol. 2, p.5, al-Halabi edition.
( ) Narrated by Al-Baihaqi from Abi Huraira.
10
( ) al Fatawa al Hindiyah, Vol. 4, p.42; al Musali, al Ekhtiar, Vol. 2, p.507, al Halabi edition.
11
( ) al Jazaire, al Fiqh ala al Mathahib al Arba’a, Vol. 2, p.120; al Qabawi, Rafeeq al Asfar (abstract of Hashiat ibn
Abdeen), 224. al Jazaire, al Fiqh ala al Mathahib al Arba’a, Vol. 2, p.120; al Qabawi, Rafeeq al Asfar (Abstract of
Hashiat Ibn Abdeen), 224.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Shari’a characterisation of the advance payment of rent
Receipt of an advance payment is not prohibited in Shari’a, but only on the basis that
it is an advance payment on account from the amount of the rent. It should not,
however, be considered (in terms of the relationship with the lessee) as a profit on the
lease, as this is an internal affair of the lessor. This is because, from the Shari’a point
of view, the rent consideration is an indivisible amount which should not be divided
into a principal and a profit. From a Shari’a perspective, profit is only viewed as the
result of a transaction of purchase and sale of a commodity for an amount in excess
of its cost.
In Ijarah, however, the whole consideration is a rent which can be accelerated or
deferred in whole or in part (provided that it is a portion of the whole rent). It can also
be paid in instalments or deferred until after consuming the benefit from the leased
asset.
Lessor’s obligations
a) Making the leased asset available
The lessor is obliged to enable the lessee to benefit from the leased asset by
making it available throughout the duration of the lease. Making the asset available
includes equipping and preparing the asset in the manner which – according to
normal practice – is considered necessary in order for the specified benefit to be
enjoyed.
Making the asset available also entails enabling the lessee to enjoy the benefit of
the leased asset. However, if anything happens during the period of the lease that
prevents the lessee from enjoying the benefit of the leased asset, for a reason not
attributable to the lessee, then the lessor is obliged to rectify the situation. For
example, repairing the leased house or removing all matters leading to inconvenient
housing.
b) Guarantee in respect of defects
In Ijarah, the option of defect is treated as in sale. The defect which entitles a
lessee to an option is one which causes an impairment in the benefits which are the
subject of the contract. The same applies if the defect occurs before fulfillment of the
benefit but after the contract is concluded. In either case, the lessee shall have the
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
option of revoking the contract or accepting the impaired benefit while being obliged to
(12)
pay the full rent . However, there are some fuqaha who are of the opinion that a
portion of the rent should be deducted for the defect.
c) Maintenance of the leased asset (see 1/6)
Lessee’s obligations
Utilisation of the leased asset is determined according to the conditions of the contract
or according to practice. The lessee is also responsible for keeping the leased asset
(13)
intact and for payment of the rent .
Fuqaha agree that the leased asset is a trust in the hands of the lessee. However, if
the leased asset is impaired without omission, violation of what is permitted, or
negligence in keeping it intact on the part of the lessee, then he is not to be liable for
such impairment because whilst the lessee is permitted by the lessor to enjoy the
benefit of the leased asset, he is not to be held as a guarantor for the leased asset.
Maintenance of the leased asset
In principle, it is not considered permissible to stipulate in the contract that the
maintenance of the leased asset is to be carried out by the lessee because this would
lead to the lessee paying a rent that includes an unknown element. According to the
schools of fiqh, this condition renders the Ijarah contract void. If the maintenance
condition is included in the contract and the lessee has benefited from the leased
asset, he should pay the fair rental amount and be reimbursed for what he spends on
maintaining the building. In addition, the lessee is entitled to be paid the equivalent fair
wage and expenses incurred in carrying out the work of maintenance if that was done
by permission of the lessor. If he does the work without the lessor’s permission, then
this will be considered to a be a gift on his part and he cannot claim any
(14)
reimbursement .
The lessor should also maintain the asset and carry out all repairs that would make it
suitable for use. If he refuses to do so, according to the opinion of the majority of
fuqaha, the lessee shall be entitled to revoke the contract unless he leased subject to
(15)
that condition .
However, the lessee can be asked to carry out the maintenance based on the
12
( ) Mula Khasro, Sharh Addor, Vol. 3, pp.78-279; al Mahbobi, Kashf al Haqaeq wa Sharh al Weqaiah, Vol. 2, p.65;
Sherazi, al Muhathab Vol. 2, p.405.
13
( ) al Fatawa al Hindiyah, Vol. 4, p.470.
14
( ) al Fatawa al Hindiyah, Vol. 4, p.443; al Bahwati, Kashaf al Qena’, Vol.4, p.16; Ramli, Nehaiat al Muhtaj, Vol. 5, p.264265; Hashiat ad Dasouqi, Vol. 4, p.47; Sharh Al Kharshi, Vol.7, p.47; al Dardeer, as Sharh as Sagheer, Vol. 4, p.63.
15
( ) Mula Khasro, Sharh Addor, Vol. 2, p.300; Hashiat Ibn Abidin, Vol. 5, p.66; Sherazi, al Muhathab, Vol. 1, p.401.
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Chapter 10.Accounting for Ijarah
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following:
a) To carry out the operating maintenance which is required as a result of using the
leased asset and is needed in order to ensure its continuous utilisation (for example,
oils needed for machines and equipment).
10.4
Reco
gniti
on of
Ijara
h
trans
actio
ns
and
journ
al
entri
es
b) Periodic maintenance which is required to enable the asset to continue providing
the benefit.
c) Maintenance that is specified in description and amount in the contract or
according to practice whether such maintenance is merely work or involves the use of
known materials or spare parts because this type of work is considered as rent taken
into consideration.
Revocation of Ijarah for a justifiable reason
Hanafis are of the opinion that it is considered permissible to revoke an Ijarah contract
unilaterally for a reason relating either to a contracting party or to the asset itself,
without the contract remaining binding. In this case, revocation is valid because it
becomes necessary when there is a reason, otherwise if the contract remains binding,
the party having the reason will be disadvantaged by something he did not agree to in
the contract. Hence, permitting revocation of the contract in such cases is meant to
prevent any one of the two parties from being forced to suffer a damage to which he
did not agree.
2. Ijarah Muntahia Bittamleek
(16)
Forms of Ijarah Muntahia Bittamleek
(17)
Ijarah Muntahia Bittamleek has many forms that focus on what the two contracting
parties have agreed upon and what they have intended to achieve from such
contracting, for example, lease or sale, Ijarah and a promise to sell, the rent they have
specified in the Ijarah, the cost of the goods in the sale transaction, and the time at
which the legal title is transferred.
Accounting issues on Ijarah and Ijarah muntahia bitamleek
• Recognition of Asset and Liability in the books of lessor and lessee.
• Recognition of Profit/ Income or Loss/ Expense
• Valuation of Asset
• Disclosure
10.4.1 Recognition and Measurement of Ijarah
16
( ) Meeting of Investment Managers (Ijarah), a paper presented by the Islamic Bank of Jordan.
17
( ) Paper of the Islamic Bank of Jordan, Meeting of Investment Managers (Ijarah) Amman.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Financial Accounting Standard No. 8 (FAS 8) sets out the accounting rules for recognizing,
measuring, presenting and disclosing ijarah and ijarah muntahia bittamleek transactions of
Islamic Financial Institutions.
The standard covers acquisition of ijarah assets, leasing of the assets, ijarah expenses and
revenues, gains and losses including Balance Sheet presentation.
3a initial
expenses
1.
Acquisition
of Assets
2. leasing of
assets
3.Expenses
&
Revenues
4. Disposal
Gains
/losses
Fig 10.3 Accounting Processes in Ijarah (as Lessor)
3a Depreciation
& Maintenance
3c Ijarah
Revenue
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
No.
Transactions /Events
Purchase of Ijarah Assets
DR
Equipment
Leasing of Ijarah Assets
Investments in Ijarah
Assets
CR.
Cash
1
2
3
Expenses incurred by lessor
4 Depreciation of Ijarah Assets
5
Ijarah Rental received
Cash
Ijarah Expenses
Depreciation Expense Accumulated
Depreciation
Profit and Loss
Cash
Cash
6
5.
6
Disposal or sale of ijarah assets
Immaterial direct costs
Material Direct Costs
Equipment
Expense
Deferred Cost
Profit and Loss
Investment in Ijarah
Assets
Profit and Loss (if
gain)
cash
Cash
Deferred Cost
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 + all
expenses necessary to bring the asset to bring the asset to intended use. Examples
of expenses are custome duties, teaxes, 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.(This requirement is currently being reviewed as a result of
feedback from industry who wants the depreciation term to be the economic life of
the asset i.e. the lease term.
Leased assets in the financial statements as Investments in Ijarah assets.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
(2) Ijarah Revenue
Ijarah revenue should be allocated propotionately to the financial period of the lease term.
Ijarah revenue is presented in the income statement as ijarah revenue.
(3) Direct initial cost
If material, should be written off as incurred. If material,shold be allocated over the lease
period consistent with lease revenue pattern.
(4) Repairs of leased assets
Repairs necessary to secure the services of the leased assets, if immaterial, should be
written off in the period, while if repairs are material and varied, a provision is set up
by regular charges to income. If lessee undertakes repairs with lessor’s consent and
they are chargeable to lessor, then it shall be expenses in the financlal period and a
payable set up for amount owed to lessee.
(5) At the end of the financial period
Amotization of initial material direct costs, cost of repairs to be charged against
provision, depreciate assets, ijarah installments receivable to be at cash eqivalent.
Accounting Problem 10-1
Operating Ijarah in the books of the lessor
On 20thth June, 2007, Shumul Bank of Bahrain BSC, brought 10 proton Gen 2 cars
from the Malaysian manufacturer at a cost of $10,000 each. The freight costs
from Malaysia to Bahrain was $20,000 and loal handling and transport costs to
the Bank’s warehouse $3,000 with another $2,000 registration costs for the
cars. Shumul Bank will lease the cars on various terms to its customers. At the
end of the year, due to newer comparable models of cars coming from
mitsubishi, the value of the cars dropped by 20%.of its original cost.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
During the year, shumul bank managed to lease all its cars on operational ijarah
contract for two years with monthly rental of US$500 per car to Bahrain Islamic
bank BSC payable ½ yearly in advance, starting 1 July 2007. During the year it
received two payments on account, the second one on 31st December 2007.
The legal costs of the ijarah amounted to $5,000 which Shumul and the
customer agreed to share equally. The bank considered considered the legal
costs immaterial. Under the terms of the ijarah, Shumul Bank will be
responsible for takaful premiums on the car (theft, fire and collision damage)
which amount US$200 per year per unit, while the customer was responsible
for 3rd party damage takaful, regular maintenance and fuel. The takaful
premium for a whole yea on theft etc was paid by the bank on 1st July, 2007.
On 1st of October, the manufacturer recalled the cars for some major repairs to be
undertaken on proton gen 2 cars. Shumul Bank requested the customer to
send in all the cars to the manufactuer for repairs. The cars were handed back
to the customer on 31st October.
Shumul Bank depreciates its Motor vehicles on a straight line basis over five years
with nil residual value and its financial year end is on 31st December. Assets
held for less than ½ month are not depreciated for the month.
Required in the books of the Shumul Bank.
(i) Journalize the necessary entries.
(ii) Prepare an extract of the balance sheet and income statement of Shumul bank
at 31st December 2007 related to the above transactions.
(iii) Comment on the profitability of the ijarah contract.
Answer:
Shumul Bank BSC Journal Entries
Dr Motor Vehicles for Ijarah
(10000*10)+20000+3000+2000
Cr Cash
125000
125000
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Purchase of 10 units of proton gen 2 for ijarah.
Dr Investments in Ijarah Assets
Cr Motor Vehicles for Ijarah
Motor vehicles leased to Bahrain rent a car
125000
125,000
Dr Legal Expenses
Cr Cash
(being legal expenses on ijarah 1/2 of $5000)
2500
Dr Takaful expenses
Dr Prepaid Takaful
Cr. Cash
1000
1000
2500
Cash
Dr Cash
Cr. Ijarah Revenue
rental received on 1st july
2000
30000
Dr Cash
30000
Advance Ijarah Rentals
Ijarah rentals for the next fiscal year in advance.
Dr, Profit and Loss
25000
Investments in Ijarah Assets
Asset impairment, loss in value of cars.
(125000 x 20%)
Dr. Depreciation
10000
Acc. Depreciation
Depreciaton on impaired value of ijarah assets
for 6 months.
30000
30000
25000
10000
Dr Rebate on Ijarah Rental
5000
Cr Cash
5000
Refund of rental for one month to customer for denial of usufruct
per fiqh rules.($500x10units)
Shumul Bank BSC
balance Sheet as at 31st December 2007
Investments in Ijarah Assets
Less impairment on assets
Gross Asset value
Less Depreciation
125000
(25000)
100000
(10000)
90000
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Prepaid Takaful
1000
Liabilities
Ijarah Revenue in Advance
30000
Income Statement for the year ended 31st December 2007
Ijarah Revenue
less asset impairment
takaful premium
legal expenses
depreciation
Rebate on ijarah rental
Loss on ijarah
30000
25000
1000
2500
10000
5000
43500
(13500)
(iii) Although the ijarah contract shows a loss of $13500 in the first six months, this was
due to unexpected impairment of $25000 and initial expenses of $2500 and the
rebate due to the product defect problems. InshaAllah, if this misfortunes do not
occur in the next financial period, the bank should make a profit of $60,000$20000(dep)-2000(takaful premium)=$38000.
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. intial
direct costs , if material, may be allocated over the lease period, otherwise they are
written off.
Accounting Problem 10-2
Operating Ijarah in the books of the lessee
Facts are same as in illustration 10-1, except that the initial direct costs are treated
as material by Bahrain Islamic Bank (BIB)and the BIB paid $100 per car per
year on third party takaful and $600 in 2007 and $1000 in 2008 for maintenance
of the cars. Journalize the required entries and show the financial statements
extracts for the year ended 31st December 2007 and 2008.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Bahrain Islamic bank
Journal Entries for 2007 and 2008
2007
Jul-01
2007
2008
Balance Sheet for Bahrain Islamic Bank BSC
Dr Ijarah Expenses
30000
Cr Cash
Dr Deferred Legal Expense
Cr Cash
30000
2500
Deferred Legal
Expense
Deferred Ijarah
Expense
Prepaid Takaful
Expense
1875
625
30000
30000
500
500
2500
Income statement for Bahrain Islamic bank
BSC
Dr. Takaful Expenses
Dr. Prepaid Takaful
Cr Cash
Dec-31
2007
2008
500
500
1000
Dr Prepaid Ijarah Expenses
30000
Cr Cash
Ijarah rental paid in advance to shumul bank
Dr Motor Vehicle mainteance Expenses
Cr Cash
Motor vehicle maintenance expenses
Dr. Legal Expenses
Cr Deferred Legal Expenses
Dr. Cash
Cr Ijarah Expense
Dr
30000
600
600
625
625
5000
5000
Ijarah Expenses
less rebate
Net Ijarah rental
legal exp on ijarah
motor car maintenance
30000
(5000)
25000
625
600
60000
1250
1000
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Jul-01
Dec-31
Dr Ijarah Expenses
Cr. Cash
30000
30000
Ijarah rental 1st installment
Dr Takaful Expenses
500
Dr Prepaid Takaful
500
Cr Cash
$100 per car 3rd party takaful payment
Dr Prepaid Ijarah Expenses
30000
Cr. Cash
2nd installment paid to shamil in advance
Dr Motor Vehicle Maintenance Exp
1000
Cr Cash
Dr legal expenses
Cr prepaid legal expenses
Deferred initial cost expensed
1250
Dr Takaful Expenses
Cr Prepaid Takaful
2007 takaful prepaid expensed
500
Dr Ijarah Expense
Cr Prepaid Ijarah Expense
2007 instalment expensed
30000
Profit and Loss ac
Cr Ijarah Expense
60000
1000
30000
1000
1250
500
30000
60000
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Ijarah Muntahia bittamleek (IMBT) in the books of the lessor bank.
As there are four permutations to this, the accounting rules will be displayed on a table corresponding to the four types of IMBT.
Through Gift
Sale for token
consideration
Sale for
remaining
installments
Gradual sale
At historical cost + all
incidental expenses
to bring asset to
current location and
use.
At historical cost +
all incidental
expenses to bring
asset to current
location and use.
At historical cost +
all incidental
expenses to bring
asset to current
location and use.
At historical cost +
all incidental
expenses to bring
asset to current
location and use.
Assets presented as
Investment in Ijarah
Muntahia Bittamleek
assets and
measured at book
value
Assets presented as
Investment in Ijarah
Muntahia Bittamleek
assets and
measured at book
value
Initial direct costs ,
expensed if
immaterial, deferred
and amortised over
term if material
Ijarah revenue prior
to sale. Allocated
proportionately over
the term of the
lease. Presented in
the income
statement as ijarah
revenue
Initial direct costs ,
expensed if
immaterial, deferred
and amortised over
term if material
Recognized in
period in which it is
due. Progressively
decline in
proportion to
lessees increased
share in property.
Transactions
Assets acquired for Ijarah
Contracting and beginning of ijarah
Ijarah revenue
Assets presented as
Investment in Ijarah
Muntahia Bittamleek
assets and measured
at book value.
Initial direct costs ,
expensed if
immaterial, deferred
and amortised over
term if material
Allocated
proportionately over
the term of the lease.
Presented in the
income statement as
ijarah revenue
Assets presented as
Investment in Ijarah
Muntahia Bittamleek
assets and measured
at book value.
Initial direct costs ,
expensed if
immaterial, deferred
and amortised over
term if material
Allocated
proportionately over
the term of the
lease. Presented in
the income
statement as ijarah
revenue
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Through Gift
Sale for token
consideration
Transactions
Repairs of leased assets
End of financial year
Expensed if
immaterial, provision
for repair established
by regular charges to
income if material and
varies from year to
year.
If lessee undertakes
the repair with
consent and
chargeable to lessor,
lessor to recognize
expense in the fin
period in which it is
incurred
Amortisation of initial
direct cost, if material
Cost of repairs
charged against
provision if it exists
Depreciation to be
consistent with dep
policy of similar
assets. However,
residual value of
asset should be nil
in calculating
depreciable amount
Ijarah installments
receivable to be
recognised at cash
equivalent value
Expensed if
immaterial, provision
for repair established
by regular charges to
income if material and
varies from year to
year.
If lessee undertakes
the repair with
consent and
chargeable to lessor,
lessor to recognize
expense in the fin
period in which it is
incurred
Amortisation of initial
direct cost, if material
Cost of repairs
charged against
provision if it exists
Depreciation to be
consistent with dep
policy of similar
assets. However,
residual value of
asset should be
token sale amount
in calculating
depreciable amount
Ijarah installments
receivable to be
recognised at cash
equivalent value
Sale for
remaining
installments
Expensed if
immaterial, provision
for repair established
by regular charges to
income if material and
varies from year to
year.
If lessee undertakes
the repair with
consent and
chargeable to lessor,
lessor to recognize
expense in the fin
period in which it is
incurred
Amortisation of initial
direct cost, if material
Cost of repairs
charged against
provision if it exists
Depreciation to be
consistent with dep
policy of similar
assets. Ijarah
installments
receivable to be
recognised at cash
equivalent value.
Gradual sale
Expensed if
immaterial, provision
for repair established
by regular charges to
income if material and
varies from year to
year.
If lessee undertakes
the repair with
consent and
chargeable to lessor,
lessor to recognize
expense in the fin
period in which it is
incurred
Repair costs should
be borne by both
parties in proportion
to ownership
Amortisation of initial
direct cost, if material
Cost of repairs
charged against
provision if it exists
Depreciation to be
consistent with dep
policy of similar
assets. The sold
portion of the leased
asset is removed
the leased asset
account and any
difference between
book value and sale
price of sold
portion must be
recognized in the
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Through Gift
Sale for token
consideration
Transactions
Sale for
remaining
installments
Gradual sale
income statement.
Ijarah installments
receivable to be
recognised at cash
equivalent value.
If the lessee refuses
to buy the shae of the
assets at the end of
the financial period,
then depending on if
the promise is binding
or not, then the
differnce between the
carrying value and the
cash equivalent value
shall either be
reunded or charged to
the lessee.
End of Ijarah term
Legal title passes to
lessee and any book
value should be
written off.
Legal title passes to
lessee provided all
insallments are paid
and lessee purchases
the asset. If lessee
declines to
purchase, then shall
be recognized as
assets acquired for
Ijarah and valued at
lower of cash
equivalent value or
book value. Any
difference to be
written off. In case
of a binding promise
of lessee, and
failure to buy, then
any loss resulting
from the difference
ifference
When all the
installments and the
price of the
purchased portions
of the leased assets
are paid, all accounts
are closed.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Through Gift
Sale for token
consideration
Transactions
Permanent impairment of leased asset before title
passes to lessee
Sale of leased assets.
If asset is
permanently impaired
before title passes to
the lessee which is
not the fault of the
lessee, the excess of
the fair value of the
rental over the
installments paid is
recognized as a
liability due to lesse
and charged to
income statement.
Sale for
remaining
installments
in cev and book
value will be
receivable from
lessee.
If asset is
permanently impaired
before title passes to
the lessee which is
not the fault of the
lessee, the excess of
the fair value of the
rental over the
installments paid is
recognized as a
liability due to lesse
and charged to
income statement.
Legal title passes to
lessee when he buys.
Lessor must
recognise any gain or
loss between selling
price and net book
value.
Gradual sale
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Accounting Problem 10-3
Ijarah Muntahia Bittamleek in the books of the lessor
On 1st January, 2007, Bank Islam Pakistan Ltd arranged an Ijarah muntahia
bittamleek financing for Pakistan Renta a car for a 4 year period. The package
was for 10 proton Gen 2 cars from the Malaysian manufacturer at a cost of
$100,000 (total cost) at a yearly rental of $37,500. The bank entered into a
maintenance contract with Proton for major service at a yearly cost of $500 per
car. If the cars were sold to the customer at an earlier date, the customer to
bear the proportionate cost. Depreciation is to be booked on a straight line
over the lease period.
The rentals to be paid in ½ yearly installments over the four years in advance
During discussion with Pakistan Renta a car, the bank considered the
following options:
Option A:
The bank promises to give the cars as a gift at the end of the contract.
Option B:
Pakistan Renta car to undertake a binding promise to buy the cars at $2,000 per car at
the end of the ijrarah period. However, in this case, the ijarah rentals to be $35,000
per year payable ½ yearly.
Option C:
The bank makes a binding promise to sell the cars to Pakistan Renta Car for the
remaining installments, provided all installments are paid on time, with a rebate of
10% on the outstanding installments.
Option D:
The bank makes a promise to sell 2 cars at the end of the first year at $10,000 per car., 4
cars at the end of the second year for $6,000 per car, 2 cars at the end of the 3rd
year for $4,000 per car and the last 2 cars at the end of the ijarah term for $2,000
per car. The installment of $37,500 to be reduced proportionately to ownerhsip.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Required:
(i) Work out the profits for the bank in each case and advise the customer which is
the best option for them in terms of cost. Assume that in case of option C,
assume that the customer exercised the option to buy at the end of the 2nd
year.
(ii) Give the journal entries under option D (in columnar form with years as
columns).
(iii) provide in columnar form, the balance sheet and the income statement extracts
from inception until the expiry of the lease for options A and B only.
(iv) For options C only, where the customer exercised the option to buy at the end
of the 2nd year, give the journal entries in the books of Pakistan Renta a car as
lessee, yearly until 2010. Pakistan Renta a car has a straight line depreciation
policy over the economic life of the car with a maxium of 4 years. At the point
of purchase, the cars had a cash equivalent value of $78,000 with an economic
life of 3 years.
Answer:
(I) without considering the time value of money
Total installments under
option
sale
price
total revenue
less
cost of car
maintenance cost borne by bank
total
cost
profit to the bank
OPTION
A
OPTION
B
OPTION
C
OPTION
D
150000
140000
75000
90000
0
150000
20000
160000
67500
142500
56000
146000
100000
20000
100000
20000
100000
10000
100000
12000
120000
120000
110000
112000
30000
40000
32500
34000
Since the most profitable option for the customer is the one which gives the least profit to the
bank.
Option A is the most profitable course of action for the
customer.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
workings options D
yr 1 revenue
ijarah installments
sale of car 2x10,000
37500
20000
yr 2 revenue
ijarah installments(8/10x37500)
sale of 4 cars at $6000
30000
24000
yr 3 revenue
ijarah installments(4/10x37500)
sale
15000
8000
yr 4 revenue
ijarah installments (2/10x37500)
sale 2 cars x2,000)
7500
4000
57500
54000
23000
11500
option D
(ii) Journal entries under option D
dr investments in ijarah assets
cr cash
dr assets for ijarah
total revenue and maint
cost
year 1
100000
year 2
total maintenance
cost
year 3
146000
year 4
100000
dr cash
cr ijarah rental
1st installment
18750
dr cash
cr ijarah rental
2nd installments
18750
dr maintenance
cr cash
5000
15000
18750
15000
18750
25000
dr cash
dr acc depreciation
cr investment in ijarah assets
gain on disposal
20000
5000
7500
4000
1000
10000
1000
5000
10000
8000
15000
40000
4000
3750
2000
20000
24000
20000
20000
5000
3750
2000
20000
3750
7500
4000
25000
3750
7500
15000
5000
dr depreciation
cr acc depreciation
7500
15000
5000
4000
20000
20000
3000
20000
4000
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
iii
Balance Sheet and Income Statement for option A
Balance sheet as at
31.12.
Investment in Ijarah
Assets
Less Acc Depreciation
Net Book Value
Income Statement
For year ended 31st
December
Ijarah Rental
Less Depreciation
Less Maintenance
total direct cost
Net profit on ijarah
2007
2008
2009
2010
100000
25000
100000
50000
100000
75000
100000
100000
75000
50000
25000
0
2007
37500
25000
5000
30000
7500
2008
37500
25000
5000
30000
7500
2009
37500
25000
5000
30000
7500
2010
37500
25000
5000
30000
7500
2007
2008
2009
2010
100000
20000
80000
100000
40000
60000
100000
60000
40000
0
0
0
2007
2008
2009
2010
35000
20000
5000
25000
10000
35000
20000
5000
25000
10000
35000
20000
5000
25000
10000
35000
20000
5000
25000
10000
Balance Sheet and Income Statement for option A
Balance sheet as at
31.12.
Investment in Ijarah
Assets
Less Acc Depreciation
Income statement for the
year ended
31st December
Ijarah Rental
Less Depreciation
Less Maintenance
total direct cost
Net profit on ijarah
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
(IV) In the books of the lessee option C.
Option C exercised at end of 2nd year
2007
2008
Dr Ijarah Expenses
18750
18750
cr cash
18750
ist
instalment
of
ijarah
rental
RAB AL MAL
Dr Ijarah Expenses
18750
18750
(CAPITAL
ISLAMIC
Cr Cash
18750BANK
PROVIDER)
(MUDARIB)
2nd instalment of ijarah rental
2009
2010
18750
18750
Dr Motor Vehicles
Cr Cash
Cr Profit and Loss account
Acquisition of previously leased assets at 10%rebate
of remaining instalments with cash equivalent value of $78000
INVESTMENT
78000
67500
10500
Dr Maintenance Expenses
Cr Bank Islam pakistan
5000
Dr Bank Islam Pakistan
Cr Cash
Payment of maintenance expenses
for cars paid on behalf by Bank Islam Pakistan
5000
Dr Depeciation of Motor vehicles
Acc Depreciation
depreciation at 1/3 cev of 78000
5000
5000
5000
5000
5000
26000
5000
26000
26000
26000
10.5 Asset and Liability measurement
In the case of IMBT assets, the balance sheet and Income Statement presentation is as
shown:
Balance Sheet
Ijarah or Ijarah Muntahia Bittamleek Assets
XX
Less : Accumulated Depreciation
(XX)
Net Book value of IMBT Assets
XX
*Jointly or self finance assets
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Income Statement
Ijarah Revenue
XX
Less : Depeciation on Ijarah Assets
(XX)
Less: maintenance and other costs
XX
Less : Direct costs amortized.
In the case of operating Ijarah assets, the balance sheet presentation is as shown
Balance Sheet
Investment in Ijarah Assets
Less : Accumulated Depreciation
Net Book value
XX
(XX)
XX
*Jointly or self finance assets
The income statement presentation is similar to the IMBT Income statement.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
CIPA Multiple Choice
Questions
1 Mr. ABC leases a car, for 5 years, from an Islamic Bank in a transaction of Ijarah
Muntahia Bittamleek through sale for a token consideration. At the end of
the Ijarah term, the cash equivalent value of the car is US$ 1,000 while the
net book value is US$ 1,500. Mr. ABC is not obliged to purchase the car,
and at the end of the Ijarah term, he decides not to purchase it. Therefore,
the Islamic Bank should do the following:
a) The car is recognized as Assets Acquired for Ijarah at US$ 1,500 and loss is
recognized at US$ 500.
b) The car is recognized as Assets Acquired for Ijarah at US$ 1,000 and loss is
recognized at US$ 500.
c) The car is recognized as Fixed Assets at US$ 1,500 and loss is recognized at US$
500.
d) The car is recognized as Fixed Assets at US$ 1,000 and loss is recognized at US$
500.
2. The “Assets for Rent” as provided in the extract of Consolidated Statement of
Financial Position below, supports the following statements:
a) Bank Al-Iman has sold an asset to a third party and leased back the asset over a certain tenor.
b) Bank Al-Iman has purchased the asset from a third party supplier and rented the asset out over
a certain tenor.
c) Bank Al-Iman erroneously reports the asset for rent as “investments” when it should be
reported as “receivables”.
d) All of the above.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Bank Al-Iman
Consolidated Statement of Financial Position (extract)
as at 31 December, 2005
2005
US$
__________
Assets:
Cash and cash equivalent
Sales receivables
Investments:
Investment securities
Mudaraba financing
Musharaka investments
Participations
Inventories
Investment in real estate
Assets for rent
Istisna’a
Total investments
Other assets
Fixed assets (net)
Total assets
146,323,796
4,680,445
29,850,000
10,000,000
5,000,000
205,000,000
2,000,000
130,250,000
183,500,000
1,000,000
__________
566,600,000
15,832,000
50,940,500
__________
784,376,741
__________
3. Sulaiman owns a tractor and leases it to Hamzah for a fixed rent over one year.
Sulaiman requests Hamzah to provide a guarantee either by pledging an asset in
Hamzah’s ownership or finding a guarantor, to ensure that Sulaiman is able to
recover the remaining amount of the lease.
Which of the following statements is accurate based on the above transaction?
a) The transaction is invalid because of excessive gharar due to the fact that the exact form of
guarantee is not specified.
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‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
b) The transaction is invalid because it is not permissible to stipulate a guarantee from a lessee as
the lessee is holding the asset on a trust basis.
c) The transaction is valid because there is a fixed rental fee.
d) Only (a) and (b) are true.
Question 10-1
a) How does the practice of AITAB in Malaysia differ
conceptually and in accounting aspects from al-ijarah
muntahia bit tamleek according to FAS 8 of AAOFI
b) Bank Mualamalat entered into a ijarah muntahia
bitamleek agreement with Ali & Co. to finance the
purchase of factory machinery which runs on gas at
$400,000. The terms are as follows:
Ali & Co. to pay a deposit of 10% of the price to the bank on the
signing of the ijarah contract. They are to pay Bank Muamalat ijarah
rental of $50,000 every 6 months for 5 years. At the end of 5 years, the
salvage value of the machine would be $ 50,000. The bank will
transfer the ownership of the machine to Ali& Co for $20,000.
During the ijarah period Ali & Co. paid the following expenses with
respect to the machine:
Every year : routine greasing and gas fuel related to use of machinery
$10,000
Year 3 and 4, Takaful on the machine against fire, explosion and theft,
$4000 and $6,000 respectively for years 3 and 4. In the early part of year 5,
the machine broke down for 6 months and had to be repaired at $25,000
before it became usable again. It paid all the rentals due according to fiqh
muamalat principles envisaged in the contract.
Bank Muamalat had to pay legal expenses of $10,000 before it signed the
ijarah contract which it considers material. It also paid Takaful expenses
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‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
against fire, explosion and theft on the machinery in year 1,2 and
5 for $3,000 per year.
Required:
(i)
(ii)
Journal entries in the books of Bank Muamalat for the 5 years period
of the ijarah.
Extract of the balance sheet and income statement for the same period.
(IIUM B.Acc, semester 2, 2004/2005, Q4)
Question 10-2
Bank Syari’ah Berhad entered into an Ijarah contract with Mahabbah Sdn.
Bhd. to lease an equipment for a period of 3 years. The Bank purchased
an equipment from a local trader on the 1st of January 2000 for $160,000.
The Bank also incurred legal fees of $1500 relating to the Ijarah contract,
which the bank considered to be material.
Other details about the Ijarah are as follows:
Fair value of equipment:
At the beginning of 2000
At the end of the lease i.e. 31 December 2002
Number of installments on bi-monthly basis
Rentals at the end of every two months
Estimated useful life
Estimated residual value at the end of useful life
Estimated expenditure incurred in the second year
$160,000
$ 20,000
18
$12,000
3 years
$16,000
$12000
Required:
a. Prepare journal entries to record the above Ijarah contract in the books of
Bank Syari’ah Berhad assuming the lease was treated as:
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‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
i.
ii.
Ijarah Muntahia Bitamleek through sale for a token consideration (agreed
to be equivalent to 50% of the estimated residual value at the end of
useful life)
Al-Ijarah Thumma al-bay’ (AITAB)
The journal entries should cover the following periods:
At the beginning of Ijarah;
On receipt of first rental;
At the end of second year; and,
At the end of Ijarah term.
b. Explain the differences between Operating Ijarah and Financing Ijarah.
(IIUM B.Acc, semester 1, 2004/2005, Q2)
Question 10-3
Bank Islam entered into an Ijarah contract with Tamrin Bhd. to lease an
equipment for a period of 4 years. The Bank purchased an equipment
from a local trader on the 1st of January 2003 for $260,000. The Bank also
incurred legal fees of $3000 relating to the Ijarah contract, which the bank
considered to be material.
Other details about the Ijarah are as follows:
Fair value of equipment:
At the beginning of 2003
At the end of the lease i.e. 31 December 2006
Number of installments on bi-monthly basis
Rentals at the end of every two months
Estimated useful life
Estimated residual value at the end of useful life
Estimated expenditure incurred in the second year
Required:
$260,000
$ 30,000
24
$15,000
4 years
$20,000
$15,000
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Prepare journal entries to record the above Ijarah contract in the books of
Bank Islam assuming the lease was treated as:
i.
ii.
Ijarah Muntahia Bitamleek through sale for a token consideration (agreed
to be equivalent to 50% of the estimated residual value at the end of
useful life)
Al-Ijarah Thumma al-bay’ (AITAB)
The journal entries should cover the following periods:
At the beginning of Ijarah;
On receipt of first rental;
At the end of second year; and,
At the end of Ijarah term.
Question 10-4
Malaysian Ijarah House provide a lease finance to STM Bhd for assets worth
$10 million for a period of 15 years. The rental revenue is 3% higher than
market operating lease rate of 10% of the financing amount.
Required:
a. Distinguish between operating Ijarah and Ijarah Muntahia
Biltamleek.
b. Explain why Ijarah Muntahia Biltamleek is not finance lease.
c. If STM Bhd decides to acquire the asset at end of period, what is
your advice on the accounting policy.
(IIUM B.Acc, semester 1, 2000/2001, Q2)
Question 10-5
Islamic leasing or Ijarah is a flexible mode of financing. However not all
assets are suitable for leasing.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
An industrial equipment worth $ 50,000 with a useful life of 10 years was
purchased by an Islamic bank and leased to an enterprise 2 years ago for
a period of 5 years. At the end of year 3 the client decided not to continue
with the lease and returned the asset to the bank.
Required:
a. Distinguish the characteristics of Ijarah and finance lease.
b. State the journal entries that will be recorded for the purchase, lease
and the recovery of the asset in accordance to AAOIFI FAS No.8.
(IIUM B.Acc, semester 2, 1999/2000, Q4)
Question 10-6
Bank Syariah Berhad entered into an Ijarah contract with Takaful
Berhad to lease equipment for a period of 3 years. Bank Syariah
Berhad purchased an equipment from a local trader on 1st of January
2000 for $60,000. The Bank also incurred legal fees of $500 relating to
the Ijarah contract, which the bank considered to be material.
Other details about the Ijarah are as follows:
Fair value of equipment:
At the beginning of 2000
At the end of the lease i.e. 31 December 2002
Number of installments on quarterly basis
Rentals at the end of each quarter
Estimated useful life
Estimated residual value at the end of useful life
Estimated expenditure incurred in the second year
Required:
$60,000
$2,000
12
$6,000
3 years
$4,000
$1,200
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
a) Prepare journal entries to record the above Ijarah contract in the books of
Bank Syariah Berhad assuming the lease was treated as Ijarah Muntahia
Bitamleek through sale for a token consideration (agreed to be equivalent to
50% of the estimated residual value at the end of useful life) for the following
periods:
At the beginning of Ijarah;
On receipt of first rental;
At the end of first year; and,
At the end of Ijarah term.
b) Explain the differences between Ijarah Muntahia Bitamleek (as defined by the
AAOIFI FAS 8) and Al-Ijarah Thumma Al-Bay’ (AITAB) as practiced by
Malaysian financial institutions;
c) Outline the contractual conditions of Ijarah financing as prescribed by the
Syari’ah.
(IIUM B.Acc, semester 2, 2002/2003, Q2)
Question 10-7
Bank Mukminin Berhad entered into an Ijarah contract with Barakah Sdn.
Bhd. to lease an equipment for a period of 5 years. Bank Mukminin
Berhad purchased the equipment from a local trader on the 1st of January
2000 for $100,000. The Bank also incurred legal fees of $1,000 relating to
the Ijarah contract, which the bank considered to be material.
Other details about the Ijarah are as follows:
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Fair value of equipment:
At the beginning of 2000
At the end of the lease i.e. 31 December 2004
Number of installments on quarterly basis
Rentals at the end of each quarter
Estimated useful life
Estimated residual value at the end of useful life
Estimated expenditure incurred in the fourth year
$100,000
$6,000
20
$6,000
5 years
$3,000
$1,200
Required:
a) Prepare journal entries to record the above Ijarah contract in the books of
Bank Mukminin Berhad assuming the lease was treated as Ijarah Muntahia
Bitamleek through pre-determined value (agreed to be equivalent to the lower
of the fair value at the end of the year or $4000) for the following periods:
At the beginning of Ijarah;
On receipt of first rental;
At the end of first year;
At the end of fourth year; and,
At the end of Ijarah term.
b) Explain the similarities and differences between the Islamic concept of Ijarah
and the conventional concept of leasing.
(IIUM B.Acc, semester 1, 2003/2004, Q2)
Question 10-8
Bank Shari’ah Malaysia Berhad has entered into an Ijarah contract with
Ummah Sdn. Bhd. to lease an equipment for a period of 5 years. Bank
Shari’ah purchased an equipment from a foreign trader on the 1st of
January 2000 for $180,000 and incurred custom duty of $20,000. The Bank
also incurred legal fee of $5,000 relating to the Ijarah contract, which the
bank considered to be material.
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Both parties have agreed that the installments should be paid every
quarter. The rental payment was agreed $5,000 per month. The net
realizable value of the equipment is expected to be $20,000 at the end of
the useful life of the asset.
In year 1, Ummah Sdn. Bhd. has found technical default in the equipment
and incurred $10,000 to repair the equipment necessary to retain its full
working order.
Every year, Ummah Sd. Bhd. incurred routine
maintenance costs due to wear and tear amounting to $500 per year.
Required:
(a) Prepare journal entries to record the above Ijarah contract in the
books of Bank Shari’ah as Ijarah Muntahia Bitamleek through sale for a
token consideration (agreed to be equivalent to 50% of the estimated
residual value at the end of useful life) for the following periods:
•
At the beginning of Ijarah
•
On receipt of first rental
•
At the end of first year and,
•
At the end of Ijarah term.
(b)
Determine the profit on Ijarah financing from year 1 to year 5.
(c) Prepare journal entries to record the above Ijarah information as
required in part (a) according to Al-Ijarah Thumma Al-Bay’ (AITAB)
financing as practiced by most Malaysian financial institutions.
(d) Explain how the conventional accounting concept of Substance over Form
influenced the asset recognition policy on Ijarah financing.
(IIUM B.Acc, semester 1, 2005/2006, Q2)
Question 10-9
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Chapter 10.Accounting for Ijarah
‫اﻟﻤﺤﺎﺳﺒ ﺔ ﻟﻺﺟﺎرة‬
Leasing ending with ownership (Ijarah Al Muntahia Biltamleek) is a
category of financing where the lessee expects to own the asset through
purchase or other forms of transfer.
Required:
a. Briefly explain the types of Ijarah Al Muntahia Biltamleek and why it is not
a finance lease.
b. An equipment that cost $ 480,000 is leased for 10 years for a construction
project. It has a useful life of 12 years with no residual value. Under a no$al
operating lease a lease payment of $ 60,000 per annum is received. The
maintenance cost is $ 10,000 per annum. Compute the following:
i.
Total rental net income from the operating lease for a 10 year lease
period.
ii.
Estimated Selling price if the asset is purchased at the end of the
lease period.
iii.
If the lease payment is $ 80,000 as the lessee intends to take
ownership, determine the fair rental amount and recovery amount
if the lease equipment is impaired after 5 years.
c. Show the relevant journal entries for both Operating Ijarah and Ijarah Al
Muntahia Biltamleek when the equipment is leased by the lessor.
(IIUM B.Acc, semester 1, 1999/2000, Q4)
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Chapter 10.Accounting for Ijarah
Question 10-10
An International Equipment Leasing Company has provided both finance
and operating lease to developers and manufacturers that require
specialized leasing equipment to conduct their operating activities. The
company is exploring the possibility of adopting Islamic Leasing
arrangement for some of its equipment. The management has provided
the following information :
Lease Equipment :
Cost or fair market value
Estimated useful life
Estimated residual value:
At the end of year 2
At the end of year 3
At the end of year 4
At the end of year 5
RM550,000
5 years
Estimated residual value (RM’000)
425
319
240
150
The company is proposing two leasing plans :
Plan A
Lease term of 3 years
Lease payments of RM200,000 per annum
No purchase or renewal option
Plan B
Lease terms of 4 years
Lease payments of RM150,000 per annum
Purchase potion at an exercise price of RM250,000 at the end of year 4
Lessee guarantees the residual value at the end of year 4
Renewable option is a lease payment of RM100,000, for every additional year.
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Chapter 10.Accounting for Ijarah
Required:
(i)
What would you advise the company on plans A and B ?
(ii)
Prepare extracts of balance sheet at the end of the lease period for both
plans and indicate the implications of the exercise of the purchase option.
(IIUM B.Acc, semester 1, 1998/1999, Q2)
Question 10-11
Bank Mualamalat entered into a ijarah muntahia bitamleek agreement with
Ali & Co. to finance the purchase of factory machinery which runs on gas
at RM400,000. The terms are as follows:
Ali & Co. to pay a deposit of 10% of the price to the bank on the signing
of the ijarah contract. They are to pay Bank Muamalat ijarah rental of
RM50,000 every 6 months for 5 years. At the end of 5 years, the salvage
value of the machine would be RM 50,000. The bank will transfer the
ownership of the machine to Ali& Co for RM20,000.
During the ijarah period Ali & Co. paid the following expenses with
respect to the machine:
Every year : routine greasing and gas fuel related to use of machinery
RM10,000
Year 3 and 4, Takaful on the machine against fire, explosion and theft,
RM4000 and RM6,000 respectively for years 3 and 4. In the early part of
year 5, the machine broke down for 6 months and had to be repaired at
RM25,000 before it became usable again. It paid all the rentals due
according to fiqh muamalat principles envisaged in the contract.
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Chapter 10.Accounting for Ijarah
Bank Muamalat had to pay legal expenses of Rm10,000 before it signed the
ijarah contract which it considers material. It also paid Takaful expenses
against fire, explosion and theft on the machinery in year 1,2 and 5 of
RM3,000 per year.
Required:
i. Journal entries in the books of Bank Muamalat for the 5 years period of
the ijarah.
ii. Extract of the balance sheet and income statement for the same period.
( IIUM MBA, 2005/2006, Q6)
Question 10-12
Bank Islamic Malaysia Berhad has entered into an Ijarah contract with
Amal Sdn. Bhd. to lease an equipment for a period of 3 years. The Bank
purchased a specialised equipment from a local trader on the 1st of January
2004 for RM1,500,000 and incurred transportation cost of RM50,000. The
Bank also incurred legal fee of RM15,000 relating to the Ijarah contract,
which the bank considered to be material.
Both parties have agreed that the installments should be paid every
quarter. The rental payment was agreed RM60,000 per month. The fair
value of the equipment in 3 years time is expected to be RM100,000 based
on the estimate of certified valuer.
At the beginning of the year 2004, Amal Sdn. Bhd. incurred repair cost of
RM50,000 to enable the equipment to be used properly. In the same year,
Amal also found technical default in the equipment and incurred RM30,000
to repair the equipment necessary to retain its full working order. Every
year, Amal Sdn. Bhd. incurred routine maintenance costs due to wear and
tear amounting to RM1,500 per year.
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Chapter 10.Accounting for Ijarah
Required:
(a) Prepare journal entries to record the above Ijarah contract in the books of
Bank Shari’ah as Ijarah Muntahia Bitamleek through equivalent value
method as prescribed by AAOIFI FAS 8 for the following periods:
•
At the beginning of Ijarah
•
On receipt of first rental
•
At the end of first year,
•
At the end of second year, and,
•
At the end of Ijarah term.
(b) Determine the profit on Ijarah financing from year 1 to year 3.
(c) Prepare journal entries to record the above Ijarah information as required in
part (a) according to Al-Ijarah Thumma Al-Bay’ (AITAB) financing as
practiced by most Malaysian financial institutions.
(d)
Explain in what ways and why the accounting treatments on AITAB
financing are similar to accounting treatments on Bai’ Bithaman Ajil
financing.
(IIUM B.Acc, semester 2, 2005/2006, Q2)
Question 10-13
On 1 February 2006, Al-Barakah Islamic Bank (AIB) agreed to finance the
purchase of factory machinery with Sime Larby Limited (SLL) based on
Ijarah Muntahia Bil Tamleek (IMBT). The purchase price of the machinery is
RM200,000. The details about the transactions are as follows:
i.
AIB purchased the machinery from London-based supplier on 1
May 2006. The transportation cost, custom duties and legal
documentation are RM30,000, RM20,000 and RM1,000 respectively.
The legal fee is considered immaterial whereas other costs are
regarded material.
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Chapter 10.Accounting for Ijarah
ii.
iii.
iv.
v.
On 1 July 2006, AIB officially signed the IMBT financing contract
with SLL to lease the machinery for a period of 5 years. The
monthly rental instalment agreed to be paid by SLL is RM6,500. The
machinery was estimated to have a useful life of 5 years and the
estimated residual value at the end of useful life is RM20,000.
SLL could not pay on time for the last instalment in the year 2007,
but subsequently paid the amount plus a 1% penalty stipulated by
Bank Negara Malaysia (Central Bank) in the first month of the year
2008.
In the year 2008, the machine broke down for 6 months and had to
be repaired by SLL at RM30,000 before it became usable again.
On 31 December 2010, SLL opts for early settlement, which means
SLL wants to get ownership of the machinery before the actual
contractual date of completion. It is the policy of AIB to give 20%
rebate at pro rata basis on the remaining instalments if an
instalment or more has been paid in earlier than the date it has been
scheduled.
Required:
a. Journal entries in the books of Al-Barakah Islamic Bank (AIB) for
the 3 years period (2006 to 2008).
b. Journal entries and calculations for the early
arrangement between AIB and SLL in the year 2010.
settlement
c. Extract of the Balance Sheet and Income Statement for the period of
2006, 2007, 2008 and 2010.
d. What would happen to the books of Al-Barakah Islamic Bank (AIB)
if the above arrangements is Al-Ijarah Thumma Al Bai’ (AITAB)?
(IIUM B.Acc, semester 2, 2008/2007, Q3)