ACCOUNTING ISSUES

ON IJARAH CONTRACT

Topic 4
SPRING 2012/2013
UNIVERSITY COLLEGE OF BAHRAIN

FAS
FAS 88 (AAOIFI)
(AAOIFI)

Nature
Nature of
of Ijarah
Ijarah Financing
Financing
Ijarah is the ownership of the right to the benefit of using an
asset in return for the consideration
Transfer of ownership of a service for an agreed upon
consideration (operational)
Examples-rental of fixed assets
-rental of a package of services

Nature
Nature of
of Ijarah
Ijarah Financing
Financing
ELEMENTS :
Offer & Acceptance,
Lessor, Lessee
Object of the contract
rental amount and service

-- continuedcontinued Rent should be contracted (similar to price)

Rental payment can be non-monetary and of the same
kind of benefit
Flexibility of rental consideration subject to time, place,
distance and usage
Rental is due upon fulfilling the condition in the contract
Prepayment and unearned rent is acceptable

Duties
Duties of
of Lessor/
Lessor/ Lessee
Lessee
A. Lessors Obligations
Making the leased asset available
Guarantee in respect of defects
Maintenance of the Leased asset
B. Lessees Obligations
Utilization of leased asset according to contractual
conditions
Rental payment and safeguard asset

Classification
Classification of
of Ijarah
Ijarah

IJARAH FINANCING

Operating Ijarah
No transfer of title to lessee

Ijarah Muntahia Bittamleek

Ownership is transferred to
lessee

Types
Types of
of Ijarah
Ijarah
Operating Ijarah- Ijarah where the title of assets are not transferred to the
lessee
Ijarah Muntahia Biltamleek
- Ijarah where title of assets are transferred to the lessee by
way of gift, token price, pre- determined price, equivalent
price and gradual transfer of share holding

Methods
Methods of
of Transfer
Transfer of
of Ownership
Ownership in
in
Ijarah
Ijarah Muntahia
Muntahia Biltamleek
Biltamleek

Ijarah Muntahia Bil Tamleek

Gift
At the end
Of period

Token price at
End of period price

Equally
Within lease
period

Gradual
transfer
during lease
period

Operating
Operating Ijarah:
Ijarah: Recognition
Recognition
Measurement
Measurement &
& Disclosure
Disclosure
Recognition of Ijarah asset upon acquisition
Measurement of Ijarah asset at historical cost
and any impairment loss as well as depreciation
is borne by the lessor
Assets, inclusive of all expenses to acquire,
recognised at historical cost
Recognise any permanent reduction in value
Presented as Investments in Ijarah assets
10

Operating
Operating Ijarah
Ijarah recognition
recognition ,,
measurement
measurement &
& disclosure
disclosure
Ijarah revenue should be allocated
proportionately to the financial periods in the
lease term
Initial Ijarah direct costs can be amortized if
material
Repairs if material can be allocated with
provision for repairs
Any repairs undertaken by lessee with lessors
consent is an expense in the lessors books.
11

Recognition
Recognition of
of Ijarah
Ijarah Asset
Asset &
&
Income
Income
Dr Equipment
Cr Cash
(Cash purchase of equipment for Ijarah Financing)

Dr Ijarah Financing Asset

Cr Equipment
(Provides Ijarah financing to lessee)

Dr Cash
Cr P&L
( Repayment received from lessee & income recognition)

Dr Depreciation Expense
Cr Accumulated Depreciation Ijarah Financing asset
( Depreciation cost of Ijarah Financing asset)

12

Ijarah
Ijarah Muntahia
Muntahia Biltamleek:
Biltamleek:
Recognition,
Recognition, Measurement
Measurement &
&
Disclosure
Disclosure

Ijarah Muntahia Bittamleek

Lease payments are usually higher in this form
compared to operating ijarah
Revenue, initial cost and repairs expense rules remain
the same as operating ijarah

13

Acquiring
Acquiring Ownership
Ownership through
through
Gift:
Gift:
Assets acquired for ijara shall be recognized & measured as
treated in operating lease above.
At beginning of period:
Leased assets shall be presented in Statement of Financial
Position under heading Ijara Muntahia Bitamleek Assets.
Leased assets shall be measured at Book Value.
Initial direct cost shall be accounted for as same as its
treatment in operating lease.

Cont.
Cont.
Ijara Revenue:
To be accounted for as treatment in operating Lease.
Repairs of Leased Assets:
To be accounted for as the treatment in operating lease.

At
At end
end of
of Financial
Financial Period:
Period:
Same treatment as above for Amortized Initial Direct Cost,
Provision for Repairs & Ijara Installments Receivable.

However, in calculating depreciation of leased assets Residual

Value shall be zero.

Acquiring
Acquiring Ownership
Ownership For
For Token
Token
or
or amount
amount specified
specified in
in Contract:
Contract:
Same accounting treatment as operating lease regarding:
Recognition & measurement of assets acquired for
lease.
Initial Direct Cost, Repairs & Revenues.

Leased assets shall be presented in Statement of Financial

Position under Ijara Muntahia Bitamleek Assets.

At
At end
end of
of Financial
Financial Period:
Period:
Same accounting treatments as the operating lease regarding:
Recognition of Amortized Initial Direct Cost, Provision for
repairs, and measurement of Ijara Installments Receivable.

At
At end
end of
of Ijara
Ijara Term:
Term:
Legal title passes to lessee after paying all Installments and
Purchase price.
If lessee refuses to buy & he is not obliged to fulfill his promise,
then:
Asset shall be presented in Statement of Financial Position
under, Assets Acquired for Ijara.
Shall be valued at Cash Equivalent Value or Net Book
Value whichever is lower.
Difference between two amounts shall be recognized as loss
in period in which it occurs.

Cont.
Cont.

If lessee is obliged to fulfill his promise and he decided not to

do so and Cash Equivalent Value is lower than Net Book
Value, the difference shall be recognized as Receivable Due
from lessee.

Acquiring
Acquiring Ownership
Ownership for
for
Remaining
Remaining Installments:
Installments:
Same Accounting treatment as operating jjarah regarding:
Assets acquired for Ijara (Recognition, Measurement &
Presentation).
Ijara Revenue, Repairs of asset, Depreciation, Initial cost
& permanent material reduction in value of asset .

Cont.
Cont.
Sale of Leased Asset:
Title shall pass when lessee pays remaining installments prior to
end of lease term.
Remaining Installments shall be the Price to acquire leased asset.
Lessor (bank) shall recognize any Gain or Loss resulting from
difference between Selling Price & Net Book Value.

Acquiring
Acquiring Ownership
Ownership through
through
Gradual
Gradual Sale:
Sale:
Same Accounting Treatments as above for:
Assets acquired for Ijara (Recognition, Measurement &
Presentation).
Leased Assets (presentation & Measurement).

Ijarah
Ijarah Muntahia
Muntahia Biltamleek
Biltamleek Vs
Vs
Finance
Finance Lease
Lease
Ijarah Muntahia Biltamleek
Asset reported in the lessors
books depreciated
Maintenance costs borne by the
lessor
Ijarah revenue is not divisible

24

Finance lease
Finance lease is reported
as receivables
No depreciation &
maintenance costs is
borne by the lessee

Some
Some remarks
remarks
Conventional accounting adopts the concept of substance
over form, on the other hand AAOIFI FAS 8 adopts form
over substance (Shariah Compliance)
AAOIFI recognized Ijarah asset as Fixed Asset (incidental
to legal ownership)
Thus, repair cost is the expense of the lessor (I.e the bank)
but the conventional practice is borne by the lessee
01/09/16
Ijarah contract offered by Malaysian institutions
in AlIjara Thumma al-bay , on the other hand AAOIFI adopted
Ijarah Muntahia Bitamleek

25

 Bank Muamalat entered into an ijarah muntahia bit tamleek with

Ali & Co to finance the purchase of factory machinery which runs
on gas at $400,000. The terms are as follows:
Rental payment is $50,000 semi-anually for 5 years
The salvage value at the end will be $50,000
Ownership is to be transferred at $20,000
During the ijarah period, Ali & co paid the following expenses
related to the machine:
Takaful Insurance in year 3 and 4 for fire and theft,
respectively $4,000 and $6,000
Machine broke down for 6 months & was repaired for
$25,000

26

 Bank Muamalat also had to pay certain expenses:

Legal expenses of $10,000 before signing the contract, which
is considered material
Takaful expenses for year 1, 2 and 5 for fire and theft for
$5,000

Make the journal entries for Bank Muamalat!

Make and extract of the balance sheet and income
statement

27

Dr. Machinery

400,000

Cr. Cash
Dr.

Ijarah Muntahia bittamleek

Cr. Machinery

Dr. Deferred cost

Cr. Cash

400,000
400,000
400,000

10,000
10,000

01/09/16
28

Dr. Cash
Cr. Ijarah revenue

Dr. Takaful Expense

Cr. Cash

Dr. Depreciation Exp

Cr. Acc Depreciation

100,000
100,000

5,000
5,000

70,000
70,000
01/09/16
29

Dr. Amortization exp

Cr. Deferred Cost

2,000
2,000

30

Dr. Cash
Cr. Ijarah revenue

100,000
100,000

Dr. Takaful expense

Cr. Cash

5,000
5,000

Dr. Depriciation expense

Cr. Accumulated Dep

70,000
70,000

01/09/16
31

Dr. Amortization exp

Cr. Deferred cost

2,000
2,000

32

Dr. Amortization Exp

Cr. Deferred Cost

Dr. Deprication expense

Cr. Accumulated Dep

2,000
2,000

70,000
70,000

33

Dr. Cash
Dr.Takaful Expense
Cr. Ijarah Revenue

96,000
4,000
100,000

34

Dr. Cash
Dr.Takaful Expense
Cr. Ijarah revenue

Dr. Deprication expense

Cr. Accumulated Dep

94,000
6,000
100,000

70,000
70,000

35

Dr. Amortization Expense

Cr. Deferred Cost

2,000
2,000

36

Dr. Amortization Exp

Cr. Deferred Cost

2,000
2,000

Dr. Takaful expense

Cr. Cash

5,000
5,000

Dr. Depreciation expense

Cr. Accumulated Dep

70,000
70,000

01/09/16
37

Dr. Acc depreciation

Dr. Cash
Dr. Loss on disposal
Cr. Ijarah muntahia bittamleek

350,000
20,000
30,000
400,000

38

Dr. Cash
Dr. Repair Exp
Cr. Ijarah Revenue

25,000
25,000
50,000

39

Extract of Balance Sheet

Ijarah muntahia
Bittamleek

400

400

400

400

400

( Acc Depreciation )

70

140

210

280

350

Net

330

260

190

120

50

Deffered Cost

10

( Amortization )

Net

40

Extract of Income Statement

Ijarah revenue

140

100

100

100

50

( Takaful expense )

( Amortization )

( Depreciation )

70

70

70

70

70

( Repair expense)

25

Loss on Sale

( 30 )

Net Revenue

41

62

23

24

22

( 82 )

ACCOUNTING QUESTIONS &

ANSWERS ON IJARAH

Ijarah
Ijarah Accounting
Accounting Question
Question 22

Bank Sharia Malaysia Berhad has entered into and ijarah contract with
Ummah Shd.Bhd. To lease an equipment for a period of 5 years. Bank Sharia
purchased the equipment from a trader on the 1st of January for RM180,000
and incurred custom duty of RM20,000. The bank also incurred legal fees of
RM5,000 which is considered to be material.
Both parties agree installments should be paid every quarter, of RM5,000 per
month. The net realizable value of the equipment at the end is expected to be
RM20,000
In year one Ummah found technical default in the equipment and incurred
RM10,000 to retain its full working order. Every year, routine maintenance
costs were RM500.

Ijarah
Ijarah Accounting
Accounting Question
Question 22 continued
continued

The transaction is an ijarah muntahia bit tamleek through sale for a token
consideration, agreed to 50% of the estimated residual value at the end of the
useful life

Prepare the journal entries only for the following periods:

At the beginning
On receipt of the 1st rental
At the end of a 1st year
At the end of the ijarah term

Compute the profit of the ijarah financing from throughout the period!

Journal
Journal Entry
Entry Beginning
Beginning

Dr. Equipment
Cr. Cash

200,000
200,000

Dr. Ijarah Muntahia bittamleek

Cr. Equipment

200,000
200,000

Dr. Deferred Cost

Cr. Cash

5,000
5,000

Journal
Journal Entry
Entry On
On receipt
receipt of
of the
the 1st
1st
payment
payment

Dr. Cash
Cr. Ijarah Revenue

15,000
15,000

Journal
Journal Entry
Entry The
The end
end of
of Year
Year 11

Dr. Cash
Dr. repair expense
Cr. Ijarah revenue

5,000
10,000
15,000

Dr. Amortization Exp 1,000

Cr. Deferred Cost
1,000
Dr. Depreciation Expense36,000
Cr. Acc Depreciation
36,000

Journal
Journal Entry
Entry -- End
End of
of Ijarah
Ijarah term
term

Dr. Amortization exp

Cr. Deferred Cost

1,000
1,000

Dr. Deprication exp

36,000
36,000

Cr. Acc Depreciation

Journal
Journal Entry
Entry -- End
End of
of Ijarah
Ijarah term
term
continued
continued

Dr. Cash
Cr. Ijarah Revenue

15,000
15,000

Dr. Acc Depreciation

Dr. Cash
Dr. Loss of Sale
Cr. Ijarah muntahia bittamleek

180,000
10,000
10,000
200,000

Extract of Income statement

Profit for year 1

Ijarah revenue
Less : Cost
Initial direct cost
Repair cost
Depreciation

60,000
(1,000)
(10,000)
(36,000)
4,000

Extract of Income Statement continued

Year 2-4 (annual)

Ijarah revenue
Less : Cost
Initial direct cost
Depreciation

60,000
(1,000)
(36,000)
23,000

Extract of Income Statement continued

Year 5
Ijarah revenue
Less : Cost
Initial direct cost
Loss on Sale
Depreciation

60,000
(1,000)
(10,000)
(36,000)
13,000

Thank
Thank You
You

53