Islamic Financial Accounting IJARAH by MEZAAN BANK

Islamic Financial Accounting
Standard-2
IJARAH
Interpretation and Implementation
Ahmed Ali Siddiqui

Vice President & Manager
Product Development & Shariah Compliance
Meezan Bank Limited
Scope of Presentation
The scope of this presentation comprises of the following;

- Definition and Salient feature of Ijarah
- Application of the Standard
- Major difference Between Accounting of Finance Lease and Ijarah
(Operating Lease)
- Accounting Policies and Recording Procedures of Ijarah transaction as
per the requirements and guidelines of IFAS-2
- Accounting Policies for Ijarah
- Recording procedure and disclosure requirements of Ijarah
transaction as per IFAS-2
- Points for discussion
Concept of Ijarah
Definition and salient Feature of Ijarah
• Ijarah is an Islamic alternative of Leasing.

• Leasing backed by an acceptable contract is an
acceptable transaction under Shariah.
“Ijarah is a contract whereby the owner of an

asset, other than consumable, transfers its
usufruct to another person for an agreed period
at an agreed consideration.”
Salient Feature of Ijarah
 Contrary to Finance Lease, in Ijarah the ownership of the

assets remains with Lessor (the bank) and only its right of
usage is transferred to the lessee.
 Until the assets to be leased are delivered to the lessee, no

lease rental become due and payable. (i.e. Ijarah cannot be
recorded until the subjected asset is delivered to the lessee.)
 The title of the assets remains with the Lessor during the
entire lease term.
 The Lessor bears all the risk and reward associated with the
ownership to the asset.
 All cost associated with the asset to bring it into usable form
and condition should be borne by the lessor.
Types/Classification of Ijarah
1. Operating Ijarah
Operating Ijarah is a lease that does not include

a promise that the legal title in the leased asset
will pass to the lessee at the end of the lease
1. Ijarah Muntahia Bittamleek (Ijarah wa Iqtina)
It is a lease that concludes with the legal title in the

asset passing to the lessee after Ijarah. Ijarah
Muntahia Bittamleek includes:
 Ijarah through gift
 Ijarah & transfer of legal title at the end of the lease for a
token consideration or other amount as specified in the lease
 Ijarah through transfer of title prior to the end of lease at a

price pre-decided
3. Ijarah tul Musha or Joint ownership Ijarah
It is a lease where Bank & customer jointly owned

the leased asset. Bank gives its share to the
customer on lease.
After the term of Ijarah, the treatment is similar to

Ijarah Muntahia Bittamleek
Process of Ijarah
(Muntahia Bittamleek)
Process of Ijarah
. .
VENDOR ISLAMIC BANK Agreeme CUSTOMER
nt-1
 The customer approaches the Bank with the

request for Ijarah financing and enters into a
promise to lease agreement.
 The Bank purchases the item required for
leasing and receives title of ownership from the
vendor
 The Bank makes payment to the vendor
Process of Ijarah
. .
VENDOR ISLAMIC BANK Agreeme CUSTOMER
nt-2
 The Bank leases the asset to the customer after

execution of lease agreement.
 The customer makes periodic payments as per
the contract.
 At the end of the tenure customer can purchase
the asset from the bank with the help of separate
Sale agreement.
Accounting Standard for Ijarah
IFAS 2 - Ijarah
Application of Standard
The Islamic Financial Accounting Standard (IFAS)-2 “ IJARAH” was issued

by the Institute of Chartered Accountants of Pakistan and was adopted by the
Securities and Exchange Commission of Pakistan vide its notification S.R.O
431 (i)/2007 dated May 22,2007.
Effective date
IFAS-2 becomes operative for financial statements covering periods beginning

on or after July 01, 2007.
Retrospective application of this IFAS is not mandatory. i.e. the IFAS is

applicable for Ijarah commencing on or after July 01, 2007.
Major difference between accounting of Finance Lease
and Ijarah
Finance Lease (pre-adoption method) Ijarah (post-adoption method)
• Leases are recorded as financing in the 1) Ijarah assets are recorded at cost less
books of Lessor (the bank). accumulated depreciation and impairment.
2) Un-earned income i.e ‘excess of 2) Rental from Ijarah is recognized as income

aggregate rentals over cost of the asset” on accrual basis.
are recorded at the inception of lease and
amortized over the lease term. 3) Costs, including depreciation is charged to
• Provision against Doubtful debts is income statement.
calculated according to the criteria given 4) Assets leased out should be classified
in Prudential Regulations for banks. according to it nature, distinguished from the
• Leases are disclosed net of provision, assets in own use. (i.e. Plant & Machinery,
income suspense and unearned income. Vehicle etc.)
• Revenue is recorded to the extent of 5) Lessor should make an impairment testing
income portion of the rentals based on for the asset on a regular basis. Any impairment
the manner which produce a constant should be dealt in according to the
rate of return. requirements of IAS 36 “ Impairment of
assets.”
Accounting Policy for Ijarah
Ijarah Asset Recognition
• All Ijarah transactions are to be recorded as “Asset Acquired

for Ijarah” at sum of all Cost incurred by the bank in acquiring the
asset..
• Assets are to be stated at their cost less accumulated

depreciation and impairment if any.
• Depreciation is to be charged to income applying the method
which reflects the pattern in which the asset’s future economic
benefits are expected to be consumed by the bank.
• In respect of addition and disposal of assets, depreciation will
be charged from the month of acquisition till the month of
disposal.
Accounting Policy for Ijarah
Revenue Recognition.
Ijarah rentals are to be recognized as income on accrual basis in a
systematic manner over the lease period
Expense Recognition
Carrying costs, including depreciation, incurred in earning the
Ijarah income are recognized as an expense in the Income
statement.
Case Study for Ijarah
Below is the case study for the understanding of
suggested Ijarah accounting:
Example Amount in Rs./%

Asset Price 100,000
Monthly rentals 5,000
Tenure 3 years
Security Deposit 10,000
Delivery Time 1 month
Recording Procedures and Disclosure
requirements
Following are the scheme of accounting entries to be recorded in the book of
Lessor (the bank)
Jan 1, 2007
1) At the time of payment to the client for the purchase of asset on behalf of
bank or directly to the supplier by the bank ;
Dr Advance against Ijarah 100,000

Cr Pay Order / Party Account 100,000
Dr Cash 10,000
Cr Security deposit 10,000
Feb 1, 2007
2) When the asset is deliver to the lessee
Dr Asset acquired for Ijarah 100,000

Cr Advance against Ijarah 100,000
requirements
Feb 28, 07
3) Accrual of income when it is due( Ijarah rentals are considered as income)
Dr Rental receivable 5,000

Cr Rental Income 5,000
Feb 28, 07
4) Recording of depreciation on Ijarah Asset
Dr Depreciation expense 2,500

Cr Accumulated depreciation 2,500
{(100,000-10000)/36}
requirements-continued
Disclosure in Balance Sheet at month end (Feb 28,07)
Assets at cost 100,000

Less:
Accumulated Depreciation (2,500)
Provision for Impairment ( )
Net book value 97,500
5) At the time of receiving of Rental following entry would be passed:
Dr Party Bank A/c 5,000

Cr Ijarah rental receivable 5,000
6) At the time of maturity of Ijarah Contract
Dr Security Deposit 10,000

Cr Party Bank A/c 10,000
Dr Party Bank A/c 10,000
Cr Asset acquired for Ijarah at wdv 10,000
7) In case of default in payment of rental
Dr Provision for doubtful debt (expense) XXX

Cr Provision for doubtful debt (accumulated) XXX
(with the amount of rental receivable previously accrued and taken to
income)
8) Provision for Impairment of Ijarah assets
Dr Provision for impairment (expense) XXX

Cr Provision for impairment (accumulated) XXX
Disclosure in Balance Sheet at period end

Assets at cost XXX
Less:
Accumulated Depreciation (XXX)
Provision for Impairment (XXX)
Net book value XXXX
Rental Receivable
Rental receivable XXXX
Less:
Provision for doubtful debt (XXX)
Net rental receivable XXXX
Common Questions Raised
 Where Asset acquired for Ijarah will be reported in the Balance

Sheet (Under the classification of financing)
 Does Ijarah will be consider for ADR.
 What will be the guidelines for provision for doubtful debt and
Income suspense in case Ijarah is consider as financing under
prudential regulations for banks.
 In case Ijarah does not fall under the definition of financing,
what will be the guidelines for general provisions for consumer
finance..
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Islamic Financial Accounting

Interpretation and Implementation

Ahmed Ali Siddiqui

The scope of this presentation comprises of the following;

• Ijarah is an Islamic alternative of Leasing.

“Ijarah is a contract whereby the owner of an

 Contrary to Finance Lease, in Ijarah the ownership of the

 Until the assets to be leased are delivered to the lessee, no

Operating Ijarah is a lease that does not include

1. Ijarah Muntahia Bittamleek (Ijarah wa Iqtina)

It is a lease that concludes with the legal title in the

 Ijarah through transfer of title prior to the end of lease at a

3. Ijarah tul Musha or Joint ownership Ijarah

It is a lease where Bank & customer jointly owned

After the term of Ijarah, the treatment is similar to

 The customer approaches the Bank with the

 The Bank leases the asset to the customer after

The Islamic Financial Accounting Standard (IFAS)-2 “ IJARAH” was issued

IFAS-2 becomes operative for financial statements covering periods beginning

Retrospective application of this IFAS is not mandatory. i.e. the IFAS is

Finance Lease (pre-adoption method) Ijarah (post-adoption method)

2) Un-earned income i.e ‘excess of 2) Rental from Ijarah is recognized as income

• All Ijarah transactions are to be recorded as “Asset Acquired

• Assets are to be stated at their cost less accumulated

Example Amount in Rs./%

Dr Advance against Ijarah 100,000

Dr Asset acquired for Ijarah 100,000

Dr Rental receivable 5,000

Dr Depreciation expense 2,500

Assets at cost 100,000

Dr Party Bank A/c 5,000

Dr Security Deposit 10,000

Dr Provision for doubtful debt (expense) XXX

Dr Provision for impairment (expense) XXX

Disclosure in Balance Sheet at period end

 Where Asset acquired for Ijarah will be reported in the Balance

 Does Ijarah will be consider for ADR.

Income suspense in case Ijarah is consider as financing under

prudential regulations for banks.

 In case Ijarah does not fall under the definition of financing,

what will be the guidelines for general provisions for consumer

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