ACCOUNTING FOR ZAKAT

Chapter 7
Course Outline
• Islamic Principles of Zakat
• Methods of measurement and determination of zakat base

• Methods of valuation of zakat base

• Disclosure requirements
Definition of Zakat
• Literary, Zakah means blessing, purification, increase and cultivation of good
deeds. It is called Zakah because it blesses the wealth from which it is paid and
protects it.

• In Shari’a, Zakah is an obligation in respect of funds paid for a specified type of

purpose and for specified categories. It is a specified amount prescribed by Allah
the Almighty for those who are entitled to Zakah as specified in the Qur’an. The
word Zakah is also used to indicate the amount paid from the funds that are
subject to Zakah.
 ZAKAH vs. SADAQA
 Zakah is not religious charity, which is termed Sadaqah (although Sadaqah is sometime used in the
Qur’an to mean Zakah). Charity is a voluntary affair, whereas Zakah is a compulsory levy on
wealth and income, once it exceeds a certain amount termed nisab. According the Qur’an it is a
right of the poor on the wealth and income of the rich.

And in their wealth and possessions (was remembered) the right of the (needy,) him who asked,
and him who (for some reason) was prevented (from asking). Az-Zariyat 51:19
• In the Prophet’s (saw) time and during the time of his successors, zakah was collected and
distributed by the Islamic state as per the instructions of the Qur’an thus:

Of their goods, take alms, that so thou mightest purify and sanctify them; and pray on
their behalf. Verily thy prayers are a source of security for them: And Allah is One Who
heareth and knoweth At-Tauba (The Repentance) (9:103)
Cash and cash equivalent
• Cash and cash equivalent include local and foreign currency and deposits
with the central bank and other Institutions which the Islamic bank can
withdraw in full on demand.

• For Zakah purposes cash and cash equivalent includes, in addition to the
above, gold or silver in the form of currencies, bullion or other.
 FIQH OF ZAKAH

SOURCES
AGRICULTURE CASH AND GOLD
OF
ZAKAT

INVENTORY LIVESTOCK
SOURCES OF ZAKAT
• Zakah is levied on gold and silver (or money, bank account balances, financial papers) ,
livestock (cattle, sheep/goats, camels), agricultural produce of staple crops (wheat, rice),
business working capital (inventory, receivables, cash and cash equivalents), Under each
sources, there are further detailed fiqh rules which vary among the schools of thought.

ZAKAH in Today’s Economy

• FAS no. 9 and the AAOIFI shari'ah standard (11) on Zakah, Sheikh Yusuf Qaradhawi’s
seminal work and the FatÉwÉ of the Islamic Fiqh Academy of the OIC are all making the
rules of Zakah more relevant to today’s economy.

• Islamic financial institutions are businesses and therefore have to pay business zakat.
Provision for Tax and Zakat
Nature and Definition

• A provision for tax arises when current (or prior periods) tax charge is unpaid at
the end of an entity’s accounting period. Current tax is the expected tax payable
(or receivable) on the taxable income or loss for the year, using tax rates enacted
by the end of the reporting period, and any adjustment to the tax in respect of
previous financial years. Current tax is one of the components of income tax
expense (in addition to deferred tax expense) in the determination of profit or loss
of an entity for the reporting period.

• Zakat represents business zakat payable by an entity to comply with the

principles of Shariah and as approved by the Islamic banks’ Shariah
Committee. A business entity only pays zakat on its business and does
not pay zakat on behalf of depositors or shareholders.
CONDITIONS FOR LIABILITY TO ZAKAH

1. Unencumbered possession

• The possession or ownership must be complete. In other words, the owner must have
control over the property especially power of disposal.

• Similarly, there is no Zakah on public funds, or funds held for waqf (endowment) for
charitable purposes and the funds of charitable organizations and property of NGO’s.,
because they do not have a specific owner, and are designated for spending it on
causes which benefit society in general. However, waqf ahli or family waqf is subject to
zakah.

2. The asset must be capable of growing or increasing.

• The growth can be in real terms by reproduction (livestock) or by potentiality e.g. stock
which is intended to be traded. Growth by estimation may take place if the asset has
the potential to yield a surplus and this includes cash and cash equivalent including gold
and silver, even if they are not invested. However, assets held as part of fixed or non-
circulating capital (notably fixed assets) are not subject to Zakah.
3. Nisab

• Nisab is the amount exceeding which zakah becomes payable. If the zakatable base
amounts to less then the nisab amount, zakah is not payable. The nisab differs for
different sources of zakah.

• For gold, silver, cash and business working capital, the nisab is the monetary
equivalent of 85 grams of gold or 595 grams of silver for each individual. In case of
agriculture and livestock, the nisab for these categories are prescribed in the Shari’a.

• In the case of partnerships and corporations the nisab is calculated on the combined
wealth of the owners. For agricultural crops and livestock, it is in terms of quantity
of output and number of animals of each type.
4. Hawl and Zakah rates.

• Hawl is the fiscal period of zakah. It is one lunar year. Although the start and ending
month is not fixed, normally Muslims pay their zakah in Ramadhan, the fasting month
to obtain additional rewards from Allah.

• Businesses such as Islamic financial institutions, however, follow the Gregorian

calendar which follows the solar year which is longer (365 or 366 days) as compared
to the lunar year which has 354 days.

• H’awl and Zakah rates [ 2.5%(per Lunar year) and 2.5775% per Solar year)]

• Exception: except in the case of agriculture where the Zakah is payable on the day of
harvest at 5 or 10%.

• For business working capital, gold and cash, the rate is 2.5% per lunar year. If the
Islamic banks follows the Gregorian solar year, then this rate is uplifted by
365/354x2/5%= 2.5775% per solar year.
5. Duplication of Zakah

• Zakah is payable only once every lunar year. It cannot be payable twice during the same
lunar year. However, if an asset forming part of working capital (e.g. agricultural produce
or livestock) is sold during the year and replaced by another asset of a similar or
different kind (e.g. cash), then a further Zakah is payable.

6. Tax

• The payment of tax does not the discharge the duty to pay zakah. Moreover, tax is not
deducted from the amount of Zakah due. However, the current tax payable (not deferred
tax can be deducted before arriving at the zakah base, since it is an account payable. In
some jurisdictions such as Malaysia, the amount of zakah paid can be claimed as a tax
deductible expense. For personal taxation, any amount of zakah paid to authorized
collections centres can be deducted as a rebate from the income tax payable.

7. Zakah on unlawful or suspect funds

• If the income cannot be returned, then zakah has to be paid and the balance must be
given to charity. The charity payment cannot be considered zakah.
Recognition and Measurement

• According to Technical Release i–1 (TRi-1), zakat for the current period shall be recognized when:
a. an entity has a current zakat obligation as a result of a zakat assessment; and
b. an outflow of resources embodying economic benefits will be required to satisfy the
zakat obligation.

• The amount of zakat assessed shall be recognized as an expense in the period in which it is incurred.

• When an entity pays zakat on its business assets, such amount of zakat is recognized as an expense
and included in the income statement for the period in which it is incurred.

• Zakat shall be assessed when the entity has been in operation for at least 12 months (i.e. for the
period known as haul). Zakat on business shall be calculated by multiplying zakat rate with the assets
that are subjected to zakat (zakatable assets). The rate of zakat on business, as determined by the
National Fatwa Council, is 2.5% of the zakatable assets.
• In determining zakatable assets, an entity may apply one of the following methods as
recommended by the Malaysian Islamic Development Department (JAKIM) in Panduan Zakat di
Malaysia, 2001:
a. the Adjusted Working Capital method (Net asset method); or
b. the Adjusted Growth method (Net invested fund).

• The adjusted working capital method calculates zakat base as net current assets, adjusted
for items that do not meet the conditions for zakat assets and liabilities. The adjusted growth
method calculates zakat base as owners' equity and long-term liabilities, deducted for
property, plant and equipment and non-current assets, and adjusted for items that do not
meet the conditions for zakat assets and liabilities as determined by the relevant zakat authorities.

• The method used for the determination of zakat base shall be applied consistently from one period
to another. On the date zakat is assessed, an entity shall measure zakat assets and liabilities on the
same measurement basis as used in the preparation of its financial statements.
Determination of the Zakah base

• Net Assets method (Prescribed by Fuqaha)

• Net invested funds method (used by government organizations).

METHODS OF
DETERMINING
ZAKAT BASE

NET ASSETS NET INVESTED

METHOD FUNDS METHOD
Net Assets Method

• In the net assets method, the asset side of the balance sheet is used to compute
the zakah base.

• We exclude fixed assets in the calculation as these are not zakatable. We first add
the current assets which are zakatable, taking care to value some of these at
cash equivalent values as opposed to historical cost shown in the balance sheet.
The standard requires that assets acquired for trading should be measured at
the cash equivalent value (market selling price) on the Zakah date.

• We then we deduct current liabilities which are payable within a year. From this
sub total we deduct that part of equity which belongs to minority interest,
unrestricted investment account holders (these two groups are asked pay by
themselves).

• We also deduct that part of the equity belonging to the government, waqfs,
endowments, charities and NGOs unless they are privately owned. This last
group of items is not zakatable.
NET ASSETS METHOD RM
CASH AND CASH EQUIVALENTS XX
NET RECEIVABLES XX
INVENTORY XX
MARKETABLE SECURITIES XX
IJARAH INVESTMENTS XX
FINANCING ASSETS (MUSHARAKA, MUDARABAH, SALAM AND ISTISNA RECEIVABLES) XX
DEPOSITS WITH OTHER BANKS AND CENTRAL BANKS XX
ASSETS SUBJECT TO ZAKAH XXXX
LESS: CURRENT LIABILITIES XX
EQUITY OF UNRESTRICTED INVESTMENT ACCOUNTS XX
MINORITY INTEREST XX
EQUITY OWNED BY GOVERNMENT XX
EQUITY OWNED BY PUBLIC ENDOWMENT FUNDS XX
EQUITY OWNED BY CHARITIES AND NGO’S
ZAKATABLE BASE XXXX
Net Invested Fund Method
• In the net invested fund method, we start on the liability side (the funds side) and add
up all the components which make up the shareholder’s funds and then we add the
long term liabities (zakatable) and then we deduct the fixed assets and
investments not acquired for trading as these are not zakatable. We ignore the
Investment Account Holders funds, minority interest and equities of other than
shareholders.

• That these two methods results in the same amount can be proven by a simple algebraic
expression

• Let FA = Fixed Assets, CA= Current Assets , CL= Current liabilities, SF= Shareholders

• funds, IAH and MI = investment account holders and minority interest equity and LTL=
long term liabilities. Assume there are no govt, endowment or ngo equity.
• The asset side of the balance sheet is:
FA+CA-CL ……………………(i)
= the liability side of the balance sheet;
SF+ IAH +MI+LTL…………… ..(ii)
• Now using Net Assets method, we take CA-CL-IAH-MI as the zakah base (iii)
• Using Net Invested fund method we use SF +LTL-FA as the zakah base (iv)
• But FA+CA-CL=SF+IAH+MI+LTL (i)=(ii) balance sheet equation, A=L+E
• Rearranging this, we get CA-CL-IAH-MI=SF+LTL_FA
• Therefore, (iii)=(iv)
NET INVESTED FUNDS METHOD RM
PAID UP CAPITAL XX
RESERVES XX
PROVISIONS NOT DEDUCTED FROM ASSETS XX
RETAINED EARNINGS XX
NET INCOME XX
LIABILITIES NOT DUE IN THE COMING YEAR XX
TOTAL INVESTED FUNDS XXXX
LESS: NET FIXED ASSETS XX
INVESTMENT NOT ACQUIRED FOR TRADING (e.g. REAL ESTATE FOR RENT) XX
ZAKATABLE BASE XXXX
Presentation and Disclosure

 The amount of zakat assessed for the current period shall be presented as a line
item on the face of the income statement. An entity shall disclose in the notes
accompanying the financial statements the method used in the determination of
zakat base, its responsibility towards payment of zakat on business and the major
components of zakat. Components of zakat may include current zakat expense,
zakat payment, zakat liability and any adjustments recognised in the period for
zakat of prior periods.
1. Faqir - a person without any property or employable skills or an incapacitated person due to age or
physical infirmity.
2. Poor - differs widely throughout the world. Since the zakah funds must first be distributed in the
neighborhood in which they are collected, the relative poverty in the area as well as cost of basic
need to be taken into account
3. The zakah collector - include zakah collection and distribution management and governance
expenses. In Malaysia, a group of Muslim accounting firms have been appointed by the state zakah
collection agencies as zakah assessors.
4. Muallaf – new converts to Islam. This money is given to new converts to Islam for them to learn
about Islam and to take care of their initial difficulties, perhaps a half-way house if they are thrown
out by their families.
5. To free slaves - Since, this category does not technically exist anymore; scholars have opined that the
money can be given to oppress Muslims in countries who are trying to liberate themselves from
oppression.
6. Insolvent and bankrupt - Some scholars say the insolvency or bankruptcy should be due to perhaps
guaranteeing loans for good causes such as building masjids or due to halal business failures. Zakah
money can be used to pay back the debts owed by the bankrupt businessmen.
7. In the way of Allah - Some scholars especially the Hanafi school has restricted the scope of this category
to the poor to perform Haj and military expenditure for jihad. However, contemporary scholars, especially
in Malaysia has interpreted this widely to include almost anything, e.g. setting up vocational and
professional teaching institutions, hospitals, scholarship for poor school and university students,
publishing dawah material and holding Islamic conferences.

8. The stranded wayfarer- If while traveling, the traveler runs out of money or is more likely these days,
he gets robbed or he loses his baggage and wallet along with his credit cards, this person is entitled to
zakah.
ACCOUNTING ILLUSTRATION

• Please refer to the attached questions; Salam Islamic Bank Berhad

 Current Assets

SOLUTION : NET ASSET METHOD Cash and balance with bank and agents 149,834
Deposits and placements with financial institutions 2,035,500

Dealing Securities 1,423,615

Investment Securities 494,546

Other assets 127,229

Financing of customers 3,888,403 (3,886,903 + 1500)

Bills Receivable 8902 (9052 – 150)

Total Current Assets 8128029

Less: Current liabilities

Deposits from customers 7295364

Deposits and placement of banks and other financial institutions 55133
Bills payable (56978-350) 56628
Other liabilities 106378
Total Current Liabilities 7513503
Zakatable Amount (T. CA-T. CL) 614526
Zakat Due (2.5775% x 614526) 15839.40765
 $ ‘000
Share Capital 500000
SOLUTION : NET INVESTED FUNDS METHOD

Reserves 478453
Bill Payable 350 LTL
Total Shareholders Funds 978803
Less: Deposit with BNM 212460 Non tradable
766343
Less:
Fixed Assets 126186 127,686 - 1500
Bill Receivable 150
Subsidiaries 25223
Due from related companies 258
Total Fixed Assets and others 151817

Zakatable Ammount 614526 SF +LTL-FA

Zakat Due (2.5775%) 15839.40765
THANK YOU