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Murabahah and Murabahah for Purchase Orderer

Islamic Financial Transactions

Faizal Jaffar Omer Bin Thabet Huzaifa Baffa

0800907 0800944 0700410

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Purpose

To highlight key features and appropriate accounting treatments associated

with Murabahah and Murabahah for Purchase Orderer contracts

● Definition

● Key elements

● Recognition and Measurement

● Illustration

Outlines

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Murabahah is the most widely used financing instrument

Contract Definition Key conditions

MurabahahSale of goods at acquisition

cost plus an agreed profit mark

up.

● Sale of specified goods at

acquisition cost plus an

agreed profit mark up based

on promise (wa’d) to

purchase given by the

purchaser.

● Promise to purchase may be

binding or non-binding

Seller should disclose

to the purchaser the:

●Price at which the

goods is purchased

(acquisition cost); and

● Amount of profit

Murabahah for

Purchase Ordrer

(MPO)

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Transaction structures

Transactions description:

(1) Islamic bank purchase the goods for murabaha sale from the vendor and pays for it.

(2) Islamic bank enters into a murabaha contract with customer and delivers the good.

(3) The customers pays the bank in installments/cash over the contract period.

Risk exposure●Holding inventory of acquired goods

Murabahah

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Transaction structures

Transactions description:

(1) Customer place an order with Islamic bank to purchase goods with the promise (may be binding or non binding)

(2) Islamic bank purchase and pays for the goods from the vendor.

(3) Islamic bank executes a murabaha contract of sale with customer and delivers the goods.

(4) The customer pays for the goods on an installment/cash basis to the bank.

Risk exposure●Holding inventory of acquired goods in the event that the customer fails/cancel the purchases

Risk mitigation measure/ instruments●Islamic bank accept Hamish Jiddiyyah (security deposit) or Urboun

Murabahah for Purchase Orderer

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Hamish Jiddiyyah

●The amount paid by the purchase orderer upon request of the seller. This is to ensure that the orderer is serious in his order of the asset.

●Islamic bank (the seller) may recover the actual loss incurred from the amount of Hamish Jidiyyah in the event that the customer fails to fulfill the binding promise to purchase; or

●refund the deposit to customer under the non-binding promise

Urboun

●The amount paid by the customer (purchase orderer) to the seller.

●The amount of Urboun shall form part of the purchase price in the event that the customer proceeds with the sale and takes delivery of the asset

Risk mitigation measure

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Recognition and Measurement and Journal Entries

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Recognition and Measurement and Journal Entries

No.Transaction DRCR

1Purchase of Asset by BankEquipment Cash/AP

2Murabaha saleMurabah financing

(cost=profit)

Equipment

(cost+deferred profit )

3Installment receiptcashMurabah financing

4Recognition of profit as each installments received

Deferred profit Profit &loss

5Termination of contractA/RMurabah financing

6Rebate for early paymentDeferred profitMurabah financing

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Measurement of Murabah financing Assets

Upon acquisition of Assets:

With obligation : Assets should be measured at lower of historical cost.

Without Obligation: Assets should be measured at cash

equivalent value. )reflect current value & protect the bank/ financier(.

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Measurement of Murabah financing Assets

Price discount if obtained after acquisition should not be treated as revenue but to reduce the cost of the relevant goods unless agreed by SSB.

Upon financing the customer: Murabaha receivables should be recorded )by the

bank( at face value )cash equivalent value( less provision for doubtful debts

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Measurement of Murabah financing Assets

Income recognition of Murabaha financing assets Profits are recognized at time of contracting for cash or

credit transaction not exceeding the current financial period.

If credit period is one financial period with a single installment , the recognition methods are: Accrual basis method recognizes profit based on a proportionate

allocation of profits whether cash is received or not. Cash basis method recognizes profit as and when the installments

are received

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Measurement of Murabah financing Assets

Principle of matching expenses with income is applied.

Deferral profits )unearned( shall be offset against Murabaha receivables in the balance sheet.

Settlement amount is based on outstanding financial amount )accrual basis(

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Accounting Illustration

An Islamic financial institution provides a financing of $100,000 at a constant rate of return of 10% for a period of 5 years and requires an annual installment payment of $ 30,000.

solution: Unearned income = )5 x 30,000( – 100,000 = RM

50,000. Income = 10000)10% of RM100,000( per year.

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Accounting Illustration

Balance sheet:

Income Statement:Murabaha Income 10000

Year 0Year 1Year 2Year 3Year 4

Murabaha financing

150000120000900006000030000

Unearned income

)50000()40000()30000()20000()10000(

Net receivable

10000080000600004000020000