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Chapter 6

Mudarabah is a contract where one party provides capital and the other provides labor and management. Profits are shared according to a predetermined ratio, while losses are borne solely by the capital provider. Accounting for mudarabah financing requires recognizing the asset when delivered to the mudarib. Income is recognized when profits are realized, while any losses reduce undistributed profits or are borne by the capital provider. Financial statements must disclose balances and transactions related to mudarabah financing.

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52 views

Chapter 6

Mudarabah is a contract where one party provides capital and the other provides labor and management. Profits are shared according to a predetermined ratio, while losses are borne solely by the capital provider. Accounting for mudarabah financing requires recognizing the asset when delivered to the mudarib. Income is recognized when profits are realized, while any losses reduce undistributed profits or are borne by the capital provider. Financial statements must disclose balances and transactions related to mudarabah financing.

Uploaded by

Abdiwahab Abdikadir
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 6

ISLAMIC ACCOUNTING AND FINANCE

MUDARABAH FINANCING:
Issues on Accounting and Disclosure

1
Nature of Mudarabah Financing
• Mudarabah is a contract in which one party
provides capital ( Rabbul mal/ capital
provider) and the other party provides work
(Mudarib / entrepreneur)
• Profits : Shared between the parties
according to a predetermined profit sharing
ratio
• Losses : To be borne by the capital
providers-
• Violation of the stipulated contract by the
entrepreneur, the entrepreneur bears such
loss
Some Legal Principles of
Mudarabah Transactions
• Both capital provider and the entrepreneur
should have the capacity to enter into
contract of agency (wakalah).
• Religion is not condition for both parties.
• Capital must be in the form of money not
commodity (some fuqaha see that it can be trade & non-
monetary assets). Also should be available.
• Capital must be delivered to the possession
of mudarib entirely
• No debt to be treated as capital
• Manner of disbursement (lump sum or in
several installments).
Some Legal Principles of
Mudarabah Transactions
• Subject matter of mudarabah: capital, labor &
profit should be clear.
• Offer and Acceptance
• Profit: the amount received that exceeds
the capital
• Profit Sharing Ratio should be determined
at the time of contracting and profit to be
shared should be known
• Capital provider bears the loss unless due
to trespass or omission.
Some Legal Principles of
Mudarabah Transactions (continued)
• No work interference by
capital provider Profit Recognition
• The entrepreneur should 1. Realization Method:
comply with Shari’ah according to Hanbali and
rules Shafie is when the
• The entrepreneur should revenue is earned i.e. after
comply with capital determining its costs
provider’s instructions
• No guarantee of recovery 2. Distribution Method:
of fund except for according to Maliki it is
betrayal guarantee realized upon distribution
(performance bond) between the two parties
Recognition of Mudarabah Financing –
(Asset)
Dr Mudarabah Financing
Cr Cash
(Being provided Mudarabah financing to Mudarib)

Dr Cash
Cr Mudarabah Financing
(Being repayment or Mudarabah repaid by Mudarib)

Dr Cash
Cr P&L
(Being received profit from Mudarib)

Dr P&L
Cr Mudarabah Financing
(Being set off Mudarabah loss borne by Rabbul Mal)
Forms of Mudarabah Transactions

Bilateral Mudarabah Re-Mudarabah (Two tier


(Simple Mudarabah) Mudarabah) : Three parties
and includes capital
One party of capital provider intermediate
provider and another party Mudarib (entrepreneur) and
of entrepreneur final mudarib (entrepreneur)
Multilateral Mudarabah: If there is one party of
capital provider and several
Several parties of capital parties of entrepreneurs will
provider and one party of it be still considered as
entrepreneur multilateral mudarabah?
Illustration of Bilateral Mudarabah

•C1 provides $200,000 to If Loss is $ 50,000


E1 and PSR is 70:30
•C1 bears the loss of
If profit is $80,000 $50,000, and
• C1 recovers $200,000 - recover $150,000 capital
capital and shares
$56,000- profit
•E1 shares $24,000 profit
Illustration of
Multilateral Mudarabah
C1 provides $100,000 If loss is $50,000

C2 provides $100,000 •C1 bears the loss of


$25,000 and recover
PSR is 70:30, If profit is $ $75,000 capital
80,000
•C2 bears the loss of
•C1 recovers $100,000 capital
$25,000 and recover
and shares $28,000 profit $75,000 capital
•C2 recovers $100,000 capital
and shares $28,000 profit
•E1 shares $24,000 profit
Illustration of Re-Mudarabah
•CI provides If profit is $400,000
$1000,000
•E2 shares profit of $160,000 (400,000 x
•PSR between C1 0.4)
and E1 (intermediary)
is 70:30 •E1 shares profit of $72,000 (400,000x
0.6x 0.3)
•PSR between
E1(intermediary) and •C1shares $168,000 (40,000 x 0.6x0.7)
E2 is 60:40
If loss is $200,000
•C1 bears the loss of $200,000 and recover
$800,000 capital.
•IB & E1 will loose their efforts, time, etc.
Mudarabah Investment forms
• Depositors deposit their money in the bank
using Al-Mudarabah saving/ investment account
• The bank acts as an entrepreneur to invest
funds deposited by depositors into profitable
ventures
• The profit from such a venture is shared

• Unrestricted Mudarabah ( Al- Mudarabah Al-


Mutlaqah)
• The unrestricted Mudarabah is known as the
general investment account where the bank
commingles the funds of many depositors and
invests according to its own criteria
Mudarabah Investment forms

• Restricted Mudarabah (Al-


Mudarabah Al- Moqayyadah)
• The restricted Mudarabah is
known as specific investment
account where the depositors
specify the projects that their
funds is supposed to be
invested in.
Accounting issues on Mudarabah
• Recognition of Asset and
Liability
• Recognition of Profit/ Income
or Loss/ Expense
• Valuation of Asset
• Disclosure
Recognition and Measurement of
Mudarabah Financing

• FAS 3, Mudarabah Financing is a


standard for the provision of
Mudarabah financing by the
Islamic banks.
• It does not deal with the deposits
side of receiving the funds on
Mudarabah basis but on the
assets side.
Measurement of Mudarabah capital at the end of the
financial year after contracting

• Measured at initial carry value except for


repayment of capital which should be deducted
from the Mudarabah financing.
• However if the partial loss of the capital occurs
(eg. theft and fire) before the work on the
Mudarabah is started (and not due to negligence
of the Mudarib), this should also be deducted
from Mudarabah financing account and debit to P
&L
• If the whole of Mudarabah capital is lost, Rabbul
Mal must bear the loss and terminate the contract
• Any unpaid amounts remaining becomes a
receivable of the bank from ex-mudarib.
Measurement of Mudarabah capital at the
end of the financial year after contracting
• Periodic losses incurred in the
course of a continuous
Mudarabah shall be set off
against previously earned profits
that have not been distributed
between both parties
• Otherwise, these losses will be
held in suspense until profits are
realized thereafter and set off
against them
Recognition of Income/ Profit or
Expense/ Loss

Dependent on
1. Profit Sharing Ratio
2. Duration and weightage
3. Profit Distribution Policy
Maturity Period of Investment (Unrestricted )
Account
1 month
3 months
6 months
9 months
12 months
15 months
18 months
24 months
36 months
48 months
60 months and above
(5 years and more)
AAOIFI : Presentation and Disclosure
of Mudarabah Financing
Balance Sheet

Mudaraba Financing ( Non Monetary XX


Mudarabah Asset)*
Less : Provision for decline in value of (XX)
Mudarabah Assets
Net Mudarabah Financing XX

*Jointly or self financed assets

Income statement

Mudarabah income XX
AAOIFI : Accounting treatment for
Mudarabah Transactions
• Recognition: At time of • Upon Termination – any
delivery ( non monetary) outstanding capital is
or payment ( including recognised as receivable due
piecemeal in the case of from the Mudarib
instalments) to the • Profit recognition
Mudarib or placing it - At the time of liquidation or
under his disposition full settlement of accounts
• Classification: The (or any portion thereof)
account should be called between the parties
Mudarabah Financing and - Any profit due and not paid
in the case of non- will be a debt especially
monetary assets, “ Non within an accounting period
or financial period
monetary Mudarabah
Assets”
END

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