Chapter 06

Accounting for Musharakah Financing

 Introduction
Musharakah financing is where an Islamic bank enters into a partnership with entrepreneur(s)

to invest in a feasible business project. If there is profit, it will be shared based on pre-agreed

ratio, and if there is loss, it will then be shared according to capital contribution ratio.

In the case of Musharakah Mutanaqisah, capital is not permanent and every repayment of

capital by the entrepreneur will diminish the total capital ratio for the capital provider. This

will increase the total capital ratio for the entrepreneur until the entrepreneur becomes the sole

proprietor for the business.

ACCOUNTING FOR MUSHARAKAH
FINANCING - AAOIFI FAS 4
 According to AAOIFI FAS 4, recognition of the Islamic bank’s
share in Musharakah capital (cash or assets) shall be recognized
when it is paid to the partner or made available to him on account
of the Musharakah.
 This share shall be presented in the Islamic bank’s books under a
Musharakah financing account with (name of client) and it shall be
included in the financial statements under the heading Musharakah
financing.
ACCOUNTING FOR MUSHARAKAH 4.1.4
FINANCING - AAOIFI FAS 4
 AAOIFI FAS 4 also prescribed that measurement of the Islamic
bank’s share in Musharakah capital at the time of contracting, shall
be measured by the amount paid or made available to the partner on
account of the Musharakah.
 The Islamic bank’s share in Musharakah capital provided in kind
(trading assets or non-monetary assets for use in the venture) shall
be measured at the fair value of the assets (the value agreed
between the partners), if the valuation of the assets results in a
difference between fair value and book value, such difference shall
be recognized as profit or loss to the Islamic bank itself.
ACCOUNTING FOR MUSHARAKAH 4.1.4
FINANCING - AAOIFI FAS 4
 Expenses of the contracting procedures incurred by one or both
parties (e.g., expenses of feasibility studies and other similar
expenses) shall not be considered as part of the Musharakah capital
unless otherwise agreed by both parties.
 Measurement of the Islamic bank’s share in Musharakah capital
after contracting at the end of a financial period shall be measured
at historical cost (the amount which was paid or at which the asset
was valued at the time of contracting).
ACCOUNTING FOR MUSHARAKAH 4.1.4
FINANCING - AAOIFI FAS 4
 The Islamic bank’s share in the diminishing Musharakah shall be
measured at the end of the financial period at historical cost after
deducting the historical cost of any share transferred to the partner
(such transfer being by means of a sale at fair value).
 The difference between historical cost and fair value shall be
recognized as profit or loss in the Islamic bank’s income statement.
ACCOUNTING FOR MUSHARAKAH 4.1.4
FINANCING - AAOIFI FAS 4
 If the Diminishing Musharakah is liquidated before complete transfer is made
to the partner:-
 The amount recovered in respect of the Islamic bank’s share shall be credited to the
Islamic bank’s Musharakah financing account .
 Any resulting profit or loss, namely the difference between the book value and the
recovered amount, shall be recognized in the Islamic bank’s income statement.
 If the Musharakah is terminated or liquidated and the Islamic bank’s due share
of the Musharakah capital (taking account of any profits or losses) remains
unpaid when a settlement of account is made, the Islamic bank’s share shall be
recognized as a receivable due from the partner.
ACCOUNTING FOR MUSHARAKAH 4.1.4
FINANCING - AAOIFI FAS 4
 AAOIFI FAS 4 also recommended that recognition of the Islamic bank’s share
in Musharakah profits or losses shall be recognized in the Islamic bank’s
accounts at the time of liquidation.
 In the case of a constant Musharakah that continues for more than one
financial period, the Islamic bank’s share of profits for any period, resulting
from partial or final settlement between the Islamic bank and the partner, shall
be recognized in its accounts for that period to the extent that the profits are
being distributed; the Islamic bank’s share of losses for any period shall be
recognized in its accounts for that period to the extent that such losses are
being deducted from its share of the Musharakah capital.
ACCOUNTING FOR MUSHARAKAH 4.1.4
FINANCING - AAOIFI FAS 4
 If the partner does not pay the Islamic bank its due share of share of profits
after liquidation or settlement of account is made, the due share of profits shall
be recognized as a receivable due from the partner.
 If losses are incurred in a Musharakah due to the partner’s misconduct or
negligence, the partner shall bear the Islamic bank’s share of such losses. Such
losses shall be recognized as a receivable due from the partner.
 The Islamic bank’s unpaid share of the proceeds shall be recorded in a
Musharakah receivables account. A provision shall be made for these
receivables if they are doubtful.
EXAMPLE 2
 Bank Shari’ah Malaysia Berhad provided working capital to Tijarah Construction Sdn. Bhd.
based on the principle of musharakah mutanaqisah amounting to RM400,000.
 Profit and loss sharing ratio as agreed by both parties is similar to the ratio of capital
contribution which is 30:70 (Bank: Customer) at the beginning of the contract.
 The repayment shall be equal throughout the contract period. However, Tijarah Construction
had financial difficulties during year 2 and thus only managed to pay 50% of the agreed
repayment amount. Half of the amount outstanding in year 2 has been paid in year 3 and
another half was paid in year 4.
 Tijarah Construction also experienced financial difficulties in year 4 whereby the repayment
outstanding at the end of the year was amounting to RM35,000.
 The profit and loss for the above project is as follows:
 Year 1 Profit of RM180,000
 Year 2 Loss of RM150,000
 Year 3 Profit of RM220,000
 Year 4 Loss of RM80,000
EXAMPLE 2
30/4 = 7.5
 Accrual basis:
Year 1
Dr Musharakah Mutanaqisah Financing account 400,000
Cr Cash account 400,000
(Musharakah financing for the customer)

Dr Cash account 100,000

Cr Musharakah Mutanaqisah Financing account 100,000
(Repayment by the customer)

Dr Cash account 54,000

Cr Profit and Loss account 54,000
(Profit received from Musharakah Financing)
Year 2
Dr Cash account (half agreed repayment) 50,000
Dr Profit and Loss account (150,000 x 0.225) 33,750
Dr Receivable account 16,250
Cr Musharakah Mutanaqisah Financing account 100,000
(50% of the agreed repayment amount paid by the customer and loss recognition for Year 2)
Year 3
Dr Cash account [100,000+8,125 (final year)] 108,125
Cr Musharakah Mutanaqisah Financing account 100,000
Cr Receivable account 8,125
(Repayment by the customer for Year 3 and half of the amount outstanding in Year 2)
Dr Cash account 33,000
Cr Profit and Loss account 33,000
(Profit sharing for Year 3)
Year 4
Dr Profit &Loss A/C (loss shared) 6,000
Dr Cash Account 65,000
Dr Account Receivable (35,000-6,000) 29,000
Cr Musharakah Mutanaqisah Financing account 100,000
(Being repayment paid by the customer with outstanding amount N35,000 & loss for Year 4)

Dr Cash Account 8,125

Cr Account Receivable 8,125
(Being repayment by the customer for half of the amount outstanding in Year 2)
 CASH BASIS
Year 1
Dr Musharakah Mutanaqisah Financing Account 400,000
Cr Cash Account 400,000
(Being Musharakah financing for the customer)

Dr Cash Account 100,000

Cr Musharakah Mutanaqisah Financing Account 100,000
(Being repayment by the customer)

Dr Cash Account 54,000

Cr Profit and Loss Account 54,000
(Being profit received from Musharakah financing)
Year 2
Dr Cash Account 50,000
Cr Musharakah Mutanaqisah Financing A/C 50,000
(Being cash received but no loss recognised)
Year 3
Dr Cash Account (100,000+8,125) 108,125
Cr Musharakah Mutanaqisah Financing A/C 108,125
(Being 50% of the agreed repayment amount paid by the customer)
Dr Cash Account (Profit) 33,000
Cr Profit and Loss account 33,000

(Being profit received from Musharakah financing)

Year 4
Dr Cash Account (65,000+8,125) 73,125
Cr Musharakah Mutanaqisah Financing A/C 73,125

(Being repayment made by the customer with outstanding amount N35,000)

(b) comments:
i. Different basis of recognition (i.e. cash vs. accrual) will lead to different amount of profit
recognize
ii. Accrual basis will lead to more complex recognition of profit/income. When there is a loss, it
needs to be set-off against the amount due or the financing repayment.
iii. When the partner faced financial problem and did not pay as scheduled, accrual basis require
allocation of repayment after taking into account profit/loss for that year.
iv. Accrual basis would provide true and fair reflection of profit/loss than cash basis.
 Presentation and disclosure

AAOIFI FAS 4 also prescribed the following presentation and disclosure

:requirements for musharakah financing