3 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 ratioLosses : To be borne by the capital providers-Violation of the stipulated contract by the entrepreneur , the entrepreneur bears such lossIs the capital provider a sleeping partner?
4 Some Legal Principles of Mudarabah Transactions Profit: the amount received that exceeds the capitalProfit Sharing Ratio should be determined at the time of contracting and profit to be shared should be knownCapital provider bears the loss unless due to trespass or omissionOffer and AcceptanceCapital (can be trade & non- monetary assets)No debt to be treated as capitalManner of disbursement (lump sum or in several installments)
5 Some Legal Principles of Mudarabah Transactions (continued) Profit Recognition1. Realisation Method: according to Hanbali and Shafie is when the revenue is earned i.e. after determining its costs2. Distribution Method: according to Maliki it is realised upon distribution between the two partiesNo work interference by capital providerThe entrepreneur should comply with Shari’ah rulesThe entrepreneur should comply with capital provider’s instructionsNo guarantee of recovery of fund except for betrayal guarantee (performance bond)
6 Forms of Mudarabah Transactions Bilateral Mudarabah (Simple Mudarabah)One party of capital provider and another party of entrepreneurRe-Mudarabah (Two tier Mudarabah) : Three parties and includes capital provider intermediate Mudarib (entrepreneur) and final mudarib (entrepreneur)Multilateral Mudarabah:Several parties of capital provider and one party of entrepreneurIf there is one party of capital provider and several parties of entrepreneurs will it be still considered as multilateral mudarabah?
7 Illustration of Bilateral Mudarabah C1 provides RM100,000 to E1 and PSR is 70:30If profit is RM40,000C1 recovers RM100, capital and sharesRM28,000- profitE1 shares RM12000 profitIf Loss is RM 20,000C1 bears the loss of RM20,000, andrecover RM80,000 capital
8 Illustration of Multilateral Mudarabah C1 provides RM50,000C2 provides RM50,000PSR is 70:30, If profit is RM 40,000C1 recovers RM50,000 capital and shares RM14,000 profitC2 recovers RM50,000 capital and shares RM14,000 profitE2 shares RM12,000 profitIf loss is RM20,000C1 bears the loss of RM10,000 and recover RM40,000 capitalC2 bears the loss of RM10,000 and recover RM40,000 capital
9 Illustration of Re-Mudarabah CI provides RM100,000PSR between C1 and E1 (intermediary) is 70:30PSR between E1(intermediary) and E2 is 60:40If profit is RM40,000E2 shares profit of RM16,000 (40,000 x 0.4)E1 shares profit of RM 7,200 (40,000x 0.6x 0.3)C1shares RM16,800 (40,000 x 0.6x0.7)If loss is RM 20,000C1 bears the loss of RM20,000 and recover RM80,000 capital
10 Accounting issues on Mudarabah Recognition of Asset and LiabilityRecognition of Profit/ Income or Loss/ ExpenseValuation of AssetDisclosure
11 Recognition of Mudarabah Financing - ( Asset) Dr Mudarabah FinancingCr Cash(Being provided Mudarabah financing to Mudarib)Dr CashCr Mudarabah Financing(Being repayment or Mudarabah repaid by Mudarib)Cr P&L(Being received profit from Mudarib)Dr P&L(Being set off Mudarabah loss borne by Rabbul Mal)
12 Recognition and Measurement of Mudarabah Financing FAS 3, Mudarabah Financing is a standard for the provision of Mudarabah financing by the Islamic banks and does not deal with the deposit side of receiving the funds on Mudarabah basis
13 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 & LIf the whole of Mudarabah capital is lost, Rabbul Mal must bear the loss and terminate the contractAny unpaid amounts remaining becomes a receivable of the bank from ex-mudarib.
14 Non Monetary MudarabaH capital Is discouraged by fuqahaValued at fair value , any difference between fair value and book value goes to the profit and loss
15 AAOIFI : Presentation and Disclosure of Mudarabah Financing Balance SheetMudaraba Financing ( Non Monetary Mudarabah Asset)*XXLess : Provision for decline in value of Mudarabah Assets(XX)Net Mudarabah Financing*Jointly or self financed assetsIncome statementMudarabah income
16 exampleBank Syari’ah Berhad contributed RM1,000,000 for a four-year Mudaraba financing at the profit sharing ratio of 70:30 between the Bank and Ihsan Corporation (Mudarib) respectively.Assume that the venture incurred a loss of RM150,000 in the first year; realised a profit of RM50,000 in the second year; incurred a loss of RM250,000 in the third year; and realised a profit of RM350,000 in the fourth year.Required:a. Calculate the profit/loss earned/incurred by the bank for the Year 1 to Year 4b. Prepare the necessary journal entries for Year 1 and Year 2
18 Nature of MusharakaH Financing A partnership between the Islamic bank and its clients, where both parties:Contribute equal or varying amounts of capital to establish a new project or share in an existing one;Capital can be on permanent or declining (capital) basis and will have his due share of profits; and,Partners share proportionate losses according to the capital contribution and not other wise.
19 MusharakaH Principles Competent contracting partiesThe capital shall be in cash, gold or silver or equivalent; realty (goods, real estates machines); or intangible rights (e.g. patents) or equivalentsThe partner does not guarantee another partner’s capital or funds except in case of negligence or omission.Any exchange or sale of capital to the other partner should not be at historical cost but at the fair value at the time of sale.Profits can vary with the agreement and capital contribution and to be distributed upon completion.Loss to be shared according to capital contribution (credit guarantee) and can be carried forward or offset.
20 Journal entries Dr Musharakah Financing Cr Cash ( Being financing for customers / partners)Dr CashCr Musharakah Financing(Being repayment by customers/ partners)Cr P&L(Being profit received from Musharakah financing)(Being payment received for the purchase of banks share in a Diminishing Musharakah)
21 Types of MusharakaH Financing Constant Musharakah: the partner’s share in Musharakah capital remains (constant) throughout its periodMusharakah Diminishing to Ownership: one party has the right to purchase a part of the other party’s share which declines until one becomes the sole proprietor of all capital (Musharakah Mutanaqisah)
22 Illustration of Diminishing MusharakaH BConstant CCR or PSR?
23 Accounting Treatment of MusharakaH Financing Recognition & MeasurementUpon receipt or deposited in a Musharakah Account known as “Musharakah Financing”.Constant Musharakahcapital:the capital at the end of period is measured based on historical cost.Diminishing Musharakah capital:measured at historical cost after excluding the sold portion (fair value) is the basis of measurement.Any difference between fair value and historical cost is the bank’s profit or lossUpon termination:Outstanding capital becomes receivable.
24 Presentation and Disclosure of MusharakaH Financing Balance SheetMusharakah Financing * XXLess : Provision for loss in Musharakah Financing (XX)Net Musharakah Financing XX* Jointly or Self FinancedAssetsIncome StatementMusharakah Income XX
25 EXAMPLEAli entered into a Mudarabah agreement with Bank Muamalat who agreed to provide RM300,000 financing. Profit sharing between Ali and the bank in ratio of 4:6 respectively. Profits and losses for the first two years of the agreement were as follows:Year 1: Loss RM100,000Year 2: Profit RM50,000It was agreed to convert the Mudarabah to a Musharakah with Ali putting in RM100,000 as capital. The new profit sharing ratio was Ali 60% and Bank 40%. The results of the Musharakah venture was as follows: Year 3: Profit RM150,000, Year 4: Profit RM100,000, Year 5: Loss RM50,000. The bank decided to terminate the agreement at the end of year 5. It was agreed that RM20,000 of the loss was due to negligence of Ali.Required:Prepare journal entries for Year 1 to Year 5.