1. Accounting for Islamic Banks and Financial Institutions Chapter 2 Accounting for Islamic Deposits and Investment Accounts Part 2

2. Unrestricted Mudharabah and Restricted Mudharabah (Investment Accounts) Islamic investment accounts  There are at least two types of Islamic investment accounts  Unrestricted Mudharabah ( Mudharabah mutlaqah).  Restricted Mudharabah (Mudharabah muqayaddah)

3. Unrestricted Mudharabah and Restricted Mudharabah (Investment Accounts) Unrestricted Mudharabah ( Mudharabah mutlaqah).  According to AAOIFI, Unrestricted Investment Account is where the investor fully authorizes the bank to invest the funds without restrictions as to where, how and what purpose the funds should be invested as long as it is deemed appropriate.  Mixing of funds from other sources is permitted and separate disclosure in the financial statement is therefore required.

4. unrestricted investment account

5. Unrestricted Mudharabah and Restricted Mudharabah (Investment Accounts) Restricted Mudharabah (Mudharabah muqayaddah) Restricted Investment Account is where the investor restricts the manner as to where, how and for what purpose the funds are to be invested.  No mixing of funds is allowed from other sources to ensure proper management and accountability of the funds.  A separate disclosure (off-balance sheet) in the form of Statement of Restricted Investments is required to be kept by the Islamic bank.

6. restricted investment account

7. Accounting issues on Mudarabah  Recognition of Asset and Liability  Recognition of Profit/ Income or Loss/ Expense  Valuation of Asset  Disclosure 7 equity of unrestricted investment account holders equity of restricted investment account holders

8. Equity of unrestricted investment account  Equity of unrestricted investment account holders shall be recognized when received by the Islamic bank.  In case the Islamic bank makes it a condition that the funds will not be invested before a certain date, then the funds received shall be recorded in a current account until their date of investment is due.

9. Equity of unrestricted investment account  Equity of unrestricted investment account holders shall be measured by the amount received by the Islamic bank at the time of contracting.  At the end of a financial period, equity of unrestricted investment account holders shall be measured at their book value (balance recorded in the books of the Islamic bank).

10. Profits of unrestricted investment account jointly financed investment  Profits of an investment jointly financed by the Islamic bank and unrestricted investment account holders shall be allocated between them according to the contribution of each of the two parties in the jointly financed investment.

11. Losses of unrestricted investment account jointly financed investment  Loss resulting from transactions in a jointly financed investment (other than that in which final settlement of the investment account is made) : 1. in the first instance should be deducted from any undistributed profits on the investment. 2. Any such loss in excess of the amount of undistributed profits should be deducted from provisions for investment losses formed for this purpose. 3. The remaining loss, if any, should be deducted from the respective equity shares in the joint investment of the Islamic bank and the unrestricted investment account holders, according to each party’s contribution to the joint investment.

12. unrestricted investment account Loss due to misconduct or negligence  Loss due to misconduct or negligence on the part of the Islamic bank, based on the opinion of the shari’ah supervisory board of the Islamic bank, shall be deducted from the Islamic bank’s share in the profits of the jointly financed investment.  In case the loss exceeds the Islamic bank’s share of profits, the difference should be deducted from its equity share in the joint investment, if any, or recognized as due from the Islamic bank.

13. Assets, liabilities and equity of Restricted Investment Account  Equity of restricted investment account holders shall be measured by the amount received by the Islamic bank.  Assets and liabilities relating to equity of restricted investment account holders shall be treated separately from the Islamic bank’s assets and liabilities.

14. Assets, liabilities and equity of restricted investment account  In the case of more than one type of restricted investment accounts in the form of investment funds or portfolios, the amount of each type shall be recognized separately.  At the end of a financial period, equity of restricted investment account holders shall be measured at its book value (balance recorded in the books of the Islamic bank).

15. Accounting Recognition  Conventionally, banks recognize customers deposit as liability as it is a clear cut lending activity between depositors (lenders) and bank (borrowers). Thus, deposits are clearly a liability to the Bank.  The main contentious issue to recognize Mudharabah investment account is to consider it as a liability or a kind of equity.

16. disclosure in the financial statement  Equity of unrestricted investment account holders shall be presented as an independent category in the statement of financial position of the Islamic bank between the liabilities and the owners’ equity.  Not considered a liability. Why ?  not considered part of ownership equity because they do no enjoy ownership rights (e.g voting right).

17. disclosure in the financial statement  Information on equity of restricted investment account holders shall be presented in the statement of changes in restricted investments and their equivalent (Off-Balance Sheet) or at the foot of the statement of financial position.

18. disclosure in the financial statement  disclosure should be made, in the notes on significant accounts, of the percentage of the funds of unrestricted investment account holders which the Islamic bank has agreed with them to invest in order to produce returns for them.

19. journal entries for unrestricted Mudharabah investment account The following are the recognition of and journal entries for unrestricted Mudharabah investment account: Dr. Cash Cr. Equity of Unrestricted Mudharabah Investment Account (with deposit received from Rab ul-mal/Capital provider) Dr. Equity of Unrestricted Mudharabah Investment Account) Cr. Cash Account with deposit repaid to rab ul-mal capital provider Dr. Profit and Loss Account or Reserve Account Cr. Equity of Unrestricted Mudharabah Investment Account with profit disbursed to rab ul-mal

20.  Investment account holders enter into a profit sharing agreement with the bank and are normally issued investment certificates.  Unlike fixed deposits there is no contracted interest expense and the investment account is not guaranteed.  The principles of Mudharabah have created a class of depositors that can be construed as quasi- shareholders.

21. methods of distributing profits Separate Investment Account Method (SIAM)  SIAM is where the Islamic bank will share the gross profit with depositors/investors.  The administrative expenses such as provisions and overhead (indirect expenses) will be borne by the Islamic bank. Thus, depositors/investors will not be burdened by administrative expenses.

22. Example 1: The illustration of SIAM is as follows: N Income from Sales, Investment & Financing 30,000,000 Less: Direct Cost of Sales, Investment & Financing 15,000,000 15,000,000 Less: Distribution of Profit to Depositors/ Investors (PSR = 30%) (4,500,000) Net Income to the Islamic Bank (PSR = 70%) 10,500,000 Add: Fee Based Income 1,500,000 Less: Overhead and Other Admin. Expenses (4,000,000) Net Income to the Islamic Bank (Before Tax & Zakat) 8,000,000 methods of distributing profits

23. Pooling Method (PM).  While, pooling method is where the profit is shared at net income rather than gross income in the case of SIAM. The rationale of this method is the bank has the right to share the administrative and other overhead expenses with the depositor/investors. methods of distributing profits

24. Example 2 The illustration of PM is as follows: N Income from Sales, Investment & Financing 30,000,000 Less: Direct Cost of Sales, Investment & Financing 15,000,000 Less: Overhead and Other Admin. Expenses 4,000,000 19,000,000 11,000,000 Add: Fee Based Income 1,500,000 Net Income to the Islamic Bank 12,500,000 Less: Distribution of Profit to Depositors/ Investors (PSR = 30%) (3,750,000) Net Income to the Islamic Bank (Before Tax & Zakat) 8,750,000 methods of distributing profits

25. Question Two  In the year 2012, Bank Ummah Nig. PLC earned annual profit attributable to Unrestricted Mudharabah Investment Account (Mudharabah mutlaqah) before distributing profit to the Bank, amounting to N10,000,000. Depositor’s profit sharing ratio under Mudharabah deposit account is currently at 70:30 between depositors and the Bank, respectively.  The following is the information pertaining to deposit types, average balance, and the weights used for Mudharabah deposit account in the Bank for the year 2012.

26. Deposit TypeAverage BalanceWTS ≤ 6 months30,000,0000.60 ≤ 9 months40,000,0000.80 ≤ 12 months10,000,0001.00 > 12 months20,000,0001.20 100,000,000

27. (a)You are required to compute and determine: i.Weighted average balance for each deposit type. ii.Depositor’s share of profit based on the weighted average balance. iii.Depositors rate of return for each deposit type. (b) Based on the depositors rate of return as computed in part (a) above, determine the profit attributable to the following depositors in the Mudharabah General Investment Account of Bank Ummah: i.A who invested N 500,000 for the duration of 6 months. ii.B who invested N 420,000 for the duration of 12 months. iii.C who invested N 230,000 from 1st January 2012 to 15 October 2012.

28. Question Two: Suggested Solution (a) i.Weighted average balance for each deposit types. Formular Average Bal. x Weights (obtained for exampleby multiplying N30,000,000 by 0.6 = N 18,000,000). ii.Depositor’s share of profit based on the weighted average balance (obtained for example by dividing N 18,000,000 by N 84,000,000 and multiplying it by N7,000,000= N1,500,000). Formular Weighted Balance x Total profit Total Weighted Balance iii. Depositors rate of return for each deposit types (obtained for example by dividing N1,500,000 by N 30,000,000 and multiplying it by 100% = 5.00%).

29. (b) Thus, the amount of profit for each depositor can be determined as follows: A = N 500,000 x 5.00% = N 25,000 B = N 420,000 x 8.33% = N 34,986 C = N 230,000 x 8.33% = N 19,159