Chapter 07

Accounting for Murabahah Financing

ACCOUNTING FOR
MURABAHAH FINANCING
INTRODUCTION
Murabahah financing is an asset based financing widely used for house and
motor vehicle financing by Islamic banks. It is the most widely used financing
instrument as it somehow resembles a loan contract.
 Bay’ Al-Murabahah (‫ )بي**ع المرابح**ة‬is basically an arrangement where the
customers, who wishes to purchase certain goods or assets, requests the bank to
purchase the items and sell them to him at cost plus a declared profit.
 The Islamic bank determine the cost price of the commodity that it bought, and
sells it at a declared profit.
 In simple terms, Murabahah is sale of goods at cost plus mark up where the
purchaser should be informed of the cost of goods or assets and the profit
amount.
 MURABAHA CONDITIONS
 The Murabaha conditions include the following:
A. The Islamic bank should make the cost or capital outlay known to the client.
B. The first contract should be valid.
C. The contract should be free of usury.
D. The Islamic bank should disclose any fault which occurs after the purchase and should disclose all
what is related to the fault.
E. The Islamic bank should disclose the terms applicable to the purchase price, for example if the
purchase was on credit.
F. If any of the conditions in (a), (d) or (e) is not met, the purchaser shall have the
option to:
1. proceed with the sale as it is;
2. have recourse to the seller for the discrepancy; or
3. cancel the contract.
 It is worth noting that a Murabaha sale in the above context means the selling of a
product owned by the seller at the time of negotiation and contracting. (FAS 2,
appendix B)
INTRODUCTION
THE SIMPLE MURABAHAH
 The simple Murabahah is as follows:
Figure 1: Simple Murabahah Financing
Mark-up

Seller Buyer

Price = Cost + Pre-Determined Mark-Up

 INTRODUCTION
MURABAHAH TO THE
PURCHASE ORDERER
Figure 2: Murabahah to Purchase Orderer

Mark-up

Seller Buyer

Supplier/
Developer

Murabahah to the Purchase Orderer is where it involves three parties, namely, the purchase
orderer, the purchaser and the seller. It involves intermediary due to lack of expertise or need for
credit facility.
MURABAHAH TO THE
PURCHASE ORDERER
1. The customer orders the bank to purchase goods, which it promises (this
may be binding or non binding) to buy from the bank giving it some profit.
2. The bank buys and pays for the goods from the vendor.
3. The banks executes a murabaha contract of sale to the customer and delivers
the goods.
4. The customer pays for the goods on an installment basis to the bank.
MURABAHAH TO THE
PURCHASE ORDERER
 In a murabaha to the purchase orderer, the promise to buy of the customer (the
purchase orderer) may be binding or non binding. This result from different
shari’a opinions. One group of scholars view that the promise is non-binding
because:
1. The bank cannot sell what it does not possess (at the time of making the promise)
2. The goods may be defective , deficient or unnecessary when delivered.
 However, this will present problems to the Islamic banks as it incurs cost to
purchase the goods and as a financing institution would not want to be left
with unsold inventory.
MURABAHAH TO THE
PURCHASE
 In order to reduce the ORDERER
risk of the Islamic bank, the bank may
require a deposit from the orderer (potential customer) to ensure his
seriousness. Under the shari’a, there are two types of deposits
which the bank can demand:-
1. Hamish jiddiyyah
2. Urboun
MURABAHAH TO THE
PURCHASE ORDERER
These two deposits are defined by FAS2 as follows:-

 Hamish jiddiyyah
 It is the amount paid by the purchase orderer upon request of the purchaser to
make sure that the orderer is serious in his order of the asset. However, if the
promise is binding and the purchase orderer declines to purchase the asset, the
actual loss incurred to the purchaser shall be made good from this amount.
 Urboun
 It is the amount paid by the client (orderer) to the seller (i.e., the original
purchaser) when the former purchases an asset from the seller. If the customer
proceeds with the sale and takes the asset, then the urboun will be part of the
price; otherwise, the urboun will be the seller.
MURABAHAH TO THE PURCHASE ORDERER
 Hamish Jiddiyayah is problematic, because, in case of a non-binding
promise, the bank will have to return the deposit in full to the potential
customer, even if it subsequently incurs a loss in selling the goods,
which the original orderer had refused to take delivery. In case, the
promise is binding and the customer declines, the bank can deduct any
losses and expenses it incurs on transaction from the deposit and return
the excess. If the loss is greater than the deposit, the customer becomes
liable for the balance.
 In case of urboun deposit, this is deducted from the purchase price if the
customer proceeds with the sale. If not, the customer looses his deposit,
even if the deposit is more than the loss incurred by the bank
MURABAHAH TO THE
PURCHASE ORDERER
 In order to make it safer for Islamic banks, it should make the
contract a binding promise and then require Hamish Jiddiyah or
Urboun.
 However, this does not solve the problem of credit risk i.e. payment
default by customer. To mitigate this, the bank may request for a
guarantee from the customer. The goods sold under murabaha can
be a collateral for the debt. In this case, however, the customer
cannot sell the goods until the debt is repaid to the bank.
MURABAHAH TO THE
PURCHASE ORDERER
 In the case of late payment and procrastination by the customer,
the bank normally cannot levy any penalty as this would amount to
interest. If the shari’a board agree on a penalty, then this penalty
cannot be recognized as revenue but given away as charity.
 The Islamic bank can institute legal proceedings to recover the debt
and financial damage caused by procrastination (e.g. legal fees,
“lost opportunity”).
 Unless the goods sold are collateral, the goods cannot be taken by
the Islamic bank to settle outstanding debt.
 MURABAHAH TO THE
 PURCHASE
If ORDERER
the indebted owner is insolvent and fails to settle the debt, the bank should
defer collection until he becomes solvent.
 If the bank gets a discount on the purchase price, this will belong to the bank
unless it was obtained at the time of making the promise to buy (by the
customer) or before the Murabaha sale was concluded.
 The last rule to consider is early settlement of the debt or a lump sum payment
before scheduled time. Since, the transaction is a sale, the bank is under no
obligation to give a discount to the customer. However, due to competitive
pressures, the Islamic banks do give a discount for early settlement. This is
allowed under the shari’a and is called ‘ibra. The amount must be agreed
between the bank and the customer at the time of settlement or before the lump
sum payment is made.
BAI’ AL MUAJJAL OR BAI’
BITHAMAN AJIL
 Another related model of Murabahah financing .
 It is basically a trade-deal in which the seller allows the buyer to pay
the price of a commodity at a future date in lump sump or
installments.
 Bay’ al muajjal refers to a sale against deferred payment (either in
lump sump or instalments).
 If the sale is to be paid by instalments then the specific term used is
bai’ bithaman ajil.
 Bay’ al-muajjal need not have a reference to the profit margin that the
supplier may earn. Its essential element which distinguishes it from a
normal sale is the deferred payment.
BAI’ AL MUAJJAL OR BAI’
BITHAMAN AJIL
 In general, the sale (bai’) of any permissible thing is permissible,
provided that there is consent by both parties.
 Majority of the Muslim jurists allow the selling price in deferred
sale to be set higher than the cash sale provided the object of the
sale must come into the possession of the bank before being handed
over to the other party.
BAI’ AL MUAJJAL OR BAI’
BITHAMAN AJIL
 In addition, in case of default or delay of the payment by the
customer, the price can no longer be raised. If the customer is in
financial difficulty, more time should be given to him, and another
date be fixed for the payment of the balance of the price.
BAI’ AL MUAJJAL OR BAI’
BITHAMAN AJIL
 In order to be accepted in shari’ah, bai’ al-Murabahah should ensure the
following matters:
1. The Islamic bank must actually hold and own the property before selling it
to the customer
2. The first sale and purchase transaction between the bank and the producer of
the commodity being a separate transaction altogether from the second sale
and purchase transaction between the bank and the customer.
BAI’ AL MUAJJAL OR BAI’
BITHAMAN AJIL
3. The Islamic bank should give the option to the customer whether to buy or
refuse the goods upon seeing them, thus, it cannot enforce a binding
promissory purchase contract on the customer.
4. The Islamic bank should bear the risk in the trade, i.e. by being responsible
for the goods prior to its sale and actual delivery to the customer.
5. The Islamic bank should not take deposits in advance from the customer
because such deposits signify the obligation to buy the goods and they also
mean that the actual transaction takes place before the bank buys the goods;
BAI’ AL MUAJJAL OR BAI’
BITHAMAN AJIL
6. The cost price must be known by the purchaser at the time of the contract
(majlis al-‘aqad);
7. The profit over the cost price must be specified and known by both parties;
8. The cost price must be something that is quantifiable and substitutable;
9. The Murabahah must not involve any of ribawi items, payable by the same,
which, may result in the occurrence of riba in the excess amount over the
cost price. For instance, selling a kilogram of wheat for a kilogram of wheat
also, plus a profit, which turns this case to be a clear riba al fadl;
10. The vendor must have bought the item for the bay’ al Murabahah in a valid
sale and purchase contract.
MURABAHAH FINANCING – AAOIFI FAS 2
RECOGNITION OF ASSETS
 AAOIFI FAS 2 provides that ownership of the purchased asset is transferred to
the buyer at the time of contracting. Thus, accounting journal entries to
recognize the asset (financing) and income (profit) are as follows:
 At the time of contracting (Recognition of BBA Financing asset):
Dr. Murabahah / BBA Financing Account (with the Cost + Profit )
Cr. Cash Account or Account Payable (with the Cost)
Cr. Unearned Financing Income Account (with the profit (mark-up))
 When the installment is received:
Dr. Cash Account
Cr. Murabahah / BBA Financing Account (with the installment received )
MURABAHAH FINANCING –AAOIFI FAS 2
RECOGNITION OF ASSETS
 When the installment is due but not yet received:
Dr. Receivable Account
Cr. Murabahah / BBA Financing Account (with the instalment due)
 When income is due to be recognized (accrual basis):
Dr. Unearned Financing Income Account
Cr. Profit and Loss Account (with the Murabahah / BBA Income due)
 Note: Unearned income account is created to gradually and equally recognise
income throughout the contract period. Unearned income account represents
the total mark-up or profit to be received.
MURABAHAH FINANCING –AAOIFI FAS 2
MEASUREMENT OF ASSET
 AAOIFI FAS 2 considered two alternatives on this issue:
1. The first alternative was to measure the asset available for deferred
payment sale at their purchase price.
2. The other alternative was to measure those assets at their acquisition cost,
which is the purchase price plus any direct expenses associated with the
acquisition process.
 AAOIFI preferred the second alternative, which capitalizes direct
expenses associated with the acquisition process.
MURABAHAH FINANCING –AAOIFI FAS 2
MEASUREMENT OF ASSET
 AAOIFI FAS 2 also considered two alternatives in the valuation of assets
available for deferred payment sale at the end of the financial period:
1. The first alternative was to value the assets at their fair value.
2. The other alternative was to value the assets at their book value.

 AAOIFI preferred the first alternative because these assets are treated as
investments rather than fixed assets. Accordingly, their measurement at fair
value should enable the institution to recognize and measure any unrealized
gains and losses arising from the investment. This is in line with the alternative
measurement attribute to the cash equivalent value concept.
EXAMPLE
 ABC Islamic Bank provides a Murabaha of US$ 200,000 for a Commodity at a
constant rate of return of 10% for period of 5 Years and requires an annual
installment payment of 60,000.
Requirement
1. Prepare an extract of the Balance Sheet and income statement at the
beginning and end of Year 1.
2. Prepare journal entries to record all the above transactions in the book of
Bank.
EXAMPLE
Solution
 Total Unearned income = (5 × 60,000) – 200,000 = $ 100,000
 Income per year = $ 20,000

Balance sheet
Year 0 Year 1
Murabaha receivable (300,000) (240,000)
Unearned Murabaha income (100,000) (80,000)
Net receivable 200,000 160,000
Income statement
Murabaha Income 20,000
 Dr. Cr.
Commodity a/c 200,000
Cash/Creditor a/c 200,000
(Purchase of Commodity)
Murabaha Receivable 300,000
Commodity at cost 200,000
Deferred Murabaha Profit 100,000
At time of Murabaha Sales
Cash 60,000
Murabaha Receivable 60,000
Recognition of profit on each installment‘s received
Deferred Murabaha Income 20,000
Profit and Loss 20,000
MURABAHAH FINANCING –AAOIFI FAS 2
QUESTION ONE
 Bank Shari’ah provides a financing facility based on Murabahah to the Purchase
Orderer principles to Ahmad Ali for the purpose of house purchase.
 The financing is amounting to N300,000 at a constant rate of return 8% for a
period of 5 years.
 At the end of the contract, Ahmad owes the bank amounting to N32,000.
 As part of the normal requirements, the customers will be charged a penalty fee
of 3% per annum for any outstanding amount due at the end of the contract and
the amount collected is normally disbursed as charity.
MURABAHAH FINANCING –AAOIFI FAS 2
QUESTION ONE
 You are required to:

i. Prepare an extract of the balance sheet and income statement of Bank Shari’ah from the
beginning till the end of the contract to show the amount of net receivable and Murabahah
income.
ii. Prepare journal entries to record all the above transactions in the book of Bank Shari’ah
(including the treatment for penalty fee).
iii. Explain the shari’ah requirements on the policy of charging penalty fee for default in
repayment by customers.
iv. Explain the similarities and the differences between Murabahah to the Purchase Orderer, and
Bai’ Bithaman Ajil financing.
QUESTION ONE: SUGGESTED SOLUTION
:(I) EXTRACT OF BALANCE SHEET
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
BBA (420,000-84,000) (336,000-84,000) (252,000-84,000)

Financing 420,000 336,000 252,000 168,000 84,000 0

(120,000-24,000) (96,000-24,000) (72,000-24,000)

Unearned
Income 120,000 96,000 72,000 48,000 24,000 0
Net
Balance 300,000 240,000 180,000 120,000 60,000 0
(1) 8% X 5 = 40% (2) 300,000 X 140% = N420,000 (3) 120,000/5 = N24,000 (4) 420,000/5 = N84,000
JOURNAL ENTRIES )II(
Year 0
Dr. Cr.
Dr. Murabahah Financing Account 420,000
Cr. Cash account 300,000
Cr. Unearned Income 120,000
(Recognition of Murabahah Financing)
JOURNAL ENTRIES )II(
Year 1 to Year 4
Dr. Cr.
Dr. Cash Account 84,000
Cr. Murabahah Financing Account 84,000
(Being repayment by customers)
Dr. Unearned Income Account 24,000
Cr. Profit and Loss Account 24,000
(Being recognition of income)
JOURNAL ENTRIES )II(
Year 5
Dr. Cr.
Dr. Account Receivable 32,000
Dr. Cash account (84,000-32,000) 52,000
Cr. Murabahah Financing Account 84,000
Dr. Unearned Income Account 24,000
Cr. Profit and Loss Account 24,000
(Being recognition of income)
 JOURNAL ENTRIES )II(
…..Year 5
Penalty = 3% x 32,000 x 1/12 = 80/month
Dr. Cr.
Dr. Account Receivable 960
Cr. Penalty (BBA) Account 960
(Being penalty charged)
Dr. Cash Account 960
Cr Account Receivable 960
(Being penalty paid by customer)
SHARI’AH REQUIREMENTS )III(
:ON PENALTY CHARGES
(iii) Shari’ah requirements on penalty charges:
A. Can be imposed only minimum amount e.g. only 1% per annum
on payment in arrears and cannot be compounded.
B. Maximum amount of penalty or ta’widh cannot exceed total
amount of the remainder’s balance.
C. Penalty obtained by the Bank or the financier may be earned
and distributed according to normal profit distribution policy or
distributed as charity.
iv) Similarities between Murabahah to Purchase Orderer and BBA
1. Both are trade financing (sale at mark-up)
2. Both involved 3 parties (bank, seller, buyer)

(i) Differences between Murabahah to Purchase Orderer and BBA

S/No Murabahah
1. Obliged to disclose mark-up
2. Sale plus mark-up – repayment
can be deferred or lump-sum
3. Customer may opt not to
purchase (i.e. no obligation)
4. 2 contracts executed at 2
different times – need to
recognize asset temporarily
BBA
Disclosure of mark-up is not
obligatory
Repayment is deferred (deferred
payment sale)
Customer obliged to purchase
2 contracts executed at the same
time – receivable is created.