CHAPTER 5
ISLAMIC ACCOUNTING AND FINANCE
Accounting for Islamic Deposits and
Investment Accounts
1
An Introduction to Islamic Deposits
•The term “deposit” or “wadiah” means “to leave
something with someone who is not the real
owner for the purpose of safe-keeping”.
•It represents the main sources of the Islamic
commercial banks.
•The deposits collected from surplus units –
investors- are used for financing to deficit units-
customers-.
•The bank plays the of role of “financial
intermediary”.
2
Types of Islamic Deposits
• Based on the Islamic contractual
arrangements, Islamic Banks categorize
Islamic Deposits into the following
types:
– Current account (wadiah) deposits
– Savings account (wadiah) deposits
– Savings account (mudarabah) deposits
– Investment accounts (unrestricted
mudarabah)
– Investment accounts (restricted mudarabah)
3
Mobilization of Deposits & Funds
Current &
Investment Shareholders
Savings
Deposits Funds
Deposits
Pool of Funds
Sales Financing Investments
Types of Islamic Deposits
1. Under wadiah contract
depositor deposits a certain
amount of money in the
Bank for the Purpose of safety
2. Bank utilizes the money
5. Hibah to a depositor In various form of
Is based on banks Investment and financing
Discretion
4. 100% profit 3. Profit earned
goes to the bank by the bank
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Principles of wadiah deposits &
accounting implications
• Wadiah is one of the most used principle in the
Islamic banking systems.
• It is used for the acceptance of deposits; current
and savings.
• As a form of contract-aqd-, all fiqh Schools agree
and approve the principle of wadiah.
• According to the aqd requirement the depositee
must return the deposited to the depositor at any
time upon request.
• All depositors should be asked to give permission to
the IB to mobilize the funds as conditioned by the
depositor.
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Principles of wadiah deposits &
accounting implications
• No return is promised or expected but a “hibah”
may be given to the depositors.
• Deposits are treated as liability, in the records
of the Islamic Bank, as they are guaranteed
custody account.
– Journalizing of deposits are follows:
• Deposit received from customers
– Dr Cash A/C, Cr Wadiah deposit A/C
• Deposit paid to the depositor
– Dr Wadiah deposit A/C, Cr Cash A/C
• Hibah given to the depositor
– Dr P & L A/C, Cr Cash A/C
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Principles of Mudarabah investment
account
• IB accumulate deposits and investments from
customers thru various channels.
• IB use saving a/c, current a/c, or investment a/c
• Deposits are either wadiah yad damanah or yad
amanah.
• Mudarabah deposit is based on partnership
whereby a rabul mal (customers) gives specified
amount of capital to the mudarib (IFI).
• IB acts as entrepreneur to trade with the capital.
• The profit is shared b/w the two according
to an agreed PSR.
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Principles of Mudarabah investment
account
• If there is a loss, it will be borne by the
Rabulmal who is the financier while the
mudarib suffers the fruitless efforts if the loss
is not resulted because of negligence.
• Generally, based on mudarabah aqd, the
bank may act as either the rabulmal or the
mudarib.
• It also may act a both rabulmal and mudarib
(two-tier mudarabah).
• In this case bank involves in 2 saperate
contracts of mudarabah.
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Accounting issues on mudarabah
investment account
• AAOIFI standard FAS 6, deals with the issues
related to funds received by IB for
investment as a mudarib.
• The agreement may be based on either
restricted mudarabah or unrestricted
mudarabah.
• Equity of unrestricted investment a/c holders
are recognized when it is received.
• Equity of unrestricted investment a/c holders
is measured by the amount received by IB at
the contracting date.
10
Accounting issues on mudarabah
investment account
• Profit of unrestricted investment jointly
financed by IFI and Investment a/c holders
should be shared according to the
contribution of each party or as agreed.
• The loss resulted from transactions will be
deducted from the profit before distribution.
The excessive loss will be deducted from the
provisions formed for that purpose.
• If there is capital loss, it should be borne
according to the capital contribution ratio.
11
Accounting issues on mudarabah
investment account
• If the loss occurred as a result of
misconduct or negligence, of any part, that
loss will be borne by the responsible party.
• Assets and liabilities of restricted
investment a/c holders is treated
separately from the IB’s assets and
liabilities.
12
Accounting Recognition
• CB, treat customers deposits as liability as
it resembles lending activity b/w depositors
(lenders) and CB (borrowers).
• In IB, is it liability or equity?
– For restricted mudarabah, it will be treated
as off-balance sheet as it deals with specific
investors, with particular terms.
– For unrestricted mudarabah, the IB
manages at its discretion & considers
Equity of Unrestricted investment a/c.
13
Accounting Recognition
• The following are the recognition of and
journal entries:
• Deposit received from Rabulmal
– Dr Cash a/c, Cr Equity of unrestricted mudarabah
investment a/c
• Deposit paid to the Rabulmal
– Dr Equity of unrestricted mudarabah investment a/c
Cr Cash a/c
• Profit disbursed to Rabulmal
– Dr P & L a/c or Reserve a/c, Cr Cash a/c
14
Accounting Recognition
• Accounting wise, the investment a/c
holders are neither a shareholder’s
equity nor a liability.
• Because depositors/investors does not
assume the rights of the equity holders
nor guaranteed liability.
• Mudarabah investors are not equivalent
to shareholders as they’re not owners,
and also technically are not creditors as
the contract is an investment contract.
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Accounting Recognition
• Some IFIs (in several Muslim countries),
treat as a quasi-shareholders.
• In Malaysia, IFIs treat mudarabah
investment a/c holders as conventional
depositors, which is based on “lending-
borrowing relationship”.
• Even though it is a unique account for
IFIs, it is an accounting challenge.
16
Methods of profit distribution
• Two methods for IFIs profit distribution.
– Separate investment a/c method (SIAM)
– Pooling method (PM0
• under SIAM: admin expenses and
overhead will be borne by IB. profit is
distributed at the gross income.
• Under PM: profit is shared at the net
income rather than gross income.
17
Methods of profit distribution
• Two methods for IBs profit distribution.
– Separate investment a/c method (SIAM)
– Pooling method (PM)
• Under SIAM: admin expenses and
overhead will be borne by IFI. profit is
distributed at the gross income.
• Under PM: profit is shared at the net
income rather than gross income.
18
Methods of profit distribution
Separate Investment Pooling method
Account Method Sales, Investment &
Sales, Investment & Financing Income
Financing Income (Jointly ( Jointly funded ) after
funded) after deducting deducting COF
COF • Add: Fee based income
• Less : Distribution to • Less: Overhead
Investment account expenses
holders • Net income to IFI
• Net income to IFI • Less: Distribution to
• Add: Fee based income Investment Account
• Less: Overhead expenses- holders
• Net income to IFI • Net income to IFI
Methods of profit distribution
Comment on and criticize the methods!
• Which method is fair? and
• Which one is not fair?.
• Which one do you recommend?
• Which one favors IFIs? And
• Which one favors depositors/investors?
20
Methods of profit distribution
Comment on and criticize the methods!
• National Shariah Advisory Council Malaysian
Central Bank) has made a ruling on the issue
of profit allocation and distribution.
• Most of the fuqaha are on the opinion that
profit distribution should be made at the gross
level of the income. Why?
• However, some fuqaha are on the opinion
that expenses can be deducted from the
mudarabah investment funds. Why?
21
Illustration of Profit Distribution
Annual Profit – RM 90,000
Depositor’s PSR- 0.8 RM 72,000
Deposit Average WT Weighted Invstrs/ Invtrs/
depositor’s dpositor’s
Types Balance S Balance
Share Return
<=6 100,000 0.6 60,000 4,320 4.32%
months
<= 9 300,000 0.9 270,000 19,440 6.48%
months
<= 12 250,000 1.0 250,000 18,000 7.20%
months
> 12 350,000 1.2 420,000 30,240 8.64%
months
1,000,000 1,000,000 72,000
Specific disclosure on Mudarabah-
Deposit & Financing (by AAOIFI)
• Restricted or • Sharing revenue from
Unrestricted? banking operations
• Investment weights • Profit allocation between
• Profit Sharing ratio equity & restricted
• Expenses incurred by investments
Investment Depositors • Expenses charged to
• Provisions restricted investments
• Administrative • Agency based investment
expenses (incentives)
• Sharing profits with • Separate Investment
current & savings
Account method or Pooling
accounts
method?
Specific disclosure on Mudarabah-
Deposit & Financing
• Why it is necessary to
disclose mudarabah
investment account holders
and their information?
END
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