WORKSHOP ON ACCOUNTING OF IJARAH UNDER IFAS

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WORKSHOP ON ACCOUNTING OF IJARAH UNDER IFAS 2

• Presentation By
• Omar Mustafa Ansari
• Partner Islamic Financial Services
• Ford Rhodes Sidat Hyder Co.

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OUTLINE

• What is Ijarah?
• Difference of treatment
• Accounting by Bank as Lessor
• Purchase of asset and lease
• Additional treatments
• Sale and lease back transaction Operating
  Ijara
• Sale and lease back transaction Ijarah Muntahia
  Bittamleek

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What is Ijarah?

• Ijarah is a contract whereby the owner of an
  asset, other than consumables, transfer its
  usufruct to another person for an agreed period
  for an agreed consideration.
• Ijarah Muntahia Bittamleek / Ijarah wa Iqtina is
  an Ijarah transaction in which, the ownership of
  the subject asset, is expected to be transferred
  to the lessee after the end of the lease term.
• Ijarah and Ijarah Muntahia Bittamleek are by
  nature purely leasing transactions in which the
  subject matter is the usufruct of the asset and
  not the amount of money as in case of a finance
  lease. In other words it is not a financing
  transaction and instead, it is a substitute to
  financing transactions.

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Ijarah Difference of Treatment

• The IFAS 2 issued by ICAP, as well as, the
  AAOIFI standard suggest the accounting treatment
  similar to an operating lease transactions with
  certain exceptions.
• On the other hand, the conventional banks, as
  well as, Islamic banks currently operating in
  Pakistan are accounting for Ijarah as a financing
  transaction, just like finance lease in
  accordance with IAS-17. Modarabas, are however,
  not following IAS-17.

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Ijarah Accounting by Islamic Bank as Lessor

• Asset is recognized at historical cost and
  depreciated as per normal depreciation policy
  with an expected realizable value at the end.
• According to AAOIFI standard, these are presented
  as Investments in Ijarah Assets, while as per
  IFAS 2, these are included in property, plant
  and equipment with separate disclosure.

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Ijarah Accounting by Islamic Bank as Lessor

• Depreciation has to be calculated in line with
  the methods allowed by IAS 16. Most suitable
  method is generally the straight line method
  because, the rentals are generally also accounted
  for on a straight line basis.
• Depreciation term shall generally be equal to the
  lease term, except where it is expected that the
  asset will be given on Ijarah again, to same or
  some other customer, in which case, the
  depreciable life shall be equal to the assets
  useful economic life.

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Ijarah Accounting by Islamic Bank as Lessor

• Lease rentals including other associated charges
  and Ijarah related expenses are allocated
  proportionately in financial periods over the
  lease term.
• Initial direct cost is amortized over the lease
  term. However, IFAS-2 allows that the same may be
  charged to income as and when incurred.
• Repairs undertaken are recognized as expense.
• According to AAOIFI Standard, a provision for
  repairs is established if repairs are material
  and differ in amount from year to year.

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Purchase of Assets and Lease
Lease rentals of Rs. 12 million over lease term
Rs. 210 M
Records Assets at historical cost
Rs. 10 M
Lessee
Lessor




Deposit recorded as liability Monthly rentals
recorded as revenue over the term (when due)
Depreciation Repair and Maintenance including
provision for repairs Expenses incidental to
ownership
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Ijarah Muntahia Bittamleek Additional Treatments

• IFAS 2 does not deal with Ijarah Muntahia
  Bittamleek separately.
• Same accounting treatment should be applied as in
  case of Ijarah, as according to the substance of
  transaction, all the risks and rewards remain
  with the lessor.
• In case of expected selling price is Nil or fixed
  or equivalent to some pre agreed amount, the
  residual value for the purpose of depreciation
  should be equivalent to such amount.

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Impairment

• In case where a leased asset has become impaired,
  that is when the expected future economic
  benefits from that asset are lower than its
  carrying amount, the IAS 36 shall be applied to
  work out the recoverable amount and any resultant
  impairment shall be recognized as a loss.
• Impairment provisions according to prudential
  regulations should also be recorded in addition
  to specific impairment as discussed above.
  However, the matter of applicability of
  prudential regulations needs certain
  clarifications from SBP.

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Sale and Lease Back Transaction Operating
Ijarah Lessees Perspective

• Sale and lease back resulting into an Ijarah
• If the sale price is same as that of its fair
  value any gain or loss shall be recognized in
  period in which such transaction occurs and
• If the sale price is different from its fair
  value any gain or loss shall be amortized /
  allocated as an adjustment to Ijarah expenses
  over the lease term.

Sale price




Equal to fair value
Different from fair value
Gain or loss allocated as an adjustment to Ijarah
expenses / amortized over the lease term
Gain or loss recognized in period in which
transaction occurs
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Sale and Lease Back Transaction Ijarah Muntahia
Bittamleek Lessees Perspective

• According to AAOIFI Standard, in case of sale and
  lease back resulting into Ijarah Muntahia
  Bittamleek, gains or losses resulting from sale
  shall be allocated as an adjustment to Ijarah
  expenses over the lease term.