Accounting for Mudarabah Financing

1. Accounting for Mudarabah
Financing
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2. Contents
 Accounting for Mudarabah Financing
 Introduction
 Principles of Mudharabah Financing
 The conditions for the capital in a mudharabah
 Accounting for Mudharabah Financing –AAOIFI FAS 3
 Financing Model of Mudarabah financing
 Calculation and exercises
 Conclusion
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3. Introduction
 Mudarabah is a kind of partnership between the two
parties:-
 where one partner contributes capital and
 the other one contributes efforts as manager or entrepreneur.
 The profit of the venture is share at an agreed ratio while
the losses are borne by the capital provider.
 The investment comes from“Rabb-ul-Maal” (Investor)
while the management and work is an exclusive
responsibility of the working partner, who is called
Mudarib.
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4. Principles of Mudharabah Financing –AAOIFI
(Shariah standards)
There are three fundamentals for mudharabah
financing, namely:
i. The two contracting parties, i.e. rab al-mal (capital
provider) and mudharib (entrepreneur)
ii. The subject matter of the mudharabah, i.e. capital,
labour and profit; and
iii. The offer and acceptance.
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5. Continued…………..
 the two contracting parties, i.e. rabul-mal and
mudharib, both of them must have the capacity to
enter into a contract of agency (wakalah).
 This is because, the authorization by the rabul-mal to
the mudharib is considered to be a form of agency,
whereby, the rabul-mal is the principal and the
mudharib is the agent.
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6. i. The capital must be in the form of money and not
commodities.
ii. The capital must be specified, determined and
known at the time of the contract.
iii. The capital must be in the form of available cash.
Thus ,it cannot be in the form of a pending debt or
absent cash.
iv. The capital must be delivered to the possession of
the mudharib entirely.
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AAOIFI (Shariah standards)-The conditions for the
capital in a mudharaba financing are:

7. Accounting for Mudharabah Financing –
AAOIFI FAS 3
Recognition of Mudaraba Financing
 When the capital is paid to the mudarib or placed in his
disposition then Mudaraba financing capital is recognized
by debiting Mudaraba Financing and crediting cash.
 If the capital is paid in installments, each installment is
recognized as capital when paid.
 Expenses of contracting procedures such as feasibility
studies are not considered Mudaraba capital unless
specifically agreed.
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8. Financing Model of Mudaraba financing
 Profit sharing between rabul-mal and mudharib will
depend on the forms of mudharaba transactions. At
least there are three forms of mudharabah financing:
i. Two-sided Mudharabah (Simple Mudharabah): One
party of capital provider and another party of
entrepreneur.
ii. thirty-sided Mudharabah: Several parties of capital
provider and one party of entrepreneur.
iii. Re-Mudharabah (Two Tier Mudharabah): Three
parties that includes capital provider, intermediate
mudharib (entrepreneur) and final mudharib
(entrepreneur)
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9. Two-sided Mudaraba
 Two-sided Mudaraba , where there is one capital provider
and one entrepreneur (can be an organization such as an
Islamic bank.
 The distinguishing feature of any Mudaraba is that;
 the profit sharing ratio between the rabul mal and the
mudarib (Islamic bank) is agreed beforehand.
 Any losses, other than those incurred due to negligence
or mismanagement of the mudarib is borne by the rabul
mal, the mudarib looses his labour as he is not paid any
salaries or fee.
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10. Two-sided Mudaraba
RAB ALMAL
(CAPITAL
PROVIDER)
ISLAMIC BANK
(MUDARIB)
INVESTMENT
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11. Example:
 If, as in the above diagram, Rabbul Maal invested $200, 000
with Mudarib (the Islamic Bank) in the profit sharing
ratio of 70:30 (70% to Rabbul Maal and 30% to the bank),
then if the investment results in a profit of $80,000,
 Solutions:-
 then the bank will get 30% i.e. $24,000 (30%x $80,000) and
the Rab al Mal will get $56,000 (70% x $80,000).
 However, if the investment resulted in a loss of $80,000
instead, then all this loss of $80,000 will be borne by the
rab al mal, unless the mudarib was negligent.
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12. Exercise 1 :
 The profit sharing ratio between Islamic bank and the
investment account holders (assume only one investment
account) is 60% for investment account holder and 40% of
Islamic banks. Islamic banks act as a Mudarib for fund
management. The Mudaraba contract states that Islamic
bank can only deduct the operating expenses before
distributing the income to the investors and Mudarib. The
deductible operating expenses are 35% of total expenses.
 Find the profit distributable among the Unrestricted
Investment Account holders?
 Find the expenses of unrestricted investment account
holders?
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13. Thirty-sided Mudarabaha financing
 Thirty-sided mudarabaha, where there are at least
two capital providers and one entrepreneur.
 In this case, where there are profits, after the bank gets
its share, the depositors are allocated the profits in
according to their capital.
 In the case of Islamic banks, there are many
investment account holders and profit allocation can
become complex especially when the depositors do
not have co-terminus contracts with the bank i.e they
invest for different periods of time.
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14. Many-sided Mudaraba
RABALMAL 1
(CAPITAL
PROVIDER)
VENDOR
ISLAMIC BANK
(MUDARIB) INVESTMENT
RABALMAL 2
(CAPITAL
PROVIDER)
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15. Example:
 In the chart above, two depositors (RM1 and RM2) invest
$100,000 with (Islamic Bank) who invests it, under a mudaraba
contract. Let the profit-sharing ratio between the depositors
and the mudarib being 70:30 respectively.
Solutions:-
 If the ventures returns a profit of $80,000, then the mudarib
(Islamic Bank) gets (30%x$80,000), $24,000 and the rabs al mal
share $56,000. This amount is agreed between RM1 and RM2 in
proportion to their capital investment i.e 1:1 in this case,
therefore they each get $28,000.
 If the loss is $40,000, then RM1 bears $20,000 and RM2 bears
$20,000, since they contributed equal amounts of capital. The
Islamic Bank loses its labour (efforts) but does not bear any
losses, if it has NOT been negligent.
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16. Exercise 2
 An Islamic bank has Two Restricted Investment Account
(RIA) based on Mudaraba contract. Let the profit-sharing
ratio between the depositors and the mudarib being 75:25
respectively. Under the agreement of RIA Islamic bank can
only use the fund in the restricted or specified business
activity. Real estate financing is one of the investments
categorized under RIA contract. The Islamic bank invested
$ 450,000 with a reputable investment. At the end of the
year returns a profit of the $ 250,000 and second year
returns loss ($50,000).
 Find the income distributable to the Two RIA holders.
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17. Exercise 3
 Capital contribution by the Mudarib. (Sometimes the
Mudarib contribute additional capital, in this case the first
the profit or loss belongs to the Mudarib will be distributed
and then the rest will be shared between the investor and
the Mudarib. The profit and loss sharing ratio between the
investor and Islamic bank is 20% of Islamic bank and 80%
of investment account holders. The Islamic bank invested
with their additional capital of 30% in a project.
 Find if the project earned a profit for the year is $ 150,000 or
loss of $ 100,000 how much both Islamic bank and the
investment account holder will get as a return.
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18. Re-Mudaraba financing
 Mudharabah structure may also be based on two-tier
structure or re-mudharabah where 3 parties i.e.
capital provider (depositors/investors), intermediate
mudharib (Islamic bank) and final mudharib
(entrepreneurs).
 Re mudaraba where, the entrepreneur sources and
hires another mudarib under another mudaraba
contract
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19. Re Mudaraba
RAB ALMAL
(CAPITAL
PROVIDER)
ISLAMIC BANK
(MUDARIB1)
INVESTMENT
ENTREPRENUER
(MUDARIB 2)
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20. Example:
 This is the Rabbul Mal (RM) provides $100,000 capital
to Mudarib (MU1) with PSR 70:30.
 This is in turn handed over to Mudarib 2 (MU2) with
profit sharing ratio 60:40. If the venture earns a profit
of $50,000,
Solutions:-
 then MU2 gets 40% of $50,000= $20,000,
 M1 gets 30%x60%x$50,000=$9,000 and
 the rab al mal gets 70%x60%x$50,000=$21,000.
 However, if the investment results in a loss of $30,000,
this loss is borne by the rab al mal, MU2 and MU1
just passes on their loss to rabbul maal (RM). 20

21. Example :
Illustration of Multi-Period Mudharabah Financing
 Company A has entered into a mudharabah contract with
Bank Shari’ah in which the company provides monetary
capital of $2,000,000 to be managed and invested by the
Bank.
 The Bank provides Mudharabah Al-Muqayadah
investment account facility whereby the Bank will invest in
a specific project as agreed by the client.
 For this project there is another investor, Company B who
had agreed to invest $1,000,000. The profit sharing
between three of them is 2:1:1 for Company A, Company
B and the Bank respectively.
 Bank Shari’ah then entered into another mudharabah
contract (Re-Mudharabah) with Company C to undertake
a housing development project and they had agreed on the
profit sharing ratio of 80 : 20 (Bank : Company C).
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22. Continued……..
 Bank Shari’ah had agreed to contribute the $3,000,000
as monetary capital based on a three-year
mudharabah financing contract (mudharabah
muqayaddah). Assume the following results of the
venture:
Year Profit / (Loss)
1 (750,000)
2 700,000
3 1,500,000 22

23. Continued…………..
 You are required to:
 Determine the profit/loss of the above transactions.
 Show how profit/loss will be allocated for all parties
involved based on (i) Each Period method and (ii)
End of Contract method of profit recognition.
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24. Each Period Method
Years
Total Profit
/Loss Bank ( Rabul Mal) 80% Company C ( Mudarib)20%
1 (750,000.00) (750,000.00) -
2 700,000.00 560,000.00 140,000.00
3 1,500,000.00 1,200,000.00 300,000.00
1,450,000.00 1,010,000.00 440,000.00
YEAR1:
Bank = 0
Company A = (750,000) x 2 / 3 = (500,000)
Company B = (750,000) x 1 / 3 = (250,000)
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25. Continued…………..
 YEAR2:
Bank = 560,000 x 1 / 4 = 140,000
Company A = 560,000 x 2 / 4 = 280,000
Company B = 560,000 x 1 / 4 = 140,000
 YEAR3:
Bank = 1,200,000 x 1 / 4 = 300,000
Company A = 1,200,000 x 2 / 4 = 600,000
Company B = 1,200,000 x 1 /4 = 300,000
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26. Continued…………..
 Total
Bank = 440,000
Company A = 380,000
Company B = 190,000
Company C = 440,000
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27. End of Contact Method
 End of Year3:
Company C =1,450,000 x 0.2 = 290,000
Bank = 1,450,000 x 0.8 x 1 /4 = 290,000
Company A = 1,450,000 x 0.8 x 2 / 4 = 580,000
Company B = 1,450,000 x 0.8 x 1 / 4 = 290,000
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28. Comparison between two method
 Each Period Method
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 End of Contact Method
1. Bank = 440,000
2. Company A = 380,000
3. Company B = 190,000
4. Company C = 440,000
1. Bank = 290,000
2. Company A = 580,000
3. Company B = 290,000
4. Company C = 290,000

29. Exercise 1
 Investor A has entered into a mudharabah contract with
Dahabshiil Bank in which the company provides monetary
capital of $1,000,000 to be managed and invested by the Bank.
The Bank provides Mudharabah Al-Muqayadah investment
account facility whereby the Bank will invest in a specific project
as agreed by the client. For this project there is another investor,
investor B who had agreed to invest $500,000. The profit sharing
between three of them is 45:35:20 for investor A, investor B and
the Bank respectively. Dahabshiil Bank then entered into
another mudharabah contract (Re-Mudharabah) with investor C
to undertake a housing development project and they had
agreed on the profit sharing ratio of 70 : 30 (Bank : investor C).
 Dahabshiil Bank had agreed to contribute the $1,500,000 as
monetary capital based on a two-year mudharabah financing
contract (mudharabah muqayaddah). Assume the following
results of the venture:
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30.  Year/Profit / (Loss)
 Year 1 (50,000)
 Year 2 700,000
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31. The End
Thank You..!
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