1. AN
INTRODUCTION
TO
ISLAMIC FINANCE
1

2. CONTENTS
 Musharakah
 Mudarabah
 Murabahah
 Ijarah
 Salam and Istisna’
2

3. Musharakah
 Musharakah is an arabic word which means “sharing”
 means participation of two or more persons in a
certain business with defined amount of capital
according to a contract for jointly carrying out a
business and for sharing profit and loss in specified
proportions
3

4. • 2 broad categories:
• Sharikah al-mulk i.e property partnership
• Sharikah al-’aqd i.e contractual partnership
• 5 types of Sharikah al-’aqd:
• Sharikah al-mal or finance partnership
• Sharikah al-a’mal or labour partnership
• Sharikah al-wujuh or credit partnership
• Sharikah al-’inan or limited investment partnership
• Sharikah al mufawadah or unlimited investment
Musharakah
4

5. Sharikah al-mulk
 The origin of the partnership is the joint
ownership of property.
 Joint ownership is its only qualification, and no
joint exploitation of property is necessary.
 It occurs when two or more people are partners in
the possession of property.
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6. Sharikah al-mulk
 The rule governing this type of sharikah is that
any increase in the property shall be shared by
the co-owners in proportion with the extent of
their ownership.
 Each of them is in the category of a stranger in
regard to any action on the part owned by his
colleague.
 It is unlawful for either partner to perform any
act with respect to the other’s share except with
the latter’s express permission.
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7. Sharikah al-mulk
 In terms of liability of the partners, they are quite
independent of each other, except for actions
based on express authorization by any of the
partners.
 Their partnership is only in terms of ownership
and potential sharing of any profit or increase in
the co-owned property, not in term of sharing
the liabilities arising from the partners’ actions.
7

8. Sharikah al-mulk
 This type of sharikah may not be known in the
common law. In fact mere joint-ownership is
generally insufficient to constitute a partnership
in common law.
8

9. Sharikah al-’aqd
 The origin of the partnership is the contract
between the parties.
 The structure of this type of sharikah may have
more similarities with the normal partnership in
common law.
 For sharikah al `aqd, joint ownership is not an
element necessary for the establishment of the
partnership.
9

10. Sharikah al-’aqd
 The emphasis is rather on the joint exploitation
of capital and the joint participation in profits
and losses, based on the terms of the partnership
contract.
 Joint ownership is one possible consequence, and
not a prerequisite for the formation of sharikah al
`aqd
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11. Sharikah al-’aqd
 The jurists further sub-divide Sharikah Al Aqd
into various other categories.
 The subdivisions depend on a number of factors.
If the underlying factor is the subject matter of
capital contribution, sharikah al `aqd can be sub-
divided into three main categories:-
(1) sharikah al amwal,
(2) sharikah al a`mal
(3) sharikah al wujuh.
11

12. Sharikah al-’aqd
 When the subject matter of the capital is money,
it becomes sharikah al amwal (monetary
partnership).
 If the capital is in the form of labour, it becomes
sharikah al a`mal (labour partnership).
 If the capital is in the form of reputation or
creditworthiness, it becomes sharikah al wujuh
(reputation partnership).
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13. Sharikah al-’aqd
 The jurists also make further sub-divisions to
sharikah al `aqd based on the terms of the
contract, i.e., whether the partners are required
to contribute equally to the capital and enjoy full
equality in exploiting the capital and sharing the
profit or not.
 Based on this consideration, sharikah can be
divided into two types, sharikah al mufawadah
and sharikah al ‘inan.
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14. Sharikah al-’aqd
 Sharikah al mufawadah means an unlimited
investment partnership, whereby each partner
must contribute equally to the capital, and enjoys
full and equal authority to transact with the
partnership capital or property.
14

15. Sharikah al-’aqd
 This type of sharikah clearly implies unlimited
liability on the part of partners since they are
both agents and guarantors of each other.
 Sharikah al’inan can be defined as a limited
investment partnership.
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16. Sharikah al-’aqd
 Whereby each partner may only transact with the
partnership capital according to the terms of the
partnership agreement and to the extent of the
joint capital. Hence, their liability towards third
parties is several but not joint.
 The liability of partners in Sharikah Al`inan
resembles that of modern-day limited liability
partnerships.
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17. Sharikah al-’aqd
 Both Sharikah Al-Mufawadah and Sharikah
Al`inan can occur in all the three earlier types of
sharikah, i.e., Sharikah Al Amwal (monetory
partnership), Sharikah Al A`mal (labour
partnership) and Sharikah Al Wujuh (reputation
partnership).
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18. Sharikah al-’aqd
 Sharikah Al Mufawadah is rarely opted for due to
the higher degree of responsibility and the
practical difficulty to achieve full equality
between the partners in all aspects of the
partnership
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19. Mudarabah
 means that one party provides capital and the other
utilises it for business purposes under the agreement
that profit from the business will be shared according
to a specified proportion.
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20. Mudarabah - Introduction
• “Mudaraba” is a kind of partnership where
partner involve in business;
• Mudarabah is partnership between persons
in which one partner gives money to another
for investing in profitable avenues.
• The investor (fund provider/supplier) is
called “Rabb-ul-Maal while the person who
utilizes this fund (the fund manager) is called
“Mudarib”;
• Mudarib is exclusively responsible for
management of the business.
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21. Mudarabah - Introduction
Mudarabah Capital:
• In principle, the capital of Mudaraba should
be provided in the form of cash.
• However, it may be presented in the form of
kind i.e. tangible assets which will be
valued as per mutual consent;
• The value (in cash) of the assets will be the
Mudaraba capital;
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22. Mudarabah - Introduction
Mudarabah Capital:
• The Capital of Mudaraba should be clearly
known to the contracting parties and
defined in terms of quality and quantity in a
clear manner;
• Debt (receivable) can not be the capital of
Mudarabah.
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23. Mudarabah - Introduction
• Mechanism of Profit and Loss distribution:
• The contracting parties should stipulate in
the contract the profit shares (in defined
terms) for each one;
• The profit sharing ratio should be:
• Specific; and
• of the profit expected to be earned by the
venture;
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24. Mudarabah - Introduction
• Therefore following method is not allowed:
• Unknown ratio;
• A ratio attributed to future settlement;
• A ration linked with the capital (in terms of
x% of the capital);
• A lump sum settlement as profit;
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25. Mudarabah - Introduction
• Mechanism of Profit and Loss distribution:
• Losses in Mudaraba shall only be born by
Rabb-ul-Mal and not by the Mudarib;
• Mudarib will also suffer loss in shape of not
receiving anything as profit;
• The Mudarib shall only be responsible for
losses if the loss happened due to his
negligence and willful misconduct.
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26. Mudarabah - Types
• There are two types of Mudarabah:
• Restricted Mudarabah (Mudarabah
Muqayyadah):
• It is a kind of Mudarabah in which the
capital provider restricts the Mudarib to
perform business with certain restrictions.
These restrictions may be for place
(geographical restriction), particular type
of investment (sector wise restriction) or
any other restriction provided these
restrictions do not unduly constrain the
Mudarib from business operations. 26

27. Mudarabah - Types
• Unrestricted Mudarabah (Mudarabah
Mutlaqah):
• It is a kind of Mudarabah in which the
capital provider (Rabbul Maal) does not
put any restriction the Mudarib.
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28. Mudarabah - Rules
• Supply of funds:
• The basic feature of Mudaraba is that the
the capital is provided by Rabbul Maal and
the Mudarib is responsible for the
management only;
• However, it is allowed for Mudarib to add
capital into the business of Mudaraba if
agreed with Mudarabi;
• In such cases Musharaka and Mudaraba are
combined.
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29. Mudarabah - Rules
• For example, “Zuhaib” gave to “Rahman
Hayder” Rs.100,000/- for Mudaraba. R.
Hayder added Rs. 50,000/- from his own
with the consent of Zuhaib;
• This type of partnership will be treated as a
combination of Musharaka and Mudaraba;
• Here the Mudarib may allocate for himself a
certain percentage of profit on account of
his investment as Sharik, and at the same
time he may allocate another percentage for
his management and work as a Mudarib.
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30. Mudarabah - Rules
• Termination of Mudarabah:
• The contract can be terminated at any time
by either of the two parties after giving a
notice to the other party.
• If all assets are in form of cash and some
profit has been earned on the principle
amount, it shall be distributed between the
parties according to the agreed ratio.
• If the assets of the Mudaraba are in other
form the Mudarib shall be given an
opportunity liquidate them and the actual
profit may be determined. 30

31. • Murabaha is a particular kind of sale
and not a financing in its origin.
• Where the transaction is done on a
“cost plus profit” basis i.e. the seller
discloses the cost to the buyer and adds
a certain profit to it to arrive at the final
selling price.
31

32. Basic rules for Murabaha financing:
 Asset to be sold must exist.
 Sale price should be determined.
 Sale must be unconditional.
 Assets to be sold:
 a) Should not be used for un-Islamic purpose.
 b) Should be in ownership of the seller at the time of
sale; physical or constructive.
MURABAHA

33. Step by step Murabaha Financing
1. Client appointed as agent to purchase goods on
bank’s behalf
2. Bank gives money to agent/supplier for purchase of
goods.
3. The agent takes possession of goods on bank’s
behalf.
35

34. Step by step Murabaha Financing
4. Client makes an offer to purchase the goods from
bank through a declaration.
5. Bank accepts the offer and sale is concluded.
6. Client pays agreed price to bank according to an
agreed schedule. Usually on a deferred payment
basis (Bai Muajjal)
36

35.  Purchase of raw material; for meeting working
capital needs of trade and industry.
 Medium to long term requirements for purchase of
land, building and equipment.
 Trade finance products including imports, exports
and bill purchase.
Applications of Murabaha

36. Accounting Treatment for
Murabaha under IFAS-1
1- Payment to the customer for the purchase of goods on
behalf of bank or directly to the supplier(vendor) by
the bank :
Advance against Murabaha Dr
Customer A/C Cr
38

37. Accounting Treatment for
Murabaha under IFAS-1
2- At the time of sale of goods to the customers with
signing of Declaration by the bank and the client:
Murabaha Dr
Murabaha Profit Receivable Dr
Advance against Murabaha Cr
Deferred Murabaha Income Cr
39

38. Accounting Treatment for
Murabaha under IFAS-1
3- At the time of Booking of Accrual @ profit rate each
month the following entry would be passed*.
[(amount x Profit rate) x 30 / 365]
Deferred Murabaha Income Dr
Murabaha Income Cr
*this entry will be passed at the end of each month till maturity.
40

39. Accounting Treatment for
Murabaha under IFAS-1
4- On Maturity of Murabaha transaction and at the time
of receiving of final payment following entry would be
passed:
Customer A/C Dr
Murabaha Cr
Murabaha Profit Receivable Cr
41

40. • Literally, it means “To give something on
rent”
• Ijarah is an Islamic alternative of Leasing.
• Leasing backed by an acceptable contract
is an acceptable transaction under Shariah.
IJARAH

41. • The question of whether or not the
transaction of leasing is Shariah compliant
depends on the terms and conditions of
the contract.
• Several characteristics of conventional
agreements may not conform to Shariah
thus making the transaction un-Islamic
and thereby invoking a prohibition.
IJARAH

42. • Risk and rewards of ownership lies with the
owner i.e. any loss to the asset beyond the
control of the lessee should be borne by the
Lessor.
• Late payment penalty cannot be charged to
the income of the Lessor.
• Lease and Sale agreement should be
separate and non contingent.
IJARAH - Key Difference

43. • The customer approaches the Bank
with the request for financing and
enters into a promise to lease
agreement.
• The Bank purchases the item required
for leasing and receives title of
ownership from the vendor
• The Bank makes payment to the
vendor
IJARAH - Process

44. • The Bank leases the asset to the
customer after execution of lease
agreement.
• The customer makes periodic rental
payments as per the contract
• At the end of the tenure customer can
purchase the asset from the bank with
the help of separate Sale agreement.
IJARAH - Process

45. 1. Leasing is a contract where the owner of
an asset transfers its use to another person
against an agreed price.
2. However, ownership of the leased asset
remains with the Lessor
Rules of Ijarah

46. 3. Since ownership of the leased asset
remains with the Lessor, all rights and
liabilities relating to ownership are borne
by the Lessor.
All rights and liabilities relating to use are
borne by the Lessee.
Rules of Ijarah

47. 4. Subject matter of Lease should be
Valuable, Identified and Quantified.
5. The period of Lease must be determined
in clear terms.
6. The Lessee is responsible for damage to
the asset caused by fraud or negligence.
Rules of Ijarah

48. 7. Any damage to the asset not caused by the
Lessee’s neglect, is to be borne by the
Lessor.
8. Normal maintenance is Lessee’s
responsibility.
Rules of Ijarah

49. 9. Lease rentals for the entire lease period
must be fixed at the time of Agreement;
a) Different amounts of rents can be fixed
for different periods, but they must be
known.
b) The rent may be tied to a known
benchmark, acceptable to both parties.
Rules of Ijarah

50. 10. The Lessor cannot increase the rent
unilaterally
11. The Lessor may receive the rent in
advance, but such payment should be
recorded as an Advance rental. Balance
Sheet should reflect this payment as
Liability, since rent can be received only
for use of an asset.
Rules of Ijarah

51. 12.The Lease period will start when the asset
has been delivered to the Lessee
- in a usable condition
- whether or not the Lessee has started
using it
13.If the leased asset is destroyed, the lease
will terminate.
Rules of Ijarah

52. • If the Lessee contravenes any term of the
Lease agreement the Lessor may
unilaterally terminate the agreement
• If there is no contravention, the agreement
can only be terminated by mutual consent
Termination of Ijarah

53. Accounting Treatment of Ijarah
Transactions
 Rental Calculation
 Rent = (asset cost paid by the bank x rate)/[1-
(1/(1+rate)n)]
 Rentals are to be recognized as income on accrual
basis in a systematic manner over the lease period,
whereas carrying costs, including depreciation,
incurred in earning the Ijarah income are recognized
as an expense in the Income statement.
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54. Accounting Treatment of Ijarah
Transactions
1. At the time of payment to the client for the purchase of
asset on behalf of bank or directly to the supplier by
the bank
Customer A/c Dr
Security Deposit Cr
2. When asset is delivered to Lessee
Asset acquired for Ijarah Dr
Advance against Ijarah Cr
56

55. Accounting Treatment of Ijarah
Transactions
3. Accrual of income when it is due( Ijarah rentals are
considered as income)
Rental Receivable Dr
Rental Income Cr
4. Recording of Depreciation expense for Ijarah Asset
Depreciation Expense Dr
Accumulated Depreciation Cr
57

56. Accounting Treatment of Ijarah
Transactions
5. At the time of receiving of Rental following entry
would be passed:
Customer A/C Dr
Ijarah Rental Receivable Cr
6. At the time of maturity of Ijarah Contract
Security Deposit Dr
Customer A/C Cr
58

57. Salam
(Forward Purchase)
 A salam transaction is the purchase of a commodity
for deferred delivery in exchange for immediate
payment. It is a type of sale in which the price,
known as the salam capital, is paid at the time of
contracting while delivery of the item to be sold,
known as subject matter of salam, is deferred.

58. Salam
(Forward Purchase)
 Uses:
 Purchase of commodities (financing for
production of agricultural
commodities/ minerals)
 Liquidity requirements of sugar mills,
etc.

59. Principles of Salam
 An exception to the possession
 A contract opposite to Murabaha
 Payment of full price at spot - otherwise selling
debt for debt
 Allowed in fungible commodities

60. Principles of Salam
 Product of a particular origin can't be specified
 Quality and quantity decided in unambiguous
terms
 The commodity should remain in the market
throughout the period of contract (different opinions).

61. Principles of Salam
 The time of delivery should be sufficient to allow use
of Salam capital conveniently
 A security/guarantee is preferred as safeguard to the
risk of default
 Only commodity is delivered and not the money

62. Parallel Salam
The disposal of commodity at the end of Bank can be
through:
a. Parallel Salam: may sell commodity,
before the date of delivery, to some other
purchaser for the date of original
delivery. The period in second contract
will be shorter than the original contract,
but price will be higher than the original
contract.

63. Parallel Salam
The disposal of commodity at the end of Bank can be
through:
b. Unilateral Promise: Promise of purchase
can be obtained from third party for
delivery on the date of original contract.
Price in this promise is set higher than
parallel salam because the promisor has
to pay nothing.

64. Rules of Parallel Salam and Third Party
Promise
• Both the contracts i.e. Salam and parallel
Salam must be independent of each
other
• Parallel Salam is allowed only with third
parties
• The third party giving unilateral promise
should not pay the price in advance.

65. Accounting Treatment
1. Entry, at the time of signing contract and raising
money to client as Salam Financing.
Salam Financing Dr
Cash Cr
2. At the time of signing Parallel Slam with another
client.:
Cash Dr
Parallel Salam Financing Cr
67

66. Accounting Treatment
3. When goods are received from client-I
Salam Goods Dr
Salam Financing Cr
4.Goods are given to client-II (Parallel Salam)
Parallel Salam Dr
Salam Goods Cr
Profit & Loss A/C Cr
68

67. Istisna
Introduction
Istisna is a sale transaction where commodity is
transacted before it comes into existence.
Definition
It is an order to produc or to manufacture a specific
commodity for the purchaser.

68. Conditions of Istisna
 the subject of Istisna is always a thing which needs
manufacturing
 Manufacturer use his own material
 Quality and Quantity should be agreed in absolute
term
 Purchase price should be fixed with mutual consent

69. Price of Istisna
 Price of Istisna may be spot and deferred therefore
Istisna is applicable where Salam is not applicable.
 Price of Istisna can be paid in installments.
 The installments may be tied up with different stages
of manufacturing.

70. Right of Rejection
When the required goods have been manufactured
by the manufacturer, purchaser can exercise his
right to reject the goods based on the defects in the
manufactured goods

71. Revoking of Istisna
 The contract of Istisna can be cancelled unilaterally
before the manufacturer starts working.
 After starting the work, Istisna cannot be cancelled
unilaterally.

72. Accounting Treatment of Istisna
Transaction
1. Entry at the time of disbursement of Istisna
financing
Istisna Financing Dr
Customer’s A/c Cr
74

73. Accounting Treatment of Istisna
Transaction
2. At the time of receipt of Installment amount:
Customer’s A/c Dr
Istisna Financing Cr
Profit Receivable Cr
75