Journal of Islamic Accounting and Business Research

A critique on accounting for murabaha contract: A comparative analysis of IFRS

and AAOIFI accounting standards
Mezbah Uddin Ahmed, Ruslan Sabirzyanov, Romzie Rosman,
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murabaha contract: A comparative analysis of IFRS and AAOIFI accounting standards", Journal of
Islamic Accounting and Business Research, Vol. 7 Issue: 3, pp.190-201, https://doi.org/10.1108/
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JIABR
7,3
A critique on accounting for
murabaha contract
A comparative analysis of IFRS and AAOIFI
190 accounting standards
Received 1 April 2016
Mezbah Uddin Ahmed
Revised 1 April 2016 Research Affairs Department,
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Accepted 14 April 2016 International Shari’ah Research Academy for Islamic Finance,
Kuala Lumpur, Malaysia
Ruslan Sabirzyanov
Shari’a Division, Abu Dhabi Islamic Bank, Abu Dhabi,
United Arab Emirates, and
Romzie Rosman
Islamic University of Malaysia, Cyberjaya, Malaysia

Abstract
Purpose – The purpose of this paper is to examine the accounting treatment and reporting of a murabaha
contract and its implication to the financial statements of Islamic banks. In addition, the paper also explains
the implication of time value of money on the measurement of a murabaha contract and the concept of
substance over form in recognising financial transactions.
Design/methodology/approach – This study reviews the accounting treatment and reporting for a
murabaha contract as stated in the Financial Accounting Standards (FAS) of the Accounting and Auditing
Organization for Islamic Financial Institutions (AAOIFI) and the application of a murabaha contract as a
financial instrument based on International Financial Reporting Standards (IFRS).
Findings – The paper finds that, while IFRS-based financial reporting primarily focuses on economic
consequences of financial instruments, AAOIFI further takes into consideration the legal structure of the
instruments, which are based on Shari’ah precepts. The paper also finds that IFRS-based financial reporting
cannot always capture the distinctive structure of the murabaha and, hence, may lack representational
financial reporting. However, the IFRS recognizes the substance of a murabaha contract as financing, and the
majority of Islamic banks in Malaysia report it as one of financing and not as a trading contract. For
measurement, IFRS adopted the concept of time value of money where the profit allocation is based on
amortized cost, which is similar to the measurement of conventional loan transactions that apply the concept
of effective interest rate. Meanwhile, AAOIFI uses a straight-line basis to allocate the profit of a murabaha
contract.
Practical implications – The forthright discussion and the observations of the paper are expected to
assist regulators and standard setters in developing accounting standards that are in convergence but also
cater to the unique characteristics of Islamic financial transactions.
Originality/value – The paper criticizes both accounting treatment of a murabaha contract based
Journal of Islamic Accounting and on the AAOIFI and IFRS and then suggests an extension of these treatments to be adopted to
Business Research
Vol. 7 No. 3, 2016 improve the reporting.
pp. 190-201
© Emerald Group Publishing Limited Keywords IFRS, Islamic banks, Financial reporting, Murabaha, AAOIFI, Time value of money
1759-0817
DOI 10.1108/JIABR-04-2016-0041 Paper type Research paper
 Introduction Accounting
International and national regulators and standard setters have made substantial for murabaha
efforts in recent times towards developing a single set of financial reporting
standards. Making the effort a success, the International Financial Reporting
contract
Standards (IFRS) issued by the International Accounting Standards Board (IASB)
have already been adopted by 116 jurisdictions in the world requiring all or most of
their listed companies and financial institutions to apply IFRS requirements in 191
preparation of financial statements (IFRS Foundation, 2015a, 2015b, 2015c, 2015d,
2015e). However, in relation to accounting treatments for unique Islamic financial
instruments, the main challenge is on the agreement of a single set of financial
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reporting standards that is globally acceptable. A study conducted by the

Asian-Oceanian Standard-Setters Group (AOSSG) in over 132 Islamic financial
institutions of 31 countries has identified that 38 per cent of Islamic financial
institutions apply a differential requirement for the financial reporting of Islamic
financial instruments (Ahmed, 2015). The Financial Accounting Standards (FAS)
issued by the Accounting and Auditing Organisation for Islamic Financial
Institutions (AAOIFI) and the IFRS are the two primary alternatives that have been
mainly adopted or considered upon by national standard setters and regulators. As
the world moves towards convergence to IFRS, a critical question arises on the
application of IFRS for Islamic financial instruments due to absence of Shari’ah
consideration in these standards and the resulting divergence between accounting
principles of IFRS and AAOIFI FAS.
The remaining sections of this paper are organized as follows. The next section
deliberates the background, which explains the general accounting concept and
specific accounting concept of Islamic financial transactions via definition and
objectives. It also briefly highlights the disclosure requirement for Islamic financial
transactions, different treatments of two key accounting principles, which are
substance over form and time value of money, along with available alternatives
towards conclusion of the best approach in adhering to the accounting standards.
The paper continues to explain the legal structures of a murabaha contract to
further examine and evidence the divergence of accounting treatment between IFRS
and AAOIFI. Next, the paper summarizes the discussions and findings of the
accounting treatment for Islamic financial transactions by looking at the
arrangement of a murabaha transaction, measurement of murabaha asset at
acquisition and based on obligation of promise via purchase order, followed by
discounts on credit purchase, sale recognition and recognition of profit, as well as
murabaha receivables at the initial and end periods. Finally, this paper outlines
conclusions and recommendations for consideration.

Background
The American Accounting Association (1966) defined accounting as “the process of
identifying, measuring and communicating economic information to permit
informed judgements and decisions by users of that information”. Accounting is the
language of businesses. The better one understands the language, the better one can
manage the financial aspects of a business. Many aspects of modern business
activities critically rely on accounting. The Conceptual Framework for Financial
Reporting, Para QC4, of the IASB states:
 JIABR If financial information is to be useful, it must be relevant and faithfully represent what it
purports to represent. The usefulness of financial information is enhanced if it is comparable,
7,3 verifiable, timely and understandable.
These features allow users of financial statements to compare how an entity’s business
performance varies across different years as well as comparing its performance against
similar entities in the same industry group.
192 When it comes to Islamic financial institutions, the main distinguishing feature of
their businesses from conventional counterparts is Shari’ah compliance, i.e. compliance
with Islamic legal principles in all aspects of business, including financial reporting. One
of the primary distinguishing factors of Islamic finance is avoidance of interest in
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commercial dealings. Hence, legal structures of Islamic financial instruments are

fundamentally different than interest-based instruments, even though, in economic
substance, they may appear similar [Malaysian Accounting Standards Board (MASB),
2012]. Therefore, to ensure relevance and faithful representation of Islamic financial
instruments, there is a need for different accounting treatment, as it originates from the
Islamic worldview and Shari’ah requirements.
Abdul Rahman (2010) describes accounting for Islamic financial institutions as the
process that provides appropriate information to stakeholders of an entity, which will
enable them to ensure that the entity is continuously operating within the bounds of
Shari’ah and delivering on its socioeconomic objectives. This suggests that accounting
for Islamic financial institutions cannot be confined only within economic consequences
of transactions; it also needs to incorporate religious and social values. The differences
between traditional and Islamic values in financial reporting lie in the objectives of
providing the information; the type of information identified; how it is measured, valued,
recorded and communicated; and to whom the information will be communicated
(Mohamed Ibrahim, 2009). The differences in financial reporting are also due to the
disclosures made by an Islamic financial institution: for example, disclosures on the
adherence or departure from Shari’ah [Malaysian Accounting Standards Board
(MASB), 2012]. The Asian-Oceanian Standard Setters Group (AOSSG) (2010) identified
two key accounting principles: substance over form and the notion of time value of
money, which may result in IFRS-based financial reporting for Islamic financial
instruments being questionable.
The AAOIFI in its Objectives of Financial Accounting (Para 4/2) identified a number
of differences between the objectives of a traditional financial institution and an Islamic
financial institution [Accounting Auditing Organisation for Islamic Financial
Institutions (AAOIFI) 2010a, 2010b, 2010c, 2010d]. AAOIFI argues that the foundation
of an Islamic bank does not permit the separation between temporal and religious
matters; thus, the religious rulings apply in all aspects of the banking activities. AAOIFI
reasons that those who deal with Islamic banks are concerned, in the first place, with
obeying and satisfying God in their financial and other dealings, which results in
differing information needed than in traditional banks. The AAOIFI further pointed out
that the relationship between an Islamic bank and its clients is significantly different
than that of traditional banks; further, the functions of Islamic banks are different.
Based on the issues raised in relation to the accounting principles used by IFRS, it is
obvious that there are differences in opinion between the AAOIFI and IFRS when
applying accounting techniques to Islamic financial transactions. Therefore, the
question that arises is whether accounting for Islamic financial transactions should
 have its own exclusive standards and accounting treatments, which constitute a parallel Accounting
system of accounting along with its conventional counterpart, or harmonise and be for murabaha
comparable, but not necessarily identical, to its conventional counterpart, or converge
fully with conventional accounting standards (Mohamed Ibrahim and Yaya, 2005;
contract
Abdullah, 2010).
Mohamed Ibrahim (2007) argues that there is a need for a different set of standards
for Islamic financial institutions, as they are not based on the capitalist worldview, 193
which underlies the transactions that current IFRS caters towards. He then opines that
conventional accounting is based on providing information that is useful in
decision-making, while an Islamic counterpart is based on accountability to God and
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Shari’ah compliance. This constitutes the difference in the objective of accounting itself.
Naim (2010), who considers that Islamic financial institutions are required to discharge
their accountability in accordance with Shari’ah, also supports this view.
On the other hand, the Association of Chartered Certified Accountants (ACCA),
together with KPMG in their joint report (ACCA and KPMG, 2010), supports the
harmonisation of both the AAOIFI’s accounting standards and IFRS, as they are
complementary to one another, meaning that IFRS standards have to be fine-tuned to
accommodate Shari’ah principles. As the AAOIFI joined the Consultative Group on
Shariah-Compliant Instruments and Transactions of IASB [Accounting Auditing
Organisation for Islamic Financial Institutions (AAOIFI), 2014], steps have been taken
in this direction.

Legal structure of murabaha contracts

A murabaha contract is among the Islamic financial instruments that have been
extensively discussed in literature. The AAOIFI defines murabaha as the sale of goods
at cost plus an agreed profit mark-up (Financial Accounting Standard No. 2: Murabaha
and Murabaha to the Purchase Orderer, Appendix B, Item 1/1). It further provides the
characteristics, conditions and the types of murabaha. It is worth noting that there are
two types of murabaha arrangements, both of which are recognised by the AAOIFI:
(1) murabaha, where an Islamic bank sells commodities to any willing buyer; and
(2) murabaha to the purchase orderer, where an Islamic bank acquires an asset for
an identified purchase orderer based on the orderer’s specifications and sales the
asset to the orderer.

The latter arrangement is by far the most common in modern Islamic finance and banking
practices. In a murabaha to the purchase orderer arrangement, two parties negotiate
and promise each other to execute an agreement according to which the orderer asks the
purchaser to purchase an asset of which the latter will take legal possession. The orderer
promises the purchaser to purchase the asset from him and give the ordered a profit thereon.
The two parties would conclude a sale after the possession of the ordered to the asset
(Financial Accounting Standard No. 2, Appendix B, Item 1/2/1).
Sale on credit is not a requirement of a murabaha contract; however, availing credit
facility from the bank often is the primary motive of Islamic bank customers to purchase
assets based on murabaha. In case of a credit sale, a customer may settle the obligation
at a lump sum payment or in any agreed number of instalments. The selling price of a
murabaha asset cannot be altered once the price is agreed upon between the Islamic
bank and the customer [International Shariah Research Academy for Islamic Finance
 JIABR (ISRA), 2012]. In the present-day Islamic banking practice, murabaha is a form of
7,3 financing that is often used to finance asset purchases.

Islamic financial transaction of murabaha contracts

Financial Accounting Standard No. 2 of the AAOIFI deals with the revenues, expenses,
gains or losses and receivables arisen from a murabaha sale. In IFRS-based reporting, if
194 the arrangement is treated as a trading arrangement, the relevant standards will be IAS
2 Inventories for recognition of inventory costs, IAS 18 Revenue for recognition of
revenue and profit from a murabaha sale and IFRS 9 Financial Instruments for
recognition and measurement of receivables arisen from credit sales. Hence, under IFRS,
the substance of the Islamic financial transactions based on a murabaha contract need to
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be examined to determine whether it is a financing or trading arrangement. Meanwhile,

under AAOIFI, there is a specific accounting standard in relation to murabaha contract.

Measurement of murabaha asset at acquisition

Based on AAOIFI Financial Accounting Standard No. 2, Para 2, murabaha assets are to
be recognised as historical cost at initial recognition. The historical cost is defined as the
purchase price or acquisition cost of the asset and any other directly related expenses
incurred by the bank in acquiring the asset: for example, customs duties and other
purchase taxes, transport and loading charges, insurance, etc. AAOIFI overlooked any
discussion of the types of overhead to be excluded or included in the cost of murabaha
assets. However, under IFRS, murabaha assets meet the definition of inventories as
stipulated in IAS 2, Para 6 and Para 8, as the murabaha assets are held for sale in the
ordinary course of business of an Islamic bank. Inventories are to be recognised at initial
recognition at cost, which includes cost of purchase, cost of conversion and other costs
incurred in bringing the asset in the present location and condition (IAS 2, Para 10). IAS
2 elaborated upon the types of costs that can be included in the cost of inventories and
the types of costs to be excluded.
From the analysis, there is no apparent difference between the two standard setters in the
measurement criteria of murabaha assets at initial recognition. However, the lack of
explanatory discussions by AAOIFI may allow greater room for individual interpretation
and, hence, result in differences in practice.

Subsequent measurement of murabaha asset if the purchase orderer is not obliged to

fulfil promise
AAOIFI applied an economic consequences concept while determining accounting
treatment for the murabaha assets that are held by an Islamic bank to sell to the
purchase orderer who is not obliged to fulfil the purchase promise (Financial Accounting
Standard No. 2, Appendix D). In such a case, murabaha assets are to be measured at
cash equivalent value, i.e. at net realisable value, if there is an indication of non-recovery
of the costs (Financial Accounting Standards No. 2, Para 4). AAOIFI defines the cash
equivalent value as the number of monetary units that would be realised as of the
current date (Statement of Financial Accounting No. 2, Para 89). If there is a decline in
asset-carrying value, then Financial Accounting Standard No. 2, Para 4, requires
recognition of a provision to reflect decline in the value.
In IFRS-based reporting, IAS 2, Para 9, specifies that the inventories are to be carried
at lower cost and net realisable value. The net realisable value is calculated by deducting
expected costs to sell from the expected selling price of the inventories (IAS 2, Para 6).
 Any write-down of inventories to net realisable value is to be recognised as an expense Accounting
in the period the write-down occurs. Subsequent to a write-down, if the net realisable for murabaha
value of same inventories increases, then the reversal of the write-down to is be
recognised to the extent of the previous write-down in the period in which the reversal
contract
occurs (IAS 2, Para 34).
There is no probable difference between the two standard setters except that
Financial Accounting Standard No. 2 lacks clarification pertained to a number of issues 195
that may allow differing interpretations. AAOIFI has not specified whether the costs to
sell inventories are to be deducted from determination of net realisable value. It also has
not specified how to deal with a reversal of a previous write-down. Furthermore, the
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AAOIFI has not clearly stipulated whether the write-off provision is to be net-off against
the carrying value of the asset or to be recognised as a separate component in liabilities,
even though the former is the norm in IFRS-based reporting. Unlike IAS 2, Financial
Accounting Standard No. 2 provided only a narrow definition and discussion pertaining
to determination of net realisable value of inventories that may fail to accommodate the
complex or unusual transactions.

Subsequent measurement of murabaha asset if purchase orderer is obliged to fulfil promise

Financial Accounting Standard No. 2, Para 3 of AAOIFI requires murabaha assets that
are held for sale to the purchase orderer who is obliged to fulfil a purchase promise,
which is to be carried at historical cost, unless the value declines because of damage,
destruction or other unfavourable circumstances. If the latter happens, the requirement
is to reflect the decline in the valuation of the assets at end of the financial period. Similar
to the previous section, the basis of conclusion for these stipulations by the AAOIFI is
economic-consequences driven.
IAS 2, Para 9, requires, as a general rule, inventories to be carried at lower cost and net
realisable value, and the net realisable value of inventories is calculated based on its expected
selling price less costs to sell (IAS 2, Para 6). But, if the inventories are held to satisfy a firm
sale, then the net realisable value is based on the contract price (IAS 2, Para 31).
There is no apparent difference between the two standard setters, as the contract
price in a firm murabaha sale will be higher than the cost. However, the term
“unfavourable circumstances” referred to in FAS 2, Para 3, may cause confusion in
implementation of the standard, as AAOIFI did not specify whether the term excluded
decline in the market value due to non-physical damage factors, which may allow some
to argue, decline in the market value because of competition or obsolescence, which are
also part of “unfavourable circumstances”, even though AAOIFI may have implied only
the physical damage factors.

Discount received by Islamic banks on credit purchase

Financial Accounting Standard No. 2, Para 5 and Para 6 of the AAOIFI offer two
alternative accounting treatments if an Islamic bank receives a probable discount from
a supplier on its credit purchase. In the first alternative, the discount received is to be
recognised against the cost of the relevant assets, i.e. deducted from the assets. In the
second alternative, the discount received is to be recognised as revenue of the Islamic
bank if decided by the Shari’ah Supervisory Board (SSB) of the Islamic bank. In
Financial Accounting Standard No. 2, Appendix B, Item 3(f), AAOIFI explains that
some Shari’ah scholars are of the opinion that such a discount is to be deducted from
 JIABR Islamic bank’s selling price, i.e. reducing the profit of Islamic bank. However, FAS 2 did
7,3 not extend the discussion explaining how such a reduction in selling price or profit to be
recorded in the financial statements of an Islamic bank, especially if the sale was in cash
or the customer’s liability already settled.
In IFRS-based reporting, IAS 2, Para 11, requires trade discount, rebates and other
similar items to be deducted from cost of inventory. IAS 2 did not refer to prompt
196 payment discount in any of its stipulations.
Based on the comparison, it is evident that IFRS requirements can be in conflict with
rulings given by the SSB of Islamic banks. Nevertheless, if relevant inventories are still
in the books of the Islamic bank, only then the discount received can be deducted from
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the cost of inventory; otherwise, the bank has no other suitable option but to recognise
the discount received in the income statement as income. If this is so, then there is no
probable difference between the two standards. Even so, both of the standard setters
need to extend their discussion in this regard, particularly addressing the possible
economic consequences ensuing from Shari’ah precepts.

Sale recognition point

As per Financial Accounting Standard No. 2, Para 8 of AAOIFI, the time of “concluding
the sale contract’ is the recognition point of murabaha sales. However, the standard did
not clarify further at which point a sale contract concludes, which may result in
significant confusion in practice and result in financial reporting mismatch between
reporting entities as recognition of a murabaha sale.
IAS 18 includes a broad discussion on revenue recognition point from sale of goods;
however, in terse, a sale of goods is recognised primarily when the entity transfers
significant risks and rewards of ownership of the goods to the customer (IAS 18, Para 14-19).
The contract conclusion point from Shari’ah perspective and from traditional perspective
may not be the same. Hence, the identification of contract conclusion point from the Shari’ah
perspective is an important financial reporting issue for Islamic financial institutions,
especially for recognition of a murabaha sale. The absence of clarification in FAS 2
regarding the point at which a murabaha contract is concluded allows for greater room of
interpretations and, thus, may result in different sale recognition points in AAOIFI-based
reporting. Moreover, unlike IAS 2, Financial Accounting Standard No. 2 did not address
many of the practical circumstances that may arise in a sale contract.

Recognition of profit from murabaha sales

If the murabaha sale is for cash or for credit that does not exceed the current financial period,
then the whole profit is to be recognised at the time of contract (Financial Accounting
Standard No. 2, Para 8). If the credit period exceeds the current financial period, then the
profit is to be recognised as deferred profit and to be offset against murabaha receivables
(Financial Accounting Standard No. 2, Para 9). FAS 2 allows two alternatives in realising the
deferred profit in the income statement. The preferred method is proportionate allocation
over the credit period irrespective of instalments receipt by the bank. The alternative
method, if allowed by the SSB of the Islamic bank, is to allocate the deferred profit based on
receipt of instalments (Financial Accounting Standard No. 2, Para 8). The alternatives are
allowed by AAOIFI due to the differences in juristic views on the timing of profit recognition
(Financial Accounting Standard No. 2, Appendix D).
 However, in IFRS-based reporting, full profit is to be recognised at the time of sale if the Accounting
sale is in cash or if the credit term allowed is of short-term. However, if the credit term allowed for murabaha
is of long-term, then the credit allowed can be seen as a financing arrangement and there
probably will be no recognition of profit at the time of sale as the receivables discounted to
contract
present value will be equivalent to the cost of the asset, i.e. the amount of financing at present
value made by the Islamic bank (IAS 18, Para 11a). The difference between the discounted
value and the nominal value will subsequently be recognised in an income statement as 197
profit through amortization and unwinding of discounting process of the murabaha
receivables (IAS 18, Para 11; IAS 39, Para 11; IFRS 9, Para 5.1.1 and Para B5.1.1).
There is no apparent difference between the two standards if the asset is sold for cash
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or the credit period is of short term. However, there will be a timing difference in profit
recognition in the income statement if the asset is sold for credit and the credit period
extends to several financial periods due to differences in profit measurement technique
and recognition criteria, as illustrated in Appendix. Even though in cumulative, the total
profit recognised based on FAS and IFRS will be equal, if the preferred method is
adopted in AAOIFI-based reporting, the differences in the measurement techniques of
AAOIFI and IFRS would result in the reported profit in IFRS-based reporting to be
higher in the income statement in the earlier years but lower in the later years. This is
due to the concept of time value of money that is applied based on effective profit rate
calculation for murabaha financing. The cash basis profit recognition alternative of
AAOIFI also can be a differentiating factor between the two standards setters.

Measurement of murabaha receivables at initial recognition

Short- or long-term, the receivables are to be recognised at face value at initial
recognition (Financial Accounting Standard No. 2, Para 7) as that is the selling price of
a murabaha asset and represents the Islamic bank’s claim over the customer. The face
value is defined in Financial Accounting Standard No. 2, Para 9:
[…] as the selling price that is agreed between the Islamic bank and the client. For financial
reporting purpose, the deferred profit resulting from murabaha sale with long-term credit is to
be deducted from receivables in statement of financial position.
In IFRS-based reporting, at initial recognition of long-term receivables, the amount
recognised is determined by discounting the future cash receipts to present value (IAS
18, Para 11; IFRS 9, Para 5.1.1 and B5.1.1). The short-term receivables are not discounted
if the effect is immaterial (IAS 39, Para AG84).
The measurement of long-term murabaha receivables at initial recognition is
different between IFRS and FAS, as the former measures the amount based on mere
economic consequences, whereas the latter also takes into account the Shari’ah
consideration of determination of revenue and receivables. However, in this regard, the
financial reporting requirement of AAOIFI is designed in a way that there is no
difference between the IFRS and FAS in terms of net impact in the financial position of
bank. There is no difference in the short term because, in both cases, the receivables’
amount will be at face value, i.e. not discounted. There is no difference in the long term
because, in AAOIFI-based reporting, the deferred profit is deducted from the face value
of receivables, the net of which at initial recognition is equal to the present value of
receivables in IFRS-based reporting, as in Appendix 1. This can be an ideal example of
the convergence opportunity of IFRS and AAOIFI standards.
 JIABR Measurement of murabaha receivables at period ends
7,3 At the end of financial periods, the receivables are recognised at their cash-equivalent value,
which is referred to in Financial Accounting Standard No. 2, Para 7, as the amount of
receivables at end of the period less any provision for doubtful debts. But, the cash
equivalent value is defined in Financial Accounting Standard No. 2 as the monetary units
that would currently be realised. AAOIFI further allows recognition of a general provision
198 for investment risks in addition to provision of doubtful debts if the Islamic bank or its SSB
finds it necessary (Financial Accounting Standard No. 2, Appendix D). The justification
provided by AAOIFI for choosing cash-equivalent value is based on the concepts of
representational faithfulness and the concept of matching revenue with expenses (Financial
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Accounting Standard No. 2, Appendix D). However, the AAOIFI did not clarify its position
on whether rebate or deduction of part of profit for early settlement, if offered by a bank as
part of customary practice or regulatory requirement, shall be considered or ignored in a
cash-equivalent value calculation. The AAOIFI also did not clarify its position on how an
Islamic bank shall deal with deferred profit in case of receivables impairment.
As required by IFRS 9, Para 4.1.1, a financial asset can be subsequently measured
either at fair value or at amortized cost. Murabaha receivables appear to meet the
definition of financial assets measured at amortized cost because Islamic banks hold
the financial asset to collect contractual cash flows, and the contractual terms of the
financial asset give rise to specified dates to cash flows that are solely payments of
principal and profit that very likely to be based on market interest rates of similar
financing instruments (IFRS 9, Para 4.1.2). If there is any objective evidence that the
murabaha receivable measured at amortized cost is impaired, then the loss is recognised
directly or through use of an allowance account (IAS 39, Para 58).
The AAOIFI’s requirement to measure a period-end receivable balance at
cash-equivalent value appears to be similar to the measurement at fair value in
IFRS-based reporting as the fair value definitions of both standards seem to be similar.
IAS 32, Para 11, defines fair value as the price that would currently be received. Hence,
there is a possible contradiction between the measurement techniques of two standards
that may result in different receivables balance and impairment loss recognition. If there
is no impairment loss and the question of rebate is ignored, then in subsequent
measurements, the net receivables amount will continue to grow wider in IFRS-based
reporting than in AAOIFI-based reporting to a point of time after which the difference
will start to become narrower. At end of the receivables financing period, the balances
will be nil in both sets of standards as in Appendix 1.

Conclusion
From the discussion, it is evident that IFRS of IASB or FAS of AAOIFI are not
comprehensive enough to deal with particular accounting issues of an Islamic financial
instrument: in this case, the reporting for Islamic financial transactions adopting a
murabahah contract. IFRS applies the concept of substance over form and time value of
money in the recognition and measurement of a murabaha contract. The murabaha
contract is recognised as murabaha financing, and the measurement is based on
amortized costs, which apply the concept of time value of money. In contrast, the
AAOIFI recognises a murabaha contract as a murabaha receivable to show that the
transaction is a trading activity; however, it is not clear whether the concept of time
value of money is applied in the measurement, which is based on a straight-line method.
 Even though IFRS issued by IASB covers the accounting issues in great detail, on Accounting
occasion, the IFRS requirements conflict with the Shari’ah precepts, as identified by for murabaha
AAOIFI or juristic opinion by SSB of the Islamic banks. Convergence or a separate set of
standards, whatever the initiative will be in the days to come, both standard setters can
contract
benefit from one another through sharing of experience and of expertise in their
respective areas. Further research is needed, especially in the application of new IFRS 15
revenue from contracts with customers, which may have an impact on the reporting of 199
Islamic financial transactions based on the murabaha contract.

References
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IASB achieve higher levels of cooperation”, available at: www.aaoifi.com/en/news/aaoifi-iasb-
achieve-higher-levels-of-cooperation.html
Ahmed, M. (2015), “Financial reporting of Islamic financial institutions: the rationale, the present, and
the future”, Islamic Finance News, Annual Guide, Kuala Lumpur, pp. 8-9.
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available at: www.masb.org.my/index.php?option⫽comcontent&view⫽category&id⫽67&I
temid⫽94
 JIABR Mohamed Ibrahim, S.H. (2007), IFRS vs AAOIFI: The Clash of Standards? International Accountant,
Hog Kong.
7,3
Mohamed Ibrahim, S.H. (2009), Accounting and Auditing for Islamic Financial Institutions, IIUM Press,
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Further reading
International Accounting Standards Board (IASB) (2014a), Application of IFRS 15 to permitted Islamic
Finance Transactions, IFRS Foundation, Kuala Lumpur City.
International Accounting Standards Board (IASB) (2014b), IFRS: International Financial Reporting
Standards, International Accounting Services Board, London.

Appendix

AAOIFI IFRS

Purchase of asset from vendor Purchase of asset from vendor

Dr Murabaha inventory 241,000 Dr Murabaha inventory 241,000
Cr Cash 241,000 Cr Cash 241,000
Sale of asset to customer Sale of asset to customer
Dr Murabaha receivables 426,807 Dr Murabaha receivablesa 241,000
Cr Revenue 426,807 Cr Revenue 241,000
Dr Cost of sales 241,000 Dr Cost of sales 241,000
Cr Murabaha inventory 241,000 Cr Murabaha inventory 241,000
Deferred profit ⫽ Revenue ⫺ Cost of sales ⫽ a
Fair value of the receivables;
185,807 i.e., present value of future
receivables (IAS 18: 11)

Statement of Financial Position

Statement of Financial Position Murabaha receivablesa ⫽
Murabaha receivables ⫽ 426,807 ⫺ 185,807 241,000
⫽ 241,000

Note: Dr: Debit; Cr: Credit; If an Islamic bank purchases an asset for RM 241,000 and sells the asset at
Table AI. 4.25% annualized profit rate, whereby the selling price will be paid by the customer over 30 years in
Journal entries at equal monthly instalments, the resultant journal entries
a
in the books of Islamic bank at initial
initial recognition: recognition probably would be as given in the table; for comparison purposes, the phrase “murabaha
AAOIFI FAS- vs receivable” is used for IFRS-based reporting; however, Islamic banks in Malaysia that apply IFRS
IFRS-based reporting recognise it as “murabaha financing”
 AAOIFI
Accounting
Murabaha receivables for murabaha
Cr Murabaha Dr Deferred Cr I/S: Profit from balance net of deferred profit contract
Month Dr cash receivables profit murabaha sales in SFP

1 1,185.58 1,185.58 516.13 516.13 240,330.56

2 1,185.58 1,185.58 516.13 516.13 239,661.11
3 1,185.58 1,185.58 516.13 516.13 238,991.67
201
4 1,185.58 1,185.58 516.13 516.13 238,322.22
5 1,185.58 1,185.58 516.13 516.13 237,652.78
... ... ... ... ... ...
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356 1,185.58 1,185.58 516.13 516.13 2,677.78

357 1,185.58 1,185.58 516.13 516.13 2,008.33
358 1,185.58 1,185.58 516.13 516.13 1,338.89 Table AII.
359 1,185.58 1,185.58 516.13 516.13 669.44 Journal entries at
360 1,185.58 1,185.58 516.13 516.13 0 each month end:
AAOIFI FAS-based
Note: I/S⫽ income statement reporting

IFRS
Cr Murabaha Cr I/S: Profit from murabaha Murabaha receivablesb
Month Dr cash receivablesb sales balance in SFP

1 1,185.58 332.03 853.54 240,667.97

2 1,185.58 333.21 852.37 240,334.76
3 1,185.58 334.39 851.19 240,000.37
4 1,185.58 335.57 850.00 239,664.79
5 1,185.58 336.76 848.81 239,328.03
... ... ... ... ...
356 1,185.58 1,164.80 20.77 4,700.61
357 1,185.58 1,168.93 16.65 3,531.68
358 1,185.58 1,173.07 12.51 2,358.61
359 1,185.58 1,177.22 8.35 1,181.39
360 1,185.58 1,181.39 4.18 0 Table AIII.
Journal entries at
Notes: b For comparison purposes, the phrase “murabaha receivable” is used for IFRS-based each month end:
reporting; however, Islamic banks in Malaysia that apply IFRS recognise it as “murabaha financing” IFRS-based reporting

Corresponding author
Mezbah Uddin Ahmed can be contacted at: mezbah.u.ahmed@gmail.com

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