Accounting For Islamic Financial Transactions - Exercises

PART A

An Islamic bank bought goods for $100,000 and it entered into a Mudharabah contract with a client in which the goods were the mudharib capital. At the time of the contract, the goods had fair value of $110,000. The mudharib (client) sold the goods for $120,000.

1. During the same year, the mudharib bought another consignment of goods at $120,000 and sold it for $130,000.
2. Profit is allocated between the Islamic bank and the mudharib at the ratio of 70% to 30% respectively.

Required

Determine the profit of the Islamic bank if the mudharabah goods are valued at:

1. Historical cost
2. Fair value

PART B

An Islamic bank paid $100,000 for a two-year Mudharabah contract. Profit is shared in the ratio of 2:1 between the Islamic bank and the mudharib, respectively.

Assume that the Mudharabah:

Realised a profit of $9,000 in the first period.

Incurred a loss of $21,000 in the second period.

Required

Show how the profit to be allocated between the Islamic bank and the Mudharib will appear in their respective financial statements at the end of the first and second period if the profit of the Mudharabah is determined at the end of:

1. Each period.
2. The contract.

ANSWER

PART A

1. Historical Cost

For the 1st transaction, the overall profit would be = $120,000 - $100,000 = $20,000.

The 2nd transaction, the profit would be = $130,000 - $120,000 = $10,000.

Overall profit = $20,000 + $10,000 = $30,000.

Thus, the bank’s share would be = 70% x $30,000 = $21,000.

2. Fair Value

For the 1st transaction, the overall profit would be = $120,000 - $110,000 = $10,000.

The 2nd transaction, the profit would be = $130,000 - $120,000 = $10,000.

Overall profit = $10,000 + $10,000 = $20,000.

Thus, the bank’s share would be = 70% x $20,000 = $14,000.

PART B

1. Each period

First Period: Realised profit of $9,000

Bank        = 2/3 x $9,000 = $6,000

Mudharib = 1/3 x $9,000 = $3,000

Second Period: Loss of $21,000

Bank        = Absorb all losses ($21,000)

Mudharib = 0

2. The contract

Profit of $9,000 in the first year and loss of ($21,000) in the second year. Thus, the overall net loss for the whole 2 year tenure contract is ($12,000).

Bank        = Absorb all losses ($12,000)

Mudharib = 0