Range Of Ijarah-Based Contracts Used By Islamic Financial Institutions And Differences Between Ijarah And Leasing

Research Methods

The Ijarah contract is said to be similar to conventional leasing. Explain the range of Ijarah-based contracts used by Islamic Financial Institutions. With reference to operating and financial leases discuss the similarities and differences between Ijarah and leasing. Outline how any differences in contract lead to differing accounting treatment of these contracts. Discuss the AAOIFI standards and IFRS recommended accounting treatment of the Ijarah/leasing contracts. Suggest ways of reconciling any variations in interpretation.

This research paper would explain the concepts, roles and importance of the Ijarah contract in the form of conventional leasing. In adition to this, it should also be noted down that, this research paper would also explain the range of Ijarah-based contracts used by Islamic Financial Institutions. On the other hand, with reference to operating and financial leases, this research paper would discuss the similarities and differences between Ijarah and leasing. At the same time, this rserach paper would also help the readers in understanding that  how any differences in contract lead to differing accounting treatment of these contracts. Apart from this, this paper would also discuss the AAOIFI standards and IFRS recommended accounting treatment of the Ijarah/leasing contracts. Finally, this paper would also suggest different ways of reconciling any variations in interpretation.

Moreover, it should also be noted down that, this research paper would also be more beneficial, helpful and effective for the readers, researchers and students in understanding a wide range of topics in the area of Islamic finance. At the same time, this paper would also be more effective and appropriate in using concepts of Ijarah contract in the form of conventional leasing. So, this this paper would be more beneficial and effective.

In order to fulfil the research objectives and aims in the context of this paper, secondary source of information are used so that associated outcomes can be achieved in an effective and proper manner. For case, for this research paper, books, research articles, published material, current news etc are used as means of secondary source of information in order to collect the information asocisted with the topics.

Ijarah contract is the maid of the arabic word ijara that means the providing services and goods temporarily for a wage. It indicates the ijarah contract means providing products and services on a lease or rental term. In the Islamic banking, the ijara contract is given the right to use the object of a person or party for a period of time but the owner retains the ownership of the assets. The ijara contract is similar to a lease in thier the owner rents or leases his property or goods to a lessee for a fee or rent for a specified number of periods (Saleem, 2012). The ijara contract in the Islamic banking is necessary of the same design as an instalment leasing agreement. For example, in ijara contract, th lessor is responsible for najor maintenance in the conventional lease contracts.

Ijarah Contract

The Islamic Finance Accounting Standard (IFAS) “Ijarah” was issued by the Insititute of Chartered Accounts of Pakistan and its notification SRO 431 (i)/2007. IFAS becomes operative for financial ststements covring periods after July 01, 2007. The following features of ijara based lease contract is differentiate from a conventional lease:

• The lessor must own the assets for the full lease period
• If the lessee fails to payments or delays payments then the lessor can not have right to charge compound interest (Ahmad, 2009)
• The leased asset’s is used by lesser for special perspose that is mentioned in the contract.

Ijara is an exchange transaction in which a known advantage emerging from a predetermined resource is made accessible consequently for an installment, however where responsibility for resource itself is not exchanged. The ijara contract is basically of the same outline as a portion renting assention. Where altered resources are the subject of the lease, such can come back to the lessor toward the end of the lease period, in which case the lease tackles the highlights of a working rent and hence just a part amortization of the rented resource’s quality results. In an option approach, the renter can concur at the start to purchase the benefit toward the end of the lease period in which case the lease tackles the way of a contract buy known as ijara wa iqtina (actually, rent and possession). A few legal scholars don’t allow this last plan on the premise that it speaks to pretty much an ensured monetary return at the beginning to the lessor, similarly as a present day interest-based money lease. The terms of ijara are sufficiently adaptable to be connected to the contracting of a worker by a head honcho consequently for a lease that is really an altered compensation (Iqbal & Mirakhor, 2011). Some for the most part concurred conditions for ijara are as per the following:

• The leased item should be exchanged to the resident on consummation of the lease understanding and ought to be of a condition that is fit for execution of the obliged undertakings. The lessor ought to exchange the rented things to the renter in their finished structure.
• The lessor should transfer the leased items to the lessee in their completed form.
• The usufruct of the leased item should have value (Ahmad, 2009)
• The sum and timing of the lease installments ought to be concurred ahead of time, however the concurred timetable and measure of those installments require not be uniform.
• The lease installment timetable gets to be dynamic upon complete securing of the usufruct of the rented products, whether such usufruct is indeed delighted in by the lessor or not.
• The time of the lease must be determined.
• The states of utilization of the rented things must be expressed.
• The lessor must have full ownership and legitimate responsibility for resource preceding renting it (Eisenberg, 2012).
• The leased asset must keep on existing all through the term of the lease. Things which are devoured during the time spent utilization, ammo for case, can’t be rented.
• In contrast with most traditional fund rents, the obligation regarding support and protection of the rented thing under ijara remains that of the lessor all through.
• A cost can’t be foreordained for the offer of the benefit at the expiry of the lease. Notwithstanding, lessor and resident may concur the continuation of the lease or the offer of the rented advantage for the renter under another understanding toward the end of the starting lease period (Ayub, 2009).
• In the occasion generally installment of rental, the ijara may be ended quickly.
• The lessor may guarantee pay for any harm brought on to the rented resources as an aftereffect of care.

In recent times, many Ijarah-based contracts or products used by Islamic Financial Institutions with different combinations of contracts such as ADCB (Abu Dhabi Commercial Bank) offers ijara home financing, as does SABB (Saudi British Bank) Amanah. Moreover, Maybank Malaysian-based institute offers car financing with a combination of an ijara contract and a bai (purchase) contract (Iqbal & Mirakhor, 2011). According to the sharia principles, the mainly three types of Ijarah-based contracts or ijara arrangements exist in the Islamic Financial Institutions these are:

Lease-ending ownership/lease with ownership (ijara muntahia bitamleek/ijara wa iqtina): In this ihara contact, the leaseholder (lessee) the leased asset at the end of lease period. This contract does not contain any promise to buy and sell the assets at the end of lease period but the bank may offer a verbal promise of transfer of ownership or purchase schedule for the asset (Ayub, 2009). It means in this contract, the leaseholder is also allowed to mke a verbal promis to purchase the asset. In this situation, the purchase price is decided on the basis of market value of the asset or a negotiatible price.

Major Differences Between Acciounting of Ijarah and Finance Leasing

Operating lease (operating ijara): Operating lease ijara-based contract does not included any promise related to purchase the asset at the end of the lease contract. Moreover, this ijara contract is the hire arrangement or contract with the lessor only (Mourik & Walton, 2013).

Forward lease (ijara mawsoofa bil thimma): Forward lease ijara-based contract is a combination of redeemable leasing and construction finance (istisna) agreement. This lease is accomplished for a future date, so it is called forword leasing. Forward lease ijara-based contract purchase the project (generally a construction project) as a whole at its closing or completion (Eisenberg, 2012).

The below table indicates the major differences in the finance leasing and ijarah leasing:

Finance leasing	Ijarah Based Leasing
Leases are recorded ad financing in the book of lessor (the bank)	Ijarah assets are recorded at cost less accumulated depreciation and impairment.
Un-earned income such as exceess of the agreegate rentals over cost of the asset are recorded at the inception of lease and amortized over the lease tearm	Rentaal from ijarah is only recognized as income on accrual basis.
Profision against doughtful debts is calculated on the basis of creterial given in prudential regulations for banks	Costs included depreciation is charged to income statement
Leases are disclosed net of provision, income suspense and unearned income.	Assets leased out should be classified according to its nature and distinguished from the assets in own use such as plant, machinerary, vehicle, etc.
Revenue is recorded to the extent of income portion of the rentals based on the manner that produce a constant rate of return.	Lessor should make an imparment testing for the asset on a regular basis according to the requirements of IAS 36 (Impairment of assets).

(Source: Iqbal & Mirakhor, 2011)

Ijarah accounting policy is the different with the lease accounting that are described in the below:

Ijarah Asset Recognistion: All ijarah transactions are to be recorded as “Asset Acquired dor Ijarah” at sum of all cost incurred through the bank in acquiring the asset. The other terms are:

• Assets are to be expressed at their cost less accumuled depreciation and impairment if any.
• Depreciation on asset is to be charged to income applying the method that reflects the pattern in that the asset future economic benefits are expected to be consumed by the bank.
• In consider of addition and disposal of assets, depreciation of asset will be charged from the month of acquisition till the month of disposal (Ayub, 2009).

Revenue recognition: In Ijarah lease contract, rentals are to be recognized as income on accrual basis over the lease period in a systematic manner.

Expenses recognise: In Ijarah lease contract, carring costs including depreciation and incurred in earning the Ijarah income are recognized as an income in the owner or bank income statement (Eisenberg, 2012).

The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards and International Financial Reporting Standards (IFRS) recommended of nthe banks, financial institutes and owners regarding the accounting treatment of the Ijarah/leasing contracts. The below table described the key differences of accounting treatment between IFRS and AAOIFI:

Item	IFRS (IAS 17)	AAOIFI (FAS 8)
Classification of leases	Lease is named a money lease on the off chance that it exchanges generously all the dangers and prizes accidental to possession. A lease is named a working lease in the event that it doesn’t exchange generously all the dangers  and rewards accidental to proprietorship	All leases should be classified as an operating lease.  Ijarah ending with an exchange of possession ought to be dealt with as two different exchanges of working lease  and deal, and not as a money lease.
Leases in the financial statements of lessees	At the beginning of the lease term, residents should perceive money rents as resources and liabilities in their announcements of budgetary position at sums equivalent to the reasonable estimation of the rented property or, if bring down, the present estimation of the base lease installments, every decided at the commencement of the lease. The markdown rate to be utilized as a part of computing the present estimation of the base lease installments is the interest rate understood in the lease, if this is practicable to focus; if not, the renter’s incremental obtaining rate might be utilized. Any starting direct expenses of the tenant are added to the sum perceived as a benefit  (Ayub, 2009).	In the event of Ijarah consummation with an exchange of possession, the tenant would perceive lease installments as costs all through the lease term. At the point when the benefit is exchanged to the tenant, the resident would perceive the advantage obtained (Eisenberg, 2012).
Leases in the financial statements of lessors	Lessors might perceive resources held under a fund rent in their announcements of monetary position and present them as a receivable at a sum equivalent to the net interest in the lease	In the event of Ijarah consummation with an exchange of possession, the lessor would show a benefit in its announcement of budgetary position, and perceive lease portions as income all through the lease term. At the point when the advantage is exchanged to the tenant, the lessor may perceive an increase or misfortune on transfer.

(Source: Atmeh & Abu-Serdaneh, 2012)

Recommendations and Conclusion

On the bsis of above disucsion, it can be recommended that, there are different ways, strategies, approaches and methods can be used in order to reconciling any variations in interpretation. For example, the analysis about the financial statements or records is one of the most significant methods that can be used in an effective and more significant manner. Along with this, it can also be concluded that, Ijarah Contracts are playing a major role in the development of the Islamic fincial systems (Godfrey & Chalmers, 2007). In addition to this, all these are the financial instruments that are also playing a more significant role in the improving the overall growth of Islamic economy in an effecvitve and porper manner. At the same time, it can also be suggested that, the government organizations in the Islamic economic should conduct and provide specific guidleines, rules and regulations so that innovativenes and reliability of such financial instrument can be improved in and effective and more significant manner (Ayub, 2009).

References

Ahmad, A.U.F. (2009) Theory and Practice of Modern Islamic Finance: The Case Analysis from Australia. USA: Universal-Publishers.

Atmeh, M. A., & Abu-Serdaneh, J. A. R. (2012). A Proposed Model for Accounting Treatment of Ijarah. International Journal of Business and Management, 7(18), p. 49-56.

Ayub, M. (2009) Understanding Islamic Finance. USA: John Wiley & Sons.

Eisenberg, D. (2012). Islamic Finance: Law and Practice. USA: Oxford University Press.

Iqbal, Z. & Mirakhor, A. (2011) An Introduction to Islamic Finance: Theory and Practice (2^nd ed.). USA: John Wiley & Sons.

Saleem, M.Y. (2012). Islamic Commercial Law. USA: John Wiley & Sons.

Mourik, C. & Walton, P. (2013). The Routledge Companion to Accounting, Reporting and Regulation. UK: Routledge.

Monash studies in global movements series

Godfrey, J.M. & Chalmers, K. (2007). Globalisation of Accounting Standards. UK: Edward Elgar Publishing.