WORKSHOP ON ACCOUNTING OF IJARAH UNDER IFAS – 2 Presentation By: Omar Mustafa Ansari Partner – Islamic Financial Services Ford Rhodes Sidat Hyder & Co.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. OUTLINE  What is Ijarah?  Difference of treatment  Accounting by Bank as Lessor  Purchase of asset and lease  Additional treatments  Sale and lease back transaction – Operating Ijara;  Sale and lease back transaction – Ijarah Muntahia Bittamleek

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. What is Ijarah?  Ijarah is a contract whereby the owner of an asset, other than consumables, transfer its usufruct to another person for an agreed period for an agreed consideration.  Ijarah Muntahia Bittamleek / Ijarah wa Iqtina is an Ijarah transaction in which, the ownership of the subject asset, is expected to be transferred to the lessee after the end of the lease term.  Ijarah and Ijarah Muntahia Bittamleek are by nature purely leasing transactions in which the subject matter is the usufruct of the asset and not the amount of money as in case of a finance lease. In other words it is not a “financing” transaction and instead, it is a substitute to financing transactions.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Ijarah – Difference of Treatment  The IFAS – 2 issued by ICAP, as well as, the AAOIFI standard suggest the accounting treatment similar to an operating lease transactions with certain exceptions.  On the other hand, the conventional banks, as well as, Islamic banks currently operating in Pakistan are accounting for Ijarah as a financing transaction, just like finance lease – in accordance with IAS-17. Modarabas, are however, not following IAS-17.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Ijarah – Accounting by Islamic Bank as Lessor  Asset is recognized at historical cost and depreciated as per normal depreciation policy with an expected realizable value at the end.  According to AAOIFI standard, these are presented as Investments in Ijarah Assets, while as per IFAS – 2, these are included in property, plant and equipment with separate disclosure.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Ijarah – Accounting by Islamic Bank as Lessor  Depreciation has to be calculated in line with the methods allowed by IAS – 16. Most suitable method is generally the straight line method because, the rentals are generally also accounted for on a straight line basis.  Depreciation term shall generally be equal to the lease term, except where it is expected that the asset will be given on Ijarah again, to same or some other customer, in which case, the depreciable life shall be equal to the asset’s useful economic life.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Ijarah – Accounting by Islamic Bank as Lessor  Lease rentals including other associated charges and Ijarah related expenses are allocated proportionately in financial periods over the lease term.  Initial direct cost is amortized over the lease term. However, IFAS-2 allows that the same may be charged to income as and when incurred.  Repairs undertaken are recognized as expense.  According to AAOIFI Standard, a provision for repairs is established if repairs are material and differ in amount from year to year.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Lease rentals of Rs. 12 million over lease term Records Assets at historical cost Rs. 10 M Lessor Rs M Lessee Depreciation Repair and Maintenance – including provision for repairs Expenses incidental to ownership Purchase of Assets and Lease Deposit – recorded as liability Monthly rentals – recorded as revenue over the term (when due)

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Ijarah Muntahia Bittamleek – Additional Treatments  IFAS – 2 does not deal with Ijarah Muntahia Bittamleek separately.  Same accounting treatment should be applied as in case of Ijarah, as according to the substance of transaction, all the risks and rewards remain with the lessor.  In case of expected selling price is Nil or fixed or equivalent to some pre agreed amount, the residual value for the purpose of depreciation should be equivalent to such amount.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Impairment  In case where a leased asset has become impaired, that is when the expected future economic benefits from that asset are lower than its carrying amount, the IAS – 36 shall be applied to work out the recoverable amount and any resultant impairment shall be recognized as a loss.  Impairment provisions according to prudential regulations should also be recorded in addition to specific impairment as discussed above. However, the matter of applicability of prudential regulations needs certain clarifications from SBP.

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Sale and Lease Back Transaction – Operating Ijarah – Lessee’s Perspective  Sale and lease back resulting into an Ijarah:  If the sale price is same as that of its fair value any gain or loss shall be recognized in period in which such transaction occurs; and  If the sale price is different from its fair value any gain or loss shall be amortized / allocated as an adjustment to Ijarah expenses over the lease term. Equal to fair value Gain or loss recognized in period in which transaction occurs Different from fair value Sale price Gain or loss allocated as an adjustment to Ijarah expenses / amortized over the lease term

Presentation By: Omar Mustafa Ansari – Partner – Ford Rhodes Sidat Hyder & Co. Sale and Lease Back Transaction – Ijarah Muntahia Bittamleek – Lessee’s Perspective  According to AAOIFI Standard, in case of sale and lease back resulting into Ijarah Muntahia Bittamleek, gains or losses resulting from sale shall be allocated as an adjustment to Ijarah expenses over the lease term.