Elaborate on the accounting treatment of Mudharaba or Musharaka Financing (T):
Accounting treatment of Mudharaba Financing

The capital that provided by Rab al-mal whether in form of cash or kind is recognized when paid to the mudarib. This is the view of majority of the jurists and if in instalment, it should paid of each other. Then, present in financial statements under ‘Mudaraba Financing’ or ‘non-monetary Mudaraba assets’ if not paid in cash whereas the capital is paid in kind, it should be measured at fair market value. If valuation is different from book value, then the difference should be recognized in the books of the Islamic bank as income (profit) or expense (loss). An expense incurred by either party is not considered as Mudaraba capital unless agreed upon by both parties. Any repayment of Mudaraba capital shall be deducted from Mudaraba capital and loss of capital suffered prior to inception shall be borne by the Islamic bank. However, if the loss occur after inception of work it shall not affect the measurement of Mudaraba capital. But if the whole is lost, the Mudaraba will be terminated, account settled and the loss should be treated by the Islamic bank. When a Mudaraba is liquidated, the Mudaraba capital will be specified as a receivable due from the mudarib. Profits shall be recognized when distributed by the mudarib. Losses resulting from liquidation shall be deducted from the Mudaraba capital. After that, Mudarib shall bear the losses incurred due to misconduct or negligence on his part. So, the disclosure should be made in the notes to the financial statements of any provisions made for decline in value of Mudaraba assets.

Accounting treatment of Musharakah Financing

Musharakah financing is where an Islamic bank enters into a partnership with entrepreneur(s) to invest in a feasible business project. If there is profit, it will be shared based on pre-agreed ratio, and if there isloss, it will then be shared according to capital contribution ratio. In the case of Musharakah mutanaqisah , capital is not permanent and every repayment of capital by the entrepreneur will diminish the total capital ratio for the capital provider. This will increase the total capital ratio for the entrepreneur until the entrepreneur becomes the sole proprietor for the business. The repayment period is dependent upon the pre-agreed period. This scheme is more suitable for the existing business that need new or additional capital for expansion. The salient feature of Musharakah is on the profit and loss sharing arrangement which is based on fair distribution of risks and efforts. The need for proper accounting to measure the capital contribution is very important in the case diminishing Musharakah (Musharakah mutanaqisah). This is due to the Shari’ah requirement as in the case of loss, the loss must be fairly distributed based on capital contribution ratio. The Musharakah financing is an equitable concept that reflects the rights of the partners. The profit and loss sharing concept encourage partners to effectively contribute in the business. The accounting implications indicate that Musharakah financing needs proper accounting recognition, measurement and disclosure to ensure true and fair accounting for repayments of capitals, and profit and loss sharing between partners. Despite its equitable arrangement, Musharakah financing is not widely offered by Islamic bank due to various factors such as passive risk appetite of the bank, lack of trustworthy entrepreneurs etc.