A COMPARISON BETWEEN REPORTING OF

CONVENTIONAL LEASING AND ISLAMIC LEASING

Abstract

All over the world financial institutions are striving to serve their customer in a better way. In

this era of competition Islamic finance and banking present new product in front of customers

which is according to SHARIAH compliances and capturing a large market of Islamic

communities this study focused at Ijarah and conventional lease the two characteristics of

conventional and Islamic banks and also looks at how they are accounted and treated under

AAOIFI and IAS respectively. The paper discusses similarities and differences between Ijarah

and conventional leasing in detail under AAOIFI and IAS.

Objective

The main objective of this study is to provide a better detail overview of difference between

Islamic banking and conventional banking for Ijarah and conventional leasing and to find out the

differences and similarities between Ijarah and conventional lease and accounting and treatment

of both type leases.

Methodology

The report is compiled after analyzing and studying numerous characteristic of Ijarah and

conventional lease contracts from different sources including internet, research papers online

journals and websites of different banks and books.

Research limitations

Information provided in this paper is purely subjective and it is not backed by any statistical

analysis and empirical evidence.

Introduction

There are two types of banking system

1. Islamic banking system

2. Conventional banking system

Islamic banking system:

Islamic banking system is a system that is according to principle of Islamic shariah and operates

according to guiding principles of Islamic economics. In Islamic law interest is not allowed

payment and collection of interest (riba) and usury is also prohibited in Islamic laws. Islamic law

also prohibits investments and trading in businesses which considered as unlawful financially

risky.

Conventional banking system:

Conventional banking system truly based on this principle you can get more if you have more or

more you have more you can get and little you have little you get and if you have nothing you

get nothing. Conventional banking system suffered a lot in case of delaying in repayment from

loan taker conventional banking system charged on loan or debt on monthly installment and

penalty is also charged in case of late payment.

Islamic banking system vs conventional banking system:

Major difference between conventional and Islamic banking system is Islamic law (shariah) does

not allowed interest and people are forbidden to take profit or extra amount above principle

amount that is being lend without acquiring certain level of risk. To double the amount that is

being invested is forbidden and it is been asked to equally share gain between the investor and

manger who provide expertise.

In Islamic banking system risk and liability is beard by the banks in transactions with customer

while in conventional banking system risk is eliminated liability is not taken instead take interest

from customer taking benefit of interest without bearing liability is considered as Haram in

Islam. .

Principles of Islamic and conventional bank:

1) Interest based transaction is not present.

2) Economic activities like oppression commonly called zulm and speculation called gharar

is avoided.

3) Production of goods and services which violate Islamic law is strictly prohibited and

considered haraam.

4) Islamic tax called zakat is practiced Islamic banks.

Conventional banking system based on the principle of debtor and creditor relationship and

interest is charged because it is considered as opportunity cost of money or price of credit.

Islamic banks functions, activities and method of operating guided by Islamic shariah and based

on Islamic principles.

On the other hand conventional bank modes of operating and functions extracted from solely

manmade Principles.

Distinguishing features or characteristics of conventional or Islamic banks shown as below that

create border line between two banking systems.

I. Risk bearer:

In case of conventional banks investor is assured that he will get fixed or previously decided

interest rate and no risk is beard by investor.

While in Islamic banks risk is shared between investor and manager of funds.

II. Profit:

The main purpose of conventional banks is to maximize profit and aims at getting more money

that is being invested without any restrictions

Islamic banks are subject to Islamic law and Islamic law restrictions in maximizing profits they

have to follow shariah for earning profits.

III. Zakat:

Islamic banks provide service of zakat collection and have zakat collection centres for this

purpose through which they also pay zakat.

Conventional banks have no concerned with zakat and does not provide this service.

IV. Basic function:

Islamic banks fully aware of their customer business and understand their customer business

because their Basic function is participation in partnership business.

The basic function of conventional banks is to lend and get money back including compounding

interest.

V. Penalty:

In Islamic banks no extra amount is charged for late payment or in case of defaulter customer is

asked to pay certain amount for charity.

Conventional banks charged compounded interest or extra money for late payment or in case of

defaulter.

VI. Growth with equity:

The goal of Islamic banks is to make sure growth with equity focused on public benefit or

interest.

Conventional banks does not make sure growth with equity and Usually focused on their

interest.

VII. Borrowing money:

It is easier for commercial banks to borrow money from market that is based on interest.

For conventional banks it is not easy because they have to carry out transaction that is according

to shariah.

VIII. Project appraisal:

In Islamic banks lots of importance is given and work is being done on appraisal and

development of project because profit and loss are shared equally.

An Islamic bank does not give much attention towards project appraisal and developing projects

because they have fixed income coming out of loan or advances.

IX. Emphasis:

Islamic banks are more interested and care about viability of projects and emphasis greatly on

projects.

On the other side conventional banks care about credit worthiness of their clients or borrower

and much concerned about good borrower.

X. Relationship:

Relationship that exists between clients and bank in case of conventional banking system is

borrower and lender or debtor and creditor.

In case of Islamic banks this relationship takes form of investor and trader or partner or as buyer

or seller.

XI. Guarantee of deposits:

Islamic banks provide guarantee of repayment of funds to their clients in case of al-wadiah only

called deposit account but client have to equally share profit and loss in case of account based on

mudarabah.

Guarantee is being provided in all deposits by conventional banks.

AAOIFI

INTRODUCTION

AAOIFI stands for accounting and auditing organization for Islamic financial institutions. it is

autonomous nonprofit organization that develop and set shariah standards or accounting, auditing

governance and rules and regulations for Islamic industry and institutions. This independent

international organization including central banks, Islamic financial institutions, participants

from Islamic banking and finance sector and have 200 members from 45 countries was registered

on 27 marches in 1991 in Bahrain and created on 26 February 1990 in Algiers as a result of

agreement signed by Islamic financial institutions. Islamic countries supported implementation

of AAOIFI and issued guidelines based on standards of AAOIFI including Pakistan and Saudi

Arabia and South African countries. From the commencement of AAOIFI it has issued 80

standards including 26 accounting, 5, auditing 40 shariah, 7 governance, 2 codes of ethics.

The main difference between IAS and AAOIFI is IAS has not specified industry it is for all

economic and social activities. And it is type specific for accounting only.

While AAOIFI is not type specific cover 1) accounting 2) shariah 3) auditing 4) governance and

ethics based on shariah and industry specific it is for Islamic finance sector only.

Purpose of Establishing AAOIFI:

First reason of establishing AAOIFI is AAOIFI established standards specifically for Islamic

financial institutions that is not counter by IASB or IFRS and could not be followed by IFI

which is set by IFRS and IASB like in the case of investment account funds and ijarah in

Islamic financial institutions which is treated differently under IASB and AAOIFI.

Literature Review

We have studied different articles and research papers consult with journals and books regarding

Ijarah and conventional lease for literature review. On the basis of which we have concluded this

report cracks of these articles and research paper is as follows.

Mohamed Ibrahim and Shahul Hameed in their research paper IFRS VS AAOIFI the clash

of standards. said that Islamic leasing contract cannot be capitalized in customer books because

it is according to shariah compliance and requirements result is asset which is leased depreciated

in bank books which is opposite to IAS 17(Iv) and because of contradicting functions of Islamic

banks with these standards Islamic banks could not follow IAS 30. There is huge difference

exists between both standards and it will exist in future as well. Differential structural objective

is the reason of difference between these two standards AAOIFI purpose is to develop standards

while IFRS is not fulfill shariah requirements and there is social, legal and economical difference

exists between Islamic and conventional banks functions and standards.

Ros Aniza Mohd.Shariff and Abdul Rahim Abdul Rahman carried out an explanatory study

and compare standard for conventional leasing IAS 17 and Ijarah FAS 8 result of this study was

there is lots of difference exist between conventional leasing and Ijarah as well as standards and

accounting set for both concepts .Ijarah is classified as operating lease and MUNTAHIA

BITTAMLEEK in according to AAOIFI and this classification is on the basis of transferred of

title of leased asset at the end of contract .

Ust Hj Zaharuddin Hj in his article difference between Islamic and conventional bank said

that Islamic and conventional banks are different from each other on the basis of following

reasons. Islamic banks based on the principles of SHARIAH and followed Islamic law in every

activity like in investment, transaction and interest is not charged and unlawful business is

prohibited. While conventional bank based on manmade principles and there is no concept of

ZAKAT collection.

Mateeha Fatima in his research paper on the topic difference between similarities and

difference between conventional lease and Ijarah compared various characteristics of

conventional leasing and Ijarah including Ownership, risk bearer, starting time for rental

obligation, usefulness of property, penalty, repossession of an asset, premature termination, and

asset has a value upon completion of leased period, equivalent to a sale, determination of rent,

sale and lease as one transaction, effect of premature termination. It is concluded that there is no

significant difference between two contracts. Difference exists only on the basis of sales and

lease back as one transaction and starting time for rental obligation is different.

G.Mustafa in his research paper termination of accounting standards for Islamic bank

explain Ijarah as transfer of services for agreed upon period while in conventional lease contract

can be altered and Islamic lease contract cannot altered .AAOIFI have similar aims of improving

international financial reporting practices and to bring transparency in financial markets but IAS

standards does not specify Islamic bank financial instruments.

Main Body

IJARAH

IJARAH (ISLAMIC LEASING)

Introduction

The word Ijarah means the transaction hat include giving something on a rental basis. It can

signify the paying of wages to employees (Ijarah Amal) as well as the renting of an asset (Ijarah

Ain). In this paper we will only address the second type of transaction, Ijarah Aina, and in simple

word as Ijarah. In the Ijarah Aina contract, there is no option for the lessee to buy the asset at the

end of the lease. However, there is another type of Ijarah contract, referred to as Al-Ijarah

Thumma Al-Bai (AITAB), wherein the lessee can buy the asset at the end of the lease. InIjarah

Aina, the lessor rents the assets to benefit from their use without having ownership transferred to

the lessor.

Since ownership to the asset is not being transferred,only the intangible transaction exist in

which the seller gain the right to its use for a specific period of time. This right to use is known

as manfaah in Arabic. Dissimilar the conventional lease, an Ijarah is a “contract” whereby a

financial institution, using Islamic principles, purchases and then leases the asset required by the

client in trade for a rental fee that is not related to interest. In this contract, the lessor embrace the

property and may have the right to provide the lease payments at various intervals agreed to in

advance in the contract with the lessee, so ,with the surity that the rental payments are equal to

the residual balance value of the asset as well as the opportunity cost of the lessor, that is, his go

without the use of the assets.

The risks of ownership of the asset keep on with the lessor. In this arrangement, Ijarah’s legal

characteristics are like to those of a sale-and-purchase transaction, with the exception that the

physical asset is not transferred and there is a specific time limit on the use of the asset. It should

be distinguished that the basis of funds used by the financial institution to finance Ijarah

transactions must be halal. Ijarah can be constricted on an asset that is however to be build as

long as it is fully depict in the contract, provided that the lessor should normally be able to

obtain, or buy the asset being leased by the time set for its release to the lessee.

Types of Ijarah

Islamic financial institutions use the lease as in which they purchase the assets and rent them out

to customers in return for rental. They use two models, known as Ijara hand Al-Ijarah Muntahiya

Bittamleek.

Ijarah:

In this type of Ijarah, the financial institution purchases the assets that have a high degree of

marketability. It charges these assets to other parties on stipulations and setting agreed upon for a

exact time. After the extinction of that period, the asset will be departing to the financial

institution. The institution then leases the same asset to a new lessee and at the same time tolerate

the risk of recession or moving back demand for the asset. At the end of the lease, it may choose

to dispose of the asset.

This type of Ijarah is appropriate for costly assets, such as airplanes, ships, industrial equipment,

and agricultural machinery. In accumulation, these assets take a long time to produce, because of

the fact that there is an increasing demand for leasing them. The financial institution benefit from

the transaction by having ownership of the asset while at the same time taking a return by leasing

it

Al-Ijarah Muntahiya Bittamleek (IMB):

This type of Ijarah is one that ends with ownership. In this type the financial institution

purchases the asset base on a promise to a customer. Because the customer promises to have the

asset, the asset will not be go back to the financial institution at the end of the lease period, like it

is in the case of an operational lease, but as a substitute will be bought by the lessee. The first

type of Ijarah is different from IMB in that the earlier does not recommend an option to the

customer to buy the leased asset at the end of the lease period . If the lessee chooses to buy the

asset, a new contract will be done.

Terms and conditions of the Ijarah Contract

There are some limitations in Ijarah. Which are discussed below.

Required and Prohibited Terms and

Conditions

Lessee and lessor

1. The lessor (muajir) must be legally wise and proficient to enter into the contract (“aqil”)

2. The lessee (mustajir) must be an mature, or in Islamic terms must have reached youth (baligh)

3. The lessee must be intellectual as defined by Sharia Law.

4. It is illegal for the lessor or lessee to be coerced into entering into a contract.

5. It is forbidden for the lessee or lessor to be bankrupt or to be squanderer.

Asset Being Leased

1. The asset must be proficient of being explained in detail.

2. The financial institution must be the owner of the asset during the life of the lease.

3. The asset being leased must be legal

4. The seller must be capable to carry the asset to the lessor.

5. The asset must be of use and important to the lessor.

6. The full details about the asset must be known by both the seller and the buyer.

7. The risk of ownership of the asset relaxes able with the lessor.

Benefits

1. A value can be established for the benefit of lessee

2. The lessor has the legal right to use and lease the asset.

3. The asset’s use and the asset itself must be acceptable under Islamic law.

4. The way that the lessor of the asset will use the asset must be recognized

5. The timing of the lease must be clearly defined.

Rental (Lease) Payments

1. The lease or rental amount must be clearly mentioned by both lessee and lessor.

2. Different amounts of rent or lease payments can be set for differently.

3. The lease phase begins leading release of the asset to the lessor. Whether the lessor is using

the asset or not is unrelated.

4. It is illegal for the lessor to increase the rent or lease payment.

Contract (Aquad) Issues

1. The contract needs to be written in clear way using the past or present tense, not in the future

tense.

2. The approval of the proposel of the contract must be settled leading with the offer, and both

must be at the same time.

Standard Features of Ijarah:

Contracts Offered by Financial Institutions:

General Terms

The Ijarah leasing contract transmits the benefits or use of an asset obtains by the financial

institution for the use of the lessee at a settled price. The total amount of the lease involves the

original cost of the asset to the financial institution and the institution’s “profit margin.”

Rental Payments and Term

1. The financial institution defines rental payments that may be either fixed or variable.

Normally, if variable payments are incorporated the payment amount increases by a definite

amount at a definite time.

2. Generally the rental amounts are based on equivalent installments.

3. The terms of the lease or rental contract can be for more then seven years and change from

institution to institution.

Rebates and Penalties

1. In the case of late payments, the amount must be charge to the lessee.

2. Rebates on early recovery are not permitted by the shari’a boards.

Termination

If the terms of the contract are not met by the lessee, the lessor can break the contract.

Conventional Leasing Contracts :

A conventional leasing contract is a contract between a Lessor and a Lessee for the hire of a

specific asset. The lessor keep the ownership of the asset but the right to use the asset is given to

the lessee for an decided period of time in return for a series of payments paid by the lessee to

the lessor.

Types of Lease:

The most common types of leases are operating leases and finance leases.

1. Finance Lease

A finance lease involve full-payout, non cancellable agreement, in which the lessee is liable for

repairs, taxes and insurance.

Finance leases are most striking in cases where the lessee wants the tax benefits of ownership or

expects the equipment's residual value to be high. These leases are planned as equipment

financing agreements with residuals up to 10 percent. The lessee purchases the equipment upon

lease termination at a pre-agreed amount. The term of a finance lease be apt to be longer, nearly

layer the useful life of the equipment.

2. Operating Lease

An operating lease is mainly attractive to companies that repeatedly inform or replace equipment

and want to use equipment without ownership, but also want to return equipment at lease-end

and pass up technological obsolescence.

Operating is a agreement with three unique features: (i) the cost of the asset is not fully

amortized over the lease period, (ii) the lessor provides preservation of the asset and (iii) the

asset is usually returned to the lessor. Therefore, the lessee has the gain of procuring an asset,

utilizing it for its benefit and returning the same when it has served its purpose.

The features of an operating lease are different from that of a financial lease, and could be listed

as:

1) Title to the asset must not repeatedly pass to the lessee as one of the conditions of the lease

term.

2) The lease contract must not hold an option to purchase the asset at a good deal price.

3) The lease term must be for less than 75% of the monetary life of that asset.

Sale And Lease Back and Direct Lease: In the understanding of sale and lease back, the lessee

sells his asset or equipment to the lessor with an advanced accord of leasing back to the lessee

for a fixed lease rental per period. It is exercised by the entrepreneur when he wants to free his

money, invested in the equipment or asset, to make use of it at all rest for any reason.

Direct lease is a simple lease where the asset is either owned by the lessor or he holds it.

Single Investor Lease and Leveraged Lease: In single investor lease, two parties are involve -

lessor and lessee. The lessor established the money to finance the asset or equipment by way of

equity or debt. The lender is free to get better money from the lessor only and not from the lessee

in case of non-payment by lessor. Lessee is at liberty to pay the lease rentals only to the lessor.

Leveraged lease has three parties – lessor, lessee and the financier or lendor. Equity is set by

the lessor and debt is financed by the lender or financier. This invoive a direct connection of the

lender with the lessee and in case of failure to pay by the lessor, the lender is also free to obtain

money from lessee. Such transactions are done through a trustee.

Domestic and International Lease: If all the concerned parties live in the same country it is

domestic lease.

International lease has further two types:

1. Import lease: the lessor and lessee live in the same country but the supplier is in a

different country

2. Cross border lease: regardless of where the object to be leased is if the lessor and lessee are

in two different countries it is cross border lease.

A Comparison between Leasing and Ijara h:

Following are some of the factors on the basis of which Conventional Lease is different from

Ijarah, these have been discussed briefly.

1. The Contract

Under conventional leasing there is either financial leasing or loan leasing both contradict with

shari’a. In financial leasing there is a condition of hire purchase and in loan leasing you have to

pay interest; both are not permissible.

Ijarah does not contain either of these conditions.

2. Rights & Liabilities of Lessor and Lessee

Lessee is responsible for any loss under conventional leasing where as under Ijarah all risks are

taken by lessor as ownership remains with him.

3. Rentals recovery in case of theft and loss

In case of theft or accident the lessee will continue to pay the rent till the settlement of insurance

claim. In case of Ijarah if the asset is stolen, lost or destroyed the lessee will stop paying rent.

4. Penalty for late payment

A fine is charged if a late payment is made under conventional leasing this is like an interest or

Riba which is not allowed. In case of Ijarah a fine is charged but it goes to the charity fund

account of the bank

5. Insurance premium

The insurance expense comes under the lessee, insurance is independent of the lease contract.

Under Ijarah however the expense of insurance is taken by the lessor. The lessor may charge

more rent for it but it should be paid by the lessor and the lessee.

6. Purchase of asset

When the lease period is completed the asset is automatically transferred to the lessee under

conventional leasing. Under Ijarah the sale of the asset is not an automatic part of the contract for

sale the parties will have to agree upon a separate contract.

7. Signing of Lease Contract

The contract can take place at any time as long as the lessee is not already the owner of the asset

Whereas Ijarah has some conditions that have to be fulfilled before the contract can be void.

i) The asset has come in to existence

ii) The asset is owned by the lessor

iii) The asset is in the possession of the lessor

Difference between IAS 17 and Standards of AAOIFI for Ijarah

The AAOIFI recommended Standard for Ijarah (Financial Accounting Standard (FAS) 8) and the

Standard formulated by International Accounting Standard 17 (IAS 17) for conventional leasing

differ in many aspects.

Difference of Definitions:

According to IAS 17 “lease is an agreement whereby the lessor conveys to the lessee in return

for a payment or series of payments, the right to use an asset for an agreed period of time.

Further it explains that “a lease is classified as a finance lease if it “transfers substantially the

risks and rewards incidental to ownership”. And a “lease is classified as an operating lease if it

does not transfer substantially all risks and rewards incidental to ownership.”

Ijarah is defined as “ownership of the right to the benefit of using an asset in return for

consideration”. However AAOIFI definition represents the additional condition that the benefit

should be according to the Shari’a.

So this is how the difference between the two starts, AAOIFI standard are according to the

shari’a where as IAS are not (they are manmade).

Shari’ah does not permit Ijarah for use of an asset for payment of interest and involving

merchandise considered as haram nor for unlawful transactions.

AAOIFI FAS 8 also includes a classification of the instrument into two categories. If the contract

refers to a promise to the effect that the legal title would ultimately pass on to the Musta’jir’

(lessee) at the completion of the lease period, it is referred to as “Ijarah Muntahia Bittamleek”. In

I MB which is sometimes considered similar to the conventional finance lease, at the expiry of

the term the passing of the legal title to lessee could occur either :

(a) on transfer on payment of balance rentals,

(b) as a gift,

(c) on payment of a token or for an amount specified in the contract or

(d) on the gradual transfer of the title.

As per AAOIFI Juristic Rules on fulfillment of the promise, for the transfer of asset, a contract

separate from the Ijarah contract should be signed. The lessee has an option, which he may or

may not exercise. Thus IMB would have the characteristics or the substance of a conventional

lease only if the lessee exercises the option. In the absence of such exercise IMB for all intents

and purposes is an operating lease. Hence saying that IMB and a conventional finance lease are

the same is not correct.

The main difference between the Ijarah Muntahia Bittamleek and the conventional finance lease

is that in the IMB the lessor undertakes full ownership risks of the leased asset, however the

passing of the risk to the lessee is a must for a lease to be classified as a finance lease under IAS.

In Ijarah the risk follows the legal title unless the damage is caused by the negligence or the

misconduct of lessee.

In IAS since the risk is taken by the lessee and the ownership is transferred to him at the end so

the asset is recorded in the books of the lessee, with the right to claim depreciation. In Ijarah as

explained before repairs, maintenance and insurance remains to the account of lessor so it is

recognized as asset with the lessor and the lessor has the right to depreciate it, and the lessee

records the rental expenses.

When Asset is Out of order:

During the period the asset is out of order Ijarah rentals are in suspension so that lessee, who

cannot benefit from the use of the asset is provided relief. Shari’a also prohibits the levy of

penalty in an Ijarah arrangement for delayed payments, unlike in a conventional lease.

The delayed payments problem in an Ijarah contract can be dealt by various means such as

inclusion of a donation clause, by acceleration of installments or by the cancellation of the

contract.

Difference in Accounting:

AAOIFI- FAS 8

• The nature of Ijarah rental is that it represents consideration for the right to use an asset.

The rent does not consist of a capital component and an interest element. Hence the application

of accounting methodology adopted for conventional lease rentals under International

Accounting Standards of recording ‘lease rentals receivable’ and ‘interest in suspense’ in the

books of the lessor would cause an issue in accounting for ‘rentals under Ijarah’. FAS 8

formulated by AAOIFI requires that both assets rented on the basis of Ijarah and IMB to be

recorded in the books of the lessor. The two categories of assets should be shown in the

Statement of Financial position under the heading “investments in Ijarah assets” and “Ijarah

Munthia Bitamleek Assets” respectively on initial recognition at cost and at book value

thereafter.

• Depreciation expense is recorded by the lessee under conventional leasing but in Ijarah it

is done by the lessor. It shall be on the basis of the depreciation policy of the lessor, in

calculating the depreciation of Ijara Bitamleek Assets residual value is taken as zero, if the

lessee’s acquisition of ownership at the end of the period is through gift. On the other hand if the

transfer to the lessee is at a token or amount specified in contract, the said amount should be

subtracted in determining the depreciable cost.

• Installments of forms, i.e. Ijarah and IBM should be presented in the income statement of

the lessor as “Ijarah Revenue” on accrual basis allocated proportionately according to the term of

the lease recognized in the period in which they are due. Where the lessee acquires title through

gradual sale the revenue decreases progressively.

• The Ijarah installment paid is presented in the lessee’s income statement as “Ijarah

expense” allocated over the lease period recognized when due under both forms of Islamic

leases.

IAS 17

Leases in the financial statements of lessees

• Operating Leases: Lease payments under an operating lease shall be recognised as an

expense on a straight-line basis over the lease term unless another systematic basis is more

representative of the time pattern of the user’s benefit.

• Finance Leases: At the commencement of the lease term, lessees shall recognise finance

leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the

leased property or, if lower, the present value of the minimum lease payments, each determined

at the inception of the lease. The discount rate to be used in calculating the present value of the

minimum lease payments is the interest rate implicit in the lease, if this is practicable to

determine; if not, the lessee’s incremental borrowing rate shall be used. Any initial direct costs of

the lessee are added to the amount recognized as an asset.

Leases in the financial statements of lessors

• Operating Leases: Lessors shall present assets subject to operating leases in their

balance sheets according to the nature of the asset. The depreciation policy for depreciable leased

assets shall be consistent with the lessor’s normal depreciation policy for similar assets, Lease

income from operating leases shall be recognized in income on a straight-line basis over the

lease term, unless another systematic basis is more representative of the time pattern in which

use benefit derived from the leased asset is diminished

• Finance Leases: Lessors shall recognize assets held under a finance lease in their balance

sheets and present them as a receivable at an amount equal to the net investment in the lease. The

recognition of finance income shall be based on a pattern reflecting a constant periodic rate of

return on the lessor’s net investment in the finance lease.

Tax issues involving Ijarah

the cost of Ijarah is higher than a normal loan because of the taxes and transactional costs on the

additional steps.

The legal fees and stamp duty because of the transfer of title (in Ijarah Munthia Bittamleek) and

the property transfer tax may increase the cost of the whole process.

Interest on loans is tax deductable but the rents on the Ijarah are not which is another reason;

why Ijarah may appear more costly than loans.

Conclusion

After studying and analyzing various articles and research paper it is concluded that there is

significant difference between Ijarah and conventional lease and both are treated differently

under FAS 8(AAOIFI) and IAS 17. These differences are on the basis of their accounting and

characteristics; which are identified.

1. The main difference between Ijarah and conventional lease is absence of interest in Islamic

banks for the treatment of Ijarah while in conventional banks interest is accounted.

2. Difference is on the basis of risk bearing in conventional leasing lessee is responsible for all

the losses and damage irrespective of circumstances and all the risks and rewards are

transferred to lessee while in Ijarah lessor is responsible for risk related to ownership while

lessee is responsible for usage related losses.

3. In case of late payment lessee has to pay certain amount to lessee and that amount is taken

into the income which is haram in Islam while in Ijarah individual is asked to donate certain

amount to charity and this amount is credited to charitable funds.

4. In conventional lease installment recovery commences right after the contract but in Ijarah

rental recovery starts after the delivery of asset or property.

5. Leased agreement can be signed any time by lessee without delivery of asset while in Ijarah

leased contract cannot be signed until unless asset comes under the possession of lessee.

These are characteristics of Ijarah and conventional lease that create difference between both

terms that is why both are treat differently under different standards.

Under AAOIFI lessor records leased object under the head of asset and has to be depreciated

over the years while in conventional lease financial lease is recorded under asset or liabilities in

balance sheet by lessor and operating lease is recorded under the head of expenses.

International Islamic University Islamabad

AN ASSIGNMENT OF ISUES IN FINANCIAL REPORTING

A COMPARISON BETWEEN REPORTING OF CONVENTIONAL LEASING AND ISLAMIC LEASIN

SUBMITTED TO

Ms. Misbah Wadood

Submitted By

Faiza Abbas

References:

1. http://www.aaoifi.com/aaoifi/TheOrganization/Overview/tabid/62/language/en-US/Default.aspx

2. IFRS vs AAOIFI: The Clash of Standards by Mohamed Ibrahim, Shahul Hameed

International Centre for Education in Islamic Finance

3. Research paper: The Implementation of Accounting Standards for Islamic Banks by: G. Mustafa

4. Differences Between Islamic Bank and Conventional banks by Ust Hj Zaharuddin Hj Abd

Rahman

5. Research paper: difference and similarities between conventional operating lease contracts

Writer: Mateeha Fatima(college of management sciences)

6. An exploratory study ofIjarahaccounting practices in malaysian financial institutions.by Ros

Aniza Mohd. Shariff and Abdul Rahim Abdul Rahman

7. © Islamic Finance Today – Pioneer Publications (Pvt) Ltd

(http://www.sailanmuslim.com/news/Ijarah-a-more-compassionate-form-of-leasing-suresh-r-i-

perera-llb-attorney-at-law-acma-director-tax-regulatory-kpmg-sri-lanka/)