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Income State of Islamic Banks Report

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Updated: May 10th, 2022

Introduction

The first Islamic bank was founded in 1975 at which point only the most fundamental contracts were available and they included safekeeping accounts, sale and profit-and-loss sharing contracts. The first Islamic products were largely developed to cater to government and corporate requirements. But the growth in the size and wealth of the Muslim population alongside an increasing desire of Muslims to have available financial instruments which are Sharia-compliant has created a challenge to provide consumers with products with a similar or higher rate of return to those on offer in the conventional sector, yet which still conform to Islamic principles.

This has led to banking innovations at the consumer level including Islamic bank accounts, Islamic credit cards and Islamic mortgages. The primary purpose of this paper is to give the detailed component of the income statement of the Islamic bank.

The previous research shows that there is an increase in globalization and the growing attraction of Islamic finance worldwide. The increased globalization lead to the need for studying the financial statement of the Islamic banks and especially the income statement of the Islamic banks which determine the profit to be shared by the investors.

The paper discusses the methodological approaches to the component of the income statement of the Islamic bank, a brief literature review, sample data and results.

Methodology

The study present of the income statement of the Islamic banks by its nature is a library search. The content analysis of the income statement is the key tool that is intended to be used for necessary information material. The source of the information in this study will be extracted from the income statement of Al Rajhi Banking & Investment Corporation and Kuwait Finance House for the year ended 2011. Any necessary information for the study will be extracted using the descriptive method then it will be critically analyzed and interpreted using the explanatory method.

The study of the components of the income statement of the Islamic bank can be done using the previous research done and the financial report written by the board of directors. In this paper, the research was done using two case studies of Al Rajhi Banking & Investment Corporation and Kuwait Finance House. The income statement of the two banks is analyzed in detail in the next chapters.

Literature review

The income statement of the Islamic banks is prepared in accordance with the principles of Islam and Sharia. The previous research shows that there are several Islamic banks that are operating all over the world and all of them operate on Sharia principles. The Islamic scholars have established the principles and the norms that govern the preparation of the financial statement of the Islamic banks without violating the norms of Islamic ethics.

According to Stephen (2008), the basic principle of Islamic banks is the sharing of the profit and loss and the prohibition of the interest. Therefore, the income statement of the Islamic banks is being prepared to determine the profit realized by the bank during certain financial periods of time. The profit realized from the income statement of the bank is then shared according to Islamic laws.

Operating Income

Income from Islamic banking services is recognized as and when the related services are rendered. Fees from advisory and corporate finance activities are recognized net of service taxes and discounts on completion of each stage of the assignment. Other fees and commissions on services and facilities extended to customers are recognized on inception of such transactions. In addition, Income from rental and Sukuk is recognized based on the contractual agreement of the bank and the customer.

The income statement of the Islamic banks includes the operating income generated by the banks. Operation incomes are the income generated by the banks from the normal operation of the bank. Operation income from the Islamic bank included income like Gain from foreign exchange, Rental Income, Unrealized gain on revaluation of investment properties, Unrealized gain on revaluation of securities held-for-trading, Service charges and Commission received

bank Al Rajhi Kuwait Finance House
Other operating income RM’000 RM’000
Gain from foreign exchange 6,236 8,475
Rental Income 5,506 5,462
Unrealized gain on revaluation of investment properties 1,255 4,294
Unrealized gain on revaluation of securities held-for-trading 138 765
Others 1,454 1,798
Service charges 13,794 12,303
Commission received 5,648 12,444
total operating income 34,031 45,541

The Islamic banks realize the income from the foreign exchange. Foreign Exchange is said to be a system or process of converting one national currency into another and of transferring the ownership of money from one country to another country. In our case studies, the Al Rajhi Banking & Investment Corporation earned a total of MR6, 236,000 from the gain from foreign exchange while the Kuwait Finance House earns a total of MR12, 303,000 from the foreign exchange.

In our case studies, the income statement of the Islamic banks includes an unrealized gain on revaluation of investment properties. The Islamic banks record remarkable profit in their income statement benefited from the revaluation gain during the time of the booming property market but report in their income statement huge losses suffering from the revaluation deficit in the case of a downturn of the property market.

Asset revaluations are permitted in the accounting principle used in the Islamic bank. Gains on the revaluation are included in another comprehensive income statement of the Islamic banks but are not subsequently recycled into income statements (Rahman 2010).

Only in the financial period that the related asset is disposed of, such gains can be realized. In addition, where there is an impairment of the assets subsequent to the revaluation, such impairment charges are first matched against the previous revaluation’s surplus. In cases where the impairment charge is larger than the revaluation gain previously recognized in favor of the asset, the excess impairment charge is recognized in the income statement.

The income statement of the Islamic bank includes the income from renting properties to other institutions in their income statement. Rental income is an income received from rental properties. The banks normally build the properties with the aim of renting them to other institutions which do not have the resources to build. In our case studies, the Al Rajhi Banking & Investment Corporation earned a total of MR5, 506,000 as rental income while Kuwait Finance House earns a total of MR5, 462,000 from rental income.

The Islamic banks also include the unrealized gain on revaluation of securities held-for-trading in their income statement in our case studies the Al Rajhi Banking & Investment Corporation earned a total of MR138,000 while the Kuwait Finance House earns a total of MR765,000 as unrealized gain on revaluation of securities held-for-trading.

The Islamic banks also include the commission received in the income statement. Any commissions received by the Islamic bank are being recorded in the income statement of the bank when determining the total profit made by the bank. In our case studies, the Al Rajhi Banking & Investment Corporation recorded a total of MR5,648,000 while the Kuwait Finance House recorded a total of MR12,444,000 as a commission received during the year ended 2011.

From our case study, Islamic banks earn incomes from banking services. The most common services they provide include transfers of money, collection of bills, trading of forex among others. These banks charge the clients some fee for the provision of these services, which acts as their major source of profit. Where the bank’s own money is not involved is provided on a commission or charges basis. In our case studies, the Al Rajhi Banking & Investment Corporation earned a total of MR13,794,000 from the bank services while the Kuwait Finance House earn a total of MR12,303,000 from the bank services charge.

In our case studies, the Islamic banks normally operate two deposit account demand accounts and savings accounts. In our case studies, the income statement of the Islamic banks includes an unrealized gain on the revaluation of investment properties.

The Islamic banks record remarkable profit in their income statement benefited from the revaluation gain during the time of the booming property market but report in their income statement huge losses suffering from the revaluation deficit in the case of a downturn of the property market.

Income from financing and investment

The income statement of the Islamic bank contains income from financing and investment. In a case study of Al Rajhi Banking & Investment Corporation and Kuwait Finance House in Kuwait, the income from financing and investment is evaluated as follows. Finance income is recognized using the effective profit method. In our case studies, the financing income on financing assets is recognized on a constant rate of return basis

Investment income for the year ended 2011

bank Al Rajhi Kuwait Finance House
investment income from: RM’000 RM’000
General investment deposits 182,392 165,559
Other deposits 124,116 74,650
Financing and advances 170,190 152,695
Money at call 12,202 12,864
Securities held-to-maturity 4,901 7358
deposit with financial institutions 10,788 3,070
income from general invest 108,427 64,222
total finance and investmentincome 613,016 480,418

In our case studies the Islamic banks earn income from general investment. Some of the general investments made by the Islamic bank are joint venture investments. In a joint venture, both the bank and the customer share the profit of the investment depending on the degree of participation or the contribution to the project. The profit is shared in a pre-determined fashion. The Islamic banks also finance the project while the client or the customers provide management skills. The contribution from the investment is shared in pre-agreed proportion, but in case the project realizes a loss the bank bears the whole loss.

To reduce the risk from investing in such projects the banks normally estimate the expected income from each of the projects the bank is financing after ascertaining that the money is payable to the bank. Where the investment realizes more profit than estimated the excess income goes to the client while if profit is lower than estimated the bank accepts the lower rate (McKee,1999).

In addition, the Islamic banks earn income from general investment from the investment of the sell and buy back kind of the investment. The Islamic banks are also involved in the investment whereby they buy the asset or property from the customer on the condition that the customer will buy back the property. In our case studies, Al Rajhi Banking & Investment Corporation earns a total of RM108, 427,000 from the general investment while the Kuwait Finance House earns a total of RM64, 222,000 from the general investment.

In our case studies, Islamic banks earn income from financing and giving advances to customers. Some of the financing activity of Islamic banks includes buying items for the client. The client’s consent to repay the bank the principal amount and the agreed interest rate. Furthermore, the banks make income from leasing an item to customers for an agreed period of time. The customers agree to pay the lease amount agreed on. Furthermore, the banks make income from leasing an item to customers for an agreed period of time. The customers agree to pay the lease amount agreed on.

Another financing activity of the Islamic banks is proving hire purchases prices. The Islamic banks also earn income from hire purchases whereby they buy the asset or the property and then lend the property to the customer at an agreed amount of money and at a given period. After the end of the agreed period of time, the ownership of the property automatically changes to the client.

The Islamic banks lend finance to other financing institutions which offer Islamic products. The banks agree with the financial institution on how the money will be utilized. The bank and the financial institution agree on how the profit will be shared. In addition, the Islamic bank also leads money to other unIslamic financial institutions but they monitor the utilization of the money lent. But when lending to the institution that is governed by Sharia law they normally don’t monitor the utilization of the fund. The Islamic banks lend finance to other financing institutions which offer Islamic products. The banks agree with the financial institution on how the money will be utilized.

The Islamic banks may lend to financial institutions whose products embrace sharia law. In this case, they do not investigate much about the purpose for which the money is used. But if they are lending to financial institutions with both Sharia-compliant products and non-Sharia ones they demand details on how the money is used our case studies the income from lending in the financial institution is included in the income from other deposits were by Al Rajhi Banking & Investment Corporation earn a total of RM124, 116,000 while the Kuwait Finance House earns a total of RM74, 650,000 from other deposit.

In our case studies, the Islamic banks earn income from importing the properties for the customers. The Islamic banks import properties on behave of the customer using their own finance. They provide the finance to the import of the property whereby the customer cannot be able to raise enough funds on the condition that the bank and the customer will share the profit on the sale of the property. This is called the letter of credit.

In our case studies, the Islamic banks earn income from giving the advance to the customers. Some of the advanced services offered by Islamic banks are loans with service charges. These investment banks give loans without interest but they recognize their expenses through levying a service charge. The rate of the charge is subject to a maximum agreed by the relevant authorities.

In order to assist those poor people, the Islamic banks set aside some money that they lend at no interest rate. For example, needy people who can qualify for these no-cost loan are small-scale farmers, small businessmen and producers and needy customers of the banks.

In addition, Islamic banks also provide overdrafts to their customers who are subjected to a certain maximum. The overdraft is advanced to the customers at a pre-agreed interest rate. The overdraft is meant to assist the customers to meet their short-term obligation and they can be recalled at any time by the bank. In our case studies, the Al Rajhi Banking & Investment Corporation earned a total of MR170, 190,000 while Kuwait Finance House earns a total of 152,695 from financing and advances given to the customers.

. The Islamic banks also earns an income from securities held to maturity. In our case studies, Al Rajhi Banking & Investment Corporation earned a total of MR4,901,000 while the Kuwait Finance House earn a total of MR7358,000 for the security held to maturity. Securities held to maturity are a financial asset with fixed or determinable payments and it also has a fixed maturity that has a positive intent and ability to hold to maturity

The Islamic banks also earn income from Musharaka al-Mutanaqisa. Musharaka al-Mutanaqisa sets aside some amounts that are treated as a floating rates. The partnership entity then rents out the property to the borrower and charges rent (Ridzwa, 2005).

Another financing activity of the Islamic banks is proving hire purchases prices. The Islamic banks make income from hire purchase prices whereby the banks purchase the item on behave of the client and then hire it to the customer for an agreed amount of money for a given period of time. After the end of the agreed period of time, the ownership of the property automatically changes to the client.

The Islamic banks lend finance to other financing institutions which offer Islamic products. The banks agree with the financial institution on how the money will be utilized. The bank and the financial institution agree on how the profit will be shared. But if they are lending to financial institutions with both Sharia-compliant products and non-Sharia ones they demand details on how the money is used our case studies the income from lending in the financial institution is included in the income from other deposits were by Al Rajhi Banking & Investment Corporation earn a total of RM124, 116,000 while the Kuwait Finance House earns a total of RM74, 650,000 from other deposit.

In our case studies, the Islamic banks earn income from importing the properties for the customers. The Islamic banks import properties on behave of the customer using their own finance. They provide the finance to the import of the property whereby the customer cannot be able to raise enough funds on the condition that the bank and the customer will share the profit on the sale of the property. This is called the letter of credit (Mervyn 2007).

The Islamic banks also assist the poor people by setting aside some money which they lead at zero interest rate. For example, needy people who can qualify for this no-cost loan are small-scale farmers, small businessmen and producers and needy customers of the banks.

In addition, Islamic banks over overdraft to their customer in which they determine the creditworthiness of the customer before lending the money The overdraft is advanced to the customers at a pre-agreed interest rate. The overdraft is meant to assist the customers to meet their short-term obligation and they can be recalled at any time by the bank. In our case studies, the Al Rajhi Banking & Investment Corporation earned a total of MR170, 190,000 while Kuwait Finance House earns a total of 152,695 from financing and advances given to the customers.

The Islamic banks also earn an income from securities held to maturity. In our case studies, Al Rajhi Banking & Investment Corporation earned a total of MR4,901,000 while the Kuwait Finance House earn a total of MR7358,000 for the security held to maturity. Securities held to maturity are a financial asset with fixed or determinable payments and it also has a fixed maturity that has a positive intent and ability to hold to maturity

The Islamic banks also earn income from Musharaka al-Mutanaqisa. Musharaka al-Mutanaqisa plays a major role in Islamic banks because it puts in place a floating rate which takes the form of rent rate. The difference between the net disposal proceeds and the carrying amount is recognized in the income statement in the period of the retirement or disposal (Roszaini 2012).

Investment properties are stated at fair value, representing open-market value determined annually by external values. Fair value is based on active market prices, adjusted, if necessary, for any difference in the nature, location or condition of the specific asset. If this information is not available, the banks use alternative valuation methods such as recent prices of less active markets or discounted cash flow projections. Changes in fair values are recorded in the income statement.

When the bank disposes of the asset the companies either realize a gain on disposal or a loss on the deposal. The Gains and losses on disposals are determined after determining the total depreciation of the asset and the fair or the market value of the asset. If there is gain on disposal the gain is recorded as the income in the income statement.

In our case studies, the Islamic banks earn income from giving the advance to the customers. Some of the advanced services offered by Islamic banks are loans with service charges. These investment banks give loans without interest but they recognize their expenses through levying a service charge. The amount charged is determined by the responsible authorities and the maximum value they agree on is what is used.

Market Expenses

The Islamic banks incur marketing expenses. The marketing expenses encompass the promotion, sales, and distribution of products and services.

bank Al Rajhi Kuwait Finance House
marketing expenses RM’000 RM’000
marketing expenses 2,491 3,202

The Islamic banks only incur the marketing expenses that are absolutely necessary for the success of the banks and they are considered when putting together a marketing budget. Those marketing expenses are being included in the preparation of the income statement of the Islamic banks. In our case study, the Al Rajhi Banking & Investment Corporation earned a total of MR2491,000 for marketing expenses for the year ended 2011 while the Kuwait Finance House incurs the marketing expenses of MR3202,000 for the year ended 2011

Marketing is done in order to attract more customers. They help to attract new customers to come for the services of the bank these in return enable the bank to realize more profit. The marketing expenses in the income statement are added together with other expenses in order to determine the net profit of the bank.

Marketing serves more than one purpose; initially, it is a form of communication by which the banks are able to inform others of our product or service in hopes that they will gain interest in what the Islamic banks offer. Marketing is a multi-dimensional process made up of various strategies. Each process is vital to the functionality and success of the campaign as a whole. Of course, one of the main and most important goals of any marketing campaign or strategy is to increase sales and profitability. Therefore, the Islamic make use of the marketing tools to increase the number of customers who come for their services.

Marketing serves more than one purpose; initially, it is a form of communication by which the banks are able to inform others of our product or service in hopes that they will gain interest in what the Islamic banks offer. Marketing is a multi-dimensional process made up of various strategies. Each process is vital to the functionality and success of the campaign as a whole. Of course, one of the main and most important goals of any marketing campaign or strategy is to increase sales and profitability. Therefore, the Islamic make use of the marketing tools to increase the number of customers who come for their services.

These Islamic banks ensure an effective marketing campaign that raises awareness of the services, creates a desire for them and encourages action to buy them. Raising awareness and creating interest is usually done through promotional strategies. The most common type of promotional strategies includes exhibitions, websites, and direct mail, and email among others. The marketers must be very strategic while using these strategies to make sure that they are effective. They should take care of the 4P’s of marketing to ensure the product is the addressed issue by every strategy that is adopted. The 4P’s of marketing takes care of product, place, price and promotion itself and all together leads to increased sales during the promotion. The sales have to ensure that the demand realized in the market is converted to actual sales in the market. Satisfied customers then will come back with another customer but also recommend the services to friends.

Office Rent

In our cases studies, the Islamic banks incur rental expenses. The rental expenses are the payment made by the bank to the owner of the property for the use of the property.

bank Al Rajhi Kuwait Finance House
rental expenses RM’000 RM’000
Office rental 6,952 6,582

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR6, 952, 000 as office rental while the Kuwait Finance House incur a total of MR6, 582, 000 for office rental. The rental expenses are being included when preparing the income statement of the Islamic banks.

Depreciation of property and equipment

The Islamic banks depreciate their assets and include the depreciation of the asset when preparing the income statement. In our case studies, the depreciation of property, plant and equipment is provided for on a straight-line basis. To write off the cost of each asset to its residual value over the estimated useful life the following rate is being used:

bank Al Rajhi Kuwait Finance House
property rate rate
Office equipment and furniture 10% 12%
Motor vehicles 16.60% 13.50%
Computer equipment 33.30% 19.60%
Renovations 20% 25%

Depreciation incurred

Bank Al Rajhi Kuwait Finance House
Amount RM’000 RM’000
depreciation expenses 15,337 14,513

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR15, 337,000 for depreciation while Kuwait Finance House incur a total of MR1, 4513, 000 for depreciation for the year ended 2011. Depreciation of the property and equipment is calculated to write down the cost of the property and equipment on a straight-line basis over the expected useful lives of the assets concerned. Assets in progress are not depreciated as these assets are not available for use by the bank.

At each balance sheet date, the Bank assesses whether there is any indication of impairment.

Amortization of intangible assets

Intangible assets can be defined as an asset with an indefinite useful life. The impairment loss for these assets is assessed on yearly basis. It may also be done more frequently depending on the prevailing need and purpose. For the purpose of impairment testing, intangible assets are allocated to cash-generating units which are expected to benefit from the synergies of the business combination or the intangible asset. Impairment is recognized in the income statement of the Islamic banks when the carrying amount of the cash-generating units, including intangible assets, exceeds the recoverable amount of the cash-generating units (Beechy, & Conrod, 2002, p. 585).

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
Amortization of intangible assets 12,032 8,737

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR12, 032,000 for amortization of the intangible asset while the Kuwait Finance House incur a total of MR8, 737, 000 for the amortization of the intangible asset. The amortization is included in the income statement of the Islamic banks.

The useful lives of intangible assets are assessed to be either finite or infinite. Intangible assets with finite lives are amortized on a straight-line basis over the estimated economics useful lives and assessed for impairment whenever there is an indication that the intangible asset may be impaired. The amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at least at each balance sheet date. The amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at least at each balance sheet date. The amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at least at each balance sheet date. The amortization period and the amortization method for an intangible asset with a finite useful life are reviewed at least at each balance sheet date.

Impairment loss

An impairment loss in regard to securities held-to-maturity are identified in the income statement as the difference between the amount assets and the present value of estimated cash flows of the asset. An allowance account is used as a tool to mitigate the value of the asset carrying amount.

According to the international accounting standard if there is evidence of the occurrence of the impairment loss the amount of the loss is discounted. The carrying amount of the financing is reduced through the use of an allowance account and the amount of the loss is recognized in the income statement.

According to the accounting principles of Islamic banks, a change (decrease) in the amount of impairment loss is ascribed to events that come up after the date the impairment was initially recognized. The allowance account is used to record the initial amount of impairment loss identified previously. The amount of the reversal is recognized in the income statement in the impairment charge for credit loss. The amount of the reversal is recognized in the income statement in the impairment charge for credit loss.

Electronic data processing expenses

The income statements of the Islamic banks are inclusive of the electronic data processing expenses. Examples of some of the electronic data processing systems used in the Islamic banks is equipment, components, connections and extensions thereof, being the property of the Insured or the property of others leased, rented or under the control of the Insured.

Bank Al Rajhi Kuwait Finance House
Amount RM’000 RM’000
Electronic data processing expenses 16,051 19,726

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR16, 051, 000 for electronic data processing expenses while the Kuwait Finance House incur a total of MR19, 726, 000 for the electronic data processing expenses.

Personnel Expenses

The largest portion of the resources of the Islamic banks is allocated to personnel costs. They locate a large portion of the direct cost to be personnel-related costs that is salary, wages and other fringe benefits. The banks ensure that the effort committed for each individual is reasonable in the context of the contribution by the individual. The personnel expenses are inclusive when preparing the income statement of the Islamic bank’s

BANK Al Rajhi Kuwait Finance House
Personnel Expenses RM’000 RM’000
Statutory contributions 7,672 11,750
Salaries and wages 35,648 37,934
Allowance and bonuses 13,390 16,134
Others 5,902 4,101
Total Personnel Expenses 62,612 69,919

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR62, 612, 000 for the personnel expenses while the Kuwait Finance House incur a total of MR69, 919, 000 for the personnel expenses.

In our case, items such as Wages, salaries, bonuses, paid annual leave among others are matched with the services that were provided in a given period. They are reflected in the income statement of the year in which it occurs for example all the benefits of the employees in our case studies for the year ended 2011 are reflected in the income statement of the year 2011 irrespective of the time of the payment.

A provision is recognized for the amount expected to be paid under short-term cash bonus or profit-sharing plans if the bank has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee and the obligation can be estimated reliably. A provision is recognized for the amount expected to be paid under short term cash bonus or profit-sharing plans if the bank has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee and the obligation can be estimated reliably (Zamir 2008)

A defined contribution plan is a pension plan under which the Bank pays fixed contributions to the national pension scheme, Employees’ Provident Fund.

The banks are liable to contribute a defined amount of the fund and then submit the fund to the relevant authority. The amount contributed by the banks is supposed to be reflected in the income stamen of the year in which it occurs. After the payment by the bank on other liability, the bank is liable to the employees.

Auditors’ remuneration

The audit fees incurred by the banks are included in the preparation of the income statement of the Islamic banks. In our case studies, the Islamic banks normally incur statutory audit fees in which the company is legally required to hire an external auditor to audit the financial statement of the banks independent of the management of the banks. The external auditor is legally answerable to the shareholder of the company. In addition, the Islamic bank also employs an internal auditor to oversee the internal adherence to the rules and regulations of the company. The audit fees are included in the income statement of the company.

bank Al Rajhi Kuwait Finance House
Auditors’ remuneration RM’000 RM’000
statutory audit fees 75 68
others 342 251
total Auditors’ remuneration 417 319

In our case studies Al Rajhi Banking & Investment Corporation incur a total of MR75, 000 for the external auditing and an MR342, 000 for internal audit while the Kuwait Finance House incur a total of MR68, 000 for the internal audit and an MR251, 000 for the internal audit. Audit fees are incurred by the bank monthly where the banks have an internal auditor. The external auditor is legally answerable to the shareholder of the company. In addition, the Islamic bank also employs an internal auditor to oversee the internal adherence to the rules and regulations of the company. The audit fees are included in the income statement of the company.

Bad debt written off

According to the international financial reporting standard requires that if financing is uncollectible, it is supposed to be written off against the related allowance for financing impairment. Such financing is written off after all the necessary procedures have been completed and the amount of the loss has been determined. The bad debt written off is supposed to be reflected in the income statement of the Islamic banks. Debt is being recognized as bad debt if it is declared unrecoverable.

The bad debt is charged to the income statement and any subsequent increase in recoverable amount is recognized in the income statement.

Takaful and insurance

The income statement of the Islamic banks includes takaful and insurance. A takaful is a kind of Islamic insurance, where members contribute money into a pooling system in order to guarantee each other against loss or damage. Takaful-branded insurance is based on Sharia, Islamic religious law, and explains how it is the responsibility of individuals to cooperate and protect each other. The insurance is being paid either yearly or quarterly as per the agreement. They are being included in the income statement for the period in which it occurs.

bank Al Rajhi Kuwait Finance House
Takaful and insurance RM’000 RM’000
Takaful and insurance exp 1,098 867
total Takaful and insurance 1,098 867

In our case study case studies the Al Rajhi Banking & Investment Corporation incurred a total of MR1, 098, 000 for the Takaful and insurance expenses while the Kuwait Finance House incur a total of MR869, 000 for the Takaful and insurance expenses.

Premises

The income statement of the Islamic bank includes the expenses of the premises. The premises expenses are determined and then included in the general expenses of the banks.

Bank Al Rajhi Kuwait Finance House
Premises RM’000 RM’000
premises expenses 3,371 4,191
total premises exp 3,371 4,191

In our case studies the Al Rajhi Banking & Investment Corporation incurs a total of MR3, 371, 000 for the expenses of the premises while the Kuwait Finance House incur a total of MR4, 191, 000 for the expenses of the premises. These are some of the expenses which are incurred by the bank through the renovation of the premises. In addition, there include any other expenses incurred on improving the value of the premises.

Security Service Charges

In order to ensure the security of the banks, they contract security services to the security firms. In return, the banks pay the security services charge to the security firms. The security service charges incurred by the bank are included in the expenses of the bank in the income statement of the company.

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
security services charges 1,830 2,294
total security charges 1,830 2,294

In our case study the Al Rajhi Banking & Investment Corporation incur a total of MR1, 830, 000 while the Kuwait Finance House incur a total of MR2, 294,000 for the security service charges. Security services charges are variable expenses that are incurred by the bank periodically.

Communication Expenses

The income statement of the Islamic banks includes the communication expenses. Communication expenses are incurred when the banks communicate to their customers and the expenses incurred from communicating within the organization.

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
Communication 1,636 1942
total communication expenses 1,636 1942

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR1, 636, 000 as communication expenses for the year ended 2011 while the Kuwait Finance House incur a total of MR1,942, 000 for the communication expenses. The communication expenses are included in the determination of the income statement of the bank.

Administrative Expenses

The administration expenses can be defined as the amount of money spent in the operation of the banks that are not directly associated with the provision of the services of the bank. The income statement of the Islamic banks included the general and administrative expenses. These expenses may include salaries paid to personnel involved in activities other than sales, rent and light expenses among others. The administration expenses are incurred in the process of administering the operation of the company.

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
administration expenses 4,591.00 6, 812
total administration expenses 4,591.00 6, 812

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR4, 591, 000 for the administration expenses while the Kuwait Finance House incur a total of MR6, 812, 000 for the administration expenses for the year ended 2011.

Repairs and maintenance

The income statement included the repairs and maintenance expenses. The banks incur the expenses of the repair and maintenance of the machinery and equipment. The repair and maintenance are normally meant to increase the efficiency of the machine. The expenses of the repair and maintenance are included in the income statement in order to determine the net profit.

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
repair and maintenance 1,833 1,564
total repair and maintenance 1,833 1,564

Like another conventional bank the Islamic banks also incur repair and maintenance expenses and they are required to be included on the financial period in which they occur irrespective of the period of the payment. Therefore, they are required to be included in the financial period in which they are accrued (Stephen, 2008).

In our case studies, the Al Rajhi Banking & Investment Corporation incur a total of MR1, 833, 000 for the repair and maintenance while the Kuwait Finance House incur a total of MR1, 564, 000 for the repair and maintenance for the year ended 2011.

Costs associated with maintaining computer software programs are recognized as an expense as incurred. Development costs that are directly attributable to the design and testing of identifiable and unique software products controlled by the banks are recognized as intangible assets when It is technically feasible to complete the software product so that it will be available for use.

Direct attributable costs that can be capitalized as part of the software product include software development employee costs and appropriate portion of relevant overheads. Other development expenditures that do not meet these criteria are recognized as an expense as incurred. In our case studies, computer software development costs are amortized over their finite useful lives over five years.

Costs associated with maintaining computer software programs are recognized as an expense as incurred. Development costs that are directly attributable to the design and testing of identifiable and unique software products controlled by the banks are recognized as intangible assets when It is technically feasible to complete the software product so that it will be available for use

Allowance

Allowances realized by the Islamic banks are treated as income in the income statement. Allowances are added to the other income in order to get the total income received in that specific finance period. There are different kinds of allowance that Islamic banks can receive. The allowances help the banks to avoid losses. They also help to increase the profit of the bank. In addition, the bank may give the allowance to the employees as a benefit to them. The bank gives the employees allowance as part of their salary they are treated as an expense to the bank. They are treated as expenses in the books of accounts and other records of the banks.

Loss on disposal of the asset

When there is disposal of the asset of the bank or where no future economic value of the asset the bank is either realizes a gain or a loss. The determination of Gains and losses on disposals are determined by comparing the proceeds from the disposal of the asset and the fair value of the asset. If there is a loss on disposal the loss is recorded as the expense in the income statement. The assets of the company are disposed of when they cannot be used to the profitability of the company.

Provision of the bad debt

The Islamic banks provide the provision based on the present legal and constructive obligation as a result of past events and a reliable estimate of the amount can be made. Provisions are presented on the balance sheet and are meant to identify the current best estimate. When there is any decrease in the provision of the bad debt, the decrease is treated as an income, but if there is an increase in the provision, it is treated as an expense in the income statement of the bank.

Type of allowance

General allowances

According to Stephen (2008), the general allowance contains all the allowances of the impairment which are established to be available in a pool of loans that are identical. In some financial institutions, general allowance is dependent on the performance of the items included in the portfolio in which the provision is made. The review of loans, for instance, and their performance can be taken into consideration to ensure general allowance is justified. The general allowances should not be used to cater for some specific allowances as and when they fall due.

General allowances account for impaired losses that are incurred on a given portfolio item. It is a major step in realizing the amount of customer’s impaired losses. The loss that is incurred by the customers may not be identified by the bank. Such unpredictable events should be disclosed at a reasonable time during the preparation of financial statements to ensure they are duly accounted for. They affect the preparation of financial statements and classification of loans and should, therefore, be accounted for in advance or at a reasonable time. When individual impaired loans losses have been unveiled, some specific loans can be taken in place of general allowances. This can only be carried out when there is adequate information released.

Restructured troubled loans

The borrower may be unable to service advanced to him by a financial institution in which case an agreement must be made to ensure that all matters are settled without much harm (Stephen, 2008). The agreement can take various forms for example the remitted money may be reduced or the interest rate may be lowered, this agreement will further implicate that the money agreed on will now attract a new interest rate as per the time period similar to what the loan is worth as per the lender.

A financial institution weighs such a loan by lowering the investments recorded and getting the current value up to the agreed time. This aspect will hence be a charge to statements of income for the time in which the agreement has been reached.

Income recognition

According to the Stephen (2008) the interest that occurs on the impaired loan is not liable to contribute to net income if any doubt exists concerning the collectability of the loan principal or that of the interest. When there are impaired loans, the banks are faced with two alternatives. They may either put an end to the accumulation of interest rates or some allowances may be set aside as provisions for accruing interest.

Allowance for impairment on financing and advances

The Islamic banks make allowance for losses based on objective evidence of an impairment arising. Whilst management’s judgment is guided by the relevant BNM guidelines, judgment is made about the future and other key factors in respect of the recovery of the financing and advances. Amongst factors considered is the Group’s aggregate exposure to the borrower,

The net realizable value of the underlying collateral value, the viability of the customer’s business model and the capacity to generate sufficient cash flow to service debt obligations and the aggregate amount and ranking of all other creditor claims. The actual amount of the future cash flows and their timing may differ from the estimates used by management and consequently, may cause actual losses to differ from the impairment made (Diane, 2009). The net realizable value of the underlying collateral value, the viability of the customer’s business model and the capacity to generate sufficient cash flow to service debt obligations and the aggregate amount and ranking of all other creditor claims.

Total distributable income

The distributable income is the income received from all fund investment less total management expenses incurred during that financial period. First, the total income is determined where all the income is added together and the total management expenses are added together then the difference is then determined.

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
Income derived from the investment of depositors’ funds and others 326,784 397,132
Income derived from the investment of shareholders’ funds 34,072 41,904
Allowance for impairment on financing -33,472 -10,367
Other expenses directly attributable to
the investment of the depositors’ funds
-6,292 -13,763
Impairment loss on securities -27,457 -21,454
Total distributable income 293,635 393,452

In our case studies the Al Rajhi Banking & Investment Corporation incur a total of MR29, 3635, 000 while Kuwait Finance House the realized a total ofMR393, 452, 000 as the total distributable profit. First, the total income is determined where all the income is added together and the total management expenses are added together then the difference is then determined.

Net distributable income

Net distributable income is the amount of the profit realized by the bank after deducting all the direct expenses and overheads. The net distributable income is realized before the tax is deducted.

bank Al Rajhi Al Rajhi
amount RM’000 RM’000
Total distributable income 259,886 358,235
Income attributable to depositors -147,396 -197,050
Personnel expenses -46,192 -61,228
Other overheads and expenditures -42,899 -68,882
net 23,399 31,075

In our case study the Al Rajhi Banking & Investment Corporation realized a total of MR23, 399, 000 while the Kuwait Finance House realized a total of MR31, 075, 000 as the net distributable income.

Profit after Zakah and taxation

According to McKee (1999), Zakat represents business zakat payable by the Bank to comply with the principles of Sharia and as approved by the Sharia Advisory Council. The Bank only pays zakat on its business and does not pay zakat on behalf of depositors or shareholders. The zakat provision is borne by the Bank’s Holding Company. In our case studies, there was no zakat payable by the bank.

The profit realized by the Islamic bank after the Zakah and taxation is determined by determining the amount of the Zakah during that financial period and the amount of tax payable during that financial period. The total tax payable and the total amount of Zakah are then added from the net distributable income.

bank Al Rajhi Kuwait Finance House
amount RM’000 RM’000
net 23,399 31,075
Zakah 0 0
taxation 30,649 21,328
Net profit for the financial year 54,048 52,403

The tax expense is determined according to the tax laws of the country in which the bank is operated and includes all taxes based upon the taxable profits for the financial year.

According to Rahman (2010), the deferred tax is realized only when there is a prediction that in the coming financial period the taxable profit will be realized in which the adjustment for the deferred tax can be made. It is calculated using the tax rate that has been enacted and is applied when the related deferred tax is available.

Deferred taxes are measured and recognized based on the tax rates that are expected to apply in the period when the asset is realized. Estimates are made as to the number of taxable profits in these periods which will enable the deferred tax to be realized.

The Islamic banks lend finance to other financing institutions which offer Islamic products. The banks agree with the financial institution on how the money will be utilized. The bank and the financial institution agree on how the profit will be shared.

Conclusion

The income statement of the Islamic bank is prepared based on provisions, and judgments that have an impact on the accounting standard that is applied when deterring the value of income and expenses (Haniffa, 2012). The actual results may not always be the same as the estimates talked about. In most cases, there are discrepancies. The actual outcomes may be different from these calculations. Those provisions are revised on every finance period in order to cater for a change that may occur during that period.

Significant areas of estimation, uncertainty and critical judgments used in applying accounting policies that have a significant effect on the amount recognized in the financial statements include the following allowance for impairment on financing and advances, Impairment assessment of securities held-to-maturity and deferred taxes.

The research concluded that Islam is not just a religion but a complete mean of life that consist of the political, economic and social system. The research revealed that Islam provides guidance on the ways human beings should live. Some of the principles used in the preparation of the financial statement of the Islamic banks prohibited the exploitation of the poor through charging the interest on the loan advance to them.

In addition, the principle used in the preparation of the financial statement and specifically the income statement are not meant to help the Islamic society only but they are there to help the general public.

References

Beechy, TH & Conrod, JED 2002, Intermediate Accounting, 4th Canadian Edition, McGraw-Hill Ryerson, Canada.

Diane, W 2009, Accounting and Business Ethics: An Introduction, Imperial College Press, New York.

Haniffa, R 2012, Islamic Accounting, Imperial College Press, New York. McKee, Y 1999, Accounting Services, the Islamic Middle East, and the Global Economy, John Wiley & Sons, Inc., New York

Mervyn, K. 2007, The Handbook of Islamic Banking, Thomson Learning, South Melbourne.

Rahman, 2010, Introduction to Islamic accounting theory and practice, Edward Elgar Publishing, UK.

Ridzwa, H 2005, Issues in Islamic accounting, Thomson Learning, South Melbourne.

Roszaini, H 2012, Islamic Accounting, Thomson Learning, South Melbourne.

Stephen, J 2008, Global Assemblages: Technology, Politics, and Ethics, Thomson Learning, South Melbourne.

Zamir, I 2008, Risk Analysis for Islamic Banks, Edward Elgar Publishing, UK.

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