Istisna A

THE STRUCTURE

Istisna'a: Bank contracts to have a specific asset MANUFACTURED or CONSTRUCTED and then delivers it to the customer. The asset need not exist at contract date. Unlike salam: payment may be deferred or in stages (not required upfront).

Shariah requirements:

1. The asset must be described with sufficient specificity to prevent gharar (uncertainty).
2. The contractor (manufacturer/builder) agrees to produce the described asset.
3. Delivery terms (time, place, condition) must be agreed.

PARALLEL ISTISNA'A

Parallel istisna'a: The bank enters CUSTOMER ISTISNA'A (bank is contractor, sells to customer) and a separate BACK-TO-BACK ISTISNA'A (bank is buyer, construction company is contractor).

The bank is in the middle as intermediary. The two contracts must be INDEPENDENT (bank bears construction risk in both).

AAOIFI FAS 10 — REVENUE RECOGNITION

Apply the PERCENTAGE OF COMPLETION method:

Revenue recognised = Contract revenue x % completion to date — Previously recognised revenue

% completion methods:

1. Cost incurred to date / Total expected contract cost
2. Architect/engineer certification of physical progress
3. Milestones achieved

Period-end accounting entry (% of completion method): Dr: Istisna'a Receivable / Contract Asset [Revenue to recognise this period] Cr: Revenue from Istisna'a [Same]

Dr: Construction Costs / WIP [Costs incurred this period] Cr: Cash / Payables [Same]

Period profit = Period revenue - Period costs incurred

If contract is a LOSS-making contract (expected costs > contract price): Recognise the FULL expected loss immediately in the current period. Dr: Loss on Istisna'a Contract [Full expected loss] Cr: Provision for Istisna'a Loss [Same]

IFRS 15 COMPARISON

IFRS 15 over-time revenue recognition applies if:

• Customer simultaneously receives and consumes benefits (services)
• Customer controls the asset as it is created (construction on customer's land)
• Seller's performance creates an asset with no alternative use + enforceable right to payment

Arithmetic of % completion is IDENTICAL under AAOIFI FAS 10 and IFRS 15. Key difference: AAOIFI requires explicit Shariah compliance confirmation of milestone specifications (to satisfy gharar prohibition). IFRS 15 does not require this.

PARALLEL ISTISNA'A — NETTING QUESTION

Gross vs. Net presentation:

GROSS (default): Show:

• Istisna'a Receivable from customer (asset)
• Istisna'a Payable to contractor (liability)

NET (if offset criteria are met — IAS 32):

• Net asset or net liability position

Criteria for netting: Must have both a legal right to set off AND the intention to settle on a net basis or simultaneously. In most parallel istisna'a structures, these criteria are NOT met → GROSS presentation is required.

BALANCE SHEET IMPACT: Gross presentation can double the reported balance sheet size. This has direct regulatory capital implications for the bank.

MANDATORY DISCLOSURES

AAOIFI FAS 10:

1. Accounting policy: percentage of completion method
2. Revenue recognised from istisna'a in the period
3. Contract assets (amounts due from customers)
4. Contract liabilities (amounts due to customers — advance receipts)
5. Expected losses on onerous contracts
6. For parallel istisna'a: gross vs. net presentation basis
7. Shariah compliance: confirmation specifications were sufficient to prevent gharar

IFRS 15 (IFRS regimes):

1. Disaggregation of revenue (by contract type: istisna'a vs. other)
2. Contract balances (opening, recognised, invoiced, closing)
3. Performance obligation satisfaction timing
4. Significant judgments: method for estimating % completion