International Journal of Basic & Applied Sciences IJBAS-IJENS Vol: 11 No: 02

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Shariah on Direct and Indirect Cost in Murabahah

Muhammad Pisol B Mat Isa,
Management and Humanities Universiti Teknologi PETRONAS
Bandar Seri Iskandar, 31750 Tronoh, Perak
Tel: 05-3687746 (Off), Fax: 05-3656280 E-Mail: mpisolmatisa@petronas.com.my

M Yusof Ibrahim
Dekan Pusat Pengajian Siswazah dan Penyelidikan
Kolej Universiti InsaniahLebuhraya Sultanah Bahiyah,
05350 Alor Star,Kedah Darul Aman
Tel: 04-7717087 (Off), Fax: 604-7320164Email: dryusof@insaniah.edu.my

Hezlina Bt M Hashim
Management and Humanities Universiti Teknologi PETRONAS
Bandar Seri Iskandar, 31750 Tronoh, Perak
Tel: 05-3687738 (Off), Fax: 05-3656280 E-Mail: hezlina_hashim@petronas.com.my

Abstract-- Murabahah contract is an unconditional contract of

sale between the seller and buyer, where the goods, cost price,
markup and payment date are clearly defined, agreed and
documented. The important element is that the price in
murabahah should be mutually agreed upon based on the cost
and margin. This paper aims to discuss the above costs (direct
and indirect) from shariah point of view and recommend the
opinion which can be applied in modern murabahah transaction.
This paper is a concept paper where the data from the views of
shariah was gathered regarding to cost used in trading and
comparison with the conventional financial cost has been made
to show the direct and indirect cost in murabahah financing is
accepted on unaccepted by the Shariah. The study found that the
direct and indirect cost in murabahah financing is accepted by
the Shariah, however it is only recommended for the cost which
contributes to the product.

I.
INTRODUCTION
Murabahah is one of the famous financing facilities used by
Islamic banking due to low risk. According to Abdullah Saeed
the asset of murabahah constitutes approximately 75% of the
entire asset in the Islamic bank. The facility is about cost plus
financing where the bank acts as first buyer and resale to the
customer with its cost plus profit (Abdullah Saeed 1996). The
cost of murabahah should be disclosed when the contract is
sealed. The disclosure of the cost should be done in an honest
manner or otherwise the contract could be dissolved (Kamal
Khir et al. 2008). In modern conventional costing, it involves
basically two types of cost which is direct and indirect cost
(overhead cost). The above mentioned cost is currently applied
in murabahah financing, and reported in bank financial year
report. The Shariah definitely has its own view regarding to
the above matter, however the discussion in the fiqh literature
never mention direct and indirect as a terminology in
murabahah.

There is no specific research has been done on the shariah

point of view towards direct and indirect cost in murabahah
financing. However the Muslim jurists along the centuries had
attempted to discuss the issue based on mode of transaction
during their time. Imam al-Mirghinani concluded that the
possibility of adding the cost of cutter, disigner, weaver and
tailor into the capital cost of business (al-Marghinani, 1990).
Other Muslim jurist such as al-Dusuqi considered any cost
which contributes to the successful of the trading transaction
should be charged to the costomer (al-Dusuqi, 1993), those
discussion was not mentioning to the direct and indirect cost
as practiced in Islamic banking. There is a research which
tried to link the indirect cost into the performance of Islamic
bank and uses as a determinant for profit calculation in
murabahah financing (Saiful Rosly and Mohd Afandi 2003).
Kamal Khir, he did mention in general about indirect cost as a
component of the financing cost his research on murabahah
transaction practice, he also extend further the computation of
cost which currently applies in Islamic banking (Kamal Khir
et al. 2008). The other research on indirect cost is done as a
component of the determinant of profit by Islamic bank, where
the indirect cost comes under the component of the calculation
of profit in Islamic bank, among the research are done by
(Hasan and Bashir, 2003), he studied the effects of controlled
and uncontrolled variables of Islamic banks profitability and
concluded that the indirect cost is adversely related.
Thus there is a need to thoroughly discuss these terms as it is
currently applies in Islamic bank and gives correct perspective
from the view of shariah to this application.

Murabahah and Cost

Murabahah refers to a particular kind of sale and has nothing
to do with financing in original sense. If a seller has agreed
with his purchaser to provide a particular commodity with

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certain amount of profit added to his costs, it is called
murabahah transaction. The basic ingredient of murabahah is
that the seller discloses the actual cost he has incurred such as
overhead and service cost in acquiring the commodity plus
profit margin.
Murabahah is a form of trust and honor sale, the seller must
be faithful in his cost calculation and the buyer must trust the
seller. The seller should not prepare false statement of the
cost. If he does so, and it is known later by the buyer, the
contract of sale is considered null and void (Nik Norzrul et al.
2003). After discussing the true cost, a profit margin may be
agreed upon by both parties. In murabahah contract, the seller
(normally a bank) involves in the business transaction himself,
where the bank has to deal in real process of business (buying
and selling) of the goods. If otherwise, the bank is considered
giving out loans as making an interest (riba) where its role is
no other than a creditor (Hasroleffendy, 2011), which is
similar to a conventional financing process. Murabahah is
often referred to as cost plus financing. The contract
involves the sale of an item on the deferred basis. The item is
delivered immediately and the price to be paid for the item
includes a mutually agreed profit margin.
The essential element of murabahah is the buyer should be
aware of the cost price of goods. For example, the bank
purchased machinery for RM 100,000 and sold it to the
customer using murabahah facility with 10 percent mark-up.
The buyer should also be aware of the profit margin used for
mark-up. The profit in murabahah can be determined by
mutual consent, either in lump sum or through an agreed ratio
of profit to be charged over the cost (Kamal Khir et al. 2008).
The murabahah contract should clearly define the goods, cost
price, mark-up, payment date and period of payment.
Hence, the murabahah contract is so much concerned on the
total price. The excess charge over the cost will be considered
as dishonesty. According to al-Kasani if an element of
dishonesty is found in this contract and is known later by the
buyer, the contract is nullified and the buyer has a right to
reject the contract (Al-Kasani, 1998). There are few items
which contribute to the total cost of price such as insurance
premium, inflation and overhead cost. This paper will only
discuss the overhead cost and its allocation to products based
on the conventional perspective and will be reviewed by the
Shariah
point of views.

Cost in Conventional Practice

74

This section will describe the conventional costing approach

adopted by the manufacturing, trading as well as the service
organizations. The management accounting system in which
costing system forms one of its components, has been in used
for the past two centuries. Its origin can be traced to the
emergence of managed, hierarchical enterprises in the early
nineteenth century, such as armories and textile mills (Johnson
1986). The system were initially develop to provide
information needed to replace information formally available
from market transactions so that the efficiency of the internal
production processes could be measured as product moved
internally from stage to stage (Kaplan & Atkinson 1998).
Today the system has undergone changes to respond to the
challenges brought about by advances in technology and
communication as well as changes in the production process.
Although new techniques have been introduced like Activity
Based Costing and Activity Based Management, the
traditional method of cost determination is still widely
practiced.

Traditional Costing
In the traditional costing method, product cost is determined
through a two-steps process; cost accumulation and cost
assignment. In the cost accumulation step all expenses
incurred by the organization are being identified and recorded
in their natural accounts such as; material, payroll, rent,
electricity, and commission. They could be recorded
periodically (daily, weekly or monthly) or on real-time basis
(as it happen). The identification and accumulation of
expenses are facilitated by the use of documents (such as bills,
invoices, notes and receipts) as evidence of transaction.
However with the advent of information technology, the
Information Technology (IT) is taking over the job
progressively. The use of bar code and scanner make the job
of capturing and recording information on sales more efficient.
The output of the cost accumulation stage is the list of account
balances.
Product and Period costs
To determine the cost of products or services produced and to
prepare the financial statements of the business, the
accumulated cost has either to be assigned to products or
shown as period cost. Product costs are costs that can be
identified with goods produced or purchase for resale. They
will first form part of the inventory on hand and shown as an
asset (except for the service enterprise). When the inventory is
sold, the costs will be considered as cost of goods sold and be
deducted from the sales. In contrast, the period cost will be
considered as expense for the period and deducted from the
gross
profit.

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Product cost

Accumulated costs

Period cost

The determination of whether a particular cost is a period or a

product cost is influenced by the type of business operation;
manufacturing, trading of service and the products produced.
Cost of electricity for example could be considered as product
cost in manufacturing organization because the machines used
to produce the products are run by electricity. At the same
time the amount is significant. In trading operation, electricity
expense will normally be considered as period cost because
there is no link between the cost of electricity and the products
the business is trading. Take for example a hypermarket. They
consume large amount of electricity for lighting and freezer.
However, it is difficult if not impossible to charge the
electricity cost to the products or the goods it sells. For service
organization, cost of electricity could be an important element
of product cost such as the LRT or Electric train. The cost of
electricity normally forms a sizable portion of total cost of
providing the services. Thus it can be considered as product
cost. However in the service operation, the product(s) the
business produce cannot be stored. Therefore although
electricity is considered as product cost, it will never be
inventoried and the whole amount is charged as cost of service
provided and be deducted from sales.

Cost Assignment
The product costs will have to be assigned to product(s) the
organization produced. This is done by classifying the product
costs into direct and indirect costs. Normally cost assigned to
products will include; salary of plant manager, depreciation of
plant, material used in the products, lubricant used on the
machinery, laborers wage, rent of the trading premises and
design cost. If the business operation produces only one
product, all product cost could be assigned to the product
without any difficulty. However this is very rare situation.
Normally business operations produce or sell more than one
product. Therefore we need to assign costs to the individual
products. To perform that, we need to categorize costs into
direct and indirect cost. The direct cost normally includes
direct-material and direct-labor. Indirect costs include all cost
associated with the production process that the company
cannot trace to the goods or services produced in an
economically feasible way (Horngren et al. 2008). This
normally includes janitor, forklift truck operators, plant guard,
and storeroom clerk. These costs are also referred to as factory
overhead, indirect manufacturing cost, or factory burden.

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Direct material

Direct cost

Product cost

Direct labor

Indirect cost

Direct-material cost include the acquisition costs of all

materials that the company identifies as part of the
manufactured goods and that it can be traced to the
manufactured goods in an economically feasible way
(Horngren et al. 2008). Examples are wood and paint in
furniture manufacturing. Minor items often excluded from this
category such as nail and sand paper used in furniture
manufacturing because the cost of tracing these items are
greater than the benefit derived (not economically feasible).
Direct-labor costs include the wages paid to employees that a
company can trace specifically and exclusively to the
manufactured goods in an economically feasible way
(Horngren et al. 2008). This may include wages of machine
operators and assemblers. It does not include factory

maintenance workers and factory cleaners because their

service can not be traced to the products in an economically
feasible way.
Assigning Direct cost
Tracing the direct cost to products could be complicated by
the number of products produced and the number of processes
or departments involved. For illustration purposes a company
producing two products (wooden cabinets and tables) through
two departments (cutting and assembling) will be used. The
relevant direct materials cost will be assigned first to the
departments (based on the requisition records) and then to the
products based on direct tracing (items and quantities used).
Diagrammatically the tracing of direct material and direct
labor expense can be shown as follows;

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Direct material/Direct labor

Tracing

Tracing

Cutting

Assembling

Tracing

Cabinets

Tracing

Tables

Cabinets

The same method could be used for direct labor. Different

type of labor could be traced and assigned to departments and
products based on the labor hours recorded for departments
and products.

Tables

directly traced to products and services produced. These costs

are normally grouped into one and labeled as Factory
overhead. The assignment of these costs to products or
services has to be done through allocation using appropriate
allocation-bases.

Assigning indirect cost

As described earlier the indirect cost includes costs that have
been identified as part of the products cost, but cannot be

Product/service 1

Factory
Overhead

Allocation using
allocation- base

Product/service 2

Product/service 3

In most cases, the production process involves more than

one department. In that case, the allocation of overheads will

involve two stages; allocation to departments followed by

allocation to products or services.

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Product/service 1
Department X

Factory
Overhead

Allocation using
allocation- base

Allocation using
allocation- base

Product/service 3

Department Y

So far we have discussed the costing process adopted by cost

management system in business enterprises. The objective of
the process among others is to determine the cost of products
produced for sale. To achieve an accurate result i.e. accurate
product cost, the system must ensure the two stages; cost
accumulation and cost assignment be performed in a correct
manner and free from error. Specifically the system should
ensure that;
i.
No cost item is left out or unaccounted for, and
ii.
The allocation base(s) used is(are) appropriate
(nothing else could be better)
As mentioned earlier, the costing system described does apply
to the three types of business activity; manufacturing, trading
and service. Although there are fundamental differences
between the three with regard to merchandise inventory (the
manufacturing has three types; material, work in process and
finish goods, trading only hold finished goods while the
service do not hold any) and the cost elements involved,
however the cost determination stages and approaches adopted
are similar.

Views of Muslim Jurists on Direct and Indirect Cost in

Murabahah
Generally the Jurist does not question the validity of the costs
incurred for murabahah business. The seller should include
the cost borne by them in the price set in murabahah
transactions. All expenses involved in acquiring the
commodity like freight and custom duty, etc. which are
considered as direct costs to the related goods are allowed by
shariah. However the recurring and fixed expenses of the
business like salaries of the staff and the rental cost of the
premises is still arguable among Muslim jurist. The rent and
salary are borne by the business entity when they run the
business. Most of early discussion by Muslim scholars focuses
on one department and one product environment. In that

Product/service 2

situation they were not concern with indirect costs as they

were not borne by their business (no premise rent or salaried
staff) or there is no need for assignment (only one product).
Furthermore the cost was not significant and the owner of the
business does not receive a monthly salary as in the modern
business management. However, in modern businesses
indirect cost is crucially important to the success of the
business and without it the product would not be able to reach
the purchaser. With that understanding, the indirect cost
should be included in the murabahah product cost. To achieve
that we need to consider the jurists views on the elements of
the murabahah costs, and apply them in the modern
murabahah transactions.
It was a consensus among Jurists that the direct costs incurred
by the business entity (seller) are to be included in the selling
price in murabahah transaction. They only dispute on the
indirect costs which do not contribute traceable value to the
product. This issue needs a close investigation as the
murabahah is very much concerned about the charging of
cost. The failure of addressing the cost properly would lead to
nullification of the contract.
According to al-Marghinani from Hanafi, he said that every
expense used by a seller, for instance cost incurred for
tailoring, painting and transportations of the goods should be
included in cost. This is based on the common acceptance
throughout centuries that all the above costs are about
bringing value to the traded goods (al-Marghinani, 1990).
However he did mention on the costs which are not related to
the product itself such as the salary for the guardian of the
animal should not be included in calculation of the profit. The
view of Marghinani can be interpreted as that he agreed on the
direct costs to be part of the murabahah cost as it contributes
to the availability of the product to be delivered to the
customer. However the indirect costs should not be included
in the profit calculation.

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Al-Dusuqi from Maliki says that the costs incurred in adding
value to the products such as painting can be included as
murabahah cost. The use of expertise and skill in decorating
the product can be charged as a cost and used in calculating
profit charged to the seller. However, costs such as
transportation can be included as a cost, but should not be
used to calculate the profit portion of the murabahah price (alDusuqi, 1993). Based on al-Dusuqis view the cost of painting
is direct cost (it adds value to the product) and to be included
in a product cost and the seller is allowed to charge a certain
profit on the product cost. However the indirect cost such as
the transportation will be included in the product cost but it
should not be used to compute the profit element in the
murabahahs selling price. Another jurist, alish from Maliki
has started discussion on the indirect cost incurred in relation
to murabahah transaction. He said that costs which have no
direct linkage to the product should follow the common
practice in the particular society (alish, 1987) The authors are
of the view that this flexible idea may support the inclusion of
indirect cost as a murabahah cost.
The other groups of jurists including from Shafie, Syiah,
Zaydiyyah and Imamiyyah, say that every cost which gives
value added to the product should be calculated as a cost in
murabahah. Imam al-Rafie stated that if you say I sell this
product based on my purchasing price in murabahah
transaction, then the murabahah price should include the
purchasing price only. However, if you say, I sell this product
with my cost, then it may include all cost incurred related to
the product or cost not related to product such as amount paid
to driver, cutter and painter (Al-Imam al-Rafie, 1993). These
jurists agreed that the costs which are not related to and add
value to the product such as hiring a slave and his cloth,
buying fixed asset are not the cost of products. Al-Rafie
concluded that the costs which are directly and indirectly
related to the product should be charged as cost of trading and
should be calculated as part of the murabahah cost. However
his view on expenses incurred in hiring a slave and paying for
his cloth and depreciation of fixed asset should be classified as
period cost and have no direct link to the product. Exception
was given if the slave was bought specifically for that

Component
Selling Price

Computation formula
CF+(CF*i*n/360)

Total Profit

SP- CF

78

particular business, in which case it may be included as

indirect cost.
Imam al-Bahuti from Hanbali has similar view with other
jurists, when he said that all expenses incurred should be
considered as product cost. He added that the seller needs to
detail all his expenses to the purchaser, for instant I bought
the cloth amount 10 Dinar and paid for tailor with 10 Dinar.
He also said any cost which does not give an additional value
to the product cannot be considered (al-Bahuti, 1996)
In modern businesses, due to the scale of the business and
products traded, there are many costs involved and most of the
costs contribute to successful of the business. Among these are
rent, salary, telephone and electricity bill, stationary,
computer, and photocopying machine. All these costs
contribute directly and indirectly to the successful of the
business. According to al-Rafie, alish and al-Bahuti indirect
cost could be assigned to the product cost. Therefore indirect
costs (overhead cost) should be recognized in calculating the
price in murabahah transaction. However the period cost such
as salary of managers, depreciation of asset value, and cost of
marketing are excluded from cost of murabahah. To achieve
an accurate overhead cost in murabahah transaction, the cost
assignment or apportionment need to be properly performed.
In examining the practice, we found that the calculation of
murabahahs cost in Islamic banking in Malaysia involves
direct cost only. The practice is in accordance with the
standard released by IFSB (Islamic Financial Services Board).
According to the IFSB, A Murabahah contract refers to an
agreement whereby the IIFC (Institution Offering only Islamic
Financial Services) sells to a customer at acquisition cost
(purchase price plus other direct cost) plus an agreed profit
margin, a specific kind of asset that is already in its
possession (IFSB, 2005).
As an example, the formula used in computing the selling
price and total profit for the period of financing is offered by
Kamal Khir et al (Kamal, 2008) as follow:

Details
CF= Cost of Finance (purchase price+ Direct Cost)
i = Rate of Return per Annum
n = period of financing in days
360 is the total number of days in a year and some
bank follow 365 days.
SP = Selling Price
CF = Cost of Financing

Obviously the above formula does not include indirect cost in

its calculation. If the indirect cost needs to be included in the

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Murabahah selling price, we have to decide how the indirect

cost elements be defined and whether it will be used as a basis
to compute profit.
II.
CONCLUSION
In conventional accounting, based on the nature of the cost,
product costs are costs that can be identified with the goods
produced or purchased for resale and are classified as direct or
indirect. On the other hand, period costs will be considered as
expense for the period and deducted from the gross profit.
From the shariah point of view, we found that the jurists are
consensus on the direct costs incurred and that these costs can
be included as murabahah cost. However differences of
opinions between jurists exist in accounting for the indirect
cost. The majority of jurist agreed the indirect cost be incurred
in murabahah financing. The implication of this study is that
indirect cost can be included in murabahah cost calculation
when proper cost definition and assignment method is
formulated.

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