4.25 Recognition of income and expenses
Recognition of income and expenses
i. Interest
For all financial instruments measured at amortized cost and interest bearing financial instruments, interest income or expense is recorded at the effective interest rate, which is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or a shorter period, where appropriate, to the net carrying amount of the financial asset or financial liability. The calculation takes into account all contractual terms of the financial instrument and includes any fees or incremental costs that are directly attributable to the instrument and are an integral part of the effective interest rate, but not future credit losses. The carrying amount of the financial asset or financial liability is adjusted if the Group revises its estimates of payments or receipts. The adjusted carrying amount is calculated based on the original effective interest rate and the change in carrying amount is recorded as interest income or expense.
ii. Fee and commission
The Group earns fee and commission income from a diverse range of services it provides to its customers. Fee income can be divided into the following two categories:
• Fees earned for the provision of services over a period of time are accrued over that period. These fees include commission income and other management and advisory fees. Loan commitment fees for loans that are likely to be drawn down and other credit-related fees are deferred (together with any incremental costs) and recognized as an adjustment to the effective interest rate on the loan. When it is unlikely that a loan will be drawn down, the loan commitment fees are recognized over the commitment period on a straight-line basis.
• Fees or components of fees that are linked to a certain performance are recognized after fulfilling the corresponding criteria.
iii. Murabaha
Murabaha income is recognized on a time apportioned basis over the period of the contract based on the principal amounts outstanding.
iv. Ijara
Income from Ijara is recognised on a declining-value basis, until such time a reasonable doubt exists with regard to its collectability.
v. Wakala
Estimated income from Wakala is recognised on an accrual basis over the period, adjusted by actual income when received. Losses are accounted for on the date of declaration by the agent.
vi. Income on balances with financial institutions
Income on balances with financial institutions is calculated, on account, based on the expected/anticipated profit rates net of relevant fees and expenses.
vii. Dividend income
Income is recognized when the Group’s right to receive the payment is established.
viii. Insurance income
Insurance contracts
Insurance contracts are those contracts where the Group has accepted significant insurance risk from another party (the “policyholders”) by agreeing to compensate the policyholders if a specified uncertain future event (the “insured event”) adversely affects the policyholders.
Once a contract has been classified as an insurance contract, it remains an insurance contract for the remainder of its lifetime, even if the insurance risk reduces significantly during this period, unless all rights and obligations are extinguished or expire.
Premiums earned
Premiums written are taken into income over the terms of the policies to which they relate on a pro-rata basis. Unearned premiums represent the portion of premiums written relating to the unexpired periods of coverage.
Commissions earned
Profit commission is accounted for as and when received while other commissions are accounted for when earned.
Claims
Claims comprising amounts payable to contract holders and third parties and related loss adjustment expenses, net of salvage and other recoveries, are charged to income as incurred. Claims comprise the estimated amounts payable, in respect of claims reported to the Group.
The Group generally estimates its claims based on previous experience. Claims requiring court or arbitration decisions are estimated individually. Independent loss adjusters normally estimate property claims.
The Group does not discount its liability for unpaid claims as these are expected to be settled within one year of reporting date.
4 Use of estimates and judgements
The preparation of the Group’s consolidated financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities and the accompanying disclosures, and the disclosure of contingent liabilities. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period or in the period of the revision and future periods if the revision affects both current and future periods. Uncertainty about these assumptions and estimates could result in outcomes that could require a material adjustment to the carrying amount of the asset or liability affected in the future periods.
(a) Judgments
In the process of applying the Group’s accounting policies, management has made the following judgements, apart from those involving estimations, which have the most significant effect on the amounts recognized in the consolidated financial statements:
i. Consolidation of entities in which the Group holds less than majority of voting rights
The Group considers that it controls Insurance House P.S.C. even though it owns less than 50% of the voting rights. The Company is the largest shareholder of Insurance House P.S.C. with 45.61% equity interest. Furthermore, the Company has substantial and material board presence and control over key financial and operational decisions.
ii. Classification of properties
Management decides, on acquisition of a property, whether it should be classified as investment property, property and equipment or as property held for sale. Properties acquired by the Group are recorded as investment properties if these were acquired for rental purposes, capital appreciation or as a settlement of loan. Properties held for own use are recorded as property, fixtures and equipment. Properties are recorded as held for sale if their carrying amounts will be recovered through a sale transaction.
(b) Estimates and assumptions
The key assumptions concerning the future and other key sources of estimation uncertainty at the reporting date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below. The Group based its assumptions and estimates on parameters available when the consolidated financial statements were prepared. Existing circumstances and assumptions about future developments, however, may change due to market changes or circumstances arising beyond the control of the Group. Such changes are reflected in the consolidated financial statements when they occur.
i. Fair value of investment properties
The Group engaged an independent valuation specialist to assess fair value for its investment properties using a valuation methodology based on the ‘comparable market value method’. The key assumptions used to determine the fair value of investment properties and sensitivity analyses are disclosed in Notes 6 and 26.
ii. Fair value of unquoted investments
As described in Note 6, management uses their judgment in selecting an appropriate valuation technique for financial instruments not quoted in an active market. Valuation techniques commonly used by market practitioners are applied. Such financial instruments are valued using discounted cash flow and capitalization of sustainable earnings analysis based on assumptions supported, where possible, by observable market prices or rates. The estimation of fair value of unquoted shares includes some assumptions not supported by observable market prices or rates. Details of assumptions used and of the results of sensitivity analyses regarding these assumptions are provided in Note 6.
iii. Measurement of the expected credit loss allowance
The measurement of the expected credit loss allowance for financial assets measured at amortized cost and FVTOCI is an area that requires the use of complex models and significant assumptions about future economic conditions and credit behavior (e.g. the likelihood of customers defaulting and the resulting losses). Explanation of the inputs, assumptions and estimation techniques used in measuring ECL is further detailed in Note 5(b).
A number of significant judgements are also required in applying the accounting requirements for measuring ECL, such as:
• Determining the criteria for significant increase in credit risk;
• Determining the criteria and definition of default;
• Choosing appropriate models and assumptions for the measurement of ECL;
• Establishing the number and relative weightings of forward-looking scenarios for each type of product/market and the associated ECL; and
• Establishing groups of similar financial assets for the purposes of measuring ECL
iv. Provision for outstanding claims
Considerable judgement by management is required in the estimation of amounts due to contract holders arising from claims made under insurance contracts. Such estimates are necessarily based on significant assumptions about several factors involving varying, and possible significant, degrees of judgement and uncertainty and actual results may differ from management’s estimates resulting in future changes in estimated liabilities. The Group generally estimates its claims based on previous experience. Claims requiring court or arbitration decisions are estimated individually. Independent loss adjusters along with the Group’s internal legal counsel normally estimate such claims. Management reviews its provisions for claims incurred on a quarterly basis.
