Journal of Islamic Finance, Vol. 5 No. 2 (2016) 037 – 052 IIUM Institute of Islamic Banking and Finance ISSN 2289-2117 (O) / 2289-2109 (P) A Framework for Determination of Actual Costs in Islamic Financing Products Azman Mohd Noor a , Muhamad Nasir Haron a a Institute of Islamic Banking and Finance, International Islamic University Malaysia Abstract Islamic banking commonly considered as an alternative to the conventional banking system, conducts its business based on certain financial contracts in order to attain profit, while doing away with the element of interest ( riba). Among the services offered by Islamic financial institutions (IFI) are financing products and fee-based services to generate profits free from interests and other non-permissible incomes. The fee-based services conducted by Islamic banks may raise some Shari’ah issues such as the practice of charging a fee on services related to loan (qard) facility. Similarly, in financing activities, the IFI also imposes some amount of compensation or related charges in the case of late payment or default events for such financing. This paper aims to discuss the mechanism to determine the calculation of such actual charges and fees from Shari’ah perspective. Nevertheless, this paper does not intend to discuss the issue of “pricing” for Islamic financial products to determine its sales price and profit margin. This paper proposes Shari’ah compliance parameters on the computation of the actual costs for some related financing products offered by Islamic financial institutions. © 2016 by The International Islamic University Malaysia Keywords: Mechanism, actual cost, Shari’ah issues, Islamic financial products 1. Introduction: Overview of Concept of Actual Cost The definition of “taklifah” or cost from an accounting perspective is the amount of expenses borne by the owner of a certain financial product for its production, which will provide an economical value now or in the future; regardless of it being a trading commodity or a service. (Khalil, 2005: 242) The meaning of cost in relation to loans or financing is defined by AAOIFI (2010: 271) as the direct costs, which do not bring any additional benefit that can be categorized as riba. However, with regards to the discussion of actual cost, there is no specific definition for the term taklifah fi’iliyyah or actual incurred cost. It is subjective and depends on the financing situation and features of the financing product utilised. 2. The Concept of Benefit (Manfa‘ah) of Loan From Shari’ah Perspective The concept of benefits (manfa‘ah) derived from loan is a very substantive concern to be discussed because the determination of actual cost is a vital issue, which is related to the recent practices in the industry. In this vein, the discussion for the benefits derived from loan can be categorised into the following circumstances (Al-Umrani, 2006: 374): 2.1 The benefits gained by the Lender In this circumstance, the benefits derived from such loan specifically meant for the lender are prohibited by Shari’ah. The benefits can be as follows: i) The benefit is the excess amount (riba) and not part of the loan amount. According to Al-Shatibi (n.d: vol.4, 29-30), the effective cause (‘illah) for the prohibition of riba is any excess without a justified compensation (‘iwad). For example, a loan associated with interest element or