Part 1: Literature Review and Analysis on The Implementation of IFRS 9 In Islamic

Financial Institutions.
The adoption of IFRS 9 by Islamic financial institutions is still at a very early stage.
However, a number of Islamic financial institutions have already implemented the new
standard, and many more are in the process of doing so. The overall objective of IFRS 9 is to
provide a single, coherent financial reporting framework that is applicable to all entities
(PWC, 2017). This includes Islamic financial institutions. The standard sets out the
recognition, measurement, presentation and disclosure requirements for financial instruments.
It also contains provisions for the treatment of hedge accounting and for the impairment of
financial assets. The way financial assets are categorised and measured differs significantly
between IFRS 9 and earlier accounting rules (IAS 39). Financial assets are divided into three
groups under IFRS 9: amortised cost, fair value via other comprehensive income (FVOCI),
and fair value through profit or loss (FVTPL). The contractual cash flows of a financial asset
and the business strategy for managing it are used to classify it. The amortised cost category
includes financial assets held for the purpose of collecting contractual cash flows, where such
contractual cash flows exclusively include principal and interest payments. The fair value via
other comprehensive income category includes financial assets held both for the purpose of
selling them and for the collection of contractual cash flows. Financial assets held for trading
purposes fall under the fair value through profit or loss category.
All financial institutions that follow the Shari'ah are collectively referred to as Islamic
financial institutions. Generally speaking, a Shari'ah board made up of multiple scholars
qualified to give a fatwa on the Shari'ah-compliance of a financial product is required for a
financial organisation to qualify as an Islamic financial institution. A trade association for the
financial industry based in the United Kingdom, International Financial Services London,
estimates that as of the end of 2007, there were 280 Islamic financial institutions globally
with a combined total of US$729 billion. However, there are conflicting statistics regarding
the size and total number of Islamic financial institutions worldwide. (Aris et al, 2013). The
rating company S&P predicts that the market will be worth USD 1600 million in 2015. In
Malaysia, example of Islamic financial institutions is Affin Islamic Bank Bhd, CIMB Islamic
Bank Bhd and more. Mudarabah (profit-sharing and loss-bearing), Wadiah (safekeeping),
Musharaka (joint venture), Murabahah (cost-plus), and Ijara (leasing) are some of the forms
of Islamic banking and finance. Since 1993, rules and guidelines for Islamic financial
institutions have been published by the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI). 25 accounting standards, seven auditing standards, six
governance standards, 41 Shari'ah standards, and two codes of conduct have been published
by the organisation by 2010. In the areas of Shari'ah, accounting, auditing, ethics, and
governance, 94 standards had been released by it by 2017.
According to Alamad's research (2019), the solely payment of principal and profit test
(SPPP) and the Islamic financial institutions' business strategy for managing the financial
assets are what define the classification and measurement of an Islamic financial instrument
under IFRS 9. When applying IFRS Standards, the economic substance is the analysis's
primary concern. As previously mentioned, the Musharaka Mutanaqisah's (DMI) home
finance may take the form of a hybrid structure made up of three contracts: the musharaka
(partnership), the ijara (lease), and the bay (sale). The transaction's financial structure is
intended to make up for the Islamic financial institutions' delayed payment profile. The
contract for this sale is acceptable. This approach would be comparable, in accordance with
IFRS 9, to paying principal and/or interest payments on a typical mortgage provided by non-
Islamic financial institutions. The three contracts known as musharaka (partnership), ijara
(lease), and bay' (selling), which is not generally a separate contract, should be interpreted
from an IFRS 9 standpoint as an unified framework arrangement for house finance that is
analogous to a mortgage loan. Using IFRS 9, it is also necessary to look at the contractual
terms and circumstances of home loan products and analogous equity-based instruments that
Islamic financial institutions provide to their clients and which impact the return on financed
assets. In all written agreements involving equity-based financial instruments, the researcher
has demonstrated that consideration of the time value of money, counterparty credit risk,
other fundamental financial risks, operating costs, and profit margin are all significant
contractual elements. In relation to the application of IFRS 9 in Wakala Investment, the study
came to the conclusion that the return on the Wakala investment instrument is composed of
the investment amount, which is equivalent to the principal for a conventional loan, and a
muwakkil profit, which is computed on the investment amount and is meant to account for
time value of money, credit risk, and liquidity cost. Contrarily, prior to the implementation of
IFRS 9, the return on the Commodity Murabaha Instrument (CMI) consisted of the sale price,
which is equivalent to the principal for a conventional loan, and an agreed profit, which is
based on the purchase price and is meant to compensate for the sale price's deferred payment
as well as the credit risk and liquidity cost.
To study the implementation of IFRS 9, Morshed (2020) has carried out research on
the application of Sukuk by IFRS’s Compliant Firms. The problem has developed when
IFRS-compliant enterprises become more desirable for Sukuk investment as listed firms.
They are required to utilise IFRS alone and are aware of the accounting conflict, thus the
firm's willingness to comply is consequently decreased. The categorization and Expected
Credit Loss (ECL) model application on the Sukuk, with an emphasis on IFRS9, are the
fundamental difficulties in relation to the Sukuk. Since the researcher interviewed IFRS
specialists to come up with a solution for the classification to be IFRS compliant and take
into account Sukuk shariah features, the results indicate that the categorization of the Sukuk
under IFRS 9 is crucial. The respondents strongly advocate that expected credit loss model be
applied to Sukuk by IFRS-compliant businesses. They also concur that application of the
provision itself does not misrepresent the Sukuk's Islamic component and is crucial for the
accuracy of accounting data and risk management. They made comments about how using
interest rate events is only appropriate for risk assessment and not for interest gain, which is
against Islamic law; it is preferable to use other Shariah-acceptable factors. This argument
can complement another viewpoint in the literature study. According to Misman and Ahmad
(2011), Malaysia adjusts the impairment depending on discount rates, although they contend
that the rates are simply utilised to calculate the impairment. However, since IFRS 9 employs
the interest rate as a discount factor and does not take any reasonable considerations into
account, it is unsuitable for Islamic banks in Indonesia to apply this standard. It demonstrates
the necessity of a specific Islamic accounting standard.
Islamic Financial Services Board (IFSB, 2018) has also conducted a survey to identify
the possible implications of the Expected Credit Loss (ECL) approach to Islamic banks on
IFRS 9 implementation. Nearly 90% of the jurisdictions that participated in the study said
they already use IFRS, and all of those that planned to do so said that starting in 2018,
Islamic banks will be expected to start using the standard alongside their conventional
counterparts. The majority of the jurisdictions who responded said they have assessed the
effects of IFRS 9 on their local banking industry through research. Three of them sent the
IFSB information on how the expected credit loss approach to asset impairment might affect
banks' capital ratios, and two of them explicitly gave information on how it might affect their
Islamic banking industries. The expected credit loss method would not significantly affect the
capital ratios for its whole banking industry, at least one jurisdiction determined based on its
early analysis. Furthermore, due to the fact that different jurisdictions use different ways to
distinguish between general provisions and specific provisions, IFRS 9 does not distinguish
between them, which could cause inconsistencies. The majority of the responding Regulatory
and Supervisory Authority claimed that they will start to require more disclosures from banks
operating in their nations, both Islamic and conventional. In three of the four jurisdictions that
planned to use IFRS 9 and where Islamic banking is considered "systemically vital," banks
would be required to provide additional information after the expected credit loss method was
implemented. The types of disclosures raised by respondents centred on the governance and
models used to estimate provisions; these disclosures are probably within the purview of
those who establish accounting and auditing standards. According to 63% of respondents,
Basel Committee on Banking Supervision and other standard-setters would need to provide
Islamic banks with assistance beyond what is now provided in order for them to apply IFRS
9. The three main areas for additional guidance were the supervisory assessment procedure,
the distinction between general provisions and specific provisions, and changes to credit risk
management frameworks, which relate to trigger points for moving assets between IFRS 9
stages, evaluation of "significant increases in credit risk," and the definition of "default,"
among other things.
An insight been discussed by IASB (IFRS, 2016) in the implementation of IFRS 9 to
Islamic Finance. In the paper, they have looked at how IFRS 9's classification and subsequent
measurement provisions applied to Islamic financing products and made an effort to stay
narrowly focused on topic and have not strayed into other facets of the Standard, like credit
impairment or term modification. Although significant, those subjects do not seem to present
any special difficulties when applied to Islamic finance. Many of the contracts that result
from authorized transactions in Islamic finance are classified and measured at amortised cost
according to the standards in IFRS 9. To come to that conclusion, though, requires a full
examination and comprehension of the contract terms, not just knowledge of their formalities.
Contract terms that incorporate elements not present in a fundamental lending arrangement
and would prevent the contract from being classified as an amortised cost are expressly
prohibited by IFRS 9. Hence, it is important that each individual needs to start out with a
 thorough understanding of Islamic financial institutions and markets. This can be attributed to
the different economic and financial elements that have had several effects.

Differences Islamic Finance from Conventional Accounting

The concepts of Islamic law, known as Shariah, serve as the foundation for the
banking system defined as Islamic finance. This form of finance is unique from conventional
banking in a range of fundamental characteristics, including the ban of interest and the
sharing of risk between the client and the financial institution.
i. Prohibition of interest
First and foremost, the prohibition of interest stands out as the primary distinction
between conventional accounting and Islamic finance. The principle that it is forbidden to
collect or issue interest, also known as Riba, is central to the practice of Islamic finance (Sani
Kabiru Saidu, 2018). Riba is a term that refers to usury, which is defined as the process of
making loans at excessively exorbitant interest charges. Since it is considered unethical and a
kind of exploitation, Shariah (the religious law of Islam) prohibits it (Azeez, 2018). From this
perspective, we can see that Islamic finance is doing an important thing, which is to
guarantee that businesses would not pose a danger to others whilst also still turning a profit,
as well as contributing to achieving a balanced allocation of income, rather than just between
the shareholders of a particular company, and also between society as a whole (HALIM,
2017). However, there are none of these limits in place at conventional banking institutions.
The conventional method of accounting places a significant emphasis on interest, which
means that they are predicated on the idea of interest. Interest serves as the primary source of
revenue for institutions and various types of monetary organizations. Additionally, high-risk
trading, short selling, or the resale of loans are not an uncommon activity for people to
engage in.
ii. Risk Sharing / Profit and Loss Sharing
Furthermore, the emphasis placed on risk sharing would be another essential
distinction that can be seen between conventional accounting and Islamic finance. In the
conventional method of accounting, depositors or savers are not exposed to any form of risk
(SEKRETER, 2011). Besides, the lender under the conventional finance contract is the one
who takes on the risk of the borrower not paying back the debt, and the borrower is not given
any say in whether the project is profitable or unprofitable. Islamic finance, however. offers
another alternative, called PLS (profit-loss sharing) (SEKRETER, 2011). Both the risks and
the benefits associated with a particular financial activity are split in a predetermined
proportion between the banking companies and the depositors or savers who use the services
of these banks (SEKRETER, 2011). In Islamic finance, financial transactions are often
structured in such a way that the risks are divide and distribute among the various
stakeholders involved. A good example of this is a Murabahah agreement, in which the
purchaser and vendor negotiate and consent upon a cost for the acquisition of an item, and the
purchaser subsequently makes payments to the vendor in the form of instalments over the
course of a certain amount of period. Whenever the cost of the property goes up, then the
purchaser is the one who comes out ahead, but when the cost of the property goes down, then
the vendor is the one who takes the hit. In term of risk sharing, we can draw the conclusion
that the method of Islamic finance known as profit-loss sharing is much more equitable and
beneficial than conventional accounting approach known as interest-based accounting, not to
mention that it results in a better sustainable economy with a minimal wage difference (Reza
Gholamia, 2021). But when comes to engaging with monetary dealings, market participants
such as the financial industries, government, banking business, firm, and citizens will still
continue to use the conventional accounting method (Reza Gholamia, 2021). This is the case
although the widespread expectation that Islamic Finance approach (profit-loss sharing) will
have a favourable influence.

Challenges Faced by Islamic Financial Institutions in Adopting International Financial

Reporting Standards
The prohibition of Riba and the emphasis placed on risk sharing create a variety of
outcomes for the method in which Islamic financial organizations present their financial
information. Firstly, considering Islamic financial organizations are not entitled to raise profit
through interest, these organizations are forced to explore new ways to make money.
Secondly, due to the nature of agreements in which risk is borne equally by the stakeholders
involved in the agreement, Islamic financial organizations are expected to reveal facts
regarding the risks that they are incurring. Last but not least, given the fact that Islamic
financial organizations are held to a unique set of laws than conventional financial
organizations, it could become problematic for Islamic financial organizations to conform to
international financial reporting standards (IFRS). For instance, the IFRS for Islamic
institutions mandates the publication of details relating to the different sorts of transactions
that are engaged in, the threats that exist, and the estimated cash flows. There is a possibility
that Islamic financial institutions do not have ready access to this data, or that it is impossible
to measure. The difficulties that Islamic financial institutions have met when attempting to
implement IFRS brings into more focus the requirement for additional study and research in
this field.
Islamic banks are held to similar regulatory standards as their conventional
counterparts, but in addition, they are obligated to act in accordance with the rules of Shariah.
For this reason, it may be challenging to encourage them to embrace international financial
reporting standards, since these standards are often inconsistent with Shariah. Islamic Finance
firms experience a number of barriers when attempting to follow International Financial
Reporting Standards (IFRS).
First and foremost, in the context of executing international financial reporting
standards, one of the biggest complex challenges that Islamic financial organizations
experience is keeping guaranteed that their financial reports are always in compliance with
the Shariah. This is caused by the reason that Shariah restricts the collection of interest and
demands that revenues be allocated between the client and the financial institution. Therefore,
Islamic financial organizations are compelled to come up with new strategies to keep track of
their transactions, which could be tough to do in a way that meets the requirements of
international accounting.
Furthermore, IFIs are faced with the challenge between adhering to distinctive
characteristics of their operations and expanding business through deeper integration into the
global financial markets. While IFIs are eager to truly comply with and conduct their
business in accordance with Islamic principles, they also have to ascertain that there is
international accounting and financial standardization in order to be part of the global
financial market. IFIs are concern about whether being complaint with IFRS would result in
violating any Shariah principles.
Moreover, financial based on the security of assets is the challenge will be facing
when adopted IFRS. The principle of asset-backed finance is the basis upon which Islamic
Financial is based. According to IFRS accounting for a sale and leaseback transaction, the
asset stays on the balance sheet of the original owner during the whole transaction (Islamic
Financial Institutions and the Implications of Accounting under IFRS, 2012); nevertheless,
Islamic financing is often offered against the value of the physical assets. This may make it
more difficult to determine if the sale and leaseback was carried out in a way that is
compatible with Shariah law.
Last but not least, the principle of risk sharing drives Islamic financial systems. It is
possible to lessen the impact of his danger by supplying high-quality extra disclosures. The
fundamental accounting is prescribed by IFRS for instance, it specifies that the sale and
leaseback be accounted for as a financing transaction, but IFRS does not prevent an IFI from
providing extra useful disclosures in the notes to the financial statements. In light of this, the
IFI is able to and should make further information available to its shareholders and
consumers so that they may reach their own conclusions about the Shariah compliance of the
organization's dealings. This indicates that the client and the institution participate equally in
both the profits and the losses of the business. Because of this, getting precise measurements
and reports on profitability may be challenging. (Islamic Financial Institutions and the
Implications of Accounting under IFRS, 2012)
 References

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Islamic
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IFRS. (2016). Issues in the application of IFRS 9 to Islamic Finance. Retrieved from,
https://www.ifrs.org/content/dam/ifrs/groups/islamic-finance-consultative-group/
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Misman, F. N., & Ahmad, W. (2011). Loan loss provisions: Evidence from Malaysian
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Morshed, A. (2020). Applying IFRS9 with Sukuk by IFRS’s Compliant Firms. International
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