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Islamic
Issues and challenges of IFRS 9 in financial
Malaysian Islamic financial institutions

institutions: recognition
criteria perspective 239
Marziana Madah Marzuki Received 7 April 2020
Revised 28 September 2020
Faculty of Accountancy, Universiti Teknologi MARA – Cawangan Kelantan, 24 December 2020
Machang, Malaysia Accepted 26 December 2020

Abdul Rahim Abdul Rahman, Ainulashikin Marzuki and

Nathasa Mazna Ramli
Faculty of Economics and Muamalat, Universiti Sains Islam Malaysia,
Nilai, Malaysia, and
Wan Amalina Wan Abdullah
Universiti Sultan Zainal Abidin, Kuala Nerus, Malaysia

Abstract
Purpose – The purpose of this paper is to investigate the effects and challenges of the new amendment of
International Financial Reporting Standards (IFRS) 9 in Malaysia from the perspectives of regulators,
auditors, accountants and academicians in Malaysian Islamic financial institutions. For the purpose of this
study, this paper focuses on the recognition criteria perspective of the standard, which provides a basic
understanding of the financial reporting framework.
Design/methodology/approach – Using 10 series of semi-structured interviews undertaken with key
individuals in regulatory bodies, audit companies, full-fledged Malaysian Islamic Banks and Malaysian
higher learning institutions.
Findings – The findings revealed that IFRS 9 strengthens International Accounting Standards 39 in
terms of relevance and reliability, recognition of financial instruments and identification of business
models. Nevertheless, Islamic financial institutions face challenges in terms of a faithful
representation of fair value, substance over form, identification of financial instruments before
recognition criteria and the extent of the role of risk management in reducing manipulation in
identifying business models.
Research limitations/implications – This study provides implications to regulators and standard
setters in Malaysia to enhance the quality of financial reporting framework and practices in Islamic financial
institutions in this country using IFRS 9.
Practical implications – Practically, the findings of this study can be used by the regulators to resolve the
issues that arise in adopting IFRS 9 among Islamic financial institutions to further enhance financial reporting
quality.

Journal of Islamic Accounting and

Business Research
Vol. 12 No. 2, 2021
The authors wish to express their gratitude to the Ministry of Higher Education, Malaysia for pp. 239-257
funding this research project through the Grant Scheme 600-IRMI/PBT 5/3 (031/2019) and University © Emerald Publishing Limited
1759-0817
Teknologi MARA (UiTM) Kelantan for the administrative support. DOI 10.1108/JIABR-04-2020-0100
JIABR Originality/value – The findings of this study are very important to ensure that the adoption of IFRS
among Islamic financial institutions are in line with Sharīʿah principles. To date, no studies have been done
12,2 on the challenges of adopting IFRS 9 among Islamic financial institutions in Malaysia.
Keywords Malaysia, Relevance, Reliability, Islamic financial institutions, IFRS 9,
Recognition criteria
Paper type Research paper
240
1. Introduction
The financial crisis that began midway through 2007 and continued through the end of 2008
resulted in the collapse of numerous commercial and investment banks. The crisis resulted
in a near systemic collapse of the banking sector, on which commercial lending activity
depends on (Barth and Landsman, 2010). Among the critiques of financial reporting that
were analyzed during the financial crisis are fair values, asset securitization and derivatives.
Barth and Landsman (2010) highlighted that the critiques are because of the different
objectives between regulators and standard setters. The objective of financial reporting
issued by standard setters is to provide information that is useful to investors and creditors
in making investments, credit and resource allocation decisions. While the objective of
regulators is to reduce the level of risks to which bank depositors are exposed to and
mitigate systemic financial risks. Therefore, the regulators do not limit themselves to
information contained in general purpose financial reports. They have to make their own
adjustments to recognize financial statement amounts to better suit their objectives.
In realizing the conflicted objectives, International Accounting Standards Board (IASB)
replaced IAS 39 with International Financial Reporting Standards (IFRS) 9 to meet the
objectives. IFRS 9 Financial Instruments was issued on July 24 2014 as a replacement for
IAS 39 Financial Instruments: Recognition and Measurement. Among the main
requirements of the standards include recognition and measurement, impairment,
derecognition and general hedge accounting. The issuance of IFRS 9 in 2014 supersedes all
previous versions and it is mandatorily effective for periods beginning on or after January 1
2018 with early adoption permitted. Previous versions of IFRS 9 may be adopted early
provided that the initial application of the version is before February 1 2015. IFRS 9 was
issued as a complete standard including the requirements previously issued and the
additional amendments to introduce a new expected loss impairment model and limited
changes to the classification and measurement requirements for financial assets. The
objective of the new standard is to simplify accounting for financial instruments and to
address perceived deficiencies, which were highlighted by the recent financial crisis.
Nevertheless, the application of IFRS’s standards on accounting and reporting of
financial instruments may pose some challenges to Islamic financial institutions due to the
number of possibilities of conflicts with the Sharīʿah principles. The need for harmonizing
accounting regulations and standards to the principles of Islamic finance increases with the
fact that Islamic finance has been growing exponentially globally even in countries where
Muslims are a minority, and the fact that Islamic finance has its own alternate products to
almost all conventional financial products with assets estimated to worth approximately
USD2.44tn (Islamic Financial Services Board, 2020). Therefore, the objective of this study is
to investigate the effects and challenges of IFRS 9 adoption among Malaysian Islamic
financial institutions focusing on the recognition criteria of IFRS 9. We focus on recognition
perspective, as recognition criteria is the initial criteria and is considered the first important
thing that needs to be fulfilled before going further to other conceptual frameworks such as
measurements and presentation and disclosure of financial reporting. To gain in-depth
views of these important parties, we used in-depth interviews and focused on one main Islamic
regulator, three auditors, two accountants and four academicians who are directly involved financial
in the adoption of IFRS 9 in Islamic financial institutions.
Malaysia provides an appealing institutional setting to be studied as it is among the earliest
institutions
countries in Asia that fully converge to IFRS in 2012. Thus, all companies are mandatory to
comply with the IFRS including Islamic financial institutions. However, despite observable
economic similarities with transactions already addressed by IFRS, some believed that Islamic
financial transactions need to be accounted for in a different manner because of its distinctive 241
nature compared to conventional ones (Mohd. Hanefah and Singh, 2012). In conjunction to this
matter, Paragraph 19 of IAS 1 allowed the departure from the IFRS framework and adopt
Sharīʿah principles, with reference to Paragraph 20 of IAS 1. Nevertheless, concurrently,
Paragraph 16 of IAS 1 also states that an entity shall comply with all the requirements of IFRS.
Therefore, AOSSG (2010) advocates that standard-setters may need to consider harmonizing
their plans for convergence to be Sharīʿah-compliant as any difference between these two may
lead to divergent treatments of various transactions in various jurisdictions and might still be
evident in the future. Mohd. Hanefah and Singh (2012) stressed that as Bank Negara Malaysia
and Securities Commission Malaysia have identified Islamic finance as a potential growth area,
which is vital for enhancing Malaysia’s position as a popular foreign direct investment
destination, this research is timely needed.
Several studies have been done to investigate the benefits of the replacement. Onali and
Ginesti (2014) examined the market reaction to 13 announcement dates related to IFRS 9 for
over 5,400 European-listed firms and found an overall positive reaction to the introduction of
IFRS 9. Onali, Ginesti and Ballestra (2017) also investigated investors’ reactions to the
standard-setting process of IFRS 9 for over 3,000 European-listed firms and provided evidence
that higher pre-adoption information quality and lower pre-adoption information asymmetry
have a positive impact on market adjusted return (MAR). In contrast to previous research
studies, which provided an extant review on the effects of IFRS 9 on financial reporting quality
from the perspective of investors, this study fills the gap by providing a review and debate on
the recognition of IFRS 9 from the perspectives of other users of financial statements.
Our study contributes to the international debate on whether IFRS 9 can enhance the
relevance and reliability of financial reporting of Islamic financial institutions as a medium for
the stakeholders in making their decisions. Malaysia provides a unique institutional setting as
their financial reporting standards are adopted from common law countries such as the UK and
the US but they have institutional structures that are similar to code law countries, which can
be characterized as having low enforcement, concentrated ownership and less shareholder
activism (Ball et al., 2003). We based our analysis on the explicit and implicit objectives of
financial reporting quality, and, thus, provide some suggestions for improvement in the future.
The rest of this paper is organized as follows. In Section 2, we discuss the convergence of
Malaysia to IFRS 9. Section 3 discusses the literature review on the objective of financial
reporting in terms of relevance and reliability criteria. Section 4 discusses the methodology used
in this research. In Section 5, we highlight the findings of our research and provide suggestions
for improvement of the standard. Section 6 concludes by summarizing our review and discussion.

2. Malaysia’s convergence to international financial reporting standards 9

Malaysia has fully converged to IFRS in 2012 and the standard has been renamed to
Malaysian Financial Reporting Standards (MFRS) to suit the country’s institutional setting.
Because of the replacement of IAS 39 with IFRS 9 by the IASB, Malaysian Accounting
Standards Board has also issued a complete version of MFRS 9 Financial Instruments to
replace MFRS 139 Financial Instruments: Recognition and measurement in November 2014.
JIABR The standard is a principle-based standard, which introduced a new approach for the
12,2 classification and measurement of financial assets by subjecting financial assets to the “cash
flow characteristics” and “business model” tests (Deloitte Academy, 2019). In addition, the
standard makes changes in terms of accounting in financial liabilities, impairment and
hedge accounting. The new standard, nevertheless, retains certain principles in MFRS 139
such as the requirements on derecognition of financial assets and liabilities, as well as
242 classification and measurement of financial liabilities. Below is the summary on key
changes between MFRS 139 and MFRS 9 (Table 1):
MFRS 9 Financial Instruments is effective for annual periods beginning on or after
January 1 2018, with early application permitted. Even though the main focus of the
amendment is on the measurement parts of the standard, some of the amendments may also

Items MFRS 139 MFRS 9

Classification and measurements The classification categories for financial The categories consist of
assets under IAS 39 consist of held to amortized cost, fair value
maturity, loans and receivables, Fair through other
Value. Through Profit or Loss (FVTPL), comprehensive income
and available-for-sale. The classification (FVOCI) and FVTPL that
of categories determines their reflects the measurement
measurement
Bases the classification on specific Bases the classification of
definitions for each category financial assets on
contractual cash flow
characteristics and the
entity’s business model for
managing financial assets.
a
Overall, the IFRS 9
financial asset classification
requirements are considered
more principle-based than
under IAS 39
Derivative financial assets/liabilities that Removes the cost exception
are linked to and settled by, delivery of in IAS 39 for derivative
unquoted equity instruments, and whose financial assets/liabilities.
fair value cannot be reliably determined Therefore, all derivative
are required to be measured at cost liabilities will be measured
at FVTPL
Allows certain equity investments in All equity investments are
private companies for which the fair value measured at fair value
is not reliably determinable to be
measured at cost
Impairment Has different models for different Applies a single impairment
financial instruments. Impairment losses model to all financial
are recognized on initial recognition and instruments subject to
at each subsequent reporting period, even impairment testing
if the loss has not yet been incurred

Table 1. Notes:. A business model refers to how an entity manages its financial assets to generate cash flows. It is
determined at a level that reflects how groups of financial assets are managed rather than at an instrument
Key changes between level. IFRS 9 identifies three types of business models, namely, “hold to collect,” “hold to collect and sell”
MFRS 139 and MFRS and “other.” Many entities may only have one business model but it is possible to have more than one.
9 Source: The Kosovo Banker (2017)
affect other conceptual financial reporting frameworks such as recognition criteria of the Islamic
standard. As the amendment is still new and the standard is complex, it is believed that the financial
requirements of the new standard pose challenges to Malaysian companies. The Chief
Financial Officer of Bank Islam Malaysia Berhad stressed that one of the challenges that
institutions
may be faced by the bank in adopting MFRS 9 is the high cost of implementation, especially
on the systems development and the related consultancy services, which was estimated to
be as high as RM50m for Bank Islam (Accountants Today, 2018). Despite the high cost, such
investment is highly unavoidable and fundamental to comply with the standard’s
243
requirements. Technically, companies may face limited availability of skilled resources to
cope with the technical requirements of the new standard. For example, in terms of
classification and measurements, companies may face challenges in determining the
characteristics of cash flow arising from individual contracts and to determine whether they
solely represent payments of principal and interest.
Because of the challenges, the applicability of IFRS 9 among the Islamic financial
institutions need more attention from the standards setters, regulators and practitioners to
serve the needs of stakeholders. In addition, the economic and health crisis such as the
pandemic of Covid-19 that happen recently has created adverse impacts such as cutting
down production, unemployment and cash flow constraints. Even though many packages
and products have been provided by the conventional banks to help nations to safeguard
employment and maintain their livelihoods, the easiness of interest-based loans may create a
debt trap for households and business firms in the long run, which will have a negative
impact on the economic system (Freedman et al., 2010). Thus, the roles of Islamic financial
institutions are crucial to help the people to fight the crisis. This is because Islamic finance is
an interest free system, which is claimed to be responsible, ethical, sustainable and manage
to prevent shock and risks. Islamic finance has proven to be resilient because of the nature of
its products and instruments, which offers a balanced solution to channel the funds to end-
users while at the same time do not increase the level of debt (Ahmed, 2010; Kayed and
Hassan, 2011).

3. Literature review
3.1 Theoretical framework of international financial reporting standards convergence
Previous research studies have provided empirical evidences that IFRS convergence brings
benefits to the adopters such as improving transparency, quality and comparability of
financial reports (Lara et al., 2008), experienced a greater increase in abnormal return
volatility and abnormal trading volume (Landsman et al., 2012), increases liquidity and
decrease the cost of capital for mandatory adopters as compared to voluntary (Daske et al.,
2013), improved the quality of information between capital markets (Horton et al., 2013) and
attract more analysts as voluntary adopters (Kim and Shi, 2012a, 2012b). One of the
characteristics of IFRS that may lead to better financial reporting quality is that the
restriction to recognize incurred losses can significantly reduce income smoothing.
Despite its benefits, Uzma (2016) stressed that the acceptance of IFRS as a new paradigm
of accounting is not without its share of challenges and inherent problems. Theoretically,
previous research studies have indicated that harmonized standards do not necessarily lead
to harmonized accounting practices and comparable financial reporting. According to
Guerreiro et al. (2020), this issue arises because the adoption of IFRS is not a binary decision
as the decision ranges from convergence with national accounting standards under State
intervention, to adoption of IFRS without modification or delay. Guerreiro et al. (2020)
highlighted that institutional arguments of institutional theory have the potential to provide
JIABR explanations for the diffusion of IFRS. They view that the evolution of accounting practices
12,2 in organizations is shaped largely by competing institutional logics.
Institutional logics are “the socially constructed, historical patterns of material practices,
assumptions, values, beliefs and rules by which individuals produce and reproduce their
material subsistence, organize time and space and provide meaning to their social reality”
(Thornton and Ocasio, 1999). The theory views society as composed of interacting
244 institutions, and thus, heterogeneity are observable from the contradictions between the
logics of different institutional orders. The variety of logics from an institutional order will
provide multiple forms of rationality, and, thus, provide a basis for explaining
organizational variety and resistance to change (Lounsbury, 2008; Marquis and Lounsbury,
2007), for example, to change to IFRS.
This situation has been tested and empirically proven that accounting harmonization,
which is expected from IFRS, has been impeded. For example, Carneiro et al. (2017) analyzed
the process of accounting harmonization in 13 countries of the Latin American Accounting
Standards Setters (GLASS) group and found that in most GLASS countries, banks and
financial institutions have resisted adopting IFRS because of concerns about the technical
complexity of financial instruments standards and the effect of fair value accounting
measurements. Maroun and Van Zijl (2016) found that the coercive pressures of
stakeholders’ expectations have also influenced how companies complied with IFRS 10 and
12, leading to a conclusion that the logic of resistance that occurs when specific accounting
standards are operationalized in complex social settings are shaped by the interests of users.

3.2 Empirical evidences of international financial reporting standards 9 adoption: investors’

perspective
Several studies have been done to investigate benefits from the replacement. Onali and Ginesti
(2014) examined market reaction to 13 announcement dates related to IFRS 9 for over 5,400
European-listed firms and found an overall positive reaction to the introduction of IFRS 9.
According to them, IFRS 9 reduces and simplifies many rules in IAS 39 and increases cross-
country comparability. With the increases in cross-country comparability, IFRS 9, therefore,
should decrease the degree of asymmetric information, especially for international investors
and increase the value relevance of accounting data for investment decisions (Chen et al., 2013).
Nevertheless, they conclude that regulation is particularly beneficial to shareholders of firms in
countries with weaker rule of law and a smaller divergence between local generally accepted
accounting principles and IAS 39.
In a further study, Onali et al. (2017) investigated investors’ reactions to the standard-
setting process of IFRS 9 of over 3,000 European-listed firms and provided evidence that
higher pre-adoption information quality and lower pre-adoption information asymmetry
have a positive impact on MAR. Thus, their result concludes that there is empirical evidence
to which investors’ reactions to IFRS 9 is affected by firm-specific factors. In particular,
MAR is positively related to size, has a dispersed ownership structure, there is market
liquidity for the firm’s stock and has a Big 4 auditor. Their result also provides evidence that
financial firms react relatively worse than non-financial firms to the IFRS 9 adoption events.

3.3 The risk of international financial reporting standards 9 adoption

From the Islamic point of view, there are less studies done to investigate whether IFRS 9 is
suitable to be used for Islamic instruments. Shafii and Rahman (2016) highlighted that for
Islamic financial assets, the measurements cannot be done using amortized cost as the
future cash flow receivable does not constitute solely the payment of principal and interest.
Thus, it does not fit into a default classification category of “amortized cost.” However, if it is
measured using fair value measurement, Sharīʿah issues may also arise during the adoption Islamic
of fair value at Level 2 (reference of asset values from input other than quoted prices in financial
active markets) and Level 3 (use of discounted cash flow method to arrive at asset valuation)
due to the existence of uncertainty or gharar as compared to Level 1 (fair value referring to
institutions
quoted prices of similar assets). Thus, they provide justification that IFRS 9 may not be
suitable to be used for Islamic financial assets. Other studies have also highlighted that the
changes in IFRS 9 may also lead to the issue of uncertainty. For example, D - urovic (2019)
explained that under impairment requirements of IFRS 9, the measurement of impairment 245
loss provisions need to be based on an expected credit loss accounting model rather than on
an incurred loss accounting model. The requirement is made due to significant increases in
credit risk since initial recognition. One of the weaknesses of incurred loss model is that
there is a delay in the recognition of impairment arising from credit losses until a credit loss
is probable or has been incurred (Gebhardt, 2016; Hashim et al., 2015). Therefore, banks need
to forecast future conditions, which did not affect the period on which the historical data is
based. The forecast activity may influence the bankers to use uncertainty data, which leads
to gharar in Islam. Hashim et al. (2015) thus, added that compliance with professional and
legal regulations is not a sufficient guarantee for ensuring quality financial reporting. In
spite of this, ethical behavior in the process of providing the desired quality is more
important.
Overall, their findings support the argument that IFRS 9 adoption may not lead to higher
accounting quality, per se, for all firms and this may be because of investors’ views about the
expected costs and benefits of IFRS adoption among firms, thus, warrant further research to
investigate the effects of IFRS 9 once the implementation of this standard has taken place.
Despite the studies done on the effects of IFRS 9, there are scarce studies done to investigate
the effects of this standard on Islamic financial institutions from the viewpoint of
practitioners such as accountants and auditors, regulators, as well as academicians. Thus,
this study tries to fill the gap by focusing the investigation on the effects of IFRS 9 on the
recognition criteria of the standard. We focus on recognition as this conceptual framework
will determine other conceptual frameworks in financial reporting.

4. Methodology
To gain in-depth views of respondents, we used an in-depth interview method focusing on
four parties of respondents who are directly involved with the adoption of IFRS 9. In line
with the objective of this research, which is to gain in-depth views of practitioners,
academicians and regulators on the IFRS 9 adoption, we established a potential list of
interviewees from all the parties and subsequently selected 10 interviewees consisted of 2
accountants, 3 auditors, 4 academicians and 1 main regulator. For the practitioners, the
selection made were based on their experience in adopting the standard. Meanwhile, the
academicians were selected based on the number of years teaching financial reporting
standards, familiarity with the IFRS 9 standard and number of research studies done related
to IFRS adoption in Malaysia. Our respondents consisted of one academician who has less
than five years of experience and three senior academicians who have more than 10 years of
experience in teaching financial reporting standards and hold the title of Associate Professor
and Professor. In addition, one regulator is selected as they were directly involved in
regulating financial reporting standards and ensuring the adoption of the standards.
According to Guion (2001), as in-depth interviews use an open-ended and discovery-oriented
method, it allows the interviewer to deeply explore the respondents’ feelings and
perspectives on a subject. This will result in rich background information, which can shape
further questions relevant to the topic. In-depth interview is an effective qualitative method
JIABR for getting people to talk about their personal feelings, opinions and experiences. It is also an
12,2 opportunity to gain insight into how people interpret and order the world. It is also an
effective qualitative method for allowing interviewees to talk about their personal feelings,
opinions and experiences, and, thus, provide an opportunity to gain insight into how people
interpret the situation described (Milena, 2008). Table 2 provides the details of the
interviewees:
246 For the purpose of gaining insight views of our respondents, the in-depth interviews were
conducted in the form of semi-structured interviews, using a tape recorder. The length of the
interviews ranged from 2 to 3 h. To facilitate the interviews, we prepared a list of questions
as an interview guide. In line with the aforementioned research objective, we provided
questions based on three main issues:
(1) The trade-off between relevance and reliability in recognition criteria of IFRS 9.
(2) The challenges in recognizing contractual provisions of financial instrument in
IFRS 9.
(3) The issues arise in three classifications of business models prescribed by IFRS 9.

To allow for a comprehensive discussion on these pertinent topics, some probing questions
were also outlined in our interview guide. All the interviewees were guaranteed with
confidentiality and were also assured that their identities will not be revealed in any
publication. The guarantee enables the interviewees to feel more comfortable in answering the
questions freely and honestly. After obtaining data from the interview sessions, we transcribed
the data to attain general ideas of what the interviewees were responding to and to further
reflect on its meaning before the data was encoded into themes.

5. Findings and discussion

5.1 Recognition criteria of international financial reporting standards 9: the trade-off
between relevance and reliability
IFRS has been introduced by the IASB beginning 2005 to enhance financial reporting
quality in terms of enhancing transparency and comparability of financial statements.
Accounting standards setters have historically determined that the two important
determinants of financial reporting quality are the concept of “relevance” and
“reliability” (Ball, 2006). Information in financial statements is relevant when it is
capable of making a difference to a financial statement user’s decision. In contrast,

No. Interviewees Positions Years of experience

Interviewee No.1 Regulator Regulator of Accounting Bodies More than 17 years

Interviewee No.2 Academician A Senior Academician More than 20 years
Interviewee No.3 Academician B Academician Four years
Interviewee No.4 Academician C Senior Academician More than 12 years
Interviewee No.5 Academician D Senior Academician More than 20 years
Interviewee No.6 Auditor A Audit Partner International Big Firm More than 15 years
Interviewee No.7 Auditor B Audit Partner International Big Firm More than 20 years
Interviewee No.8 Auditor C Audit Partner International Big Firm More than 15 years
Interviewee No.9 Accountant A Chief Financial Officer 18 years
Table 2. Banking Industry
Details of Interviewee No.10 Accountant B Chief Financial Officer More than 21 years
interviewees Banking Industry
information is reliable if a user can depend upon it to be materially accurate and if it Islamic
faithfully represents the information that it purports to present. Faithful representation financial
means that the information reflects the real-world economic phenomena that it intends
institutions
to represent (Palea, 2013). Thus, significant misstatements or omissions in financial
statements reduce the reliability of the information contained in them. FASB (Financial
Accounting Standards Board) Concepts Statement No. 2, Qualitative Characteristics of
Accounting Information states that: 247
The qualities that distinguish better (more useful) information from inferior (less useful)
information are primarily the qualities of relevance and reliability[. . .] The objective of
accounting policy decisions is to produce accounting information that is relevant to the
purposes to be served and is reliable. [Paragraph 15].
Relevance and reliability are both critical for the quality of financial information.
Nevertheless, some FASB constituents have questioned certain trade-offs between relevance
and reliability that the Board has made in setting accounting standards. Both the FASB and
IASB have to consider the costs and benefits of the tradeoff between relevance and
reliability when assessing how best to measure specific accounting amounts and whether
measurement is sufficiently reliable for financial statement recognition. These two
qualitative characteristics are related such that an emphasis on one will hurt the other and
vice versa. Hence, accounting standards setters have to trade-off between them (Johnson,
2005). For example, accounting information is relevant when it is provided in time, but at
early stages, information is uncertain, and hence, less reliable. Thus, if we wait for the
information to gain its reliability, its relevance is lost.
Therefore, we interviewed the respondents on whether there is any trade-off between
relevance and reliability when preparing financial reports in Islamic financial institutions
when using IFRS 9. Most of the respondents agree that there is no issue of trade-off between
the two as both are needed in preparing financial reports. One of the auditors responded that
there is no issue of trade-off between relevance and reliability as auditors are doing the audit
based on true evidence. He expressed that:
In Malaysia, we have to follow MFRS, which is based on IFRS. We have no choice. Thus,
there is no issue of trade-offs because we have to follow the rules. For an auditor, our main
concern is the relevancy of information, but of course, we have to wait for reliable evidence.
Nevertheless, we have the deadline to sign the auditor’s report. So, as long as we follow the
deadline and get reliable evidence, there is no issue of trade-off.
The statement of Auditor B is also typical:
There is no issue of trade-off between relevance and reliability in preparing financial
reports because, as an auditor, our main objective is to provide true and fair view information.
Hence, whether the information is reliable or relevant, the most important thing is fair
presentation and adequate consideration.
Both statements are supported with the statement by the regulator who stated that:
In 2018, the term reliability in the financial reporting conceptual framework has been
taken out. The term reliability has been replaced with faithful representation as faithful reflects
a better conceptual framework as compared to reliability. When you say that you are faithfully
reporting the financial information, it means that you presenting the real economic
phenomena. For example, we have two floors of the building, one is used for our operation and
another one is rented out. So, the one that is used for the operation we disclose as our
property, plant and equipment and the one that is rented out is disclosed as investment
property. That is why economic substance is very important. Thus, in 2018, substance over
form is included back in the conceptual financial reporting framework.
JIABR Despite the unanimity of no issue of trade-off between relevance and reliability, some of
12,2 the respondents responded that whether there is an issue of trade-off or not, it depends on
the situation. Auditor C expressed his view that:
If we talk about the financial reporting perspective where the financial statement has gone
through approval by the board and audited, I do not think that we have a trade-off between
relevance and reliability because no matter what, the information disclosed has to be relevant
248 and also reliable. However, if we talk about management reporting where we have the dateline
to submit a report to the management, let’s say you have to submit within five days, then there
is the issue of trade-off between relevance and reliability because you have to comply with the
dateline.
The statement of Academician A is typical:
It is no issue of trade-off but if we have time constraints then yes, there is an issue on the
tradeoff between relevance and reliability.
Their views are consistent with previous research. According to Schöndube-Pirchegger
and Schöndube (2017), the question whether relevance or reliability renders accounting
information more useful is still far from obvious. Thus, they view that, to answer the
question, we have to understand the purpose of accounting information, for example,
whether it is used for valuation or contracting purposes. Thus, different objectives might
have different preferable characteristics of accounting information.
From the perspective of academicians, there are various opinions on the issue of
relevance and reliability. Academician A expressed that:
Financial reporting standards are more toward relevance compared to reliability especially
on the issue of fair value.
This view is then supported with the view from Academician C who expressed his view
that:
Relevance and reliability are both needed and important for accounting information,
especially in the decision-making process. Historical cost is more reliable but we have a problem
in terms of relevance. Meanwhile, fair value is more relevant even though they might have a
problem in reliability.
In summary, there is no issue of trade-off between relevance and reliability when
preparing financial reports for Islamic financial institutions using IFRS 9 because for
practitioners, especially auditors, they have to follow financial reporting standards and have
to ensure all accounting information are faithfully presented within the accounting period.
The issue of trade-off between relevance and reliability arises if there is a time constraint in
presenting accounting information. Therefore, with the adoption of IFRS 9, there is no issue
of relevancy as the practitioners put more importance on faithful representation of
accounting information. Nevertheless, accounting standards are more toward relevancy if
accounting information has to be disclosed at fair value. Thus, when fair value is used as a
measurement in accounting information, Islamic financial institutions might have a problem
of faithful representation. Thus, when fair value measurement is used in measuring Islamic
financial assets, then, the issue of relevancy has to be taken care of. If both relevance and
faithful representation are needed in the financial reporting conceptual framework, then, it
has to be ensured that the fair value measurements are faithfully represented in accounting
information.

5.2 Recognition criteria of financial asset and financial liability in international financial
reporting standards 9
The principles for the recognition of financial assets and liabilities of IFRS 9 is carried
forward from IAS 39. According to the initial recognition of IAS 39, the standard requires an
entity to recognize a financial asset or liability on its financial statement only when it Islamic
becomes a party to the contractual provisions of the instrument. Based on these criteria, financial
there is no significant impact on the recognition of financial assets or financial liabilities, as
the adoption of IFRS 9 as the criteria is carried forward from IAS 39. To date, there is still no
institutions
debate on the recognition criteria of this standard, as the focus is more on the classification
and measurement of the standard. Therefore, this paper tries to explore the issue on the
application of recognition criteria in terms of its relevance and reliability on accounting
information. 249
The recognition time provided by the standard pursues the question of when can the
firms confirm that they have become a party to the contractual provisions of the instrument?
Is it when they sign the contract? Or when they start to receive or pay the first contractual
cash flow? Or is it when they have received or paid all the entitled contractual cash flows?
The ambiguity posted by the criteria also raises the issue of relevance and reliability as timely
reporting will result in less reliability, whereas delay in reporting will result in less relevance.
Taking into consideration revenues as a performance measurement of a financial asset, for
example, the revenue is recorded when it is realized. Schöndube-Pirchegger and Schöndube
(2017) highlighted that revenue is recorded when it is realized, which can be indicated by
transferring significant risks and control over the goods to buyers. In addition, the amount to
be recorded needs to be reliably measurable and the actual flow of benefits to the firms has to
be probable. Thus, in the case of financial instruments, if it is recorded when the contract is
signed, at that point of time, the risk and reward is already transferred to the parties involved.
Nevertheless, the amount reported is quite noisy as the contractual cash is not confirmed yet.
Thus, the recognition is relevant yet less reliable. In contrast, if the financial instrument is
recorded when the firms receive all the entitled contractual cash flows, the amount recorded
will be less relevant and delay in reporting will affect contractibility. However, the amount can
be safely assumed, and thus, less noisy.
Nevertheless, when we asked our interviewees, most of them agreed that the recognition
criteria stated in the standard is clear and very straight forward. They agreed that financial
instruments either financial asset or liability is recognized once both parties become a party
to the contractual agreement regardless of whether the contract is executed or disbursed.
The keyword in the recognition criteria is contractual, which highlights the commitment of
the parties toward the contract. Auditor C highlighted that:
I think, in terms of recognition, it is not too difficult as it is always about the point of time.
When we talk about financial instruments, we are talking about a transaction and this
transaction should be simple. So, everything must be based on the contract. There is no
ambiguity as there is offer and acceptance and it happens simultaneously. The date when they
agree to sell and the time of signing of the contract is almost the same day. The time difference
is insignificant. Thus, there is not so much challenge in terms of the recognition of financial
instruments.
The regulator viewed that:
In terms of recognition, what is important is what has been treated in the contract. It
depends on what has been agreed when you sign the contract because the keyword is
contractual.
This statement is also supported by all four academicians:
Based on the recognition criteria, the financial instrument is recognized when you become
a party to the contractual agreement regardless of whether you have received the
disbursement or not.
It is clear and straight forward. We recognize the financial instrument when there is an
agreement between the two parties or when the asset and liability is transferred.
JIABR When there is a contract, there is a commitment to implement the contract.
12,2 We must recognize based on the contractual provisions of the instruments. The statement
is very general. Contractual means we have the contract and this refers to the contractual cash
flow.
Nevertheless, one of the auditors highlighted that:
Problems will arise when the contract is not fully documented, making it difficult when
250 defining the recognition criteria.
In addition, Academician C stressed that:
If we form the recognition criteria based on the contract, then the standard is more toward
form over substance. However, in our discussion, we still highlighted it as substance over form.
If we based it on the contract, then it provides the basis that form is stronger than substance.
This will become the issue. For example, Ijarah contract. We record it as a financial
instrument but, in the nature of contract, it is leasing. Then, we should refer to leasing
standards and not financial instruments. The same goes to Murabahah To Purchase Orderer
(MPO). It is trading but we do not refer to IFRS 15 but, instead, we also classify it as a
financial instrument.
Overall, the interviewees supported that the keyword to recognition criteria of IFRS 9 is
contract. Nevertheless, the interviewees highlighted that the recognition criteria might give
rise to the issue of substance over form in recognizing the product as a financial instrument.
This may be solved if the standard includes the identification of financial instruments before
recognizing it as a financial instrument. This is consistent with what has been highlighted
by one of the academicians who said that:
[. . .] whether the financial instrument is an asset or a liability, it depends on the execution
and disbursement. In terms of recognition, the standard needs to be more comprehensive.
However, if you look at the counter party’s perspective, the evaluation might be different. It is
between buyers and sellers or issuers and investors. However, these two different perspectives
have been mixed up within the standard. It will be challenging in terms of valuation. Some of
the standards they have identified as part of recognition criteria. For example, intangible
assets. Sometimes, when we are a little bit cloudy, we need to identify first before we recognize.
The same goes to financial instruments. When we issue the financial instruments, then, it
becomes a financial instrument. If not, then the financial instrument does not exist.

5.3 Identification of business models in international financial reporting standards 9

Among the changes in IFRS 9 is the classification categories for financial assets under IAS
39 of held to maturity, loans and receivables, fair value through profit or loss (FVTPL) and
available for sale has been compressed to only three business models, which are hold to
collect, hold to collect and sell and others. Classification of the business models will
determine the measurement of the financial assets. Financial assets are comprising either
debt or equity components. With the introduction of IFRS 9, all equity components are
measured at fair value. Meanwhile, for debt components, financial assets are measured at
amortized cost if the entity intent to hold it until maturity date (hold to collect). Nevertheless,
if the entity is uncertain whether to hold until maturity date or maybe to sell it in the future
date, then, they should classify it as hold to collect and sell and measure it using fair value
through other comprehensive income (FVOCI). The third classification, which is others, is
for the entity with the intention to trade financial assets, thus, the measurement should be
using fair value through profit and loss (FVPNL).
Despite the three classification models, there is less evidence on how the entities
determine their business models with the introduction of this new amendment. Therefore,
we interviewed our respondents on the basis of determining the business models and how
far the new amendment can enhance financial reporting quality in Islamic financial Islamic
institutions. The regulator highlighted that: financial
To decide, which business models to choose, the company needs to come out with their
policy and the policy needs to be complete. This policy needs to be approved by the board. Once
institutions
it is approved by the board, then it cannot simply be changed. For the bankers, they rely on
solely payments of principal and interest (SPPI) test to decide, which business models to
choose.
The revised reporting standard IFRS 9 has also introduced one new system for financial 251
instruments called the SPPI test. SPPI test is a test that is to be conducted by financial
institutions for the purpose of assessing contractual cash flow features contained in a
financial asset. According to IFRS 9, the contractual cash flow needs to be SPPI. If the
financial assets pass this test, then, the instrument qualifies as either amortized cost or
FVOCI. If it fails to meet the SPPI test criterion above, such financial assets will be classified
as FVTPL, which means that the profit or loss gained from trading has to be shown in their
profit and loss. This testing is required on the contractual cash flow characteristics of each
instrument, instead of the overall portfolio or business.
Meanwhile, cash flows from equity instruments and derivatives do not contain principal
or interest elements. Therefore, such assets will be classified as FVTPL. Equity instruments,
which is not held for trading may initially opt for FVOCI but it will be an irreversible option.
So, the only utility of the SPPI test is with respect to such financial assets, which are debt
instruments.
Auditor B stressed that there are two important factors in determining the classification
of financial instruments, which are cash flow objective and financial intention. Auditor C
stated that:
In IFRS 9, you have to determine the business models. You need to determine whether it is
SPPI. Thus, the entities need to have the process, and the task of an auditor is to audit the
process to ensure that the recognition of the business models are done accordingly.
This is supported by Auditor A who expressed that:
When an entity buys financial instruments, they have to go through the SPPI test. This test
is about two things. One is about your cash flow characteristics and the second one is your
business model whether you want to hold it for maturity or for trading. If for trading, then you
have to use FVPNL. However, the challenge is to determine the fair value. As an auditor, we
have to go through the entity’s justification for the business model chosen to ensure that the
instrument has passed all the tests.
From the view of preparers of financial statements, Accountant A emphasized that:
To me, the classification of the business model in IFRS 9 is quite the same as IAS 39. It is
just a change in terms. What we did is initially mapping it to hold, collect and keep it until the
maturity date. Then, subsequently, we look back at the contract to see any ambiguous area
and prepare again the contract to make it clearer. IFRS 9 is easier as once we confirm it is hold
to collect, then, no need for us to review back. The challenge is when we have ambiguities, we
have to review back the contract in detail one by one. That makes it difficult for us. However, it
is only initial. Once we get familiar, then, we understand it better. Another challenge is when
we want to present it in financial statements. If let’s say last year, we have a lump sum figure
of hold to collect, then, suddenly, this year we have to allocate to different business models.
Then, we have to explain in the disclosure. Usually, we will sit down with the auditors to
categorize it. Nevertheless, for the second year, there should be no problem.
We also asked the interviewees if there is any possibility of hidden motives by the
company to choose any of the business models in determining the measurement of their
financial instruments. One of the academicians replied that the possibility of manipulating
JIABR the business models for the sake of their financial statements has been catered for by the
12,2 standard setters. She said that:
Basically, standard setters have already predicted the hidden motive of the entities. That is
why for the equity components of financial assets, there is no amortization of cost. This is because
equity components of financial assets usually can be traded in the market, and thus, we can get
the market price. Therefore, all the equity components of financial assets should be valued at fair
252 value. They have to decide either FVOCI or FVPNL. However, for these alternates, the standard
has prescribed that if the entity chooses to value at FVOCI, then it is irrevocable.
Nevertheless, two of the academicians opined that the alternates of business models
chosen might lead to financial reporting manipulation. Academician B stated that:
When the entities have several alternates, then there should be an opportunity to
manipulate. At this point of time, risk management will be involved.
The role of risk management in selecting business models have also been raised by the
regulator. She stated that:
The new amendment of IFRS 9 has forced the finance and risk department to actually
speak to each other.
Based on the findings of the interview, it can be summarized that the new issuance of
IFRS 9 replacing IAS 39 still poses challenges and issues to users in Malaysia in terms of the
technicality of the standard especially to Islamic banks, which have to adhere to Islamic
laws or Sharīʿah. First, the issuance of IFRS 9 requires users to recognize financial assets
based on the contract, which are more toward form over substance. Nevertheless, if financial
assets contracts in Islamic banks such as Ijarah and MPO are recognized based on the form,
they are not a type of financial instrument. For example, Ijarah is a leasing contract and
MPO is a trading contract. Thus, the recognition of Islamic financial assets is still based on
substance over form. From an Islamic perspective, there is still a debate among Islamic
jurists. Hamour et al. (2019) highlighted that The Shafi’i School is more inclined toward form
over substance and is in conflict between internal will and external consent, which approved
only what has been written in the contracts as a rule in the courts. Nevertheless, the Hanafi
School strictly adheres to substance over form in exchange of offer and acceptance. Sharīʿah
stresses that both form and substance are important, but they shall not contradict each
other. However, in case of inconsistencies that arise between the two, the Sharīʿah law
prioritizes substance over form.
Second, in terms of identification of business models, the SPPI test requires contractual
cash flows need to be SPPI to qualify as either amortized cost or FVOCI. As Islamic financial
assets do not constitute solely the payment of principal and interest, it needs to be measured
using fair value measurement and this will give rise to Sharīʿah issues especially during the
adoption of fair value at Level 2 (reference of asset values from input other than quoted
prices in active markets) and Level 3 (use of discounted cash flow method to arrive at asset
valuation). These two levels involve uncertainty or gharar as compared to Level 1 (fair value
referred to quoted prices of similar assets). The findings are consistent with the issues
highlighted by Shafii and Abdul Rahman (2016). From Sharīʿah perspective, it leads to the
conclusion that IFRS 9 may not be suitable to be used for Islamic financial assets. Despite
that, Islamic banks in Malaysia still need to comply with the requirements of the standard.
Therefore, understanding of these two issues concludes that IFRS 9 can be applied in
Islamic financial institutions provided that those who are involved in the application of the
standard must acknowledge the role of Sharīʿah in economic activities. Even though there is
still debate among the Islamic scholars on whether substance over form or form over
substance, the most important thing is the application of accounting standards by Islamic
financial institutions must fulfill the Sharīʿah objectives. In other words, the Islamic scholars
should achieve consensus among them to make sure that the Islamic financial instruments Islamic
are Sharīʿah-compliant rather than “making it Sharīʿah-compliant.” Atmeh and Maali (2017) financial
highlight that various techniques have been used by the Islamic banking to claim that their
products are Sharīʿah-compliant. That is why even after three decades of their introduction,
institutions
functionally Islamic financial institutions still remain not much difference with conventional
banking (Khan, 2010). For example, the current practice of Murabahah contracts is still
resembles trade financing as the Islamic banks play the role of the seller after the goods are
certainty bought by buyers. This practice leads to deviation from Sharīʿah as the bank does 253
not bear the risk of unsold goods as normal traders do (Ismail and Tohirin, 2010). Previous
research studies have argued that the form over substance technique is one of the
approaches used by Islamic financial institutions that is intent to avoid riba but at the same
time actually open back the door to Riba (Rosly, 2010). El-Gamal (2008) highlights that
according to Sharīʿah rules stated in Hadith “matters are determined according to
intentions” and “in contracts, the effect is given to intention and meaning and neither words
nor forms.” Thus, following the substance of most transactions conducted by Islamic
Financial Institutions, which is merely a secured loan is, therefore, comply with the Sharīʿah
rules. Nevertheless, some of the Islamic scholars do not agree with its function is due to the
charge of interest, which is prohibited in Sharīʿah. Unfortunately, the interest is clearly
practiced in IFRS. This situation creates a dilemma for the Islamic financial institutions as
they have to comply with the standard.
As the adoption of fair value measurement also involves with uncertainty or gharar
especially for Levels 2 and 3, the Islamic financial institutions need to reduce the adoption of
fully fair value, and thus, in this situation, cash equivalent value may be the best choice for
Islamic financial institutions as recommended by Accounting and Auditing Organizations for
Islamic Financial Institutions, which is fully adopted by some of the middle east countries.
According to Wahyuni-TD (2017), to avoid Sharīʿah issues in accounting measurement, the
valuation of assets and liabilities for the purpose of accounting measurements should consider
the types and the nature of assets and liabilities. In doing these professional duties, accountants
should understand that they have to adhere to the code of ethics based on the Holy Quran and
Sharīʿah principles to gain rewards from Allah SWT not only in this word but more
importantly in the hereafter. Thus, understanding the Sharīʿah objectives are crucial issues to
ensure that Sharīʿah are complied in every aspects of life.

6. Conclusion
IASB has issued IFRS with the objective to enhance the credibility and comparability of
accounting information. Ball (2006) states that IFRS is designed to make earnings more
informative, provide more useful balance sheets and to reflect economic substance more
than the legal form. The issuance of IFRS 9 in replacement of IAS 39 is one of the recent
efforts by IASB to improve the quality of IFRS in simplifying accounting for financial
instruments and address perceived deficiencies, which were highlighted by the recent
financial crisis. Such new effort is expected to increase cross-country comparability, and,
hence, should decrease the degree of asymmetric information, especially for international
investors and increase the value relevance of accounting data for investment decisions.
Nevertheless, the application of IFRS’s standards in accounting and reporting of
financial instruments may pose some challenges to Islamic financial institutions due to a
number of possibilities of conflicts with the Sharīʿah principles. Based on the interviews
with regulators, auditors and accountants in Malaysian full-fledged Islamic banks and audit
companies, as well as academicians in Malaysian public universities, our findings revealed
that there is no issue of relevance and reliability in IFRS 9 as the standard is more toward
JIABR presenting a faithful representation of information. The standard also provides clearer
12,2 guidelines in recognizing financial instruments based on the contracts provided and agreed
between the parties. The compression of business models into only three classifications and
the SPPI test reduces the possibility of manipulation in valuing financial instruments.
Nevertheless, there are several issues that still need further discussion, especially among
regulators and standard setters in terms of how far the use of fair value can faithfully
254 represent financial information. Among the issues are, namely, substance over form in the
contract, the need of identification criteria before recognizing financial instruments, the
existence of an interest in SPPI test, the nature of Islamic financial assets and the extent of
the role of risk management in reducing manipulation in identification of business models.
In spite of the issues highlighted, especially from the Sharīʿah perspective, practitioners in
Islamic banks highlighted that they have to comply with the standard as its applicability is
made compulsory by the regulators.
The findings of this study thus, require further attention from the standard setters and
regulators in Malaysia to ensure that accounting standards can be harmonized with the
principles of Islamic finance. Even though the purpose of IFRS convergence is to enhance
comparability and consistency of financial reporting, it should also provide useful information to
the users of financial statements to enhance the quality of financial reporting. As the main clients
of Islamic banks are Muslims, these banks have to provide accurate information to Muslim users
and play their role in helping users to comply with Sharīʿah principles. Thus, they may face a
dilemma to fulfill this role while complying with the regulations provided by the regulators. Such
a dilemma needs attention from regulators and standard setters in this country.
This study is limited to the discussion of issues on the recognition of IFRS 9. Future
research may also discuss the issue of measurements, disclosure and presentation of IFRS 9.
In addition, our main limitation was that some of the interviewees lack knowledge on
Sharīʿah issues. Therefore, some of the Sharīʿah issues cannot be further elaborated.
Furthermore, this study is limited to the perspective of preparers of financial statements and
standard setters. Future research may also take into consideration the view of investors and
other users of Islamic financial institutions’ financial statements, which may view the
applicability of IFRS 9 in the context of Malaysia’s institutional setting. Malaysia provides a
unique institutional setting as it is known as a multiracial country, which consists of
different race and religion. The setting may pose more challenges to the preparers and
standards setters as they have to balance between the rules provided and the needs of users
of Islamic financial institutions’ financial instruments. Regardless of that, the discussions
can provide suggestions to regulators to improve IFRS 9, and hence, increase the quality of
accounting information in Malaysian Islamic Financial Institutions as demanded by IASB.

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Corresponding author
Marziana Madah Marzuki can be contacted at: marzianamadah@uitm.edu.my

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