Adoption of IFRS in Malaysia - Essay Example

Adoption of IFRS in Malaysia Introduction The method of financial ment preparation is of great essenceto all the stakeholders in a particular set of economy. Harmonization of the manner in which various items are treated in the accounting system allows for comparability. Comparability is used to rate the performance of regional economies and institutions against other regions. IFRS and Accounting, and Auditing Organization of Islamic Financial Institutions (AAOIFI) were founded based on establishing a unified way of reporting the financial transactions across all the sectors. However, the two types of standards differ in the manner in which various items are treated in the accounting system (MIDA 2014, p. 16). On the other hand, IFRS was enacted to harmonize the universal accounting procedures and processes into a harmonized system. This study will cover the implementation of the IFRS by the country of Malaysia. The paper will have a candid review of the adoption of the IFRS by Malaysia, and the conflicts that this move presents to the application of the AAOIFI standards. As a start off, the paper evaluates the financial and accounting system in Malaysia. AAOFIFI and IFRS are then evaluated with respect to their components, procedures of application and treatment of various financial transactions. The paper then compares and contrast the accounting treatment of both standards before discussing the procedures that are used by the Malaysian authorities to implement IFSR and overcome Conflicts with AAOIFI (Schoon 2009, p.50). The study finalizes by analysing the effectiveness of the IFRS implementation strategy in Malaysia. Malaysia Financial System The financial system of Malaysia is made up of Islamic and conventional financial institutions which operate in parallel. The apex of financial and monetary structure in Malaysia is the Bank Negara, which is the Malaysian Central bank. The financial system comprises the banking and non-banking system. The banking system is made up of 21 Islamic banks, 25 commercial banks and 15 investment banks. To compliment banking institutions are the non-banking financial institutions. In Malaysia, there are 43 insurance and re-insurance companies, 13 Takaful Operators, four retakaful operators and six development financial institutions. The Islamic financial system in Malaysia has continued to grow and develop. Currently, the Islamic financial system comprise of Takaful, Retakaful, Islamic Capital Market and Islamic Interbank Money market. MIFC (International Islamic Financial Centre) was opened in the year 2006, with the aim of strengthening the role of Malaysia as an Islamic financing intellectual epicentre (Rahman, Rahim and Shariff 2013, p. 63). Financial Reporting Act, 1997 bestows the mandate of issuing accounting standards in Malaysia, to Malaysia Accounting Standards Board (MASB). On June 2011, this board issued the exposure draft whose objective was converging the accounting practice in Malaysia with IFSR by January of the year 2012. The issuance of the draft was in line with the formulation of the new Malaysian Financial Reporting Standards (MFRS) Framework. The framework comprises the accounting standards which were effective in Malaysia from first January of the year 2012. The standards deal with employee benefits, fair value measurement, joint arrangements, consolidation and financial instruments amongst others (Zakaria and Shaf 2013, p. 41). The implementation of the standards presents the Islamic Financial Institutions with the challenge of ensuring that they comply with the IFS without violating compliance with the Shariah principles. IFRS IASB issues IFRS Standards that offer a framework on how the financial statements are supposed to be presented and prepared. IFRS provides guidance on the financial statements’ qualitative characteristic, objectives, elements, elements recognition, elements measurements and various concepts. The standards aim at enhancing constancy and uniformity in the accounting practice. IFRS is used by more than 100 countries around the world. Some countries like Canada, Argentina, and Korea adopted the IFRS in the year 2011 while other countries such as USA and Japan have set their convergence years like 2014 and 2016 respectively. Other countries are realigning their use GAAP (Generally Accepted Accounting Principles), to totally comply with the IFRS. In Malaysia, the compliance with IFRS was effective from January 2012 and the institutions that were mainly affected are Islamic Institutions (Deloitte 2014, p.10). AAOIFI The accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) is vested with the role of issuing and formulating International Islamic Finance Standards. The board has issued 80 standards entailing 40 Shariah standards, two codes of ethics, five auditing standards, 26 accounting standards and seven governance standards. AAOIFI is supported by more than 40 countries and is based in Bahrain. The formulation of the Islamic accounting standards was motivated by the divergence in the manner in which the conventional financial institutions operates as compared to the Islamic financial institutions. Islamic financial institutions operate in a sharia compliant manner. The Islamic banks use different Islamic financing concepts which include mudharabah (profit sharing), ijarah (leasing) and musyarakah (partnership). The essence of these products is to avoid ribah (interest) and encourage profit sharing deals between the financial institutions and their customers (PWC 2013, p. 45). Comparison of IFRS and AAOIFI The proponents of Islamic accounting standards point to the difference in the aim of financial reporting in conventional accounting compared to the Shariah perspective. The essence of financial conventional financial reporting is to provide information to the stakeholders; however, the Islamic premise conceptualizes financial reporting to be wider. In the Islamic perspective reporting covers revealing whether an institution is Shariah compliant and whether it is abiding by concepts of charity, business ethics and fairness (KPMG 2013, p. 21). The AAOIFI developed unique financial standards owing to the peculiarity in Islamic transactions and to bridge the reporting gaps in the IFRS (Ariff & Iqbal 2011, p. 320). The main difference between Islamic reporting standards and the IFRS is on the accounting concept of substance over form. IFRS emphasises on the economic nature of the transaction. On the other hand, Shariah compliance finance emphasises on the contractual nature of the transaction. To underpin the criticality of contractual aspects are Islamic products such as istisna, musharaka, mudaraba and sala, which present different obligations and rights, attached. An example of this conflict is in the treatment of ijara. This is an operating lease and under IAS17, there appears to be not different in treatment to either the lessor or lessee. However, use of ijara wa iqtina, which operates like the conventional hire purchase, presents some conflicts. In the conventional contracts (IAS17), the lessee treats the assets under lease as such, while the lessor books interest and rent receivable. This is because the rewards and risks associated with the asset ownership are the substances that have been transferred to the lessee. On the contrary, the Islamic IFAS2 and AAOIFI’s FAS8, the critical part is the contractual legal part. This means that the lessor retains the property ownership. As such, the IF records ijara as its assets (MASB 2011, p. 35). For the accounting purposes, it means that the lessor retains the account for the item that has been leased. In the Islamic banking, the common practise is using the investment structure which is based on mudharabah. In the conventional banks, customer deposit system is used. The salient features of these two accounts create major differences that affect the manner in which they are reported. AAOIFI’s FAS6 provides for the treatment of unrestricted investment accounts (URIA) as quasi equity form. The loss on the account is borne by the investor which principally makes them equity investor or residual claimant, unless the loss is due to the negligence of IFI. The URIA is treated by many banks (that base their accounting on IFRS or Malaysia GAAP) as a liability in their statement of the financial position. However, AAOIFI standards provide for the treatment of this account in mezzanine level between equity and liability. Treatment of the investment reserve is very different between conventional financing and the Islamic finance. In the Shariah compliant method, any loss accrued from the mudaraba investment, the depositor customer will bear the entire loss. Under IFRS, bearing of the loss by the investor depends on the nature of the contractual agreement. The profit equalization reserve is required to be set by the IFI under AAOIFI. This means that the IFI has to set aside profit share with investors, which is not permitted by the IAS39. Another major difference between the two accounting standards is the inclusion of the concepts of the time value of money concept and recognition that is based on the future probability by the IFRS. In the AAOIFI, time value of money is not recognized all the times and recognition is mainly based on the rights and obligations (ACCA 2013, p. 32). 5.0 Approach of Malaysian Government to AAOIFI and IFRS conflicts In Malaysia, different approaches are used to solve the conflicts that exist between the conventional fiancé and the Islamic finance. In IFRS, substance over form serves as a key tenet. Shariah compliant financial institutions in Malaysia consider the obligations name the rights that are created by the transaction rather than the form. This does not contravene the IFRS standard because the impact of the transaction is the same to the total value of the financial statement. Different types of transactions are treated according to their peculiar nature in a manner that is compliant to the Shariah and the one that does not contravene IFRS. For example, ijarah contract is treated a lease contract in the Islamic banks while, in the conventional banks, it is treated as a hire purchase agreement. In either way, the treatment of the item does not affect the total impact of the transactions in the books of account. Various products have been designed that tries to make the convergence of IFRS possible in Malaysia. Sukuk is one of the products that have been developed which offers more comparability between both Islamic finance and conventional finance. Sukuk replaces the conventional commercial papers and bonds. Sukuk is traded like the normal bond and it is traded on amortised cost that does not contravene IAS 39. When there is a controversy between the IFRS and the AAOIFI standards the authorities in Malaysia requires that, the Islamic Financial institutions report in IFRS standards. The Bank Negara Malaysia Shariah Advisory Council accepts the IFRS treatment of major items for the purposes of reporting. The council accepts the concepts of the time value of money, probable economic benefit recognition, and the concept of substance over form. The councils are the opinion that these concepts are applied with total compliance with the Shariah principles (Ibrahim and Hameed 2008, p. 98). Time value of money is accepted because of its consideration of economic growth or contraction. The is taken as the price for the contract that are taken and not taken in exchange for a loan issued. Application of the Shariah compliant laws in makes the financial institutions in Malaysia to use fair value, as opposed to the market interest rate. However, the fair value used is benchmarked on the conventional interest rate. In financial reporting, the Malaysian IF use Shariah compliant reporting. While reporting, the IF’s break down the complaint and non-compliant transactions. The general conception of reporting in Malaysia is that, financial reporting in itself is the transaction recording that neither validates nor nullifies Shariah. The Islamic Financial Services Act of the year 2013 was enacted to enhance compliance to the Shariah (IASB 2014, p. 89). In takaful, the participant pool fund together and the takaful operator charges a management fee. The participants in this contract share the returns and losses. This is in contrary to the conventional insurance where there are the sale and buying of policies. The contact falls in IFRS four due to the element of risk sharing. The operator of the takaful is required to add more funds in case of deficit. The ‘top up’ is used to fund qard (interest-free loan). Qard is treated as an expense to the operator or as a financial instrument. In order to comply with IAS 39, quard is measured on the fair value in initial recognition. The qard is consolidated under the IFRS (ACCA 2013, p. 18). Discussion The strategy adopting in the implementation is working effectively, however, it is attracting a number of criticism. The time value of money recognition concept is mainly considered non-Shariah compliant. Value an item and discounting it to the present time requires the application of the interest rate. This is against the riba that is prohibited in Shariah. IAS 39 requires that any item that is held as either asset or liability be recognized at its maturity value using that effective rate which factors in discounts, account fee and premiums. However, the Islamic banking does not accept the higher value of the future amount than the current amount but takes into consideration permissible (halal) in the murahabah agreement. However, the most commonly used practice in Malaysia is the fair valuing which is constituent with both Islamic banking and IAS 39. The use of finance leases has been very effective. The practice of Islamic Bank buying the asset and diminish transferring it to the customers is gaining acceptance to the conventional banks. In the contract, the Islamic Institution treats the asset under lease, as an asset in its balance sheet. This is in line with IFRS. Other strategies such as recognition of substance over form have attracted various criticisms. However, the manner in which various products such as takal are designed has been very effective in addressing these critics. Takaful and development financial institutions treatment of various transactions have been successful in ensuring comparability in financial reporting. Conclusion IFRS and AAOIFI standards were formulated to form the basis for accosting standardization. Despite various shortcomings, Malaysia has successful aligned its accounting system with IFRS. The courtly has designed various products and procedures of recognizing and treating items that are in line with both Shariah law and IFRS. IFRS and AAOIFI standards have major differences based on the nature of Islamic products. However, Malaysia has adopted an accounting system which creates solution to the conflicts that arise between these two standards. References List ACCA (2013). Harmonising financial reporting of Islamic finance [Online] Accessed 22nd April 2014. Available at: http://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-af-hfrif.pdf Ariff, M. & Iqbal, M. (2011). The Foundations of Islamic Banking Theory, Practice and Education. Cheltenham, Edward Elgar Pub. BNM (2014). Overview of Islamic finance in Malaysia [Online] Accessed 22nd April 2014. Available at: http://www.bnm.gov.my/index.php?ch=fs_mfs&pg=fs_mfs_bank Deloitte (2014). Islamic accounting [Online] Accessed 22nd April 2014. Available at: http://www.iasplus.com/en/resources/topics/islamic-accounting IASB (2014). IFRS Foundation and the IASB [Online]. Accessed 22nd April 2014. Available at: http://www.ifrs.org/Pages/default.aspx Ibrahim M., and Hameed S., (2008). IFRS vs AAOIFI: The Clash of Standards? [Online] Accessed 22nd April 2014. Available at: http://mpra.ub.unimuenchen.de/12539/1/The_Clash_of_Standards_international_accountant_article.pdf KPMG (2013). Empowering Islamic Finance [Online]. Accessed 22nd April 2014. Available at: http://frsic.mia.org.my/at/at/2013/08/03.pdf MASB (2011). Financial Reporting Issues relating to Islamic Finance [Online] Accessed 22nd April 2014. Available at: http://www.ifrs.org/Meetings/MeetingDocs/IASB/Archive/Leases/Leases-0611b02D-app.pdf MIDA (2014). Banking, Finance and Exchange Administration [Online]. Accessed 22nd April 2014. Available at: http://www.mida.gov.my/env3/index.php?page=banking-system PWC (2013). Open to comparison: Islamic finance and IFRS [Online] Accessed 22nd April 2014. Available at: https://www.pwc.com/bm/en/services/assets/Open_to_comparison-Islamic-finance-IFRS.pdf Rahman A., Rahim A., and Shariff M. (2013). An exploratory study of ijarah accounting practices in Malaysian financial institutions. International Journal of Islamic Financial Services 5(3). Schoon, N. (2009). Islamic banking and finance. London, Spiramus Press. Zakaria N., Shaf Z., (2013), Adoption of International Financial Reporting Standards and International Accounting Standards in Islamic Financial Institutions from the Practitioners’ Viewpoint. Middle-East Journal of Scientific Research 13(2), pp 42-49, 2013; Read More