IFRS Vs GAAP Accounting Standards

There has been a growing demand over the past twenty years to unite the business world under one conceptual framework for reporting financial statements. Currently, there are two types of frameworks used throughout the accounting world. They are the General Accepted Accounting Principles ( GAAP) and International Financial Reporting Standards (IFRS).

Presently more than seven thousand companies within one hundred countries worldwide use IFRS instead of GAAP. In order to harmonize these foreign capital markets, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have been working together to converge GAAP with IFRS. The main purpose of this conversion is to have one general global financial reporting standard that allows financial statements to become more relevant and reliable. This would also allow for both United States and foreign companies to become more consistent and comparable within their financial statements. The overall objective of this conversion is to provide better financial information for capital providers, lenders, and stockholders.

Generally Accepted Accounting Principles (GAAP) is a rule based system used in the United States. These rules are used to prepare, present, and report the financial statements of companies. The Securities and Exchange Commission (SEC) requires that GAAP must be followed in publicly traded companies. GAAP is composed of many rules but there are four fundamental ideas. These include consistency, relevance, reliability, and comparability. Consistency means that all information is gathered and present the same throughout all periods. Relevance relates to the idea that all information presents is significant to the company. The reliable aspect means that all information given in the financial statements is reliable or true and able to be verified. Comparability is probably the most significant part of GAAP. Since all business will be using the same system of financial reporting, it will be easier to compare companies. Without the ability to compare companies, investors would have a difficult time evaluating companies and holding each company up to industry benchmarks and competitors.

International Financial Reporting Standards ( IFRS) is a principle based system used by over one hundred countries around the world. These principles are general guidelines that should be followed but there is flexibility. The main goal of IFRS is for financial statement to reflect true and accurate information about a company. The lack of guidance under the IFRS commonly requires management to estimate, assume, and make judgment calls in financial reporting.

Both methods, GAAP and IFRS, have similar fundamental ideas but tend to differ when it comes to the specific details. First, there is the financial statement presentations. Both systems have similar components of a complete set of financial statements. These statements include a balance sheet, income statement, statement of cash flows, other comprehensive income for GAAP or statement of recognized income for expenses for IFRS, and accompanying notes. Both methods require the statements be prepared using the accrual basis of accounting. There are some differences however. Under GAAP regulations, the balance sheet must contain the last two most recent years. All other statements must cover a three-year period. IFRS only requires the information in the previous period. GAAP does not have a general requirement for the layout of the balance sheet or income statement, while IFRS has a list of minimum items that have to be included. The classification of expenses under GAAP are required to be presented based on function. IFRS allows companies to choose from either function base or nature of expense. If function is selected, then the nature of some expenses must be listed in the notes.

Another category of differences is inventory. Inventory is defined as assets held for sale in the ordinary course of business, in the process of production for such sale, or to be consumed in the production of goods or services. The ways to measure cost, standard cost method or retail method, are similar under both GAAP and IFRS. Also under both systems, the cost of inventory includes direct expenditures to ready inventory sales, included allocated overhead. Selling costs and general administrative costs are excluded from the cost of inventories. Under GAAP, Last In First Out (LIFO) costing method is acceptable. It is not explicitly required for all inventories of similar nature to have to follow the same formula. In IFRS however, LIFO is prohibited. The same formula must be used on all inventories. The way that inventory is measured is also different. GAAPs inventory is carried at the lower of cost or market. Inventory is carried at the lower of cost of net realizable value under IFRS standards.

The completion of the earning process and the realization of assets from completion are considered revenue recognition. Under both systems, revenue is not recognized until it is both realized and earned. Both systems have certain criteria that has to be met before the revenue is recognized. Under GAAP, there are four main criteria, persuasive evidence, delivery, fixed/ determinable pricing, and collectability assured. IFRS has five different criteria that need to be met. These criteria are transfer of risk and reward, no continuing management involvement, measurement reliability, probable economic benefit, and cost to be incurred reliably. Another difference is construction contacts. Under GAAP, construction contracts may be, but not required to be, combined or segmented if certain criteria is met. Under IFRS, construction contracts are combined or segmented if certain criteria is met. The criteria for GAAP and IFRS are different.

Intangible assets are defined as a non-monetary asset without physical substance. The definition is the same under both systems. Both systems require that there be probable future economic benefits and costs that can be reliably measured. Start-up costs are never capitalized. The amortization of intangible assets over their estimated useful lives is required under both GAAP and IFRS. If there is no foreseeable limit to the period over which an intangible asset is expected to create new cash inflows then the useful life is considered to be indefinite and the assets does not get amortized. The differences arise when looking at development cost. In accordance to GAAP, development cost are expenses as incurred unless addressed by a separate standard. Computer software, however, are capitalized once technological feasibility is established. Under IFRS, development costs are capitalized when technical and economic feasibility of a project can be demonstrated. There are no separate guidelines in relations to computer software costs. Advertising costs also show a difference. GAAP allows advertising and promotional cost to be expense either as incurred or when the advertising takes place for the first time. Advertising and promotional costs are expensed as they are incurred under IFRS. Another difference is that revaluation is not allowed under GAAP while IFRS allows revaluation to fair value of intangible assets other than goodwill.

In conclusion, there are many constrictions in converting U.S. GAAP to IFRS. However, the conversion is needed and talks about the conversion have begun. The conversion of the GAAP framework will completely change how companies report their financial results in the coming years. The adaptation from GAAP to IFRS will create the benefits of stronger comparability and consistency between U.S. and foreign corporations' financial statements. The merger between the two accounting standards will produce more transparent and understandable standards that will provide a major advantage for investors.


Article Source: Colleen Hendricks