The generally accepted accounting principles based (U.S. GAAP) and the International Financial Reporting Standards-based (IFRS) are the two standards that guide the financial reporting process. GAAP is a rule-based system while the IFRS is a principle based system. IFRS is used in more than 100 nations across the globe while GAAP is only used in the US. The purpose of this research paper is to identify the critical differences between GAAP and IFRS and areas that are expected to be revised in the future.
The primary difference between GAAP and IFRS is that GAAP is rule-based in comparison with the principle-based IFRS. IFRS has room for different interpretations and explanations for one transaction, a reason for the many disclosures in the financial statement. According to Jategaonkar et al. (2014), IFRS captures the economics of a transaction better than GAAP because it offers room for different interpretations. Another difference lies in the method used to assess accounting treatment. Under GAAP, research is focused on literature while IFRS focuses on facts and patterns.
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The statement of financial position is a crucial financial statement detailing the company’s assets and liabilities at a particular period. The liabilities are on the right side while assets are placed on the left side. The statement of financial position comes with supplementary information to clarify the figures on the balance sheet. The supplemental information not only explains the financial numbers, but the accounting methods used.
The specific differences between IFRS and GAAP in the statements of financial position are many. The first difference is that GAAP mandates that assets, liabilities, and equity be reported in the diminishing order of liquidity (Evans et al., 2015). In the statement of financial position, total assets equal total liabilities and shareholder’s equity. IFRS rules are not specific regarding the balance sheet format, but assets and liabilities are presented separately.
GAAP uses the Last In, First out (LIFO) method of inventory estimates while companies under IFRS use FIFO method. The LIFO does not reflect on the exact flow of inventory. IFRS and GAAP also have different approaches toward inventory write-down reversals. GAAP does not support the reversal of the write-down amount when the market value of the asset increases. GAAP standards are stringent in the case of inventory reversals, while IFRS allows the amount of the write-down to be reversed. Another difference is in the reporting of development costs. Under IFRS, a company’s development cost is capitalized to enable the company to leverage depreciation on fixed assets (Edel, 2014). Under GAAP, development costs are expensed in the same year they occur, and they cannot be treated as capital. Companies under IFRS rules also consider whether intangible assets such as research and development will have an economic benefit in the future (Jategaonkar et al., 2014). Alternatively, companies reporting under GAAP standards treat intangible assets using the fair market value, and they do not consider a future economic benefit.
Additionally, the two approaches differ in the earnings-per-share (EPS) reporting. Under IFRS reporting, EPS is calculated for continuing operations, discontinued operations, and net income. IFRS does not consider discontinuing operations in the calculation of EPS. GAAP standards use incremental shares to calculate EPS in comparison to IFRS which uses the treasury stock method. Additionally, the many accounting differences between GAAP and IFRS affect net income available to common shareholders, hence the differences in EPS.
Other differences are in deferred taxes reporting, adjustments to assets and liabilities, and net pension assets. Under IFRS standards, deferred assets are under noncurrent on the statement of financial position while GAAP standards allow for deferred taxes to be classified as current and noncurrent. IFRS rules require disclosure of expectations of future adjustments to assets and liabilities on the notes while GAAP rules only require a summary of accounting policies.
Evidently, GAAP and IFRS have different approaches to the statement of financial position. The differences are in the reporting of long-term debt, nonrecurring activities, inventory measures, deferred taxes among others. As companies go global, the small differences in GAAP and IFRS reporting substantial effects such that some will prepare different statements of financial position using IFRS and GAAP. As Securities and Exchange Commission (SEC) is working towards transitioning GAAP to IFRS, some areas of both GAAP and IFRS standards will be revised. GAAP has many rules, and it restricts the financial activities of companies or accountants.
IFRS offers flexibility in comparison to GAAP such that companies can utilize any method they wish to in preparing the balance sheet. Companies can manipulate assets and liabilities to hide financial problems for example by changing the inventory valuation. IFRS standards require that changes to rules should be justifiable, but companies can easily ‘invent’ justifiable reasons when they are in tough positions. As many countries continue adopting IFRS, there is a need to revise IFRS standards to deal with the inconsistency problem. IFRS gives companies the freedom to report development costs and intangible assets while taking into consideration the future economic changes leading to inconsistencies.
In conclusion, as SEC and IASB work towards convergence of GAAP and IFRS, there is a need to evaluate the benefits and challenges of each approach. The goal of the convergence should not be the creation of a universal standard only; rather it should be the creation of a standard that addresses the problems associated with GAAP and IFRS.
References
Edel, L. (2014). The similarities and differences between the financial reporting standards under United States. GAAP versus IFRS. Global Journal of Management And Business Research .
Evans, M. E., Houston, R. W., Peters, M. F., & Pratt, J. H. (2014). Reporting regulatory environments and earnings management: US and non-US firms using US GAAP or IFRS. The Accounting Review , 90 (5), 1969-1994.
Jategaonkar, S. P., Lovata, L., & Sierra, G. E. (2014). US GAAP versus IFRS: Analyst Forecast Errors for Foreign Private Issuers.
