IFRS Versus GAAP
There are two sets of accounting rules accepted for international use: U.S. standards referred to as Generally Accepted Accounting Principles (GAAP), and international standards known as International Financial Reporting Standards (IFRS). The first is developed by the Financial Accounting Standards Board (FASB), whose power is derived form the United States Securities and Exchange Commission (SEC). The second is developed by the International Accounting Standard Boards (IASB), an independent London-based accounting standard-setting body. Although GAAP and IFRS share some similarities in presenting their financial statements, they do not agree on every issue. Differences do exist in reporting and classifying elements of Income Statements and Balance Sheets between these two sets of rules.
Differences between International Financial Reporting Standards and GAAP
Unlike the more detailed GAAP rule-based standard, IFRS principle-based tends to be simpler in its accounting and disclosure requirements. The Income Statement is a required statement under IFRS as it is under GAAP and is known as the ” Statement of Comprehensive Income”. IFRS’ statement of comprehensive income is similar to the one used by GAAP; nevertheless, few differences exist when comparing these two income statements.
Presentation of the income statement under GAAP follows either a single-step or multiple-step format. However, IFRS does not mention a single-step or multiple-step approach. Under IFRS, entities are required to classify expenses by either their nature (such as cost of material used, direct labor incurred, advertising expense, depreciation expense, and employee benefits), or their function (such as cost of goods sold, selling expenses, and administrative expenses). Although GAAP does not have that requirement, the SEC requires a functional presentation. While GAAP defines income from operation, IFRS does not recognize this key measure. In addition, extraordinary items are prohibited under IFRS; whereas, under GAAP, entities must report extraordinary items if they are unusual in nature and infrequent in occurrence. The portion of profit or loss attributable to the non-controlling interest (or minority interest) is separately disclosed in IFRS’ statement of comprehensive income. Furthermore, while IFRS identifies certain minimum items that should be presented on the statement of comprehensive income, GAAP has no minimum information requirements. However, the SEC imposes stricter presentation requirements.
The presentation of the balance sheet is a requirement under both GAAP and IFRS. The most visible difference is how IFRS refers to this statement as the ” Statement of Financial Position” rather than the Balance Sheet. The statement of financial position’s accounts are classified under IFRS, which means that similar items are grouped together to arrive at significant subtotals. Also, the IASB indicates that the parts and subsections of financial statements are more informative than the whole; as a result, the IASB does not encourage the reporting of summary accounts by themselves ( for example, total assets, total liabilities, etc.). Unlike GAAP, IFRS’ current assets are usually listed in the reverse order of liquidity. For instance, under IFRS, cash is listed last. In addition, most companies under IFRS present current and non-current liabilities as separate classifications on the face of their statements of financial position, except in industries where liquidity presentation provides more useful information. It is crucial to point out some major differences in reporting items in the balance sheet between GAAP and IFRS.
Under the current asset section, inventory is valuated differently under IFRS. The use of (LIFO) last-in-first-out is prohibited under IFRS. In addition, unlike GAAP, if inventory is written down under lower-of-cost-or-market valuation, it may be reversed in a subsequent period up to the amount of the previous write down under IFRS. Furthermore, IFRS permits the revaluation of property, plant, and equipment, and intangible assets and reports them as other comprehensive income.
IFRSs use different terminology in the equity section in its statement of financial position. For instance, Share Capital is the par value of share issued. It includes ordinary shares ( referred to as common share) and preferences shares ( referred to as preferred shares). Share Premium under IFRS’ equity section is the excess of amounts paid-in over the par value.
A major problem caused by the disparity that is related to financial statement’s presentation of GAAP and International Financial Reporting Standards is the lack of uniformity. This problem creates difficulty in comparing financial statements across GAAP and IFRS. As a result, it is rational for U.S companies that have foreign subsidiaries to convert to IFRS in order to make it easier for stakeholders to make comparisons and allow themselves to access global capital markets. However, switching to International Financial Reporting Standards may not be beneficial to small U.S firms; the conversion will result in incremental costs that might outweigh the benefits.