IFRS vs. GAAP

There are two sets of accepted accounting rules for international use: American standards called 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 from the United States Securities and Exchange Commission (SEC). The second is developed by the International Accounting Standards Boards (IASB), an independent accounting standards-setting body based in London. Although GAAP and IFRS share some similarities in their financial statement presentation, they do not agree on all issues. There are differences in reporting and classifying income statement and balance sheet items between these two sets of rules.

Unlike the more detailed GAAP rules-based standard, the principles-based IFRS tends to be simpler in its accounting and disclosure requirements. The Income Statement is a mandatory statement under IFRS as it is under GAAP and is known as the “Statement of Comprehensive Income”. The IFRS statement of comprehensive income is similar to that used by GAAP; however, there are few differences when comparing these two income statements.

GAAP income statement presentation follows a single-step or multi-step format. However, IFRS does not mention a single-step or multi-step approach. Under IFRS, entities must classify expenses by their nature (such as the cost of material used, direct labor incurred, advertising expenses, depreciation expense, and employee benefits) or by their function (such as cost of goods sold, selling expenses, and administrative expenses). Although GAAP does not have such a requirement, the SEC does require a functional filing. While GAAP defines operating income, IFRS does not recognize this key measure. Additionally, extraordinary items are prohibited by IFRS; while, under GAAP, entities must report extraordinary items if they are of an unusual nature and of infrequent occurrence. The portion of profit or loss attributable to the non-controlling interest (or minority interest) is disclosed separately in the IFRS statement of comprehensive income. Additionally, while IFRS identifies certain minimum items that must be presented in the statement of comprehensive income, GAAP does not have minimum reporting requirements. However, the SEC imposes more stringent filing requirements.

Balance sheet presentation is a requirement under both GAAP and IFRS. The most visible difference is how IFRS refers to this statement as “Statement of Financial Position” instead of Balance Sheet. The accounts in the statement of financial position are classified under IFRS, which means that similar items are grouped together to arrive at significant subtotals. In addition, the IASB indicates that the parts and subsections of the financial statements are more informative than the whole; as a result, the IASB does not encourage the reporting of summary accounts per se (eg total assets, total liabilities, etc.). Unlike GAAP, IFRS current assets are generally listed in the reverse order of liquidity. For example, under IFRS, cash is listed last. In addition, most companies under IFRS present current and non-current liabilities as separate classifications in their statements of financial position, except in industries where the presentation of liquidity provides more useful information. It is crucial to point out some important differences in information elements on the balance sheet between GAAP and IFRS.

In the current assets section, inventory is valued differently under IFRS. The use of last in, first out (LIFO) is prohibited under IFRS. Also, unlike GAAP, if inventory is depreciated at the lower of cost or market value, it may be reversed in a later period up to the amount of the prior depreciation under IFRS. In addition, IFRS allow the revaluation of property, plant and equipment and intangible assets and report them as other comprehensive income.

IFRS uses different terminology in the equity section of your statement of financial position. For example, share capital is the par value of issued shares. It includes ordinary shares (called common shares) and preferred shares (called preferred shares). The issue premium under the equity section of IFRS is the excess of the amounts paid over the face value.

A major problem caused by the disparity related to the presentation of GAAP and IFRS financial statements is the lack of uniformity. This issue creates difficulty in comparing financial statements across GAAP and IFRS. As a result, it is rational for US companies that have subsidiaries abroad to convert to IFRS to make it easier for stakeholders to make comparisons and enable them to access global capital markets. However, switching to IFRS may not be beneficial for US small businesses; the conversion will result in incremental costs that could outweigh the benefits.