AN OVERVIEW OF GAAP VS IFRS

A Brief Guide About Major Differences Between IFRS and GAAP

Accounting standards are critical to ensuring that a company’s financial information and financial statements are accurate and present a true and fair view about the financial position, financial performance and changes in financial position of an organization.

Businesses prepare their Financial Statements using the two main sets of accounting standards namely GAAP and IFRS.

GAAP, also referred to as US GAAP, is an acronym for Generally Accepted Accounting Principles. This set of guidelines is set by the Financial Accounting Standards Board (FASB) and adhered to by most US companies.

IFRS stands for International Financial Reporting Standards. These principles are dictated by the International Accounting Standards Board (IASB) and followed in many countries outside the US.

Deciding which set of standards to use depends on whether your company operates in the US or internationally.

Let’s look at the few major differences between IFRS and GAAP accounting.

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1. Rules vs. Principles

GAAP tends to be more rules-based, while IFRS tends to be more principles-based. Under GAAP, companies may have industry-specific rules and guidelines to follow, while IFRS has principles that require judgment and interpretation to determine how they are to be applied in a given situation.

However, convergence projects between FASB and IASB have resulted in new GAAP and IFRS standards that share more similarities than differences. For example, the recent GAAP standard for revenue from contracts with customers and the corresponding IFRS standard IFRS 15, share a common principles-based approach.

2. Inventory Methods

Both GAAP and IFRS allow First In, First Out (FIFO), weighted-average cost, and specific identification methods for valuing inventories. However, GAAP also allows the Last In, First Out (LIFO) method, which is not allowed under IFRS. Using the LIFO method may result in artificially low net income and may not reflect the actual flow of inventory items through a company.

3. Inventory Write-Down Reversals

Both methods allow inventories to be written down to market value. However, if the market value later increases, only IFRS allows the earlier write-down to be reversed. Under GAAP, reversal of earlier write-downs is prohibited. This makes inventory valuation more volatile under IFRS.

4. Fair Value Revaluations

IFRS allows revaluation of the following assets to fair value if fair value can be measured reliably: inventories, property, plant & equipment, intangible assets, and investments in marketable securities. This revaluation may be either an increase or a decrease to the asset’s value. Under GAAP, revaluation is prohibited except for marketable securities.

5. Impairment Losses

Both standards allow for the recognition of impairment losses on long-lived assets when the market value of an asset declines. When conditions change, IFRS allows impairment losses to be reversed for all types of assets except goodwill. GAAP takes a more conservative approach and prohibits reversals of impairment losses for all types of assets.

6. Intangible Assets

Internal costs to create intangible assets, such as development costs, are capitalized under IFRS when certain criteria are met. These criteria include consideration of the future economic benefits.

Under GAAP, development costs are expensed as incurred, with the exception of internally developed software. For software that will be used externally, costs are capitalized once technological feasibility has been demonstrated. If the software will only be used internally, GAAP requires capitalization only during the development stage. IFRS has no specific guidance for software.

7. Valuation of Assets

Under both sets of standards, long-lived assets, which include property, plant, and equipment, are initially valued at acquisition cost. Under both GAAP and IFRS, fixed assets are depreciated over their estimated useful life. If the asset consists of multiple components with different useful lives, IFRS requires separate depreciation of those components. Component depreciation is allowed under GAAP, but isn’t mandatory.

Under IFRS, assets can be later revalued to fair value, whether this is an increase or a decrease in value. Revaluation is not allowed under GAAP.

8. Investment Property

IFRS includes the special category of investment property, which is defined as property held for rental income or capital appreciation. Investment property is initially measured at cost, and can be subsequently revalued to fair value. GAAP has no such separate category of investment property.

9. Lease Accounting

While the approaches under GAAP and IFRS share a common framework, there are a few notable differences. IFRS has a de minimus exception, which allows lessees to exclude leases for low-valued assets, while GAAP has no such exception. The IFRS standard includes leases for some kinds of intangible assets, while GAAP categorically excludes leases of all intangible assets from the scope of the lease accounting standard.

10. Financial Statements

Under GAAP, balance sheet assets are reported in descending order of liquidity, with current assets at the top. Owners’ equity is reported at the bottom. IFRS reverses the order of liquidity and starts with non-current assets, and places owners’ equity in the middle, between assets and liabilities.

The statement of cash flows is also a bit different. Under GAAP, interest paid, interest received, and dividends received are all classified as operating activities. Dividends paid go under financing activities. IFRS is more flexible: interest and dividends paid can be either operating or financing activities, while interest and dividends received are either operating or investing activities. Companies can choose the option that seems most appropriate for their particular situation.

Income statements are also a bit different under the two sets of standards. Under IFRS, entities can classify expenses either by function or nature (depreciation or salaries, for example). If a functional classification is chosen, then at the very least, allocations must be made to present selling expenses separately. While GAAP itself has no such requirement, SEC registrants must follow specific rules, which include functional categories and specific line item descriptions. In practice, most US entities use a functional classification.

IFRS is used in more than 110 countries around the world, including the EU and many Asian and South American countries. GAAP, on the other hand, is only used in the United States and few more countries in US regime.

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