Know the differences between the two accounting standards
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The IFRS vs US GAAP refers to two accounting standards and principles adhered to by countries in the world in relation to financial reporting. More than 110 countries follow the International Financial Reporting Standards (IFRS), which encourages uniformity in preparing financial statements.
On the other hand, the Generally Accepted Accounting Principles (GAAP) are created by the Financial Accounting Standards Board to guide public companies in the United States when compiling their annual financial statements.
Definition of Terms
The IFRS is a set of standards developed by the International Accounting Standards Board (IASB). The IFRS governs how companies around the world prepare their financial statements. Unlike the GAAP, the IFRS does not dictate exactly how the financial statements should be prepared but only provides guidelines that harmonize the standards and make the accounting process uniform across the world.
Both individual and corporate investors can analyze a company’s financial statements and make an informed decision on whether or not to invest in the company. The IFRS is used in the European Union, South America, and some parts of Asia and Africa.
The GAAP is a set of principles that companies in the United States must follow when preparing their annual financial statements. The measures take an authoritative approach to the accounting process so that there will be minimal or no inconsistency in the financial statements submitted by public companies to the US Securities and Exchange Commission (SEC). It enables investors to make cross-comparisons of financial statements of various publicly-traded companies in order to make an educated decision regarding investments.
Key Differences between IFRS vs. US GAAP
The following are some of the ways in which IFRS and GAAP differ:
1. Treatment of inventory
One of the key differences between these two accounting standards is the accounting method for inventory costs. Under IFRS, the LIFO (Last in First out) method of calculating inventory is not allowed. Under the GAAP, either the LIFO or FIFO (First in First out) method can be used to estimate inventory.
The reason for not using LIFO under the IFRS accounting standard is that it does not show an accurate inventory flow and may portray lower levels of income than is the actual case. On the other hand, the flexibility to use either FIFO or LIFO under GAAP allows companies to choose the most convenient method when valuing inventory.
The treatment of developing intangible assets through research and development is also different between IFRS vs US GAAP standards. Under IFRS, costs in the research phase are expensed as incurred. Costs in the development phase may be capitalized based on certain factors. On the other hand, US GAAP generally requires immediate expensing of both research and development expenditures, although some exceptions exist.
3. Rules vs. Principles
The other distinction between IFRS and GAAP is how they assess the accounting processes – i.e., whether they are based on fixed rules or principles that allow some space for interpretations. Under GAAP, the accounting process is prescribed highly specific rules and procedures, offering little room for interpretation. The measures are devised as a way of preventing opportunistic entities from creating exceptions to maximize their profits.
On the contrary, IFRS sets forth principles that companies should follow and interpret to the best of their judgment. Companies enjoy some leeway to make different interpretations of the same situation.
4. Recognition of revenue
With regards to how revenue is recognized, IFRS is more general, as compared to GAAP. The latter starts by determining whether revenue has been realized or earned, and it has specific rules on how revenue is recognized across multiple industries.
The guiding principle is that revenue is not recognized until the exchange of a good or service has been completed. Once a good’s been exchanged and the transaction recognized and recorded, the accountant must then consider the specific rules of the industry in which the business operates.
Conversely, IFRS is based on the principle that revenue is recognized when the value is delivered. It groups all transactions of revenues into four categories, i.e., the sale of goods, construction contracts, provision of services, or use of another entity’s assets. Companies using IFRS accounting standards use the following two methods of recognizing revenues:
Recognize revenues as the cost that can be recovered during the reporting period
For contracts, revenue is recognized based on the percentage of the whole contract completed, the estimated total cost, and the value of the contract. The amount of revenue recognized should be equal to the percentage of work that has been completed.
5. Classification of liabilities
When preparing financial statements based on the GAAP accounting standards, liabilities are classified into either current or non-current liabilities, depending on the duration allotted for the company to repay the debts.
Debts that the company expects to repay within the next 12 months are classified as current liabilities, while debts whose repayment period exceeds 12 months are classified as long-term liabilities.
However, there is no plain distinction between liabilities in IFRS, so short-term and long-term liabilities are grouped together.
Thank you for reading CFI’s guide to IFRS vs. US GAAP. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:
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