GAAP Vs IFRS

The United States economy is increasingly globalizing numerous investment opportunities around the world, which has created a need for a singular set of accounting standards that all companies can practice and understand. However, a universal accounting system already exists that currently is not being used by the U.S. The necessity for globalization has resulted in U.S. companies and financial institutions preparing for the inevitable transition from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS.) With over 100 countries already using IFRS, the American GAAP system is steadily growing outdated. This demand for internationally comparable information is why we need to prepare for the transition from GAAP to the already internationally established IFRS. Understanding what will change, as well as what will stay the same, will help prepare for the transition of systems and the move towards the goal of globalization.

A critical difference between both systems is how each defines basic financial elements. Under GAAP, assets are defined as “probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events” (Shamrock). IFRS defines assets as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity” (Shamrock). The main difference between these two definitions is that IFRS is relatively lenient when recognizing something as an asset, whereas the U.S. GAAP system has much stricter protocols. Another discrepancy can be found in the IFRS system’s use of the word “expected” when referring to liabilities. Additionally, a commonality between the two systems is their definition of equity as “the residual interest in the assets of the entity after deducting all its liabilities” (Shamrock). Understanding how each financial element is defined under each system is critical before beginning to try and compare other more complicated differences.

The Financial Accounting Standards Board (FASB) creates and maintains U.S. GAAP codification, and the International Accounting Standards Board (ISAB) does the same for IFRS. Both are overseen by a group of trustees (Shamrock). This similarity is an important common factor between the two systems. When it is time, the transition process will be made easier by the consistency of regulations between each system. Nonetheless, a major difference between GAAP and IFRS lies in the fact that one is more “rule-based” while the other is “principle based.” When using the U.S. rule-based system, accountants must follow a specific set of rules outlined by GAAP; there are clear criteria that outline exactly how to prepare financial statements. However, “under IFRS and using principle-based accounting, general principles are put forward and companies must ensure that their financial statements fairly and accurately represent the principles” (Ventureline.com). Therefore, principle-based accounting has much more room for individual interpretation of what is expected on financial statements.

A final, but important, note of interest is the difference in presentation of financial statements between GAAP and IFRS. “Under both frameworks, the components of a complete set of financial statements include: balance sheet, income statement, other comprehensive income, cash flows, and notes to the financial statements. Both US GAAP and IFRS also require that the financial statements be prepared on the accrual basis of accounting” (Ernst & Young). Although the overall financial statement requirements are the same between the two systems, there are many smaller differences in what is required on these statements. An example of this can be seen when dealing with inventory: under GAAP, allowable methods of recording inventory include First In First Out (FIFO), average cost, and Last In First Out (LIFO). While GAAP allows all three methods, LIFO costing is prohibited under IFRS (Mirza).

The current economy is globalizing at a rapid rate, and the United States must prepare to switch accounting systems in order to stay competitive with the rest of the world; the differences between the GAAP system and IFRS are creating barriers in international business. With over 100 countries already using the IFRS and generating internationally comparable financial statements, it is certain that the US will transition in the near future. By understanding the discrepancies between the two systems and preparing for an inevitable switch in accounting systems, the US is moving toward the goal of globalization.

References:

“US GAAP versus IFRS: The Basics.” Review. Ernst and Young LLP, Dec. 2011. Web

Mirza, Abbas Ali., and Nandakumar Ankarath. International Trends in Financial Reporting under IFRS: Including Comparisons with US GAAP, China GAAP, and India Accounting Standards. Hoboken, NJ: Wiley, 2013. Print.

Shamrock, Steven E. IRS and US GAAP: A Comprehensive Comparison. Hoboken: Wiley, 2012. Print.

“RULES-BASED ACCOUNTING Definition.” RULES-BASED ACCOUNTING DEFINITION. Ventureline. Web. 14 Apr. 2014.