IFRS and GAAP: The Similarities and Differences

It is only a matter of time before the accounting profession is completely converged into one set of high-quality international standards. Over a decade now, there has been advancements in converging the U.S. generally accepted accounting principles with the International Financial Reporting Standards. As the two accounting standards continue to converge into a single set of international standards, one will realize that there are many similarities and differences between the methods. Although the differences may provoke a need for compromise, the similarities reveal that the convergence is an attainable goal.

Generally accepted accounting principles, or GAAP, are the common set of accounting standards in the U.S. GAAP, issued by the American Institute of Certified Public Accountants (AICPA), has been an ongoing development for the past 60 years; it includes the following items: Financial Accounting Standards Board (FASB) Standards, Interpretations, and Staff Positions; Accounting Principles Board (APB) Opinions; and AICPA Research Bulletins. Today, the Securities and Exchange Commission (SEC) oversees all U.S. accounting practices, making sure the accounting practices adhere to GAAP standards. GAAP establishes standards to make financial records relevant and reliable for all interested investors, stockholders, or other financial readers. So what about international companies? How do these companies develop financial information? International companies cannot just prepare their financial information under GAAP standards; they have to take the International Financial Standards rules into consideration as well.

The International Accounting Standards Board (IASB) in London developed the International Financial Reporting Standards (IFRS or iGAAP). Today, the European Union requires all companies in Europe to follow accounting practices under the IFRS method. Over 100 countries currently use IFRS. When the U.S. completely adopts IFRS, it will be easier to compare U.S. companies to foreign companies, and would therefore allow U.S. companies to raise capital in foreign markets.

GAAP and IFRS are alike in many ways, thus making the convergence a realizable task. The conceptual frameworks of both methods are very similar in structure, referring to their accounting objectives, elements, and qualitative characteristics. A major similarity between GAAP and IFRS is that both standards use an income statement, a balance sheet, and a statement of cash flows. When dealing with cash and cash equivalents, both methods are essentially the same. Another major similarity is that both GAAP and IFRS prepare financial statements on an accrued basis; meaning revenue is recognized when it is realized or realizable. There are many other similarities between GAAP and IFRS, and will therefore help in a complete convergence in the near future, but before there is one international financial accounting set of standards, the differences between GAAP and IFRS have to be taken into consideration.

One major difference between accounting practices in GAAP and IFRS is that GAAP is rule-based while IFRS is principle-based. Principle-based accounting allows for different interpretation of the same transactions, where rule-based GAAP follows a set of rules in preparing financial statements – this means there is no room for error. In other words, GAAP standards are extremely strict in accounting practices and disclosure requirements, whereas IFRS practices are less restrictive; for example, the GAAP method is stricter when preparing income statements, where it requires use of a single-step or multiple step approach – IFRS does not mention either approach. In addition to the multiple-step income statement in GAAP, unusual and infrequent items must be included as extraordinary items – extraordinary items are prohibited in IFRS. There is also a major difference between the two methods in relation to the LIFO (last in first out) cost flow assumption. Only GAAP accepts the LIFO method for inventory valuation, whereas IFRS can only use average cost and FIFO (first in first out) for inventory valuation. The differences between the two methods need to be resolved to benefit economic globalization.

The different methods can be problematic to potential investors in international markets, because it will be difficult to interpret and understand financial information. It will be financially beneficial for the global economy when the accounting standards are merged into one set of rules. The FASB and IASB have issued a memorandum of understanding where they are to make the existing financial standards compatible, and once ensured, they intend on keeping compatibility. In efforts to converge, FASB has issued a rule that permits a fair value option for financial instruments. In 2009 the SEC allowed some U.S. companies to use IFRS, with plans on a full convergence by 2016.

In conclusion, it is important for economic globalization that GAAP converges with IFRS into one set of high-quality international standards. A unified set of accounting standards will provide companies, investors, creditors, financial users, etc. with helpful information that is relevant and reliable for making financial decisions. The similarities with GAAP and IFRS already provide some ease with the merge. And though there are still many differences, short-term and long-term efforts are in practice with hopes to merge GAAP and IFRS in the near future.

Source by Daniel Maz