Differences Between IFRS & US GAAP
The International Financial Reporting Standards (IFRS) were established in 2001 and the European Union adopted them in 2005. It is hoped that businesses all over the world will adopt these standards. The adoption of IFRS will help the financers and investors all over the world in understanding the financial situations of the businesses they invest in, grant credit to, or do business with. A standard system of accounting and financial reporting is an incentive for the countries to develop accounting that meets the world standards on accounting. The IFRSs are accepted and applied in over 110 countries.
United States' Generally Accepted Accounting Principles (US GAAPs) are developed by the Financial Accounting Standards Board (FASB). FASB is an organization of financial analysts, accountants, and regulators who develops accounting practices to meet the continually changing needs of the market. Whenever a new accounting issue arises, the FASB studies the issue, develops a proposed accounting treatment, and send it to the users of financial statements for review and comments.
One of the hallmarks of GAAPs is a special emphasis on smooth presentation of earnings from year to year. Smooth presentation of earnings gives the users of financial statements a sense of normalized results instead of actual cash in and cash out. This is known as the accruals basis of accounting.
U.S. GAAPs also put special emphasis on disclosures. The GAAPs require the organizations to explain and disclose their assumptions for different expenses in the footnotes to the financial statements. The footnotes are an integral part of the financial statements. They should be carefully read for better understanding of the organization and its financial statements.
Differences Between IFRSs and GAAPs
Although the underlying philosophy behind IFRSs and GAAPs is very much similar, there are some important differences. At the conceptual level, the IFRSs are considered to be ''principles based" accounting standards while on the other hand GAAPs are considered to be more "rules based" accounting standards. Arguably, by being ''principles based" accounting standards, the IFRSs capture and represent the economic reality of the transactions better than the GAAPs. Other than this, some of the most important differences are discussed below.
- Reversal of Write Downs of Inventory
If inventory has been written down, the IFRSs allow to reverse the write down in future periods if certain criteria are met. On the other hand, the U.S. GAAPs prohibit any reversal of such inventory write downs.
- Method of Inventory Costing
The IFRSs allow costing of inventory using only the "first in, first out (FIFO)'' and ''average costing (AVCO)'' method. The IFRSs prohibit the use of the ''last in, first out (LIFO)'' method. On the other hand, the U.S. GAAPs allow usage of LIFO method of costing.
- Treatment of Intangible Assets
Intangible assets are things like advertising costs, research and development costs, patents etc. Under the IFRSs, the acquired intangible assets are recognized only if they have future economic benefits and can be measured reliably. On the other hand, under U.S. GAAPs, the acquired intangible assets are required to be recognized at the fair value.
- Classification of Assets and Liabilities
The IFRSs "require" classification of assets and liabilities as current and long term. On the other hand the U.S. GAAPs "recommend" classification of assets and liabilities as current and long term.
- Presentation of Deferred Taxes
Under IFRSs, the deferred taxes are presented on the statement of financial position as a separate line item. Under U.S. GAAPs, the deferred taxes are presented within the assets and liabilities.
- Treatment of Extraordinary Items
The IFRSs prohibit classification and presentation of any item as extraordinary item. The U.S. GAAPs allow presentation and classification of extraordinary items if they are unusual and infrequent.
- Treatment of Bank Overdrafts
Under IFRSs, the bank overdrafts can be included in the cash if they are used for cash management. The U.S. GAAPs, allow the bank overdrafts to be charged as financing activity.
- Treatment of Minority Interest
Minority interest is the ownership position by significant but not majority shareholders. Under IFRSs, the minority interest is presented in the equity as a separate line item. Under the U.S. GAAPs, the minority interest in presented in the liabilities as a separate line item.
Constant efforts are being made to minimize the differences between the IFRSs and GAAPs. The IASB and the FASB have been collaborating with each other to remove differences so that financial statements prepared under IFRSs and the financial statements prepared under U.S. GAAPs are more homogenized.