GAAP stands for Generally Accepted Accounting Principles and is used in accounting and financial reporting worldwide.
IFRS stands for International Financial Reporting Standards and is the accounting standard for businesses based outside of the US and EU. IFRS is a set of rules developed and approved by the International Accounting Standards Board (IASB), which is made up of leading accounting experts from the world over. The IFRS rules are enforced by the International Accounting Standards Committee (IASC) and are applied by external accounting firms and auditors when preparing accounts and financial statements for companies based outside of the US and EU.
Issuing Authorities of GAAP and IFRS
The GAAPs are developed by the Financial Accounting Standards Board (FASB), whose power is derived from the United States Securities and Exchange Commission (SEC). IFRS are developed by the International Accounting Standard Boards (IASB), an independent London-based accounting standard-setting body.
Although GAAP and IFRS share similarities in presenting their financial statements, they do not agree on every issue. Differences exist in reporting and classifying elements of Income Statements and Balance Sheets between these two sets of rules.
Differences between International Financial Reporting Standards and GAAP
Unlike the more detailed GAAP rule-based standard, IFRS principle-based tends to be more straightforward regarding accounting and disclosure requirements. The Income Statement is required under IFRS as it is under GAAP and is known as the ” Statement of Comprehensive Income”.
IFRS’ statement of comprehensive income is similar to the one used by GAAP; nevertheless, few differences exist when comparing these two income statements.
Presentation of the income statement under GAAP follows either a single-step or multiple-step format. However, IFRS does not mention a single-step or multiple-step approach. Under IFRS, entities are required to classify expenses by either their nature (such as cost of material used, direct labour incurred, advertising expense, depreciation expense, and employee benefits) or their function (such as cost of goods sold, selling expenses, and administrative expenses).
Although GAAP does not have that requirement, the SEC requires a functional presentation. While GAAP defines income from the operation, IFRS does not recognize this key measure. In addition, extraordinary items are prohibited under IFRS, whereas, under GAAP, entities must report extraordinary items if they are unusual in nature and infrequent in occurrence.
The portion of profit or loss attributable to the non-controlling interest (or minority interest) is separately disclosed in IFRS’ statement of comprehensive income. Furthermore, while IFRS identifies certain minimum items that should be presented on the statement of comprehensive income, GAAP has no minimum information requirements. However, the SEC imposes stricter presentation requirements.
The presentation of the balance sheet is a requirement under both GAAP and IFRS. The most visible difference is how IFRS refers to this statement as the ” Statement of Financial Position” rather than the Balance Sheet. The statement of financial position’s accounts is classified under IFRS, which means that similar items are grouped to arrive at significant subtotals.
Also, the IASB indicates that the parts and subsections of financial statements are more informative than the whole; as a result, the IASB does not encourage the reporting of summary accounts by themselves ( for example, total assets, total liabilities, etc.). Unlike GAAP, IFRS’ current assets are usually listed in the reverse order of liquidity. For instance, under IFRS, cash is listed last.
In addition, most companies under IFRS present current and non-current liabilities as separate classifications on the face of their statements of financial position, except in industries where liquidity presentation provides more useful information. It is crucial to highlight some significant differences in reporting items in the balance sheet between GAAP and IFRS.
Under the current asset section, inventory is evaluated differently under IFRS. The use of (LIFO) last-in-first-out is prohibited under IFRS.
In addition, unlike GAAP, if inventory is written down under lower-of-cost-or-market valuation, it may be reversed in a subsequent period up to the amount of the previous write-down under IFRS. Furthermore, IFRS permits the revaluation of property, plant, equipment, and intangible assets and reports them as other comprehensive income.
IFRSs use different terminology in the equity section of their statement of financial position. For instance, Share Capital is the par value of the share issued. It includes ordinary shares ( referred to as common shares) and preference shares ( referred to as preferred shares). Share Premium under IFRS’ equity section is the excess of amounts paid over the par value.
A major problem caused by the disparity related to the financial statement’s presentation of GAAP and International Financial Reporting Standards is the lack of uniformity. This problem creates difficulty in comparing financial statements across GAAP and IFRS. As a result, it is rational for U.S. companies that have foreign subsidiaries to convert to IFRS to make it easier for stakeholders to make comparisons and allow themselves to access global capital markets.
However, switching to International Financial Reporting Standards may not benefit small U.S. firms; the conversion will result in incremental costs that might outweigh the benefits.