November 01, 2021

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GAAP VS. IFRS: What are the key difference

GAAP VS. IFRS: What are the key difference

Overview

Currently, various financial reporting standards are used by businesses around the globe, including IFRS, US GAAP, CAS, etc. Despite a lot of efforts taken to eliminate the differences between GAAP vs. IFRS standards, the financial data prepared based on either one cannot be simply merged with the other. Thus, it is important to be able to read the financial data of a business and understand the main differences when different standards are applied.

International Financial Reporting Standards serve as a guidance for maintaining bookkeeping records and preparing financial reports so that investors (real or potential) and management can get acquainted with the complete financial picture of the company and make a certain management decision.

The IFRS board is a huge organization of several hundred people who prepare standards, meet with business representatives, participate in conferences, and make decisions. Their main task is to make the financial statements reliable. These standards are used in over a hundred countries and gaining more popularity in the US.

In a broad sense, the term GAAP can be applied to the national standards of any country. In a narrow and most common sense, it is associated more with the US where it is adhered to most frequently. That is, as a rule, these are the national standards of the US accounting system.

GAAP VS. IFRS: What are the key difference

Key differences

When you compare GAAP vs. IFRS, they both have pros and cons. On the one hand, GAAP may be more convenient for preparers who can use straightforward standards that have guidance for each step. At the same time, close to excessive details and a complex hierarchy of US standards complicate their use. As for the quality of information generated on the basis of IFRS and US GAAP, there is no single answer applicable in any situation: both compromise on the reliability of reporting in favor of rationality and ease of accounting.

  • Rules vs. PrinciplesThe first difference that is worth pointing out is that the GAAP is rule-based. The international standards are focused more on guidance and judgment or principles. The first gives companies and other entities very strict and inflexible rules that they must follow and comply with. Although the IFRS also has standards the businesses must comply with, if there are significant reasons they do not want or cannot follow these standards, they can explain them in the notes to the financial reports and deviate from the standards based on their judgment. It brings a lot of flexibility to accounting.
  • Revenue recognitionUS GAAP requires evidence of arrangement between buyer and seller for the earnings to be recognized, so the product should be delivered or services should be rendered at that time. Moreover, the price of the item or service the customer received is determined or determinable and the seller is reasonably sure of collecting the money. When it comes to the IFRS, it is recognized when there is a good likelihood the company will receive an economic benefit from the transaction in question. The bookkeeper should be able to measure the costs and know when the transaction will be completed.
  • Classification of liabilitiesUnder GAAP, the liabilities are segregated as current and non-current, while the international rules have no such segregation. This means that businesses can group long and short-term debt and not make a distinction between the two. For instance, you would not split a long-term debt under the IFRS into the portion due this year and the remaining portion that will be paid sometime in the future.
  • Inventory treatmentGAAP actively adheres to the LIFO method, while IFRS prohibits the use of this inventory method because this way businesses can make their net income seem to be lower than it actually is and the actual movement of inventory through a business might not be properly reflected. The good news is that both standards allow FIFO, weighted average cost, and specific identification methods for valuing inventories. Both standards also allow the businesses to write down the inventory if it losses value. If the value goes up again, the IFRS allows reversing the written down inventory value back up.
  • Asset valuationAn acquisition cost is used for the initial recording of the fixed assets of a business no matter which set of standards they use. There are, however, some distinctions in GAAP vs IFRS when it comes to depreciation. Although companies depreciate assets over their useful life in both cases, the IFRS requires separate depreciation of asset components if they have a different useful life. For instance, you would depreciate the engine of complex machinery separately from its body that typically lasts more than the engine. If the company follows GAAP, it can also do components depreciation, but it is not mandatory.
  • IntangiblesIf intangible assets are created via research and development, the business can consider the results as an asset and capitalize these costs. At least, this is what happens as far as the IFRS is concerned. GAAP, though, tells businesses to report these costs on their Income statement as expenses. The exception is an internally developed software that would be used externally.
  • ReportingAlthough the majority of the items you would see on the Balance sheet prepared according to either of the standards do not differ much, the order in which they are presented is the opposite. So, you would see cash listed as the first item with GAAP and as the last item with IFRS. When it comes to the Income statement, companies would list their expenses based on the nature of these expenses under GAAP, while the other standard allows to group them according to their functionality. The IFRS is also more flexible when it comes to presenting dividends and interest on the Cash flow statement.
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Author: Charles Lutwidge

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