Introduction
IFRS refers to accounting standards that are issued by the International Accounting Standards Board (IFRS). They are global standards that are adopted by several countries in the world. They are principle -based standards that guide the company on how to present items in the financial statements. GAAP on the other hand refers to General Accepted Accounting Standards which are accounting standards that are used in a given jurisdiction. Each country has their own GAAPs. The IFRS and GAAP have similar accounting concepts however at times they may differ on such areas such as fair value, liabilities and revenue recognition and consolidation. The US GAAP and IFRS differ on the presentation of the financial items and the recording and presentation of certain items as follows:
Differences in the Income Statement
There is no prescribed format of presenting the financial statements under IFRS; the company can present the expenses by either the function or the nature. There are however minimum items that have to be disclosed in the financial statements. The company may use a single-step format under US GAAP where all expenses are deducted at once from the sales figure. The company may also use the multi-step method where the difference of the sales and cost of sales is shown as the gross profit. Income and expenses are then shown to arrive at the income before tax (PWC, 2010). There are items that the company has to disclose so that the management can explain the financial performance of the company due to their impact on the items in the financial statements. Under IFRS, the items are disclosed in the financial statements or the notes. The US GAAP does not describe the items as
exceptional but as significant items. The presentation of extraordinary items in the financial statements under IFRS is prohibited. However, it is allowed under US GAAP. These items are infrequent and unusual such as negative goodwill arising out a business combination being written off. Under IFRS, if a company prepares a statement of recognized income and expense then a company cannot prepare a statement of changes in shareholder’s equity as a primary statement. The company should provide the supplementary equity information in the notes to the financial statements. Statement of equity can be presented as a primary statement where a statement of recognized income and expense were not presented as primary statements.
Under US GAAP, the statement of equity may be presented as a primary statement since there are no statements of recognized income and expense under GAAP. In the income statements under IFRS, there are items recognized directly in equity such as fair value gains on fixed assets, intangible assets, certain financial instruments and investments and foreign exchange translation differences. Under US GAAP, the revaluation of fixed assets and intangible assets is prohibited. Items should be presented at the historical costs and never at the revalued value whether it is a revaluation gain or loss.
Differences in the Balance sheet
Under the IFRS, the company presents current and non-current assets and current and non-current liabilities. They are separate classifications disclosed in the balance sheet. The assets and liabilities are presented in the order of liquidity. The management has the liberty to prepare the balance sheet in whichever format they want to use. Under the GAAP method the total assets and liabilities and shareholder’s equity figures are reflected and they should tally. The items are also shown in terms of decreasing liability. The management can choose whether to classify or not classify the items in the balance sheet.
Under IFRS off-setting of assets and liabilities is not allowed except where the company has a legally enforceable right to offset the items. The company should be intending to settle the transactions on a net basis. There must be both the master netting agreements and the intention to offset certain items by the company. Under US GAAP, the company is allowed to offset is allowed between parties where they have enforceable rights and intend to do so. For derivative financial instruments, the company can offset using the master netting arrangements. In the balance sheet, in IFRS, the minority interests are presented as components of equity however under US GAAP, the minority interests are not part of equity but as a separate liability line item.
Advantages of IFRS financial statements to the users
- The users of the financial statements will be able to compare the statements with other statements anywhere in the world where IFRS are also being adhered to. Many markets in the world are demanding conformity and moving towards uniform presentation of financial statements.
- A company will find it easier to raise capital abroad as foreign investors are able to analyze its financial statements compared to its competitors.
- There are considerable cost savings for multinationals when they adopt IFRS. Where different accounting standards are used in different countries there are costs incurred in adjusting their information systems and updating documentation. There is also the cost of training employees and hiring outside consultants. All these costs are eliminated with use of IFRS.
Disadvantages
- The application of IFRS requires a lot of interpretation by the companies. The rules and standards are not strict or specific. This acts as an obstacle to IFRS becoming a global standard as it incorporates the value judgments of accountants (Hail, 2009).
- Company officials come up with their own interpretations which can create a loophole for them to manipulate and embezzle money from the company through items such as reserves.
- Application of IFRS will lead to a higher tax hike for companies due to the way inventories will be presented in the statements. In US GAAP, the inventory method of last in First Out (LIFO) is used which lowers profit leading to lower taxes. In IFRS, the use of LIFO is not allowed. It is prohibited.
Conclusion
A company has to make a decision whether to use the US GAAP or IFRS in the preparation of its statements. The advantages and disadvantages of each method have to be weighed. The implementation processes and costs of the alternate method should also be considered. The company should also choose the method with the least risk in financial manipulation of the financial statements.
References
Hail, L., Leuz, C. & and Wysocki, P. (2009). Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors. Social Science Research Network. Web.
PWC (2010). IFRS and GAAP Similarities and Differences. PWC. Web.