Differences between Generally Accepted Accounting Principles and International Financial Reporting Standards - Essay Example

The differences between GAAP and IFRS of the of the Table of Contents Introduction 3 General differences between GAAP and IFRS 3 Details about two major differences 5 Principle versus Rule based 5 Methodology 6 GAAP and IFRS reporting standards and impact 6 Advantages and disadvantages of each approach 7 Advantages of IFRS 7 Disadvantages of IFRS 7 Advantages of GAAP 8 Disadvantages of GAAP 8 Issues on the merging of the standards 8 References 10 Introduction This paper highlights differences between Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), in a detailed manner. GAAP is a standard framework consisting of guidelines and rules for accounts, which are acknowledged as accounting practices. There are certain standards, rules and conventions present in GAAP that are used by accountants for preparing, summarizing and recording the financial statements. GAAP can be referred to as the accounting standard, which is used in United States of America (USA). IFRS is a common language that is globally used for affairs related to business so that company accounts can become comparable and understandable across international boundaries. Several nationally used accounting standards are gradually being replaced by IFRS. This comprises certain rules, which accountants need to follow in order to render accounts comprehendible, comparable, relevant and reliable (Needles & Powers, 2012). General differences between GAAP and IFRS The major differences between GAAP and IFRS can be discussed as follows (Shamrock, 2012): US GAAP IFRS Major difference: Conceptual framework The conceptual framework under GAAP is a non-authoritative form of guidance, which is rarely referred to by ones who prepare financial statements. It is more rules based. The conceptual framework is used by preparers of financial statements so as to gather adequate reference. It is more principles based. Major Difference: Methodology It is based on research. It is based on facts. Requirement of Financial periods In GAAP, there are presentations of balance sheet of a single year. There is no necessity to present the most recent comparative period in the financial statement under any circumstances. Yet, as per SEC guidelines, financial statements for three of the most recent periods of reporting are to be presented. As per the rules laid down in IFRS, there should be disclosure of comparative information of all amounts related to the preceding period in the financial statement of the current period. Income Statement and Balance Sheet Layout There are no requirement to prepare the income statement and balance sheet as per any specific layout. Public companies are still required to abide by the requirements present in Regulation S-X (Wiecek & Young, 2009). There is no standard layout that is needed to be followed as per IFRS, except a list containing minimum line items. The requirements laid down here are prescriptive enough compared to Regulation S-X (Wiecek & Young, 2009). Classification of deferred tax assets and liabilities in the balance sheet The classification here is done on the basis of nature of the related asset and liability. Here all amounts are classified in the balance sheet as non-current. Classification of the expenses in the Income Statement There is no requirement to classify items in the income statement as per their nature or function. However, as per SEC guidelines, it is necessary for all registrants to present expenses based on their functions. H ere expenses can be presented by the entities based on their nature and function. If function is selected, then certain disclosures is needed regarding nature of the expenses in the end notes. Criteria for extraordinary items in the Income Statement The criterion is restricted to items that are not frequent and unusual. Prohibited. Classification of income taxes paid The income taxes are needed to be considered as the operating activities, in general. The income taxes under this framework are considered under the operating activities, only if they cannot be classified as investing or financing activities. Details about two major differences The details about major differences between US GAAP and IFRS can be discussed in a detailed manner below: Principle versus Rule based The major difference in the conceptual framework of U.S. GAAP and IFRS lies in the fact that the former is rule-based; whereas, the latter is more of principle-based. The inbuilt characteristic that a principle based framework carries can be described as the ability for different interpretations for same transactions. So, this situation can be regarded as second-guessing, which creates immense amount of uncertainty and thus, requires extensive disclosures in financial statements. The board of standard setting can clarify the areas of discussion or interpretation that lack clarity in this system. Nonetheless, IFRS consists of certain guidelines and stances, which can be considered or judged as a set of rules, rather than that of principles. Therefore, during adaptation of U.S. GAAP, various English observers commented that this were more rule-based than IFRS, which is rather principle-based (Epstein & Jermakowicz, 2008). Further Major Differences highlighted: Consolidation — While U.S. GAAP favours a risk and reward model, IFRS prefers more of a control-based model. So, few entities that are consolidated as per FIN 46(R) might require disclosure in a disjointed manner under IFRS (Wiecek & Young, 2009). Statement of Income — The extraordinary items are not segregated in the income statement of IFRS; on the other hand, these items are presented underneath net income in US GAAP. Inventory — A disadvantage of IFRS can be identified as the inability of entities following this system to use LIFO (Last in First Out) method of stock value recording. The organizations following the framework of U.S. GAAP can efficiently make use of both LIFO and FIFO (First in First Out) methods for stock valuation. Earning-per-Share( EPS) — IFRS does not consider average of individual interim periods at the time of calculation of EPS, unlike U.S. GAAP that computes average of individual interim periods of the incremental shares. Development costs — These costs are taken as expenses by those entities, which follow the U.S. GAAP framework, unlike those under IFRS, where these costs are capitalized easily on meeting certain criteria (Wiecek & Young, 2009). Methodology There are differences between the two approaches, which can be estimated on the basis of methodology used to evaluate accounting treatments. A thorough review of the pattern of various facts is conducted under IFRS; but, more importance is given on research under U.S. GAAP framework. Hence, these are the major differences that can be identified in this paper through the research work (Walton, 2009). GAAP and IFRS reporting standards and impact While GAAP is widely used in U.S., IFRS is a global reporting framework that is used by more than 110 countries all over the world (KPMG, 2013). While GAAP is more rules based, IFRS is a principal-based system. All countries worldwide require abiding by IFRS in order to bring in the required uniformity in accounting framework. The impact of IFRS framework might be positive on the management as they can consult it during lack of interpretation in certain issues. Unlike IFRS, there are no provisions in the framework, which can help management to look out for solutions in absence of an interpretation for certain issues in GAAP. Both GAAP and IFRS have different accounting standards, but there are various problematic areas that IFRS needs to resolve in order to be more acceptable for companies. If few improvements are brought in the international standards, then there would be huge possibilities for U.S. based companies to switch over to the IFRS framework by 2016 (Shamrock, 2012). The common accounting regime can help investors to compare various entities of the world. This could also help the companies to better analyze opportunities for cross-border acquisitions. A common accounting regime will be a boon to accounting firms, which will be able to successfully guide companies through this new system. The rules and requirements of IFRS are lesser than that of GAAP, which is another aspect that can create a positive impact on financial systems of the companies. Advantages and disadvantages of each approach Advantages of IFRS If companies based in U.S. start using the IFRS framework, then the deals and transactions with other companies who similarly follows this framework will be much easier. The stockholders of other countries will have a better understanding of the way the companies in U.S. are performing. The productivity and clarity offered by IFRS framework is commendable. The analysts who are using this system can easily use the professional judgment to handle specific transactions instead of going through a number of rules and wasting time. The financial preparers can also prepare the financial statements in a more understandable and simplistic form for the investors and several companies using the IFRS framework. Disadvantages of IFRS The countries like, U.S., who adapts IFRS freshly might face several problems as an entire system for performing their jobs has to be relearned. There might be losses or fall in profit margins as the accountant would take a considerable time to relearn the entire system of preparing financial statements by following IFRS (Ernst & Young, 2013). Advantages of GAAP The major advantage of GAAP is the flexibility offered. This allows entities to prepare the financial statements as per their requirement so as to accurately disclose the current situation of the company. As GAAP does not follow rule-based accounting, disclosures made by companies are more informative and least time consuming as compared to IFRS. Disadvantages of GAAP The major disadvantage of following IFRS for preparation of the financial statement can be lack of transparency. As each company can prepare their statements with varying perspectives, preparers can speculate with different financial facts. As companies prepare the financial statements as per their need, these statements might vary in their style, thereby hindering comparison between two entities from different industries. There may be more mistakes in reporting because of the strict set of rules in accounting (Ernst & Young, 2013). Issues on the merging of the standards If the accounting standards of IFRS and GAAP are merged, then there would be no single standard to judge the economic condition of various companies in different parts of the world (McEwen, 2009). The companies following GAAP might be in a more advantageous situation as they will be able to prepare financial statements as per their viewpoints. These companies will be able to manipulate as well as make mistakes more easily as compared to firms who use IFRS framework. The shareholders in a particular country will not be able to judge the financial condition of a company following a different framework of accounting in another part of the world (Needles & Powers, 2012). The analysts will also not be able to judge the economic condition of countries based on performance of their companies, in case they follow separate accounting frameworks. References Epstein, B.J., & Jermakowicz, E.K. (2008). Wiley IFRS 2008: Interpretation and Application of International Accounting and Financial Reporting Standards 2008. New York: John Wiley & Sons. Ernst & Young. (2013). International GAAP 2013: Generally Accepted Accounting Principles under International Financial Reporting Standards. Chichester: John Wiley & Sons. KPMG. (2013). US GAAP comparison. Retrieved from http://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/IFRS-GAAP-comparisons/Pages/IFRS-compared-to-us-gaap-2013.aspx. McEwen, R.A. (2009). Transparency in financial reporting: A concise comparison of IFRS and US GAAP. Great Britain: Harriman House Limited. Needles, B., & Powers, M. (2012). International Financial Reporting Standards: An introduction. Connecticut: Cengage Learning. Shamrock, S.E. (2012). IFRS and US GAAP, with Website: A comprehensive comparison. New York: John Wiley & Sons. Walton, P. (2009). An Executives Guide for Moving from US GAAP to IFRS. New York: Business Expert Press. Wiecek, I.M., & Young, N.M. (2009). IFRS primer international GAAP basics. New York: John Wiley & Sons. Read More