The US Generally Accepted Accounting Principles vs International Financial Reporting Standards - Term Paper Example

A Comparison between IFRS and the U. S. GAAP Currently, there are two major accounting principles in the world: the United States Generally Accepted Accounting Principles (U. S. GAAP) and the International Financial Reporting Standards or IFRS. With the recent spate of conversions of some countries to the IFRS, the current ongoing conversions of other countries to the IFRS and the recognition that the IFRS is becoming more and more global, the U. S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) had already made plans to converge the two principles. Although there are similarities between the two, their differences are major and will affect greatly the entities affected by the conversion. In terms of the general, underlying principles and accounting for commonly – occurring transactions, the two principles are actually more similar than different. Despite these similarities, however, the approaches taken by the two principles are different (i.e., IFRS is principle-based while the U. S. GAAP is rule-based). In addition, major differences are also found in their accounting treatments for significant accounts and complex transactions. This article aims to compare and to contrast the U. S. GAAP and the IFRS. It takes into account the similarities and differences between these two accounting principles. It utilizes materials from various accounting firms and accounting standards board in its comparison. As this topic is so diverse (some publications comparing the two principles have over one hundred pages), only a basic comparison will be done in this article. A Comparison between IFRS and the U. S. GAAP The 2006 Memorandum of Understanding or MOU (as updated in 2008) issued by the FASB and the IASB have set the path towards the convergence of U. S. GAAP and the IFRS. The MOU affirmed the two Board’s commitment to “developing common, high quality standards” (FASB, 2009). The ongoing efforts to converge the U. S. GAAP with IFRS have raised a lot of concerns and a lot of questions as to how different or similar the two sets of accounting principles are. The following briefly compares the two principles and outlines their similarities and differences. General Comparison Despite their differences, the “general principles, conceptual framework and accounting results” (Ernst & Young, 2009) between these two principles are basically the same or similar. In fact, according to Ernst & Young (2009), the accounting treatment for transactions that commonly occur in companies is the same under both principles. The basic difference of these two principles is their general approach. According to the 2008 comparison between the two principles as published by Deloitte, IFRS are more principle – based, “with limited application guidance” while the U. S. GAAP, on the other hand, are more rule-based, “with specific application guidance”. The numbers of individual standards of the two principles differ to a great extent. IFRS only has nine (9) IFRS, thirty (30) International Accounting Standards, a Framework and several interpretations (Deloitte, 2009). IASB (according to the FASB website), on the other hand, already has one hundred forty – eight (148) Statement of Financial Accounting Standards, forty – eight (48) FASB interpretations and numerous EITF abstracts. Similarities and Differences As stated in the previous page and according to the 2009 publication of Ernst & Young, there are many similarities between the U. S. GAAP and IFRS. For one, the basic components of the financial statements are similar. They both have the balance sheet, income statement, other comprehensive income (under U. S. GAAP) or statement of comprehensive income (under IFRS), statement of cash flows and the related notes to financial statements. For another, they both require the accrual basis of accounting in the preparation of the financial statements, except for the statement of cash flows. Lastly, both of them recognize the concepts of materiality and consistency in the preparation of the financial statements. Other similarities include the requirement of both U. S. GAAP and the IFRS that each financial statement and notes be clearly identified. Both of them also requires that the company disclose the name of the reporting entity, whether the financial statements cover a group or a single entity, the date of the financial statements, the currency used and the level of rounding of (Grant Thornton, 2009). The differences between these two lie on the guidance specific to each component of the financial statements and to each account found within these financial statements. For the layout of the balance sheet and income statement, there is really no specific requirement under the U. S. GAAP for any specific layout. This is similar to the IFRS; however, the IFRS has a list of minimum items to be presented on the face of the balance sheet and income statement (Ernst & Young, 2009). In the balance sheet presentation, the differences between these two principles lie on the presentations of debt and deferred taxes. In this case, the IFRS is more stringent in the sense that it has a stricter criterion when it comes to classifying debt (that did not meet a debt covenant) to non-current liabilities. IFRS is also stricter in the classification of deferred taxes as it only considers a non-current classification for this account, notwithstanding the actual classification of the related asset or liability. For the statement of income, extraordinary items are prohibited under IFRS but are allowed under the U. S. GAAP. For discontinued operations, both the U. S. GAAP and the IFRS restrict this classification to significant components that are “held for sale or to be disposed of”. However, under U. S. GAAP, there is the provision that, after the sale, there will be no “continuing significant cash flows or involvement with the disposed entity” (Ernst & Young, 2009). There is no such provision under the IFRS. For the statement of cash flows (according to Grant Thornton, 2009), the two principles have a lot of similarities. They both require the reporting of cash flows using the operating, investing and financing activities. They both also allow the direct and indirect methods. The classifications of dividends and interest paid and interest and dividends received are also the same. The main difference lies on the discontinued operations. With the U. S. GAAP, “separate disclosure of cash flows related to discontinued operations is not required to be presented”. Under IFRS, the disclosure (attributable to operating, investing and financing) is required. For current assets, there are no significant differences in accounting for cash as well as the criterion to be used in the classification of the short-term financial instruments (i.e., less than three months). Inventories, however, are another matter. All costing methods are acceptable under the U. S. GAAP, however, the last-in, first-out inventory costing method is not allowed under the IFRS. Under the IFRS, the measurement of inventories is at the lower of cost or net realizable value while, under the U. S. GAAP, the measurement of inventories is at the lower of cost or market. IFRS requires the cost formula to be consistently applied to those inventories with similar nature and use, a requirement that is not shared by the U. S. GAAP. Lastly, IFRS allows write-downs of inventory values to be reversed, while a reversal of the write-down due to an increase in market value is not allowed by the U. S. GAAP. For property, plant and equipment, the similarities include similar general requirements for the recognition of property, plant and equipment and allowing the capitalization of borrowing costs incurred for the acquisition of property, plant and equipment. However, when it comes to depreciation, the IFRS has a concept of componentization where the different components of an item of property, plant and equipment are depreciated differently. There is no such requirement in the U. S. GAAP. Impairment testing also differs between the two, with the IFRS using a “one-step impairment test” and the U. S. GAAP requiring a “two-step impairment test” (PriceWaterhouseCoopers, 2009). In the liabilities section, for provisions, the two principles differ in their definition of the word “probable” (PriceWaterhouseCoopers, 2009). The definition of probable under the IFRS will result to an earlier recognition of provision in the entity’s balance sheet. The treatment of financial instruments also differs between the two. An example is a compound instruments that are not convertible, such instruments will be “classified wholly within liabilities or equity” under U. S. GAAP while they are required to be bifurcated under IFRS (PriceWaterhouseCoopers, 2009). For convertible instruments, both allow bifurcation, however, under U. S. GAAP, there are certain criteria that must be met before bifurcation happens. These criteria are not found under IFRS. Other differences in accounting for financial instruments also exist, making the convergence of the accounting standards for financial instruments a major challenge for both the FASB and the IASB. When it comes to revenue recognition, of all the areas of differences between these two principles, perhaps nothing is as different as their revenue recognition provisions. The differences are largely due to the fact that their basic approaches differ. The guidance of U. S. GAAP on revenue recognition is “extensive and includes a significant volume of literature” while, under IFRS, only “two primary revenue standards capture all revenue transactions” (PriceWaterhouseCoopers, 2009). As to expense recognition, the major differences of these two principles lie on the recognition of employee benefits and share-based payments. Conclusion The U. S. GAAP and IFRS have their similarities, from the basic framework to the concepts of materiality and consistency to the presentation of financial statements and finally, to some of the specific accounts. However, the specific guidance of these two principles really varies, mainly due to the fact that their approaches differ. With U. S. GAAP using a rule-based approach, it has lots of provisions and accounting options for different transactions. On the other hand, with the IFRS, its principle-based approach provides fewer guidelines that are, nevertheless, still all-encompassing. With the convergence between these two principles, it remains to be seen how such differences will be reconciled, if they will be reconciled at all. References Deloitte (2008). IFRS and U. S. GAAP: A Pocket Comparison. Retrieved from: http://www.iasplus.com/dttpubs/0809ifrsusgaap.pdf. Deloitte (2009). Summary of International Financial Reporting Standards. Retrieved from: http://www.iasplus.com/standard/standard.htm. Ernst & Young (2009). U. S. GAAP vs. IFRS: The Basics. Retrieved from: http://www.ey.com/Publication/vwLUAssets/IFRS_v_GAAP_basics_Jan09/$FILE/IFRS_v_GAAP_basics_Jan09.pdf. Financial Accounting Standards Board (2009). Completing the February 2006 Memorandum of Understanding: A Progress Report and Timetable for Completion September 2008. Retrieved from: http://www.fasb.org/intl/MOU_09-11-08.pdf. Financial Accounting Standards Board (2009). Pre-Codification Standards. Retrieved from: http://www.fasb.org/jsp/FASB/Page/PreCodSectionPage&cid=1218220137031. Grant Thornton (2009). Comparison between U. S. GAAP and International Financial Reporting Standards. Edition 1.3. Retrieved from: http://www.grantthornton.co.nz/Assets/ documents/Services/ifrs/US_GAAP_v_IFRS_Comparison_June2009(1.3).pdf. PriceWaterhouseCoopers (2009). IFRS and US GAAP: Similarities and Differences. Retrieved from: http://www.pwc.com/en_US/us/issues/ifrs-reporting/assets/ifrs_usgaapsep09.pdf. Read More