GAAP vs. IFRS: An Overview

The standards that govern financial reporting and accounting vary from country to country. In the United States, financial reporting practices are set forth by the Financial Accounting Standards Board (FASB) and organized within the framework of the generally accepted accounting principles (GAAP). Generally accepted accounting principles refer to a common set of accepted accounting principles, standards, and procedures that companies and their accountants must follow when they compile their financial statements.

International Financial Reporting Standards (IFRS) are a set of international accounting standards, which state how particular types of transactions and other events should be reported in financial statements. IFRS are issued by the International Accounting Standards Board (IASB), and they specify exactly how accountants must maintain and report their accounts. IFRS was established in order to have a common accounting language, so business and accounts can be understood from company to company and country to country.

More than 100 countries around the world have adopted IFRS, which aim to establish a common global language for company accounting affairs. While the Securities and Exchange Commission (SEC) has openly expressed a desire to switch from GAAP to IFRS, development has been slow.

GAAP

If a company distributes its financial statements outside of the company, GAAP must be followed. If a corporation's stock is publicly traded, financial statements must also adhere to rules established by the U.S. Securities and Exchange Commission.

GAAP addresses such things as revenue recognition, balance sheet, item classification, and outstanding share measurements. If a financial statement is not prepared using GAAP, investors should be cautious. Also, some companies may use both GAAP- and non-GAAP-compliant measures when reporting financial results. GAAP regulations require that non-GAAP measures are identified in financial statements and other public disclosures, such as press releases.

IFRS

The point of IFRS is to maintain stability and transparency throughout the financial world. IFRS enables the ability to see exactly what has been happening with a company and allows businesses and individual investors to make educated financial decisions.

IFRS is standard in the European Union (EU) and many countries in Asia and South America, but not in the United States. The Securities and Exchange Commission won't switch to International Financial Reporting Standards in the near term, but will continue reviewing a proposal to allow IFRS information to supplement U.S. financial filings. Countries that benefit the most from the standards are those that conduct a lot of international business and investing.

Key Differences

The primary difference between the two systems is that GAAP is rules-based and IFRS is principles-based. This disconnect manifests itself in specific details and interpretations. Basically, IFRS guidelines provide much less overall detail than GAAP. Consequently, the theoretical framework and principles of the IFRS leave more room for interpretation and may often require lengthy disclosures on financial statements. On the other hand, the consistent and intuitive principles of IFRS are more logically sound and may possibly better represent the economics of business transactions.

Perhaps the most notable specific difference between GAAP and IFRS involves their treatment of inventory. IFRS rules ban the use of last-in, first-out (LIFO) inventory accounting methods. GAAP rules allow for LIFO. Both systems allow for the first-in, first-out method (FIFO) and the weighted average-cost method. GAAP does not allow for inventory reversals, while IFRS permits them under certain conditions.

Another key difference is that GAAP requires financial statements to include a statement of comprehensive income. IFRS does not consider comprehensive income to be a major element of performance and therefore does not require it. This difference leaves some room for mixing owner and non-owner activity within IFRS-based financial statements.

Key Takeaways

  • GAAP is a common set of accepted accounting principles, standards, and procedures that companies and their accountants must follow when they compile their financial statements. 
  • IFRS is a set of international accounting standards, which state how particular types of transactions and other events should be reported in financial statements.
  • Some accountants consider methodology to be the primary difference between the two systems; GAAP is rules-based and IFRS is principles-based.