IFRS vs. GAAP: An Overview
Systems of accounting, or accounting standards, are guidelines and regulations issued by governing bodies. They dictate how a company records its finances, how it presents its financial statements, and how it accounts for things such as inventories, depreciation, and amortization.
How a company reports these figures will have a large impact on the figures that appear in financial statements and regulatory filings. Investors and financial analysts must be sure they understand which set of standards a company is using, and how its bottom line or financial ratios will change if the accounting system were different.
- Accounting standards and guidelines for best practices differ by region and may be company-specific.
- IFRS is a global set of standards used by 15 of the G20 countries.
- GAAP is specific to the United States and has been adopted by the SEC.
IFRS stands for International Financial Reporting Standards. The International Accounting Standards Board (IASB) is the accounting standards body for the IFRS Foundation.
The predecessor to the IFRS Foundation, the International Accounting Standards Committee, was formed in 1973. Initial members were accounting bodies from Australia, Canada, France, Germany, Japan, Mexico, Netherlands, the U.K. and the United States. Today, IFRS has become the global standard for the preparation of public company financial statements and 144 out of 166 jurisdictions require IFRS standards.
Fifteen of the G20 countries have adopted IFRS. China, India and Indonesia have national accounting standards that are similar to IFRS, while Japan allows companies to follow the standards on a voluntary basis. In the United States, foreign listed companies may use IFRS and are no longer required to reconcile their financial statements with GAAP.
The IFRS Foundation works with more than a dozen consultative bodies, representing the many different stakeholder groups that are impacted by financial reporting.
GAAP stands for generally accepted accounting principles and is the standard adopted by the Securities and Exchange Commission (SEC) in the U.S. With the exception of foreign companies, all companies that are publicly traded must adhere to the GAAP system of accounting.
The best way to think of GAAP is as a set of rules that companies follow when their accountants report their financial statements. These rules help investors analyze and find the information they need to make sound financial decisions.
IFRS is a principle of the standard-based approach and is used internationally, while GAAP is a rule-based system compiled in the U.S.
The IASB does not set GAAP, nor does it have any legal authority over GAAP. The IASB can be thought of as a very influential group of people who are involved in debating and making up accounting rules. However, a lot of people actually do listen to what the IASB has to say on matters of accounting.
When the IASB sets a brand new accounting standard, a number of countries tend to adopt the standard, or at least interpret it, and fit it into their individual country's accounting standards. These standards, as set by each particular country's accounting standards board, will in turn influence what becomes GAAP for each particular country. For example, in the United States, the Financial Accounting Standards Board (FASB) makes up the rules and regulations which become GAAP.
Although the majority of the world uses IFRS standards, it is not part of the financial world in the U.S. The SEC continues to review switching to the IFRS but has yet to do so.
There are some major differences that exist between the two sets of accounting standards. These include:
- Inventory: The first is with the LIFO Inventory. GAAP allows companies to use the Last in, First out (LIFO) as an inventory cost method. But LIFO is banned under IFRS.
- Development costs: Under GAAP, these costs are considered expenses. Under IFRS, the costs are capitalized and amortized over multiple periods.
- Write-downs: GAAP specifies the write-down amount of an inventory or fixed asset can't be reversed if the market value of the asset subsequently increases. On the other hand, the IFRS allows the write-down to be reversed.
For more information on GAAP and its effect on financial statements in the United States, check out 12 Things You Should Know About Financial Statements.