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. To answer this question, it's important to differentiate between International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) to get a better grasp of the function they serve in the world of accounting.
- 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 voluntarily. 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. Except for 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, several 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.
Some major differences 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. This applies to the internal costs of developing any intangible assets.
- 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. This results in inventory values fluctuating more frequently under IFRS than under GAAP.
- Fixed Assets: Under GAAP, fixed assets such as property, plant, and equipment (PP&E), must be recorded at historical cost (the purchase price), and depreciated accordingly. Under IFRS, fixed assets are also valued at cost, but companies are allowed to revalue fixed assets to the fair market value.