IFRS and GAAP: similarities and differences

It is only a matter of time before the accounting profession fully converges on a set of high-quality international standards. For more than a decade, there has been progress in converging US GAAP with International Financial Reporting Standards. As the two accounting standards continue to converge into a single set of international standards, one will realize that there are many similarities and differences between the methods. Although the differences may provoke a need to compromise, the similarities reveal that convergence is an achievable goal.

Generally Accepted Accounting Principles, or GAAP, is the common set of accounting standards in US GAAP, issued by the American Institute of Certified Public Accountants (AICPA), has been a continuous development over the past 60 years; includes the following elements: Financial Accounting Standards Board (FASB) standards, interpretations, and staff positions; Opinions of the Accounting Principles Board (APB); and AICPA Research Bulletins. Today, the Securities and Exchange Commission (SEC) oversees all accounting practices in the US and makes sure they adhere to GAAP standards. GAAP sets standards to make financial records relevant and reliable to all interested investors, shareholders, or other financial readers. So what about international companies? How do these companies develop financial information? International companies cannot simply prepare their financial information under GAAP standards; they must also take into account the rules of the International Financial Regulations.

The International Accounting Standards Board (IASB) in London developed International Financial Reporting Standards (IFRS or iGAAP). Today, the European Union requires all companies in Europe to follow accounting practices under the IFRS method. More than 100 countries currently use IFRS. When the US fully adopts IFRS, it will be easier to compare US companies with foreign companies and thus allow US companies to raise capital in foreign markets.

GAAP and IFRS are similar in many ways, making convergence an achievable task. The conceptual frameworks of both methods are very similar in structure, in terms of their accounting objectives, elements and qualitative characteristics. One big similarity between GAAP and IFRS is that both standards use an income statement, a balance sheet, and a statement of cash flows. When it comes to cash and cash equivalents, both methods are essentially the same. Another important similarity is that both GAAP and IFRS prepare financial statements on an incremental basis; which means that revenue is recognized when it is realized or realizable. There are many other similarities between GAAP and IFRS and therefore will help in a complete convergence in the near future, but before there is a set of international financial accounting standards, the differences between GAAP and IFRS must be noted.

An important difference between the accounting practices in GAAP and IFRS is that GAAP is based on rules, while IFRS is based on principles. Principle-based accounting allows for a different interpretation of the same transactions, where rule-based GAAP follows a set of rules in the preparation of financial statements, which means there is no room for error. In other words, GAAP standards are extremely strict regarding accounting practices and disclosure requirements, while IFRS practices are less restrictive; For example, the GAAP method is more stringent when preparing income statements, where it requires the use of a single-step or multi-step approach; IFRS does not mention either approach. In addition to the GAAP multi-step income statement, unusual and infrequent items should be included as extraordinary items; extraordinary items are prohibited in IFRS. There is also a big difference between the two methods regarding the LIFO (last in, first out) cost flow assumption. Only GAAP accepts the LIFO method for inventory valuation, while IFRS can only use average cost and FIFO (first in, first out) for inventory valuation. The differences between the two methods must be resolved for the benefit of economic globalization.

The different methods can be problematic for potential investors in international markets, because it will be difficult to interpret and understand the financial information. It will be financially beneficial for the global economy when accounting standards are merged into a single set of rules. The FASB and IASB have issued a memorandum of understanding that they must make existing financial standards compatible and, once secured, they intend to maintain compatibility. In an effort to converge, the FASB has issued a rule that allows a fair value option for financial instruments. In 2009, the SEC allowed some US companies to use IFRS, with plans for full convergence by 2016.

In conclusion, it is important for economic globalization that GAAP converges with IFRS on a set of high-quality international standards. A unified set of accounting standards will provide companies, investors, creditors, financial users, etc. with useful, relevant and reliable information for making financial decisions. Similarities to GAAP and IFRS already provide some ease with the merger. And while there are still many differences, short- and long-term efforts are underway with the hope of merging GAAP and IFRS in the near future.