General Accepted Accounting Principles (GAAP) are accounting regulations used to plan, present, and report financial statements for various business entities while International Financial Reporting Standards (IFRS) are principle-based values, interpretations, and formal framework that the International Accounting Standards Board (IAS) adopted. This paper will explain differences and similarities between the US GAAP and IFRS.
Comparison Between US GAAP and IFRS
This research will mainly focus on comparison of the following standards: first time adoption, business combinations, financial statement presentation, inventories, and statement of cash flows, revenue recognition, expense recognition, liabilities, group accounts and assets.
a)First Time Adoption
The IFRS framework constitutes definite standard and procedures used in the application of IFRS for the mere first time (Deloitte, 2008). The first time adoption of IFRS provides the framework for implementing IFRS by addressing how IFRS should be effectively implemented on the reporting date of an organization’s first time adoption of IFRS. Issues addressed in the financial statement include PPE and business combination, assets, share-based payments, pension plan accounting, and mandatory exceptions. Additionally, comparative information is organized and presented according to IFRS (PriceWaterhouseCoopers, 2007).
All changes resulting from the first-time application of IFRS are implemented against the opening earnings retained from the first session and presented on the basis of IFRS. Several adjustments are made against other classes of equity or goodwill. Furthermore, any organization’s first IFRS financial statements should present reconciliations of loss or profit with respect to the last period reported under the previous GAAP of equity. This occurs when the end of the period is fast approaching taking into account the resultant equity at the beginning of the earliest period, which is essentially presented in the first IFRS financial statements (PriceWaterhouseCoopers, 2007).
In the case of GAAP, accounting principles should be reliable, for any financial information displayed in the comparative financial statements. The US GAAP does not provide precise guidance on the first-time adoption of its accounting principles. Nonetheless, first-time adoption of US GAAP necessitates a complete retrospective application (PriceWaterhouseCoopers, 2007). Several standards provide specifications on the transitional treatment required for first-time application of standards. Precise rules do apply for curved out entities along with first-time presentation of financial statements for the public. There is no condition to present reconciliations for loss or profit and/or equity on first-time adoption of the US GAAP. First-time adoption of IFRS was issued on June 19, 2003 and became effective on January 2004 (PriceWaterhouseCoopers, 2007).
Business combinations entail joining separate entities into one reporting business or entity (Deloitte, 2008). Both IFRS and US GAAP necessitate the use of the purchase accounting method for the majority of business combination transactions. According to IFRS, business combinations within the IFRS 3 scope are accounted for as acquisitions (Deloitte, 2008). The purchase formula of accounting applies during the development stage of an entity, which may often include significant resources in the nature of goodwill. In IFRS 3, acquisition of such a business is regarded as a business combination and goodwill is acknowledged as a different asset, rather than being considered in the carrying totals of the additional asset in the transferred set (Deloitte, 2008).
In the US GAAP, the use of a purchasing system of accounting is a requirement for many business combinations. This happens when the entity acquired meets the description of a business. The definition of a business entity under US GAAP is parallel to IFRS. Nonetheless, if the acquired business is in its development stage, this will imply that it has not started its planned operations; hence, it is regarded as not being a business (Deloitte, 2008). It is similar to IFRS in that if the purchased operations are not an entity, individual assets along with liabilities are acknowledged at their comparative fair value and there is no goodwill recognized.
In IFRS, the cost of acquisition is represented through shares issued and recorded at their fair value on the date which the exchange took place (Deloitte, 2008). The published selling price of a share on the day of exchange is the confirmation of the fair value in any active market. In the case of US GAAP, shares issued as considerations, are estimated at their market price over a considerable period of time before and after the day the parties will arrive at an amicable agreement regarding the purchase price (Deloitte, 2008). The anticipated transaction will be announced, pursuant to this. Additionally, the date for getting the value of marketable securities is not subject to regulatory or shareholder approval.
c)Financial Statement Presentation
The U.S. GAAP and IFRS offer limited directions on statement presentation. Furthermore, presentation directions in the U.S GAAP are dispersed in the standards. Users of financial statements have frequently expressed displeasure that the information is not linked across various statements and that different items are in some cases aggregated in one number (Thornton, 2009). In the case of IFRS, an entity is supposed to apply IAS when preparing and presenting general purpose financial statements which have to be in agreement with IFRS (IAS1.2). General purpose financial statements are those aimed at meeting the requirement of users who are not obliged to obey by specific requirements of an entity in order to make reports intended for their unique information needs (Thornton, 2009).
In IFRS, a complete financial statement consists of the following elements: a statement of financial position at the end a certain period, a comprehensive statement for a particular time, cash flows statement for the period, and a statement of change in equity for the period (Thornton, 2009). An entity may make use of titles for statements that do not necessarily have to be used in IAS 1. An entity is expected to present with equal prominence all financial statements in a comprehensive set of financial statements (IAS 1.11). On the other hand, in the US GAAP, financial statements consist of income statement, balance sheet, and a statement of complete income (Thornton, 2009). This statement can be reported differently or combined with the statement of changes in stockholders’ equity or income statement. The statement of changes in stockholders’ equity instead reveals changes in the separate accounts comprising of stockholders’ equity, which can be made in the notes of the financial statements (Thornton, 2009).
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In reference to the statement of cash flows, unlike the IFRS, the U.S GAAP does not demand a third party balance sheet (Whittington & Delaney, 2010). In both IFRS and U.S GAAP, an entity is not allowed to correct wrong policies by revealing the accounting policies, which have been used. In IFRS, an entity whose financial statements are in compliance with IFRS shall make an open and unreserved statement of this compliance in the notes (Whittington & Delaney, 2010). An entity is not expected to explain financial statements to be in compliance with IFRS except if they are in compliance with all the necessities of IFRS. On the other hand, U.S GAAP does not have similar necessities (Whittington & Delaney, 2010).
The goal of IAS 2 is to reinforce the accounting treatment of inventories. It offers guidance on the determination of cost and consequently is recognized as an expense (Thornton, 2009). In IFRS and U.S GAAP inventories are regarded as assets (IAS 2.6) since they can be sold in the course of business or during the production of such a sale. However, IAS 2 is applicable to all inventories except for financial instruments and biological assets arising from agricultural activity, for example, an agricultural produce that is undergoing harvesting and work that is currently under progress, especially construction contracts and associated service contracts (Thornton, 2009).
In IFRS, the cost of inventories consists of all purchase costs, conversion cost, and other costs encountered when taking inventories in their current condition and location (Kimmel, Kieso, & Weygand, 2010). In U.S GAAP, the cost of inventories entails all expenditures incurred during the usual business operation of transforming the service or product to its current condition and location. In IFRS, inventories are entered based on the net possible value of an item. In some situations, it may be proper to group related items. Unlike IFRS, in the US GAAP, a turnaround of a write-down for an increase in the market value is not allowed (Kimmel, Kieso & Weygandt, 2010). In IFRS, when inventories are sold, the total amount of the inventories will be recognized as an expense at the moment in which the related revenue was identified. In the U.S GAAP, a reversal of a write-down for a hike in the market value is not allowed (Kimmel, Kieso & Weygandt, 2010). In IFRS, an entity shall make use of the same cost formula for inventories that are similar in nature and use to the entity. Various cost formulas may be justified for inventories having different uses or nature. In the U.S GAAP, similar cost formula does not necessarily need to be applied to inventories having identical use and nature (Kimmel, Kieso & Weygandt, 2010).
e)Statement of Cash Flows
IFRS – IAS 7 does not give exemptions for offering statement of cash flows. The U.S GAAP offers an exemption for offering a statement of cash flows as follows: highly liquid investment organizations that meet specified guidelines; define benefits of pension plans; and other employee benefit plans. In IFRS, cash flow consists of demand deposits and cash in hand. Cash equivalents are temporary liquid investments that are easily convertible to known cash, which are dependent on the occurrence of insignificant changes in value (PriceWaterhouseCoopers, 2007). Any investment qualifies to be a cash equivalent, if it has the maturity of up to three months after the acquisition date. And, in U.S. GAAP cash flows depicts changes in cash and cash equivalents. In common practice, only investments that have validity term three months or lesser time are classified as cash equivalents.
In IFRS, bank borrowings are commonly regarded as financing activities. Nonetheless, in some states, bank overdrafts that are repayable on demand become an essential part of an entity for cash management (PriceWaterhouseCoopers, 2007). In such situations, bank overdrafts are regarded as a constituent of cash equivalents. A property of this banking arrangement is that the bank balance constantly fluctuates from positive to overdrawn. However, in the U.S GAAP, bank overdrafts are added to liabilities and removed from cash equivalents (PriceWaterhouseCoopers, 2007). Variations in overdraft balances are financing activities.
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In both the IFRS and GAAP, the statement of cash flows reports cash flows classified by the following: investment activities, operation activities, and financial activities. In IFRS, cash flows that arise from the following financing, investing and operations activities can be reported on a net basis: cash receipts and payments for items with quick turnover, short maturities, and large mounts (PriceWaterhouseCoopers, 2007). In the U.S GAAP, payments and receipts should be shown in gross. Particular items may be presented in net form as long as they have a quick turnover, have large amounts and short maturities. Items, which qualify for net reporting, are cash flows that pertain to loans receivable, investments, and debt, on condition that the original maturity of liability or asset is less than three months (PriceWaterhouseCoopers, 2007).
In IFRS, an entity discloses the constituents of cash equivalents shall provide a reconciliation of the amount, which is in its cash flows taking into account the equivalent items in the financial position statement. In the U.S GAAP, total cash and cash equivalent at the start and end of the period illustrated in the statement of cash flows should be same as titled line items or subtotals in the balance sheet (PriceWaterhouseCoopers, 2007).
In IFRS, the specific method chosen for sale of goods offering services, interest, royalties and dividends should be met so that the revenue can be recognized. The revenue recognition method that is common to each of these is the possibility that the economic advantages associated with the transaction will move to the entity such that the revenue and costs can be measured reliably (PriceWaterhouseCoopers, 2007). The recognition method is applied to revenue arising from the sale of goods. Interest revenue is acknowledged on a basis which takes into account an asset’s effective yield. Royalties is identified based on an accrual basis (PriceWaterhouseCoopers, 2007). Dividends can only be recognized after shareholders right to acquire them has been established. In the U.S GAAP, the guidance is wide, and it may result in considerable actual differences. There exist various foundations of revenue recognition guidance, for instance, FAS, SOPs, SABs, AAERs and EITFs (PriceWaterhouseCoopers, 2007). The U.S GAAP puts emphasis on revenues realized and earned. Revenue recognition entails an exchange transaction. Further guidance for Securities and Exchange Commission (SEC) registrants spells out the criteria that entities should observe before revenue is realized and earned. SEC offers guidance that is related to precise revenue recognition situations.
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In IFRS, the percentage-of-completion method helps in accounting service transactions. Revenues can be recognized on a straight-line basis when the services are conducted by an indeterminate number of acts during a specified period. Revenues can only be recognized for the period in which expenses have been incurred and are only recoverable once the outcome of any service transaction cannot be measured reliably (PriceWaterhouseCoopers, 2007). In U.S GAAP, service transaction are accounted through proper guidance or, if none, when collectability is rationally assured, delivery has happened, services have been offered, persuasive evidence of a pact exists, and there is a rigid or determinable sales price. Revenue is not recognized whenever the outcome of a service transaction cannot be reliably measured (PriceWaterhouseCoopers, 2007).
In IFRS, interest expenses are recognized based on an accrual basis that uses proper interest method. The directly attributable transaction costs, discount or premiums arising from the issue of debt instrument are repaid using the effective interest method. The U.S GAAP is similar to the IFRS on the issue of interest expense; however, the contractual life of the debt instrument is used in practice (Ernest & Young, 2010). In both IFRS and U.S GAAP, the cost of offering the benefits must be calculated from rational and systematic standpoint over the period in which employees are offering their services to the entity (Ernest & Young, 2010). In both frameworks different pension plans into defined benefit plans and defined contribution plans.
In IFRS and US GAAP, the pension cost is measured as the contributions payable to the fund on a periodic basis. Unlike in IFRS, if a plan does not have individual participant accounts, for US GAAP purposes it is not a defined contribution plan. According to IAS 19, Employee Benefits, a cautious analysis of terms and conditions of the plan are inclusive as long as its legal position is performed to establish if the essence of the arrangement is that of a defined benefit or contribution plan (Ernest & Young, 2010). In IFRS, an employers’ social security liability arising from a share-based payment transaction is recognized over identical periods and a share-based expense. On the other hand, the employer payroll relies on the employee’s stock-based compensation, which is identified as an expense on the day on which the event triggering payment and measurement of tax to the taxing body occurred.
IFRS has precise standards regarding accounting of various categories of provisions. On the other hand, US GAAP has various standards aimed at addressing particular types of provisions, for instance, restructuring costs and environmental liabilities (Ernest & Young, 2010). In both frameworks, they prohibit recognition of expected costs, which includes costs associated with proposed but not yet effective legislation. In both frameworks, the amount is regarded as a provision that the best measurement of the required expenditure will settle the current obligation in a balance sheet date (Ernest & Young, 2010). The expected cash flows are discounted through a pretax discount rate that reflects current market rates based on the periodic value of money and precise risks to the liability when the effect is material. If various estimates are predicted and there is no amount in the choice is more probable than any other quantity in the variety used to estimate the liability (Ernest & Young, 2010).
In IFRS, a variety of estimates are presented, and no amount in the range is more likely compared to any other amount in the variety, for example, the minimum amount is used to estimate the liability (Ernest & Young, 2010). Provisions are only discounted if the timing of cash flows is reliably determinable or fixed. Disparities may come about in the selection of discount rate, especially in the area of asset retirement obligations.
In both frameworks, grants are only recognized once there is sound assurance that both conditions for their receipt will be observed, and it will be received (Ernest & Young, 2010). Revenue-based grants are deferred in a balance sheet and released to the income statement equivalent to the related expenditure, which is to be compensated. Grants, which relate to recognized assets, are presented in a balance sheet as either deferred income or by deducing the grant in order to arrive at the asset’s carrying amount (Ernest & Young, 2010). Therefore, the grant is regarded as a reduction of depression. However, in US GAAP, there are obligations tied to the grant. Revenue recognition is held until these conditions are observed. Furthermore, contributions for purchase of long-lived assets are reported when it is received.
In IFRS, for group accounts, a parent expected to present consolidated financial statements, which include all its subsidiaries. Nonetheless, a parent is not obligated to give consolidated financial statement if the following conditions are observed: in the event, the parent equity or debt is not traded in a public market, the parent whose partially or wholly-owned subsidiary of a different entity and its formal owners, including individuals not entitled to vote, have been notified, and do not have an objection to the parent not to present consolidated financial statements; the intermediate or ultimate parent of the parent generated consolidated financial statements, which comply with IFRS (Deloitte, 2008). On the other hand, a parent is expected to consolidate all the entities which have an established financial interest except when the control does not rest with majority owner. According to US GAAP, there is an assumption that consolidated financial statements are meaningful compared to different financial statements (Deloitte, 2008).
In IFRS, historical cost is the primary accounting convention. Nonetheless, IFRS allows revaluation of intangible property, assets investment property, plant, and equipment. IFRS also necessitates certain groups of financial instruments and particular biological assets to be presented at fair value. However, in the US GAAP, there is a restriction on the revaluation with exemptions given to particular groups of financial instruments. In both US GAAP and IFRS, the broad asset recognition method is applicable. The intangible asset that is acquired is recognized only in the event, when the anticipated economic benefit is attributable to the assets, and the cost of the assets can be estimated in a reliable manner (Ernest & Young, 2010).
As the analysis shows, there are similarities and differences between US GAAP and IFRS standards. However, one system cannot substitute another. US GAAP system serves the needs of the national standards in accounting, whereas IFRS may serve specific needs, further to the requirements of the shareholders and/or stockholders and serve specific needs in the world of global competition. In as much as the IFRS and US GAAP frameworks have significant differences, the underlying principles informing their formulation focus on improving the present financial reporting standards. Clearly, there is a move towards promoting standardization in the accounting reporting practice. More specifically, in US GAAP’s case, paper does not provide a clear guideline compared to IFRS. In the Business Combinations framework, US GAAP proposes a unique framework in which the market price determines the asset value, which IFRS proposes the cost of acquisition. In financial statement presentation, the guidelines of both standards for reporting inventories point towards a similar reporting standard. In Statement of cash flows both systems require investment and financial activities to be equally reported. In dividend recognition a slight variation can be observed in the stakeholder reporting requirements. Additionally, the guidelines provided by both IFRS and US GAAP in reference to liabilities,
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Group accounts and assets different provisions are provided for each standard. Generally, the aim of the standards is to streamline the reporting functions by merging what is practiced at regional and internal levels.
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