GAAP vs. IFRS: An Overview
Each country sets its own standards for financial reporting. In the United States, accountants follow the generally accepted accounting principles (GAAP) when they compile financial statements. Outside the U.S., many countries follow the International Financial Reporting Standards (IFRS), which aims to establish a common global language for company accounting.
About 160 jurisdictions have made a public commitment to IFRS reporting standards, and 147 require public listed entities to follow IFRS accounting standards. While the U.S. Securities and Exchange Commission (SEC)has openly expressed a desire to switch from GAAP to IFRS, development has been slow.
Key Takeaways
- GAAP, or Generally Accepted Accounting Principles, is the common set of accepted accounting standards and procedures that U.S. companies and their accountants must follow when they compile their financial statements.
- IFRS is aset 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.
- Many countries are transitioning all financial reporting to the IFRS standard.
GAAP
In the United States, if a company distributes its financial statements outside of the company, it must follow generally accepted accounting principles, or GAAP. If a corporation's stock ispublicly traded, financial statements must also adhere to rules established by the U.S.Securities and Exchange Commission.
GAAP addresses such things asrevenue recognition,balance sheet,item classification, and outstanding share measurements. If a financial statement is not prepared usingGAAP, 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
International Financial Reporting Standards (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.
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 theEuropean Union(EU) and many countries in Asia and South America, but not in the United States. TheSecurities 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 difference appears in specific details and interpretations.
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 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.
Investing
When a company holds investments such as shares, bonds, or derivatives on its balance sheet, it must account for them and their changes in value. Both GAAP and IFRS require investments to be segregated into discrete categories based on asset type.
The main differences come in recognizing income or profits from an investment. Under GAAP, it's largely dependent on the legal form of the asset or contract. Under IFRS, the legal form is irrelevant and only depends on when cash flows are received.
What Is the Difference Between the IASB and FASB?
The International Accounting Standards Board (IASB), founded in 2001 and based in Canary Wharf (England) oversees and updates the International Financial Reporting Standards (IFRS). The Financial Accounting Standards Board (FASB) establishes and updates the accounting rules for the GAAP standard in the U.S.
Which Is Better: IFRS or GAAP?
This is a matter of perspective. IFRS is more principles-based, while GAAP is rules-based. A focus on principles may be more attractive to some as it captures the essence of a transaction more accurately. In practice, however, since much of the world uses the IFRS standard, a convergence to IFRS could have advantages for international corporations and investors alike.
How Are Expenditures Related to Research and Development Treated Under U.S. GAAP vs. IFRS?
, or R&D, is a large expense in many industry sectors. Under GAAP R&D expenses are booked as they occur. This is true under IFRS as well, however, IFRS also requires certain R&D expenditures to be capitalized (e.g. some internal costs like prototyping).
The Bottom Line
Any company that distributes financial statements publicly should use some form of established accounting principles. Two common ones are GAAP and IFRS.
In the United States, generally accepted accounting principles, or GAAP, are used by businesses with public financial disclosures. This system uses rules-based accounting. However, many countries are adopting the use of International Financial Reporting Standards, or IFRS, as an established international accounting system.
IFRS is principles-based and may require lengthy disclosures in order to properly explain financial statements. It is the established system in the European Union(EU) and many Asian and South American countries. It has not yet been adopted as an official system in the United States. However, any company that does a large amount of international business may need to use IFRS reporting on its financial disclosures in addition to GAAP.
