Without accounting standards, companies could distort their financial results to make themselves appear more successful, and it would also be much more difficult to compare the performance of different companies.
That’s where Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) come in. These two guidelines (one US, one international) are what most businesses follow when preparing their financial statements. Financial StatementsWith these accounting standards in place, investors can be confident that companies are reporting their financials accurately, so companies can make informed decisions about where to invest their funds.
Learn more about the differences between GAAP and IFRS in this guide.
What are Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles (GAAP) GAAP is an accounting standard set by the Financial Accounting Standards Board (FASB) of the United States Securities and Exchange Commission (SEC). It is a rules-based system that all publicly traded companies in the United States and Canada must follow when filing their financial statements. The purpose of GAAP is to help investors analyze financial data, compare different companies, and make informed financial decisions.
What are International Financial Reporting Standards (IFRS)?
International Financial Reporting Standards (IFRS) are accounting standards set by the International Accounting Standards Board (IASB). They are guidelines followed by 15 of the G20 countries. China, India, and Indonesia do not follow IFRS accounting standards but have similar standards. Japan, on the other hand, allows companies to follow IFRS standards if they wish.
GAAP vs. IFRS: What is the difference between GAAP and IFRS?
Both GAAP and IFRS Financial Document Structure And submitted, and both in many cases Comprehensive Benefit Reporting—There is a big difference.
When considering the differences between IFRS and GAAP, there are two main differences:
- Execution: GAAP is rules-based, meaning that U.S. public companies are legally required to follow its dictates. IFRS, on the other hand, is standards-based, meaning that following its guidelines is encouraged but not required. As a result, IFRS theoretical frameworks and principles are open to interpretation and may result in lengthy disclosures in financial statements.
- Source and scope: GAAP is US based, while IFRS is used worldwide. The IASB, which develops IFRS, has a global influence and its accounting standards are adapted to the accounting regulations of countries around the world. The only exception is the United States, where the SEC requires US companies to use GAAP when preparing their financial statements.
There are other notable differences in how GAAP and IFRS treat specific elements of various financial statements, including these six:
1. Inventory Valuation Method
The process for calculating the value of your inventory is Inventory Valuation.
There are three standard accounting methods for inventory valuation:
- of First in, first out (FIFO) methodThis assumes that the first (or oldest) items in your inventory will be sold first.
- of Last in, first out (LIFO) systemThis assumes that the last (or newest) items in your inventory will sell first.
- The weighted average method uses the amount received from selling a portion of your inventory to determine the value of the remaining portion.
The differences between IFRS and GAAP with respect to inventory valuation methods are as follows:
- GAAP: Under GAAP, a company can use any of the three inventory valuation methods listed above. When using FIFO, GAAP determines inventory valuation using net asset value, which is calculated by subtracting the total value of a company’s liabilities from the total value of its assets.
- IFRS: IFRS allows the FIFO and weighted average methods, but not the LIFO method, because the LIFO method can be manipulated to distort a company’s earnings to reduce its tax burden. When using FIFO, IFRS uses net realizable value, which considers how much proceeds an asset is likely to generate when it is sold, minus estimates of costs, fees, and taxes associated with the sale.
2. Cash flow statement
a Cash flow statement It is a financial statement that shows exactly how cash and cash equivalents flow in and out of a company during a particular reporting period.
GAAP and IFRS treat the statement of cash flows differently, particularly in how interest and dividends are classified.
- GAAP: Interest paid, interest received, and dividends received are all reported in the operating section, while dividends paid are reported in the financial section.
- IFRS: All interest and dividends can be listed in either the operating section or the financial section.
3. Balance Sheet
a Balance sheetA balance sheet is a financial statement that summarizes a company’s assets, liabilities, and shareholder equity at a specific point in time. To help investors and other interested parties read a balance sheet quickly and accurately, it is important to know how a balance sheet is constructed.
GAAP and IFRS differ in how categories are arranged on the balance sheet.
- GAAP: Assets should be arranged in order of liquidity, with the most liquid assets listed first: current assets, non-current assets, current liabilities, non-current liabilities, and owner’s equity.
- IFRS: We suggest arranging assets in reverse order of liquidity, with the least liquid assets first: non-current assets, current assets, owner’s equity, non-current liabilities, current liabilities.
4. Revaluation of assets
The value of a company’s assets may fluctuate over a period of time. When this happens, the assets need to be revalued (reassessed). Revaluing assets is very important as it can save you money on replacing fixed assets that have outlived their useful life. It also gives investors a more accurate understanding of the company’s operations. Moreover, revaluing assets reduces the debt-to-equity ratio, making the company’s financial position healthier.
GAAP and IFRS have different approaches to asset revaluation.
- GAAP: It only allows revaluation of fair market value of marketable securities (such as investments and stocks).
- IFRS: It allows for the revaluation of more assets, including plant, property and equipment (PPE), inventory, intangible assets and investments in marketable securities.
5. Reversal of inventory impairment
A company’s inventory can decrease in value over time. For example, if market or technological factors cause an asset to decrease in value, it is classified as an “impairment loss.” Both GAAP and IFRS require a company to write down inventory as soon as the cost of the inventory exceeds its net realizable value (i.e. how much revenue the inventory is expected to generate when sold).
Although the loss is often permanent, the asset’s value may increase again if the impairment factor disappears. GAAP does not allow companies to revalue assets to their original value in such cases. IFRS, on the other hand, allows some assets to be written down to their original value and adjusted for depreciation.
6. Development Costs
In accounting, development costs are the internal costs incurred in development. Intangible assetsIntangible assets are assets that do not have a physical form, such as patents, intellectual property, or customer relationships. GAAP considers these intangible assets as expenses, but IFRS allows companies to capitalize them and amortize them over multiple periods. Therefore, accounting standards determine where intangible assets are listed in financial statements, which affects their ultimate recording on the balance sheet.
Which is better: GAAP or IFRS?
It depends. Generally, IFRS is widely used around the world and is suitable for companies that operate in multiple countries. If your business operates internationally or has plans to expand globally, IFRS offers an easier transition. Using IFRS also makes it easier to attract overseas investors or enter into international partnerships.
GAAP is US-focused and appropriate for companies that operate solely in the US. In fact, GAAP is often required for compliance purposes: the US Securities and Exchange Commission (SEC) requires US-based companies to adhere to GAAP, which is especially important for publicly traded companies.
Frequently asked questions about GAAP and IFRS
What is the difference between IFRS and GAAP?
GAAP stands for Generally Accepted Accounting Principles, which are the generally accepted standards for financial reporting in the U.S. IFRS stands for International Financial Reporting Standards, which are an internationally accepted set of accounting standards used in most countries around the world.
The main differences between GAAP and IFRS are:
- GAAP is a framework based on legal authority, whereas IFRS is based on a principles-based approach.
- GAAP is more detailed and prescriptive, whereas IFRS is at a higher level and allows more flexibility.
- GAAP requires more disclosures whereas IFRS requires less disclosures.
- GAAP focuses on the historical cost of assets, whereas IFRS allows flexibility in valuing assets.
Why isn’t IFRS used in the United States?
IFRS (International Financial Reporting Standards) are not used in the United States because the U.S. government has not adopted them as official accounting standards. Instead, the United States uses its own Generally Accepted Accounting Principles (GAAP). The U.S. government has indicated that it is considering adopting IFRS, but has not yet done so.
What are the differences between GAAP and IFRS in inventory?
GAAP and IFRS have some different requirements regarding inventory.
- Under GAAP, inventory must be valued at the lower of cost or market value, whereas under IFRS, inventory must be valued at the lower of cost or net realizable value.
- GAAP does not allow inventory write-offs, but IFRS does.
- GAAP requires that inventory be valued using certain cost flow assumptions (such as FIFO or LIFO), whereas IFRS has no such requirement.
Can U.S. companies use IFRS?
Yes, U.S. companies can use IFRS. U.S. companies can use both GAAP and IFRS. If a U.S. company operates internationally, using IFRS may be more attractive.
