gaap vs ifrs

The Evolution to IFRS from GAAP


Target Audience: International Financial Reporting Standards Interest, IFRS vs GAAP, Accounting Standards News & Updates Interest, Accounting Consulting Firm Interest, Business Owners, Chief Financial Officers, Interest in GAAP IFRS standards


Why the recent movement towards the use of International Financial Reporting Standards (IFRS) as a basis for financial reporting? 

Feeley and Driscoll (888) 875-9770 highlights the Securities and Exchange Commission's (SEC) November 2008 proposed Roadmap evaluation of the major differences between IFRS and US Generally Accepted Accounting Principles (GAAP).  Find out how the transition to IFRS could have an impact on your company.

IFRS UPDATE

On Wednesday, February 24, 2010 the SEC reiterated its support for International Financial Reporting Standards (IFRS), this is conditional upon the accomplishment of a number of milestones. The SEC staff has developed a comprehensive work plan that will help to keep the process moving forward. The staff will regularly report progress to commissioners and a decision will be made in 2011 as to whether or not IFRS will be incorporated into the U.S. financial reporting system.

gaap vs ifrs

Does the SEC’s Roadmap Affect Your Company?

Qualification
Under the proposed Roadmap, the SEC will decide by the year 2011 if U.S. companies will be required to use IFRS beginning in 2014.  Large companies may be allowed early adoption in the year 2010, if they meet certain qualifying standards. To qualify, a company must meet two criteria:

  • The company must be one of the twenty largest companies in its industry (measured by market capital), and
  • Other companies in that industry must primarily use IFRS reporting standards already. 

Transition
The Roadmap is a staged transition for using IFRS standards beginning with large accelerated filers for fiscal years ending on or after Dec. 15, 2014. Any remaining accelerated filers would begin IFRS filings for years ending on or after Dec. 15, 2015. Non-accelerated filers, including smaller reporting companies, would begin IFRS filings for years ending on or after Dec. 15, 2016.

Feedback
The SEC voted to seek comments on the proposed Roadmap until February 19, 2009, however they have extended the comment period to April 20, 2009.  The additional time is meant to recognize the importance of comparability while allowing preparation time for those who are interested in commenting.  The SEC believes, along with many others, that IFRS standards have greater potential in providing a common platform for companies and investors to compare financial information.

Find out how our International Tax Services can help navigate GAAP vs. IFRS for you coordinating US Corporate Tax and International Accounting. Email us or call us at 1 (888) 875-9770.

IFRS vs GAAP

Underlying Differences
Unlike U.S. GAAP rule-based standards, IFRS standards tend to be principle-based.  Typically, rule-based standards are easily applied and enforced when compared to principle-based standards, however, along with rules, come exceptions.  Exceptions to the rule-based standards of US GAAP add a level of complexity that often results in application issues.  The move towards IFRS principle-based standards, accounts for exceptions to the rules by allowing judgment to exist when applying the standards to a company’s financials.  Conversely, US GAAP encourages companies to comply with set laws and discourages evaluating the economic substance of a company’s activities.

The Purpose of IFRS as a Global Accounting Standard
The trend towards IFRS has evolved around a widespread agreement to synchronize accounting standards internationally. The ultimate goal is to reduce costs for multi-national corporations, and to allow investors to make valid comparisons between companies across the world.  Users of financial statements have pushed for the development of global standards that provide more consistent and comparable reporting worldwide. 

Large and Small Companies
IFRS does not only affect large international companies.  Smaller companies in the U.S. who look overseas for new investors or potential alternative financing sources will also have to be aware of these new reporting standards.  Upon implementation of IFRS, users will have the ability to compare the performance of all companies regardless of their country of operation.  IFRS is seen as more than just a way to provide a global accounting standard - it is also an opportunity to look into the quality and integrity of management through judgments made when reporting financial results. 

Accounting Standards Comparison in Detail

Financial Statement Presentation
The concept of comparability is one of the underlying concepts brought forth under IFRS.  Single year financial statements are not permitted (the only exception being for first year companies) yet they are allowed under GAAP.   

Consolidations
Under IFRS, subsidiaries must adopt all the accounting policies of the parent company in consolidation.  Before the adoption of the parent's accounting policies, it must be determined whether or not a specific entity is considered a related party required to consolidate. Such a determination of a consolidation under GAAP is based off of the Variable Interest Entity (VIE) model under FIN 46.  Under FIN 46, consolidation decisions are based on determining who has the right to incur the income and losses of a related entity.  Determinations are made naming the primary beneficiary of the related entity and assessing the relationship.  IFRS focuses on the notion of control in determining whether a parent-subsidiary relationship exists.  Control is defined as the ability to rule over the operating assets of an entity in order to obtain the benefits. 

Compensation
Compensation of key management is a required disclosure under IFRS, where as under GAAP it is not.

Accrued Expenses 
IFRS requires a detailed disclosure of the nature of each accrued expense and the nature of the changes to those accrued expenses.  Under GAAP, accrued expenses are not required to be individually disclosed in the financial statements – increasing the transparency of financial statements.

Inventory 
The last-in-first-out (LIFO) costing methodology for inventory is prohibited under IFRS.  The change to IFRS would force a company to adopt the first-in-first-out (FIFO) methodology or weighted average cost method. The adoption of a new costing method could significantly impact the operating results of an entity.

Impairment of Long-lived Assets
There are differences in the testing for the impairment of long-lived assets held for use.  These differences could potentially lead to earlier impairment recognition under IFRS.  GAAP uses the undiscounted cash-flow method in determining the recoverability of an asset, where as IFRS requires the use of an entity-specific discounted cash flow or fair value measurement.  By having different testing requirements the determination of whether an asset is impaired or not could differ from one set of standards to the next (affecting the previously recognized loss). 

Carrying Value of Assets
Under GAAP, assets are generally carried at historical cost (with a few exceptions for certain financial instruments), whereas under IFRS historical cost is the primary basis of accounting, however the ability to revalue assets (to fair market value) is allowed.  By revaluing assets, there may be significant differences in the carrying value of these assets versus GAAP.

Depreciation
IFRS requires that separate, significant components of an item of property, plant and equipment be recorded and depreciated separately. If an asset has multiple aspects each with different lives, the asset must be depreciated in segments, rather than as a whole.  IFRS annually evaluates the residual value of an asset at the balance sheet date.

Leases
Under GAAP, there is specific guidance in making the determination as to whether a lease is considered operating or capital.  The four specific criteria surround:

  1. Ownership transferring to the lessee,
  2. a bargain purchase option,
  3. lease term in relation to the economic useful life - 75%, and
  4. the present value of minimum lease payments in relation to fair value of the leased asset - 90%. 

IFRS focuses on the overall substance of the transaction and substantiality all of the risks or rewards of ownership are transferred to the lessee.  IFRS measures all of the criteria GAAP uses, yet it does not place a specific threshold on the amount.  This is a classic example of how GAAP follows a strict set of rules while IFRS necessitates judgment-based decisions.

Income Taxes
There are several differences between IFRS and GAAP relating to accounting for and reporting of income taxes: 

  • The tax rate used for measuring deferred taxes under GAAP is the enacted tax rate in place when the timing difference is expected to reverse, whereas under IFRS, the substantially enacted tax rate is used. 
  • Under GAAP, the classification of the deferred tax asset or liability is either short-term or long-term depending on the underlying relationship of the timing difference.  Under IFRS, deferred tax assets and liabilities are always recorded as long-term.
  • Under GAAP (for non-public companies), a reconciliation of the expected tax expense to actual is not required in detail and only a disclosure of the nature of the reconciling items is required.  IFRS requires the complete reconciliation, including the nature and amounts.

Construction Contracts
Under GAAP, while the percentage of completion method is preferred, the completed contract method is acceptable in certain situations.  GAAP does allow for the completed contract method in certain situations where a reliable estimate cannot be made and there is not an expected loss to be incurred on the project.  IFRS specifically prohibits the use of the completed contract method, and instead recommends the use of the cost recovery method when percent complete can not be reliably estimated.

Combining and segmenting contracts is allowed, but not required under GAAP, however when certain criteria are met under IFRS, it is a requirement.  The impact can substantially change a company’s revenue contingent upon the circumstances within each contract (for example, the majority of costs incurred are on the segment of a project carrying lower margins than the rest of the project.  In this case under IFRS, less income would be recognized if the job was broken out into segments).

In Conclusion

Numerous dissimilarities exist when comparing the two accounting standards, IFRS and GAAP.  These differences may affect your company in one way or another but due to the broad range of topics and inability to review the entire volume of changes, the intricate details of the standards can be explained or outlined further by contacting Feeley & Driscoll, P.C.  

Reference:
International Accounting Standards Committee Foundation. A Guide through International Financial Reporting Standards (IFRSs). London: IASCF Publications, 2007 <www.iasb.org>

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