What is all the fuss about and what is the latest in the GAAP Vs IFRS debate?
The International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Standards (GAAP) are the world’s two main accounting systems. The IFRS is set and developed by the International Accounting Standards Board and is widely used in most of the countries. GAAP is set and developed by the Financial Accounting Standards Board and mainly used in the United States of America. These two accounting systems have a few differences between them which pose a challenge to international companies operating within the jurisdiction of both systems. We shall look at the major differences between them as well as the efforts being done to bring them to a point of convergence for one globally accepted financial reporting system. It is important for business owners and accountants and financial analysts to understand both systems and their variations to make sense of financials in any of the systems.
Rules based vs. principle based
This is the major difference between these two systems. GAAP is rules based whereas IFRS is principle based. What this means is that in GAAP all transactions must abide by a specific set of rules. There is no room for professional interpretation or exceptions. In IFRS we have room for professional interpretation based on certain principles. There can be different interpretations for the same situation.
We had earlier alluded to this in our definition of these two systems. GAAP is exclusively used in the United States whereas IFRS is used internationally in more than one hundred companies.
Development costs are expensed in the year they occur in GAAP Vs IFRS where they can be capitalized under certain conditions. Capitalizing development cots allows business to leverage on depreciation of fixed assets.
In the GAAP system, the Last In First Out, LIFO method is allowed whereas in the IFRS it is not allowed as it has been seen to result in inaccurate income levels.
Still on inventory, GAAP does not allow reversal in cases where the market value of a write-down has increased. This system is highly cautious of inventory reversal. In IFRS, the amount of the write –down can be reversed to reflect positive changes in the marketplace.
They are assessed at their fair market value in GAAP Vs IFRS where they are assessed on whether they may have a future economic benefit.
Liabilities are classified differently under these two systems. Under GAAP, there are current liabilities which are those expected to be settled within 12 months and noncurrent liabilities which will not be settled within a year. Under IFRS, all liabilities are considered noncurrent.
GAAP Vs IFRS and the future
There have been efforts to merge these two systems to have one robust, globally accepted accounting system that international businesses can use. Having one system is beneficial to businesses, accountants, analysts and regulators as it enables comparability and certainty to investors. However, changing to one system is not very straightforward; it is a gradual process which the United States Securities and Exchange Commission is working on. The FASB and IASB continue to work together to develop standards relating to financial reporting.