There are two sets of accounting rules accepted for international use: US standards called Generally Accepted Accounting Principles (GAAP) and international standards known as International Financial Reporting Standards (IFRS). The first is developed by the Financial Accounting Standards Board (FASB), whose power is derived from the United States Securities and Exchange Commission (SEC). The second is developed by the International Accounting Standards Boards (IASB), an independent accounting standard-setting body based in London. Although GAAP and IFRS share some similarities in the presentation of their financial statements, they do not agree on all issues. There are differences in reporting and classifying items on income statements and balance sheets between these two sets of rules.
Unlike the more detailed GAAP rule-based standard, the IFRS principle-based standard tends to be simpler in its accounting and disclosure requirements. The Income Statement is a required statement under IFRS as it is under GAAP and is known as the “Statement of Comprehensive Income”. The IFRS statement of comprehensive income is similar to that used by GAAP; however, there are few differences when comparing these two results statements.
The GAAP income statement presentation follows a single-step or multi-step format. However, IFRS does not mention a single-step or multi-step approach. Under IFRS, entities must classify expenses by their nature (such as the cost of material used, direct labor incurred, advertising expenses, depreciation expense, and employee benefits) or by their function (such as cost of goods sold, selling expenses, and administrative expenses). Although GAAP does not have such a requirement, the SEC requires a functional filing. Although GAAP defines income from operations, IFRS does not recognize this key measure. Additionally, extraordinary items are prohibited by IFRS; whereas, under GAAP, entities are required to report extraordinary items if they are unusual in nature and infrequently occurring. The portion of the profit or loss attributable to the non-controlling interest (or minority interest) is disclosed separately in the IFRS statement of comprehensive income. In addition, while IFRS identifies certain minimum elements that must be presented in the statement of comprehensive income, GAAP does not have minimum reporting requirements. However, the SEC imposes more stringent filing requirements.
Balance sheet presentation is a requirement under both GAAP and IFRS. The most visible difference is how IFRS refers to this statement as a “Statement of Financial Position” instead of a Balance Sheet. Accounts in the statement of financial position are classified under IFRS, which means that similar items are grouped together to arrive at meaningful subtotals. In addition, the IASB indicates that the parts and subsections of the financial statements are more informative than the whole; as a result, the IASB does not encourage the reporting of summary accounts by themselves (eg total assets, total liabilities, etc.). Unlike GAAP, IFRS current assets are generally listed in the reverse order of liquidity. For example, under IFRS, cash is listed last. In addition, most IFRS companies present current and non-current liabilities as separate classifications in their statements of financial position, except in industries where the liquidity presentation provides more useful information. It is crucial to point out some important differences in the reporting elements on the balance sheet between GAAP and IFRS.
In the current assets section, inventory is valued differently under IFRS. The use of last-in-first-out (LIFO) is prohibited under IFRS. Also, unlike under GAAP, if inventory is reduced according to the lower of cost or market valuation, it may be reversed in a subsequent period up to the amount of the previous reduction under IFRS. In addition, IFRS allow the revaluation of property, plant and equipment and intangible assets and report them as other comprehensive income.
IFRS uses different terminology in the equity section of your statement of financial position. For example, the share capital is the nominal value of the issued shares. Includes common shares (referred to as common shares) and preferred shares (referred to as preferred shares). The share premium under the equity section of IFRS is the excess of amounts paid over face value.
A major problem caused by the disparity related to the presentation of GAAP and IFRS financial statements is the lack of consistency. This problem creates difficulty in comparing financial statements through GAAP and IFRS. As a result, it is rational for US companies that have foreign subsidiaries to convert to IFRS to make it easier for interested parties to make comparisons and allow them to access global capital markets. However, switching to IFRS may not be beneficial to small US companies; the conversion will result in incremental costs that could outweigh the benefits.