IFRS Versus GAAP: Differences And Convergence

We often see on job ads requiring 'applicants must have both IFRS and GAAP knowledge'. But what does it mean?

IFRS (International Financial Reporting Standards) is the globally adopted method for accounting and issued by the IASB (International Accounting Standard Board), while GAAP* (Generally Accepted Accounting Principles) is exclusively used within the United States and issued by FASB (Financial Accounting Standard Board).

When a company advertises in its job ad specifically requiring knowledge of IFRS and GAAP, this usually means that the company is doing business in both the US and in countries outside of the US. For example, a UK company may have a US subsidiary company or a US company may wish to acquire a Malaysian company.

It is very important to understand the basic differences between IFRS and GAAP but also to appreciate the convergence initiatives to bring both of them closer.

(* there is also UK GAAP, but it refers to FRS 100, FRS 101 and FRS 102 for SMEs)

Differences

Approach and Methodology

GAAP focuses on research and is rule-based, whereas IFRS looks at the overall fact patterns and is based on principle.

Consolidation

IFRS uses the control model and GAAP uses the risk and reward model

Statement of Income

On an IFRS financial statement, the concept of extraordinary item has disappeared. For GAAP financial statement, an extraordinary item is shown below the net income.

Inventory

IFRS accepts FIFO (First-In, First-Out) and average method but LIFO (Last-In, First-Out) is disallowed. GAAP allows FIFO, LIFO and average method. In IFRS, value of inventory written off can be reversed if market value increases but GAAP disallowed reversals.

Fair Value Revaluations

IFRS allowed many asset categories that can be measured reliably for fair value revaluations but GAAP only allows such revaluations for marketable securities.

Impairment Losses Reversals

Except for goodwill, IFRS allows for reversals on impairment losses subject to certain criteria. However, GAAP disallows such reversals.

Earnings per Share (EPS)

IFRS does not average the individual interim period EPS calculations whilst GAAP does.

Intangible Assets

IFRS allows the capitalisation of intangible assets, but GAAP requires expensing off the cost, except for internally developed software.

Investment Property

We can find distinct categories of investment properties on an IFRS financial statement but there is no separate category for GAAP.

Lease Accounting

IFRS has de minimus exception and can include leases for some kinds of intangible assets but GAAP has no de minimus exception and no lease treatment for intangible assets.

Convergence

Since the turn of millennium, the convergence of IFRS and GAAP has been ongoing to eliminate the gaps between them. Many factors have accelerated the convergence process, in particular rapid globalisation, the introduction of the Sarbanes-Oxley Act (SOX), the gradual recognition of IFRS by Securities and Exchange Commission (SEC) and the economic and financial crashes.

Convergence brings many benefits such as transparency, clarity, simplification and comparability of financial statements. The obstacles against convergence include the high costs involved on changes to financial reporting and internal controls and the perception on the integrity of the changes in the countries affected, therefore convergence can take time and will need high level of patience and diplomacy. The debate continues, not unlike the deliberation on metric and imperial systems.

Sources

1. IFRS website: https://www.ifrs.org/
2. Wiley's IFRS and US GAAP: A Comprehensive Comparison - Steven E. Shamrock
3. IFRS Foundation. "Why Global Accounting Standards?"
4. Financial Accounting Standards Board. "Comparability in International Accounting Standards."