Over the years, countries all over the world have been developing their own accounting standards, each being different in their own way. Due to globalization, it has become critical for countries to take into consideration the restrictions surrounding accounting practices. The main practices today are U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). The FASB (Financial Accounting Standards Board) and the IASB (International Accounting Standards Board), started a convergence project to combine both sets of principles to alleviate business transactions globally. This article will discuss exactly what IFRS aims to solve, the key differences it has compared to U.S. GAAP, and the impact it will have on organizations in the United States.
The International Financial Reporting Standards were designed to make global financial business as easy as possible. Most people view this as a major importance because global markets will best be served if using the same set of accounting principles. Already over 115 countries use IFRS and the goal now is too merge these particular standards with U.S. principles. One set of standards will significantly improve financial information reported to investors because there are so many multinational corporations that exist today and view the market on a global scale. Also, mergers and acquisitions among U.S. and foreign companies, indicate the strong possibility for the same tendencies to occur in the future. The international significance of financial markets as well as information technology, are just a few of the other reasons why it is becoming so important to be able to communicate on a more comprehensive level worldwide.
There are certain key differences between among the standards related to GAAP and IFRS. One major difference relates to their conceptual approach. U.S. GAAP tends to be more detailed and is considered “principle-based”. It uses research that is focused more on the literature in accounting treatment. IFRS is simpler in its accounting and disclosure requirements and is referred to as “rule-based”. This methodology reviews facts and patterns more in depth.
Another distinguishing difference between IFRS and GAAP is accounting for inventories. Under U.S. GAAP, LIFO is a very common method for recording the value of inventory, where a firm records the last units purchased as the first ones that are used or sold. IFRS does not permit the use of LIFO. If GAAP were to fully change to the principles under IFRS, LIFO would completely be eliminated. This could cause issues to many U.S. firms, such as large income tax liabilities because firms will have to revalue their inventory.
IFRS and GAAP also differ in the way that they recognize revenue. GAAP is significantly more detailed when it comes to the guidance of specific types of transactions. IFRS only uses two specific standards: IAS 18 Revenue and IAS 11 Construction Contracts. GAAP outlines concepts and then provides detailed rules. One major difference is that IFRS allows revenue with contingent and questionable amounts to be recognized earlier, while GAAP requires a specific amount to be set in order to recognize revenue.
While these differences are just a select few of those that exist, they still give a flavor for the impact this convergence could have on a business. In recent years, there has been a push for U.S. companies to adopt IFRS and present their financial statements in a way that would make them easier for comparison around the world. Companies will have to have a change in management reporting and may have to upgrade systems to be in accordance to IFRS. The SEC (Securities Exchange Committee) hasn’t yet required U.S. companies to adopt IFRS, so they still prepare financial statements under GAAP. However, some multinational corporations have started using IFRS for their foreign subsidiaries. Converting to IRFS will have major effects on U.S. companies and not just in financial reporting. It will affect a company’s operations, information technology systems and tax reporting requirements, as well as internal reporting and measurements in performance.
Convergence projects are still in effect to develop compatible accounting standards over time. The FASB and IASB are working to try and ease the transition for when the use of IFRS becomes necessary. They are addressing issues related to leases, revenue recognition, financial statement recognition, fair value measurements, liabilities and equity, the statement of comprehensive income and financial instruments. Although there are certain differences between the two sets of standards, having a universal accounting language makes comparisons between businesses and foreign competitors a lot simpler. Companies will have to adjust for changes and prepare for IFRS, but in the long run, this conversion can provide cost savings, especially for multinational corporations. There still is a long way to go, but the SEC firmly believes that combining the two standards will benefit U.S. investors.