Financial reporting may have different standards, such as GAAP or IFRS, in every country, but yet have one goal. Which is why we’ll look to explain GAAP vs IFRS similarities, that is to say, what and where both standards are used, their differences and yet similarities.
The true importance of financial statements reporting is for it to be read and understood, as well as hoping that it depicts a positive, clear picture of the company’s financial performance and situation.
No matter how you look at it, you hope to increase your capital and, if your wish is to expand, have investors or creditors invest in your company.
And, for such things to be possible, let’s understand where and how GAAP and IFRS are used, what makes them similar yet, different.
What is GAAP?
GAAP (Generally Accepted Accounting Principles) are the rules-based accounting standard used in the US that companies and their accountants must adhere to when they collect and arrange their financial statements.
They allow investors to easily compare the financial information of different companies and companies’ financial reports to be recognized internationally.
It is especially beneficial for companies that are looking to expand around the world, searching for investment opportunities.
What is IFRS?
Issued by the London-based International Accounting Standards Board (IASB), IFRS (International Financial Reporting Standards) are a group of international sets of accounting standards, which business entities are required to follow, to report their financial results. It is so, to produce consistent reports, for a transparent common accounting language to avoid frauds or mistakes.
IFRS is recognized by and primarily adopted by more than 100 countries except the United States.
It is especially propitious for companies that are looking to expand around the world, searching for investment opportunities, as it eliminates risks of business deals and intricacy.
What is the difference between GAAP & IFRS?
Of course, countries across the globe have their accounting standards. As previously stated, in the United States (US), the standards are classified under the GAAP whereas more than 100 countries comply within the IFRS framework.
So what is the difference between GAAP and IFRS? It basically constitutes the procedure in which financial statements are reported.
1. Rules-based vs Principles-based
The Generally Accepted Accounting Principles (GAAP) system is the rules-based accounting method set by the Financial Accounting Standard Board (FASB) that is used in the United States. Companies and their accountants must adhere to the rules when they compile their financial statements by performance measurements of their revenue, expenses, assets or liabilities. These allow investors an easy way to compare the financial information of different companies.
On the other hand, IFRS, the most common international accounting standard, is not a rules-based system, but a principles-based. The IFRS states that a company’s financial statements must be understandable, comparable, and applicable to financial transactions.
IFRS measures performances thanks to revenue and expenses, assets and liabilities and more.
It is the process of adjusting accounting to a company’s principles, rather than the company adapting to accounting rules.
2. Inventory methods
Both GAAP and IFRS differ in the procedures used for their inventory valuation. You have 3 that go by the name of:
- First in First Out (FIFO): This inventory method functions according to the innate inventory flow, where the first item, the oldest one in the inventory to be sold. Though LIFO reigns in the US, it is still many companies’ preference because when a firm reports their financial results using LIFO, they tend to lose financial standing as it lowers their net income and potentially dwindle shareholders’ potential interest.
- Last In First Out (LIFO): Means that the last, recent item is the first to be sold therefore, the first to be charged as the cost of goods sold (COGS). Though many companies prefer to work with FIFO, it is the LIFO form of inventory, performed under GAAP, that is mainly used in the US.
Now I digress, but this is to summarize, GAAP favors every inventory valuation procedure and IFRS does all except LIFO, the US’s cherished one.
Weighted inventory: is the average cost of the last items to linger in the inventory.
3. Cash flow statement
It is essential to understand, get to know a company's financial health and its ability to generate cash flow.
The balance sheet: The format of the balance sheet in the US is different from that of other countries. In the GAAP’s, it starts with current assets whereas in the IFRS’ balance sheet, there are the noncurrent assets.
They both decree different methods and orders of the categories concerned in the balance sheet. GAAP requests for companies to list their accounts in terms of order of liquidity and the speed with which they can be switched to cash. Items, such as owner’s equity, current and non-current liabilities as well as, current and non-current assets in the GAAP sheet are organized in the descending order, that is to say, from most liquid to least.
But, in IFRS, it is the opposite, the balance sheets indicate those from the least to most liquidity.
Companies adhering to GAAP should state their interest paid and interest received as operating activities, but under IFRS, interest paid could either be classified in the operating or the financial activity and interest received, in the operating or investing.
For the dividends paid for GAAP, it is included in the financial section whereas IFRS, in the operating or financial section and for the dividends received,
GAAP= operating and IFRS= operating or investing section.
Fixed assets: which you can say corresponds to companies’ capital investment and differs from IFRS to GAAP. When the asset’s value decreases, losing its value position, it is seen as an impairment and either remains permanently so or miraculously redeems itself.
It is in this aspect that GAAP and IFRS intervene, though differently.
GAAP chooses to recognize fixed assets at their present cost value and not that initial value that has been lost, while IFRS leaves it up to the company to reevaluate and report a fair value to the fixed asset. Whichever value it has, whether increase or decrease, it should be its true value.
Here is a recap of what was written below:
|Stands for||Generally Accepted Accounting Principles||International Financial Reporting Standards|
|Inventory method||Last-in, first-out; first-in, first-out; or weighted-average cost||First-in, first-out or weighted-average cost|
|Over 100 countries|
|Cash flow statements||
Starts with current assets
Assets and liabilities in descending order
Starts with noncurrent assets
Assets and liabilities in ascending order
|Operating or the financial activity|
|Operating or Investing section|
|Operating or the financial activity|
|Operating or Investing section|
Sadly or fortunately, if you are a US based company, then you are inclined to use the GAAP standards. Nonetheless, there is a probability that the US Securities and Exchange Commission might accept the IFRS someday.
What are the similarities between GAAP and IFRS?
They both have the same accounting objectives where the income/ financial statements should consist of balance sheet and cash flow statements are used.
They both use accrual accounting for their financial statements, meaning balance sheets, which determine a company’s assets and liabilities and income statements, the company’s revenue and expenses.
Not only that, but GAAP and IFRS both believe in financial statements’ transparency towards investors.
Tax: Regardless of companies’ geolocation, tax is required by every one to pay. Of course, the amount depends on the accuracy of your reports.
Examine cash flow: This part is quite necessary for investors as it is this cash that reimburses them. They want to ensure that the company has enough to disburse and pay for their expenses.
Lease: the lease standard, which balance sheets should be marked as Right of Use Assets, or have a report on, once the 12 months are surpassed.
Obviously the main similarity would be to converge the two and have the US recognize the IFRS, which could reduce rates of cost, rules and some difficulties that exist at the moment.
Now that you have an idea of the GAAP vs IFRS similarities, hopefully one day there could be some sort of agreement between them.