We are in a world with an increasingly global economy, so it’s important for business owners and accounting professionals to be aware of the differences between the two predominant accounting methods used around the world. International Financial Reporting Standards (IFRS) – as the name implies – is an international standard developed by the International Accounting Standards Board (IASB).
GAAP (generally accepted accounting principles) is a collection of commonly-followed accounting rules and standards for financial reporting. GAAP is established by the Financial Accounting Standards Board (FASB).
Let’s look at the 10 biggest differences between IFRS and GAAP accounting.
1.Local vs. Global
IFRS is used by many countries around the world. IFRS is designed to provide a global framework for how public companies prepare and disclose their financial statements. Adopting a single set of world-wide standards simplifies accounting procedures for international countries and provides investors and auditors with a cohesive view of finances. IFRS provides general guidance for the preparation of financial statements, rather than rules for industry-specific reporting.
GAAP on the other hand, is only used in the United States. Companies that operate in the United States. and overseas may have more complexities in their accounting. In the United States, the Securities and Exchange Commission (SEC) mandates that financial reports adhere to GAAP requirements. The Financial Accounting Standards Board (FASB) stipulates GAAP overall and the Governmental Accounting Standards Board (GASB) stipulates GAAP for state and local government. Publicly traded companies must comply with both SEC and GAAP requirements.
2.Rules vs. Principles
GAAP tends to be more rules-based, while IFRS tends to be more principles-based. Under GAAP, companies may have industry-specific rules and guidelines to follow, while IFRS has principles that require judgment and interpretation to determine how they are to be applied in a given situation
However, convergence projects between FASB and IASB have resulted in new GAAP and IFRS standards that share more similarities than differences. For example, the recent GAAP standard for revenue from contracts with customers, Auditing Standards Update (ASU) No. 2014-09 (Topic 606) and the corresponding IFRS standard, IFRS 15, share a common principles-based approach.
Both GAAP and IFRS allow First In, First Out (FIFO), weighted-average cost, and specific identification methods for valuing inventories. However, GAAP also allows the Last In, First Out (LIFO) method, which is not allowed under IFRS. Using the LIFO method may result in artificially low net income and may not reflect the actual flow of inventory items through a company.
4.Inventory Write-Down Reversals
Both methods allow inventories to be written down to market value. However, if the market value later increases, only IFRS allows the earlier write-down to be reversed. Under GAAP, reversal of earlier write-downs is prohibited. Inventory valuation may be more volatile under IFRS.
5.Fair Value Revaluations
IFRS allows revaluation of the following assets to fair value if fair value can be measured reliably: inventories, property, plant & equipment, intangible assets, and investments in marketable securities. This revaluation may be either an increase or a decrease to the asset’s value. Under GAAP, revaluation is prohibited except for marketable securities.
Both standards allow for the recognition of impairment losses on long-lived assets when the market value of an asset declines. When conditions change, IFRS allows impairment losses to be reversed for all types of assets except goodwill. GAAP takes a more conservative approach and prohibits reversals of impairment losses for all types of assets.
Internal costs to create intangible assets, such as development costs, are capitalized under IFRS when certain criteria are met. These criteria include consideration of the future economic benefits.
Under GAAP, development costs are expensed as incurred, with the exception of internally developed software. For software that will be used externally, costs are capitalized once technological feasibility has been demonstrated. If the software will only be used internally, GAAP requires capitalization only during the development stage. IFRS has no specific guidance for software.
GAAP requires that long-lived assets, such as buildings, furniture and equipment, be valued at historic cost and depreciated appropriately. Under IFRS, these same assets are initially valued at cost, but can later be revalued up or down to market value. Any separate components of an asset with different useful lives are required to be depreciated separately under IFRS. GAAP allows for component depreciation, but it is not required.
IFRS includes the distinct category of investment property, which is defined as property held for rental income or capital appreciation. Investment property is initially measured at cost, and can be subsequently revalued to market value. GAAP has no such separate category.
While the approaches under GAAP and IFRS share a common framework, there are a few notable differences. IFRS has a de minimus exception, which allows lessees to exclude leases for low-valued assets, while GAAP has no such exception. The IFRS standard includes leases for some kinds of intangible assets, while GAAP categorically excludes leases of all intangible assets from the scope of the lease accounting standard.
Understanding these differences between IFRS and GAAP accounting is essential for business owners operating internationally. Investors and other stakeholders need to be aware of these differences so they can correctly interpret financials under either standard.