GAAP and IFRS
The GAAP is defined as the generally accepted accounting principles which are normally set by the Financial Accounting Standards Board (FASB) in the United States. All companies and accountants in the country must follow the principles set by the FASB in preparing their reports. On the other hand, the IFRS, International Financial Reporting Standards, are accepted accounting principles that companies and accountants practice globally. IFRS are issued and controlled by the International Accounting Standards Board (IASB). The main reason for the establishment of IFRS was to have a common accounting language that will be understood by businesses and companies from one country to the other. Currently, IFRS is used in more than 144 countries globally. Major global economies that are yet to switch to IFRS are Japan, China, and the USA. Both GAAP and IFRS possess some differences and similarities on different items. This essay will outline the differences and similarities between IFRS and GAAP on how they treat various items in reporting.
Outline of the general differences
Both IFRS and GAAP have differences and similarities in the mode of application and operation. The GAAP is more rules-based, while the IFRS is more principle-based. The GAAP rules are specific to the industry and serve as the guidelines which must be followed (FASB, 2020). The IFRS principles require judgment and interpretation, depending on how they are being applied.
The other difference between the two methods is in the treatment of the inventory. Both allow the use of First In, First Out (FIFO), and the weighted-average cost on inventories (Ross, 2020). They differ when it comes to the treatment of the Last In, First Out (LIFO) method, which is allowed by GAAP and not allowed under the IFRS.
On the inventory, they also differ on the inventory write-down reversals. They both allow all the inventories to be written down using the market values. However, the change of valuations will only be allowed under the IFRS Firm (Team, 2020). GAAP will not allow this reversal, thus making the inventory’s valuation extremely volatile under the IFRS.
The other difference between the two accounting methods is on the treatment of the fair value revaluations. Under the IFRS, there is a revaluation of assets such as the intangible assets, plant, property and machinery, and market securities if they have a measurable fair value (IFRS Foundation, 2020). This revaluation is prohibited under the GAAP except only on the marketable securities.
Both accounting methods do not agree on the treatment of impairment losses. There is recognition of the impairment loss on long-lived assets by both standards. This is on the occasion when the market value of the assets declines. IFRS is more flexible after the change of normal market conditions, and it allows for the reversal of the impairment loss on all assets except on the goodwill (Ross, 2020). On the other hand, GAAP does not allow reversals of the impairment losses on all assets due to its conservative nature on the matter.
The two standards also differ widely in the treatment of intangible assets. The IFRS considers the use of the internal costs to create intangible assets in the company. Some of the costs include the development costs with the consideration of having future economic benefits. On the other hand, GAAP will treat development costs as the expenses incurred (FASB, 2020). The only costs considered as intangible assets under the GAAP are the ones on an internally developed software. The IFRS does not have a principle on how the software costs should be treated.
Lease accounting is treated differently by the two standards. The approach is different in various aspects. The IFRS allows for the exceptions by lessees on leases for low-valued assets (IFRS Foundation, 2020). This is not allowed under the GAAP. Also, the IFRS excludes the leases on some various intangible assets while the GAAP does not allow any exclusion on leases.
There is also a difference in how investment property is treated under the two standards. There is a special kind of investment property, such as the property held for rental income or for capital appreciation. In this category, the investment property is measured at a cost that is valued at market value. However, the GAAP does not have a separate treatment of the investment property.
Lastly, both GAAP and IFRS have a different way of treating fixed assets. Long-lived assets such as the buildings and equipment are valued using their historical costs, which are again depreciated accordingly (Ross, 2020). On the other hand, such assets can be revalued over time using the market value. This can make their costs go up or down depending on the market value. If the assets have different components that have different useful lives, the IFRS requires those assets to be depreciated separately. GAAP does not require the depreciation of the different components of the assets.
- Assets—financial assets
IFRS and GAAP have a distinctively different way of treating financial assets. The areas in which they differ are in recognition of the financial assets include the loans and receivables, equity investments, debt securities, and the embedded derivatives in financial assets.
Equity investments—measurement
All the equity investments are measured at the fair value. Also, all the changes in the fair value are recognized throughout the earnings. There is also the use of the net asset value (NAV), which is only used after certain conditions have been met (PwC, 2020). It is used without adjustments, and it serves as the practical method of measuring funds such as private equity funds, hedge funds, and real estate funds. The entities are in a position to select a measurable alternative for the equity interests which do not have a ready fair value. When it is under the alternative, the equity interests will be recorded at the cost of less impairment. The asset’s face amount can be adjusted either up or down depending on market value and the price changes. These rules are under the ASC 321.
IFRS has a different approach to the measurement of equity investments. All the investments in the equity investments are measured at their fair value. Also, the instruments are held for the trading are supposed to be classified at the FVTPL. All other entities’ instruments can change their initial recognition in a bid to portray its fair value rather than profit and loss. The IFRS does not have a uniform method for calculating the NAV; thus, it is calculated differently in different countries.
Loans and receivables—classification
Under the GAAP, the treatment and classification of the loans and receivables are under the ASC 320. It defines how and when the asset should be treated as a debt. The asset should be commonly available in the securities exchange market or being recognized as the medium for investment when issued (PwC, 2020). Also, loans and receivables, in most cases, may require a separate fair value when they have the features of embedded derivatives. Some of the loans and receivables may not fall under the ASC 320 and will be fully explained under the ASC 320. Under this rule, loans will be classified as loans at the moment when they are set for investment where they are amortized at a certain cost. Also, the loans will be carried at fair value at the moment when the fair value is elected.
Under IFRS, the loans and receivables are covered under IFRS 9. They are under the model of the entity’s business model in terms of managing its assets and the instrument’s characteristics. In the business model, the asset is determined through a higher level of aggregation, and the business can have different models set for different portfolios. Some of the business practices, such as the factoring, affect the normal business operations, therefore requiring measurement and classification (PwC, 2020). The IFRS states that the financial asset should be measured at the amortization cost if it’s held under ‘hold to collect’ business model. Also, if the financial asset’s contractual terms are leading to cash flows to the business specified as SPPI on specified dates. The IFRS also states that the financial asset should be measured under the FVOCI if it is held under the business model to increase cash flows and sell the financial asset.
Eligibility for the fair value option
Under GAAP, entities are allowed to elect their fair value option for all financial assets that are recognized except for assets such as investments in a consolidated subsidiary (PwC, 2020). Also, the fair value option can only be selected when there is initial recognition of the asset or on the specified date.
Under the IFRS, the asset can only be measured at their FVTPL is when it has been established that it reduces the measurement and inconsistency recognition. It can also be measured when it leads to the recognition of the gains and losses of the asset from different bases.
- Financial liabilities and equity
The IFRS and the GAAP require that issuers of the financial instruments determine what is required between equity and financial liability. However, there is a difference between the two standards as some classifications can lead to varying classifications of identical instruments. The IFRS has a principle that requires that the financial instrument to be classified as a financial liability of the issuer can settle the obligation using cash or another financial asset (PwC, 2020). The GAAP classifies most financial instruments to be more equity –classified as compared to IFRS. This is because most of the financial instruments have the potential to be equity-classified if it is conditional for the issuer to settle it using cash or another financial asset.
The IFRS outlines that redeemable instruments have a high chance of being classified as a financial liability. This is because most of the financial instruments have provisions that allow the settlement to be made in cash or another financial asset in the event when a contingent occurs. The insurer is not in a position to unconditionally fail to settle using cash or another asset. Thus, the GAAP will be more specific than IFRS in classifying financial instruments as equity-classified.
A financial instrument can result in delivery or the receipt of the insurer’s own shares. This results in the difference between IFRS and GAAP on how such an instrument is treated. Under IFRS, there will be a need for a conversion feature in a net share settlement to be classified as a financial liability (PwC, 2020). This will not be required under the GAAP. Any further classification under the GAAP will cause a need to determine whether it appropriate to classify it as equity.
In the written options, there is a big difference in how the GAAP and IFRS treat them. The GAAP classifies the freestanding written put options of an entity as financial liabilities with the fair value throughout the earnings (U.S. Securities and Exchange Commission, 2020). On the other hand, IFRS recognizes written put options and measures them as a gross financial liability. They are recorded at a discounted value of the amount to be settled and later accredited to their settlement amount.
References
Firm Team, (2020). IFRS and GAAP Accounting: Top 10 Differences & Effects on Business. Retrieved 20 August 2020, from https://www.firmofthefuture.com/content/top-10-differences-between-ifrs-and-gaap-accounting/
Financial Accounting Standards Board, (2020) “About the FASB.” Accessed August 20, 2020.https://www.fasb.org/facts/index.shtml
IFRS Foundation, (2020) “Why Global Accounting Standards? Accessed August 20, 2020. https://www.ifrs.org/use-around-the-world/why-global-accounting-standards/
IFRS Foundation, (2020) “About the International Accounting Standards Board (Board)”Accessed August 20, 2020. https://www.ifrs.org/groups/international-accounting-standards-board/
PwC (2020). Retrieved 20 August 2020, from https://www.pwc.com/us/en/cfodirect/assets/pdf/accounting-guides/pwc-ifrs-us-gaap-similarities-and-differences.pdf
Ross, S. (2020). What’s the Difference Between GAAP and IFRS?. Retrieved 20 August 2020, from https://www.investopedia.com/ask/answers/011315/what-difference-between-gaap-and-ifrs.asp
U.S. Securities and Exchange Commission, (2020). “Financial Reporting Manual: Topic 8 – Non-GAAP Measures of Financial Performance, Liquidity, and Net Worth. Retrieved 20 August 2020 https://www.sec.gov/corpfin/cf-manual/topic-8