Financial reporting in the US is on the verge of a monumental shift from the rules driven Generally Accepted Accounting Principles (GAAP) towards the more principle based International Financial Reporting System. (IFRS) As one would expect from a shift between systems that are fundamentally different, this will mean a lot of changes to how companies report their business activities. These changes include the reporting of inventory, leases, income taxes, and consolidation of subsidiary companies.
One of the big differences between GAAP and the IFRS is how companies keep track of their inventory. Under GAAP, companies are allowed to use the last in first out (LIFO) method to keep track of inventory. A large reason why companies use LIFO is a way to keep company's tax lower. This occurs when the cost of goods sold increases, therefore making a company's net income lower than it actually is. As a result of the apparent lower income, they have to pay fewer taxes. Companies can also alter their financial statement by upping their inventory costs right be for the period ends, making the latest, most expensive batch of inventory sold. Under the IFRS, companies will have to use the first in first out (LIFO) method of inventory. The effect of using FIFO will be the opposite of LIFO in that companies will pay more taxes than assuming their cost of their goods sold is steadily rising, because their net income will appear to be larger. Another major difference between GAAP and IFRS if inventory is written down under GAAP, once inventory has been written down, any reversal is prohibited. The IFRS allows write-downs which have been recognized in previous years to be reversed through the income statement in the period in which the reversal occurs.
Leases under GAAP are much stricter in the way they are reported than they are under the IFRS. Under GAAP, there is specific guidance in making the determination as to whether a lease is considered an operating or capital lease. The four specific criteria include: if there the ownership transfers to the lessee, if there is a bargain purchase option, lease term in relation to the economic useful life (75%) and the present value of minimum lease payments in relation to fair value of the leased asset. (90%) The IFRS focuses on the overall substance of the transaction and substantiality all of the risks or rewards of ownership are transferred to the lessee. IFRS measures all of the criteria GAAP uses, yet it does not place a specific threshold on the amount. This is a classic example of how GAAP follows a strict set of rules while IFRS is more principle based.
There are several differences between IFRS and GAAP relating to accounting for and reporting of income taxes. The tax rate used for measuring deferred taxes under GAAP is the enacted tax rate in place when the timing difference is expected to reverse, whereas under IFRS, the substantially enacted tax rate is used. Under GAAP, the classification of the deferred tax asset or liability is either short-term or long-term depending on the underlying relationship of the timing difference. Under IFRS, deferred tax assets and liabilities are always recorded as long-term. Under GAAP a reconciliation of the expected tax expense to actual is not required in detail and only a disclosure of the nature of the reconciling items is required, where as the IFRS requires the complete reconciliation, including the nature and amounts.
The IFRS rules for reporting subsidiary company are different under GAAP. Under the IFRS, subsidiaries must adopt all the accounting policies of the parent company in consolidation. With GAAP, it must be determined whether or not a specific entity is considered a related party required to consolidate. The consolidation decisions are based on determining who has the right to incur the income and losses of a related entity. The IFRS focuses on the notion of "control," where GAAP is based on Control is defined as the ability to rule over the operating assets of an entity in order to obtain the benefits.
GAAP and the IFRS are fundamentally very different. GAAP is ruled based as demonstrated in how it states inventory, leases, income taxes, and consolidation of subsidiary companies are reported; while the IFRS is exceedingly focused on principles. Because of these philosophical differences, there will be numerous changes companies will need to make in order to comply with the new regulations. Despite the work needed to make the changes, the benefits appear to out weigh the costs.
Article Source: http://EzineArticles.com/?expert=Morgan_Hoffman
http://EzineArticles.com/?Differences-Between-IFRS-Vs-GAAP&id=7400493
No comments:
Post a Comment