The United Sates will begin the switch from Generally Accepted Accounting Principles(GAAP) to International Financial Reporting Standards(IFRS) in 2014. This transition will bring significant changes in the way accountants treat, record, report, and interpret financial and other relevant industry information within U.S. and foreign companies. It is therefore important, before we begin to learn accounting in practice according to IFRS, that we inform ourselves about the key similarities and differences between GAAP and IFRS. Thorough research of web articles concludes that both systems of accounting have numerous similarities but have significantly more differences. Once completed, convergence will break down the accounting standards translation barriers that domestic and foreign firms currently have among their accounting processes and lead to harmonization in the accounting world.
Today, the majority of United States' businesses are involved in overseas markets and most foreign companies are already using IFRS. The Securities Exchange commission has recognized this and released a statement in support, in February of 2010, of the need for a universal, unified set of accounting standards to be followed, and that IFRS is the best suited set of standards to take on that role. The SEC also developed a road map to achieve this task of convergence and plans to make a final decision in 2011 regarding the definite incorporation of IFRS into the United States. The recent economic recession that affected the majority of the world is one such reason a global set of accounting standards is in need. Many worldwide capital markets were affected by the recession and this only strengthens the argument of the need for a unified set of accounting standards. The convergence of IFRS and GAAP will unify all companies in a common financial reporting language and will iron out any differences domestic and foreign firms encountered in the past. Before this convergence begins, it is important to have a discussion of a few of the major similarities and differences between IFRS and GAAP regarding the Financial Statements, Inventories, and Revenue Recognition so that we may begin to understand how greatly this convergence effort will affect us as U.S. GAAP users.
Before any interested party can begin to examine the internal workings of a company they usually begin in the same place, the financial statements. Financial statements are useful for a multitude of reasons to investors, creditors, directors, internal and external managers etc. and comparability of foreign and domestic financial statements is essential to the modern business. Fortunately, IFRS and GAAP already consider the same financial statements to be the accepted standard for reporting. Under both systems, the preferred statements are: the Income Statement, Balance Sheet, Other Comprehensive Income Statement which is called the Statement of Recognized Income and Expense under the IFRS system, the Statement of Cash Flows, and the Notes to the Financial Statements. Both frameworks require the accrual method of accounting be used with the exception for the Statement of Cash Flows. Both frameworks however, have their significant differences. GAAP allow comparative statements be issued or even a single year in some cases. The balance sheet must be presented with the two most recent years as a comparison and all other statements must cover a three-year period based upon the balance sheet date. Under IFRS, all reports must be released comparatively with the previous period. A standard layout of the balance sheet and the income statement is not necessary under GAAP however, public companies must follow specific rules. Under IFRS, there is no standard layout, just a list of minimum items that must be disclosed. Balance sheets under GAAP must present debt to be paid in more than one year as a long-term liability while IFRS requires all debt to be classified as current unless the agreement to pay the debt was made prior to the balance sheet date. Under GAAP, expenses are classified according to function. IFRS allows expenses to be classified according to function or nature of such expense. Extraordinary items must be unusual and infrequent in occurrence to be included in GAAP income statements whereas extraordinary items are prohibited under IFRS. This is certainly not an all-inclusive list of the differences between the financial statements under both of the frameworks. It is clear to see though, how even the slightest differences between a set of two financial statements, one IFRS and one GAAP, could lead a user of such statements into a troubling situation.
Most businesses in the U.S. and worldwide all have one aspect in common, inventories. Luckily, the basis for valuing inventory under IFRS and GAAP is cost. They both define inventory as assets held for sale in the ordinary course of business, in the process of production for such sale, or to be consumed in the production of goods or services. The cost of inventory is also supported by the money that was spent readying inventory for sale, such as freight-in. Likewise, the two standards have their differences when it comes to reporting inventories. Under GAAP, any cost method can be used for inventories whereas IFRS prohibits LIFO and requires the same costing method be applied to all inventory similar in nature. GAAP requires inventory be measured at the lower of cost or market value. IFRS states that inventory must be measured at the lower of cost or net realizable value. There are several more issues to deal with regarding inventories, in particular mark-down reversals of inventory under each system are different. There are currently no ongoing convergence efforts regarding inventory by the FASB and IASB.
The most important asset to a business, many say, is cash. Without cash the business will be in trouble when it comes time to pay off debts, make any capital expenditures, or simply get lines of credit. One of the ways of getting cash is from revenue into the business. Revenue is defined as the gross inflow of economic benefits during the period arising in the course of the ordinary activities of the entity when those inflows result in increases in equity except increases in equity from distributions from owners.
Under both sets of standards, revenue is not recognized until it is earned or realized(or realizable). When discussing the sale of goods, GAAP requires that there is a legal transfer of ownership and the goods have been delivered at a set price and the seller can reasonable expect payment. Under IFRS, revenue can only be recorded when the risks and rewards of ownership are transferred and the buyer has control of the goods. When recording service revenue, GAAP does not allow any up front revenue recognition if the services are to be performed over a period of time. Such revenue must be amortized. IFRS does allow the option to record the revenue all at once even if the services will be performed over a period of time. In regards as to when to recognize revenue for contingencies, U.S. GAAP requires companies to wait until the contingency is resolved before they record any revenue. IFRS does allow for contingent revenue to be recorded as long as certain mandatory requirements are met. This presents a problem because a company using IFRS could potentially record revenue earlier than it actually received the inflow of assets, misleading users of financial statements.
As one can see just by viewing the similarities and differences among these three categories, the task of convergence is going to be quite challenging. The two sets of standards both have their logic in some areas yet have their downfalls in others. Convergence will benefit the United States in the sense that our financial statements will be much more easily compared to foreign companies'. Though it may take some time and money to be completely unified in our financial reporting, the benefit to global accounting harmonization far outweighs the cost.
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