IFRS: International Financial Reporting Standards

Thursday, 2 May 2013

US GAAP Vs IFRS

There has been a growing demand over the past twenty years to harmonize the business world under one conceptual framework for reporting financial statements. Currently, there are two types of frameworks used throughout the accounting world. They are United States of America General Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRS).
Presently more than seven thousand companies within one hundred countries worldwide use IFRS instead of U.S. GAAP. In order to harmonize these foreign capital markets, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have been working together to converge U.S. GAAP with IFRS. The main purpose of this conversion is to have one general global financial reporting standard that allows financial statements to become more relevant and reliable. This would also allow for both United States and foreign companies to become more consistent and comparable within their financial statements. The overall objective of this conversion is to provide better financial information for capital providers, lenders, and stockholders.
The preparation and presentation of financial statements are similar between U.S. GAAP and IFRS. These financial statements include balance sheets, income statements, cash flows, and comprehensive incomes. During their preparation, companies are required to prepare on the accrual basis in both frameworks. Furthermore, U.S. GAAP and IFRS both contain components that are recognized in equity as constituents of comprehensive income; however, net income is still unchanged by these items. U.S. GAAP allows comprehensive income to be prepared in three different formats; single income statement, combined income statement of comprehensive income, and stockholders' equity section. IFRS also permits comprehensive income to be reported in stockholders' equity or in statement of recognized income and expense (SoRIE) format. Although the two frameworks are similar in ways, several conflicts between U.S. GAAP and IFRS exist particularly in the presentation of financial statements, revenue recognition, nonfinancial assets, and fair market value.

Accounting and reporting standards, revenue recognition, and the approach to reporting non-financial assets are the three main differences between IFRS and U.S. GAAP. IFRS is based on accounting principles, whereas U.S. GAAP is rule based. Implementing IFRS allows companies to better adapt to the changes in the business environment, by not having as many guidelines in order to encourage the use of professional judgment, and in the end, discourage financial engineering. These four aspects of IFRS are believed to produce more transparent financial statements backed by straightforward thinking and flexible interpreting of accounting and reporting standards. This approach encourages a more ethical judgment than following the normal rule based U.S. GAAP. On the other hand, U.S. GAAP focuses on large complex economies that have less room for interpretation and provides a guideline approach to implementation. It is believed that if there are more rules and guidance, then a company does not need to disclose as much within their financial statements. In comparison, U.S. GAAP does not easily allow for thinking outside the box. Many individuals in the U.S. believe that U.S. GAAP should remain the "Gold Standard" because they believe that having a more rules based approach will reduce interpretation and will produce more transparent financial results. Supporters of IFRS believe that business decisions do not rely on rules, but on professional judgment. They believe that failing to disclose the professional judgment within a company's financial statement could misleads investors.

One of the biggest differences involving IFRS and U.S. GAAP, and probably the most difficult standard to convert between the two, is revenue recognition. First, revenue recognition under U.S. GAAP only occurs when it is realized or when earned. Revenue is considered earned when a transaction has taken place between two parties. Under the U.S. GAAP framework, a company can only recognize revenue in the period it was earned, regardless of the time in which they actually receive the revenue. On the other hand, IFRS recognizes revenue in an unusual way. Revenue recognition under IFRS records revenue for that period based on a percentage of completion of all revenue earned. In addition, the guidance of revenue recognition within specific industries exists under U.S. GAAP but not in IFRS. Among the two standards an individual can see where one is rule-based and other is principle in nature.

Another significant difference between U.S. GAAP and IFRS is the approach to reporting non-financial assets; some of which include intangible assets, inventory, property plant, and equipment. IFRS permits the revaluation of certain nonfinancial assets to fair market values, unlike U.S. GAAP, which only permits the use of historical costs. Reporting inventory methods between both practices varies. Last in first out (LIFO) inventory method is allowed to be used under U.S. GAAP but not under IFRS. A company that integrates IFRS and uses LIFO method would have to change to first in first out (FIFO) or weighted average cost and this could have a tremendous impact on reporting operating results and tax implications. IFRS allows for reversals of inventory write-downs for subsequent recoveries; however U.S. GAAP forbids any write-downs for inventories. In addition to inventory write-downs, if an intangible asset loses value under U.S. GAAP it has to be written down and cannot be written back up to the original value. IFRS allows the intangible assets to be written back up. These are some of the constraints and roadblocks that FASB and IASB have to contend with in the coming years.

In conclusion, there are many constrictions in converting U.S. GAAP to IFRS. However, the conversion is needed. The conversion of the U.S. GAAP framework will completely change how companies report their financial results in the coming years. The adaptation from U.S. GAAP to IFRS will create the benefits of stronger comparability and consistency between U.S. and foreign corporations' financial statements. The convergence between the two accounting standards will produce more transparent and understandable standards that will provide a major advantage for investors.

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Wednesday, 1 May 2013

GAAP and IFRS

Two important methods to be familiar with when it comes to recording financial information are GAAP and IFRS. GAAP stands for Generally Accepted Accounting Principles and IFRS stands for International Financial Reporting Standards. Over the past few years, many countries have made the switch from the GAAP method of accounting principles to the IFRS method. Each of these methods requires CPA firms and corporations to adopt different yet similar principles for recording financial information. The methods state financial standards that companies must follow when recording information on their balance sheets and income statements. Although the United States will eventually undergo the change from GAAP to IFRS, many parts of the world such as the European Union, Australia, South Africa, Singapore, and Turkey have already adopted the IFRS method. More than 113 countries around the world have put the IFRS system into use. The IFRS and GAAP methods have their own set of positive and negative attributes that have affected financial reporting in many countries.

One of the main criticisms of the IFRS method is that it allows unethical managers to hide, change, and choose numbers to make their company appear more presentable. The fact that managers can choose how they wish to present their financial information is one of the main ways IFRS differs from GAAP. The guidelines under IFRS are indistinct and allow managers to change their revenue numbers. Those who support IFRS agree that this method is more lenient when it comes to reporting information; however it is the auditors' job to use their own professional judgment when recording financial information. Although IFRS is said to provide more leeway when reporting for financial statements, there is still no method that will stop unethical managers from changing their numbers.

Matthew Birney, manager of the United Technologies Corporation's financial department stated many positive comments regarding the IFRS method. Birney stated that since there are already so many countries who have adopted the IFRS principles, there are already many experts around the world. The change to IFRS introduces the U.S. business world to many new accountants and talented people. Birney also stated that once everyone is using a single set of accounting standards, like IFRS, it will make access to new capital markets easier. Worldwide adoption of IFRS will benefit investors and accountants using financial statements by decreasing costs of comparing investments and increasing the quality of information. Also under IFRS, more investors will be more likely to provide financing which will benefit many companies.

Many countries have already adopted the IFRS system for various reasons. Each country that has put the IFRS method into use has its own reasoning for adopting the method. For instance, in 2006, the Accounting Standards Board in Canada adopted the IFRS system to try to improve its business. Before IFRS, the GAAP system had been in use for decades in Canada. By switching to the IFRS method, it allows Canada to be more involved with international commerce. The European Union executed the IFRS method to make financial reporting easier among other countries.

Because IFRS is known to allow room for error, the GAAP method may be favored more for its consistency. By operating under the GAAP method, it promotes consistency which decreases the risk for errors. One positive attribute about the GAAP method is that there are strict rules on when and how a company can record their revenue information. Because of this, the chance of error is greatly reduced. Many managers in today's business world are concerned with how their business is presented, so it is essential to have a method that prevents unethical managers from changing numbers. Also, many countries like the U.S. already have practiced the GAAP method for decades so it may be difficult to switch to another method.

Although GAAP has many positive attributes, there are some negative aspects that are important to look at as well. For instance, a negative aspect of GAAP can be portrayed with the environmental crisis. Although our country is currently facing a tough economic crisis, we are also in the middle of an environmental crisis. Issues such as global climate change, water scarcity, and ecosystem degradation not only affect environmental companies, but they also generate financial risks for their investors. The GAAP method ignores these risks which are often a result of unsustainable business strategies. By practicing strong environmental tactics, companies can develop lower costs and increase revenue from new product innovation and increased brand recognition.

In today's competitive business world, it is crucial for countries to choose which method is right for them.

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IFRS Replacing GAAP?

GAAP
Generally Accepted Accounting Principles, also known as GAAP, is an ideology used by accountants in the United States as well as other parts of the world. It was one of the most widely used standards until IFRS had come along, and started mixing its ideas with GAAP. GAAP controlled everything in the accounting world from debit and credit all the way to financial statements. The reason GAAP was so successful was because it was so consistent, everybody used the rules set forth by GAAP. These made it easy for the Securities and Exchange Commission, or SEC, to look into a company's records and financial statements and know exactly where to look for what they needed. GAAP has been dwindling out over the years to make room for a new standard created by International Accounting Standards Board called, International Financial Reporting Standard.

IFRS
International Financial Reporting Standard, or IFRS for short, has been becoming the new standard in the field of Accounting. According to Steve Showerman, of the company of Deloitte, in his article IFRS in the United States: Challenges and Opportunities, over 12,000 public companies in over 100 countries have already switched to IFRS. This includes some companies in the European Union, and other countries such as Canada will be switching over later this year. The United States is slowly moving in the direction of IFRS but that still seems to be off in the long term. The new movement from GAAP to IFRS has caused financial reporting to differ between countries and companies with offices in other countries can wind up paying the price.

What's The Difference?
Generally Accepted Accounting Principles and International Financial Reporting Standard differ in a few ways, such as their financial statements, when taking the CPA exam, test takers will need to recognize and need to perform the different financial statements. Another major difference is in the way that cost is allocated, with GAAP all assets are allocated when doing so to cost. But with IFRS the allocation waits all the way until there is a cost for the product before it breaks down the cost. With International Financial Reporting Standards there is only First-in First-out, weighted average, and specific identification for inventory purposes. This is different from Generally Accepted Accounting Principles because it uses all of these, plus it uses Last-in First-out also, for inventory. IFRS uses a one step method for impairment write-downs, compared to GAAP which uses a two-step method. This makes write-downs more common with IFRS, because it is only one step rather than two.

What does this mean for Accountants?
These differences will affect everyone from students and professors all the way to accountants and experts who have been in the field for years. It will cause accountants to learn new financial statements and will also cause them to either go back to school or learn different techniques on their own. On the CPA exam, accountants will need to remember the old standard, Generally Accepted Accounting Principles, and they will also need to learn and know the new standard, International Financial Reporting Standard. With this CPA test takers will need to realize which standard to use in which circumstances and will need to know the differences between the two standards.

Conclusion
International Financial Reporting Standard is the new standard that is sweeping the globe and according to Janice Patrisso, a partner at KPMG and a leader in the movement for IFRS, the Securities and Exchange Commission has made a compliance date for all companies to move from GAAP to IFRS between the years 2014 to 2016. The SEC had also said that it will comply with the global financial framework. In Why Switch to IFRS From GAAP?, Marquita Jennings explains that on August 27, 2008, the SEC had proposed the idea of making a road map for people to follow while they are switching from Generally Accepted Accounting Principle to International Financial Reporting Standards. And on November 14, 2008 the SEC did just that producing a 165-page document serving as a road map for people while switching from GAAP to IFRS. This will definitely make it easier to make the change when all companies must comply, and people are not really sure what they have to do to switch it to IFRS. Although people are not really sure when the change from GAAP to IFRS is coming, whether it be as early as 2014 or as late as 2016, we can all be sure that the change to IFRS is coming to the United States.