GAAP vs. IFRS
International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP) are the both formalized accounting and financial guidelines that businesses may have to follow. In the U.S., all publicly traded companies are required to report using GAAP, and in many international markets IFRS is required for publicly traded companies. Companies listed on two exchanges, say the New York Stock Exchange and the London Stock Exchange, are often required to issue financial statements under one method and also provide a reconciliation to show what their financial performance would look like under the other.
Differences Between GAAP and IFRS
General StructureU.S. GAAP is considered to be far more 'rules based' in terms of how accounting guidelines are written and applied.
Comparatively, IFRS is considered to be far more 'principles based' and the focus is on assessing the facts and ensuring the accounting treatment and financial presentation is representative of the economics of a transaction or balance.
Historical Cost vs. Fair Market ValueU.S. GAAP emphasizes the historical value of transactions in terms of valuing assets, inventory, and liabilities. There are relatively fewer mechanisms in place where it is required to 'revalue' accounts based on their current fair market value.
IFRS is far more focused on fair market value, or the current value, of transactions and accounts in the financial statements. This is perceived to provide a more accurate picture of the actual current value or economic substance of a company.
There are many examples where this difference has implications, including:
- Financial Instruments
GAAP and IFRS ConvergenceAs IFRS has been adopted in over 110 countries there is significant pressure on the U.S. regulators to harmonize its accounting with the rest of the world. In a modern economy with the rapidly shifting factors that many companies face, U.S. GAAP is widely considered to not effectively reflect many companies' true value or financial performance. There have been numerous changes to U.S. GAAP to harmonize with IFRS on specific items over the past few years, but complete adoption hasn't proceeded further than discussion.
Implications of the DifferenceThe implications of the rule based and historical cost deficiencies of U.S. GAAP have been demonstrated very publicly even though few actually know it. When Enron collapsed in 2001 many of the 'accounting scandals' they were 'guilty' of were actually allowed under the specific rule based nature of U.S. GAAP, even when they in no way reflected the true economic substance of transactions. One of many accounting loopholes used by Enron was putting liabilities in subsidiaries that were too small to be required to be consolidated into their financial statements, which is allowed under U.S. GAAP. The problem was Enron created hundreds of them. Many Enron executives went further and committed actual crimes, but the factors that really cost investor's money when the company collapsed were at the time allowed accounting practices. Under IFRS none of those accounting practices would have been allowed under the principles based rules that exist.
Posted in ...Business