Comparing and Contrasting GAAP and IFRS

Comparing and Contrasting GAAP and IFRS

For whatever reason, the United States does things their own way sometimes, even if the rest of the world does not do the same. The accounting method in the US (GAAP) is different from what most of the rest of the world uses (IFRS). There are many key differences between GAAP and IFRS. Some of the major differences come in the way they calculate the statement of income, how inventory is calculated, and what financial statements are required. The first major difference is how the income statement is constructed and what it consists of.

Most of the differences in the income statement are formatting variations. In a GAAP there are two main formats: a single step and a multistep. In the single step, all expenses are classified and subtracted to find the income before tax. With the multistep, the costs of goods sold (COGS) is deducted from sales to show gross profit. Next, other expenses or gains are totaled and subtracted from gross profit to find income before taxes. In IFRS there is no set format. However, there are several items that need to be provided on the income statement. These items include revenue, finance costs, how much profit or losses associates and joint ventures accounted for using the equity method, the method used, tax expense, post tax profit or loss because of disposal of assets or discontinued operation, and profit or loss. One of the differences that should be mentioned is that extraordinary items are not allowed on an IFRS income statement. While they are not usual and very rare on a GAAP income statement they sometimes appear there and must be duly noted. There are also several differences in the way inventory needs to be recorded between GAAP and IFRS.

In GAAP, accountants can value inventory several ways. Last in last out (LIFO), first in first out (FIFO), and weighted average are all acceptable ways to account for inventory. However, when using IFRS, weighted average and FIFO are required, while LIFO, which is used extensively in the United States, is not allowed. The reason LIFO is used so often in the United States, and not allowed under IFRS, is because LIFO is used for better accounting, whereas FIFO gives better and more accurate financial information. Another difference in the inventory valuing between GAAP and IFRS is that while inventory can be valued down in both, it can only be valued up to its cost in IFRS. For example, if the economy is down and costs for a company’s inventory decrease, the inventory can be written down to the lower cost of market in both GAAP and IFRS. The difference is that if the economy bounces back, only under IFRS can the inventory be valued back up to its current cost. Another big difference between GAAP and IFRS are the required financial statements.

There is an extra financial required by GAAP and that is the statement of comprehensive income. This statement of comprehensive income may also be included in the income statement. The statement of comprehensive income is just what it says it is — a comprehensive look at the income a company receives during the financial period. Even though IFRS does not require a specific statement of comprehensive income, all the items on it can be found in the other financial statements. For the most part, IFRS is much less demanding and has fewer formats. They both get the job done and it is hard to make a strong case that one is better than the other. So this brings up some questions: If both guidelines get to the same place, will the US ever switch to IFRS? Or should they switch? An article from the Accounting Horizons journal entitled “Potential Adoption of IFRS by the United States: A Critical View”, by Devrimi Kaya and Julian A. Pillhofer, takes a good hard look at those questions. Their conclusion, “The hazard of political pressures and the IASB’s inability to ensure the proper implementation and enforcement of IFRS significantly impair the global convergence in accounting standards. Therefore, the SEC should move cautiously toward incorporation of IFRS in the US” (Kaya and Pillhofer 294). Basically, from their findings, they believe the US should move to IFRS because of how difficult it is to know and go back and forth between GAAP to IFRS. In that quote they also mention IASB, which is the codification for the United States GAAP. Another online article by David Albrecht concluded the following: “In conclusion, it isn’t in the best interest of the United States to switch to IFRS. The initial economic damage it would do to companies by having to institute new regulations and the long-term affects it would have on our economy because less capital would be available for US investment projects would be devastating. Further, the negative impact it would have on the accounting profession, in terms of retraining and the adaptation of college curriculums, and the jobs lost to international workers more skilled in IFRS would be equally harmful”. He raises some great points as to how it would affect the US economy. Many companies would have to learn the new system and hire new accountants. This would also result in people have to go back to school to learn the new system and it would force colleges to change what they teach. It would basically set off a big chain reaction in the accounting world.

While people may have different views on whether or not the United States should change to IFRS and abandon GAAP one thing remains the same; they are different and difficult to interchange. Main differences include they way they calculate income, the rules for calculating inventory, and what financial statements are required. There are countless other differences between IFRS and GAAP, far too many to name here. Maybe one day the United States will switch to IFRS but for now it would appear as if GAAP will remain.