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The Major Differences Between GAAP and IFRS

The Major Differences Between GAAP and IFRS

GAAP, or Generally Accepted Accounting Principles, are the accounting rules that are used to present financial statements for public or private companies, non-profit organizations, and government authorities in the United States. IFRS, or International Financial Reporting Standards, are designed so that companies all over the world can compare financial statements with each other. Both bodies have similarities and differences with one another. The United States is the only place that uses GAAP, which can make it difficult to compare numbers to an international company. However, many large businesses in the United States use IFRS as well to match up against their international competition. There are five major differences between GAAP and IFRS. They are revenue recognition, financial assets, impairment of assets, intangible assets, and inventory.

When dealing with revenue recognition, GAAP uses concepts, while IFRS uses standards, making the two hard to compare. With GAAP, revenues may need to be amortized over a period of time, but with IFRS revenues can be recognized immediately. Contingent revenues are also handled differently between the two bodies. For GAAP, revenue cannot be recognized until the amount is set. For IFRS, contingent revenues can be recognized when the amount can be accurately estimated and when it is probable that the revenue will bring benefit to the business.

GAAP discusses the treatment of financial assets numerous times throughout different sections. IFRS, however, only has two standards dealing with financial assets, one for disclosures, and one for other issues. One of the major parts of dealing with financial assets is classifying them. GAAP uses legal form in classification, while IFRS organizes them based on their nature. Another big part of dealing with financial assets is when to take them off your financial statements. GAAP removes an asset when the control over it has been relinquished. IFRS looks into whether there was a transfer of assets with the rewards being passed.

GAAP uses a two-step process when testing for impairment. The first step is to decide if the carrying amount of the assets is more than the undiscounted future cash flows. If it is, then go onto the next step, which is to calculate the impairment. Impairment is equal to the amount the carrying value exceeds the recoverable amount. For IFRS, impairment is decided if the carrying value is more than the greater of the discounted cash flows or the fair value adjusted minus any disposal costs.

Both GAAP and IFRS consider intangible assets to be nonmonetary assets that do not have any physical substance. There are three major differences between the two bodies when it comes to dealing with intangible assets. The first is involving development costs. Under GAAP, development costs are expensed when they are incurred. Under IFRS, development costs are capitalized. When GAAP is dealing with advertising costs, they are either expensed as incurred or expensed when the advertising is put in place for the first time. When IFRS handles advertising costs for intangible assets, all costs are expensed when incurred. Using GAAP, revaluation is not allowed for intangible assets, but under IFRS, revaluation to the fair value of the intangible asset is permitted.

Another issue the two bodies handle differently is inventory. When using GAAP, the costing method of LIFO is acceptable, but under IFRS, LIFO is not acceptable. This creates a challenge if GAAP converges to IFRS because taxpayers are required to use the same accounting method in financial reporting and taxation. Companies currently using LIFO could be violating the conformity requirement if they are forced to change their costing method because of a change to IFRS. GAAP recognizes inventory at a lower of cost or market while IFRS recognizes inventory at a lower of cost or net realizable value. GAAP also states that the lower of cost or market adjustments cannot be reversed, while IFRS says under certain conditions, the lower of cost or market adjustments must be reversed.

Although there are numerous differences between GAAP and IFRS, the two bodies have the same overall purpose of trying to keep all financial records of companies accurate. There has been a large amount of discussion of whether the United States will convert to International Financial Reporting Standards, which would make it easier to compare our financials to overseas companies. Whether that day will come, we have no idea.