The Generally Accepted Accounting Principles – GAAP and International Financial Reporting Standards – IFRS are the set of standards used in various countries. GAAP is generally followed in the US while the IFRS was established in 2001 and is used in most countries around the world for financial reporting. GAAP is mainly based on rules while IFRS mainly relies on principles. Albeit the functioning philosophy and viewpoint behind both GAAP and IFRS is quite similar there are several key differences which are explained in this paper.
The first difference is with respect to inventory costing as the LIFO or Last in First Out method for inventory costing is allowed in IFRS while it is prohibited under IFRS. The implication of this difference results in changes in both the income statement and balance sheet of a company. When LIFO inventory valuation method is used under GAAP, the cost of sales increases which decreases the income and the inventory reported on the balance sheet also decreases but this cannot be the case under IFRS as LIFO is not allowed and thus the income statement or balance sheet cannot be favorably maneuvered or manipulated for any purposes such as taxes.
The second difference between IFRS and GAAP is in reporting intangible assets and this is why GAAP is perceived to be more rule based and IFRS more principles based. The intangible assets such as advertising costs or Research and Development are reported at fair value in GAAP on the balance sheet while IFRS only allows recognition of such intangible assets if these assets have reliability with respect to measurement and will be economically beneficial in the future. The implication again is that the balance sheet for a single company prepared under GAAP or IFRS may differ due to the reporting of these intangible assets .
The third difference is with respect to write downs or write-offs of inventory. IFRS allows reversals or write-backs of inventory which has been written down or written-off in the future while GAAP prohibits reversals or write-backs and once inventory has been written down it cannot be reversed in the future. This also has implications with respect to the assets reported on the balance sheet under GAAP or IFRS.
There are certain differences between the two aspects that are usually related with the reporting of financial statements. These differences are explained below:
- Documents included in the financial statements
IFRS: It is included in balance sheet, income statement, changes in equity and in the cash flow statement and added in the footnotes section.
GAAP: It is included in the balance sheet, income statement, statement of comprehensive income, changes in the equity, cash flow statement and finally added in the footnotes section.
- Balance Sheet
IFRS: This usually requires the separation of current and non-current assets and liabilities section.
GAAP: This system recommends separation of current and non-current assets + liabilities.
- Deferred Taxes
IFRS: This is shown as a separate item on the balance sheet.
GAAP: In this system it is included in the assets and liabilities section.
- Minority Interest
IFRS: This is included as a separate line item in the equity section.
GAAP: This is included in the liabilities section and entitled as a separate line item.
- Extraordinary Items (Items that usually do not occur on regular basis)
IFRS: These items are prohibited in this system.
GAAP: These items are allowed if they are unusual.
- Bank overdrafts
IFRS: This item is usually utilized as cash.
GAAP: This is charged as a financing activity.
There are few differences that are likely to cause certain major changes in the reported results of the organization. It should be noted that a company with great results under the system of GAAP won’t look terrible in the system of IFRS. However, organizations have to take care about extraordinary events because in these scenarios the results of both the systems usually differ. Extraordinary events usually include corporate restructuring, merger etc.
Barth, M. E., Landsman, W. R., Lang, M., & Williams, C. (2012). Are IFRS-based and US GAAP-based accounting amounts comparable? Journal of Accounting and Economics , 54 (1), 68-93.
Needles, B. E., & Powers, M. (2010). A Guide to International Financial Reporting Standards: An Introduction. Mason, OH: Cengage Learning.
Shamrock, S. E. (2012). IFRS and US GAAP, with Website: A Comprehensive Comparison. Hoboken, NJ: John Wiley & Sons.