Of late, International Financial Reporting Standards (IFRS) Vs Generally Accepted Accounting Principles (GAAP) has been one of the most debatable topics of discussion in the world of accounting. IFRS is the accounting method having universal applicability while GAAP is the set of guidelines that are used in the United States. IFRS has gained some traction is the last couple of years which is vindicated by the fact that approximately 120 nations of the world have adopted IFRS as the standard for accounting. However, approximately 90 countries have been reported to be fully consistent with IFRS guidelines. If you are either a business owner with significant global footprints, then it is very important for you to understand the differences between these two accounting methods in order to be successful globally. Here are a few of the differences between IFRS and GAAP accounting that you should be aware of:
- The United States vs rest of The World
If your business is entirely concentrated in the United States, then you may afford to ignore the dissimilarities between IFRS and GAAP. However, if your business has a presence outside the United States, then you must know that IFRS is the globally accepted accounting standard and more than hundred countries have adopted it or are in the process of its full-fledged implementation. GAAP, on the other hand, is an accounting method that is solely applicable within the United States. GAAP has an entirely different set of rules for accounting than that of IFRS which is applicable in most part of the world. As such, if you continue with GAAP, then it may not augur well for your business internationally.
- methodology of accounting
One of the major differences that you can find with IFRS and GAAP is the methodology of accounting followed by them. IFRS is a principle-based accounting method that looks at the overall patterns, whereas GAAP is an accounting method which is rule-based and focuses more on research. Since IFRS is a principle-based accounting method, there is always some scope for a different interpretation of any transaction. On the other hand, GAAP is a rule-based accounting that is governed by a specific set of guidelines and as such, you can’t afford to deviate from those rules i.e. carved in stone.
- inventory accounting
Under IFRS, you are forced to use First In, First Out (FIFO) method of inventory accounting, whereas under GAAP, you are allowed to choose between Last In, First Out (LIFO) and FIFO method for inventory accounting. Imagine a scenario where the prices of the raw material are increasing, the LIFO method inventory valuation will result in unusually low-income level because the high priced raw material that was bought last will be recognized in the income statement. As such, LIFO valuation doesn’t reflect the true financial performance of a company and IFRS forbids its usage as a prudent approach.
- reversal of inventory write-down
There is one more difference between IFRS and GAAP which is pertaining to inventory accounting and that is applicable when inventory write-down is reversed. IFRS states that in case the market value of the asset increases, then the amount of the inventory write-down can be reversed. On the other hand, in a similar situation, GAAP doesn’t allow reversal of the write-down. From this, it can be seen that when it comes to a reversal of inventory write-down, GAAP is very conservative as compared to IFRS as it does not allow any positive changes in this type of inventory accounting.
- capitalization of development cost
Under IFRS, you are allowed to identify development cost as an asset and as such, it can be capitalized given that certain criteria are satisfied. The primary benefit of this accounting is that the depreciation charge can be expensed over a period of time. However, GAAP doesn’t allow capitalization of development costs and as such it must be expensed the year they occur which results in depressed profit in that year. Here, IFRS allows you to expense the development cost over the period of time to moderate its impact on the reported profit of that single year in which it is incurred.
- accounting of intangible assets
Under IFRS accounting, the valuation of an intangible asset is done based on the likely future benefit expected out of it. On the other hand, under GAAP, intangible assets can only be recognized at their fair market value and nothing more. The examples of such intangible assets can be advertising costs or research and development costs etc.
- extraordinary or unusual items
Extraordinary or unusual items are referred to those events which are fairly infrequent in nature. Under IFRS, you are allowed to report extraordinary or unusual items in the profit and loss statement, whereas, these items are reported as a line item below the net income in the profit and loss statement under GAAP accounting method.
- fair value vs historical cost
Under IFRS, you are allowed to value the fixed assets based on the revaluation model that takes into account its fair value on the reporting date minus the accumulated depreciation and impairment losses. On the other hand, under GAAP, you must recognize the value of the fixed assets based on the cost model that takes into account the historical value of the asset minus the accumulated depreciation. Examples of fixed assets are property, furniture, and equipment, etc.
So, it is important that you understand the underlying differences between IFRS and GAAP method of accounting because it will be needed if you are planning to expand your business from a GAAP compliant nation to an IFRS compliant nation. It is also to be appreciated that both the accounting principles have their pros and cons, but IFRS being a principle-based accounting method allows you more flexibility. Please note that this is not an exhaustive list of differences, but I hope now you know something about how IFRS and GAAP differ from each other.Please click below to read more on this: A comparative study between IFRS, US GAAP and Indian GAAP.