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April 21, 2022
In the U.S., public companies must report their financial statements in compliance with generally accepted accounting principles (GAAP). While private companies are not required to follow GAAP, sticking to these regulations from day one is best practice.
In most other countries, companies report in compliance with international financial reporting standards (IFRS). The IFRS Foundation moderates over 160 countries for compliance with financial reporting guidelines.
Understanding these two entities and ensuring compliance with the method for your country is important. This is so investors and agencies can easily compare financial documents between two companies.
Wondering more about the differences in GAAP vs IFRS? Keep reading to find out in this guide to GAAP and IFRS.
GAAP and IFRS are both accounting principles used in financial reporting and outlined principles and rules for companies to follow. The purpose of both frameworks is to define how companies report their financials. This is to create standardization and consistency across the board.
Though the issuing agencies have tried to make the two frameworks similar, there are key differences.
In order to manage this standardization, a set of regulatory boards were formed both for GAAP and IFRS.
The Financial Accounting Standards Board (FASB) was formed in 1973 and monitors GAAP. The Securities and Exchange Commission (SEC) recognizes the FASB as responsible for setting accounting standards and entrusts the FASB with writing and updating business accounting rules in tandem with other agencies.
The International Accounting Standards Board (IASB) oversees the IFRS principles. This London-based board was founded in 2001 and set standards for accounting operations in many countries.
While the FASB and IASB have worked together to create one global standard, the long-term goal is to work together to eliminate GAAP and update IFRS, so all countries follow the same framework.
Both accounting frameworks use financial statements to manage cash and cash equivalents. Both use:
Both also follow the accrual method of reporting revenue.
The main difference between the two is that IFRS requires much less detail than GAAP. IFRS is more open to interpretation, so companies may have to write lengthy footnotes to accompany financial statements.
Additional differences occur in the following areas:
The differences may seem small, but they make a big impact on how businesses draft financial documents. We’ll dive further into each of these areas below.
GAAP is a rules-based framework. This means there are very detailed guidelines on how to complete transactions. GAAP has many rules companies must follow, but some are easy to manipulate.
IFRS is principles-based. The agency publishes a set of accounting principles for companies. It is up to each company to make the best decisions on meeting these principles.
GAAP allows LIFO where IFRS prohibits it. When using LIFO, companies can report income at much lower amounts than is accurate. This method also doesn't give a clear view of inventory flow.
GAAP and IFRS both allow for FIFO (first in, first out) and the weighted average inventory reporting methods. Inventory reversals are not permitted under GAAP. IFRS does allow reversals, but only under certain conditions.
Under GAAP, companies report fixed assets at cost minus depreciation.
Under IFRS, companies can revalue fixed assets. This means the cost may go up instead of down. This method of managing fixed asset value requires much more time and effort.
GAAP requires companies to report development costs as they incur them.
IFRS allows development costs to be spread out and amortized across multiple periods.
With GAAP, companies must report inventory and fixed assets at market value. Companies cannot reverse the amount of the asset even if the market value goes up.
Under IFRS, companies can reverse write-downs.
With GAAP, the balance sheet lists assets first. They also require a certain formula for listing categories. Companies must list liabilities in order of most liquid to least.
IFRS lists non-assets first. This principle also requires the opposite for listing categories: least liquid to most.
So, the document looks different based on the location of the company.
When companies file their financial reports annually, each board requires different financial statements.
For GAAP, companies must have:
For IFRS, companies must have:
Both boards require similar statements, but the layout is different for the balance sheet.
GAAP requires companies to report intangible assets at fair value. These assets could be research and development (R&D) or advertising to grow revenue.
IFRS only allows recognition of intangible assets if they have future economic value.
Both IFRS and GAAP allow businesses to recognize an impairment loss. This is for long-lived assets that have a change in market value.
The impairment loss can be reversed for all assets except goodwill under IFRS if the market changes. GAAP does not allow for reversals.
GAAP does not have an investment property category.
IFRS allows for companies to have an investment property category. This is for property used for rental income or capital appreciation.
IFRS allows for the exclusion of low-valued assets while GAAP does not.
GAAP excludes all intangible assets from leases, while IFRS allows for some.
Implications of Not Complying With GAAP and IFRS
Unfortunately, mistakes often happen in startup environments. But these mistakes are easily avoided. It's important to set up processes and systems to ensure you comply with accounting standards and avoid potentially costly mistakes.
Non-compliance with GAAP or IFRS guidelines can lead to hefty fines from the regulatory agencies. It can also impact your company's reputation with potential investors. All public companies are required by law to follow these accounting frameworks.
Running your business without a set accounting system can lead to many errors. These errors can be costly and damaging to your organization.
In the U.S., GAAP is what the SEC uses and deems that all companies use for financial reporting. Until the SEC decides IFRS is acceptable, companies must use GAAP to remain compliant.
Larger corporations with subsidiaries in other countries can adopt IFRS for those locations. But any company residing in the US must follow GAAP rules.
If it becomes possible, potential issues arise from the conversion. Many companies will have to update systems, technologies, and accounting requirements.
Transitioning from GAAP to IFRS should be an organizational-wide change. Leaders and company owners should consider the time and monetary implications of the transition to plan it accurately.
The FASB and IASB are working diligently to combine GAAP and IFRS into one global accounting framework. This is a slow-going because many processes and principles have to be considered. The differences between the two must be resolved and compiled into one before introducing a standard framework.
Companies could see many benefits once this happens. For example, IFRS will lead to:
Having a global, standardized accounting framework will be beneficial for many companies. Overall, it will make investing in businesses a more manageable task with simplified processes.
Now that you understand GAAP vs. IFRS, do you think your company is up to speed? Do you need to update your accounting practices?
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Get started early. It's important for startups and small businesses to follow GAAP guidelines. If you’re as hard-working, growth and expansion can happen anytime. So, having the framework already in place prepares you to scale and makes inevitable growth an easier task.
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