Wed. Aug 3rd, 2022

    GAAP and IFRS – Differences Between IFRS and GAAP Accounting

    International Financial Reporting Standards (IFRS: International Financial Reporting Standards) is an accounting method used in many countries around the world. It has several key differences from the Generally Accepted Accounting Principles (GAAP) that are applied in the United States. Below are the differences in general IFRS and GAAP that you should know.

    As an owner of a professional accounting firm or business, it is important to know the variations of this accounting method, in order to successfully manage your company globally, as well as domestically. Here are the top 10 differences between IFRS and GAAP accounting:

    1. Locally vs. Globaly
    As mentioned, IFRS is a globally accepted standard for accounting, and is used in more than 110 countries. On the other hand, GAAP is exclusively used in the United States and has a different set of accounting rules than most of the world. This can make it even more complicated when doing international business.

    2. Rules vs. Principle
    The main difference between IFRS and GAAP accounting is the methodology used to assess the accounting process. GAAP is research-focused and rules-based, whereas IFRS looks at overall patterns and is based on principles.

    With GAAP accounting, there is little room for exceptions or interpretation, as all transactions must comply with a certain set of rules. With principles-based accounting methods, such as IFRS, there is potential for different interpretations of the same tax-related situations.

    3. Inventory method
    Under GAAP, companies are permitted to use the Last In, First Out (LIFO) method for inventory estimation. However, under IFRS, the LIFO method for inventory is not permitted. The Last In, First Out valuation for inventory does not reflect accurate inventory flows in most cases, and thus results in reports of unusually low levels of income.

    4. Inventory Reversal
    Apart from having different methods for tracking inventory, IFRS and GAAP accounting also differ when it comes to recording write-back reversals. GAAP determines that if the market value of the asset increases, the amount of write-down is non-refundable. However, under IFRS, in this same situation, the amount of write-downs can be reversed. In other words, GAAP is too cautious about inventory reversals and does not reflect positive changes in the market.

    5. Development Costs
    Company development costs can be capitalized under IFRS, as long as certain criteria are met. This allows a business to increase depreciation on fixed assets. Under GAAP, development costs are expensed in the year they are incurred and should not be capitalized.

    6. Intangible Assets
    When it comes to intangible assets, such as research and development or advertising costs, IFRS accounting really shines as a principles-based method. It considers whether an asset will have future economic benefits as a way of valuing value. Intangible assets measured under GAAP are recognized at fair market value and no more.

    7. Income Report
    Under IFRS, extraordinary or unusual items are included in the income statement and are not separated. Meanwhile, under GAAP, they are separated and displayed under the net income section of the income statement.

    8. Classification of Liabilities
    The debt classification under GAAP is divided between current liabilities, in which the company expects to pay off debts within 12 months, and non-current liabilities, which are debts that will not be paid off within 12 months. With IFRS, no distinction is made between classifications of liabilities, because all debt is considered non-current on the balance sheet.

    9. Fixed Assets
    When it comes to fixed assets, such as property, furniture and equipment, companies that use GAAP accounting have to value these assets using the cost model. The cost model takes into account the historical value of an asset less accumulated depreciation. IFRS allows a different model for fixed assets called the revaluation model, which is based on the fair value at the current date less accumulated depreciation and impairment losses.

    10. Quality Characteristics
    Finally, one of the main differentiating factors between IFRS and GAAP is the qualitative characteristics for how accounting methods function. GAAP works within a hierarchy of characteristics, such as relevance, reliability, comparability, and readability, to make decisions based on a user’s specific circumstances. IFRS also works with the same characteristics, with the exception that decisions cannot be made in the specific circumstances of an individual.

    It is important to understand the top differences between IFRS and GAAP accounting, so that your company can accurately conduct business internationally. US-based companies must comply with special accounting regulations, even if they plan to do business internationally.

    GAAP and IFRS asset definitions

    The US GAAP framework defines assets as future economic benefits.

    The IFRS framework defines an asset as a resource from which future economic benefits will flow to the company.

    Purpose of IFRS and GAAP financial statements

    In general, a broad focus on providing relevant info to various stakeholders. GAAP provides separate objectives for business and non-business entities.

    In general, a broad focus on providing relevant info to various stakeholders. IFRS provides the same set of objectives for business and nonbusiness entities.

    Objectives of the IFRS and GAAP framework

    The US GAAP framework does not have provisions that expressly require management to consider the framework without any standards or interpretations for an issue.

    Under IFRS, company management is expressly asked to consider a framework in the absence of standards or interpretations.

    Inventory Estimate

    GAAP: LIFO, FIFO or weighted-average cost.

    IFRS: FIFO or marginal average cost (weighted-average cost).

    Under IFRS, the LIFO (Last in First out) method of calculating inventory is not allowed. Under the GAAP, either the LIFO or FIFO (First in First out) method can be used to estimate inventory.

    The reason for not using LIFO under the IFRS accounting standard is that it does not show an accurate inventory flow and may portray lower levels of income than is the actual case. On the other hand, the flexibility to use either FIFO or LIFO under GAAP allows companies to choose the most convenient method when valuing inventory.

    FIFO stands for First In First Out. This inventory valuation method follows the natural flow of inventory, assuming that the first items in inventory (i.e. the oldest) are the first sold.

    LIFO, or Last In First Out, takes the opposite approach of FIFO. Under this method, the last items to arrive in inventory (i.e. the newest) are assumed to be the first sold.

    Weighted average looks at the weighted average cost of items remaining in inventory at the time of an associated sale, which yields a figure that can then be used to value ending inventory and the related cost of goods sold.

    Inventory Reversal IFRS and GAAP

    GAAP: Forbidden.

    IFRS: Allowed under certain criteria.

    Documents required in the balance sheet  (financial statement)

    IFRS: Balance sheet, income statement, change in equity, cash flow statement, footnote.

    GAAP: Balance sheets, income statements, comprehensive income statements, changes in equity, cash flow statements, footnotes.

    Read also ? Balance Sheet | Definition, Structure, Example, Free Template

    Where are IFRS and GAAP used?

    GAAP: United States of America.

    IFRS: More than 110 countries, including the European Union.

    Cash Flow Statement

    The cash flow statement is also prepared differently under GAAP and IFRS. This is most acutely seen in how interest and dividends are classified.

    GAAP prescribes that interest paid and interest received should be classified as operating activities, while international standards are a bit more flexible. Under IFRS, a firm can choose its own policy for classifying interest based on what it considers to be appropriate. Interest paid can be placed in either the operating or financing section of the cash flow statement, and interest received in the operating or investing sections.

    For dividends, GAAP specifies that dividends paid be accounted for in the financing section, and dividends received in the operating section. When following IFRS standards, companies have a choice of how they categorize dividends. Dividends paid can be put in either the operating or financing section, and dividends received in the operating or investing section.

    To summarize, here’s a detailed breakdown of how the two standards differ in their treatment of interest and dividends.

    Cas Flow StatementsGAAPIFRS
    Interest paidOperating sectionOperating or Financing section
    Dividens paidFinancing sectionOperating or Financing section
    Interest receivedOperating sectionOperating or Financing section
    Dividens receivedOperating sectionOperating or Financing section

    Please note that this is not an exhaustive list of differences, but we hope now you know something about how GAAP and IFRS differ from each other.

    Sources: Investopedia, Harvard Business School