IFRS AND US GAAP – THE DIFFERENCE

IFRS and US GAAP – The Difference

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3rd April, 2013

 IFRS and US GAAP – The Difference 1

Introduction

The effect of globalization has stemmed plenty of new progressions and

improvements in the way finance is being dealt globally. One such noteworthy progress that

has occurred in this field recently is the unification of the Generally Accepted Accounting

Principles (GAAP) and the International Financial Reporting Standards (IFRS) (Fontes, 2005,

vol: 29) (Lucas, 2006) (H. J. Irvine, 2006). This unification is intended to result in a better

financial health and steadiness globally (Jacob, 2004).

During the last decade, it so happened that in most of the global economies, both the

labour and capital flows have been increasingly and surprisingly freed up and this in turn led

to the increase in huge amount of Foreign Direct Investment (FDI) flowing into the global

economies (Floyd, 2001, Vol: 13l, No. 2). The main reason behind this amount of huge

inflow of FDI was basically driven by the dominant nations of the world in order to enhance

their economic strength and stability.

In spite of the tendency for globalizing accounting standards among developing

countries, they have however acknowledged their need to clench the opportunities presented

by this phenomenon (United Nations General Assembly, 2004), and to attract and take

advantage of the foreign direct investment (Al-Thani, 2004). The dissimilarity of accounting

regulatory system is one of the most important problems faced by foreign investors and this

eventually has resulted in difficulty in relating financial data to evaluate performance of their

investments.

According to Soffer and Soffer (Soffer, 2003) confirm that financial statement

analysis is a general process that is employed to analyse performance of firms. It applies

many analytical tools and techniques to scrutinize financial statements and associated data to

get useful information about the firm’s performance.

 IFRS and US GAAP – The Difference 2

There are official rule-making organizations that are authorized to set the accounting

standards. The Securities and Exchange Commission (SEC), for instance, is one such agency

of the US federal government. It has the legal authority to identify and state acceptable

accounting principles of US GAAP which are aimed to govern the valuation and

measurement methods used during the preparation of financial statements (C.H. Willmot,

1992).

Since 1973 International Accounting Standards (IAS) has decided to be applied

globally and hence between the years 1973 and 2000 the International Accounting Standards

(IAS) was published by the IASC - International Accounting Standards Committee.

IAS/IFRS have been adopted in quite a few countries like Australia, France, United

Kingdom, and the United States (The International Accounting Standards Board (IASB),

2007). But, since the year 2001 IASB took over this rule-setting role and in due course

substituted the IAS with IFRS (International Financial Reporting Standards). The IASB is an

autonomous board and is based out of the United Kingdom. The fundamental objective of

IASB is to synchronize reporting globally (Pincus, 2001). For instance, since the year 2005

the financial statements of the firms that are listed within the European Union were mandated

to meet the standards of the IASB (Ball, 2005).

For investors to make optimal investment decisions, the financial information

available from the global capital markets should be transparent and consistent. In line with

this fact, during the late 90s, it was recognized that GAAP should be highlighted in a global

manner more effectively (Ampofo, 2005) and as a result of this many professional bodies

started to work on setting up of new set of global accounting standards (Deloitte, 2004). It

was after this the integration among various global capital markets began.
 IFRS and US GAAP – The Difference 3

The integration which thus took place was so strong that the effect of stability or

instability of one market would definitely influence other markets across the globe. Also,

almost all the domestic economies of the world became more susceptible to the external

shocks caused the world economy that was expanding at a faster pace. This effect of the

external shocks on various capital markets of the world also necessitated the adoption of

global accounting standards in order to increase the effectiveness of their functioning.

Though it is a well-known and widely accepted fact that countries apart and outside

the developed world have ensued the path for adopting IFRS, there is not much information

available about how to implement the new set of accounting standards into regulatory

systems which are completely unaware of the new system (Annisette, 2005, Vol: 15).

Conceptual Framework

Unlike the IFRS, the US GAAP is intended for practice by both profit-oriented as

well as non-profit oriented entities alike but with a few supplementary codifications that are

exclusively applicable to the non-profit oriented entities alone. However, the bold and plain-

text paragraphs in both IFRS and US GAAP hold equal degree of authority. Moreover, as in

the case of IFRS, any entity that claims to be compliant with US GAAP also complies with

all the various codifications as applicable. One example of such commonly applicable

codification is the disclosure requirements (KPMG IFRG Ltd, 2012).

The IASB and the US FASB have been working in alignment since the year 2002 to

accomplish union of the principles of IFRS and US GAAP as a collective set of

extraordinarily excellent global standards remains a primacy for both the IASB and the FASB

(IFRS, 2013). This initiation was in the form of a short-term project for eliminating a number

of discrepancies that exist among these two accounting standards.

Some of the most crucial discrepancies being addressed as part of this short-term

project are those which were consequential of the recent amendments made to the IASs by
 IFRS and US GAAP – The Difference 4

the new IFRS. A few of the discrepancies are liabilities classification, asset exchanges,

changes in the accounting considerations, and dealing with financial instruments (Deloitte,

2004).

There are also other differences that have cropped up in the statements issued by the

FASB recently like discontinued operations, sale of assets etc. The major variance between

FASB and IFRS with respect to fair value accounting is with valuation. While FASB

measures all assets at a fair value, IFRS measures the loan books of banks on the basis of

amortized cost.

FASB has given out numerous statements for improving the information provided in

the financial statements of a business entity. Taken separately, each of the recent disclosures

and respective requirements provides some complementary information to the users of

financial statements. Irrefutably, elements like the financial statements, cross-reference,

complementary statements, etc., make the entire course of financial reporting imprecise and

inexplicable.

Value addition is the basic reason that leads to the convergence between GAAP and

IFRS. Financial statements and reports which are prepared in accordance with the IFRS

though are similar to the ones prepared in accordance with GAAP, but with a little higher

value addition. The value addition that is spoken about here is in terms of the time that is

saved by investors to reconcile financial information as they usually do by comparing

different companies’ stocks from different places of the world. “Capital would flow more

efficiently, at less cost to more companies in more places (Gary Illiano, 2007)”.

Another factor that leads to the convergence of GAAP and IFRS is the ‘Norwalk

Agreement’ which was signed in the month of February 2006. The convergence of both

GAAP and IFRS was believed to high-quality accounting standards. “Convergence between

IFRS and US GAAP does not mean that that the accounting standards become identical.
 IFRS and US GAAP – The Difference 5

Convergence means that where transactions are the same or similar, the accounting should

be the same, or there should be enough transparency in the disclosures to allow the reader to

understand the differences (Gary Illiano, 2007)”.

The major challenge that is linked to this benefit reaped by creditors and investors is

that how would they be educated about using this new set of standards (Erhardt, 2006). “If

as a result financial statements prepared pursuant to the version of IFRS at work in a

particular jurisdiction cannot be equally asserted to comply with IFRS itself, then the

strength of more and more jurisdictions moving to or toward IFRS potentially doubles as a

weakness if that move occurs in a myriad of different ways. The result is that investors have

no clear and constant signal as to what in essence "IFRS" means (Erhardt, 2006)”.

Treatment of Current liabilities and contingencies – IFRS vs. US GAAP

The rudimentary accounting for current liabilities is the same under both US GAAP

and the IFRS. Yet, there are a couple of differences in terms of details:

 “Classification of refinanced short-term debt

 Reclassification of amounts payable on demand due to violation of debt covenants

 Bank overdrafts (Gary A. Porter, 2010)”

Both US GAAP and IFRS have independent requirements with respect to the

classification of short-term debt which has essentially been refinanced. FAS 6 of the US

GAAP allow these amounts to be categorized as long-term debt in case a refinancing

agreement is already in place prior to the date of reporting the same in the financial

statements. While in the case of IFRS, IAS 1 necessitates refinancing be done prior to the

balance sheet date in order for the same to be classified as a long-term one.
 IFRS and US GAAP – The Difference 6

Refinancing completed in the midst of the duration of the balance sheet and the date

of issuance, it is disclosed in the notes given as part of the financial statements. Likewise, if

debt becomes outstanding on demand as a result of a debt agreement violation, the amount is

categorized as a current liability except in case wherein a waiver is obtained from the lender

for a period of 12-month prior to the date of reporting in case of US GAAP) or the date of the

balance sheet in case of the IFRS. FASB and the IASB are bearing in mind this variance as

part of the joint project that these agencies have taken up in relation to financial statement

presentation (Gary A. Porter, 2010).

While both the IFRS and US GAAP describe debt almost similarly, both identify

there are difficult financial instruments that may encompass features of both debt as well as

equity. Defining the appropriate classification of these instruments can be a daunting task,

and the consequences occasionally vary amid the two standards of accounting.

According to the FAS 150, accounting for a few specific financial instruments that

encompass the features of both Liabilities and Equity, US GAAP precisely classifies certain

conditions based on which equity instruments are to be categorized as liabilities:

• Mandatorily redeemable – these are the ones which include a categorical obligation

to convert the instrument at a specified date(s) or event that is definite to occur (other than

liquidation or termination of the issuer) (Gary A. Porter, 2010)

• “Obligation to repurchase the issuer’s equity shares that may require the issuer to

transfer assets (e.g. a forward purchase contract or written put option on equity shares that

is to be physically settled or net cash settled)

• Obligation that may require issuing a variable number of equity shares. For

outstanding shares, this obligation must be unconditional to require liability treatment. For
 IFRS and US GAAP – The Difference 7

financial instruments other than outstanding shares, this obligation may be conditional

(FASB - Financial Accounting Standards Board, 2010) (Gary A. Porter, 2010)”.

The treatment of contingent liabilities under IFRS is such that the contingent

liabilities are recognised at their fair value on condition that their fair values can be assessed

consistently. The contingent liability is consequently measured at the value that is higher

originally recognised and the volume recognised as per the IAS 37 (Deloitte Touche

Tohmatsu, 2008).

The same treatment under US GAAP is as follows: Contractual contingencies are

treated and assessed on the fair value. In case of non-contractual contingencies, the

recognition is done only if there is a possibility of such contingencies meeting the

classification of either an asset or a liability on the date of acquisition. Post the recognition,

entities preserve the original amount until updated information is obtained and later measure

the liabilities at the higher amount of fair value as on the date of acquisition and the amount

according to the FAS 5 (Deloitte Touche Tohmatsu, 2008).

Disclosure of the segment liabilities

Disclosure of the segment liabilities is necessary under the IFRS only if such an

option is offered to the chief decision-making authority of the entity. Under the US GAAP,

there is no such requirement.

Liabilities Classification with respect to refinancing

Refinancing liabilities are classified to be non-current under IFRS only in case the

term of refinance is completed prior to the conclusion of the reporting period. The same in

case of US GAAP is that the liabilities under refinancing are non-current on condition that

the refinancing ends prior to the date of issuing the financial statements (Deloitte Touche

Tohmatsu, 2008).
 IFRS and US GAAP – The Difference 8

FASB 157 Standard – Fair Value Measurements

FASB has issued several statements for improving the information provided in

financial reporting. Taken individually each newly required disclosure provides some

additional useful information to readers of financial statements. FASB 157 is one such

statement and this deals with Fair Value Measurements.

FASB 157 defines the concept of fair value in accounting and ascertains an agenda for

measuring the same under the GAAP. In addition to this, FASB 157 also has expanded the

disclosures relevant to fair value measurements (FASB - Financial Accounting Standards

Board, 2010). This statement was issued on the 15th of September, 2006.

The standard also retorts to the request of investors’ for lengthened information about

the degree to which companies’ determine assets and liabilities at fair value, the aspects used

to determine fair value, and the impact of fair value measurements on the earnings (Ernst &

Young, 2006). “The standard applies whenever other standards require (or permit) assets or

liabilities to be measured at fair value. The standard does not expand the use of fair value in

any new circumstances (Ernst & Young, 2006).”

Measurement of Fair Value – Currently effective US GAAP

According to the US GAAP standard that is currently applicable, fair value

measurement standard defines a single framework to measure fair value. As in the case of

IFRS, fair value is defined as the value that a seller might receive on the sale of an asset or

the amount paid for transferring a liability in a well-ordered deal which takes place between

market participants as on the date of measurement. This simply translates to the exit price of

the asset.

In case of liabilities or an equity instrument that is held by the owner of the business,

if an estimated price for a transferring an identical liability or own equity instrument is

unavailable and the identical item is held by a different entity other than the owner in the
 IFRS and US GAAP – The Difference 9

form of an asset, then the liability or the own instrument of equity is appreciated from the

side of a market participant who holds the asset. If that does not work, other techniques of

valuation are also used for valuing the liability or the own equity instrument owing the

liability, similar to the IFRS.

Issues Addressed by FASB 157 – Multiplicity and Irregularity

In accordance to over 40 different standards of accounting currently issued under

GAAP, organizations globally are necessitated to determine and assess their assets and

liabilities at a fair value. Prior to the issuance of FASB 157, there were discrepant and a

plethora of fair value measurement procedures prevailing. This specifically relates to not so

actively traded financial products like derivatives etc.

The FASB 157 standard states fair value as the price paid or received during the

purchase or sale of an asset or a liability transfer in a systematic transaction amid the market

participants in which the particular entity that is being reported truly transacts. FASB 157

also makes it very clear that the fair value should be necessarily based on the assumptions

used by the participants in the market make at the time of pricing the particular asset or

liability.

In order to make this clarification more evident, the standard ascertains a hierarchy of

fair value that prioritizes the various kinds of information that may be used while making

such assumptions. “The fair value hierarchy gives the highest priority to quoted prices in

active markets and the lowest priority to unobservable data, for example, the reporting

entity’s own data. Under the standard, fair value measurements would be separately

disclosed by level within the fair value hierarchy (Ernst & Young, 2006).”

Implementation of FASB 157

The initial step in the implementation of the FASB 157 Standard is to recognize assets

and liabilities that are measured at fair value. In case of private equity companies, these
 IFRS and US GAAP – The Difference 10

comprise of their investment portfolio. The next step would be to recognize assets and

liabilities that are disclosed or revealed at a fair value. It would be appropriate if the

management allocates assets and liabilities to obviously distinct groups and then decide on

the principal, or the most beneficial or optimal market for sale of such assets or the transfer of

such liabilities.

Once the categorization is appropriately done, the use of inputs gained from the

market is prioritized to ascertain the value. The last step would be to assess the hierarchy of

such market-based inputs, and categorize within the hierarchy for the purpose of disclosure as

necessitated by the FASB 157 Standard (Thornton, 2009).

Treatment of Bonds – the difference between IFRS and GAAP

Convertible bonds are stated at their nominal value according to the US GAAP and

the associated valuable interest expenditure is conveyed in the income statement (P&L). But,

according to IFRS companies treat the alteration in the same manner in which they treat an

option and revalue it using the correct market rate. As this option is illustrated as external

financing, the dissimilarities in the value are recorded in the profit & loss statement. I order

to elude this revenue instability in the future; a waiver was given recently in the form of right

to a cash settlement (EPCOS, 2008).

On the contrary, when it comes to treatment under IFRS, “the value of the convertible

bond at the time of issue, excluding the option value, is recorded as a liability. Interest is

accrued over the term of the convertible bond, so that at the point of payback the full liability

is reflected in the balance sheet. This led to a higher interest expense (EPCOS, 2008).”

Every company, as on the date of balance sheet is obligated to assess if the assets are

damaged. In the instance of no impairment of assets, then the company needs to tests certain

assets intangible assets for any impairment.

 IFRS and US GAAP – The Difference 11

The choice of intangible assets may be the selection of assets which do have an

indefinite life of use. The standard also sums up the conditions under which a company can

nullify an impairment loss. A few assets are not covered under IAS 35 as they are generally

dealt with other standards like IAS 39.

Moreover, according to the IAS 35, aspects like decline in the asset’s market value

and causes like physical damage of the asset can be measured as sign for the asset’s

impairment. If it is not practical to find out the fair value less costs for selling the asset as

there exists no active market for the asset, the company can consider the value of the asset

that is in use as its recoverable sum.

The eventual integration of GAAP and IFRS was so tough that the result of constancy

or volatility of one market would unquestionably influence other global markets.

Furthermore, most of the national economies became more susceptible to the external shocks

which were indeed a result of the swiftly expanding global economy.

Conclusion

The growing global recognition and acclaim of IFRS also delivered yet another

consideration for the IASB in getting the formal convergence to a closure – the agency that

sets the standard must satisfy a growing population. With still a couple of nations now being

minority adopters of IFRS, it has become gradually imperious for the IASB to heed to the

various other voices. Following convergence with US GAAP at the cost of disregarding

apprehensions raised by the growing population was becoming an ever more expensive

exercise that eventually had to be concluded.

Nevertheless, experts approve that the formal conclusion to convergence does not

mean the project is completely dead. It has merely been relegated to a lower priority level,

probably tended to by lower-ranking staff members. “The most likely scenario is for the [US
 IFRS and US GAAP – The Difference 12

capital markets watchdog] SEC to issue a loose endorsement of IFRS without a formal

timeline, (Arons, 2012)” Bob Herz predicted.

There are numerous factors that are to be measured during the process of ascertaining

the fair value of an investment or a portfolio of an organization. The most crucial of such

factors is ascertainment of the primary market for the sale of the investment of the

organization, and also the possible presence of a secondary market as well. The FASB 157

Standard deals with precedent dissimilarities in fair value determination of investments that

lack liquidity. FASB 157 also offers superior uniformity and much-needed regulation in the

execution of fair value measurements. Ultimately, it can be stated that the fair value concept

has a superior impact on the way assets and liabilities are usually measured. To end with, it

must be acknowledged that IFRS are still developing and it is very obvious that the

development is being aimed towards attaining an increased use of fair values as a basis for

measurement. This angle should be borne in mind while debating the fact as to how IFRS

accounting profits ought to be relevant for profit distribution and if adjustments in the form of

introduction of non-distributable profits/ reserves or any other additional solvency

requirements would be permitted.

 IFRS and US GAAP – The Difference 13

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