IFRS .v.

GAAP 1

Running head: IFRS VERSUS GAAP

Understanding the difference in IFRS and GAAP

Strayer University

ACC304 ~ Andrea Coakley

Sunday, January 16, 2011

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Introduction

Proper financial reporting is vital to the accounting world both internationally and in the

United States. It is necessary for International Businesses to be able to report and compare their

financial statements with those of their investments in the United States. Investors, creditors and

companies rely on the accuracy of financial reports in order to make investment decisions. As a

result of the need for this vital information it becomes necessary for companies outside of the

United States to be able to present similar reporting as the United States. In order to ensure that

all accounting procedures are followed and to globally report it becomes necessary for these

financial reporting to be properly standardized both in the International and the United States

accounting world. The two sets of rules accepted for international reporting are the International

Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles

(GAAP).

While the IFRS method of reporting is principal based standards which establish broad rules

as well as dictating specific treatments. The International Financial Reporting Standard (IFRS) as

a result of the lack of detail guidance requires more disclosures to be reported. Whereas the

United States having significantly more standards and are more detailed, less disclosures are

required in comparison to the International Financial Reporting Standard (IFRS). This report

will provide explanations to what the convergence of IFRS and GAAP means in the financial

accounting world. It will also provide the differences between the two reporting standards and

discuss three similarities between both reporting. Finally with any change there are potential

risks involved this report will point out those risks of the IFRS and GAAP convergence.
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IFRS and GAAP, what does convergence mean

In 2001 the International Accounting Standard Board (IASB), an independent, privately-

funded accounting standard-setter based in London England took over the responsibility for

setting international accounting standards. As a result of this development the rules for IFRS was

adopted. The IFRS is considered to be “principles bases” in that it establishes broad rules as well

as it dictates specific treatments. The standards are comprised of the IFRS standards issued after

2001, IAS issued before 2001, Interpretations originated from International Financial Reporting

Interpretations committee (IFRIC) issued after 2001, standing Interpretations committee SIC

issued before 2001, and Framework for the preparation and presentation of financial statements

(1989).

GAAP, an abbreviated term meaning Generally Accepted Accounting Principles is a

codification that is comprised of many rules of how to account for various transactions in the

preparation and presentation of financial statements. The use of GAAP to prepare financial

statements provides consistency in the reporting of companies and business so that financial

analysis, banks, shareholders and the SEC all prepare their financial statements using the same

rules and procedures. GAAP is the standardized accounting system that is presently used in the

United States. The development of GAAP is influenced by the following organizations, United

States Security and Exchange Committee (SEC), American Institute of Certified Public

Accountants, (AICPA), Financial Accounting Standards Board (FASB) and Governmental

Accounting Standards Board (GASB).

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Over the years businesses based in the United States have all been required to use GAAP to

prepare and present financial statements. As globalization began to spread, and as companies

began to invest in the international market it became difficult for companies to compare financial

statements because of the different methods of reporting. Companies that conduct business

internationally were required to prepare and present their financial statements using the

International Financial Reporting Standards (IFRS) also known as iGAAP, making it very costly

to report and also inconvenient to understand two sets of rules. This is what lead to the

convergence of IFRS and GAAP.

The convergence or the coming together of IFRS and GAAP then became vital in order for

there to be one set of accounting rules for the whole world, which would make it easier for

international investors to compare financial results from different countries. Therefore,

U.S.GAAP and iGAAP are converging towards one set of international accounting standards to

be used by all companies. Both the IASB and FASB are working hard to develop standards that

will eliminate major differences in the way some transactions are accounted for and reported.

The convergence of IFRS and GAAP is needed, firstly because the entire world is being

viewed as one market. Secondly, mergers and acquisitions have led to international giants like

DaimlerChrysler and Vodafone/Mannesmann with additional mergers expected in the future.

Thirdly, the advances of technology are allowing more companies to become comfortable with

buying and selling from each other in the international world. Finally active markets throughout

the world are trading instruments as stocks, bonds or derivatives. In some countries, primary

users of financial statements are private investors; in others the primary users are tax authorities

or central government planners. In the United States investors and creditors are the driving force
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of the accounting standard formulations. As a result of the different persons such standards were

firstly developed to accommodate, there exist differences between IFRS and GAAP.

Difference in IFRS and GAAP

The Convergence of both IFRS and GAAP while it will bring about a standardization of

financial reporting there are still some similarities and some differences between them. Let’s take

a brief look at three significant differences that presently exist. Revenue recognition under the

US GAAP has specific rules for the recognition of software revenue and sales of real estate

whereas comparable guidance does not exist under IFRS. In the US public companies are

required to follow additional guidance provided by the SEC. Ultimately a single standard (IAS

18) exists under IFRS, which contains general principles and illustrative examples of specific

transactions. The major differences in revenue recognition exist in the following. Sale of goods

under US GAAP public companies must follow SAB 104 which requires that delivery has

occurred and rewards of ownership have been transferred, there is persuasive evidence of the

sale, a fix and determinable fee and collectability is reasonable assured. Under IFRS only when

risks and rewards of ownership have been transferred revenue is recognized, the buyer has

control of goods, revenue can be measured reliably and it is probable that the economic benefit

will flow to the company. Under GAAP deferred receipt of receivables discounting to present

value is only required in limited situations. While IFRS considers deferred receipt of receivables

to be a financing agreement; the value of revenue to be recognized is determined by discounting

all future receipts using an imputed rate of interest. Construction contracts under GAAP are

accounted for using the percentage-of-completion method if certain criteria are met; otherwise

completed contract method is used. IFRS on the other hand does allow construction contract to

account using the percentage-of completion method if certain criteria are met. Otherwise,
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revenue recognition is limited to recoverable costs incurred. The completed contract method is

not allowed. Another difference between GAAP and IFRS is the recording of Leases. The Lease

of Land and building under GAAP, the lease of land and buildings that transfer ownership to the

lessee or contains a bargain purchase option is classified as a capital lease regardless of the

relative value of the land. A 25% test is required if the fair value of the land at inception

represents 25% or more of the total value of the lease. Under IFRS the land and building

elements of the lease are separately considered when evaluating all indicators unless the amount

initially recognized amount of the land element is immaterial, in that case it would be treated as a

single unit for purposes of lease classification. There is no 25% test requirement to determine

whether to consider the land and building separately when evaluating certain indicators. Finally

another difference between GAAP and IFRS is the method of determining impairment –

goodwill. GAAP uses a two-step approach which requires a recoverability test to be performed

first at the reporting unit level to compare the reporting unit fair value. If the carrying amount

exceeds its fair value then impairment testing must be perform. Under the IFRS however only a

one-step approach is used which required that an impairment test be done at the cash generating

unit level by comparing the cash generating amount including goodwill, with its recoverable

amount. There are many more differences between GAAP and IFRS but there are also some

similarities which we will discuss.

Similarities between IFRS and GAAP

IFRS and GAAP does have some similarities. GAAP guidance for financial instruments is

contained in several standards including FAS 65 Accounting for Certain Mortgage Banking

Activities, FAS 107 Disclosures about Fair Value of Financial instruments, FAS 114 Accounting

by Creditors for Impairment of a Loan, FAS115 Accounting for Certain investments in Debt and
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Equity Securities, among others. On the other hand IFRS guidance for financial instruments is

limited to three standards, (IAS 32 Financial instruments: Presentation, IAS 39 Financial

Instruments: Recognition and measurement, and IFRS 7 Financial instruments: Disclosures). The

similarities with both GAAPS lies in the requirement that financial instruments be classified in

specific categories to determine the measurement of those instruments, clarification of when

financial instruments should be recognized or derecognized in financial statements and they both

required that all derivatives be recognized on the balance sheet. Both also permit the use of fair

value and detailed disclosures in the notes to financial statements for the financial instruments

reported in the balance sheet. A second similarity between GAAP and IFRS is in the recognition

of revenue. Both GAAP and IFRS revenue recognition is tied to the completion of the earnings

process and the realization of assets from such completion. Under both GAAPs revenue is not

recognized until it is both realized and earned. They both base this recognition on the transfer of

risks and both attempt to determine when the process of earnings is completed. Finally another

similarity between GAAP and IFRS is that the overall accounting for leases is similar even

though US GAAP has more specific application guidance than IFRS. They both focus on

classifying leases as either capital (IAS 17) or operating, and both separately discuss lessee and

lessor accounting.

Risk of IFRS and GAAP

While the convergence of IFRS and GAAP will bring about a more standardized method of

reporting it will also have certain risks. GAAP as we know it is a rule based approach of

reporting and require a more detailed approach to financial reporting, while IFRS is a principle

based method of reporting. This convergence of GAAPS however means that a lot of the

financial reporting will be less detailed thereby eliminating the way accounting is approached
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and recorded. While both methods require a complete set of financial statements, including the

Balance Sheet, Income Statement and Cash Flow Statement proper reporting rest in the area of

categorizing the accounts. It will be a challenge for auditors to determine if the proper recording

has been followed as a lot of details will be eliminated. Another risk is whether companies will

transfer details correctly during the transition process to allow for proper financial statement

presentation. Incorrect transfer of details can result in overstatement or understatement of the

Balance sheet accounts as well as the income statement for investor reviews. Finally litigation as

a result of false reporting while not intentional is extremely high. Proper analysis of each

company is required to ensure that every transaction are being properly recorded as the risk of

being sued will increase tremendously.

Conclusion

In conclusion as the report have described due to the global markets and the mergers between

the International companies and the US it is important for companies to all have a standardized

method of financial reporting. The Convergence between IFRS and GAAP while there still exist

some differences there are some similarities. Both are working together to ensure financial

reporting are streamlined to allow to International business and the US companies to be able to

compare financial statements with one goal in mind to grow the investment. This convergence

will be a savings for companies in the global market but will also involve some risks which over

time will be minimized as the transition is completed.

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Reference

Book

Kieso, D., Weygandt, J., and Warfield, T.(2010). Intermediate Accounting 2010 Custom

Edition

Web Page

Website: http://www.differencebetween.net/business/difference-between-gaap-and-ifrs/

Ernst, A.C. & Young, A. (2009). Quality in everything we do, Retrieved November 21, 2010

Website:

http://www.ey.com/Publication/vwLUAssets/IFRS_v_GAAP_basics_Jan09/$file/IFRS_v_G

AAP_basics_Jan09.pdf
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