Introduction
Every activity needs feedback. Every feedback is essentially a report, wouldn’t you agree? Picture this, you toil a whole year at school, scouring books endlessly, burning countless metaphorical candles through the nights, besting every other child in your class and at the end of the year, after your last exam, what is that one thing you crave? Of course, it is days in bed with uninterrupted sleep. But also, a report. A report stating that your hard work has paid off and you have achieved the highest scores and topped the class, nay, the whole school! Oh, the sweet chants of victory ringing in your ears and the proud faces of your parents; The scorn of your classmates and watching the gleam of your own eyes reflected in the shiny trophy they reward you with. Sweet dreams!
But we digress. A report, thus, is required to inform you, your educators, family and everyone else invested in your life about your progress. It showcases the level of your efforts and gives a comprehensive understanding of your learning and accomplishments during the course. While great grades help in lording them over your mates, they also help the overall improvement. Similarly, in the financial world, reporting helps develop future forecasts about benefits, improve decision making, planning the budget etc.
IFRS vs GAAP
The financial world utilizes reports like the IFRS and the GAAP to provide information on the working and progress of a company. They are both thoroughly comprehensive and intensive but they do differ from each other. The IFRS is a report widely used to give an idea of the company’s financial standing. The GAAP is a set of principles that are used exclusively in the United States. It also is a method of reporting and it reports the accounting standards of a company. There are other ways the two reporting methods differ.
Differences Between IFRS and GAAP in a Tabular Form
| Parameters of Comparison | IFRS | GAAP |
| Acronym | IFRS stands for International Financial Reporting Standards. | GAAP stands for Generally Accepted Accounting Principles. |
| Presence | The IFRS standards are used in over 120 countries. They are employed in the European Union (EU), South America, parts of Asia and Africa. | The GAAP standards are used in the United States only. |
| Definition | IFRS is a business language that is adopted universally when forming a financial report. | GAAP are a set of accounting principles and rules that are followed while making a financial report. |
| Developed by | IFRS is developed by the International Accounting Standard Board (IASB). | GAAP is developed by the Financial Accounting Standard Board (FASB). |
| Based on | IFRS is based on principles. | GAAP is based on rules. |
| Inventory valuation | The inventory valuation in IFRS is done by FIFO, LIFO and Weighted Average Method. | The inventory valuation in GAAP is done by FIFO and Weighted Average Method. |
| Development cost | The development cost of the IFRS is capitalized only under certain conditions. | The development cost of the GAAP is treated as an expense. |
| Reversal of inventory | The reversal of inventory in IFRS is permissible under certain conditions. | The reversal of inventory in GAAP is prohibited. |
What is the IFRS?
The IFRS stands for the International Financial Reporting Standards. It is a set of principles put into motion by the International Accounting Standard Board (IASB). It helps in governing the financial practices across the world. It provides guidelines on the preparation and presentation of a financial statement containing a balance sheet, income statement, cash flow statement etc.
The IFRS ensures that globally, the standards of accounting can be compared and easily understood. It provides the inspectors with a comprehensive report of the financial standing, performance, liquidity etc. of a company. This report serves the investors to make rational and economically sound decisions; analyse the financial situation of the company and decide if they should invest in it.
Presently, around 120 countries in the world use IFRS. It is used in the European Union (EU), South America and parts of Asia and Africa. Unlike the GAAP, the IFRS doesn’t set rules but gives guidelines that help make the accounting standards acceptable to all and uniform across the world. These guidelines or principles are subject to judgment and interpretation to see how they would best fit the economic situation and the company.
The inventory is valuated using the FIFO (First In, First Out) method and the Weighted Average Cost method. FIFO method is where the first asset purchased is the first to be sold. The Weighted Average Cost method is where the total cost of the goods for sale is divided by the units available for sale. Both these methods allow the inventories to be written down to the market price. Over time, however, if the price increases, the IFRS allows the written-down price to be reversed.
The IFRS allows for revaluations of assets like inventories, property, plant and equipment, intangible assets etc. to be at a fair price if they can be reliably measured. This revaluation might result in an increase or a decrease in the price of the asset.
For long-lived assets like buildings and equipment, IFRS values them at their original price but could later revalue them depending on the market value. Although, if there are separate components to the asset having different values, they need to be depreciated separately. The IFRS also values investment property or property held for rental income or capital appreciation under a separate category.
When the value of asset declines, there are impairment losses incurred. Such losses are recognized by the IFRS and when the conditions change, the IFRS allows for the impairment losses to be reversed. This reversal is allowed for all types of assets except goodwill. The IFRS also includes leases for intangible assets like patents, goodwill etc.
Internal costs to create intangible assets in the IFRS are capitalized when certain conditions regarding the future economic benefits are met. To recognize income or profits, under the IFRS, the legal form of the contract doesn’t play an important role. The profits are solely dependent on the cash flow.
What is the GAAP?
GAAP stands for Generally Accepted Accounting Principles. It is a set of rules issued by the Financial Accounting Standard Board (FASB). These rules or principles are employed by companies for financial accounting. This framework of rules and procedures is adopted by both public and private trade companies in the United States. The measures upheld by GAAP make sure that the companies have minimal or no discrepancy in their financial statements when they are submitted to the US Securities and Exchange Commission (SEC).
The principles of GAAP are updated periodically per the financial changes. This ensures transparency and consistency in the financial statement. The report provided by the GAAP benefits the investors, shareholders and creditors. The principles in GAAP are more rules-based i.e., the companies may have industry-specific rules to follow.
The inventory is evaluated using the same methods as the IFRS – the FIFO and the Weighted-Average Cost Method. Additionally, it also uses the LIFO – Last in, First Out - method. LIFO is different from FIFO in that it sells the last purchased asset first. Using the LIFO method might not correctly reflect the flow of the inventory items in the company and may lead to an artificially low net income.
Inventories can be written down at market value, just like in IFRS, but GAAP does not allow for the reversal of the prices if they fluctuate. Even revaluation of assets is prohibited under GAAP unless there are marketable securities (assets that can easily be liquified). Another thing prohibited by the GAAP is a reversal of impairment losses incurred should an asset be revalued.
Internal costs like development costs in GAAP are treated as expenses. For long-lived assets like buildings and other structures, GAAP values the property at the original cost and appropriately depreciates it. It also allows for component depreciation in the case of separate components, but it is not required. Unlike IFRS, GAAP excludes leases of all types of intangible assets from the scope of accounting standards. Under GAAP, the income and profits recognized are heavily dependent on the legal form of the asset.
Main Differences Between IFRS and GAAP In Points
Following are the main differences between IFRS and GAAP:
- The IFRS stands for International Financial Reporting Standards, while GAAP stands for Generally Accepted Accounting Principles.
- The IFRS was developed by the International Accounting Standard Board (IASB), whereas the Financial Accounting Standard Board (FASB) developed the GAAP.
- The IFRS is based on principles, while the GAAP is more rules-based.
- The IFRS is more of a business language used by over a hundred countries to report their accounting standards. The GAAP, on the other hand, is used only in the USA and is a set of guiding principles for a financial report.
- The inventory valuation in the IFRS is done by FIFO, LIFO and Weighted Average Method, while the same is done by only FIFO and Weighted Average Method in GAAP.
- The development cost of IFRS is capitalized if the conditions are met, whereas the development cost of GAAP is treated as an expense.
- The reversal of inventory is prohibited in GAAP but is permissible in IFRS under certain conditions.
- The IFRS allows fair revaluation of assets if the fair value can be measured reliably. This is prohibited by the GAAP.
- The IFRS includes leases for some kinds of intangible assets, while GAAP excludes leases for intangible assets.
- The income or profits for the IFRS are heavily dependent on the cash flow of the company. In GAAP, they are mostly dependent on the legal form of the assets.
Conclusion
Thus, the IFRS and the GAAP provide a framework for efficient financial reporting. The IFRS, an acronym of the International Financial Reporting Standards, is more of a business language that is used by companies internationally to effectively report their accounting standards. It was developed by the International Accounting Standard Board (IASB) and is employed in around 120 countries. The inventory in IFRS is evaluated using the FIFO and the Weighted-Average Cost method. Unlike GAAP, it allows for fair revaluations of assets and leases for certain types of intangible assets. It is more principle-based.
The GAAP, on the other hand, is more rules-based. It stands for Generally Accepted Accounting Principles. It was issued by the Financial Accounting Standard Board (FASB) and is employed only in the United States. GAAP provides guidelines, principles and procedures of accounting standards in a financial report. For valuation of the inventory, like IFRS, GAAP uses the FIFO and the Weighted-Average Cost methods. Additionally, it uses the LIFO method too. GAAP is more conservative in its approach and does not allow for revaluations except when the assets have marketable securities. It also excludes leases for intangible assets. However, the main difference between the two standards is that for recognizing profits, GAAP values the legal form of the asset, while IFRS values the cash flow. Knowing which is better for use is entirely dependent on the company and their workings. If they favour a rules-based approach, they could use the GAAP standards for their reports. If they prefer a principles-based approach, they could employ the IFRS standards. Recently, though, there have been efforts made to change all forms of reporting to the IFRS standards to facilitate uniformity. These efforts have yet to see fruition. Reports, thus, are incredibly important and are dependent on a multitude of factors. To ensure a report is comprehensive and thoroughly informative, guidelines must be followed. Especially if you have to showcase the report in your living room for all the guests to see and delight in wonder and admiration. Accomplishments, however big or small, need that spotlight. But, be wary of the pride since it goeth before the fall, which means we ought to be humble. A good report, thus, must be valued and all takeaways from the report must be given credence as well since it paves the way for progress and success.
References
- https://www.nerdwallet.com/article/small-business/fifo-vs-lifo
- https://corporatefinanceinstitute.com/resources/knowledge/accounting/weighted-average-cost-method/
- https://www.firmofthefuture.com/content/top-10-differences-between-ifrs-and-gaap-accounting/
