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Closing the gap between GAAP and IFRS

Updated on November 11, 2017

In the Accounting field, there are rules and general concepts that need to be followed to successfully record financial activities. Any company that makes their financial statements available to the public are required to follow generally accepted accounting principles (GAAP). Publicly traded companies are also required by law to have their financial statements audited by an independent public accountant. Management and the independent accountant must then certify the financial statements are in accordance with GAAP. This auditing process began when Sarbanes-Oxley was put into legislation and the Public Company Accounting Oversight Board (PCAOB) implemented rules requiring CEOs and CFOs to personally certify the accuracy of financial statements and disclosures.These accounting rules are particularly useful in standardizing definitions, assumptions, and methods used by companies. This helps financial analysts make better decisions when comparing one company to another. A company's financial statistics can also be compared to industry statistics when one set of accounting rules are followed throughout an industry. As financial transactions become more complex so do the generally accepted accounting principles.

Additionally, investors and foreign companies can benefit from uniform accounting standards especially when trying to expand into other foreign markets. American investors are in need of more transparency when investing outside of the U.S. Especially when it comes to full disclosure in financial statements from foreign-owned businesses setting up in the U.S. The generally accepted accounting principles (GAAP) followed in the United States are the most rigorous in the world. However, international financial reporting standards (IFRS) are followed by more than 110 countries. There are a lot of differences between the two accounting methods. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are converging both accounting methods into a single worldwide method. At a conceptual level, international financial reporting standards are more principle-based while generally accepted accounting principles are more rules based. IFRS has the advantage when it comes to representing and capturing the economics of transactions.

The main differences deal with intangible assets, inventory costs and inventory write-downs. An asset is anything of value a company owns. There are current, non-current and intangible assets. Intangible assets lack physical substance which makes it hard to measure their true value. They consist of goodwill, patents, brand recognition, trademarks, franchises, copyrights, etc. There are two types of intangibles: limited-life and indefinite-life. The first type is amortized and tested for impairment. The latter is tested for impairment on an annual basis without amortization. Amortization gradually writes-off the cost of an asset instead of doing it all at once. Testing for impairment is a comparison between the expected profit to be generated by an asset to its book value.

Under GAAP, intangible assets are recognized at fair value (market value) whereas IFRS only recognizes them if there is a future economic benefit with reliable measurability. In regards to inventory costing, the last-in, first-out (LIFO) method is not allowed under IFRS. However, GAAP allows businesses to choose between LIFO or first-in, first out (FIFO) inventory estimates. FIFO and LIFO methods are used to manage inventory and calculate how much money a company has in ending inventory, raw materials, work-in-process and finished goods. If there were a single method for inventory costing this would increase comparability between countries and eliminate the need for analysts to distinguish between both costing methods. Furthermore, write-downs on inventory can be reversed if specific criteria are met under IFRS, but once inventory is written down under GAAP reversals are strictly prohibited. Write-downs occur when inventory becomes damaged, completely destroyed or obsolete. Other areas of the convergence project involve revenue recognition, measurements, financial statement presentation, and disclosures.

There is still doubt about the convergence project even though research has documented higher quality accounting experiences when switching to IFRS. Ultimately, both methods will have to accommodate the needs of U.S. and international stakeholders by adopting standards from each other. Although, tremendous progress has been made to close the gaps the accounting approach of U.S. GAAP and IFRS continue to differ in their approach to recording financial transactions. IFRS is always fluid in response to evolving business environments while the other insists on staying rigid. The impact of all of these changes on the business environment is still up in the air and until there is an agreement between standards companies will continue to disclose contractual information in their financial statements. Accounting systems worldwide need to be examined more extensively. This would help standard setters better understand the origin of their differences and make it easier to develop similarities.

References:

Kieso, R.E., Weygandt, J.J, Warfield, T.D. (2016). Intermediate Accounting: Sixteenth Edition. New Jersey: John Wiley & Sons, Inc.

https://www.accountingcoach.com/accounting-principles/explanation

https://www.economist.com/news/finance-and-economics/21722236-rules-will-change-how-profits-are-reported-giving-investors-greater?zid=295&ah=0bca374e65f2354d553956ea65f756e0

http://www.investopedia.com/articles/economics/12/impact-gaap-ifrs-convergence.asp

http://www.investopedia.com/ask/answers/09/ifrs-gaap.asp

http://www.fasb.org/intl/convergence_iasb.shtml

© 2017 cheyne ferrara

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