Differences Between GAAP and IFRS: Cultural History and Impact
The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) are the two largest accounting principles organization, and these organizations have separate standards. The FASB created Generally Accepted Accounting Principles (GAAP), and the IASB created International Financial Reporting Standards (IFRS). Both organizations have been working on a convergence to unify the two standards since 2006. However, before these two accounting philosophies can be merged it is important to understand why differences between the two system exists, or else the desired convergence between the United States and IASB will never occur. Resource conducted in the 1980’s by S.J. Gray concluded that local accounting standards are directly impacted by the culture in which they were created (Marrero, 16). Therefore, differences in culture impacted why accounting standards are difference, and for the codification to occur a balance needs be reached between culture and accounting. This paper will explore several specific instances of how culture effected accounting systems, and the qualitative effects differences in GAAP and IFRS have on company evaluation.
One of the largest differences between IFRS and GAAP is that the IFRS system is more principles based, and the GAAP system is more rules based. In practice this means that under GAAP there is very little exceptions, no creative formatting, and all components must follow specific rules. While under IFRS there is potential for different interpretations and presentation of the same data. This indicates that IFRS countries have more professionalism-focused cultures where organizations are more oriented to allow professionals to lead themselves, and favor individual judgment over statutory control. In the United States, GAAP is more rules based indicating that while professional organization are embedded into the country, the culture of statutory control is stronger creating a rule based accounting system.
Another major difference between the IASB and FASB systems’ is the uniformity in accounting provided to the 110 countries who are members under the IFRS. According to Jose Marreno in “Are Accounting Standards Uniform? Recognizing Cultural Differences Underlying Global Accounting Standards” the higher a country ranks in terms of uncertainty avoidance, the higher they rank in terms of valuing uniformity. Additionally, this indicts that the United States reluctance to join IASB could come from an apathy toward the uniformity it would provide the county while doing business internationally. This is backed up by research completed by Clearly Cultural which surveyed 67 countries, and ranked the United States 11Th lowest on uncertainty avoidance. Furthermore, countries that rank higher in uncertainty avoidance also rank higher in having group-oriented cultures, and therefore the more risk accepting a culture the more individualistic. This reflects statistics that the United States is most individualist culture out of the 66 countries that were surveyed (Clearly Cultural). The behavior this manifests in accounting practices is that national cultures that prefer to avoid risk and favor group-orientation maintain higher secrecy and confidentiality in business, while individualistic, risk-preferring cultures tend to have higher levels of accounting note disclosures (Marreno, 17).
While the differences between GAAP and IFRS are based in culture they have a quantitative effect on the perceived performance of companies, and which system the market prefers. Accord to Chunhui Liu in “Impact of Difference Between International Financial Reporting Standards and US Generally Accepted Accounting Principles on Perceived Company Performance” United States’ GAAP is more conservative when calculating income therefore the market prefers it. Additionally, if the same company is being judged using both IFRS and GAAP, profit margin, return on assets, and return on equity will all be higher under IFRS. Consequently, IFRS overstates financial profitability ratios. In response the market prefers GAAP’s calculations. Due to of the law of one price everyone, no matter the accounting system, pays the same for a company’s stock, and because GAAP earnings calculation is more relevant to the market the market preferred GAAP. Additionally, because GAAP’s income its lower, and dividend amount is the same under both IFRS and GAAP, GAAP companies appear to be returning more of its earnings to investors which the market favors. Lastly, there are liquidity ratios, which are used to evaluate company’s debt levels, and these ratios are the same under GAAP and IFRS therefore there is no a perceived advantage for either system.
Cultural aspect like professionalism, uncertainty avoidance, and individualism effect the development of accounting systems for GAAP and IFRS. The differences in these two systems leads to higher profits under IFRS than GAAP, which leads to higher profitability ratios. Dividend payout ratios are higher under GAAP, and liquidity ratios is only negligibly different when comparing GAAP and IFRS. In the future the IASB and FASB will have to negotiate these differences in order to create the desired universal accounting standards, and as businesses continue to globalize the benefits of a universal standard continue to increase.