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GAAP is a set of standards that publicly traded businesses in the U.S. must follow when reporting financial information. IFRS, on the other hand, is the accounting standard used in the European Union, and other countries around the world.Both GAAP and IFRS are designed to maintain transparency and consistency in the financial world and make it easier for investors, creditors, and business managers to make informed financial decisions. While the two systems share similar goals and features, they use different methodology. Here’s what you need to know about U.S. GAAP vs IFRS.
What Is GAAP?
Let’s start with an understanding of GAAP. An acronym for Generally Accepted Accounting Principles, GAAP is a set of rules and principles that companies in the U.S. must follow when preparing their annual financial statements. GAAP dictates how a company can recognize revenue and expenses, what types of expenses have to be capitalized as assets, and how information needs to be presented to shareholders in an audited report.Governed by the U.S. Securities and Exchange Commission (SEC) and administered by the Financial Accounting Standards Board (FASB), GAAP was established to provide consistency in how financial statements are created and make it easier for investors and creditors to compare companies apples to apples.All publicly traded businesses in the U.S. must use GAAP in their financial statements. While small businesses that don’t get audited aren’t required to use GAAP, doing so can be useful in certain situations, such as when they are applying for small business loans.Recommended: Small Business Audits: How to Prepare
What Is IFRS?
The International Financial Reporting Standards, or IFRS, are another set of accounting standards, but these are used at the international level. IFRS is standard in the European Union and many countries in Asia and South America, but not in the United States. IFRS are issued by the International Accounting Standards Board (IASB) and are designed to create a commonality in how businesses in different countries report their accounting. This consistency in accounting language enables investors and creditors to understand a company’s financials, compare one IFRS-compliant company to another IFRS-compliant company, which helps in making investment decisions.
GAAP vs IFRS Compared
There are some commonalities between IFRS and GAAP, but also many differences. Here’s how they net out.
Similarities
Both GAAP and IFRS govern how companies should report their financial information for a given reporting period, such as one quarter or year. And, both systems are designed to simplify financial statements and provide an even playing field for investors to evaluate companies and compare one to another. GAAP and IFRS also both require companies to issue income statements, balance sheets, cash flow statements, changes in equity, and footnotes. In addition, they both require accrual vs cash accounting, and allow the use of the inventory estimates first-in, first-out (FIFO) and weighted average cost.
Differences
GAAP and IFRS differ in several key areas.
Rules- vs. Principles-Based
GAAP goes into much more detail when it comes to accounting and uses fixed rules for calculations, with little room for interpretation. This is to prevent companies from creating exceptions to the rules in order to make themselves look more profitable.IFRS, on the other hand, sets out principles that companies should follow using their best judgment. It allows for some wiggle room for companies to interpret the principles.
Inventory
While GAAP allows companies to choose the most convenient method when valuing inventory, IFRS does not permit companies to use the last-in, first-out (LIFO) method of calculating inventory. The reason is that some analysts believe the LIFO method does not show an accurate inventory flow and may portray lower levels of income than is actually the case.
Intangible Assets
The way that intangible assets like goodwill or research are recorded differs between IFRS and GAAP. With IFRS, only those intangible assets that have future financial benefit are recognized and assigned a monetary value.GAAP recognizes intangible assets at their current fair market value and doesn’t make any additional or future considerations.
Fixed Assets
There are differences in depreciation of fixed assets for GAAP vs IFRS. Under GAAP, fixed assets (such as property and equipment) are valued using the cost model, which means the purchase price of the asset less any accumulated depreciation. IFRS, on the other hand, uses the revaluation model, which is based on fair value on the date of evaluation, less any subsequent accumulated depreciation and impairment losses.
Revenue
How you address revenue differs between the two systems. With GAAP, revenue is not recognized until the exchange of a good or service has been completed. Once the transaction has been recognized and recorded, the accountant must then consider the specific rules of the industry in which the business operates.IFRS is not as strict in defining revenue and allows companies to report revenue sooner. A balance sheet using this system might show a higher stream of revenue than a GAAP version of the same balance sheet.
Liabilities
Another difference between US GAAP vs IFRS is how liabilities are classified on the cash flow statement. GAAP classifies them as either current or non-current, with those the company can reasonably repay in the next 12 months considered current, and those that will be repaid later as long-term or non-current.With IFRS, all liabilities, both short- and long-term, are grouped together.
GAAP
IFRS
Rules-based
Principles-based
Inventory cost methods allow LIFO, FIFO, and weighted average cost
Inventory cost methods only allow FIFO and weighted average cost
Intangible assets are recorded at current fair market value
Intangible assets are only recognized if they have future financial benefit
Fixed assets are valued using the cost model
Fixed assets are valued using the revaluation model
Revenue is not recognized until the exchange of a good/service has been completed
Revenue can be reported sooner
Pros and Cons of IFRS
The United States hasn’t yet decided to adopt IFRS over GAAP, though with so many other countries around the globe using it, that may happen in the future. However, there are both pros and cons to switching to IFRS.On the plus side, adopting IFRS would make it easier for U.S. companies to do business with companies overseas. It would also make it easier for inventors to compare U.S. and foreign companies. Another advantage of IFRS is that it is less detailed than GAAP, which makes it easier to implement. It also offers more flexibility, which allows companies to adapt the system to fit their specific situations. Some experts also believe that a focus on principles, rather than rules, captures the essence of a transaction more accurately.However, there are also downsides to IFRS. Because IFRS is more subject to interpretation, it often requires lengthy disclosures on financial statements. The system’s flexibility can also lead to the manipulation of standards to make an organization seem more financially secure than it is in reality. Another disadvantage to IFRS’s flexibility is that statements aren’t always comparable (which is the point of having a global standard). Finally, if the U.S. were to adopt IFRS, it would be costly for small businesses to implement the change.
Pros of IFRS
Cons of IFRS
Makes it easy to do business with other countries
Often requires adding lengthy disclosures to financial statements
Would be easier for inventors to compare U.S. and foregn companies
Can be manipulated to make a company look like it’s doing better than it is
Less detailed, more flexible, and easier to implement
Statements from one company to the next aren’t always comparable
Focus on principles captures the essence of a transaction more accurately
Adopting IFRS would be costly for small businesses
The Takeaway
IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based system used primarily in the U.S.There are several differences between GAAP vs IFRS. The biggest is that GAAP lays out highly specific accounting rules and procedures, whereas IFRS sets out principles that companies should follow and interpret to the best of their judgment. Publicly traded companies in the U.S. must follow GAAP, but for small business accounting, you don’t have to follow any specific regulations. However, following GAAP in your financial statements can be useful in certain situations, such as when getting approved for certain types of business loans. Many lenders and creditors often prefer GAAP-compliant documents or require annual financial statements that follow these principles when they issue loans.
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Frequently Asked Questions
Does the U.S. use IFRS?
Is GAAP used in the U.K.?
Is GAAP or IFRS more conservative?
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About the Author
Susan Guillory
Susan Guillory is the president of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.
