The US GAAP and IFRS are two of the most widely used accounting standards in the world, and both aim to enhance the quality of financial reporting. US GAAP is primarily followed in the US, while IFRS is adopted by over 165 jurisdictions globally. The US GAAP and IFRS have different interpretations and treatments of certain accounting issues. As a result, financial statements prepared under these two standards are not directly comparable.
We’ll compare GAAP vs IFRS, highlight their major differences, and discuss the potential future of a GAAP-IFRS convergence.
US Generally Accepted Accounting Principles (GAAP) | International Financial Reporting Standards (IFRS) | |
|---|---|---|
Definition | Are a set of accounting standards used internationally by over 165 jurisdictions | |
Issued By | Financial Accounting Standards Board (FASB), the accounting standard-setting body in the US | International Accounting Standards Board (IASB) in London, UK, with the goal of making global accounting standards to enhance comparability of financial statements across countries |
Approach to Standard-setting | Rules-based | Principles-based |
Use of LIFO Inventory | Allowed | Disallowed |
Reversal of Inventory Write-downs | Disallowed | Allowed |
Revaluation of Assets | Not allowed, except for marketable securities | Allowed |
Impairment Loss Reversals | Not allowed | Allowed, except for goodwill |
Research and Development Cost of Intangible Assets | Expensed as incurred, except for internally developed software | Allowed when certain criteria are met |
Investment Properties | Not addressed in the GAAP | Accounted for in a different fixed asset category |
Lease Accounting | Leases can be finance or operating leases | All leases are considered finance leases |
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Approach to Standard-setting
The most important distinction between IFRS vs GAAP is that IFRS is principles-based, while GAAP is rules-based. This means that IFRS focuses more on establishing the principles of accounting and letting accountants use professional judgment. On the other hand, GAAP focuses more on laying out specific rules that accountants must follow to account for transactions. Hence, IFRS is more flexible than GAAP in terms of applying accounting standards.
Use of LIFO Inventory
A commonly known difference between GAAP vs IFRS is the issue about LIFO or last-in, first-out accounting for inventory. Under GAAP, LIFO is allowed to value the cost of inventory—and in IFRS, LIFO isn’t. The framers of the IFRS disallowed LIFO due to the following reasons:
- LIFO reports inventory in the balance sheet based on old inventory costs, not on recent costs.
- LIFO distorts profitability when the price of inventory fluctuates.
Reversal of Inventory Write-downs
Whereas under US GAAP, reversals of previous inventory write-downs are not permitted, IFRS allows such reversals if the value of the inventory recovers in subsequent periods. However, in the IFRS, the reversal is only up to the amount previously written down.
To illustrate, assume that our inventory has a cost of $20,000. Due to economic downturns, its market value is only $16,000. Under the US GAAP and IFRS, the write-down of $4,000 ($20,000 to $16,000) must be recorded. Now, let’s assume that the value of our inventory is now $25,000. Here are two scenarios to consider:
- Under US GAAP, any reversal of the previous inventory write-down is not recognized. Hence, the inventory will remain to be valued at $16,000.
- Under IFRS, we can only reverse the write-down up to $4,000. Even if the full appreciation in value is $9,000 ($25,000 to $16,000), IFRS doesn’t allow valuing inventory above its original cost of $20,000. Hence, the $5,000 excess ($9,000 to $4,000) is ignored.
Revaluation of Assets
Fixed asset revaluations are not allowed in GAAP except for marketable securities, while the IFRS allows the use of the revaluation model (also known as the fair value model) in accounting for fixed assets. Under the revaluation method, companies may recognize a revaluation surplus when the carrying value of the fixed asset exceeds its fair value.
Impairment Loss Reversal
Fixed asset impairment occurs when the recoverable value Recoverable value is the most money you can get from an asset, either by selling it or by continuing to use it in your business. It helps you figure out if an asset has lost value. If what you could get from selling or using it is less than what it's currently worth on your books, you might need to lower its value in your financial records. of fixed assets decreases compared to its book value. However, circumstances may improve, which could result in an impairment reversal.
Similar to inventory write-down reversals, the US GAAP doesn’t allow impairment loss reversal, while the IFRS allows such reversals only up to the extent of the impairment previously recorded. In other words, under IFRS, an impairment reversal cannot increase the fixed asset’s value beyond its original cost.
Research and Development Cost of Intangible Assets
Under US GAAP, all research and development costs related to intangible assets—except internally developed software—are expensed as incurred. In the IFRS, capitalization of R&D cost is allowed when the project has achieved technical feasibility.
- Under US GAAP, only R&D costs of internally developed software can be capitalized. All other R&D costs of internally developed intangible assets are immediately expensed.
- All costs during the preliminary project stage are outright expensed.
- All costs during the application development stage are capitalized only if such costs are directly attributable to the software. Otherwise, all other indirect costs are immediately expensed.
- IFRS doesn’t distinguish whether the R&D is for software. As long as it is internally generated, R&D cost capitalization is possible.
- All research costs are immediately expensed.
- All development costs after achieving technical feasibility are capitalized. Otherwise, it is immediately expensed.
Investment Properties
The US GAAP doesn’t have a specific classification for investment property. However, in IFRS, investment property is a separate classification under the property, plant, and equipment section of the balance sheet.
Lease Accounting
In lease accounting, both GAAP and IFRS are now on the same page in reporting at least some leases as assets and liabilities rather than always reporting them as lease expense. This common feature has eliminated off-balance sheet reporting of leases. However, there are still major differences in the classification and treatment of lease transactions.
- Under GAAP, leases must be classified as either finance or operating lease.
- Under IFRS, all leases are classified as finance leases.
- The criteria for classifying a lease as a finance lease are similar between GAAP and IFRS. The criteria are as follows:
- There is transfer of ownership from the lessor to the lessee at the end of the lease term
- The lessee has an option to purchase the leased asset at a bargain price (a.k.a. Bargain purchase option)
- The lease covers a major part of the asset’s economic life. Under GAAP, it must be 75% of the asset’s economic life. However, in the IFRS, there are no specific quantitative criteria mentioned.
- The present value of lease payments is substantially all of the asset’s fair value. Under GAAP, it must be 90% or more of the asset’s fair value while in the IFRS, there are no quantitative criteria mentioned.
- The leased asset is so specialized that it has no alternative use to the lessor.
IFRS-GAAP Convergence
The IFRS-GAAP convergence has been in the works since 2002 when the FASB and IASB signed the Norwalk Agreement. In this agreement, both parties entered into a commitment to work together in eliminating the differences between IFRS and US GAAP.
Here are the currently harmonized standards as a result of this convergence:
- Business combinations in 2003 where the use of the acquisition model and recognition of goodwill are considered in accounting for mergers and acquisitions
- Fair value measurement, post-employment benefits, and consolidations in 2011 where
- The IFRS and GAAP have a single definition of “fair value” and how it’s accounted for and treated in a variety of accounting issues
- Defined benefit plans are now considered in accounting for post-employment benefits; and
- The concept of control is now unified between IFRS and GAAP in determining the parent-subsidiary relationship during consolidation
- Revenue recognition in 2014 where both IFRS and GAAP now follow the five-step model
- Leases in 2016 where all leases are now reported in the balance sheet
Frequently Asked Questions (FAQs)
IFRS is principles-based, which enables accountants to be more flexible and use professional judgment in applying accounting standards to complex accounting transactions. GAAP, on the other hand, is rules-based because it lays out specific rules for accountants to follow in dealing with specific accounting issues.
The US is the only country that uses GAAP.
Bottom Line
Accounting standards are present because they help companies produce understandable, comparable, and verifiable financial statements. Differences between GAAP and IFRS decrease the comparability of financial statements published in the US compared with those published internationally. But as talks continue about the IFRS-GAAP convergence, differences will exist until all accounting luminaries agree to a global and unified accounting standard.
