Two decades ago, the dominant standards for financial reporting were typically set on an individual country basis. In the US they were, and still are referred to as GAAP – Generally Accepted Accounting Principles, and although they often have different names elsewhere, the phrase “local-GAAP” is often still used generically to refer to country-specific standards.
In the late 1980’s, a new global standard began to emerge out of the UK that was based on a different set of philosophical leanings, culminating with the publication of the first set of International Financial Reporting Standards (IFRS), intended to provide a single set of principles to drive financial reporting for companies globally.
Although adoption of IFRS began in the UK and then the broader European Union (EU), indications that China, Japan, Canada, Korea, and India intended to shift towards IFRS principles created significant additional momentum towards global adoption. Today, 120 countries have opted for IFRS as the preferred standard for financial reporting and compliance.
The primary differences between GAAP and IFRS are driven largely by their overarching philosophies. GAAP tends to be conservative, steering companies toward the least optimistic interpretations of financial information and events. IFRS, in contrast, aims to provide enough flexibility to allow for a more accurate representation of an organization’s financial reality. While some argue that additional flexibility carries more risk that companies may overstate earnings, –proponents of IFRS counter that this position is exaggerated, and that the use of “principles” rather than “rules” actually creates frameworks which are more difficult to circumvent.
GAAP tends to be prescriptive, focusing on explicit rules about how certain types of transactions should be accounted for. IFRS, on the other hand, tends to be driven by broadly defined guidelines intended to shape the decisions and create consistency in how specific types of transactions are recorded.
The bodies who administer the standards typically publish examples of how different standards should be applied. Some specific differences between GAAP and IFRS that are worth noting include:
- Inventory valuation: GAAP allows for LIFO (last in first out) valuation, which aims to better represent the costs associated with replacing existing inventory. IFRS, in contrast, does not allow for LIFO, with the intent of removing older inventory first, which – particularly in inflationary times – may inflate reported income but will likely more accurately represent the current value of inventory on the balance sheet.
- Fixed assets: In keeping with its conservative leanings, GAAP requires that fixed assets be carried on the balance sheet at their original cost, net of depreciation; or at market value, if lower than book value. Again, this can lead to an understatement of asset values under GAAP. IFRS, in contrast, allows for assets to be revalued on a periodic basis to represent any material change in market value.
- Development costs: GAAP takes the more conservative position that development costs should be expensed at the time that they are incurred. IFRS permits companies to capitalize some types of development costs and amortize, in an attempt to match the development costs more accurately with the periods in which those costs subsequently generate revenues.
There are other important differences between both GAAP and IFRS, as well as the country-specific variations on GAAP that call for different treatment of specific transaction types. The examples given are highlights intended to illustrate of the kinds of philosophical differences that drive the two approaches.
The emergence of competing standards has created additional accounting complexities for finance teams at most global companies. While the standards themselves – particularly IFRS – may be open to interpretation, there is still a need for consistency in the interpretation of how they are applied. For companies which need to report to different audiences requiring the use of two or more standards, there may be the need to ensure that transaction postings to comply with one standard are separated from those required to support the other.
Fortunately, advanced accounting solutions like Mondial CRx can help. Mondial CRx is a next-generation, cloud-based consolidated accounting data hub and financial reporting system that enables distributed enterprises to produce accurate, complete, auditable financial statements that conform to multiple GAAP and IFRS reporting standards from the same core data set. If your company is struggling to deliver compliant financial reports quickly and accurately, Mondial can help. Contact us today to arrange a no-obligation demo, or download our free white paper to learn more.