John Sunna
IFRS and GAAP are two most commonly used accounting standards. The differences between them complicate the comparability of financial statements of different companies. The accounting bodies understand the necessity of convergence of the two standards. Thus, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) work on several joint projects to facilitate this process. This paper addresses the differences and similarities between IFRS and GAAP as regards accounting for financial instruments, long-term assets, and liabilities.
IFRS 8-1: What are some steps taken by both the FASB and IASB to move to fair value measurement for financial instruments? In what ways have some of the approaches differed?
Fair value measurement for financial instruments is part of the FASB and IASB conceptual framework project. Fair value is the amount the assets could be currently sold for. There are ongoing disputes about the pros and cons of implementing it. Thus, the Fair Value View supporters acknowledge that investors are willing to get a forward-looking and market-oriented financial information about an entity, while the Alternative View advocates give priority to the needs of existing shareholders and past transactions (Whittington, 2008). Thereby, both Boards had to overcome opposition from different groups. As a result, the IASB and FASB have adopted a phased approach to fair value measurement. The first step involves disclosure of fair values in the notes, and the second step allows companies to reflect some types of financial instruments at fair values in the financials, though it is not obligatory.
IFRS and GAAP apply different approaches towards impairment test of loans and receivables. Thus, under IFRS, a company should first identify specific impaired loans and accounts receivable. Then, the loans and receivables as a group are assessed for impairment. Under GAAP, such two-tiered approach is not required (Kimmel, Weygandt, & Kieso, 2013).
IFRS 9-1: What is component depreciation, and when must it be used?
IFRS and GAAP approaches towards PPE depreciation are pretty similar, however, there is one significant difference related to component depreciation. Component depreciation means that if any significant parts of a depreciable asset have different useful lives, they must be depreciated separately. IFRS requires the usage of component depreciation. For example, if the cost of a building includes personal property and land improvements with different depreciable lives, component depreciation should be used under IFRS. GAAP allows applying this type of depreciation, but in practice, such situations are rare (Kimmel, Weygandt, & Kieso, 2013, ch. 9). As a rule, under GAAP, assets are depreciated by classes such as buildings, equipment, etc. (Harrison, Horngren, & Thomas, 2013, p. 896).
IFRS 9-2: What is revaluation of plant assets? When should revaluation be applied?
Revaluation is the difference between the fair market value and the carrying value of an asset. According to IFRS, companies may revalue fixed assets to their fair value at the reporting date either up or down. Under GAAP, only impairment of assets may be reflected in the financial statements (Harrison, Horngren, & Thomas, 2013, p. 422). Under IFRS, companies should apply revaluation to all the assets within one class. Besides, assets with frequently changing prices should be revalued annually; otherwise, this procedure may be used more rarely (Kimmel, Weygandt, & Kieso, 2013, ch. 9). When an asset is revalued, the accumulated depreciation is written off, the initial amount of PPE is reduced to its fair value, and revaluation surplus or deficit is recorded. As a rule, the assets are revalued before they are sold. Besides, a company may choose to revalue its assets to a higher fair value to get a larger loan sum, if those assets are to be pledged.
IFRS 9-3: Some product development expenditures are recorded as development expenses and others as development costs. Explain the difference between these accounts and how a company decides which classification is appropriate.
There are two possible approaches to account for expenditures. Thus, they can be either expensed or capitalized. As regards the research costs, they are always expensed under both GAAP and IFRS. Under GAAP, all development expenditures are also treated like expenses and presented on the income statement. The only exception is for computer software development costs, which can be capitalized (Harrison, Horngren, & Thomas, 2013, p. 896). Under IFRS, development expenditures prior to technological feasibility are expensed. However, once the technological feasibility is reached, development costs are capitalized and presented on the balance sheet (Kimmel, Weygandt, & Kieso, 2013, ch. 9).
IFRS 10-2: Explain how IFRS defines a contingent liability and provide an example.
According to IAS 37 (“Provisions, Contingent Liabilities, and Contingent Assets”), contingent liability is either a possible obligation depending on the occurrence or non-occurrence of an uncertain future event, or a present obligation which is not recognized because payment is not probable or the amount cannot be measured reliably (Deloitte, 2016).
Under IFRS, contingent liabilities do not appear in the financial statements, they are just disclosed in the notes. Unlikely, under GAAP, contingent liabilities include a broader range of obligations. Thus, they may be either recognized or disclosed, and in some cases no disclosure is needed. Those contingent liabilities that are reported in the financial statements under GAAP are called “provisions” under IFRS (Kimmel, Weygandt, & Kieso, 2013, ch. 10). As stated in IAS 37, provision is “a liability of uncertain timing and amount”. Provision should be recognized only if it is a present obligation due to past event, payment is probable, and the amount can be estimated with sufficient reliability (Deloitte, 2016).
For example, a claim has been made against a company. If legal advisors confirm that the claim is likely to be successful and the company will probably have to pay $100,000, a provision will be required under IFRS. However, if the company’s loss is possible (not probable), or the amount cannot be measured reliably, an appropriate contingent liability will be disclosed in the notes.
IFRS10-3: Briefly describe some similarities and differences between GAAP and IFRS with respect to the accounting for liabilities.
Both IFRS and GAAP have similar definitions of liabilities and require classifying them as current (due within 12 months) or non-current. Besides, both standards specify that preferred stock should be reported as debt and not as equity if it will be redeemed at a certain point of time in future. However, there are also some differences as regards accounting for liabilities, e.g. the approach towards bonds. First of all, IFRS requires the effective-interest amortization method for bond discounts and premiums, while GAAP allows using the straight-line method. Besides, under GAAP, bonds discounts and premiums are reported separately, while IFRS requires reporting the net bond amount. Finally, under IFRS, the proceeds from the convertible bonds include equity and debt component, which is not required by GAAP.
As regards lease liabilities, they should be recorded according to their economic substance under both GAAP and IFRS. However, GAAP applies a stricter approach to determine whether the leasing agreement transfers all the risks and rewards (a “90% of fair value” test is applied). IFRS doesn’t impose such specific rules in this case. The IASB and FASB agree that there is an area for improvement in accounting for leasing, and their related joint project is primarily focused on lessee accounting.
Finally, there are some differences regarding contingencies and provisions, which have been described above (Kimmel, Weygandt, & Kieso, 2013, ch. 10).
Conclusion
Thus, IFRS requires component depreciation and allows revaluation of plant assets to their fair market value. Under GAAP, all research and development expenditures are expensed, while IFRS requires capitalization of development costs when technological feasibility is reached. According to GAAP, entities should report contingent liabilities in some cases, while IFRS requires only disclosure of contingencies in the notes. Besides, there are some peculiarities regarding bonds and leasing accounting under IFRS and GAAP. Given these and other differences between the two standards, the IASB and FASB are working on several joint projects to forward their convergence.
References
Deloitte (2016). IAS 37 — Provisions, Contingent Liabilities and Contingent Assets. Retrieved from http://www.iasplus.com/en/standards/ias/ias37
Harrison, W.T., Horngren, C.T., & Thomas, C.B. (2013). Financial Accounting (9th ed.). New Jersey: Pearson Education, Inc.
Kimmel, P.D., Weygandt, J.J., & Kieso, D.E. (2013). Financial Accounting: Tools for Business Decision Making (7th ed.). Hoboken, NJ: John Wiley & Sons
Whittington, J. (2008). Fair Value and the IASB/FASB Conceptual Framework Project: An Alternative View. Abacus, 44 (2), 139 – 168. Retrieved from http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6281.2008.00255.x/full
