In the current century, the accounting and finance field have witnessed increased efforts to converge accounting standards to globally accepted universal standards. The fact owes to the dire need of increasing comparability of the financial statements of different firms in the various countries. Undoubtedly, there exist key areas of departure in different accounting standards applied in different countries. Of more interest, is the difference that exists between the two dominant accounting systems used by various corporations around the globe. That is the U.S. Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS). It is, however, worth recognizing that the two standards are not without distinct areas in the application of some standards and treatment of some economic events and transaction. The fundamental area of departure between IFRS and GAAP lies on the fact that while the former is principles-based, the latter adopts a rules-based approach. The essay aims at comparing and contrasting the provisions and application of IFRS and GAAP laying particular emphasis on the balance sheet and statement of cash flows, valuation of inventories, income statement and related information, as well as cash and receivables.
1. Presentation of the Balance Sheet and Statement of Cash Flows
The structure of the balance sheet under IFRS differs with the one under GAAP; however, it is worth noting that the items included in the balance sheet are relatively similar under the two sets of accounting standards. Under GAAP, companies use the term “balance sheet” synonymously with the term “statement of financial position” as applied under IFRS. However, in the accounting field, the two terms appears to have no significant difference though the latter appears more self-explanatory
1.1. Structure of the balance sheet
GAAP provides for the use of a decreasing order of liquidity in the presentation of the balance sheet’s items. As such, it follows out that the highly liquid assets such as cash and cash equivalents should rank first. Besides, Under GAAP shareholder’s equity should rank as the last item on the balance sheet. In laconic, the balance sheet items appears in the following order: current assets, long-term assets, current liabilities, long-term liabilities with shareholders’ equity ranking last.
On the other hand, IFRS provides no specific order in the classification of the accounts/items in the statement of financial position. The standards merely provide a loose recommendation that firms should adopt a reverse order of liquidity in reporting the assets. As such, the least liquid assets rank first in the statement of financial position. Such classification primarily aims at providing the users of the financial statements with a clearer understanding of the asset structure of the company (Beladi, 218). In a nutshell, the accounts in the statement of financial position appear as follows; long-term assets, current assets, shareholders’ equity, long-term liabilities, and current liabilities. Also worth of note in the presentation order above, is that, in contrast to the order adopted under GAAP, shareholders’ equity rank third under IFRS with the current liabilities such as the account payables ranking last.
Concerning the separation of the current and the non-current assets and liabilities; while IFRS requires strict separation, GAAP on the other hand just provides a loose recommendation for such separation.
Presentation of the minority interest in the balance sheet
Under IFRS, minority interests otherwise known as the non-controlling interest appears as part of shareholders’ equity in the balance sheet. In contrast, minority interest appears as a separate item as part of the liabilities (long-term liabilities).
1.2. Presentation of the statement of cash flows
ASC 230 and IAS 7 act as the primary references for the presentation of the cash flow statement under the GAAP and IFRS respectively. Although the provision of the two sets of accounting standards appears the same concerning the treatment of the various item, the standards are not without some significant differences. Under both standards, cash and cash equivalents include cash in hand/bank and highly liquid short-term investment. However, GAAP prohibits the inclusion of bank overdrafts in the cash equivalents while IFRS provides for such inclusion under certain conditions.
1.2.1. Reporting cash flows from operating activities
The two standards allow for the use of both the direct as well as the indirect method in reporting cash flows from the operating activities. Most companies adopt the indirect methods. However, the two standards part ways when reconciling the net cash flow from operating activities to the net income. IFRS requires such reconciliation (reconciliation of net profit/loss to the net cash flow from the operating activities) only when using the indirect method. GAAP, however, requires such reconciliation regardless whether the company adopts the indirect or the direct method.
1.2.2. Classification of transaction component and cash flows
ASC 230-10, under GAAP, provides that should a cash receipt/payment possess the characteristics of more than one cash flows’ category, a company consider the predominant source of such a cash flow as the basis for classifying such a receipt or payment. On the other hand, IAS 7, under IFRS, provides for the separate classification of each component of a transaction as either investing, financing, or operating. As such, IFRS overlooks the predominant source of a cash flow while GAAP ignores the individual items of a transaction.
2. Accounting for Receivables: ASC 310 (GAAP) v IFRS 9/IAS 39 (IFRS)
Receivables normally arise as a result of credit sales, loans or acquisition of some financial instruments. According to Sam (2003), it is worth noting that among the receivable, trade receivables happen to be a claim to cash of a specific sort.
2.1. Recognition of trade receivables
Under GAAP, ASC 605, provides that a company should recognize a trade receivable or revenue from such a transaction when it exchanges the product or merchandise for cash or cash claims. IFRS fails to address the recognition of trade receivable expressly; however, IAS 18 comes to the rescue of accountants. According to IAS 18, an entity should recognize revenue from a trade receivable when it has transferred, to the buyer, all the significant risk and rewards associated with the ownership of the goods (Warfield et al., 371). It is, however, worth noting that as further provided by the standards, an entity may transfer the risk and reward of ownership and the legal title to the products at different times.
2.2. Classification and measurement of loan receivables
GAAP requires firms to classify loan receivables, not in the form of debt securities as held for investment or held for sale. The standards further provide for the measurement/recognition of HFS mortgage on the lower of cost or the fair value. On the other hand, IFRS 9 provides that companies should classify and amortize all debt instruments that generates cash flows to the business at cost. Firms should classify and measure all other debt instruments at their fair value through profit or loss.
2.3. Recognition of an impairment of a loan receivable
ASC 310, under GAAP, provides that a company should recognize a loan as impaired should there exist a reasonable probability that it will be unable to collect all the amount owing to it as per the contractual terms. On the other hand, IAS 39 (paragraph 58), under IFRS, provides that an entity should recognize a financial asset as impaired should there exist objective evidence of impairment after the occurrence of a loss event. Cynthia and Smith (51) defines a loss event as an event that poses an adverse impact on the cash flows from the financial asset.
3. Valuation of inventories
IAS 2 and ASC 330-10 act as primary references when accounting for inventories under IFRS and GAAP respectively. Both standards provide for three classes of inventories; raw materials, work in progress and finished goods. Further, under both sets of standards, inventory cost mainly includes the direct expenditures attributed to the inventories or getting them ready for sale or use. However, some key areas of departure arise when treating various aspect of the inventories under GAAP and IFRS
3.1. Measurement of the carrying value
The carrying value of the inventory refers to its original cost net of its accumulated depreciation, impairment or amortization. In determining the carrying value of the inventory, GAAP provides for the use of lower of cost or the market approach. However, IFRS requires the use of the lower of cost or the NRV (net realizable value). Both standards, however, define the NRV as the selling price (actual or estimate) less the selling costs.
3.2. Costing formula in the valuation of inventory
GAAP (ASC 330) allows an entity to subject different components of the inventory to different costing formula. However, IFRS (IAS 2, paragraph 25) provides for the application of the same costing formula to all components of the inventory that possess a similar nature or use.
3.3. Reversal of inventory write-downs
GAAP strictly prohibits entities from reversing inventory write-downs previously recognized. IFRS, however, requires companies to recognize any inventory write-down to its NRV as an expense in the fiscal year in which such a write-down occurs. Clyde (771) notes that the standard further provides that entities should recognize any increase in the NRV (net realizable value) of previously written-down inventory as a reduction in the inventory expense.
4. Presentation of the income statement and related items
The income statement under both IFRS and GAAP aim at primarily summarizing the results of the operations of the business. Inarguably, different transaction and economic events impact differently on the income statement depending on the treatment of such events. It is such treatment that creates an area of departure between IFRS and GAAP.
4.1. Format/structure of the income statement
IFRS provides no prescribed format for the presentation of the income statement. It allows entities to choose any method of presenting the expenses whether by function or nature. However, as a minimum, IFRS requires that some items appear in the face of the income statement which includes revenue, finance costs, tax expense, net income (profit/loss) for the period, post-tax gain, and share of post-tax results. GAAP, however, provides for a specific presentation of the income statement using a single-step format or a multiple-step format. Under the single-step format, a company should classify all expenses by function and deduct them from the total income to arrive at income before tax (Jerry et al., 874). In a multiple-step format, an entity should deduct the cost of sales from the revenue first to arrive at the gross profit then proceed to other incomes and expenses to arrive at income before tax.
4.2. Presentation of extraordinary items
While IFRS strictly prohibits the use of extraordinary items, GAAP allows such use in the income statement. As per GAAP, extraordinary items refers to unusual and infrequent items. Items which are rare for example, the negative goodwill that might arise as a result of a business combination.
4.3. Presentation of SoRIE (Statement of recognized incomes and expenses) and statement of changes in shareholders’ equity
IFRS requires that, where a company has presented a SoRIE as a primary statement, it should present the statement of changes in shareholders’ equity as a note to the accounts and not as a primary statement. However, should a company fail to present the SoRIE, it may, in its statement of changes in shareholders’ equity, separately highlight the recognized incomes and expenses. As a minimum, an entity should include in its SoRIE, net income for the period, individual items of income as well as expenses for the period which the entity has recognized directly into equity, and total incomes. However, under GAAP SoRIE appears at the bottom of the income statement or in the statement of changes in shareholders’ equity.
5. Conclusion
An analysis of the provisions of the IFRS and GAAP coupled with the application of the two standards exposes key areas of departure between the two standards. However, a decision on which of the two dominant sets of accounting standards supersedes (superior to) the other would be practically hard to make if not impossible. The increasing convergence of the IFRS witnessed in the current century sheds some light that IFRS appears more preferable.
Works Cited
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208. 5 (2009): 48-52.
Jerry, Weygandt, Kimmel Paul, and Kieso Donald. Accounting Principles. New York: John
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Walton, Peter. An Executive’s Guide of moving from U.S. GAAP to IFRS. Business Expert
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