IFRS and US GAAP: Similarities and Differences (Financial Assets)
IFRS and US GAAP: Similarities and Differences (Financial Assets)
Introduction
The US GAAP (Generally Accepted Accounting Principles) is a set of accounting standards followed in the United States. With the emergence of internationalization, cross border flow of capital, people, cultures, and ideas became very common and the situation in turn contributed to the rapid growth of multinational corporations. Since different countries followed different accounting standards earlier, it was very difficult for MNCs to record their financial/accounting transactions in a unified manner. It persuaded regulators and businesses worldwide to think of a globally recognizable accounting standard leading to the development of IFRS (International Financial Reporting Standards). Currently, IFRS is followed by over 110 countries around the world. There are many similarities and differences between these two accounting standards. This paper will critically evaluate the similarities and differences between IFRS and US GAAP in terms of treatment of financial assets.
The current US GAAP deals with the classification of financial assets based on the guidance given by ‘various specialized pronouncements’ (pwc, 2014). In contrast to this, there exists only one standard under IFRS for the classification of financial assets, and it suggests that financial assets may be classified into four such as “assets held for trading or designated at fair value, with changes in fair value reported in earnings; held-to-maturity investments; available-for-sale financial assets; and loans and receivables” (pwc, 2014). It is important to note that classification leads to measurement under both US GAAP and IFRS.
Therefore, the specialized pronouncements under US GAAP and the single standard guidance under IFRS with regard to the classification of financial assets may drive differences in measurement. Another key difference between U.S GAAP and IFRS in relation to the classification of financial assets is that the financial asset’s legal form drives classification under the former standard whereas the legal form does not drive classification under the latter accounting framework (pwc, 2014). To illustrate, under the available for category of financial assets, debt instruments (legal securities) are generally carried at fair value even if an active market is unavailable for the trade of these securities. However, a debt instrument that is not recognized as a security is carried at amortized cost even if both instruments (security and loan) bear common economic characteristics. In case of IFRS, rather than legal form, the nature of financial assets is considered (pwc, 2014).
There are some key differences in the way US GAAP and IFRS treat the potential derecognition of financial assets. One must understand the fact that these differences can have a notable effect on a range of transactions including asset securitizations. It is identified that IFRS focuses mainly on three things. First, it considers whether a qualifying transfer has been occurred. Second, IFRS examines if risks and rewards have been transferred properly. Third, in some cases, this accounting standard also checks whether control over assets under consideration has been transferred. In contrast, the US GAAP considered only whether or not a concern has surrendered its control over an asset.
A key difference has been noted between both accounting standards in terms of investments in unlisted equity instruments. US GAAP requires investments in unlisted equity instruments should be accounted at cost price unless the impaired or fair value option is chosen whereas the IFRS framework proposes a fair value measurement for those investments. In addition, it is identified that US GAAP and IFRS treat foreign exchange gains and losses on available-for-sale debt securities differently. The treatment of foreign exchange gains and losses on such securities using the IFRS framework will lead to increased income statement volatility. When it comes to effective interest rates, the US GAAP gives particular emphasis to contractual term of financial assets whereas IFRS focuses on the expected life of financial assets. To be more precise, for financial assets that are valued at amortized cost, US GAAP considers the contractual cash flows over the assets’ contractual life so as to calculate the effective interest rate whereas it calculated on the basis of estimated cash flows over the assets’ expected life under IFRS (Ernst & Young, 2012). US GAAP and IFRS differently treat the changes in expectations in relation to financial assets that are carried at amortized cost. This difference in treatment can affect the timing of income statement recognition as well as asset valuations.
With some exceptions given to some financial assets, the US GAAP allows business concerns to choose the fair value option for any recognized financial asset. In contrast, IFRS allows business concerns to choose the fair value option only when certain criteria are met although exception is given to financial assets outside the scope of IAS 39. Hence, firms need to meet very restrictive criteria in order to be eligible for using the fair value option if they adhere to IFRS standards. In addition, it is important to note that both US GAAP and IFRS provide a fair value option for treating equity-method investments. When the exercise of this option has a broad scope under US GAAP, the IFRS has set clear limits as to which companies can use it.
Similarly, significant differences between US GAAP and IFRS are identified when it comes to treating loans and receivables. When there is no legal form to drive classification under IFRS, a legal form serves the basis of ‘classification of debt securities under US GAAP’ (pwc, 2014). The significant differences in classification approaches lead to subsequent differences in measurement for the same instrument under these two different accounting frameworks.
In addition, nonderivative financial assets such as loans and receivables are valued at different amounts under US GAAP and IFRS. One of the major similarities between these accounting frameworks is that both of them permit transfer of financial assets from one category to another under special circumstances. It seems that reclassifications occur more common under IFRS. Likewise, it is identified that both these accounting standards have their own approaches while evaluating the impairment principles of available-for-sale debt securities.
With regards to the impairment principles, IFRS focuses specifically on the events that can have a significant influence on the asset cash flows despite the actual intent of the concern. However, the US GAAP follows a two-step test approach giving particular attention to the entity’s specific intents as well as expected cash flow recovery. “Regarding measurement of impairment loss upon a trigger, IFRS uses the cumulative fair value losses deferred in other comprehensive income. Under US GAAP, the impairment loss depends on the triggering event.” (pwc, 2014).
When it comes to impairment of available-for-sale equity instruments, the US GAAP recognizes whether or not the drop in fair value below cost remains for a temporary period. In case of IFRS, this accounting legislature relies on the objective evidence of impairment so as to trigger the impairment of available-for-sale equity investments (Ernst & Young, 2012). In terms of loss on available-for-sale equity securities, a new cost basis is established by impairment charges under US GAAP whereas such cost basis is not established under IFRS. Hence, the US GAAP considers further decline in value below the new cost basis as temporary in comparison to the new cost basis whereas IFRS records further drops in value below the impairment amount within the current income statement. Another key difference between IFRS and US GAAP is that the former permits the reversal of impairment losses on debt securities through income statement whereas the latter permits such reversals only for debt securities categorized as loans.
In addition, the US GAAP does not allow ‘one-time reversal of impairment losses on debt securities’ (pwc, 2014). When it comes to derecognition of financial assets, US GAAP and IFRS depend on very different models to take decisions with regard to whether or not financial assets must be derecognized. Compared to IFRS, full derecognition of financial assets is more common under US GAAP. At the same time, IFRS framework is characterized with continuing involvement presentation, for which there is no equivalent under US GAAP.
Conclusion
References
Ernst & Young. (2012). US GAAP versus IFRS: The basics. Retrieved from http://www.ey.com/Publication/vwLUAssets/IFRSBasics_BB2435_November2012/$FILE/IFRSBasics_BB2435_November2012.pdf
pwc. (2014). IFRS and US GAAP: similarities and differences. Retrieved from http://www.pwc.com/us/en/cfodirect/assets/pdf/accounting-guides/pwc-ifrs-us-gaap-similarities-and-differences-2015.pdf
