Comparing and Contrasting International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP)
By Gary Lasker, CPA, CFE
Instead of a domestic oriented economy, we now find ourselves in a world economy. Even in the world of accounting, a conservative discipline to say the least, the trend is toward globalization. Since the 1930’s, accountants have followed accounting principles generally accepted in the United States of America. Thus, globalization is here to stay as it is even entering the accounting world. IFRS [International Financial Reporting Standards] is an attempt to have a unified set of accounting standards worldwide. We will visit some of the differences between the two frameworks. This article provides some basic explanations and a few of the differences between IFRS and U.S. GAAP for inventories, fixed assets, and liabilities.
Inventory – IFRS does not allow the use of LIFO as a method for determining inventory cost. Only specific identification, the first-in, first-out (FIFO) method, and a weighted average cost formula are allowed. Inventory write-downs should generally be made on an item-by-item basis when using IFRS. U.S. GAAP allows for write-downs to be made using categories of items and like IFRS, does allow write-downs to be performed on an item-by-item basis. When certain conditions are met, IFRS allows inventories that were previously written down to market value to be reversed. On the other hand, reversals of inventory write-downs are prohibited under any circumstances in U.S. GAAP.
Intangible Assets – research and development costs are expensed as incurred in U.S. GAAP. Under IFRS, development costs can be capitalized under certain conditions.
Fixed Assets – in both the U.S. GAAP and IFRS settings, fixed assets are initially valued at cost. After initial recognition, full IFRS allows fixed assets to be adjusted to fair value. The fair value alternative is not used often due to the appraisal costs involved. IFRS requires component depreciation when patterns of economic benefits differ from the main asset, whereas U.S. GAAP does not. In U.S. GAAP, component depreciation is permitted but not required. A large fixed asset such as an airplane may be depreciated as one item under U.S. GAAP, while in an IFRS environment, various parts or components of the airplane may have different useful lives and residual values. This means that depreciation expense under these scenarios may be different. Sometimes the depreciation expense will end up higher using IFRS and sometimes the depreciation expense will end up lower.
Fixed Asset Impairment – fixed asset impairment is a little different under IFRS. Under both bodies, impairment is normally assessed when impairment indicators are present. In U.S. GAAP, when there are indicators of a fixed asset value decline, impairment is first analyzed at the end of a reporting period by estimating the undiscounted amount of the net future cash flows expected to be derived from the asset. The projected net undiscounted cash flow to be derived from the asset is then compared to the asset’s carrying amount. If the undiscounted cash flow is less than the carrying amount of the asset, the asset’s carrying amount is then compared to the asset’s fair value. If the carrying amount is less than fair value, an impairment loss is recorded. IFRS, like U.S. GAAP, requires an evaluation of a possible impairment loss if there are signs of a declining value for the asset. The IFRS calculation is two pronged. First, the fair market value less direct costs to sell and the asset’s value in use are determined. Value in use as applied in IFRS is the present value of estimated future cash flows to be derived from the continuing usage of the asset plus its disposal at the end of the asset’s useful life. The higher of 1.) fair value less costs to sell or 2.) the value in use is called the recoverable amount which is then compared to the carrying amount of the fixed asset. If the carrying amount of the asset exceeds the recoverable amount, the asset is considered impaired. An impairment loss is generally written down through profit / loss in the IFRS setting. Under U.S. GAAP, an impairment loss cannot be reversed. On the other hand, a reversal of an impairment loss is required if conditions change that warrant an increase under IFRS.
Investment Property – There is no U.S. GAAP pronouncement per se for “investment property”. In the IFRS setting, investment property is property held for appreciation or for rental. Investment property can be recorded at fair value as long as the fair value can be measured reliably and without undue cost or effort. Adjustments to fair value typically run through the profit loss accounts rather than through equity accounts.
Liabilities – a liability is defined as a present obligation as a result of a past event. Under both frameworks, the event giving rise to the liability should be probable. That is, the liability will probably be paid. However, IFRS and U.S. GAAP define the term probable differently. IFRS defines probable as greater than 50% while U.S. GAAP defines probable as a 75% to 80% likelihood of occurrence. Consequently, more liabilities are generally recognized under IFRS than with U.S. GAAP.
Currently, International Financial Reporting Standards (IFRS) has been adopted in over 120 countries. There is an expectation that many more countries will follow suit. The U.S. Securities Commission (SEC) allows foreign private issuers to list their securities on the various U.S. stock exchanges using IFRS. Before 2011 is over, the SEC is expected to render a decision on the incorporation of IFRS into U.S. GAAP. If the decision, as expected, is to incorporate IFRS, we will delve more deeply into the differences between U.S. GAAP and IFRS in future articles.