Is IFRS That Different From U.S. GAAP?

Remi Forgeas, CPA Insider | June 16, 2008 The U.S. is moving toward IFRS. Unlike what happened with other countries, IASB and FASB have been working on convergence for many years. Are the two standards still very different? For many years, countries developed their own accounting standards. They were rules-based, principle-based, business-oriented, tax-oriented in one word, they were all different. With globalization, the need to harmonize these standards was not only obvious but necessary. By the end of the 90s, the two predominant standards were the U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). And, both standard setters, IASB (International Accounting Standards Board) and FASB (Financial Accounting Standards Board), initiated a convergence project even before IFRS was actually adopted by many countries. Now, that the U.S. is clearly moving toward IFRS, as re-emphasized by the recent SEC (U.S. Securities and Exchange Commission) proposal, one wonders what the potential impacts of the differences between these two frameworks on the financial statements will be? And how financial executives can anticipate the adoption of IFRS in order to minimize the last-minute adjustments? Historical Reminder In September 1999, the FASB published its second edition of an IASC-U.S. Comparison Project, a comprehensive comparative study of IASC (International Accounting Standards Committee) standards and GAAP. This 500-page report included comparative analyses of each of the IASC's "core standards" to their GAAP counterparts. At that time, conceptually and practically, the differences between the two frameworks were numerous and significant. Since 1999, the FASB has undertaken six initiatives in order for the GAAP to converge with IFRS: 1. Joint projects conducted with the IASB (Conceptual Framework Project, Business Combination Project, Revenue Recognition Project, Financial Statements Presentation), 2. Short-term convergence project, 3. Liaison IASB member on site at FASB offices, 4. FASB monitoring of IASB projects, 5. Convergence Project and 6. Explicit consideration of convergence potential in all Board agenda decision.

In November 2008, SEC issued its proposed roadmap to the adoption of IFRS for public companies. This proposal came about one year after the ending of the reconciliation to GAAP for foreign registrants that issue IFRS financial statements. These two initiatives revealed the importance of international standards and concluded, to a certain extent, about 30 years of convergence between the two standard setters. Once the convergence effort is acknowledged and its results identified, are both standards still different? Principles Based vs. Rules Based One of the major differences lies in the conceptual approach: U.S. GAAP is rule-based, whereas IFRS is principle-based. The inherent characteristic of a principles-based framework is the potential of different interpretations for similar transactions. This situation implies second-guessing and creates uncertainty and requires extensive disclosures in the financial statements. In a principle-based accounting system, the areas of interpretation or discussion can be clarified by the standards-setting board, and provide fewer exceptions than a rules-based system. However, IFRS include positions and guidance that can easily be considered as sets of rules instead of sets of principles. At the time of the IFRS adoption, this led English observers to comment that international standards were really rule-based compared to U.K. GAAP that were much more principle-based. The difference between these two approaches is on the methodology to assess an accounting treatment. Under U.S. GAAP, the research is more focused on the literature whereas under IFRS, the review of the facts pattern is more thorough. However, the professional judgment is not a new concept in the U.S. environment. The SEC is addressing this topic in order to find the right balance between the educated professional judgment, that is acceptable, and the guessed professional judgment. Differences Between IFRS and U.S. GAAP While this is not a comprehensive list of differences that exist, these examples provide a flavor of impacts on the financial statements and therefore on the conduct of businesses.

Consolidation IFRS favors a control model whereas U.S. GAAP prefers a risks-andrewards model. Some entities consolidated in accordance with FIN 46(R) may have to be shown separately under IFRS. Statement of Income Under IFRS, extraordinary items are not segregated in the income statement, while, under US GAAP, they are shown below the net income. Inventory Under IFRS, LIFO (a historical method of recording the value of inventory, a firm records the last units purchased as the first units sold) cannot be used

while under U.S. GAAP, companies have the choice between LIFO and FIFO (is a common method for recording the value of inventory).

Earning-per-Share Under IFRS, the earning-per-share calculation does not average the individual interim period calculations, whereas under U.S. GAAP the computation averages the individual interim period incremental shares. Development costs These costs can be capitalized under IFRS if certain criteria are met, while it is considered as expenses under U.S. GAAP.

How to Anticipate the Transition? Companies have a tendency to focus their attention on the accounting and financial statements impacts of the transition to IFRS. However, this process has had a much broader impact than expected. As a first step, the transition phase has to be segregated from the going-forward application of IFRS. A reconciliation approach (i.e. identification of differences and work only on those) may be effective for the transition (less time, less cost), but going forward, this approach may create a lot of unexpected difficulties, since the tools will not be in place. Some of the questions to consider before the start of the project are: What will be the consequences on your company or organization? The Finance department will obviously have to update its processes, as will Operations, which will face potential impact on how contracts are written or how the information is gathered and maintained; and Human Resources, which will have to review the compensation packages, especially when linked to business performances. What will be the impact on management reporting and IT? The transition to IFRS will imply a change in management reporting and, in some cases, in the format of data required. For example, systems will have to be upgraded in order to gather information on liquidity risks in accordance with IFRS 7 Financial Instruments Disclosures. Likewise for R&D costs, your company will have to define procedures to enable the gathering and review of costs related to development that may be capitalized. When will changes have to be looked at? Long-term transactions should be looked at with the IFRS lenses. If a company intends to enter into a joint-venture agreement, it should review the potential IFRS accounting in order to avoid unexpected results at the time of the transition. Companies can leverage on the convergence process by implementing new pronouncements as soon as possible, especially those that are aimed to converge with IFRS, such as SFAS 141(R) on business combinations or SFAS 160 on the accounting for non-controlling interest.

When should the IFRS training begin? Due to the broad impact of the transition, your company should put in place a scalable training plan on IFRS not limited to the accounting department, even before the actual transition. Final Thought Experiences in other countries, especially in Europe, show that the process is more complex and lengthier than anticipated. However, since European countries were the first ones to make the transition, they were unable to leverage lessons learned from predecessors in the transition process and most of the time local accounting standards were not converging to IFRS. U.S. companies can learn from the mistakes of its European predecessors. * The views expressed in this article are the authors own

Comparing U.S. GAAP and IFRS Accounting Systems

By Ann C. Logue, MBA from Emerging Markets For Dummies

If youre investing in emerging markets, you need to know about the worlds two main accounting systems: Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). GAAP is used principally in the United States, although the Security and Exchange Commission is looking to switch to IFRS by 2015, the system used in the European Union and many other countries. Many countries have their own accounting systems, although most conform to one main system or the other as they work to keep their markets modern. All accounting systems follow double-entry practices that categorize transactions as revenue or expenses, assets or liabilities. The two primary accounting systems have a few differences between them that may affect the results. If you understand a little about both GAAP and IFRS, you can make a better evaluation of numbers from companies that follow neither system.

U.S. GAAP
GAAP are set by the Financial Accounting Standards Board (FASB, often pronounced as fazzbee), an organization of accountants, financial analysts, and regulators who draw up accounting practices to meet ongoing changes in the markets. Every time some new issue comes up, the FASB studies the problem, develops a proposed accounting procedure, and sends it for review and comment to different users of financial statements, including corporations and analysts. GAAP allow for:

Smooth presentation of earnings: One of the hallmarks of GAAP is an emphasis on smooth earnings results from year to year. The idea is to give investors a sense of normalized results rather than the actual cash in and cash out. For example, taxes are reported based on statutory rates, no matter what a company actually paid. Capital purchases may be depreciated over several years instead of taken as expenses in the year acquired. Although the results are designed to be smoothed, they fluctuate from quarter to quarter and from year to year. The idea isnt to make earnings look pretty so much as to help investors understand what average capital spending or average taxation should be.

Disclosure: A company needs to explain its assumptions for different expenses. All the gory information is in the footnotes to the financial statements. Under U.S. GAAP, companies are required to disclose information about their accounting choices and their expenses in the footnotes. The notes arent easy to read, but theyre key to understanding the business and its financial statements.

Comparing GAAP and International Financial Reporting Standards

The IFRS were established in 2001 and adopted by the European Union in 2005. The hope is that all the worlds businesses will move to these standards to help investors and financiers all over the world better understand the financial situation of companies they invest in, do business with, or extend credit to. Also, a standard system is an incentive for newly capitalist nations, especially China, to develop accounting that meets world standards. The philosophy behind IFRS is similar to GAAP, but there are some key differences, as shown in the following table:
Differences between IFRS and U.S. GAAP Issue IFRS Balance sheet Income statement Changes in equity Cash flow statement Footnotes Requires separation of current and noncurrent assets and liabilities Shown as separate line items on the balance sheet Included in equity as a separate line item U.S. GAAP Balance sheet Income statement Statement of comprehensive income Changes in equity Cash flow statement Footnotes Recommends separation of current and noncurrent assets and liabilities Included with assets and liabilities

Documents included in the financial statements

Balance sheet

Deferred taxes Minority interests (usually ownership positions by significant but not majority investors) Extraordinary items (events that dont occur on a regular basis) Bank overdrafts

Included in liabilities as a separate line item

Prohibited

Allowed if theyre unusual and infrequent

May be included in cash Charged as a financing if used in cash activity management

Few of these differences are likely to cause major changes in any companys reported results; a company with great results under GAAP wont look terrible under IFRS, unless it got those results with an extraordinary item, which is an event that doesnt occur on a regular basis such as a merger or a corporate restructuring. And because extraordinary items are disclosed, someone looking at the financial statements would be able to make the adjustment easily.