In the new world of technology, where people can communicate with one another in a matter of seconds, businesses have also become globalized and are constantly expanding. This has not only made the task of managing finances difficult, but has also made the reporting much more challenging. There are different bodies that have taken effective measure to bridge the gap for fair presentation of accounts by collaborating with other accounting bodies around the world. These measures have been taken to encourage a better understanding of the flow of income and profits.
Currently, there are two standards commonly used by the people around the globe, i.e., Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). To better understand the differences, let’s take a look at what these really are.
Generally Accepted Accounting Principal (GAAP)
GAAPs are the primary guidelines and principles of accounting that are issued by the Financial Accounting Standards Board (FASB). These standards are generally accepted in industry practices. GAAP is widely used in the United States and must be adhered to if financial statements are distributed to other stakeholders. If a company is listed on the stock exchange, it should prepare its financial statements in accordance with the rules laid out by the Security and Exchange Commission (SEC) in the United States.
International Financial Reporting Standard (IFRS)
IFRSs are accounting standards that outline the treatment of events and transactions in financial statements for reporting purposes. These standards are developed and issued by the International Accounting Standard Board (IASB). It is specifically stated in the IFRSs how businesses should maintain and report their books of accounts. The aim of the IASB is to introduce a common accounting language so that the accounts can be understood easily without the barrier of language if businesses are located in different countries. The IFRS is from the United Kingdom, but the standards have gained global recognition over a period of time and have since been adopted by different countries.
The Differences between GAAP and IFRS Income Statements
Although there are some similarities between the two, there are a number of differences between GAAP and IFRS in the preparation of income statements. Some of the major differences are discussed below.
Format of the Income Statement
No special format of the income statement needs to be followed under the IFRS, but GAAP prescribes a specific format to prepare one, i.e., to use a single-step or multiple-step format.
GAAP—Under a single-step format, the classification of all expenses is done by functions, and then those functions are deducted from the total income in order to derive income before tax. The multi-step format comprises a gross profit section where the cost of sales is deducted from sales, followed by the presentation of other income and expenses to reach an income before tax.
IFRS—The IFRS requires a minimum presentation of the following items in the income statement:
- finance cost
- share of post-tax results of associates and JV (joint ventures) accounted for using the equity method
- tax expense
- after tax gain or loss that is attributable to the results and to the re-measurement of discounted operations
- profit or loss for the period
A company that shows operating results should include all the items of operating nature, even if they are of irregular or unusual nature.
IFRS—There is a category of extraordinary items that are prohibited from being included in the income statement when it is prepared under IFRS.
GAAP—It allows this line item in the statement.
GAAP—This term is not used under GAAP, but an item of significant nature is separately disclosed in the income statement when income from operations is calculated and is also described in the notes.
IFRS—It requires a separate disclosure of those incomes and expenses that are exceptional in nature, size, or incidence in order to explain the business performance for the period. The disclosure of these items can either be on the face of the income statement (I/S) or in the notes.
GAAP—Extensive guidelines for revenue recognition have been provided in GAAP, and they generally focus on revenue being realized and revenue being earned. According to those guidelines, revenue should not be recognized until the exchange transaction has occurred.
IFRS—There are two accounting standards that capture revenue transactions, and they are divided into four categories, including the rendering of services, sale of goods, other use of entity asset (royalties or yielding interest on investment), and construction contracts. The criteria for revenue recognition involve profitability, which means the economic benefits of transactions will flow to the entity, and revenue and cost can be measured reliably.
Software Revenue Recognition
GAAP—Under the guidance laid out by GAAP, vendor-specific objective evidence (VSOE) of fair value should be used to find out the estimated selling price.
IFRS —Under IFRS guidelines, no such rules are present.
Discounting of Revenue
GAAP—It is required in limited situations under GAAP. for example, in case of receivables with greater than one-year payment terms, or in situations like retail land sales or license agreements for TV programs or movies.
IFRS—Where inflow of cash or cash equivalent is deferred, discounting of revenue to PV (present value) is required. It may result in lower revenue because the time value part of the actual receivable is recognized as interest/finance income.
GAAP—Development cost is treated as an expense in the GAAP, but it is capitalized if certain conditions are satisfied.
IFRS—Under IFRS, development cost is treated as an expense.
Prior-Service Cost in Employee Benefit Plan
GAAP—This cost is recognized under other comprehensive income (OCI) at the date when amendment of the plan is adopted, and it is then amortized as income over the remaining years of services of participants to complete eligibility date or life expectancy.
IFRS—All prior service cost, whether it is positive or negative, is recognized in the profit and loss (P&L) account when the amendment takes place in the employee benefit plan, and it is prohibited to be spread over a future service period, which may give rise to volatility in P&L.
Expense Recognition—Gains and Losses
GAAP—The guidelines laid out by GAAP allow entities to either record expense related to gains and losses in a period incurred within the statement of operations, or defer those gains or losses using the corridor approach.
IFRS—Re-measurement of gains and losses is immediately recognized in OCI because there is no way they can be recognized in profit or loss. Moreover, corridor and spreading approach are prohibited under IFRS.
Accounting for Taxes
The treatment of taxes is different in terms of the timing of tax recognition related to benefit plans.
GAAP—Tax related to the contribution should be recognized as a part of the net benefit cost when the contribution is made.
IFRS—Under IFRS, such taxes on benefit plans should be included in return-on-asset or while computing benefit obligation, based on their nature. For instance, in the plan, tax payable on contribution is typically included in actuarial assumptions for the calculation of benefit obligations.
There are a number of other differences between GAAP and IFRS when it comes to the statement of financial position, statement of changes in equity, statement of cash-flows, etc., and it is important for multi-national companies to understand those differences and apply them accordingly, for the true and fair presentation of their accounts.
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