IFRS versus GAAP

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Introduction

The International Accounting Standards Board (IASB) has been responsible for developing International Financial Reporting Standards (IFRS), which are currently applied in more than 100 countries. However, the US and UK have been using Generally Accepted Accounting Standards (GAAP). The original GAAP had major differences from IFRS, but the US Financial Accounting Standards Board (FASB) has been working with IASB to reduce the differences. Although there are numerous similarities between GAAP and IFRS, there are still significant differences between them (Ernst & Young, 2013). This paper explores approaches taken by the two standards in treating different components of books of accounts.

IFRS 8-1

According to the fair value measurement concept, firms should include fair values of their assets in books of accounts and hence, give an accurate picture of the value of the assets to stakeholders (Kimmel, Weygandt, & Kieso, 2013). FASB and GAAP describe steps that firms ought to use in order to adhere to the requirement of fair value measurement concept. One of the key steps is to update the values of the assets in the books of accounts so that the books reflect the current values and not historical values. Another vital step is to treat all assets in the same class in the same way (Kimmel et al., 2013). Updating of the values should affect all assets of the same type. Further, the current values should be reported in financial statements that are availed to stakeholders. However, there are some differences in the approaches taken by the two standards. GAAP requires firms to update the values of assets every time real value changes, while FASB requires firms to update the values at least once in a year. Also, FASB allows firms to revalue the fair value of operating assets, while GAAP does not allow the reevaluation unless a significant impairment occurs on an asset (Kimmel et al., 2013).

IFRS 9-1

The term ‘component depreciation’ is a method of calculating depreciation which involves separating different components of an asset and treating each component separately (Kimmel et al., 2013). Precisely, it means depreciating each part of one asset separately, rather than treating the asset as a whole during depreciation. The approach is applied in cases where an asset has different parts that vary in terms of usefulness and expected lifespan. As such, firms are required to apply the concept when depreciating an asset that is made up of different parts that have significantly varying benefits and expected lifespan (Kimmel et al., 2013). A good example is a firm’s production machinery that comprises of a computer processing unit and a main housing. The computer processing unit has a useful life of five years and its salvage value is $300. On the other hand, the main housing is expected to last for the next fifty years and its salvage value is expected to be $ 4000. It is vital for a firm with such production machinery to treat the two different parts independently when calculating depreciation.

IFRS 9-2

Reevaluation simply means changing the book value of a firm’s asset to a fair value (Bellandi, 2012). Precisely, the concept describes a process in which a firm changes the value of an asset in books of accounts as a result of a change in the real value of the asset. Firms are required to apply the concept when satiations emerge that lead to a change in the real value of one or more of its assets (Ernst & Young, 2013). A good example is a situation in which the value of land and buildings increases as a result of economic changes. In such a case, a firm should re-value its buildings and land in the books of account so that the books reflect the current value. Further, the concept requires firms to be consistent during re-evaluation; they should treat all assets of the same type in the same manner. For instance, re-evaluation of buildings should apply to all buildings of a firm (Ernst & Young, 2013).

IFRS 9-3

When recording product development expenditures, some are classified as expenses and others as costs. Development expenditures that do not lead to an improvement in the expected returns of a product are recorded as expenses. On the other hand, development expenditures that lead to improvement in the productivity of a product are recorded as costs (Bellandi, 2012). During product development, a firm determines whether to record development expenditure as a cost or an expense through checking whether the feasibility of the product being developed is achieved. Development expenditure that is incurred before a product becomes feasible is recorded as an expense, while the expenditures recorded after the product becomes feasible are recorded as costs (Bellandi, 2012).

IFRS 10-2

In simple terms, contingent liability is described by IFRS as an obligation that is likely to occur in future (Needles, Powers, & Crosson, 2012). Under IFRS guidelines, such obligations are not included in financial statements. A good example is a situation in which chemicals spill off from a firm into a nearby river that drains into a sea, leading to death of fish and other creatures in the sea. In such a case, the firm involved expects that it is likely going to be fined by government agencies that play the role of protecting the environment in the future (Needles et al., 2012). The fine that the firm expects to pay even before it is imposed by environmental regulation agencies is a contingent liability. The information about the expected fine may be reported to stakeholders, but the fine should not be included in financial statements.

IFRS 10-3

There are also several similarities in the way IFRS and GAAP explain how accounting for liabilities should be treated. For instance, both require firms to report the fair value of investments in financial accounts, rather than historical costs. Both have similar approaches to the accounting for operating assets (Bellandi, 2012). Both standards have similar as approaches to the calculation of depreciation of long-term assets. In the valuation of inventory, both standards require firms to apply the lower-of-cost-or-market rule (Bellandi, 2012). There are several differences the two standards explain how accounting for liabilities should be treated. The guidelines for IFRS require that liabilities be reported in a reverse order with regard to liquidity, while the guidelines for GAAP require that that the order of liabilities be based on their liquidity (Bellandi, 2012). Secondly, the guidelines for IFRS require firms to use effective interest method only when reporting interest expenses, while GAAP allows firms to use straight-line method in addition to the effective interest method (Bellandi, 2012). As well, IFRS requires firms to classify liabilities as current or non-current, while that is not a requirement in GAAP (Bellandi, 2012).

Conclusion

Overall, IFRS and GAAP offer guidelines regarding how different components of books of accounts of firms should be treated. As indicated in the above analysis, the standards explain various accounting concepts that firms should embrace or adhere to. Although there are numerous similarities between the standards, there are significant differences in their approaches.

References

Bellandi, F. (2012). The Handbook to IFRS Transition and to IFRS U.S. GAAP Dual Reporting. West Sussex: John Wiley & Sons

Ernst & Young (2013). International GAAP 2013: Generally Accepted Accounting Principles under International Financial Reporting Standards. West Sussex: John Wiley & Sons

Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2013). Financial Accounting: Tools for business decision making (7th ed.). Hoboken, NJ: Paul D. Kimmel

Needles, B., Powers, M. & Crosson, S. (2012). Principles of Accounting, Chapters 1-13. New York, NY: Cengage Learning. Necessarily