US and Foreign Comparison - Differences in Accounting Methods as Applied Internationally - Essay Example

International Accounting Introduction The changing world environment has led to increased application of international accounting standards. The EU started to push companies listed in its securities markets to apply international financial reporting standards in 2005. The total value of international transactions on bonds and equities by 2006 was $90 trillion per annum. This indicates how important it was to establish common international accounting standards. The International Accounting Standards Board (IASB) which was formed in 2001 is concerned with the development of high quality accounting standards accepted worldwide. The standards issues by the IASB are called International Financial Reporting Standards (IFRS). In U.S.A., the nationally accepted standards are known as Generally Accepted Accounting Practices (GAAP). The USA’s GAAP converged with IFRS in 2002. By 2005, over 90 countries started to follow IFRS. However, there are variations of financial accounting practices, auditing requirements and disclosures in different countries. This essay will highlight those variations across various geographical regions, with a main focus on U.S.A. It will also compare GAAP with IFRS. Differences in Accounting Methods as Applied Internationally Accounting methods applied in different countries differ in terms of format and terminology. In terms of terminology, the UK uses turnover and profit attributable to shareholders in its income statements, while USA firms use revenue or sales and net income respectively. On the balance sheet, USA’s accounting standards use the terms inventory, accounts receivable, payables, common stock, paid-in capital and retained earnings. On the other hand, the accounting standards of UK use the terms stock, debtors, creditors, called up share capital, share premium account, and reserves respectively (Gernon and Meek, 2001). This indicates that the two geographical regions use different terminologies to refer to the same accounting items. Different countries also allow different formats to present their financial statements. For instance, the UK accounting standards requires accountants to list noncurrent assets first in the balance sheet (Gernon and Meek, 2001). The current assets are then listed second from the least liquid to the most liquid. This also applies to Mexico, Canada and Japan. The U.S. accounting reporting standards require the assets to be listed starting with the most liquid to the least liquid. Total net assets are then obtained through combination of assets and liabilities. The format of reporting income statements also differ in different countries. U.S. companies report sales revenue and cost of goods sold as separate line items. The difference between the two items gives the gross profit. Manufacturing costs including labor, material and overhead are included as costs of goods sold (Radebaugh and Gray, 2002). On the other hand, European companies commonly use an expenditure format to present their income statements. For instance, German companies present separate line items for depreciation, personal expenses and cost of materials. There are also five geographical classifications of international accounting models: Anglo-Saxon (USA), Anglo-Saxon (United Kingdom), German (Germany, Switzerland), Latin (France, Italy, Brazil), and Asia-Pacific (Japan, China). The Anglo-Saxon model of the United Kingdom refers its standards as Financial Reporting Standards (FRS). These standards are issued by the Accounting Standards Board (ASB) which strongly supports the International Accounting Standards Board. In the German model, standards are set by the German Accounting Standards Board (GASB) which was formed in 1998. Previously, the Federal Ministry of Justice (FMJ) was historically responsible for standard setting. The Asia-Pacific model applicable in Japan uses Financial Accounting Foundation (FASF) and Accounting Standards Board (ASB) to develop accounting standards. There are various differences in different countries in terms of financial reporting methods. In USA, goodwill is only expensed if it is impaired. This rule applied since 2001. The Japanese model requires the amortization of goodwill with an economic life of five years. Under the International Accounting Standards (IAS) 38, goodwill generated internally is not capitalized (Gernon and Meek, 2001). When reporting inventories, IAS does not accept the use of LIFO method. Specific cost is recommended by the IASB, and if it is not determinable, FIFO or weighted average methods are used. In terms of Research and Development costs, the accounting standards of United States require the R&D costs to be expensed as incurred. In-process R&D in acquisitions is also recognized in USA as an expense. Similarly, IAS 38 requires that Research costs should be expense as they are being incurred (Radebaugh and Gray, 2002). However, under IAS development costs are capitalized when the product has been determined to be economically viable. The international accounting standards also require that purchased research and development costs should be capitalized and amortized. In accounting for business combinations, purchase method is applicable under the U.S. GAAP and International Accounting Standards (IAS). In Japan, pooling is not permitted. It is infrequently used in other countries as well. Fixed assets and Depreciation are also reported differently by different accounting models. Most models, including American and Japanese models value fixed assets at their depreciated historical cost. International Accounting Standards value fixed assets at value first, and subsequently values them under cost model or revaluation model. Disclosures in Anglo-Saxon models also provide the most extensive disclosures in the world. These disclosures are mainly provided as notes to the financial statements. Brazilian companies disclose investments made in relation to the environment and social projects. This is disclosed as “social report” in the notes section. In terms of recognition, U.S. GAAP requires the PPE to be carried on the balance sheet with respect to their historical cost less depreciation. Impaired assets are also written down to their fair value, and there is no revaluation of fixed assets. In contrast, European countries can choose between two methods of valuing their assets, i.e. carrying PPE in terms of their revalued amounts or historical cost. Mexico valued its assets at historical cost until 2008 when it started to use GPP. Brazilian countries used GPP until 1990s, although it is still used at the option of the company. Generally, similar financial statements are provided in different countries. For instance, balance sheet and income statements are required for companies in all countries. Statement of Cash Flows is also gaining prominence in many countries, Mexico being the latest to adopt it in 2008. Some other countries such as Australia and Germany also include a statement of changes in fixed assets in their financial statements. Differences between GAAP and IFRS in terms of Transactions or Financial Reporting One of the transactions that show some differences between GAAP and IFRS is the format of income statement. In IFRS, there is no specific format that should apply for the income statement. Expenses may be presented according to their nature or function. On the other hand, GAAP uses a single-step presentation of the income statement whereby the expenses are presented in terms of function or a multi-step presentation in which gross profits are calculated before the presentation of other income and expenses. Furthermore, IFRS does not allow the presentation of items as extraordinary while GAAP allows companies to include extraordinary transactions which are considered as unusual and infrequent. GAAP treatment is a better approach in this transaction because it takes into account extraordinary items. Secondly, GAAP and IFRS differ in terms of how they treat receivables. Loans and receivables are considered by IFRS as part of the four financial assets categories. Under US GAAP, the category of loans and receivables does not exist. According to IFRS, loans and receivables are financial assets which result from the provision of money, goods and services by enterprises. These include accounts receivables and loans. GAAP does not categorize loans receivables and trade accounts receivable with debt securities. Considering receivables as financial assets, IFRS requires that they should be valued at their fair value and to be reported on the face of the balance sheet. On the other hand, GAAP requires receivables to be measured at net realizable value and to be disclosed separately. IFRS treatment is a better approach in this case because receivables which are financial in nature are categorised as financial securities. GAAP and IFRS also differ in terms of inventory valuation. IFRS requires the valuation/measurement of inventory at the lower of cost and net realizable value. The Net realizable value is the selling price less costs of making sale and estimated costs of completion. On the other hand, GAAP requires the measurement of inventory using lower of cost or lower of market rather than net realizable value (Grant Thornton, 2007). The market refers to the cost of replacing the asset either through purchase or production. IFRS treatment of inventory valuation is a better approach because it uses the net realizable value of inventory which shows true value of inventory. The last financial reporting difference between GAAP and IFRS is the treatment of transactions in the cash flow statement. IFRS includes bank borrowings as financing activities while GAAP includes bank overdrafts as liabilities and excludes them from cash equivalents (Ernst & Young, 2012). Only the changes in bank overdrafts are treated as financing activities under GAAP. In IFRS, overdrafts are included as cash equivalents. Interest and dividends under IFRS are classified as operating or financing cash flows if they are paid, and classified as operating or investing cash flows if they are received. On the other hand, received and paid interest and dividends are all classified as operating activities under GAAP. IFRS is a better approach because it considers borrowings as financing activities. In conclusion, it is clear that accounting methods and financial reporting differ in different geographical places. The differences are shown in terms of different accounting models. Anglo-Saxon models differ from German and Japanese models in some ways. IFRS and GAAP also have some differences in terms of financial reporting and transactions. They differ in terms of income statement format, receivables presentation, treatment of cash flow items, and inventory valuation. References list Ernst & Young (2012). US GAAP versus IFRS: The Basics. London: Ernst & Young Grant Thornton. (2007). Comparison between U.S. GAAP and International Financial Reporting Standards. New York: Grant Thornton. Gernon, H., and Meek, G. (2001). Accounting: An International Perspective, 5th ed. Burr Ridge, IL: Irwin/McGraw-Hill. Radebaugh, L.H., and Gray, S.J. (2002). International Accounting and Multinational Enterprises, 5th ed. New York: Wiley. Read More