Comparison of Generally Accepted Accounting Principles and International Financial Reporting Standards - Research Paper Example

International Accounting Table of Contents Introduction 3 GAAP 4 IFRS 4 Advantages of GAAP 5 Advantages of GAAP based on prescriptive standards 5 Advantages of GAAP based on principle standards 5 Disadvantages of GAAP 6 Advantages of IFRS 6 Disadvantages of IFRS 6 Principle-based system versus Rule-based system 7 Transitional effects 7 Consequences on the company or organization 8 Impact on the management 8 Changes in the perspectives of visualizing 8 Critical evaluation of the phenomenon of switching from GAAP to IFRS 8 Conclusion 9 References 11 Introduction The interest towards the subject “International Accounting” has shown an upward rising trend over the last two to three decades and this trend can be measured by the increasing number of scholarly articles written upon the subject over the time. The paperwork has been done with an intention to add a dimension to the subject. It can well be argued that there is nothing new about “International Accounting”; indeed accounting has always been international. It has been international from the time it was originated. International accounting can be referred as international dimension of accounting comprising of accounting principles and practices. The accounting standards form the principles for the preparation and presentation of financial statements created by the International Accounting Standards Committee (IASC). The research paper highlights the major areas of similarities and differences between Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). The objective of this research paper is to find out those particular differences that are believed to be mostly encountered during practice. Before finding the pros and cons of the two accounting standards, it is essential that the actual implications and findings of both the standards are explained briefly. GAAP The name itself suggests that the contents of the theory will describe certain principles that are needed to be followed in accounting but despite this GAAP acts as a very important facilitator for investors and companies. GAAP is basically a set of procedures and standards that companies follow in order to present their financial data. Companies follow those standards as these provide them a precise mode of representation of their financial figures which is good for the analysts as it becomes hard for the company to trick them by manipulating their figures. 1 IFRS IFRS has gained popularity in recent times and has been well accepted by a huge number of countries in the world. Previously, the multinational companies had to prepare separate financial statements for each country where they had their areas of operations but IFRS has made the task easier. In IFRS the guidelines and standards are set by International Accounting Standards Board (IASB) that companies and organizations can follow when compiling financial statements. It was previously called the International Accounting Standards (IAS). IFRS provides guidance to prepare financial statements.2 The various advantages and disadvantages of both the accounting standards have to be made clear at first and then the comparison between the two can well be understood. Advantages of GAAP In order to enumerate the advantages of any accounting principle, it is important to analyze the components of it at the outset. The main components of GAAP are: Inventory costs, Debt, Stockholder’s equity, short term investment, long term investment, revenues and sales, taxation, profits, goodwill and other tangibles. 3 Advantages of GAAP based on prescriptive standards The standards are precise, clear and well-understood requirements and these can be referred as a correct way of dealing with every item. The learning of the principles is easy and convenient. There is less complexity in the principles, for example, similar items can be treated the same way. Advantages of GAAP based on principle standards GAAP is a principle based approach; which one can use to begin with laying out the input objectives of superior exposure in the matter and then supply control explaining the objectives and relating it to some common examples. It permits accountants to relate their professional verdict in assessing the matter of an operation. Following a principle based theory; it becomes hard to avoid requirements of standards. Disadvantages of GAAP There are certain drawbacks to rule - based accounting standards. Lack of excessive guidelines can create inconsistencies in the operations of the organizations. The absence of certain guidelines can create confusions and can result in the decrement of value in the field of accounting norms. A number of accountants are reluctant to use their own judgments in presenting financial statement due to the possibility of lawsuits on not confining to the guidelines 4 Advantages of IFRS IFRS is broader and more principle oriented than US GAAP in the sense that IFRS leaves the implementation of the principles on the auditors and the one who prepares the financial statements. IFRS are easier to use and results in better reporting. For this reason, investors prefer IFRS. Above all IFRS is a global approach. Disadvantages of IFRS IFRS is less detailed than GAAP and it acts as a problem in some of the cases. It also fails to do the cost-benefit analysis and the transition periods cause disconcerting results from following IFRS. It is inferior to GAAP when compared in the perspective of theory 5 Principle-based system versus Rule-based system An easier way to explain the difference would be to mention that US GAAP is rule-based and IFRS is principle-based. In principle-based framework, it sometime happens that different executions of similar issues are made and this reaches to a second thought of the matter. Also for this reason a high amount of exposures of the accounting issues are required. The areas of interpretation and discussion in a principle-based system can be clarified by the board that sets standards and then it leaves few scope of distinguishing it from rule-based system. The difference between the two approaches lies in the methodology that is used to evaluate an account. GAAP research is more focused on literature whereas IFRS uses in-depth and thorough research 6 Transitional effects The companies and the organizations try to measure the transition from GAAP to IFRS by focusing their attention on the accounting and financial statements. Before the transition, some aspects have to be evaluated in terms of the effect that they might have. Consequences on the company or organization The updating of the processes in finance department is needed with respect to the norms generally followed in IFRS approach. According to the changes made in the finance department, all other departments will also have to change their mode of operations. Impact on the management The transition will bring changes in the form of data reporting, storage and collecting. The entire system of the data maintenance has to be updated in order to cope up with the norms of IFRS. Changes in the perspectives of visualizing The long term transactions will have to be looked at in the perspective of the IFRS guidelines. The way of visualizing should be in accordance to IFRS for avoiding future confusions. Critical evaluation of the phenomenon of switching from GAAP to IFRS In order to bring a successful change to the traditional system of accounting that has been followed over the years, many companies are heading towards to switch over to IFRS. This particular section of the research paper tried to find out the advantages and disadvantages that a company may have to face due to the changes. The foremost advantage that can be enjoyed by the switching is comparability and above all reduction of cost. The multinational companies incur high amount of cost of capital because they have to keep records of different accounting standards in order to adhere to those. It provides greater flexibility to trade in terms of greater market liquidity and lower cost of capital. On the contrary to this advantage, the shortcoming that can arrive is implementation of the system itself in terms of its acceptability. One specific difference is that GAAP uses Last-In-First-Out (LIFO) method in inventory management. However, in IFRS this method is prohibited. Use of LIFO can help the companies to pay less tax because it leads to lesser gross profit. On the same note, reduced gross profit is not a preferable way out for a company. Transparency is the advantage of GAAP along with clear rules and standards. Switching to IFRS does not mean that it has been accepted due to its high quality but the major drawback is that it is giving a sort of monopoly status to the London-based IASB. The power of US towards accounting would diminish. Moreover, IASB does not have a stable of funding; the finances are primarily derived from contributions of different countries. 7 Conclusion The prime objective of the research paper was not to find out the theoretical differences between the two approaches of accounting. Rather it was solely aimed to find out the affect of the change on operations of various companies favoring the change. The transition can accompany certain major risks that cannot be even predicted by experts. There are mixed evidences around the world on the transitional issue. It has also been assessed that the cost of transition can surpass the benefits expected to be received. The adoption of IFRS by removing GAAP is something like launching a new product in the market without test marketing. Although many advantages of IFRS have been displayed over a few years now, still the goal of global acceptability seems complicated. The research paper has enumerated the pros and cons of both the systems and also the benefits and drawbacks of the switching process. The companies aiming to converge to IFRS needs a continuous monitoring of the standards with respect to its suitability. 8 References Fay, R. G. & Et. Al., No Date. “Incorporating International Financial Reporting Standards (IFRS) into Intermediate Accounting”. “University of Idaho”. http://www.cbe.uidaho.edu/Acct414/Other%20course%20materials/IFRS%20material%20For%20Students%20%28intermediate%20accounting%20topics%29%20from%20VirginiaTech.pdf Forgeas, R., 2008. “Is IFRS That Different From U.S. GAAP?”. “Historical Reminder”. http://www.cpa2biz.org/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2008/CPA/Dec/USGaap.jsp Jackson, S. B. & Pitman, M. K., 2009. “Inside the Motivations and the Methods”. “Auditors and Earnings Management”. http://www.nysscpa.org/cpajournal/2001/0700/features/f073801.htm McLaughlin, K., 2009. “IFRS—GAAP convergence likely to mean major changes in U.S. Accounting: principles-based international accounting standards are the norm for most nations”. “RMA Journal”. http://findarticles.com/p/articles/mi_m0ITW/is_5_91/ai_n31393053/ New York State Society of Certified Public Accountants, 1997-2009. “IFRS Overview”. “Background”. http://www.nysscpa.org/ifrs/overview.htm Stanford University, No Date. “GAAP (Generally Accepted Accounting Principles)”. “Cardinal Money Management”. http://www.stanford.edu/~mikefan/metrics/gaap.html The New York State Society of CPAs, 2009. “Defining Principles-Based Accounting Standards”. “The CPA journal”. http://www.nysscpa.org/cpajournal/2004/804/essentials/p34.htm Yoon, N., 2009. “Advantages and Disadvantages of switching from U.S.GAAP to IFRS”. “Bitstearm”. http://digitalarchive.wm.edu/bitstream/10288/1535/1/Yoon2009_monroeresearchpaper.pdf Read More