Difference Between GAAP and IFRS - Essay Example

Difference between GAAP and IFRS The GAAP and the IFRS are the two accounting standards that are used by businesses. The IFRS is used in over 120 countries, especially countries in the European Union, while the GAAP is used primarily in the United States. Although the two standards serve the same purpose, there are some differences in the way they operate. The most outstanding difference between the two is that while the GAAP is based on rules, the IFRS is based on principles. Unlike a rule based system, the principle based system allows for different interpretations of similar transactions. This difference between the IFRS and the GAAP is the core of other differences between the two standards. A major difference between the two standards is the way revenue is recognized. The GAAP has more extensive guidelines on revenue recognition compared to the IFRS. The IFRS has two standards of dealing with revenue recognition while the GAAP provides several concepts as well as detailed rules to deal with revenue recognition in different industries. The IFRS requires revenue to be recognized when it is likely that the benefits associated with a transaction can be traced to the entity and quantified reliably. In contrasts, the GAAP provides criterion for determinable or fixed pricing in revenue recognition. In this case revenue cannot be recognized until the amount of the revenue is ascertained. This implies that under the IFRS revenue that is not of a set amount is recognized earlier as compared to the GAAP (Erchinger, and Winfried 124). Another point of difference between the two standards is in relation to financial assets. The IFRS only provides two standards to deal with financial assets while the GAAP has extensive guidelines that apply in various industries. While the IFRS classifies assets into various categories, the GAAP classifies financial assets into pronouncements. The GAAP looks into the legal form of the entity while classifying financial assets while the IFRS considers the nature of the instrument. Financial asset classification is important as this affects income statements and the entities equity. Different classification of financial assets by the two standards can significantly affect the amount in the entity‘s financial statements. There is also a major difference in the manner the two standards treat intangible assets. While the GAAP does not allow for capitalization of internally incurred costs related to development, the IFRS allows for this capitalization when certain criteria are met. In relation to asset impairment, the IFRS prescribes a single step to test impairment while the GAAP follows a two step approach to impairment. The approach adopted by the IFRS requires the entity to compare an assets carrying amount with its recovery amount. In contrast, the GAAP provides for a comparison of the assets carrying amount and its undiscounted cash flow. If the carrying amount is greater when compared to the undiscounted cash flow, the impairment is the difference between the carrying amount and the fair value (Van der Meulen, Sofie, and Marleen 129). The two standards also differ in the way they value inventory. The GAAP allows the use of the last in first out (LIFO) and the first in first out (FIFO) as well as the weighed average in valuation of inventory. On the other hand, the IFRS only allows the use of the weighed average and FIFO. The standard does not allow the use of the LIFO method of inventory valuation. This difference means that the tax liability incurred is different depending on the standard that is adopted by the entity. Depreciation of assets is also different in the two standards. The IFRS allows for the use of accepted methods and the straight line approach in asset depreciation. The GAAP, on the other hand, allows the use of units of production in addition to the methods allowed by the IFRS. The difference in the approach of depreciating assets results in different depreciation schedules which affects the assets and revenue of the entity. With regard to leases, the two standards also adopt a dissimilar approach. The IFRS looks at the overall elements of the transaction, their extent and risks of ownership that are transferred with the lease. The measurement criteria adopted by the IFRS is similar to the one used by the GAAP with the exception that there is no specific amount stipulated. In contrast, the GAAP provides specific guidelines in determining whether a lease should be considered capital or operating. The criteria used takes into consideration the term of the lease, the value of the minimum lease payment and ownership transferring to the leasee. This difference shows how the IFRS allows decision based judgment while the GAAP follows a strict set of guidelines (Erchinger, and Winfried 124). The GAAP and the IFRS also adopt different approaches in accounting for income taxes. The GAAP uses the enacted tax rate in place to measure deferred taxes while the IFRS uses the substantial enacted tax rate to measure deferred taxes. Under the GAAP deferred taxes are classified as either long term or short term while the IFRS always classifies deferred taxes as long term. Additionally, accrued expenses under the IFRS must be disclosed in detail whereas the GAAP does not require a detailed disclosure of accrued expenses. Under the GAAP, the carrying value of assets uses the historical cost while the IFRS allows for revaluation of assets to its fair market value. There is also a difference in the manner development costs are accounted for by the two standards. The GAAP treats research and development costs as general expenses incurred by the entity. Under the IFRS some research and development costs can be capitalized. Other elements that are treated differently are extraordinary items. The GAAP defines extraordinary as losses and gains that are infrequent and unusual. The GAAP allows the extraordinary items to be treated as net income. The IFRS, on the other hand, does not allow extraordinary items to be treated as net income in the statement of income (Van der Meulen, Sofie, and Marleen 121). The differences in the two accounting standards cause a disparity in the way businesses present their financial information. Convergence is aimed at establishing a single accounting standard in order to reduce the difference between the IFRS and the GAAP. Works cited Erchinger, Holger, and Winfried Melcher. "Convergence between US GAAP and IFRS: Acceptance of IFRS by the US Securities and Exchange Commission (SEC)." Accounting in Europe 4.2 (2007): 123-139. Van der Meulen, Sofie, Ann Gaeremynck, and Marleen Willekens. "Attribute differences between US GAAP and IFRS earnings: An exploratory study." The International Journal of Accounting 42.2 (2007): 123-142. Read More