Convergence of GAAP and IFRS

convergence of GAAP and IFRS

IFRS, GAAP and convergence

The two acronyms stand for International Financial Reporting Standards and for Generally Accepted Accounting Practices. The International Financial Reporting Standards were created by the International Accounting Standards Board and they represent a set of principles, rules and regulations on reporting and accounting. The aim of these standards is that of creating a "single set of high-quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles" (Website of IFRS, 2010).

The Generally Accepted Accounting Principles are the reporting regulations used within the United States and some other countries. Their global presence is reduced in comparison to that of the IFRS and their popularity is registering significant decreases. Today, emphasis is being placed on the convergence of the two and the creation of a globally normalized reporting system.

Throughout the past recent years, efforts have been intensified in the direction of a convergence between IFRS and GAAP. The number of countries subscribing to the regulations of IFRS has significantly increased and by 2013, their total numbers are expected to be around 150 states. Before adopting the International Financial Reporting Standards, countries traditionally form their own divisions to investigate the current reporting systems in the country and to develop a plan for convergence to the IFRS. The convergence plan usually spreads out through a duration of several years. Within the United States of America, the convergence process was commenced by the Securities and Exchange Commission (SEC) and its scope is that of aligning the reporting standards in the GAAP with those of the IFRS with the final benefit of simplified and standardized reporting system which reduce the complexities of international reporting (United Nations, 2007).

2. Differences between IFRS and GAAP

The process of convergence is slow and implies tedious work. One of the reasons which created delays in the competition of the convergence is given by the differences between International Financial Reporting Standards and the Generally Accepted Accounting Principles. Some of the existent differences have been resolved throughout the past recent years, but some of them continue to raise difficulties through today. The most relevant differences which continue to exist are as follows:

a. General approach -- in case of the IFRS, the general approach is a principles-based one, whereas the general approach in the case of GAAP is a rule-based one

b. Comparative information -- the IFRS requires one year of comparative information, whereas the GAAP does not take an official stand in this aspect (SEC does however state a three-year requirement for comparative information)

c. Extraordinary items -- they are prohibited by the IFRS but accepted as rare by the GAAP

d. Jointly controlled entities -- IFRS allows both proportionate consolidation as well as equity, whereas GAAP normally requires the equity method

e. Revenue recognition -- IFRS contains 18 principles, whereas GAAP are wider as they are industry specific

f. Development costs -- capitalized and amortized under IFRS and incurred with GAAP

g. Property, plant and equipment -- IFRS permit revaluation of the assets, whereas GAAP do not

h. Inventories -- differentiated by the use of LIFO (last in, first out) as IFRS do not permit it whereas GAAP do

i. Investment property -- under the IFRS, the investment property is measured at fair value or depreciated cost, whereas under GAAP, it is only measured as depreciated historical cost (Robertson, 2009).

3. Similarities between IFRS and GAAP

In spite of the differences, fact remains that the convergence of the International Financial Reporting Standards and the Generally Accepted Accounting Principles is being eased by the existence of several similarities. In this order of ideas:

a. The primary financial statements requested under the GAAP and the IFRS are virtually the same

b. In terms of standards used for setting the environment, the IFRS use the standards of the IASB whereas the GAAP use the standards of FASB. The two boards implement similar means of setting the standards

c. The conceptual frameworks for IFRS and GAAP are highly similar

d. The recording process is the same for both accounting standards (double entry recording)

e. Both GAAP and IFRS require a balance sheet and an income statement and the balance sheets and income statements completed under two sets of principles are highly similar

f. The accounting and repotting of cash is virtually the same

g. Both GAAP and IFRS require strong internal control systems in order to comply with the accounting regulations

h. The accounting of receivables is virtually the same

i. In terms of the recording of intangible assets, the mechanisms in both GAAP as well as IFRS require the expense of costs in the research stage

j. Both GAAP and IFRS require economic agents to present their liabilities at the commencement of the balance sheet

k. The accounting of the issuance of stock to the shareholders is also similar

l. In terms of statements of cash flow, "both IFRS and GAAP require that the statement of cash flows have three major sections -- operating, investing and financing -- along with changes in cash and cash equivalents, and both permit use of the indirect or direct method" (Weygandt).

4. Risks of convergence

Just like any other international phenomenon, the convergence of the International Financial Reporting Standards and the Generally Accepted Accounting Principles is both praised as well as condemned. One the one hand sit those who argue that the convergence would lead to the formation of a standardized accounting and reporting system which would subsequently reduce the burdens of international and reporting affairs. On the other hand, there are those who argue that the convergence would bring about a series of risks. Among them the following: