GAAP vs. IFRS: Comparing U.S. and International Standards

Introduction to GAAP and IFRS

Generally Accepted Accounting Principles (GAAP) refers to the set of guidelines and the resulting framework used to standardize accounting practices in the United States. The purpose of GAAP is to ensure that third parties who wish to view the financial information of a business entity can understand it in a manner that is free from bias or inconsistencies (Colson, 2005). These principles developed out of tradition that became codified over the years and have governed accounting practices in the United States ever since.

While GAAP is the standard in the United States, other countries have their own sets of standards, which may be similar to or quite different from GAAP (Wells, 2010). Globalization has created the need for a set of international standards that would allow the same degree of consistency and lack of bias that GAAP has provided domestically. In 1989, the International Financial Reporting Standards (IFRS) were developed to fulfill this role (West, 2008). Rather than maintain two separate sets of reporting standards, the United States has considered adopting IFRS to replace GAAP. This would allow accountants to comply with only one set of reporting rules, eliminating redundancy. The proposal has generated considerable controversy in the financial community. The following sections summarize the most recent research and professional opinion regarding the transition from GAAP to IFRS.

Key Structural and Philosophical Differences

The controversy surrounding the switch from GAAP to IFRS has produced a wide range of viewpoints from professionals across the business community. The most significant controversies center on the effect this switch would have on operational management. International standards are currently the norm for most nations other than the United States, and a change from GAAP to IFRS would mean not only changes in reporting, but also changes affecting operations from the supply chain to the distribution chain. The full scope of these effects remains a subject of debate.

McLaughlin (2009) summarizes the major changes that accountants and companies would need to adjust to as the standards are adopted. One of the first and most prominent changes is the statement presentation format. The new format includes a statement of financial position that summarizes comprehensive income and cash flows. These items are divided into business, discontinued operations, financing, income taxes, and equity. According to McLaughlin, the business section of each statement is further divided into operating and investing sections, which are in turn subdivided into assets, liabilities, income, and cash flow. This format provides a much more detailed report than GAAP practices required.

Beyond these functional changes, the philosophical basis of the statements differs as well. Managers would have greater discretion under IFRS regarding where to place certain elements of their operations (McLaughlin, 2009). Although the statements are more detailed, there are fewer rules under IFRS than under GAAP. McLaughlin also found that IFRS contains fewer industry-specific guidelines than GAAP, which has broad implications for how financial data is interpreted across different sectors.

Financial and Operational Impacts on U.S. Companies

Opinions regarding the effect that IFRS would have on businesses vary considerably depending on the industry and the size of the company involved. An examination of available sources reveals that views on the financial impact of IFRS/GAAP convergence are closely tied to the specific effects it would have on a given business.

A prominent example is the disallowance of Last In, First Out (LIFO) accounting for inventory under IFRS. This change eliminates the large deferred tax liabilities created by LIFO usage. For instance, United Technologies estimated that the inability to use LIFO accounting would result in a $4 billion tax liability in the first year alone (McLaughlin, 2009), which could significantly affect business operations.

Another key issue is that IFRS allows the revaluation of fixed assets, rather than requiring the historical cost approach used under GAAP. McLaughlin highlights many other operational changes as well, including how the valuation of properties such as rented buildings and equipment would change. In many cases, using a different accounting method produces materially different results. According to McLaughlin's study, companies reporting under IFRS recorded earnings that were 6–8% higher than they would have been under GAAP — translating into greater tax liability for many organizations.

Epstein (2009) explored key issues surrounding IFRS adoption and concluded that the overall economic effects would be positive. He found that reporting quality could be expected to improve, thereby increasing public trust in corporate institutions. He also found that while GAAP contains a larger set of complex formal rules, IFRS provides investors with more reliable and consistent reporting results. Because IFRS does not include industry-specific standards, anyone can interpret the results of a financial statement without specialized industry knowledge. Epstein further found that adoption of IFRS would result in lower costs of capital for many organizations — an effect that, combined with the higher reported earnings identified by McLaughlin, translates into significantly higher tax liability for many companies.

Conclusion

The move to IFRS is being fueled by global pressure to adopt a single standard. At present, approximately 100 countries use IFRS and only two remain on U.S. GAAP (Epstein & Jermakowicz, 2008). For U.S. accountants and other financial professionals, this change represents a significant departure from familiar practices. Accountants will need to not only modify the forms they use and their reporting formats, but also adopt a different accounting philosophy. These changes are substantial and have been met with considerable resistance within the accounting community, as accountants stand at the forefront of implementation and face the greatest adjustments.

As the literature suggests, the effects of GAAP and IFRS convergence will extend well beyond accountants and touch all areas of business operations. Those in the financial sector will feel the greatest impact, but the changes will be felt broadly — including by the American public, who will benefit from greater transparency and a greater ability to compare financial statements on an equitable basis. It is anticipated that IFRS adoption will increase public trust in company financial disclosures.

Much of the literature currently available on IFRS conversion is limited to practical guidance publications helping companies understand and implement the changes. At this time, the academic community has not yet fully addressed the results and effects of the conversion, as the changes are still in progress. This represents an important area for future research. Current opinions regarding the effects of the IFRS conversion remain speculative, and once companies begin fully operating under IFRS, academic studies examining the real-world results will follow. It is still too early to determine what the actual effects of the IFRS transition will be for U.S. companies.

Many of the authors reviewed in this paper agree that the convergence of IFRS and GAAP will produce positive outcomes overall. However, for some companies, the transition will mean greater tax liability due solely to changes in accounting methods. Taken as a whole, the opinions surveyed here indicate that results will vary across companies and industries — some will benefit while others will not — but that the overall effect on the economy is expected to be positive. Although the final verdict is still years away, the changes are not expected to produce significant differences in economic indicators or other key factors in the U.S. economy.

Substantial challenges remain, both from a policy perspective and at the individual company level. The Financial Accounting Standards Board and international counterparts continue to work through the complexities of convergence. Accountants face the steepest learning curve, but professionals across legal, financial, and operational functions will also be affected. Adoption of IFRS will present challenges that span every industry and sector in the United States.

References

Beuren, I., Hein, N., & Klann, R. (2008). Impact of the IFRS and U.S.-GAAP on economic-financial indicators. Managerial Auditing Journal, 23(7), 632–649.

Colson, R. (2005). General purpose financial statements. The CPA Journal, April 1, 2005.

Epstein, B. (2009). The economic effects of IFRS adoption. The CPA Journal, March 2009.

Epstein, B., & Jermakowicz, E. (2008). Global financial reporting — growing prominence of IFRS: Implications for transactional attorneys. Business Law International, 9(1), 1–93.

Jermakowicz, E., & Epstein, B. (2008). Joining the world: U.S. companies adopting IFRS. Butterworths Journal of International Banking and Financial Law, December 2008.

Liu, C. (2009). Are IFRS and GAAP already comparable? International Review of Business Research Papers, 5(5), 76–84.

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, February 2009.

Wells, J. (2010). Accounting standards. University library resource.

West, T. (2008). More convergence of GAAP, IFRS expected in 2008. Birmingham Business Journal, January 28, 2008.