GAAP vs. IFRS: Key Differences and Real-World Comparison

Introduction

As globalization begins to hit full stride, new rules and customs must be addressed alongside older and more established practices. The International Financial Reporting Standards (IFRS) represents a global perspective on accounting rules for international organizations. The United States, by contrast, follows its Generally Accepted Accounting Principles (U.S. GAAP) to regulate domestic companies. The purpose of this essay is to examine both of these frameworks, investigating their similarities and differences. It provides background on both sets of rules before using two real-world companies' financial statements to analyze how each framework operates in practice.

In order for fairness to prevail in the marketplace, standardized comparisons must be available for investors. Financial statements serve as the great equalizer in providing this data, as important and pertinent information may be deduced by experienced accountants. While there are a number of similar methods of tabulating data under both U.S. GAAP and IFRS, there are also a number of differences that make it difficult for preparers and investors to compare financial statements across organizations.

U.S. GAAP vs. IFRS: Structural Differences

Riordan and Riordan identify the main difference between these two methodologies as rooted in their basic structure. They argue that IFRS was developed in an environment in which standards were not required by regulators. As a result, the international system is more flexible and is considered principles-based. The authors note that "evidence of this flexibility is provided in the various benchmark and alternative treatments that still remain within some of the standards. As the primary example, historical cost is the benchmark for the valuation of property, plant and equipment, whereas current valuation is an acceptable alternative for valuation under IFRS [IAS 16]" (p. 4).

U.S. GAAP is considered more conservative than IFRS and is regarded as a rules-based methodology, due in large part to the high frequency of litigation in the United States. One example of U.S. GAAP's conservatism involves inventory write-downs: IFRS permits the recovery of value following a write-down, allowing a subsequent increase for recoveries in value, whereas U.S. GAAP does not permit such recoveries.

Gill (2007) highlights additional discrepancies between the two systems. He points out that IFRS does not require a prescribed form for income statements, while U.S. GAAP mandates an exact format with specific required data. He further explains that "even where the use of U.S. GAAP and IFRS result in the same assets appearing on a balance sheet, the values attributed to those assets may be different. IFRS permits an entity to regularly revalue property, plant and equipment to fair market value. An entity cannot pick and choose under IFRS, however, and if it revalues one item within a class of assets, it must revalue all items within the same class. IFRS provides for crediting increases in values to a revaluation reserve in the equity section of the balance sheet while decreases in values are treated as expenses to the extent the decreases exceed any previous revaluation increases."

It is important to use precise terminology when discussing language-sensitive subjects such as accounting income statements. Expenses are deductible against income and cannot be depreciated. Assets are not tax-deductible against income but can be depreciated. In other words, assets represent future-based resources that are expected to generate income, while expenses are real-time costs counted against current income only.

Before examining a company's financial statements, it is also important to understand the distinction between current and long-term assets and liabilities. Current assets are financial resources that can contribute to the company within the next twelve months and generally include cash, inventory, accounts receivable, and prepaid insurance. Long-term assets include capital items such as land and buildings. Current liabilities are similarly defined by the twelve-month threshold. The central distinction between long-term and current assets or liabilities is the one-year time horizon.

Explaining Key Accounting Terms

Apple's (AAPL) balance sheet helps define its relationship between assets and liabilities. Current assets from Apple's 2012 balance sheet show that their cash and cash equivalents, a current asset, totaled $10,746,000. Apple's long-term asset of property, plant, and equipment stood at $15,452,000. Apple carried a current liability for accounts payable of $32,589,000, and a long-term deferred liability of $2,648,000.

Retained earnings is a special indicator of a company's financial health and must be reported on the balance sheet. Retained earnings represent the income a company holds after distributing dividends to its shareholders. Apple reported $101,289,000 in retained earnings on its 2012 balance sheet — nearly double its retained earnings for 2011, which stood at $62,841,000. Some analysts might interpret this sharp increase as a sign that Apple was acting cautiously in anticipation of weaker markets.

Philips is a Dutch company headquartered in Amsterdam with broad and diverse business interests. According to their website, Philips strives "to make the world healthier and more sustainable through innovation" and operates "in the health and well-being domain." As an international company, Philips is not required to file under U.S. GAAP. In fact, an entire section of the company's annual report for investors is dedicated to explaining the specific differences in how Philips reports its financials. Additionally, Philips' most recent available report at the time of this analysis was from 2011, while Apple had already released 2012 information.