October 5, 2024

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International Financial Accounting Standards Versus Generally Accepted Accounting Principals

International Financial Accounting Standards Versus Generally Accepted Accounting Principals

Though we have known for centuries of the globes spherical dimensions, the last few decades have proven that the earth might be “flat” after all. People communicate all over the world like never before, allowing transactions to flow freely from country to country. Because this is a first time occurrence as never seen in history, people are adapting rapidly to new types of problems or ways that we could make these interactions more efficient. One problem is that because of the free flow of business transactions through different countries and different law enforcements, one set of accounting standards needs to be put in place to have easier access to financial information. International Financial Reporting Standards are one set of accounting standards, put in place by the International Accounting Standards Board, which is becoming the global standard for the preparation of public company financial statements. The current lack of a uniform set of accounting standards creates problems for companies preparers and users. Many multinational companies, creditors, and investors support the idea for a global set of accounting standards, which would make it easier to compare the financial statements of a foreign competitor, to better understand opportunities, and to cut cost by using one accounting procedure company-wide.

Currently over 12, 000 companies in 113 countries have adopted international financial reporting standards as their new accounting standards. The SEC believes that this number will continue to increase. Japan, Brazil, Canada and Indian countries plan to start using IFRS in 2010 & 2011. Mexico will adopt IFRS in 2012. This same year the U.S. will include IFRS questions on their CPA exams. President Obama released the financial regulatory reform proposals, on June 17, 2009, which called for accounting standard setters to “make substantial progress toward development of a single set of high-quality global accounting standards” by the end of 2009. The United States are expected to converge and/or adopt the international standards, IFRS and cease to use their current generally accepted accounting principals, as early as 2012. The proposed deadline, which requires U.S. public companies to use IFRS, has been postponed to 2015. In order to do this, differences between GAAP and IFRS need to be recognized and eliminated.

There are several main differences between GAAP and IFRS, which are causing substantial delays in their convergence. Some major distinctions between these two standards are that the IFRS does not permit LIFO, it uses a single step method for impairment write-downs, it has different rules for curing debt covenants, reports business segments differently, has different consolidating requirements, and is less extensive guidance regarding revenue recognition than GAAP. These variations at a minimum, have to be intensely studied by FASB to conclude extensive impacts on United States companies.

The first major difference between these two set of standards is the handling of inventory. Currently, U.S. GAAP allows the costing methods for inventory of FIFO, average cost, and LIFO. The IFRS has banned LIFO and companies will have major changes in inventory valuation to fit the new standards. Also, no special rules for livestock or crop are specified in GAAP, while IAS 41 specifies the use of fair value less estimated selling costs for biological assets. Another important change in inventory accounting is that IFRS will present inventory at lower of cost or net realizable value rather than market. The IFRS will also require that lower of cost or market adjustments be reversed under defined conditions, while U.S. GAAP does not allow this reversal.

Second, IFRS has different measurement procedures for the impairment of goodwill and other intangible long-lived assets. U.S. GAAP measures goodwill impairment using a two step process that first compares the estimated fair value of the reporting unit with the unit’s book value. If the book value is greater than the fair value, goodwill is impaired and step two needs to be completed. In this next step, the fair value of net identifiable assets are established and subtracted by the reporting unit’s fair value. The excess in the fair value of net identifiable assets is to be considered the goodwill impairment. IFRS will not use this process of measurement and instead will use a single-step computation similar to other long-live assets. This measurement for long-lived assets will be done with reference to higher of value in use or fair value less costs to sell. When this impairment for the long-lived assets (not goodwill) are measured they are allowed to be reversed in certain conditions under the IFRS.

Third, GAAP and IFRS have different rules when dealing with the curing of debt covenant violations. When a debt covenant violation has occurred it must be cured before the end of the year balance sheet date because under international standards it is not permissible after year end. This will have a large impact on the way companies will chose to finance their operations. There will be more pressure for companies to renegotiate their debt or they will have to raise capital through the issuance of their equity. Violations of debt covenants will show clearly which companies are not financially strong and will continue to show future problems.

The last major difference between GAAP and IFRS is that the revenue recognition guidance is less extensive for the IFRS. The IFRS guidance on this topic fits into one book about two inches thick, while the U.S. GAAP has approximately 17,000 pages of rules and guidance. (IASB) One reason for this is that GAAP contains industry-specific instruction, for instance, the revenue made by software development. The IFRS has relatively low regulations on the way specific industries recognize revenue. Some other differences between GAAP and IFRS are differences in segment reporting and consolidations.

Segment reporting differs slightly between the two standards because GAAP is flexible about how the company defines its segments through the management approach. The internal management selects specific segments even if they differ from the financial statements, when following GAAP, because these segments correspond to the internal operations. The IFRS will not allow the management approach, and the segments used must match the financial statements. IFRS No. 8 “Operating Segments” requires the reportable segments to be disclosed in both the annual and interim financial statements, which include both business and geographical segments. Another difference is that it will be required to have two different bases of segmentation, a primary base and a secondary base.

Another distinction between these two standards is that consolidation will be handled differently. First, GAAP requires consolidation for majority owned subsidiaries, while IFRS will look at control as a factor for consolidation. Some other differences are that variable interest entities and qualifying SPEs have not been addressed by the IFRS, parent and subsidiary accounting policies will need to be conformed, and minority interests will be required in equity. When it comes to consolidating foreign subsidiaries there are additional differences to consider. In order to consolidate a foreign subsidy, the parent company needs to receive the foreign financial statements and conform to U.S. GAAP before translation of the foreign currency. This step will be eliminated and will make this type of consolidation easier. More emphasis, however, will be placed on the currency of the economy of which business actually occurs to determine the functional currency, while GAAP is open to judgment with high consideration of cash flows. And last, under GAAP the equity accounts are translated at historical value, but are not specified under IFRS.

There are many differences between the U.S. generally accepted accounting principals and the international financial reporting standards, including but not limited to topics such as, inventory, impairment measurements, the handling of debt, revenue recognition, segment reporting, and the consolidation of financial statements. With the determination for one set of reporting standards elimination of these dissimilarities will be evident through the ongoing efforts between the FASB and the IASB. The most important thing is that accountants in the United States need to be ready for this inevitable event, because after all, the world is flat.