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- International Financial Reporting Standards (IFRS) guide companies in reporting their financial results.
- IFRS is applied internationally in more than 160 jurisdictions.
- The US uses a different set of standards called Generally Accepted Accounting Principles (GAAP).
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The International Accounting Settings Board (IASB) is an accounting framework used widely by companies around the world to report their financial results.
Developed by the International Accounting Settings Board (IASB), the intent of IFRS is to create a single set of standards that are understandable, enforceable, and high quality. IFRS helps guide companies to prepare their financial statements, disclose information, and report their financial results.
IFRS also provides investors reliable and transparent information about a company's financial strength, market position, and performance. While IFRS is commonplace for international companies, the US uses a different set of standards, called generally accepted accounting principles (GAAP), which is established by the Financial Accounting Standards Board (FASB).
How do international financial reporting standards work?
While the idea has been around since the 1970s, IFRS was first widely adopted in the early 2000s.
IFRS provides accounting standards for how companies must keep records and report their financial information. The basic requirements for financial reporting include the following:
- Balance sheet: A company's balance sheet helps investors understand its financial position. IFRS influences how data on the balance sheet is reported to ensure accuracy.
- Income statement: This can be one statement, or include both the profit and loss statement as well as the statement of other income
- Statement of changes in equity: This statement displays a company's change of earnings or profit for a given financial period, also known as the statement of retained earnings.
- Cash flow statement: This statement separates a company's cash flow into investing, operating and financing activities and summarizes financial transactions for a certain period of time.
IFRS vs. GAAP
Currently, the IFRS Foundation is monitoring the use of the standards in more than 160 jurisdictions, including Canada, Australia, Mexico, and much of Europe. Even though US companies use GAAP, IFRS is permitted for US listings by foreign companies. More than 500 foreign SEC registrants use IFRS in their US filings.
While IFRS and GAAP both help guide companies on how to report financial information so that investors and other businesses can make informed decisions, the results can vary depending on which method is used. IFRS is "principles-based," while GAAP is "rules-based." Countries that have adopted the IFRS use guidelines, rather than rigorous rules, to help accountants create financial documents. Critics argue that this can sometimes result in different interpretations for the same or similar transactions, leading to second-guessing, uncertainty, and the need for increased disclosures in financial statements. GAAP provides a list of detailed rules for accountants to follow.
The two systems also have different requirements for accounting for some costs, including research and development. Another significant difference is how each allows companies to account for inventory. Both permit First In, First Out (FIFO), weighted-average cost, and specific identification methods for valuing inventories. GAAP, however, also allows the Last In, First Out (LIFO) method, while IFRS does not.
"While the FASB and the IASB have made progress in recent years converging certain key accounting standards, such as revenue recognition, significant differences still exist between US GAAP and IFRS that can make an entity's financial statements look very different," says Jeffrey Kranzel, CPA and managing director at business advisory firm Riveron. "For example, financial instrument accounting under IFRS more frequently results in mark-to-market treatment compared to US GAAP accounting standards. Therefore, an entity that either invests in financial instruments, such as structured debt, or issues financial instruments, such as warrants or convertible bonds, may see more volatility on both the balance sheet and income statement under IFRS."
Cecil Nazarath of Nazarath Global Accountants says differences in the way R&D is treated are among the most significant between the two standards.
"There has been substantial progress made in bringing the two standards closer together in important areas such as revenue recognition. However, the two standards differ greatly in areas such as research and development," Nazarath says. "Under US GAAP, all R&D costs are expensed. Under IFRS, however, only the research component is expensed - development is capitalized. As a result, companies using IFRS will appear to be more profitable than they would be under US GAAP."
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The financial takeaway
IFRS sets the standards that help guide companies on how to report their financials. They are principles-based. That gives companies flexibility in the way they account for various transactions. But it can also lead to difficulties in comparing one company's performance against another's.
While many of the world's jurisdictions have adopted IFRS or are planning to, the US uses its own standards system, known as GAAP. It is rules-based, with stricter and more specific accounting requirements. While this can make it easier to compare companies to one another, it can also make preparing the financial statements more complicated and difficult.
Regardless of whether a company uses IFRS or GAAP, the intent of each is for there to be more transparency on the strength and position of companies so that investors can compare one to another more easily.