The norms of GAAP and IFRS are quiet similar in some ways; however, some of the norms of IFRS differ from the norms of GAAP in the following ways:
• IFRS is principle based where the details are related to the economy and requires more explanation; whereas GAAP is based on more of the rules which at times become difficult to understand.
• According to IFRS rules, the statement of other gains and losses should be explained in a separate statement and if there are any kind of a change then it needs to be highlighted in the Statement of Changes in Equity; whereas according to GAAP rules there is a separate statement for gains or losses or they are combined with the Statement of Changes in Equity at the end of the accounting period.
• LIFO method is prohibited in IFRS; whereas it is permitted in GAAP.
• IFRS permits revaluations of intangible assets that are acquired from third parties in some situations; whereas GAAP does not allow revaluations.
• IFRS requires 2 years of financial statements including balance sheet, income statement, cash flow statement, changes in equity, and accounting policies and notes; GAAP on the other hand requires 3 years of these components except balance sheet.
• There is no particular format for balance sheet in IFRS. It only requires reliable and relevant information with description; On the other hand, GAAP requires a specified structure of a Balance sheet. It has to be in the decreasing order of its liquidity and can be either classified or non classified.
• Like Balance sheet, Income Statement also does not follow any standard format according to IFRS norms; however, the expenditure should be presented either in function format meaning the expenses are divided into certain functions like selling and marketing, administration and general, research and development, etc or in the nature format meaning the expenses are distributed into categories like purchases, salaries, rent, etc; whereas Income Statement according to GAAP norms has a standard format for the presentation and the expenditures are always in the function format. North America follows the function format of income statement; while the nature format is more common is some of the European countries including Italy, Spain, and France. (Baker, Ding, & Stolowy, 2005).
• IFRS prohibits the extraordinary items to be presented in Financial Statement; whereas GAAP requires these extraordinary items in the Financial Statement. For example a negative goodwill of a company is an extraordinary item which is presented in the income statement according to GAAP rules.
• If there are any changes in shareholder's equity, then it is not required in IFRS and it can be disclosed separately in the primary statement; whereas all the changes in the equity and comprehensive income has to be presented either separately as a primary statement or it can be combined with the income statement or statement of changes in equity.
• IFRS rules does not exempt cash flow statements in any kind of situations; whereas according to GAAP under some circumstances exemptions of cash flow statements are limited for certain investments and entities.
• Under IFRS the assets, contingent liabilities are all valued on fair value; whereas under GAAP the contingent liabilities are either valued on fair value or they are reasonably estimated.
• The biological assets under IFRS are measured at the difference between the fair value and estimated point of sale cost; whereas they are generally measured at historical cost under GAAP.
• Under IFRS research and development cost is capitalized; whereas under GAAP it is expensed. By expensing the companies can show less income and save on tax. (Similarities and differences: A comparison of IFRS and US GAAP, 2007)
By having so many differences one company can be analyzed differently in different countries. Their liquid funds, profitability, debt can vary depending on what kind of financial statement is being read. From the investor point of view one can have a different opinion on the same company if we have different accounting standards. (Beuren, Hein, & Klann, 2008).
Similarities :
• Both the standards require the capitalization of the intangible assets to be amortized if the criteria is met.
• The interest expense is presented on the accrual basis in IFRS as well as GAAP using the effective interest method.
• Both use the historical cost for Property, Plant and Equipment.
• Under both standards if the functional currency is not used, then the currency translation is done on the exchange rate at dates of transaction or at the average rate if the fluctuations of rates are not significant. (Similarities and differences: A comparison of IFRS and US GAAP, 2007)
Importance of IFRS:
By adapting International Accounting standards all the companies will be able to provide much more informative financial reports with much greater clarity and consistency and easily understandable with high quality. Businesses operating in multiple countries will have to follow one accounting rule to make their financial statements in different countries. This will allow the companies to expand their business network and think in one direction. (IFRS: What is driving change?). This will improve the company's internal communication, quality of reporting and will improve the company's group decision making. For example IBM which has subsidiaries in different countries have different accounting rules based on each country. By adapting international Accounting Standard it will allow the company to do accounting in same way in all the countries and this will make the company become structurally more efficient. This will reduce the complexity of preparing the financial statements as everything will be systematic. This will reduce the penalty risk as nothing will be manual.
Under IFRS the investment properties will be reported and measured by fair value. By doing so, the investment property will not be depreciated and therefore there will be no amortization cost. The land property appreciates over a period of time and therefore there is no need to depreciate it. This will benefit the real estate business by increasing the sales. (Agarwal, 2008).
The cost of capital will be reduced for the companies by using one standardized accounting system. After IFRS becomes compulsory all over the world, people working in different countries will take less time to get trained as the accounting standards will be same all over. Sometimes too many rules are followed by too many mistakes. IFRS believes in fewer rules and more on explanations in the forms of disclosures and therefore the accounting will be more accurate with fewer mistakes.
Cash planning will be improved as the dividends paid by the companies will increase. The treasury people will know the future dividends the company will be providing as before IFRS the subsidiaries used to provide dividends to parent company and parent company used to distribute the dividends based on the profit. After the adaption of IFRS there will be no such hassles and the company will directly provide the dividends; hence improving their cash management.
Investors will be benefitted as the comparison will become much easier and and much broader. They will be able to compare in a single format, leading to a much transparent and wiser decision. Adapting to IFRS standards can benefit the world's economy as the stock market will be globalized and standardized to one system. This will increase the foreign investors from all over the world. (International financial reporting standards for U.S. companies: Implications of an accelerating global trend, 2007).
Challenges faced and Important Steps needed
Changing the financial standards is not an overnight thing to do. There are lot of things which has to be taken care of and should be considered before changing the financial rules. Since every country has a different law and different tax rules, it becomes important to think all the issues before this big revolutionary change happens. Some of the issues which can be faced and necessary steps to be taken before adapting IFRS are as follows:
• Every country has a different regulatory process. So every country will have a different contract for IFRS. For example some countries require their standards to be in printed format while some countries require them in a different way in handbooks. Standards can be changed but Law cannot be changed for every country. Every country's process should be respected and the contracts should be made in such a way that the consistency is maintained throughout.
• Another issue which countries can face is the IFRS adoption cost. Every country has different income level. This cost will vary from country to country depending on the degree of change they need to make on their accounting standards. (Creighton, 2008).
• The change in accounting standard will affect the system of tax filing of the countries. As IFRS does not follow LIFO method, there are lot of countries which calculate inventories on LIFO method under GAAP norms and this can create problems for the tax filers. Local tax filings will need to be considered before any kind of a change is made.
• Companies will need to train the employees with the new standards. Initially the training might be hard as everyone will be used to of their old standards for a long time and adapting to new one always takes time; however it will less costly as once trained they will be trained for all the companies anywhere in the world. (Considering IFRS?, 2006).
• Every bank has a set rule for giving loans to the company. That can be a big issue which companies can face as IFRS requires everything to be on fair value and by doing so the profit which the company's will be calculating at the end will be less and when the company's were to use GAAP norms. So all the bank rules have to be considered before the changes and banks need to be little flexible in their rules.
Conclusion:
There has been an increase in international trade, multinational companies, foreign investments, etc and that is the reason there is a need for the financial world to become globalized. For globalized economy there is a need for one accounting language and therefore it can be said that IFRS is very important in today's financial world. Though there are lots of challenges for lot of countries to face before they adapt to this new standard; however it will bring success to all the countries as the market will become international and investors from all over will be able to invest easily in any country.
Like every coin has two sides, same way every standard has its good and bad sides. On one side if IFRS will benefit the company's globalization, on the other hand, the implications of IFRS cannot be in favor of the economy. For example if we take the Enron case, they did a huge scandal on their accounting and because of that fraud the whole company suffered. It was all under GAAP norms that SEC people got hold of them because GAAP has more rules to its norms so its is either black or white. On the hand, if it was all under IFRS, then SEC people might have taken longer to catch the fraud as rules are less under IFRS and it is more principle based. So it can be said that if IFRS is good for companies, frauds also become easy for the companies. If the countries face the challenge supporting and consider all the problems that can be faced during the revolutionary change and tries to take the important steps needed, then this change in accounting standards will be very beneficial for all the countries' economy on the global basis.
