U.S. GAAP vs. IFRS: Fixed Assets

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U.S. GAAP VS. IFRS: FIXED ASSETS

The Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) have many differences. One of these major differences is the treatment of fixed assets. The accounting world is going through a convergence. The shift from rules-based U. S. GAAP to principles-based IFRS is intended to improve transparency and comparability in global markets (Kaya, 2013). International companies have already switched to this new accounting principle, but companies in the United States have yet to convert to IFRS. Many accountants think that because IFRS is not rules-based there is too much room for error, and when it comes to fixed assets there needs to be consistency. The following paragraphs will discuss the pros and cons of using IFRS or U.S. GAAP; discuss the opinions of others in the business or who could possibly have to use IFRS instead of U.S. GAAP.

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Current Rules

U.S. GAAP

U.S. GAAP uses historical costs when recording fixed assets (Rajan & Reichelstein, 2009). This is the recorded cost of the asset at the time of purchase and is not altered during the life of the asset. Transactions using historical cost can be verified, usually with a promissory note or a debt (Diana, 2009). Therefore, the historical cost accounting system is accepted by accountants due to its objective nature since the transactions have already been completed, and it is generally easier to understandable by its users. In an article titled “Historical Cost Versus Fair Value” the author, Cozma Diana (2009), states the characteristics of historical cost are (1) that it fails to ensure the comparability of information, as similar elements are valued; (2) it reflects the decisions whether to purchase assets or contract debts, but ignores the effects of the decisions whether or not to keep the contract debt; (3) it reports any gains or losses that result from the change in price, even if their selling or cancelling have not been the cause of such gains or losses, and accounting reports are completed by using the prices from past transactions, with the market prices not referenced; (4) it provides information about the benefits expected from the assets or about the “burdens” taken by contracting debts; and (5) accounting reports are drafted based on prices resulting from past transactions, with no reference to market prices. U.S. GAAP only allows a company to use historical cost whereas IFRS allows a company to choose either method of fair value or historical (p. 863).

IFRS

If all companies converted to IFRS there would be world-wide consistency in the business world. One standard of accounting would allow national and international companies work together in a more consistent manner. The bookkeeping would be uniform and companies would work under the same guidelines simplifying the auditing process.

Vitez (2014) stated that IFRS has three separate procedures for fixed asset accounting, which include the selection of the cost or revaluation method, estimate of the useful life for the asset and residual value, and the selection of a depreciation impairment method. Under U.S. GAAP, fixed assets are valued by using the ‘cost method’ where the IFRS uses a different method which is known as the ‘reevaluation method’ (Malboeuf, 2014). These methods are different by giving companies the ability to price their assets at what they think they should be and allow them to change the cost of their fixed assets at any time.

Cost or Reevaluation Method. The cost method is based on the historical value of an asset where the reevaluation method is based on the fair value. The U.S. GAAP requires companies to disclose information about the choices that they make about their expenses in footnotes. IFRS finds footnotes unnecessary (Malboeuf, 2014). IFRS permits companies to book the value of property above the value of historical cost (King, 2008). This could lead to companies to overstate their assets in order to record higher profits.

Useful Life Estimate for the Asset and Residual Value. One issue using IFRS is that each component of the fixed asset could have residual value. Therefore, if each unit has many different components the accountant would have to journalized each component separately instead of the asset being journalized as one unit as in U.S. GAAP. The residual value for an IFRS fixed asset is the value of the item at the end of the asset’s useful life (Vitez, 2014). With IFRS each fixed asset could have many components that need to be valued, where as with GAAP the fixed asset has one useful life value.

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The Selection of a Depreciation Impairment Method. Just like with U.S. GAAP, IFRS has many different depreciation methods available for use, though each company must only select one method for each fixed asset in use (Vitez, 2014). There are some depreciation methods that work better on some fixed assets than others. Most fixed assets are assigned a depreciation method in order for the asset to be properly distributed. Seifert (2012) explains that IFRS depreciates fixed assets on a “component” basis vs. a “whole asset” basis under U.S. GAAP; this allows parts of the asset to be on different depreciation schedule than other parts of the same asset as stated by. This allows companies to replace parts of their fixed asset and allows the asset longer life and gives the fixed asset higher marker value.

Opinions: U.S. GAAP vs. IFRS

Some have described asset writedowns in U.S. GAAP as the roach motel approach: “you can get in, but you can never get out!”(King, 2008). The market value is often considered too unstable and that it is too easy to manipulate, which makes it unsuitable to be used as an estimate for the value of an asset (Diana, 2009). The characteristics of fair value is it improves the comparability by valuating similar elements in a similar way, where as historical cost fails to ensure the comparability of information, as similar elements are valuated for inhomogeneous values (Diana, 2009).

Some accountants in the U. S. prefer using U.S. GAAP based accounting, because it is a standard that many of them have only used and might be wary of the change that IFRS has in store for fixed assets. It could cause the accounting books to take longer to balance as it creates more journal entries needed to correctly itemize each fixed asset and their components. They are also hesitant to switch to IFRS because of its principle based standards, and with the trouble there has been in the recent years concerning the doctoring of accounting reports some people are worried that if we give companies too much freedom then they will be less than honest with their stockholders when profits are low or if they get in trouble with a bad business purchase or investment. A. M. King (2008) clarifies that a possible drawback for U.S. adoption of the revaluation model is that because valuation is inherently imprecise, some companies may take an aggressive approach, at least in the initial revaluation.

The ongoing battle between GAAP and IFRS results in a no set standard that is best for the U.S., neither side can agree with the other on which accounting standard is best for the U.S. The principle-based IFRS method makes it easier for U.S. Companies to manipulate or control the outcome of these standards. Companies have already found loopholes in U.S. GAAP and it is very structured. IFRS standards would create bigger issues by allowing companies to place a value on each component of a fixed asset. It would also make it harder for auditors to find errors in accounting system of a company. IFRS accounting would allow companies to change market value of their fixed assets, which in turn would allow them to overstate the true cost of the fixed asset. U.S. GAAP companies have to record fixed assets at the time of purchase, and they are not allowed to be changed until the asset is used up or disposed of during the life of the asset. Eventually one day U.S. GAAP and IFRS will come to a mutual understanding and /or agreement but until that time the U.S. will stick with U.S. GAAP accounting rules and standards for their fixed assets recording.

References

Daniels, M. B. (1933). The Valuation of Fixed Assets. Accounting Review, 8(4), 302.

Diana, C. (2009). Historical Cost versus Fair Value. Annals of The University of Oradea, Economic Science Series, 18(3), 860-865

Hughes, J. S., & Williams, M. G. (2007). Discussion of "Strategic Consequences of Historical Cost and Fair Value Measurements". Contemporary Accounting Research, 24(2), 585-593.

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Kaya, C. (2013). Fair Value versus Historical Cost: Which is actually more "Fair"?. Journal Of Accounting & Finance, (60), 127-137.

King, A. M. (2008). GAAP vs IFRS: Will the Real Fair Value Please Stand Up?. Financial Executive, 24(10), 14-16.

King, A. M. (2012). Fair Value is Unfair. Financial Executive, 28(5), 73.

Malboeuf, E. (2014, April 9). The Similarities and Differences Between The GAAP and The IFRS, Retrieved July 23, 2014, retrieved from http://ezinearticles.com/?The-Similarities-and-Differences-Between-The-GAAP-and-The-IFRS&id=8436911 Malboeuf, E. (2014, April 9). The Similarities and Differences Between The GAAP and The IFRS. Retrieved July 23, 2014,Malboeuf, E. (2014, April 9). The Similarities and Differences Between The GAAP and The IFRS. Retrieved July 23, 2014,Malboeuf, E. (2014, April 9). The Similarities and Differences Between The GAAP and The IFRS. Retrieved July 23, 2014,

Rajan, M. V., & Reichelstein, S. (2009). Depreciation Rules and the Relation between Marginal and Historical Cost. Journal of Accounting Research, 47(3), 823-865. doi:10.1111/j.1475-679X.2009.00334.x

Seifert, D. L., & Lindberg, D. L. (2012). Getting the Jump on IFRS. Strategic Finance, 93(7), 35-39.

Vitez, O., (2014). wiseGeek: What are the Different IFRS Fixed Asset Procedures?. Retrieved from http://www.wisegeek.net/what-are-the-different-ifrs-fixed-asset-procedures.htm