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IFRS is an acronym of International Financial Reporting Standards established by International Accounting Standards Board. It is regarded as a global standard that gives guidance on the preparation and disclosure of public company financial reports. GAAP on the other hand is an acronym of Generally Accepted Accounting Principles. GAAP amalgamates standards, conventions and rules which accounting professionals follow in order to record and summarize transactions as well as in preparing financial reports. IFRS and GAAP frameworks are known to exhibit differences in certain aspects. IFRS is a global standard used by companies across the world while GAAP is only used by listed companies.
GAAP differs from IFRS with respect to financial liabilities and equity. IFRS and GAAP have other aspects in common and these include revenue and inventory. The potential risk associated with IFRS and GAAP convergence includes time and cost as well as the unlikelihood of the type of support to get from the international standard setters.
IFRS and GAAP and what convergence means
IFRS is an acronym of International Financial Reporting Standards. IFRS can be defined as a group of accounting principles that were originally established under the flagship of the International Accounting Standards Board (IASB). IFRS has become a global standard and is widely used to prepare and disclose public company financial reports. It acts as a handbook that gives general direction regarding to the preparation of financial reports. This measure is applied in over 100 countries in the world and is projected that by 2015 more countries will have adopted it. This standard is significant for large companies that have expanded their business to other countries for it makes easier for them to prepare a one language financial statement, (Cook, 2005).
On the other hand, GAAP is an acronym of Generally Accepted Accounting Principles. It can be defined as a standard that provides guidelines with regard to financial accounting, however it is applied in a defined jurisdiction that in general are called Accounting Standards. GAAP amalgamates standards, conventions and rules which accounting professionals follow in order to record and summarize transactions as well as in preparing financial reports. GAAP rules and procedures, which were developed by Financial Accounting Standards Board (FASB), took long time to be established hence making them to appear complex to comprehend. GAAP is gradually replaced by International Accounting Standards because of the fact that many businesses have taken global direction thus making it insignificant in reporting financial transactions. It is only used in United States as companies located in that territory apply it during their financial reporting.
The meaning of convergence is that the United States Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) will have to jointly continue working to ensure progress in developing a high quality and compatible accounting principles. A very strong convergence is known to facilitate adoption, for it reduces its cost thus making IFRS adoption not necessary.
Significant differences between IFRS and GAAP
The International Finance Regulation Standards (IFRS) are under the control of International Accounting Standards Board (IASB). Many companies across the globe are using the IFRS in preparing and disclosing their financial reports. While on the other hand, GAAP is under the control of Financial Accounting Standards Board (FASB) and is used by listed companies, (Cook, 2005). The differences between IFRS and GAAP are known to be reducing and this has been brought about by the agenda of convergence between these organizations. In observing the aspect of revenue recognition between the two, GAAP is seen to have a comprehensive detail that provides guidance to different industries and incorporates standards that have been proposed by other local accounting standard organizations based in the United States. On the other hand, IFRS provide guidance through naming of two major revenue standards as well as interpretations with respect to revenue recognition.
Quite significant differences also exist between the two and these arise when it comes to the time of recognizing an expense and the amount to be documented. To illustrate this, we find that IFRS tends to recognize the expense of a given stock alternatives covered over a period time quicker than its GAAP counterpart.
GAAP significantly differs from IFRS when looking at the aspect of financial liabilities and equity. Hence instruments defined as equity under GAAP are treated as debt by the IFRS standards.
GAAP is viewed to have manifold avenues for consolidation compared to IFRS. Under IFRS it is observed that an organization can experience consolidation depending on the power it can exercise with respect to the financial and operational policies of another entity. An organization's responsibility of reporting and performance of other new entities can impact greatly on its financing preparations as well as many areas of its operation.
Last but not least, with regard to inventory, companies' use of Last in First out (LIFO) under IFRS is prohibited while under GAAP, companies have the right to choose between Last in First out (LIFO) and First in First out (FIFO).
Similarities between IFRS and GAAP
There are manifold similarities existing between IFRS and GAAP. In fact the differences between the two are reducing drastically and this is attributed to convergence agenda of the two organizations. IFRS and GAAP are similar with respect to the financial report presentation. Under both models one can see all elements of a set of financial reports which include balance sheet, income statement and statement of cash flows. In addition both IFRS and GAAP necessitate preparation of financial reports that are inclined to accounting accruals except cash flows statement; however the rule can be overlooked under rare occasion.
Another point of similarity between IFRS and GAAP is inventories in that they both use cost as the base for evaluation of inventory. Both frameworks give a definition of inventory as assets that are supposed to be sold during business operation or which can be consumed during the production of goods and services, (Epstein and Eva, 2008).
IFRS is also similar to GAAP with respect to revenue, in that both models recognize revenue after it has been earned or realized. Under GAAP, during discussion of the sale of goods, it necessitates legal transfer of ownership and this entails delivery of goods at agreed price and receiving of payment by the seller as expected. However with regard to IFRS, earnings are documented after the transfer of risks and rewards of ownership and the buyer has possessed the goods.
Another area of similarity between GAAP and IFRS is that both frameworks have a section the income statement that is allocated for extraordinary items. These extraordinary items are treated as material gains or losses, observed both as unusual and infrequent and therefore don't constitute part of a company's continuing business operations. However these extraordinary items are known to vary depending on the industry and region. Under GAAP, extraordinary items are classified under distinctive list, while under IFRS; the extraordinary items are incorporated with the company's other gains and losses.
Potential risks of IFRS and GAAP convergence
There are many risks associated with IFRS and GAAP convergence. The proponents of adoption have negative feeling that convergence of GAAP and IFRS will not result to accumulation of benefits. It is believed that convergence alone will hardly eliminate the all differences linked with the two standard models. IFRS and GAAP convergence involve considerable amount of money and time. It will become an uphill task for companies to integrate IFRS for they will have to train their employees to understand how it works and this involves a lot of money which companies will have to risk. In fact the longer it takes for the companies to integrate IFRS, the more costly it will be for companies, (Walton, 2009). This may make a company to face loss due to time wasted in training its employees to understand how to apply IFRS in preparing financial statements.
Another risk linked IFRS and GAAP convergence is that accountants will have to make their own assumptions and judgments during preparation of financial statements. This will force them to give thorough explanation about their reasoning simply because of the fewer rules that will come up as a result of IFRS and GAAP convergence. Challenges pertaining to the success of international convergence will haunt nations as they will not know what to do and in matter of fact they will not know the type of support to get from the international standard setters.