This article was first published in the July 2011 Ireland edition of Accounting and Business magazine.
An increasing number of international companies are preparing their financial statements under International Financial Reporting Standards (IFRS) rather than US GAAP.
Since 15 November 2007, foreign registrants on US securities exchanges may prepare their financial statements under International GAAP (as defined by the IFRSs issued by the IASB) without providing 20-F reconciliations.
Further, in May 2008, the AICPA’s governing council approved amendments to their code of professional conduct, which recognised the IASB as an international accounting standard setter.
That removed a potential barrier to the use of IFRS by US private companies and not-for-profit organisations, who now can choose whether to follow IFRS (although the numbers of such entities availing of this choice is very limited).
Conversion to IFRS is not without cost, in particular IT and staff training costs. The Securities and Exchange Commission has estimated that the average US company adopting IFRS would incur costs of approximately 0.13% of revenue. The operational efficiencies offered by shared service centres may serve to mitigate some of these costs.
Differences in approach
Sometimes the difference between IFRS and US GAAP is called a ‘principles-based’ approach (IFRS) versus a ‘rules-based approach’ (US GAAP). This characterisation is somewhat simplistic as there are some principles under US GAAP and some rules under IFRS. It is fairer to say that international accounting standards, in general, provide less detailed guidance than US accounting standards.
This is particularly visible in the case of revenue recognition, where US GAAP provides detailed guidance notes based on different types of revenue transactions. US GAAP also provides more extensive industry-specific instructions in sectors such as oil and gas, insurance, financial institutions and not-for-profits.
As regards more specific differences between IFRS and US GAAP, the IASB and the FASB have been working on ‘converging’ their accounting standards for over a decade. As a consequence, the convergence of several standards has already been completed, including ones on business combinations and fair value measurement. However, some substantive differences remain.
These include the valuation of non-current assets, leasing, revenue recognition, and other comprehensive income. This is not an exhaustive list and preparers of financial statements for entities moving from IFRS to US GAAP should consult with their professional advisers as regards the details of particular transactions.
The discussion that follows focuses briefly on differences between IFRS and US GAAP requiring a change in measurement rather than those that simply require a change in classification. Changes in classification are less problematic than measurement differences. An example of these include extraordinary items which are not separately classified in the income statement under IFRS while, under US GAAP, they are shown below the net income.
Measurement differences are, potentially, more costly as they may require additional costing systems which recalculate the cost of, for example, inventory or other assets.
When measuring inventory under IFRS, the use of ‘last in, first out’ (LIFO) is specifically prohibited. Under US GAAP, companies have the choice between LIFO and ‘first in, first out’ (FIFO). While some discussion has taken place in the US with regard to the use of LIFO, it is likely to continue as an option under US GAAP, primarily for tax reasons.
Therefore, entities who may have complied with US GAAP by using LIFO would be required to adopt FIFO or average cost under IFRS. Fortunately, US GAAP requires that entities using LIFO disclose the FIFO inventory value. Therefore, sufficient information will generally be available to adjust the LIFO inventory values in US GAAP financial statements to the FIFO values allowed by IFRS.
Impairment is another area of difference in the measurement of assets: IFRS uses a single-step method for impairment write-downs which requires that impairment testing is performed if the impairment indicators specified by IAS 36 Impairment of Assets exist. US GAAP has a two-step approach which requires that a recoverability test is performed first.
Impairment testing is only performed under US GAAP when it is determined that the asset is not recoverable. This makes impairment testing and write-downs more likely under IFRS.
Development costs may also require re-measurement under IFRS. Some development costs must be capitalised under IFRS if specific criteria are met as set out by IAS 38 Intangible Assets. Under US GAAP, with the exception of specified software development costs which are required to be capitalised under FAS 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, all development costs are expensed.
This results in a clear conflict between IFRS, which requires capitalisation in specified circumstances, and US GAAP, which prohibits capitalisation except in specified, limited circumstances.
There are, however, some differences between IFRS and US GAAP which, while fundamental, do not necessarily require a change in measurement. This is where IFRS is more promiscuous than US GAAP and, therefore, what is required under US GAAP is permitted under IFRS.
The valuation of noncurrent assets is a good example of this. US GAAP requires the use of the historical cost model and does not permit the revaluation of non-current assets. IFRS allows the valuation of non-current assets under the historical cost model or at a revalued amount.
This is unlikely to change in the context of convergence between US GAAP and IFRS as US policy makers are wedded to the reliability of historical cost in the valuation of non-current assets. However, given the choices allowed under IFRS, entities moving from US GAAP to IFRS may continue to value non-current assets under the historical cost model (as required under US GAAP) and still comply with IFRS (which permits the use of historical cost).
Readers are advised to keep an eye on the project through the links below.
Ciarán Ó hÓgartaigh is professor of accounting at UCD