GAAP AND IFRS 8
Significantorganizations in the world of finance reporting agree that thereshould be a common language globally for capital market to functionwell. However, there is a great conflict between adopting the US GAAPor the international IFRS. US GAAP stands for Generally AcceptedAccounting Principles, while the IFRS stands for InternationalFinancial Reporting Standards. IFRS was implemented to meet thedemands of the capital markets globalization and the ever increasingglobal investors. There was a great concern on which standard toadopt. Many began adopting the US GAAP trend since the United Stateshad the most investors and the biggest market in the world. As such,many accounting organizations thought that adopting the US GAAP wasthe best way. However, as other markets became globalized and moreinvestors came into being, many accounting organizations in variouscountries began disregarding the US GAAP. Further, the United Statesorganizations were strongly hit by accounting scandals somethingthat led to many countries questioning the US GAAP. In turn, manynations turned to IFRS, which was highly accepted as it led tointernational standardization of financial reporting.
Typically,US GAAP mainly targets the profit making companies while IFRS targetsboth profit and nonprofit organizations. Any business that wishes tocomply with IFRS must comply with all its requirements and make astatement showing that it is ready to do so. This also applies tocompanies that wish to comply with US GAAP. Both the two standardshave differences and similarities in various accounting principles.
Both require an organization to present a complete financial statement set. These include profit and loss account, balance sheet, and cash flow statement.
IFRS and GAAP require the accountants to present any changes made to shareholder equity. However, worth noting is that the change in GAAP are presented as notes, whereas IFRS presents the information on shareholder equity changes as a separate statement (Cook, 2005).
Differencesbetween IFRS and US GAAP
US GAAP is based on rules applicable to accounting books, while IFRS is based on principles only applicable to financial statements. This has made it easier for many companies to adopt IFRS.
GAAP requires companies to carry inventories at current costs of net realizable value to be deducted from normal profits. On the other hand, IFRS states that a firm should value inventory at net realized value.
With regard to consolidation, IFRS uses control method, whereas GAAP uses risk and reward control.
With reference to earning per share, GAAP requires the incremental share to be averaged in computation of the earnings per share, whereas in IFRS, this does not take place.
Potential voting rights in US GAAP are not put in consideration in determining significant influence. IFRS, on the other hand, potential voting rights play a significant role in determining a significant influence.
US GAAP does not require uniform accounting policies between an investee and an investor. Uniform accounting policies between investee and investor are necessary in the case of IFRS.
There is no general requirement in US GAAP to prepare a balance sheet as long as it follows the regulation S-X. However, IFRS requires accountants to prepare a balance sheet using a list of minimum items, even though there is no specific prescribed layout (Cook, 2005).
US in inventory methods
IFRSand US GAAP differ in various ways. The IASB indicates that there aredifferences and similarities between the two in accountinginventories. The major difference between the two is the methods ofinventory used by the two accounting standards. Inventory refers tofinished goods, work in progress, and raw materials owned by a firm.Inventory is considered as an asset that accountants must put intoconsideration when preparing financial records. This paper seeks todiscuss LIFO method of inventory as applied by GAAP.
Inventorymethods are based on the principle that inventory is a cost inaccounting. Accounting standards define inventory as assets held forsale. Several methods of inventory differ significantly between US. One of the differences is the use of LIFO. Whereas USGAAP allows the use of LIFO method of inventory, IFRS prohibits it.LIFO is a term that stands for last in first out. It is an inventoryvaluation that assumes that the last products in the inventory shouldbe the first to be sold in the next accounting year. A consistentformula for all inventories may not be required by US GAAP. On theother hand, same formula for inventories must be similar for IFRS.IFRS favors the use of FIFO method of inventory as opposed to LIFOmethod of inventory. FIFO refers to first in first out. In this case,the products purchased first should be sold first. This means thatwhen selling out products, it is importance to ensure that thoseproduced first leaves first. FIFO gives people a better indication ofvalue in the balance sheet. It also increases the income becauseinventories that are several years old are used to value the cost ofthe goods sold. However, there is a major disadvantage because it hasthe potential to increase the taxes that a company should pay. LIFO,on the other hand, is not a good way of ending inventory because someleftover inventories might be too old and sometimes obsolete. When acompany applies for LIFO, which results to lower taxes when priceincreases, it must continue with the same inventory methodthroughout. The company must also use the same inventory method whenreporting for financial results to all stakeholders. It is worthnoting that this lowers the net income and consequently, the earningsper share. This also means that the company must also use LIFO.Average costs, which can also be used by IFRS, falls in between LIFOand FIFO. It is important to put in mind that companies should notbenefit from making use of all the inventory methods. Each companymust choose one type of inventory method throughout the year(Carmichael, Whittington & Graham, 2012).
Theother difference exhibited in inventory method is the measurement. USGAAP requires the inventory to be carried at the lower cost of themarket. In this case, market is described as the current replacementcost, which should be no longer than the net realizable cost. Itshould also not be lesser than the net realizable value that has beenreduced by the normal sales margin. The net realizable value is theestimated selling price that is significantly less than thereasonable costs of sale and completion. On the other hand, althoughIFRS is carried at the lower cost of the market net realizable value,it is described as the estimated price, which is less than theestimated cost to make sales and completion
LIFOwas not always used under GAAP. Its implementation took several yearsand much effort from accountants and big businesses. The popularityof this method of valuation rose during the NEW DEAK in theadministration of Roosevelt. It was promoted by unfavorablegovernment policies including undistributed profits tax aimed atboosting the economy. Before then, FIFO was the most favorable formof tax while LIFO was nonexistent. FIFO was highly value during thedepression period when declining prices led to reduction in taxableincome. However, as businesses flourished after the depression,businesses began seeking other methods of valuation that would matchup with the cost of inventory. Large corporations advocated for LIFOmethod of inventory valuation as it would increase the costs of goodssold, reduce required distributions to all stakeholders, and lowerthe net income. Further, the undistributed profits did not reflect anaccurate income and profits. Amidst a great struggle and oppositions,LIFO was finally adopted (Khan & Jain, 2007).
LIFOhas received much scrutiny from various accounting organizations asit allows companies to undervalue their net income and hence pay lesstax. It also has an impact not only in firm’s net income, but alsoin total assets and noncurrent liabilities. Calculations under LIFOare complex and cumbersome in case frequent purchases are made in theevent of fluctuating rates. The costs of batches produced at the sametime may differ significantly. When the prices fall, the accountantsare required to write off stock value so as to stick to the stockvaluation. This method of inventory valuation is not suitable forincome tax authorities (Khan & Jain, 2007).
Currently,more than 110 nations globally use IFRS standards. With the increasein international investors and globalization, many accountantorganizations are fighting for a common standard of accounting. Thishas also called for convergence of the two main accounting standardsto ease international trade. The convergence is mainly used toaddress the most crucial differences that could have a major impactin international businesses. Even though the convergence is aimed atmaking most accounting standards similar, some differences willcontinue to persist (McEwen, 2009).
Carmichael,D. R., Whittington, O., & Graham, Lynford. (2012). Accountants`Handbook, Financial Accounting and General Topics.John Wiley & Sons Inc.
Cook,D. (2005). IFRS/USGAAP comparison: A comparison between international financialreporting standards and US GAAP.London: Ernst & Young.
Khan,M. Y., & Jain, P. K. (2007). Managementaccounting: Text, problems and cases.New Delhi: Tata McGraw-Hill.
McEwen,R. A. (2009). Transparencyin financial reporting: A concise comparison of IFRS and US GAAP.Petersfield: Harriman House.