9 KEY Differences Between US GAAP and IFRS

published on 11 August 2023

Did you know that more than 140 countries around the world use International Financial Reporting Standards (IFRS) for their financial reporting? However, the United States is not one of them. The US uses its own set of accounting standards, known as Generally Accepted Accounting Principles (GAAP).

This means that companies that operate in both the US and other countries may face challenges in preparing and comparing their financial statements. In this article, we will explore nine key differences between US GAAP and IFRS, and how they affect accounting and finance firms with distributed teams in different locations.

#1 Inventory valuation

One of the most significant differences between US GAAP and IFRS is the accounting method for inventory costs. Under US GAAP, companies can choose between two methods: first-in, first-out (FIFO) or last-in, first-out (LIFO). FIFO assumes that the oldest inventory items are sold first, while LIFO assumes that the newest inventory items are sold first. Under IFRS, however, LIFO is not allowed. Companies must use FIFO or another method that approximates FIFO, such as weighted average cost.

The choice of inventory valuation method can have a significant impact on the reported cost of goods sold, gross profit, net income, and inventory balance. For example, in a period of rising prices, LIFO will result in a higher cost of goods sold and lower net income than FIFO. This will also affect the tax liability of the company, as US GAAP allows LIFO for tax purposes as well. Therefore, accounting and finance firms need to be aware of the inventory valuation method used by their clients or subsidiaries in different jurisdictions and adjust their financial statements accordingly.

#2 Intangible assets

Another key difference between US GAAP and IFRS is the treatment of intangible assets that are developed internally through research and development (R&D). Under US GAAP, all costs incurred in the research phase of an intangible asset are expensed as incurred. Costs incurred in the development phase may be capitalized if certain criteria are met, such as technical feasibility, intent to complete and use or sell the asset, and probable future economic benefits.

Under IFRS, however, costs incurred in the research phase are also expensed as incurred. Costs incurred in the development phase may be capitalized only if certain criteria are met, such as technical feasibility, availability of resources, ability to measure costs reliably, and probable future economic benefits. In addition, under IFRS, intangible assets with indefinite useful lives (such as goodwill) are not amortized but tested for impairment annually or more frequently if there are indicators of impairment. Under US GAAP, intangible assets with indefinite useful lives are also tested for impairment annually or more frequently if there are indicators of impairment, but they are also subject to a qualitative assessment that may eliminate the need for a quantitative impairment test.

The difference in accounting for intangible assets can affect the reported assets, expenses, income, and equity of a company. For example, a company that capitalizes more costs under US GAAP than under IFRS will report higher assets and lower expenses under US GAAP than under IFRS. This will also affect the amortization expense and impairment losses in subsequent periods. Accounting and finance firms need to be familiar with the accounting policies and estimates used by their clients or subsidiaries in different jurisdictions regarding intangible assets and adjust their financial statements accordingly.

#3 Revenue recognition

In US GAAP, revenue recognition is governed by various industry-specific guidance that prescribes when and how revenue should be recognized based on specific criteria and circumstances. Under IFRS, however, revenue recognition is governed by a single standard that applies to all types of contracts with customers.

The single standard under IFRS is based on a five-step model that requires companies to identify the contract with the customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations, and recognize revenue when or as each performance obligation is satisfied. The standard also provides guidance on various issues such as variable consideration, contract modifications, contract costs, warranties, licenses, royalties, and principal versus agent arrangements.

The difference in revenue recognition can affect the timing and amount of revenue reported by a company. For example, a company that recognizes revenue at a point in time under US GAAP may recognize revenue over time under IFRS, or vice versa, depending on the nature and terms of the contract with the customer.

This will also affect the related expenses, Assets, liabilities, and cash flows of the company. Accounting and finance firms need to understand the revenue recognition policies and practices

used by their clients or subsidiaries in different jurisdictions, and adjust their financial statements accordingly.

#4 Leases

Under US GAAP, leases are classified as either operating leases or finance leases, depending on whether the lease transfers substantially all the risks and rewards of ownership of the asset to the lessee. Operating leases are treated as rental agreements, where the lessee recognizes lease payments as an expense in the income statement and does not recognize any asset or liability in the balance sheet. Finance leases are treated as purchase agreements, where the lessee recognizes an asset and a liability in the balance sheet and recognizes interest expense and depreciation expense in the income statement.

Under IFRS, however, leases are classified as either operating leases or finance leases only for the lessor, not for the lessee. For the lessee, all leases are treated as finance leases, unless they are short-term leases (less than 12 months) or low-value leases (less than $5,000). This means that the lessee recognizes an asset and a liability in the balance sheet and recognizes interest expense and depreciation expense in the income statement for all leases, except for short-term leases and low-value leases.

The difference in lease accounting can affect the reported assets, liabilities, expenses, income, and cash flows of a company. For example, a company that has operating leases under US GAAP will report lower assets and liabilities, higher income, and lower cash flows from operations under US GAAP than under IFRS. Accounting and finance firms need to be aware of the lease classification and measurement used by their clients or subsidiaries in different jurisdictions, and adjust their financial statements accordingly.

#5 Consolidation

Consolidation is another area where US GAAP and IFRS differ significantly. Consolidation is the process of combining the financial statements of a parent company and its subsidiaries into a single set of financial statements that represent the economic activities of the group as a whole. Under US GAAP, consolidation is based on whether a parent company has control over a subsidiary, which is determined by various factors such as voting rights, contractual arrangements, potential voting rights, and variable interests. Under IFRS, however, consolidation is based on whether a parent company has power over a subsidiary, which is determined by various factors such as voting rights, contractual arrangements, potential voting rights, and substantive rights.

The difference in consolidation can affect whether a company consolidates or not consolidates a subsidiary or an entity that it invests in. For example, a company that has a variable interest in an entity that it does not control under US GAAP may have power over that entity under IFRS, and therefore consolidate it under IFRS but not under US GAAP. This will affect the reported assets, liabilities, revenues, expenses, and equity of the company.

Accounting and finance firms need to know the consolidation policies and judgments used by their clients or subsidiaries in different jurisdictions and adjust their financial statements accordingly.

#6 Financial instruments

Under US GAAP, financial instruments are classified and measured based on various criteria such as the nature of the instrument, the business model of the entity, and the characteristics of the cash flows. Under IFRS, however, financial instruments are classified and measured based on simpler criteria such as the contractual cash flow characteristics and the business model of the entity.

The difference in financial instrument accounting can affect the reported assets, liabilities, income, and equity of a company. For example, a company that measures an investment at fair value through other comprehensive income under US GAAP may measure it at fair value through profit or loss under IFRS, or vice versa, depending on the business model and cash flow characteristics of the investment.

This will affect the volatility of the income and equity of the company. Accounting and finance firms need to be familiar with the financial instrument classification and measurement used by their clients or subsidiaries in different jurisdictions and adjust their financial statements accordingly.

#7 Income taxes

In US GAAP, income taxes are accounted for using the asset and liability method, which requires recognition of deferred tax assets and liabilities for temporary differences between the tax bases and carrying amounts of assets and liabilities. Under IFRS, however, income taxes are accounted for using the balance sheet method, which also requires recognition of deferred tax assets and liabilities for temporary differences between the tax bases and carrying amounts of assets and liabilities, but with some differences in the recognition and measurement criteria.

The difference in income tax accounting can affect the reported assets, liabilities, income, and equity of a company. For example, a company that recognizes a deferred tax asset for a deductible temporary difference under US GAAP may not recognize it under IFRS, or vice versa, depending on the probability of future taxable profits. This will affect the effective tax rate and net income of the company. Accounting and finance firms need to be aware of the income tax accounting policies and estimates used by their clients or subsidiaries in different jurisdictions, and adjust their financial statements accordingly.

#8 Share-based payments

Under US GAAP, share-based payments are accounted for using the fair value method, which requires recognition of compensation expense based on the fair value of the equity instruments or rights granted at the grant date. Under IFRS, however, share-based payments are accounted for using either the fair value method or the intrinsic value method, depending on whether the equity instruments or rights granted are vested or unvested at the grant date.

The difference in share-based payment accounting can affect the reported expenses, income, equity, and cash flows of a company. For example, a company that grants unvested stock options to its employees under US GAAP will recognize compensation expense based on the fair value of the options at the grant date, while a company that grants unvested stock options to its employees under IFRS will recognize compensation expense based on the intrinsic value of the options at the vesting date. This will affect the timing and amount of compensation expense and net income of the company. Accounting and finance firms need to be familiar with the share-based payment accounting policies and practices used by their clients or subsidiaries in different jurisdictions, and adjust their financial statements accordingly.

#9 Presentation and disclosure

The last key difference between US GAAP and IFRS is the presentation and disclosure of financial information. Presentation refers to how financial information is organized and displayed in the financial statements, such as the format, structure, classification, and aggregation of items. Disclosure refers to how financial information is communicated and explained in the notes to the financial statements, such as the accounting policies, assumptions, judgments, estimates, risks, uncertainties, and contingencies.

Under US GAAP, presentation and disclosure are governed by various rules and regulations that prescribe specific requirements for different types of entities and industries. Under IFRS, however, presentation and disclosure are governed by general principles that require relevant, reliable, comparable, and understandable information for users of financial statements.

The difference in presentation and disclosure can affect how financial information is perceived and interpreted by users of financial statements. For example, a company that presents its income statement by function under US GAAP may present it by nature under IFRS, or vice versa, depending on what provides more relevant information for users. This will affect the comparability and analysis of the company’s performance. Accounting and finance firms need to comply with the presentation and disclosure requirements and expectations of their clients or subsidiaries in different jurisdictions, and ensure that their financial statements are clear, concise, and consistent.

    🔗 Kevin Mitchell | LinkedIn
    🔗 Kevin Mitchell | LinkedIn

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