A short overview of differences
In a global environment where different aspect of growth and learning are intertwined to the utmost degree, financial accounting and reporting are no exception. The reporting world has had its significant share of changes over past decade or so, due to the impact on various event that raised concerned about the presentation of the financial statements and its users. The impact of these changes has caused the global accounting bodies to collaborate with each other and identify a common ground for disclosures in the financial statements and its consistency.
This brings us to the topic of IFRS and US GAAP reporting that covers most of the Financial Statements preparation across the world. The interesting aspect between the two boards International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) recently is the manner of collaboration and analysis they have done to streamline major differences in the reporting. There is no such thing as one size fits all but none the less efforts to ensure consistency should always be welcomed.
When it come to the financial services environment especially Hedge Funds and Private Equity funds and applying these standards; we see complexities from both set of reporting’s. Taking a step back first we need understand how they reflect across the globe and to have an overview of the differences in these standards:
At a global level most of the countries in the world follow IFRS or their local version of it. IFRS is used in more than 110 countries around the world, including the EU, Middle East, Far east, Sub-continent and South American countries. US GAAP, as it states, is only used in the United States. Companies that operate in the U.S. and overseas may have more complexities in their accounting.
IFRS tends to be more “principle based” which is open to interpretation by the users. US GAAP on the other-hand falls under the realm of being “rules based” which are clearer in the application. US GAAP mostly is clear on the requirements as compared to IFRS. There are company specific rules in US GAAP, for example in case of Investment companies they are a separate guideline to follow while reporting. Under IFRS, as it is open to interpretation, individuals preparing a set of financial statement for the same company may have two different set of financial statements based on their judgment and interpretation to determine how the standards are to be applied.
Primary Statement are defined generally as Balance Sheet, Income statement, Statement of changes in Equity and cash flow statements. One of the biggest differences which is clearly evident from looking at a set of financial prepared under IFRS and US GAAP is the comparatives. Comparatives are not required under US GAAP. Additionally, US GAAP does not prescribe the line item format in the primary statement or the manner in which each item is presented it is more of SEC (United States Security and Exchange Commission) requirement.
IFRS prescribes direct or indirect cash flow but the cash flow under US GAAP prepared for the investment companies if more of a hybrid style which includes elements of direct and indirect method. Additionally, under US GAAP Schedule of Investments (SOI) is mandatory requirement and forms a part of primary statements which differs to IFRS.
Notes to the Financial Statements
There are various differences between the IFRS and US GAAP when it comes to the disclosure notes in the financial statements in respect of valuation and measurements or comparative requirements; but the most glaring difference is the disclosure of financial highlights under US GAAP. It includes per share data, total return and ratios for net investment income and expenses as prescribed under the Investment companies’ guidelines.
On the other hand, for financial instrument considered as Level 3, a quantitative sensitivity analysis is required for financial statements presented under IFRS. US GAAP does not require such disclosure.
Master Feeder Structure
Investment companies’ guideline in US GAAP allow the financials of a feeder fund and a master fund prepared separately despite feeder holding majority of the equity in the master fund. IFRS on the other hand requires consolidation if the control over the entity is justified.
Practical Expedient and Netting
Under US GAAP practical expedient is allowed to value investments using the Net Asset Value (NAV) under specific criteria where as it does not exist under IFRS.
Netting is permitted under US GAAP for certain derivative contracts under a master netting arrangement even if the entity does not intend to settle it net. US GAAP allows companies to make a policy election to present the fair value of derivative assets and liabilities on a net basis. IFRS does not permit such an exception and the netting criteria is also strict compared to US GAAP.
IFRS allows for an exception to exclude leases for assets that are low valued or immaterial to the entity, there is no such concept in US GAAP. US GAAP excludes leases of all intangible assets, which is different to IFRS. The general approach to lease accounting otherwise is similar in both IFRS and US GAAP.
Inventories, property, plant & equipment, intangible assets, and investments in marketable securities can be revalued under IFRS, if fair value can be measured reliably. US GAAP prohibits revaluation except for marketable securities.
Inventory Valuations and Reversals
Although IFRS and US GAAP both allow First In, First Out (FIFO), weighted-average cost, and specific identification methodology for inventory valuation; US GAAP, however, also permits the Last In, First Out (LIFO) method as oppose to IFRS. LIFO method may result in artificially low net income and may not reflect the actual flow of inventory items through a company.
The option to write down inventory is consistent in both IFRS and US GAAP but only IFRS gives the option to reverse the write down. Inventory valuation may be more volatile under IFRS.
Same logic applies when it comes to impairment losses; IFRS allows impairment losses to be reversed for all types of assets when conditions change except goodwill. US GAAP prohibits reversals of impairment losses for all types of assets.
Components of Fixed Assets
Any separate components of an asset with different useful lives are required to be de-preciated separately under IFRS. Under USGAAP, component depreciation is allowable, but not required.
Costs of Intangible Assets
When the criteria is met (including future economic benefits) under IFRS, costs incurred to create the intangible are capitalized. Under GAAP, development costs are expensed as incurred, with very few exceptions such software costs capitalized during development stage. No specific guidance is available under IFRS relating to software.
IFRS allows investment property to be defined as held for rental or capital appreciation or both whereas US GAAP does not have specific categories or guidance in this respect. In addition, under IFRS, subsequent to initial recognition the property can be measured using fair value model or the cost model. If fair value model is chosen then changes in the fair value are recognised in the income statement. GAAP has no such model and there is no specific requirement to disclose fair value.
The above is a high-level view of some of the major differences between IFRS and US GAAP and understanding these differences is essential for accountants, investors, business owners and other stakeholders who operate at a global level. Note that for aspiring individuals wanting to explore the IFRS vs US GAAP world, should not only understand the differences but also similarities between them. There is a major convergence project going on between IASB and FASB to standardise the accounting rules and disclosure between IFRS and US GAAP. The is a major undertaking and with its own challenges. The agreement was signed in the year 2002 and since then work is been going on to streamline the two major reporting standards. This convergence has its own followers and critics both have meaning full arguments in favor and against it. Let’s hope what future holds is to make the standards consistent and reporting better for the readers of the financial statement
Ali Boricha, Author has over 18 years of experience in Financial Reporting, Internal controls over reporting and Accounting with Global Organizations. Qualified in 2003 and he pursed some additional qualifications as gained more knowledge of different working environments and cultures. Most of my experience relates to Financial Services especially Private Equity, Real Estate, Hedge Funds and Mutual Funds but I have exposure to non-financial services client as well. He is based in Ireland with Multidimensional organisation world-wide.
Disclaimer: The content of this article is for information only and is not offered as an advice. Readers are encouraged to consult a suitably qualified professional adviser to obtain advice tailored to their specific requirement.