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GAAP (generally accepted accounting principles) is a set of standards that publicly traded businesses in the U.S. must follow when reporting financial information. IFRS (International Financial Reporting Standards), on the other hand, is the accounting standard used in the European Union and other countries around the world.
Both GAAP and IFRS are designed to maintain transparency and consistency in financial documentation and make it easier for investors, creditors, and business managers to make informed financial decisions. While the two systems share similar goals and features, they use different methodology. Here’s what you need to know about U.S. GAAP vs. IFRS.
Key Points
• GAAP is a detailed, rules-based accounting standard used in the U.S., while IFRS is a principles-based standard used internationally.
• Public companies in the U.S. must use GAAP; public companies in the European Union, Canada, and other countries must use IFRS.
• Differences between GAAP and IFRS include how liabilities are listed on the cash flow statement and when revenue is recognized.
• IFRS allows for more flexibility and interpretation, but can lead to inconsistencies in financial reporting.
• Adopting IFRS in the U.S. could aid international comparisons but may be costly for businesses due to the transition from GAAP.
What Is GAAP?
GAAP is a set of rules and principles that companies in the U.S. must follow when preparing their annual financial statements. GAAP dictates how a company can recognize revenue and expenses, what types of expenses have to be capitalized as assets, and how information needs to be presented to shareholders in an audited report.
Governed by the U.S. Securities and Exchange Commission (SEC) and administered by the Financial Accounting Standards Board (FASB), GAAP was established to provide consistency in how financial statements are created and make it easier for investors and creditors to compare companies apples to apples.
All publicly traded businesses in the U.S. must use GAAP in their financial statements. Auditors who doublecheck these financial documents abide by an analogous set of guidelines known as “generally accepted auditing standards”, or GAAS. (GAAS vs. GAAP can be confusing, but it may help to remember that only GAAP is for accountants.)
While small businesses that don’t get audited aren’t required to use GAAP, doing so could make it simpler to report your company’s financial information. It might also make it easier to get approved for small business financing.
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What Is IFRS?
The International Financial Reporting Standards, or IFRS, is another set of accounting standards, but these are used at the international level. IFRS is standard in the European Union and many countries in Asia and South America, but not in the U.S.
IFRS, issued by the International Accounting Standards Board (IASB), is designed to create a commonality in how businesses in different countries report their accounting. This consistency in accounting language enables investors and creditors to understand a company’s financials and compare one IFRS-compliant company to another IFRS-compliant company, which helps in making investment decisions.
GAAP vs IFRS Compared
There are some commonalities between IFRS and GAAP, but also many differences. Here’s how they net out.
| GAAP | IFRS |
|---|---|
| Rules-based | Principles-based |
| Inventory cost methods allow LIFO, FIFO, and weighted average cost | Inventory cost methods only allow FIFO and weighted average cost |
| Intangible assets are recorded at current fair market value | Intangible assets are only recognized if they have future financial benefit |
| Fixed assets are valued using the cost model | Fixed assets are valued using the revaluation model |
| Revenue is not recognized until the exchange of a good/service has been completed (per industry guidelines) | Revenue can sometimes be reported sooner |
Similarities
Both GAAP and IFRS govern how companies should report their financial information for a given reporting period, such as one quarter or one year. And both systems are designed to simplify financial statements and provide an even playing field for investors to evaluate companies and compare one to another.
GAAP and IFRS also both require companies to issue income statements, balance sheets, cash flow statements, changes in equity, and footnotes. In addition, they both require accrual (vs. cash) accounting, and allow the use of the inventory estimates first-in, first-out (FIFO) and weighted average cost.
Differences
GAAP and IFRS differ in several key areas.
Rules- vs Principles-Based
GAAP goes into much more detail when it comes to accounting and uses fixed rules for calculations, with little room for interpretation. This is to prevent companies from creating exceptions to the rules in order to make themselves look more profitable.
IFRS, on the other hand, sets out principles that companies should follow using their best judgment. It allows for some wiggle room for companies to interpret the principles.
Inventory
While GAAP allows companies to choose the most convenient method when valuing inventory, IFRS does not permit companies to use the last-in, first-out (LIFO) method of calculating inventory. The reason is that some analysts believe the LIFO method does not show an accurate inventory flow and may portray lower levels of net income than is actually the case.
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Intangible Assets
The way that intangible assets like goodwill or research are recorded differs between IFRS vs. GAAP. With IFRS, intangible assets are only capitalized when certain criteria are met, such as having a definite future financial benefit.
Under GAAP, intangible assets are generally expensed as they are incurred based on their current fair market value with no other considerations required.
Fixed Assets
There are differences in depreciation of fixed assets for IFRS vs. GAAP. Under GAAP, fixed assets (such as property and equipment) are valued using the cost model, which means the purchase price of the asset less any accumulated depreciation.
With IFRS, by contrast, fixed assets are initially valued at cost but can later be revalued (up or down) based on current market value.
Revenue
How you address revenue differs between the two systems. IFRS is based on the guiding principle that revenue is recognized when value is delivered. With GAAP, however, the rules are more specific.
While revenue generally is not recognized until the exchange of a good or service has been completed, GAAP requires the accountant to consider the industry-specific rules regarding revenue recognition. Due to looser rules, the IFRS system may allow a business to report income sooner.
Liabilities
Another difference between GAAP vs. IFRS is how liabilities are classified on the cash flow statement. GAAP classifies them as either current or non-current, with those the company can reasonably repay in the next 12 months considered current, and those that will be repaid later as long-term or non-current.
Certain kinds of redeemable shares get different treatment, too. When they constitute mezzanine financing (a hybrid of debt and equity financing), GAAP-compliant public companies consider them temporary equity. IFRS, which has no “temporary equity” classification, treats them as financial liabilities.
With IFRS, all liabilities (both short- and long-term) are grouped together.
Lease Accounting
GAAP and IFRS standards treat lease accounting differently. GAAP distinguishes between operating and finance leases, while IFRS does not.
Instead, IFRS treats all leases as finance leases, which affects how expenses are reported on the income statement. IFRS splits the operating lease expense into interest and depreciation, while GAAP treats it as a simple rental expense.
In some cases, the difference in the expense calculation may alter financial ratios used by lenders and investors, such as the fixed charge coverage ratio and the net profit margin.
Development Costs
GAAP requires that companies expense most R&D costs when they are incurred. Under IFRS, research costs are expensed but many development costs are capitalized if certain criteria apply. For example, intangible assets developed within the company, such as software or chemical formulas, are generally capitalized and amortized.
Pros and Cons of IFRS
The U.S. hasn’t yet decided to adopt IFRS over GAAP, though with so many other countries around the globe using it, that may happen in the future. However, there are both pros and cons to switching to IFRS.
On the plus side, adopting IFRS would make it easier for U.S. companies to do business with companies overseas. It would also make it easier for investors to compare U.S. and foreign companies.
Another advantage of IFRS is that it is less detailed than GAAP, which makes it easier to implement. It also offers more flexibility, which allows companies to adapt the system to fit their specific situations. Some experts also believe that a focus on principles, rather than rules, captures the essence of a transaction more accurately.
However, there are also downsides to IFRS. Because IFRS is more subject to interpretation, it often requires lengthy disclosures on financial statements. The system’s flexibility can also lead to the manipulation of standards to make an organization seem more financially secure than it is in reality.
Another disadvantage to IFRS’s flexibility is that statements aren’t always comparable (which is the point of having a global standard). Finally, if the U.S. were to adopt IFRS, it would be costly for small businesses to implement the change.
| Pros of IFRS | Cons of IFRS |
|---|---|
| Makes it easy to do business with other countries | Often requires adding lengthy disclosures to financial statements |
| Would be easier for inventors to compare U.S. and foreign companies | Can be manipulated to make a company look like it’s doing better than it is |
| Less detailed, more flexible, and easier to implement | Statements from one company to the next aren’t always comparable |
| Focus on principles captures the essence of a transaction more accurately | Adopting IFRS would be costly for small businesses |
Transitioning Between GAAP and IFRS
Small U.S. companies doing business internationally may feel that they need to decide between GAAP’s rules-based approach or the IFRS principles-centered framework. Each approach has advantages and disadvantages, as discussed above.
However, it’s often debatable whether a business needs to transition from one to the other. Companies have the option of maintaining financial records under both standards.
Key Considerations for Multinational Businesses
When converting to IFRS, executives typically need to address changes in accounting and reporting practices, such as significant new standards for revenue recognition, leases and financial instruments.
The changeover also affects systems, processes, and business plans. Business owners will want to analyze the cost and complexity of adjusting the accounting system for compliance and the time and effort of training employees accordingly.
Impact on Financial Reporting and Compliance
The different accounting treatments will produce financial statements that vary in reported net income, assets, and liabilities. The disparities in reported numbers will affect financial ratios.
Some of the areas of disagreement generally include inventory valuation (FIFO vs. LIFO), categorization of R&D costs, and revaluation of assets.
The Takeaway
IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based system used primarily in the U.S.
There are several differences between GAAP vs. IFRS. The biggest is that GAAP lays out highly specific accounting rules and procedures, whereas IFRS sets out principles that companies should follow and interpret to the best of their judgment.
For small business accounting, you don’t have to follow any specific regulations. However, following GAAP in your financial statements can be useful in certain situations, such as when you’re looking to get approved for financing. Many lenders and creditors often prefer GAAP-compliant statements when they issue loans.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Does the U.S. use IFRS?
No. Public companies in the U.S. must use GAAP (generally accepted accounting principles), though many businesses opt to report their finances under IFRS (International Financial Reporting Standards) as well.
Is GAAP used in the U.K.?
No. Public companies in the UK must use IFRS as issued by the International Accounting Standards Board (IASB) with some limited modifications. However, some companies in the U.K. may also use GAAP to cater to a U.S.-based audience.
Is GAAP or IFRS more conservative?
GAAP (generally accepted accounting principles) is considered more conservative because it is highly detailed and rules-based. IFRS (International Financial Reporting Standards), on the other hand, is principles-based and leaves more room for interpretation.
Which industries are most affected by GAAP vs IFRS differences?
Because they rely heavily on leasing, industries such as retail, construction, and transportation are significantly affected by differences in how GAAP and IFRS standards treat lease accounting.
Pharmaceuticals and software, sectors that spend large sums on research and development (R&D), see contrasting outcomes based on how the accounting system expenses or capitalizes R&D costs.
Can a company use both GAAP and IFRS for reporting?
Yes, a company can use both frameworks by maintaining two sets of books. Employing both may be done as part of a transition from one system to the other. It may also be done indefinitely for statutory reporting or other reasons.
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