US GAAP vs IFRS

US GAAP versus IFRS. US GAAP: United States Generally Accepted Accounting Principles. IFRS: International Financial Reporting Standards. US GAAP and IFRS are the two main #accounting standards in the world, for use by publicly listed companies. US GAAP is developed by the FASB, the US-based Financial Accounting Standards Board headquartered in Norwalk, Connecticut. IFRS is developed by the IASB, the International Accounting Standards Board headquartered in London, United Kingdom.

⏱️TIMESTAMPS⏱️
00:00 US GAAP and IFRS acronyms
00:38 Which countries use US GAAP or IFRS
02:17 Importance of understanding US GAAP and IFRS
05:06 Comparing US GAAP and IFRS: example
06:40 Foreign issuers using IFRS
08:20 Differences between US GAAP and IFRS
12:38 Developments in US GAAP and IFRS
13:34 US GAAP and IFRS convergence
14:42 LIFO vs FIFO and other differences
15:41 Will the US adopt IFRS?

Let’s zoom out to the big picture on US GAAP versus IFRS. US GAAP is mostly rules-based, while IFRS is mostly principles-based. What does rules-based versus principles-based mean? Here’s a metaphor that viewers with children, or those that grew up with a brother or sister, might relate to: the two ways to run a family. Some parents use a rules-based system: they tell their kids which behaviors are allowed and what is prohibited: you can’t kick or punch your brother or sister, but you may give him or her a hug. Other parents may use a principle-based system: “in this family, we are nice and friendly to each other”. Is rules-based better than principles-based, or is principles-based better than rules-based? I don’t think one is better than the other, each has advantages and disadvantages. With rules, you try to provide clarity and be specific. The more specific the guidance, the more consistent the application, right? Or not quite? Unfortunately, in the case of families, by making a list of rules you might also encourage children to try things behind your back as a parent, kids might test the “limits” of the rules, and your list of rules is probably never ever going to be complete to describe each and every possible interaction between siblings. An equivalent of this in US GAAP accounting standards is the use of “bright lines”: when the FASB specifies a percentage as a minimum or maximum for applying a certain rule, companies might adapt their behavior to just meet the minimum requirements (complying with the “letter” of the standard, but not necessarily with the “spirit” of the accounting standard). With principles, you leave a lot of room for interpretation; different people might each have their own subjective interpretation of the principle. Opponents of principle-based structures would say that a lack of detailed rules might lead to more abuse, and in a business context to different interpretation for similar transactions. Neither system will be perfect, and it is not easy to find an optimal mix between rules and principles that works best.

A rules-based standard like US GAAP is definitely more sizable than a principles-based standard like IFRS. Estimates of the size of US GAAP versus IFRS vary from 7200 pages of US GAAP (when printed) versus 1300 for IFRS, to 25,000 pages of US GAAP to 2000 pages for IFRS. Whether it’s a 6-to-1 ratio or 12-to-1 ratio, rules-based is more extensive. This remains one of the criticisms of US GAAP by practitioners: a standards overload with too much detail and a high level of complexity.

It’s important to understand that both US GAAP and IFRS are changing over time. New industries emerge, new types of transactions occur, and the thinking about how certain economic transactions need to be treated accounting-wise changes. Some years, big impact changes in the standards occur. In other years, the number of changes might be large, but the impact fairly low. And sometimes things are fairly quiet in the area of standard setting. So even if you compare numbers for one and the same company over a large number of years, you might be comparing “various types of apples”. An interesting question is whether US GAAP and IFRS will converge (grow more close), or diverge (grow further apart). The FASB and IASB have been working together over the years to try to develop common standards in various areas.

Philip de Vroe (The Finance Storyteller) aims to make strategy, #finance and leadership enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better #investing decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!