IFRS and US GAAP come closer to each other and hopefully, we will have a single set of the reporting standards until 2015.
However, there is still a long way to go. Until then, there are still many companies who need to cope with IFRS reporting as well as US GAAP reporting. Finance people working for those companies know it the best—identification of differences between IFRS and US GAAP and making correct adjustments is simply laborious and demanding work.
During my professional career, I came across numerous IFRS and US GAAP reconciliations, adjustments, transformations—just name it. Here, I would like to outline the biggest differences between IFRS and US GAAP, at least those that I consider the biggest and the most challenging to remove. So let’s take a look.
1. Revenue recognition
In my opinion, it is very difficult to simply list all the differences between US GAAP and IFRS related to revenue recognition. The reason is that the guidance on revenue recognition is significantly more extensive in US GAAP than in IFRS.
IFRSs deal with revenue recognition in 2 specific standards: IAS 18 Revenue and IAS 11 Construction Contracts. On the other hand, US GAAP outlines a few concepts and then provides detailed rules for revenue recognition in different industries.
Due to this fact, it is almost impossible to simply list the differences in this area. Instead, thorough analysis of each transaction must be performed prior considering the accounting treatment. However, let me just briefly come up with the main differences for illustration:
Timing of revenue recognition can be different in several cases, especially when price contingencies are involved. Simply speaking, it is possible to recognize revenue with price not fixed yet earlier in IFRS than in US GAAP.
IFRS requires recognizing the revenue when it is probable that economic benefits associated with transaction will flow to the entity and the revenue can be measured reliably. It means that also contingent revenue (not sure about the amount) shall be recognized when 2 conditions are fulfilled.
As opposed, US GAAP sets the criterion of fixed or determinable pricing in order to recognize revenue. Thus, revenue cannot be recognized until the contingency is resolved (so amount must be set). As a result, revenue with contingent or questionable amount can be recognized earlier according to IFRS than according to US GAAP.
Other most common revenue recognition differences involve setting when the transaction with multiple deliverables shall be separated into components, method of revenue allocation to the different components, customer loyalty programs within multiple-element arrangements, construction contracts, value attributed to barter transactions, discounting of revenue (required more broadly in IFRS than US GAAP), and many others.
To reduce those dissimilarities and bring US GAAP and IFRS closer a bit more, FASB (US GAAP setting body) and IASB (IFRS setting body) issued a revised proposal of the new revenue recognition standard. This standard designs main direction for revenue recognition and corrects inconsistencies between US GAAP and IFRS.
However, the new standard on revenue recognition, if adopted, will be effective starting 2015.
2. Financial assets (IAS 39/IFRS 9)
This is another area of fundamental dissimilarities. First of all, the amount of guidance is different. While US GAAP provides extensive guidance throughout various industry-specific standards and pronouncements, IFRS has only 2 standards dealing with financial assets—IFRS 7 for disclosures and IFRS 9 for other issues.
The first thing you do with any financial asset is classification. IFRS 9 classifies financial assets into several categories, while US GAAP classifies financial assets in various pronouncements. Also, IFRS 9 classifies assets basically based on the nature of the instrument, whereas US GAAP reflects legal form in classification.
Please understand that the classification of financial assets is very important—based on classification, you measure these assets and recognize measurement gains or losses to income statement or equity. So, different classification of the same financial asset in US GAAP vs. IFRS can lead to huge variations in amounts recognized in financial statements.
With regard to financial assets, there are great variations in derecognitions—or when you remove the asset from your financial statements. US GAAP assesses whether the control (both effective and legal) over the asset was surrendered. On the other side, IFRS assesses whether there was a qualifying transfer of an asset with risks and rewards passed, and sometimes transfer of control.
As a result, some assets might be derecognized in line with US GAAP, but not in line with IFRS. For example, factoring of receivables with recourse—here, factored receivables can be derecognized according to US GAAP, but not according to IFRS (recourse factoring means that factoring company can transfer receivables back when these went bad and never would be collected; thus risk stays with original owner of receivable and not with factoring company).
There are many more variations with regard to financial assets, for example, treatment of embedded derivatives in hybrid instruments, measurement and reversal of impairment losses, fair value measurement and more. It is just impossible to include them all here in this informative article.
3. Impairment of assets (IAS 36)
There are broad differences in testing of impairment according to IFRS and US GAAP. These differences might lead to assessment whether the asset is impaired or not.
IAS 36 Impairment of Assets prescribes one-step test of impairment. The entity should compare asset’s carrying amount with its recoverable amount (higher of asset’s fair value less cost to sell or asset’s value in use).
As opposed, US GAAP applies 2-step approach: the first step is to compare asset’s carrying amount with its undiscounted cash flows and if carrying amount is lower, then no impairment loss is recognized. In the second step, if the carrying amount is higher than undiscounted cash flows, an impairment loss is calculated as a difference between carrying amount and assets fair value.
So, asset might be impaired per IAS 36, but not per US GAAP.
Also, IFRS uses discounted cash flows in impairment testing (for value in use calculation), whereas US GAAP uses undiscounted cash flows. IFRS sets more precise requirements for types of items to include in cash flows than US GAAP. Therefore, a difference in amount of impairment loss can arise.
4. Intangible assets
One of the biggest differences in this area is that US GAAP does not permit to capitalize internally incurred development costs, while IFRS does allow it—when certain conditions in line with IAS 38 are fulfilled.
Also, there are some differences in impairment testing with regard to intangible assets with indefinite useful life. These differences may result in determination whether there is an impairment loss and in earlier recognition in IFRS.
IFRS (IAS 2) does not allow LIFO (last-in-first-out) measurement of inventories, while US GAAP does. This is really huge difference for those US companies who use LIFO as their operating results and cash flows might be significantly different according to IFRS than US GAAP.
Now, you might argue with me that there are bigger differences than those listed above. Well, that’s questionable and arguable, since everybody has his own favourite pick.
During my financial and accounting practice, I considered those 5 as the most laborious and requiring much more work to understand and make appropriate adjustments between IFRS and US GAAP. Just take inventory—those few lines above cost a lot of work in order to revalue year-end inventory from LIFO (per US GAAP) to FIFO or weighted average (by the way, FIFO is easier).
Sure there is much more variations, such as potential differences in the lease classification, variations in employee benefit plans classification and recognition and many other areas.
What I truly believe is that one day, IASB and FASB reach a conclusion and there will be no differences. How much work would be saved for all preparers of the financial statements!