Most investors are familiar with the U.S. Generally Accepted Accounting Principles ("GAAP"), which are rules and procedures that publicly traded U.S. companies follow when preparing their financial statements. But, international companies don't abide by these same rules and may instead use the International Financial Reporting Standards ("IFRS"), which are designed to be a common global language for business affairs across all borders.
In this article, we'll take a look at the differences between U.S. GAAP versus IFRS and discuss some important considerations that international investors should keep in mind.
Adopting IFRS Standards
The U.S. Securities and Exchange Commission ("SEC") has been working for years on adopting IFRS standards. But the agency has repeatedly cited other priorities, like money market reform, cross-border filing, and staffing, for delaying the adoption. At the same time, regulators worry that issuers will face "change fatigue" in adopting new financial reporting measures, particularly as they're already dealing with many newly introduced fundamental FASB changes.
The SEC has also cited a number of issues that must still be addressed, including:
- Gaps that remain in rate-regulated and oil and gas industries.
- Inconsistencies in the application of IFRS around the world.
- Weak interpretive processes and enforcement across all territories.
- IASB's ill-defined coordination with individual countries and its funding process.
Still, many U.S. companies must still deal with the IFRS on a regular basis, even if they can't use it in their own filings. For instance, cross-border mergers and acquisitions, meeting the reporting needs of non-U.S. stakeholders, and monitoring IFRS requirements for non-U.S. subsidiaries are common throughout the corporate world. Over the long-term, investors can expect a gradual move from U.S. GAAP to IFRS standards, although a sudden move isn't likely.
Key Differences to Watch
International investors should familiarize themselves with the key differences between U.S. GAAP versus IFRS in order to avoid any confusion when making decisions. While some of these differences are seemingly small in nature, they could catch some investors off-guard when it comes to the lack of extraordinary items or seemingly reduced development costs. These differences also apply for some U.S. companies with operations abroad.
According to the IFRS, some of the key differences include:
- Extraordinary Items - Extraordinary items that appear below net income under U.S. GAAP are not segregated on the income statement using IFRS standards.
- Inventory Calculations - Inventory that can be reported using LIFO or FIFO under U.S. GAAP may only be reported as FIFO under IFRS standards.
- Earnings per Share - Earnings per share that are averaged during interim periods under U.S. GAAP are not averaged individually under IFRS standards.
- Capitalized Costs - Development expenses under U.S. GAAP can sometimes be capitalized under IFRS standards, if certain conditions are met.
- Going Concern - Going concern auditor notes found in U.S. GAAP reporting to warn investors of excessive risks are not required under IFRS standards.
In the end, the U.S. GAAP is more rule-based and the IFRS is more principle-based in implementation. Both of these frameworks broadly target the same objective - that is, creating a unified framework to make analysis easier for investors - but take two different approaches to reaching that goal. As a result, investors should carefully consider the differences.
Key Takeaway Points
- International Financial Reporting Standards ("IFRS") is a set of rules designed to unify reporting standards around the world.
- The IFRS differs from U.S. GAAP in several important ways that investors should carefully consider when committing capital abroad.
- While the U.S. is slowly moving towards IFRS, the transition isn't likely to occur very quickly, as regulators are hesitant to change too much at one time.
- Many U.S. companies must still deal with IFRS rules when it comes to international M&A, foreign subsidiaries or non-U.S. stakeholder reporting needs.