Welcome to the new blog area for IFRS (International Financial Reporting Standard)
IFRS is gaining lot of momentum and there has been overwhelming response to this blog series, especially lot of people wanting to understand IFRS with respect to the SAP products. Before we get there, one of the key thing that I wanted to discuss is the practical differences between US GAAP and IFRS.
Before getting into the differences, its important to note that though the U.S. and IFRS do contain differences, the general principles, conceptual framework, and accounting results between them are often the same or similar. Offcourse there are areas of divergence that can come through for many specific transactions or treatment. The approach I would take to discuss the divergence would be more with a practical vs. listing out all of the theoretical differences.
One of the primary difference between US GAAP and IFRS is one is a more rule based (US GAAP) whereas the other is more of a principle based approach. Rule based approach makes companies follow rules, though many cases companies try to find out how they can get exceptions to the rules. In a principle based approach the onus is on the Controller and the auditor of the company. Lets take a specific example :
For Leasing, US GAAP says - The lease term is equal to 75% or more of the
estimated economic life….”
Whereas IFRS says – “The lease is for the major part of the economic life
of the asset”, which could be interpreted as 75, 80 or 95% by each company.
Lets now cover each of the area separately:
1. Financial Statement preparation
Area of comparison | US GAAP | IFRS |
Financial periods to be covered | Needs to present three years ending on the balance sheet date | Have the current year and the last year comparison numbers |
Layout of balance sheet | Public companies need to follow the layout as prescribed in regulation S-X | Does not specify any layout but mentions the minimum set of items to be disclosed |
Deferred tax | Deferred tax is classified as current asset or non current asset based on nature of their asset or liability | Deferred tax is classified as non current asset |
Extraordinary items | Restricted to items that are both unusual and infrequent. Negative goodwill is always treated as extraordinary. | Prohibited |
Exceptional items occurring infrequently e.g. acquisition, discontinuation | Presented as a component of continuing operations. | Presented in financial statements as part of the main or in notes |
Performance measures | SEC prescribes what performance measures can be disclosed. For non GAAP measures, reconciliation to GAAP measure should be made | No prescribed measures, will be presently generally acceptable performance measures that would be relevant |
2. Consolidations and Business combinations
Consolidations of subsidiaries into parent company, is based on control. Both U.S. GAAP and IFRS follow this approach, though differences exist in the consideration/definition of control. Generally, under both GAAPs all subsidiaries subject to the control of the parent company must be consolidated. There are few exceptions in U.S. GAAP for certain specialized industries. Under both US GAAP and IFRS, the consolidated financial statements of the parent and its subsidiaries may have different year closing dates, but should not vary by more than 3 months.
Area of comparison | US GAAP | IFRS |
Control | Its based on control of financial interests. So the control is based on only the financial share of the subsidiary. | Determined by power to control, with control being the parent’s ability to govern the financial and operating policies of an entity to obtain benefits. Control presumed to exist if parent owns greater than 50% of the votes, and potential voting rights must be considered. |
Differing financial dates | The effect of significant events between the financial dates should be disclosed | The effect of significant events between the financial dates should be adjusted in the financial statements |
Preparation of consolidated financial statement for every parent | Always required | Not required if a parent is a again a wholly owned subsidiary of another company |
Minority interest | Shown as a separate item, not clubbed with equity | Shown as part of equity |
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In case of business combinations, in both US GAAP as well as IFRS, the acquiring entity is the entity that obtains control, and the cost of the business combination is the fair value of the consideration
transferred plus any acquisition-related transaction costs. Goodwill computations are also similar in both US GAAP and IFRS which is the difference between the investment fair value and the acquiree’s net identified. Further goodwill is subject to an annual impairment test, where the goodwill value is reassessed and adjusted if the value goes down through impairments.
Area of comparison | US GAAP | IFRS |
Date | Reasonable period of time before and after the terms of the acquisition are agreed to and announced. Otherwise, acquisition date. | It’s the acquisition date |
Negative goodwill | Allocated on a pro rata basis to reduce the carrying amount of certain acquired assets with any excess recognized as an extraordinary gain. | After reassessing the purchase price allocation, recognized immediately as income. |
Research and development | Determine fair value and expense immediately if no alternative future use. | Recognized as a finite life intangible asset separately from goodwill if the definition of an intangible asset is met and the fair value can be measured reliably. |
Combination of entities under common control | Accounted for in a manner similar to a pooling of interests (historical cost). | Outside scope of IFRS |
We compared couple of areas in this blog, will continue to discuss the differences in next blog.
Check out the earlier parts in this blog series – Global convergence through IFRS - Part I , Global convergence through IFRS - Part II and Global convergence through IFRS – Part III
