In this article, we are going to cover IFRS vs US GAAP. Before we differentiate between IFRS and US GAAP it’s important to understand their meaning and the context in which these two terms are used. US GAAP and IFRS classified as generally accepted accounting principles which in the financial and accounting word is commonly known as GAAP so in this article we are going to learn couple of things.
IFRS vs US GAAP: What is GAAP?
We’ll start with what is exactly GAAP. GAAP is broad framework or the structure which is used to prepare financial statement of the company like you know have you heard about Java C++ or HTML are used by these software engineers to write computer programs. In the same manner accountants all over the world use a language that is known as GAAP to prepare the financial statement.
But there is one huge difference between the computer language in GAAP, unlike a programmer who uses the same language irrespective of whether he is sitting in Silicon Valley or India an accountant will use the different reporting language in different jurisdictions because every country has different GAAP. For example Financial statement is india prepared with the help of Indian GAAP.
It is known as generally accepted accounting principles in India while in United States they use US GAAP and it is known as generally accepted accounting principles in US and there is one in UK which is known as UK GAAP which is used in preparation of the financial statement or the books of accounts.
So the one question arises that why this is just an example and the other countries use IFRS in general. Why they use different GAAP. Why the accountant in different jurisdiction uses different reporting language or GAAP. Well different GAAP are used because every country is governed by different set of laws.
IFRS vs US GAAP: Differences in IFRS and US GAAP
Now I want to make you understand the impact of differences in the GAAP imagine that you are a private equity hedge fund manager also you’re a private equity fund manager having millions in the coffers to invest so what would you like to do first before investing well there could be many answers to this question but most of you would definitely agree with me that you know you would be you would like to have a look at the financial health which is known as the balance sheet and profit and loss account of those companies so after searching through many good companies you finally came across newly established company let’s say pineapple inc and that’s a new company for you pineapple inc sells smartphones and in order to capture the existing market in the emerging countries like India.
Tt sells its products at a discount let’s assume buying Apple sales smartphones at a cash discount of let’s say 20% so for simplicity let’s also assume that it has sold close enough to 50000 phones annually in both India and us whose market prices let’s say close enough to $125 so how much you expect the recorded revenue in the books of accounts of the pineapple Inc in its holding company in US and subsidiary in India.
One would think that close enough to $5,00,000 or $5 million dollar is the revenue earned by the company in both US in India so the discounted price equals to 125 is a share price and if you deduct 20% if you deduct 20% from that what you get $100 so 50000 x 100 will give you $5 million so you are right in pointing out that the company earned $5 million in u.s. and India but revenue recorded in the books of account will be different in the US.
In India just right for you we here in US what will happen a company pineapple revenue will be recorded at $5 million but in India what will happen that Indian subsidiary of pineapple revenue will be recorded at 6.25 million that is 50000 into 125 well that’s a huge difference as you can see 6.25 and 5 is a huge difference that is 1.25 it’s use difference but it’s not because of the accountant in u.s. are smarter than that counterpart in India.
It’s because of the different GAAP being followed by the two countries now as per the US GAAP revenue is measured as per the fair value of the economic benefits which in simple term means that net discount and rebates while Indian GAAP that is in India is measured at the gross value of the economic benefits that is inclusive of the cash discounts lets look at how the financial statement in the two different countries will look like.
Let’s see the first is US subsidiary so in case of US subsidiary the revenue from the operation will be shown as 5 million so net profit will also be 5 million but in India case what will happen the revenue from the operation is Rs. 6.25 million and the expenses that will be deducted that is the cash discounts will be 1.25 million which will give you your net profit of 5 million now you need to note that though the net profit in both the cases is equal to 5 million over here and 5 million over here. They both are same right but the top line the figure analyzed by the analyst is different by huge of 1.25 million.
As we analyzed so if one word given the option to invest in one of the two companies he would definitely would like to invest in the Indian subsidiary despite the fundamentals in both the companies remain the same.
Also, it’s important to understand that though there are huge differences between different GAAP there are also various points of convergence so let’s have a look at the final difference between IFRS and US GAAP.
Under IFRS inventory is valued at FIFO basis and under IFRS the inventory cannot be valued on LIFO. However inventory can be valued at FIFO basis but in US GAAP it is LIFO method that has been used inventory is measured at lower at cost or NRV but over here inventory is measured at lower at cost or the market value.
If you see in terms of depreciation, IFRS follows a component approach for the depreciation that is assets belong to the same component in US GAAP. It is not amended there is no compulsory thing or there is no compulsory approach for the calculation of depreciation. The same case with it goes with the revenue IFRS rules for revenue recognition is general in nature universal and equally applied to every company.
In US GAAP for revenue recognition our industry specific like in manufacturing real estate, oil, gas it contains asset set of rules and regulation in case of intangible internally incurred development cost can be capitalized that is the research cost internally incurred development cost can be capitalized but over here in US GAAP internally incurred development cost are not allowed to be capitalized.
So after all of this, we can make some final conclusion about IFRS vs US GAAP that there is differences that we have been highlighted about and are just the tip of the iceberg and there are far more other differences between IFRS and US GAAP. In US GAAP this is far too technical depends upon the facts and the circumstances of the transaction differences in each principle may require an entire separate write-up but it is important to understand the broad principle on which they differ US GAAP as highlighted above is a rule-based accounting principle whereas the IFRS as his principal basis or universal in nature.
It’s also important to point out that US is stated that it would adopt of convergence based principle in adopting the broad principle of IFRS in your future so these differences have a huge impact on some of the businesses and Economics have decisions like M&A and capital raising foreign direct investments etc.