Introduction
Since the introduction of IFRS, a public traded companies in Europe are required to adopt the standard requirement in reporting their financial statements. While in the United States, foreign companies reporting under the new IFRS were required by the Securities and Exchange Commission (SEC) to provide a reconciliation between IFRS and the U.S. generally accepted accounting principles (U.S. GAAP) in filing their financial reports.
One of the companies subjected to this requirement is the Reed Elsevier company however many parties oppose this reconciliation requirement measure and call for the development of high-quality and transparent international accounting standards that will be followed by all companies. A number of differences exist between the two standards in reporting financial statements as noted in the reconciliation statements of Reed Elsevier company.
We, therefore, highlight the areas that show significant differences for the benefit of preparers, auditors, and regulators for a better understanding of differences that exist in these two sets of standards. Reed Elsevier helps us identify similarities and differences between the two accounting standards specifically in areas of recognition, measurement, and presentation of guidelines.
Financial Accounting Standards Board (FASB) is a body designed to establish and improve financial accounting standards for all sectors in the United States including non-governmental public and private enterprises. This standard governs the preparation of financial reports and provides guidelines and education to users, auditors, and the public as a whole. In this case, the U.S GAAP derives its force from this financial standard.
Comparison between IFRS and U.S. GAAP
In highlighting the differences between IFRS and U.S. GAAP, the essay seeks to identify areas that cause the differences that we believe are mostly encountered in accounting standards and the differences help those new to IFRS understand and appreciate the major requirements and show how these areas differ from the United States requirement. The IFRS disclose major differences between the two standards that are crucial to accounting standards under GAAP.
In financial statement presentation, for example, IFRS financial statements include balance sheets, income statements, and statements showing changes in equity arising from capital transactions including owners and distributors to owners of Statement of Recognised Income and Expense, cash flow statements, and accounting policies and explanatory notes were also included. The U.S. GAAP financial statements include a balance sheet, income statements, statements of comprehensive income that are comprised of combined income statements or statements of changes in stakeholders’ equity.
At this point, we see combined income statements and statement of stake holders’ equity that was not included in the IFRS. In addition to the financial statement, statements of cash flows are also included although with limited exemptions while the IFRS on the other hand does not provide any exemptions in cash flow statements. In IFRS, comprehensive financial information is required except for the standard requirements. The U.S. GAAP does not have any specific requirement for reporting comparative statements. It requires two balance sheets for two recent fiscal years and three income statements and cash flows (Thornton, 2007, p.4: Nobes & Parker, 2002).
Comparison between IFRS and U.S. GAAP in Balance Sheet statements
The U.S. GAAP does not have any standard format for presenting items in the balance sheet and the SEC requirement under the measurement does not require any specific line items to appear on the face of the balance sheet contrary to IFRS. Current and non-current items are presented separately in the face of the balance sheet in IFRS although exceptions may occur where presentations based on liquidity are reliable and relevant. In U.S. GAAP, balance sheets do not show separate classifications of current assets and liabilities (Reed Elsevier PLC, 2007).
In IFRS no subtotals are specified in the balance sheet while in U.S. GAAP, subtotals must be specified by reporting entities. The SEC rules under this statement require reporting of subtotals for current assets and liabilities.
IFRS shows deferred and current tax liabilities and assets as separate line items in the balance sheet and does not classify deferred tax assets as current assets while the U.S. GAAP classifies deferred tax assets and liabilities separately in current and non-current amounts and shows the resultant net current deferred tax assets or liabilities and the net non-current deferred assets or liabilities in the balance sheet.
IFRS classifies current assets as those expected to be realized within a normal operating period through sale or consumption of the asset within the 12 month period. Current assets in this financial statement are classified as cash or cash equivalents however they are not restricted to their use. The U.S. GAAP, on the other hand, classifies current assets like cash or resources expected to be realized in cash, sold, or consumed within a normal operating cycle where the period of operating cycle is more than twelve months.
Current and non-current liabilities are classified under IFRS as combined liabilities while U.S. GAAP defines liabilities separately. Current liabilities are identified as financial activities whose liquidation are expected to require the use of existing resources to be realized and may at times require them to be combined with current assets or the creation of other liabilities for liquidation. In IFRS, entity liabilities that become payable on demand are classified as current while the U.S. GAAP entities are classified as current long-term obligations eligible to be callable by a creditor because of the entity’s violation of a provision of debt at the balance sheet date.
If the violations are not cured within the specified period, the obligation will be classified as callable unless creditors have waved or lost the right to demand payments for a period of one year or within the operating cycle from the balance sheet date or rather for long term obligations containing grace period within which the violated entity may be cured, it is possible that the said violation will be cured within that period (Reed Elsevier PLC, 2007: Thornton, 2007, p.7).
IFRS stipulates that if any asset or liability combines amounts expected to be settled in 12month of the balance sheet date or recovered in the same period then the entity in addition to current and non-current assets classification should show the amount due after 12 months. The U.S. GAAP on the other hand requires that combined amounts of maturities and sinking fund requirements for all long-term borrowings be disclosed for each of the five years since the date of the latest balance sheet presentation.
In terms of interest, IFRS presents interest in the consolidated balance sheet within equity which is separated from the central shareholder’s equity. In U.S.GAAP, minority interest are not presented within shareholders equity. In IFRS, assets and liabilities, income statements and expenses are not offset unless required by IAs standards while the U.S. GAAP offsets assets and liabilities and income and expenses statements in circumstances where parties owe each other determinable amounts, where there is a right and intention to set-off and where the right to offset is enforceable by law (Thornton, 2007, p.10).
Profit and loss accounts and income statements
In profit and loss accounts, IFRS prescribes standard formats for categorising expenses such as the nature of expenses and the function of expenses. It also specifies items that must be included in the income statements and adds on information that must be either on the face of income statements or in the notes. U.S. GAAP does not prescribe any standard format for categorising expenses but rather employs single step format or multiple formats.
Line items are also not required to appear on the face of income statements. In cases where items of income and expense are material, the amounts of those items are disclosed on the face of income statements or in the notes in IFRS. Line items, subtotals and headings are also presented for relevance and further understanding. In U.S. GAAP, transactions that are unusual in nature or occur infrequently are reported as separate components of income from continuing operations. The extra ordinary items such as excess of fair values of net assets are recognised as extraordinary gains. IFRS excludes extraordinary items in its income statements (Thornton, 2007, p.10: Reed Elsevier PLC, 2007).
Financial instruments and investment property report unrealised gains through fair value adjustment and are included in income statements in IFRS. U.S. GAAP, unrealised gains and losses on investments, debts and equity securities are classified as trading and are recognised through fair value adjustments through the income statements. This measurement follows the cost model for investment property which are not recognise while losses on impairments of long term assets which are held or yet to be used are recognised and included in the income statements.
IFRS gains and losses initially recognised in equity are taken back to the income statements on subsequent realisation such as available for sale investments, hedged items and foreign exchange losses on net investment in subsidiaries. U.S. GAAP reports amounts related to pension and other post retirement benefits that are initially recognised in income statements are recycled according to provided provisions of recognised statements (Thornton, 2007, p.11 :Reed Elsevier PLC, 2007).
IFRS and U.S. GAAP Differences in Reporting Comprehensive Income in Equity
IFRS in reporting changes in equity statements recognises income and expenses as primary statements and also presents capital movement and distribution in the notes. IFRS also presents statement of changes in
equity in which is required to combine income and expenses with capital movements and distribution in statements in case of changes in equity. The U.S. GAAP requires comprehensive display of income which full set of financial statements. U.S. GAAP does not provide any standard format but net incomes are and must be shown as part of the comprehensive income in the financial statements that display the income statements. In this regard, the displayed income statements are reported as part of the income statements or as a stand alone basis. The statement also reports disclosures of any changes that may arise in separate accounts.
The changes may include stockholder’s equity in addition to the retained earnings. The statement requires the disclosed information be made in the financial statements notes or done through separate financial statements. Still on statement changes in equity, IFRS requires that certain items be divided between minority interest and parent and the effects of prior year adjustment must also be expressed in respect of each component.
IFRS employs statement of recognising income and expenses (SORIE) approach in recognising actuarial gains and losses if profit and losses are taken outside the IAS. The U.S GAAP does not immediately recognise gains and losses as part of the net periodic pension costs but later recognised them as increases or decreases in other income statements as they arise within trading periods. In terms of income divisions, minority interest are presented in consolidated profit and loss account as a deduction against after tax profits (Thornton, 2007, p.11) (Reed Elsevier PLC, 2007).
Cash flow statements
IFRS categorises bank borrowings as financial activities since bank overdrafts are payable on demands from entity’s cash management. Therefore bank overdrafts are reported as part of the cash and cash equivalents in cash flow statements. In U.S. GAAP, bank overdrafts are classified under liabilities and are excluded from cash equivalents. It also reports changes in overdrafts as financial activities. IFRS does not classify taxation cash flows as operating activities but discloses them separately under operating. U.S. GAAP on the other hand classifies Taxation cash flows as operating activities.
IFRS discloses cash flows from operating activities through direct method which shows classes of gross cash receipts and payments or it employs the indirect method which adjusts profits for non cash movements in the cash flow statements. The U.S. GAAP allows both direct and indirect methods but with a different system of presentation. It requires reconciliation between two financial activities; net cash flows and net income. If it chooses to use indirect method, interest paid and income paid must be disclosed. In IFRS, receipts and payments arising from customer transactions are reported on a net basis.
Also cash receipts and payments on items in which their turn over are realised quickly, have large amounts and which their maturities are short are reported on a net basis. The U.S. GAAP requires receipts and payments to be shown as gross although some items are reported are only reported at net for the following reasons; first, because their turnovers are quick, second, because the amounts are large and third because their maturity periods are short. Items that only qualify as net assets as those cash flows pertaining investment, loan receivables and debts (Thornton, 2007, p.13) (Reed Elsevier PLC, 2007).
Intangible assets
Intangible assets are permitted for revaluation in IFRS while the U.S. GAAP restricts the revaluation of the assets. IFRS distinguishes intangible assets from goodwill which must be identifiable from contractual or other legal rights. In U.S. GAAP, intangible assets are recognised separately from goodwill regardless of the whether the rights were transferred or separated. Both IFRS and U.S. GAAP recognise acquired intangible with definite useful life at cost less amortisation but IFRS differs where internally generated intangible representing the development must be capitalised if the stipulated conditions are adhered to while in U.S. GAAP, expenditure related to activities such as research and developments are reported as expense incurred (Thornton, 2007, p.25: Hughes & Sander, 2007, p.4) (Reed Elsevier PLC, 2007).
IFRS defines life as definite or indefinite in amortisation in the manner it classifies its intangible assets. The classifications are categorised with finite useful life on the asset over its useful life. IFRS also subjects intangible assets which are not available for use or yet to be used within an indefinite useful life to annual impairment tests while the U.S. GAAP does not classify finite useful life on the asset over its useful life unless the said life is already determined to be indefinite (Thornton, 2007, p.27) (Reed Elsevier PLC, 2007).
Impairments
For assets other than goodwill, review of level individual assets and done at lowest level for which identifiable cash flows are highly independent of the cash flows of other assets and liabilities in U.S. GAAP while the IFRS requires review at level single assets. The intangible assets in this statement are not amortised and usually reviewed at cash generating unit. Therefore goodwill is usually reviewed at cash generating unit level. Good will and intangible assets that are not amortised under U.S. GAAP are written down to fair value only if they are below carrying amounts. For IFRS, impairment losses for assets are reversed so long as they meet set conditions. U.S. GAAP does not reverse impairment losses for assets other than goodwill (Thornton, 2007, p.29: Benzacar, 2009, p.1) (Reed Elsevier PLC, 2007).
Leases
IFRS recognises lease incentives as part of the net payment over a lease tern while U.S. GAAP recognises incentives as a reduction of rent expense, the lessee or the lessor (rent income) over the lease term on straight line basis. Finance leases are reported at fair values under IFRS and if lower, they are reported at present values of the minimum lease payments. U.S. GAAP in this case reports capital leases at present values and if they are lower it reports them at fair values of the leased property.
IFRS employs rate implicit in calculating present values and occasionally uses increment borrowing rate if the first method is not practicable. U.S. GAAP capitalise assets held on capital leases if it contains bargain purchase option, depreciation or transfer of ownership. IFRS charges finance costs to give contrast rate on outstanding obligation while U.S. GAAP charges interest expense to produce constant rate on outstanding obligation (Thornton, 2007, p.33: Karanikolas, Desoulky et al, 2008, p.127) (Reed Elsevier PLC, 2007).
Potential investors reviewing financial statements of both standards will have a well informed knowledge of the company to invest in due to the comprehensive notes provided by the U.S GAAP and IFRS. This helps them make a choice between which stable companies to invest in and compare the results reported in IFRS verses U.S. GAAP. The U.S. companies may suffer a disadvantage if IFRS becomes a mandatory international financial standard since it will be subjected to competition for access to global capital (Vago, 2009, online).
References
Thornton, G. (2007). Comparison between U.S. GAAP and International Financing Reporting Standards. Grant Thornton International, 1.1, 1-90.
Benzacar, K. (2009). Focus on specific in IFRS training. The Bottom Line, p. 1-8.
Hughes, S.B., & Sander, F.J. (2007). A U.S. Manager’s Guide to Differences Between IFRS and U.S. GAAP. Management Accounting Quarterly Summer, 8 No.4, p.1-8.
Karanikolas, T., Desouky, A. R., Dyomina, l., Oldham, C., Kovacas, V., & MacGuire, R. (2008). Filling the GAAP to IFR: Teaching Suppliments for Canada’s Accounting Academics. Canadian Institute of Chartered Accountants, 657, p.1-145.
Reed Elsevier PLC. (2007). Reed Elsevier 2007 Interim Results. Web.
Vago, B. (2009). International Financial Reporting Standards Impact On Hotels. Web.
Nobes, C.W., & Parker, R.H. (2002). Comparative International Accounting, 7th ed.