Introduction
Accounting standards are guidelines that govern the recording of a company’s financial transactions. Organizations must distinguish between International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) to maintain transparent and clear accounting. IFRS is a global set of rules, while GAAP is specific to the US. Both types have pros and cons, but their primary difference lies in the perception of profit; IFRS considers it before taxation, while GAAP requires net income to be calculated after taxation.
Comparison of IFRS and GAAP Frameworks
Reporting Time
One of the main differences in the two standardized systems is how GAAP and IFRS define income. For example, GAAP requires entities to report income at the time of receipt, and IFRS requires that the income be reported when it is realized or recognized by the company (Doupnik et al., 2020).
R&D and PP&E Costs
The next difference is that GAAP requires entities to include expenditure on research and development, while IFRS is more lenient (Doupnik et al., 2020). Under GAAP, a company’s property, plant, and equipment must be accounted for at the purchase price. In contrast, IFRS may provide an option to revalue at fair market value, which is the third difference (Doupnik et al., 2020).
Net vs. Gross Income
Finally, according to GAAP, a company must report revenue, expenses, and net income on its income statement (Doupnik et al., 2020). IFRS proposes considering all income and expenses incurred in a specific period (Doupnik et al., 2020). In a global sense, GAAP focuses on net income, while IFRS focuses on profit before taxation.
Influence of the Framework on Net Profit
Reporting Time
The selected accounting system will affect the organization’s net profit. The requirement, under GAAP, to report earnings at the time of receipts calls for more stringent reporting, which could negatively impact net income, as a company cannot be flexible. With the need to report earnings once implemented, IFRS provides organizations with more freedom to enhance their financial performance (Doupnik et al., 2020).
R&D and PP&E Costs
GAAP requires businesses to include mandatory development expense items, which can incur losses for the company and increase profitability through innovation (Doupnik et al., 2020). IFRS does not introduce this obligation, so the company’s net profit is not amenable to this influence. IFRS allows entities to revalue funds rather than fix the purchase price. This may enable the company to significantly increase its profits, whereas GAAP does not provide such an opportunity.
Net vs. Gross Income
However, by requiring entities to report net income, GAAP can enhance financial performance by providing a clearer understanding of real revenue and expenses (Doupnik et al., 2020). In the case of IFRS, reporting on the period may not be sufficiently informative due to the indication of non-final profit amounts (Doupnik et al., 2020). Thus, the GAAP accounting system can be perceived as a more complex approach, while IFRS provides companies with flexibility.
Conclusion
In conclusion, the primary difference between IFRS and GAAP lies in the definition of an entity’s profit. IFRS is a more flexible system that allows companies to account for earnings after they are realized. In addition to stricter reporting, GAAP obliges companies to invest in research. At the same time, IFRS takes profit before tax into account and allows management to fix the company’s expenses after recalculating. IFRS provides organizations with more variability, which is more beneficial for the profitability and overall performance of the company.
Reference
Doupnik, T. S., Finn, M., Gotti, G., & Perera, H. (2020). International accounting. McGraw-Hill Education.