August 1, 2012 § Leave a comment

For my last blog, I am going to talk about many of the remaining differences that exist between GAAP and IFRS. These differences relate to receivables, revenue recognition, liabilities, and fair value. Most of these differences are not that drastic, but when added up, make a big difference with accountants.

GAAP and IFRS differ a little bit when it comes to how to recognize revenue. IFRS usually allows companies to recognize revenue earlier than GAAP. For both GAAP and IFRS, revenue cannot be recorded until it is realized and earned. However, IFRS has far less strict rules on when revenue can be realized, so usually companies under IFRS can record revenue earlier than GAAP. For instance, a product has to be delivered to the customer for revenue to be recognized under GAAP, however, IFRS allows companies to recognize that revenue as long as they have reasonable belief that the product will be delivered. I think that IFRS is too lenient on their rules when it comes to revenue recognition. It would be easier to cook the books under IFRS, so GAAP has the better standards in this case.

There are also a lot of differences between GAAP and IFRS when it comes to current liabilities and contingencies. One of those differences is that GAAP requires liabilities to be recognized when they become a present obligation. This means that they are recognized when the time comes that the company will start paying off the liability. IFRS recognizes the liability when the formal plan is announced. It doesn’t matter when the company plans on paying off the liability, as soon as they announce it they have to record it. Another difference is that contingent gains are not recognized under GAAP, whereas they are recognized under IFRS. IFRS has the right philosophy in these two cases. When a company decides to add a liability, they know that eventually they will have to pay it off, so that liability should be recognized from the very beginning. Also, for something to be considered a contingent gain, there has to be a very high chance of it occurring, so it is a safe bet to go ahead and recognize that gain.

GAAP and IFRS also differ about how fair value should be determined and whether or not impairment of receivables can be written back up. GAAP has developed a three level hierarchy of fair value methods. Companies use this hierarchy to determine which value they are given is the fairest. IFRS has no such hierarchy, but they are trying to develop one. This hierarchy makes fair value a lot simpler, so IFRS needs to hurry up and develop one. A company’s receivables may become impaired if the market has a sudden shift.  Companies will write down their impairments when the market drops, but will want to write their receivables back up when the market rises later. GAAP does not allow companies to write back up impairments. This is not a good rule because it means that receivables are not accurately valued on the company’s balance sheet.

 

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The Classification of Investments

July 31, 2012 § Leave a comment

This blog will explain how GAAP and IFRS differ when it comes to investments and earnings per share. Investments can be classified as either short-term or long-term assets. Earnings per share is computed to give investors an idea of how a company is doing. Earnings per share can be misleading because companies can disclose a lot of debt in the disclosed section of their statements.

GAAP and IFRS differ in many ways about how to record investments.  Investments can range from stocks to bonds to money market accounts. When a company buys a security for the purpose of an investment, they must classify that security at that time. There are three types of classifications: trading, available for sale, and held to maturity. Trading securities are ones that you plan to sell within three months. Available for sale are usually short-term, between three months and a year, and held to maturity are long-term. GAAP states that these three classifications be only used for securities. On the other hand, IFRS allows all assets to be classified as one of the three types. Also, GAAP states that once a security has been classified as trading that you cannot change it to any other classification later. IFRS allows you to keep switching your securities between the three classifications.

GAAP has the better standards in these two differences. There is no reason to classify all your assets as trading, available for sale, or held to maturity. It makes no sense for a company to label their inventory or equipment based on when they think they will sell it. Investment securities should be the only thing that needs a classification. Also, I agree with GAAP that you should not be allowed keep reclassifying your securities. Whatever you classify that security as when you get it should be what it stays as.

There are some other minor differences about measuring investments. Investments in unlisted securities and investment property must be measured at historical cost under GAAP. Under IFRS, they are allowed to be measured at fair value.  Measuring at fair value always makes more sense to me, so I think that IFRS has the better standards for measuring investments.

GAAP and IFRS also have some differences when it comes to computing earnings per share. After the income statement is completed, a company will compute its earnings per share and add that to the bottom of the statement. GAAP requires that earnings per share be calculated for continuing operations, discontinued operations, extraordinary items, and net income. IFRS only requires continuing operations and net income. They also differ in that GAAP averages the incremental shares to compute earnings per share, while IFRS uses the treasury stock method.

Right now GAAP is talking about converging some of its earning per share standards with IFRS. This is a good idea because GAAP is to complicated when it comes to earnings per share. They require more than what is needed and that ends up costing companies more money. If GAAP merges with IFRS on this issue, it would be greatly appreciated by most companies.

Long Live the Assets

July 30, 2012 § Leave a comment

So far I have explained how GAAP and IFRS differ when it comes to income statements and inventory. This blog will focus on how they differ in regards to non-current assets.  Non-current assets are assets that will not be used up entirely in one year. If a company plans to have an asset on it’s books longer than a year, then it is considered a non-current asset.


The first type of non-current assets that GAAP and IFRS differ about is long-lived tangible assets. This pretty much just includes property, plant, and equipment. When a company has an old building or piece of land that they want to restore or overhaul, they have to pay for it. GAAP requires that this overhaul cost be expensed in the correct period. On the other hand, IFRS says that this cost should be added to the value of the asset.

I agree with IFRS that the cost should be added to the asset. When the company does a major overhaul to a building, it adds value to that building. When it is time to sell that building they will be able to get more money for it. Therefore, it is not an expense. An expense is when you spend money on something and you can’t get any of that money back. In this case, the company is spending money on the building, but getting some of that money back when they sell the building.

Some other minor differences in long-lived assets involve investment properties and cost basis. GAAP requires that investment properties be carried at depreciated cost and that cost basis be used. IFRS says that investment properties be carried at depreciated cost or fair value and that companies can use cost basis or revaluation to fair value. I agree with GAAP about these two rules. Having only one option to do things makes things easier and it makes companies more comparable.

The second type of non-current assets that GAAP and IFRS differ about is long-lived intangible assets. This includes goodwill and research and development.  When a company buys another company for less than it is worth, they recognize that difference as goodwill. This goodwill can become impaired as the market changes. Under GAAP, this impairment must be measured with reference to fair value, while IFRS says it must be measured with reference to higher of value in use or fair value less costs to sell. GAAP also doesn’t allow reversals of impairment, while IFRS does. IFRS has the better rule here because it allows companies to get a more current value of the impairment.

GAAP and IFRS also differ when it comes to how to capitalize and expense research and development costs. GAAP states that all expenditures related to research and development be expensed as incurred. IFRS states that research costs be expensed, but development costs be capitalized until they reach technological feasibility. I agree with GAAP on this rule because IFRS is going to end up eventually expensing research and development, so why not do it at the beginning instead of the end.

What Is a Long Term Asset?

Inventory, Inventory, Inventory

July 29, 2012 § Leave a comment

My last blog talked about the differences between the way GAAP and IFRS step up their income statements. This blog will focus on the way GAAP and IFRS differ when it comes to how inventory should be accounted for. These two systems differ in three important areas: the allowable costing methods, how inventory is to be presented, and the reversal of market adjustments.

The first way that GAAP and IFRS differ when it comes to inventory is the allowable inventory costing methods. There are three costing methods that are widely used in accounting. Those three methods are FIFO, LIFO, and average cost. FIFO, which stands for first in first out, assumes that goods are sold in the order they are purchased. LIFO, which stands for last in first out, assumes that the last goods purchased are the first ones sold.  Average cost just takes the average cost of the inventory sold. Under GAAP, a company can chose to use any three of these methods. However, IFRS has banned the use of LIFO because they believe that it allows for income manipulation.

I agree with IFRS that the LIFO method should not be allowed. The only reason that it was created was so that companies could manipulate their inventory value to pay fewer taxes. If a company reports their inventory under LIFO, they also have to report it under FIFO. However, the opposite is not true. If a company uses LIFO then they end up having to do twice the work, which is a waste of time and money, so there is no reason to allow LIFO in the first place.

Another way that GAAP and IFRS differ is how inventory is to be presented and valued on the balance sheet. There are two ways in which inventory can be valued: lower of cost or market (LCM) or net realizable value (NRV). LCM means that inventory should be recorded at the lower of either the cost to produce it, the cost to repurchase it, or the market value of the inventory. NRV is the estimated selling price minus the estimated disposal cost. GAAP requires that inventory be valued at LCM, whereas IFRS allows inventory to be valued at LCM or NRV. In this case, I agree with GAAP. Using LCM is a much more conservative approach than NRV, and conservatism is very important when it comes to accounting. Also, it is a lot simpler if there is only one way allowed.

The third way that GAAP and IFRS differ is on the reversal of market adjustments. When you buy inventory it goes on your books at a certain price. If the value of that inventory should drop for some reason, then you are allowed to write down the value of the inventory to what it is worth now. Now let’s say that after you wrote the inventory down, the value goes back up. Under GAAP, companies are not allowed to write the inventory back up. So once you write the inventory down, you can never write it back up. Under IFRS, you are allowed to write the inventory back up to the original cost you had it on your books for. IFRS’s method is better because it gives a more current value of the inventory. With GAAP, once you write the inventory down, you are stuck with that amount. Even if the inventory triples in value you can’t recognize that gain.

 

Differences In The Income Statements

July 28, 2012 § Leave a comment

Hello, my fellow readers. I have created this blog to explain the differences between GAAP accounting and IFRS accounting. GAAP accounting is used by the United States, while every other country uses IFRS. Over the next five blogs, I will pick out five ways in which these systems differ. This blog will cover the differences between how the income statement looks and what can go on it.

The income statement is the most important statement used in accounting. This statement gives the most information about how well the company is doing. Under GAAP and IFRS, the statements can look completely different because both systems have different guidelines. A major difference between GAAP and IFRS involves the treatment of extraordinary items. In order for something to be deemed extraordinary it has to be unusual or infrequent in nature. A hurricane is Florida would not be extraordinary, but an earthquake would be. GAAP allows companies to record a gain or loss from extraordinary events in a separate section of the income statement. This section allows a company to take a loss and put it after continuing operations, which makes the companies financials look better. IFRS doesn’t believe that anything should be extraordinary, so it doesn’t allow any extraordinary items on the income statement.

As of now, GAAP is trying to work towards adapting the IFRS guidelines for extraordinary items. I think GAAP is doing the right thing by trying to get rid of extraordinary items. In today’s world I don’t think that anything should be considered extraordinary. Everyday things happen that no one would ever have believed could happen. Also, it is so hard to measure the financial impact major catastrophes, so companies would just be guessing at the impact. In the past ten years, there have only been two major events that could be considered extraordinary, the attack on the World Trade Center and Hurricane Katrina.  In both cases, the SEC ruled that neither event could be classified as extraordinary. If these two events aren’t extraordinary, then no event should ever be classified as extraordinary, so there is no reason for there to be a section for it on the income statement.

There are some other minor differences between GAAP and IFRS. GAAP requires expenses to be classified by function, whereas IFRS allows them to be classified by function or nature. Also, it is a lot easier for an operation to be considered discontinued under IFRS. OCI, also known as Other Comprehensive Income, can be presented in three different ways under GAAP: a separate statement of comprehensive income, combined with the income statement, or a change in stockholder’s equity statement. However, under IFRS they have to be presented in a separate statement of comprehensive income. These are all simple differences, but have a huge impact of the income statement. IFRS’s guidelines make more sense because they make putting together the income statement easier and more universal. GAAP allows several ways for one thing to be done, whereas IFRS tells you it has to be done this way. Universal income statements make it easier for investors to compare companies, so I think that GAAP should become IFRS when it comes to the income statement.