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.