International Accounting Standards are international principles and rules for the presentation of financial accounts. Most commonly, this term refers to what are now called ‘International Financial Reporting Standards’ (‘IFRS’).
Here, we explain what the International Accounting Standards and IFRS are, and indicate some key ways in which they differ from the ‘Generally Accepted Accounting Principles’ (‘GAAP’) that apply in the United States. This will be of interest to any organization that is required to publish financial statements and operates globally.
What Is the Definition of ‘International Accounting Standards’
Strictly speaking, the ‘International Accounting Standards’ (‘IAS’) are a specific set of norms for the presentation of financial accounts, developed by the International Accounting Standards Board (IASB). Since 2001, those standards have been released under the name ‘International Financial Reporting Standards’ (IFRS). But, more generally, the term ‘international accounting standards’ might be used to refer to any accounting standard that applies to organizations across borders. As we shall explain below, this can include other sets of accounting standards, such as GAAP in the United States.
The push for international accounting standards first arose in the years following World War Two, where record levels of international investment encouraged countries to seek consistency in the way that financial information is reported.
The International Accounting Standards Committee (IASC) was formed in 1973 as the first international standard-setting body. From that point on the ‘IAS’ were issued. A re-organization in 2001 replaced this body with the IASB. From that point on the international standards that were issued were renamed as ‘IFRS’.
Compliance with the IFRS is either required or permitted in over 140 countries around the world, including across the European Union. However, there are significant jurisdictions where IFRS have not been accepted. This includes the United States (which applies ‘Generally Accepted Accounting Principles’ or ‘GAAP’), China and Japan.
Here our focus is on contrasting the IFRS with GAAP in the US, as both may need to be considered by international businesses (we give some examples of when, further below).
What Are the International Financial Reporting Standards (IFRS)?
The IFRS is a broad system of norms for accounting. We cannot set out all of the principles and rules involved here, but some of the key features are set out below.
- Conceptual Framework
- This aspect of the IFRS sets out the purpose of financial information, the key elements of financial statements (assets, liabilities, equity, income and expenses), the qualitative characteristics of statements, when to recognize financial items in statements, and how capital maintenance is recognized.
- Financial Statements
- The IFRS financial statements are the statement of financial position (the ‘balance sheet’), the statement of comprehensive income (historically referred to as the ‘profit & loss statement’), the statement of cash flows, the statement of changes in equity, and the notes to the financial statements.
- General Principles
- A range of general accounting principles are set out in the IFRS, including the following matters:
- Going Concern
- Financial statements are presented on a ‘going concern’ basis: That is, as if the business will continue to trade indefinitely;
- Accrual Accounting
- Income and expenses are recognized as they are accrued, rather than on a ‘cash’ or ‘payments’ basis. For example, if contracted work has been performed the income will generally have accrued, and should be reported as income, even if payment has yet to be received;
- Materiality
- Financial statements need to incorporate all information which is material. That is, information which, if omitted or misstated, would influence decision-makers on that basis;
- Frequency
- Complete financial statements are required at least annually;
- Comparative Information
- Financial information needs to allow for the comparison of financial position, performance and other matters across different businesses;
- Consistency in Presentation
- Financial statements are to be presented consistently from year to year to ensure fair comparisons can be made.
- Regularity
Accountants are expected to adhere to GAAP principles regularly, not on an ad hoc basis.
- Consistency
- The same standards should be applied from financial period to financial period. If the rules applied by a business are changed, financial statements must explain why this is.
- Sincerity
- Accountants must strive always to accurately report financial information.
- Permanence of Method
This is related to the principle of consistency referred to above. The accounting standards used should allow for comparison between different businesses, as well as over time.
- Non-Compensation
- This is the GAAP-equivalent of what is called the ‘no offsetting’ rule in the IFRS. Financial items are to be listed fully and separately, without using one to ‘compensate’ for the other. For example, if a company has loaned $10,000 to a third party, and that third party has itself loaned the company $10,000, both amounts need to be accounted for separately in assets and liabilities. It is not permitted to ‘compensate’ and report the total amount as ‘$0’
- Prudence
Reporting should show good judgement, and not be wildly speculative.
- Continuity
- Valuation of assets should assume that the business will continue.
- Periodicity
- Reported amounts should relate only to the relevant single time period. This may mean recognizing an item over multiple periods.
- Full Disclosure
- There should be no attempt to ‘hold back’ or mislead on any material matters.
- Utmost Good Faith
- Similar to sincerity, all accountants must be honest, and act in good faith, in their reporting of financial information.
Are GAAP International Standards?
Strictly speaking, no. US GAAP apply only in the US, and they do not apply to all companies. However, the Securities & Exchange Commission (SEC) in the US does require their use for publicly-listed companies. It is worth noting. however, that GAAP does apply in many cases to foreign businesses operating into the United States: This may be because the business is operating in a context where GAAP compliance is legally mandated (such as the stock market), or because, as a contractual matter, a foreign business has agreed to apply US GAAP dealing with US business.
How Do GAAP and IFRS Differ?
It was originally expected that GAAP would ‘harmonize’ with IFRS over time. There are many similarities, and new developments in one system tend to be, to some extent, reflected in developments in the other. For example, the new IFRS lease accounting standard that brings leases on to the balance sheet has also been introduced into GAAP (albeit with key differences). However, there are a range of sticking points between the two systems which means that complete harmonization has not happened, and is unlikely to happen in the near future.
- Inventory
- GAAP and IFRS allow for inventory to be reported differently. Both systems allow for First in First Out (FIFO) and various other methods. However, GAAP also allows for Last In, First Out (LIFO), and this is commonly followed by US businesses. This often allows for a lower reported income than would be permitted under IFRS.
- Research and Development Costs
- Under IFRS, R&D costs can be capitalized and amortized over several periods. Under GAAP, they must be expensed as they are incurred
- Presentation of Financial Statements
- GAAP requires that assets, liabilities, and equity are presented in order of liquidity in the Statement of Financial Position. IFRS guidelines have no specific format, and often assets and liabilities are not ordered by liquidity.
- GAAP permits the income statement to include “extraordinary items” as a separate item on the income statement. IFRS does not.
Conclusion
Global compliance means being familiar with all the accounting standards that apply to the operation of your business. Many countries follow the international accounting standards known as IFRS, but many important economies, such as the US, China and Japan apply their own system. In the US, this accounting system is known as ‘GAAP’.
Businesses operating internationally need to carefully consider the accounting standards that apply across all their international locations. If seeking investment from a foreign entity, businesses also need to consider the standards that are expected by that foreign entity. This may require preparing several sets of financial statements, compliant with each applicable systems.
Horizons supports business expansion across global locations. When advising on the set up of a local subsidiary or company, a merger or acquisition, or some other form of global expansion, Horizons can support your business: They ensure that you have the necessary support to compile compliant financial statements as required under the law.
