First Identify The Formula Then Calculate The Operating Income Percentage IFRS Vs GAAP Accounting Standards

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IFRS Vs GAAP Accounting Standards

There has been a growing demand over the past twenty years to unify the business world under a conceptual framework for reporting financial statements. Currently, there are two types of frameworks used in the accounting world. They are Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).

Currently, more than 7,000 companies in over 100 countries around the world use IFRS instead of GAAP. To harmonize these foreign capital markets, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are working together to harmonize GAAP with IFRS. The main objective of this transformation is to have a common global financial reporting standard that allows financial statements to become more relevant and reliable. This allows both United States and foreign companies to be more consistent and comparable in their financial statements. The overall objective of this transformation is to provide better financial information for capital providers, creditors and stockholders.

Generally Accepted Accounting Principles (GAAP) is a rules-based system used in the United States. These rules are used to prepare, present and report financial statements of companies. The Securities and Exchange Commission (SEC) requires that GAAP be followed by publicly traded companies. GAAP is made up of many rules but there are four basic ideas. These include consistency, relevance, reliability, and comparability. Consistency means that all information is collected and presented the same across all periods. Relevance relates to the idea that all information presented is important to the company. Reliability means that all the information given in the financial statements is reliable or true and verifiable. Comparability is perhaps the most important part of GAAP. Since all businesses use the same system of financial reporting, it will be easier to compare companies. Without the ability to compare companies, it is difficult for investors to evaluate companies and hold each company to industry benchmarks and competitors.

International Financial Reporting Standards (IFRS) is a principles-based system used by more than a hundred countries around the world. These principles are general guidelines that should be followed but there is flexibility. The main goal of IFRS is financial statements that reflect true and accurate information about a company. The lack of guidance under IFRS generally requires management to make assumptions, estimates and judgment calls in financial reporting.

Both methods, GAAP and IFRS, have the same basic ideas but differ when it comes to specific details. First, there are financial statement presentations. Both systems have similar parts of a complete set of financial statements. These statements include the balance sheet, income statement, statement of cash flows, other comprehensive income for GAAP or statement of income recognized as expense for IFRS, and accompanying notes. Both methods require that statements be prepared using the accrual basis of accounting. However there are some differences. Under GAAP rules, the balance sheet must include the last two most recent years. All other statements must cover a three-year period. IFRS requires information only in prior periods. GAAP does not have a general requirement for the layout of a balance sheet or income statement, while IFRS has a list of minimum items that must be included. Under GAAP, the classification of expenses is required to be presented on a functional basis. IFRS allows companies to choose by operating basis or nature of expenditure. If a function is selected, the nature of certain expenses should be listed in the notes.

Another category of differences is inventory. Inventory is defined as property held for sale in the ordinary course of business, in the process of production for such sale, or to be consumed in the production of goods or services. The methods of measuring costs, the standard cost method or the retail method, are the same under both GAAP and IFRS. Also under both systems, the cost of inventory consists of direct expenditures on finished inventory sales, including allocated overhead. Selling costs and general administrative costs are excluded from the cost of inventory. Under GAAP, the last in first out (LIFO) cost method is acceptable. It is clearly not necessary to follow the same formula for all lists of a similar nature. In IFRS however, LIFO is prohibited. All lists must use the same formula. The way inventory is measured is also different. GAAP inventory is carried at the lower of cost or market. Inventory is carried at cost less net realizable value under IFRS standards.

Completion of income process and acquisition of property from completion is considered as revenue recognition. Under both systems, revenue is not recognized until it is realized and earned. Both systems have certain criteria that must be met before revenue is recognized. Under GAAP, there are four main criteria, persuasive evidence, delivery, fixed/fixed pricing, and collection assurance. IFRS has five different standards that need to be met. These criteria are transferability of risk and reward, continuous management involvement, measurement reliability, potential economic benefit, and reliably incurred costs. Another difference is the contact construction. Under GAAP, construction contracts may, but are not required to be combined or segmented if certain criteria are met. Under IFRS, construction contracts are combined or separated if certain criteria are met. The standards for GAAP and IFRS are different.

Intangible assets are defined as non-monetary assets without physical substance. The definition is the same under both systems. Both systems have potential future economic benefits and costs that can be reliably measured. Start-up costs are never capitalized. Amortization of intangible assets over their estimated useful lives is required under both GAAP and IFRS. If there is no foreseeable limit to the period over which the intangible asset is expected to generate new cash flows, the useful life is considered indefinite and the asset is not amortized. Differences arise when looking at development costs. According to GAAP, development costs are expenses incurred unless addressed by a separate standard. Computer software, however, is capitalized once technical feasibility is established. Under IFRS, development costs are capitalized when the technical and economic feasibility of the project is demonstrated. There are no separate guidelines regarding computer software costs. Advertising costs also vary. GAAP allows advertising and promotion costs to be expensed or expensed when the advertisement is first incurred. Advertising and promotional costs are expensed as they are incurred under IFRS. Another difference is that revaluation is not permitted under GAAP while IFRS allows revaluation to fair value of intangible assets other than goodwill.

In conclusion, there are many obstacles to converting US GAAP to IFRS. However, transformation is necessary and discussions for transformation have started. The transformation of the GAAP framework will completely change the way companies report their financial results in the coming years. Adaptation from GAAP to IFRS will create benefits of stronger comparability and consistency between the financial statements of US and foreign corporations. A merger between the two accounting standards will produce more transparent and understandable standards that will provide greater benefits to investors.

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