There are two standards in the field of accounting. The first is created by the Financial Accounting and Standards Board (FASB), whose power is derived from the United States’ Securities and Exchange Commission (SEC). The second is created by the International Accounting Standards Board (IASB), which is an independent, privately funded accounting standard-setter based in London, England. The FASB publishes its standards in the Generally Accepted Accounting Principles (GAAP) and the IASB publishes International Financial Accounting Standards (IFRSs). GAAP and IFRS do not agree on every issue. The growing complexity in international business and the increase rate of international investing has increased the need for a common standard. Since 2002, FASB and IASB have been working to converge U.S. GAAP and IFRS. One of the major efforts in the convergence has been reconciling differences between U.S. GAAP and IFRS financial statement presentation. The goal is to create a common standard for the form, content, classification, aggregation and display of line items on the face of financial statements (McClain, 2008).
The use of accounting and all financial reporting comes to a focal point in the creation and presentation of financial statements. Thus, it is vitally important that the objectives of financial reporting be clearly defined. U.S. GAAP defines the objective of financial reporting as, “The objective of general purpose external financial reporting is to provide information that is useful to present and potential investors and creditors and others in making investment, credit, and similar resource allocation decisions” (FASB, 2006). IFRS defines the objective of financial reporting as, “The objective of general purpose financial statements is to provide information about the financial position, financial performance, and cash flows of an entity that is useful to a wide range of users in making economic decisions” (IFRS, 2011). FASB’s and IFRSs’ objectives are very similar in nature; however, the way they present the information is very different.
The first major difference between U.S. GAAP and IFRS financial statement presentation isthe statement’s title. Within this difference there is a similarity, both U.S. GAAP and IFRS recognize four main financial statements. U.S. GAAP titles their financial statement’s Balance Sheet, Income Statement, Retained Earnings and Cash Flow Statement. IFRS titles their financial statements, in comparative order, Statement of Financial Position, Statement of Comprehensive Income, Statement of Changes in Equity and Statement of Cash Flows. Differences in titles is hardly material but is worth mentioning for the sake of comparison.
Another difference between U.S. GAAP and IFRS is the number of financial periods required to be reported. U.S. GAAP requires firms to follow SEC guidelines which,apart from start-up companies,require balance sheets to be reported for the two most recent years while other financial statements must report three years. IFRS, on the other hand, only requires comparative information for one year (US GAPP vs. IFRS).
The main difference between FASB and IFRS financial statement presentation is formatting. This difference is very visible when comparing the Balance Sheet/Statement of Financial Position. At first glance, the Balance Sheet and the Statement of Financial Position appear much different. One trained in U.S. GAAP will immediately notice that the IFRS Statement of Financial Position does not balance. This is due to the fact that IFRS does not separate assets and liabilities. Instead, assets and liabilities are netted together into business sections. The sections are titled with familiar accounting terms such as operating, investing and financing. Management is giving the freedom to make fair judgments as to which sections individual asset or liability accounts belong; however, management is required to disclose their basis for their classifications (Benzacar, 2009). Dividing assets and liabilities into business sections explains the differences in title. IFRS cannot legitimately call the Statement of Financial Position a Balance Sheet, because it does not have a clear balance. Underlying the presentation format, the Statement of Financial Position still balances.
Another difference found on the Statement of Financial Position is that firms may not be required to provide subtotals for short-term and long-term assets or liabilities. IFRS states, “An entity must normally present a classified statement of financial position, separating current and noncurrent assets and liabilities. Only if a presentation based on liquidity provides information that is reliable and more relevant may the current/noncurrent split be omitted” (IFRS, 2011). Again, IFRS gives management more freedom then U.S. GAAP.
IFRS’s Statement of Comprehensive Income is comparable to U.S. GAAP’s Income Statement. These financial statements have a lot in common. Both financial statements provide subtotals for discounted operations, net income and other comprehensive income. The main difference between these statements is that everything above discontinued operations is divided into the same sectionsused in the Statement of Financial Position. For example, the operating section includes sales, cost of goods sold, expenses and depreciation. These accounts are subtotaled into total operating income. The investing section would include dividend revenue, any relative expenses. These accounts are subtotaled into total investing income. Each section has its own subtotal that contributes to the firm’s overall net income.
Two elements missing from the Statement of Comprehensive Income is the income from continued operations and extraordinary items sections. IFRS requires that firms fit all items into one of the sections.
Compared to U.S. GAAP, IFRS requires firms to further differentiate line items by function and nature. For example, cost of goods sold must be subdivided into materials costs, labor costs, and overhead. Furthermore, details for general and administrative expenses must also be disclosed. Requiring further differentiate results in greater transparency, as well as, a much longer statement than U.S. GAAP (Benzacar, 2009). IFRS does allow firms to condense their statements as long as the details are reported in the statement’s notes.
The main problem in the U.S. GAAP IFRS disparity, as it relates to financial statement presentation, is not layout, rather it is uniformity. U.S. GAAP and IFRS financial statements are both functional presentations. Problems arise when comparing statements across the two standards.
There are obvious advantages to financial statement uniformity. By adopting IFRS, U.S. firms could present their financial statements in the same way as foreign competitors. This would result in ease of use forinternational investors wishing to make comparisons. This could make it easier for U.S. firms to raise capital abroad. Furthermore, large conglomerate firms, with subsidiaries aboard, may already being using IFRS. It could be relatively easy for large firms to make the transition. Bill Brushett, a Canadian CPA, feels U.S. firms should willingly present their financial statements according to IFRS. Brushett said,
As a business changes, so does the audience for its financial statements. If you’re not speaking the right financial language to new stakeholders, your company could suddenly find itself at a significant disadvantage… If youchoose not to adopt IFRS, your potential suppliers and customers may opt to do business with another company whose financial statements are more understandable and transparent to them (2).
Despite the advantages, there are numerous potential disadvantages for U.S. and foreign firms as a result of the convergence. Firms, especially smaller firms without foreign subsidiaries, will need to change programming within their accounting system. Firms will need to adjust their processes and controls to comply with new financial statement presentation guidance (US GAAP Convergence, 2011). Overall, the U.S. GAAP IFRS convergence will result in incremental costs to many firms that may outweigh the benefits.
The international business community seems to think financial statements need overhauled. In 2008, accounting firm Grant Thornton conducted a survey. The survey asked 200 chief financial officers and senior controllers of international firms whether U.S. GAAP financial statements are too complex for the average investor. 67% said yes (Leibs, 2008).
IFRS has a distinct advantage over U.S. GAAP. According to the IFRS, approximately 120 nations permit or require IFRS for domestic companies. U.S. GAAP is only required in the U.S. Because of the acceptance of IFRS, U.S. firms should adopt IFRS. However, the SEC should only require IFRS if they transition to rule based standards. Rules bases standards have a number of advantages including clarity in application and reduction of risk to investors. IFRS’s current principles based standards allow for too much manipulation and managerial discretion. There is no room for variations in financial statement presentation by different companies in similar industries. Financial statements need to be uniform.
The IASB has some concepts in common with the FASB; however, there are more differences than similarities. U.S. GAAP and IFRS both provide excellent principles; however, the United States should continue to comply with U.S. GAAP. Firms where the benefits outweigh the incremental costs, should report their financial statement in both standards. The SEC, American investors, and American firms will likely never fully accept IFRS or the IASB, because it moves control over financial standards abroad (Cellucci, 2010). Regardless of the effect of the convergence on financial statement presentation, U.S. firms will likely always follow some version of U.S. GAAP because U.S. GAAP has the support of the SEC and U.S. firms pay taxes under U.S. laws.