Certain guidelines and criteria must be observed to maintain consistency and uniformity in accounting. We refer to these as accounting principles. Each accounting body has its standards, guidelines, and other requirements.
A standard guiding concept that establishes the procedures for financial accounting is known as an accounting standard. Essentially, it is a collection of procedures and guidelines used to standardize auditing and other accounting tasks throughout an organisation consistently. It increases financial reporting’s openness and makes financial responsibility easier.
Accounting standards are relied upon by bankers, investors, and government agencies to guarantee that data regarding a certain organisation is correct and up to date. It is relevant to the financial reporting of the firm. Financial accounts, goodwill accounting, an approved technique for depreciation, company combinations, lease categorization, measuring outstanding shares, and revenue recognition are a few examples of accounting rules that are often used.
Accounting standards increase financial reporting’s openness across the board. GAAP and IFRS are the two primary accounting standards used by business organisations.
What is GAAP?
A unified set of accounting guidelines, methods, and standards known as generally accepted accounting principles (GAAP) were released by the Financial Accounting Standards Board (FASB). A public company’s financial statements must be prepared in accordance with US GAAP by their accountants.
These fundamental accounting concepts and recommendations provide the basis for more intricate and thorough accounting regulations, standards, and other sector-specific accounting procedures.
GAAP comprises authoritative standards (established by policy bodies) and generally recognised practices for capturing and disclosing accounting data. It strives to enhance financial information communication in terms of consistency, clarity, and comparability.
GAAP is important since it helps to maintain market trust. Investors would be less inclined to believe the information supplied by corporations due to their less faith in its accuracy if it weren’t for GAAP. Without that trust, fewer transactions could occur, resulting in greater trading costs and a weaker economy. By making it simpler to compare two firms “apples to apples,” GAAP also aids investors in their analysis of public corporations.
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What is IFRS?
International Financial Reporting Standards (IFRS) standards define how transactions and other accounting events must be represented in financial statements. They are made up of a collection of accounting rules. They are made to preserve the financial industry’s reputation and openness, allowing investors and company operators to make wise financial decisions.
How businesses must keep their books up to date and declare their costs and profits is outlined in IFRS in great detail. They were developed to provide a standard language so that financial statements could be easily understood from business to company and country to country. They are developed and supported by the International Accounting Standards Board.
IFRS promotes openness and faith in the financial markets worldwide and the businesses that list their shares there. Investors would be less likely to accept the financial statements and other information offered by corporations if such requirements did not exist. A weaker economy and fewer transactions might result from a lack of confidence.
IFRS also makes it simpler to do “apples to apples” comparisons across various firms and conduct basic analyses of the company’s performance.
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GAAP v.s. IFRS
Cash flow statement
A cash flow statement is a type of financial statement that details the precise inflow and outflow of cash and cash equivalents for a certain reporting period. Under GAAP IFRS, a company’s cash flow statement is created in different ways under GAAP and IFRS. The classification of interest and dividends is the clearest example of this.
GAAP: According to GAAP, dividends paid are recorded in the financing section, whereas dividends received are recorded under the operational section. Foreign criteria are more lenient than U.S. requirements in that they allow for the classification of interest collected and paid as operational activities.
According to GAAP, dividends paid out should be recorded in the finance section, and dividends received should be recorded in the operations section.
IFRS: Every interest and dividend paid under IFRS may be mentioned in the finance or operational section. A company may decide on its classification scheme for interest depending on what it deems acceptable. The cash flow statement’s operating or financing part should be used to record interest payments, and the operating or investment section should be used for interest receipts.
Companies that adhere to IFRS rules have the option to classify dividends. Dividends received could go in the operating or investment section, while dividends given can go in either one.
Inventory valuation methods
Calculating the value of your inventory is known as inventory valuation. FIFO, LIFO, and weighted inventory are the three techniques businesses use to value their inventory. First In, First Out is referred to as FIFO. The initial goods in the inventory are assumed to be the first items sold in this valuation approach, which follows the inventory’s natural flow.
The technique used by LIFO, or Last In, First Out, is the inverse of FIFO. This approach assumes that the most recent (i.e., most recent) inventory items will be the ones to sell first.
When using a weighted average, one may determine the value of closing inventory and the associated cost of sales by examining the weighted mean cost of the products still in value at the time of an affiliated sale.
The way that inventory value is handled differs between GAAP and IFRS.
GAAP: Companies cannot employ any of the three inventory valuation techniques under GAAP. When employing FIFO, GAAP calculates inventory valuation using “net asset value,” which is the sum of a company’s assets less the sum of its liabilities.
IFRS: Because LIFO may be used to manipulate a company’s results to reduce its tax burden, IFRS only permits the FIFO and weighted average methods. When utilising FIFO, IFRS calculates an asset’s “net realisable value,” which considers its potential revenue less an estimate of the expenses, fees, and taxes related to the sale.
A firm’s liabilities, assets, and shareholder equity are listed on a balance sheet, which is a financial statement. Knowing how to structure your balance sheet can help investors and other stakeholders understand it quickly and properly.
Because categories are organised under a balance sheet, GAAP and IFRS are also constructed in distinct ways.
GAAP: Working capital is listed first according to GAAP. The most liquid assets, such as non-current assets, current assets, non-current liabilities, current liabilities, and owners’ equity, must be presented first in accordance with GAAP.
IFRS: Under IFRS, non-current assets come first. According to IFRS, assets should be presented in reverse relation to current liabilities, with the least liquid assets owners’ equity, current assets, current liabilities, and non-current liabilities listed first.
The worth of a company’s assets may change over time, necessitating periodic revaluation. Asset revaluation is essential because it helps you budget for the maintenance costs of current assets once their useful life has passed and offers investors a more realistic picture of your company. Asset revaluation can also lower the company debt to equity ratio, which will improve the company’s financial image.
This resulting increase in value is handled differently under GAAP and IFRS.
GAAP: According to GAAP, the value of an asset cannot be increased once it has been impaired. It only permits the reassessment of marketable securities’ fair market value.
IFRS: The rules allow for the revaluation of some assets up towards their original cost and the adjustment for depreciation. Property, plant, inventories, intangible assets, equipment (PPE), and stakes in marketable securities are all included in the revaluation of assets.
Inventory write-down reversals
Inventory held by a corporation might depreciate over time. For instance, a loss on impairment occurs when an asset loses value due to market or technical causes. While a loss is frequently irreversible, if the impairing cause is removed, the asset’s value could rise once again.
According to GAAP and IFRS, businesses must write down inventories as long as their cost exceeds its net realisable value or the amount that the inventory is projected to bring in when sold.
GAAP: If the value of assets rises again, then In these circumstances, GAAP prohibits corporations from revaluing the asset at its original cost. Reversing previous write-downs is not permitted by GAAP.
IFRS: If the value of assets rises again, then inventory value could be more unstable under IFRS. Some assets may be valued up to their original cost under IFRS once depreciation has been considered. Only IFRS permits the prior write-down to be rectified if the market value rises.
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No matter your job or business, knowing GAAP and IFRS standards can be beneficial. Owners of foreign businesses must comprehend the distinctions between IFRS and GAAP accounting. For investors and other parties involved to analyse financials under either standard properly, they must be aware of these variances.
Conceptually, IFRS is more governed by principles, while GAAP is more rules-based. While IFRS is a worldwide standard, GAAP is mostly applied in the United States. The two criteria include, among other things, long-lived assets, investments, exceptional items, and ceased activities.
While it might be challenging to determine which is true, some people believe IFRS to be more precise than GAAP since it is seen as an accounting standard that is more grounded in principles and better represents the economy of a transaction. With Physics Wallah, you can understand and clear all your concepts without any trouble.
Frequently Asked Questions (FAQs)
Q1. Are GAAP and Accounting Standards different from each other?
Ans. Yes, GAAP and accounting standards are very different from each other.
Q2. What is the full form of GAAP?
Ans. The full form of GAAP is Generally Accepted Accounting Standards.
Q3. What is the difference between GAAP and IFRS?
Ans. In the above mentioned blog, we’ve explained the topic broadly.