Accounting standards include standardized guiding principles that help companies in various accounting matters. They help determine the policies and practices used during the financial accounting process. Similarly, accounting standards improve the transparency of this process while promoting better financial reporting. These standards also facilitate financial accountability. For most companies, following accounting standards is mandatory.
In the past, accounting principles related to a specific area or country. National standard-setting bodies overlook those standards. However, it created issues for companies and investors that traded internationally. Comparing the standards for those companies was challenging due to the difference between accounting standards. However, international standard-setting bodies took over the process and streamlined it.
Today, most companies worldwide use IFRS as their primary accounting standard. However, some companies also use GAAP, primarily in the US. Both follow similar principles. Nonetheless, they also differ in several fundamental aspects. On top of that, most investors and companies prefer the IFRS over GAAP. They consider IFRS to be better than GAAP. Before understanding the reason, it is crucial to discuss these standards in detail.
What are International Financial Reporting Standards (IFRS)?
International Financial Reporting Standards (IFRS) refer to an international accounting framework. It enforces companies to organize and report financial information within set principles and rules. Similarly, IFRS is the primary accounting standard framework to report finances for most companies. It involves various accounting standards, which come under IAS or IFRS.
IFRS comes from the International Accounting Standard Board (IASB). This board operates under the IFRS Foundation. Similarly, it is responsible for maintaining existing IFRS and developing new standards. Previously, the International Accounting Standard Committee (IASC) overlooked this process. Since 2001, the IASB took over the IASC and replaced it completely. The standards developed by the IASB fall under IFRS, while those from the IASC come as IAS.
Currently, IFRS is the only applicable financial reporting framework in over 140 countries. It promotes transparency, consistency, and comparability within companies from those countries. Companies that use these standards must report their finances under the same rules. However, IFRS is principles-based and may leave some room for different interpretations. Nonetheless, it provides a base to report financial information consistently.
IFRS guides companies in maintaining their financial records and reporting various aspects of their finances. The primary objective of these standards is to create a common accounting language understood globally. Due to its board adoption by many countries, IFRS has achieved some of its goals. However, it does not apply to the US, where GAAP is the primary accounting and financial reporting framework.
What are Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles (GAAP) include various accounting standards and common industry usage. These standards come from the Financial Accounting Standards Board (FASB). However, they only apply to companies operating within the US. GAAP standards have been developed and maintained for many years. It helps companies and organizations to manage their financial information into accounting records.
Consequently, GAAP helps summarize the accounting records into financial statements. Lastly, it also dictates the disclosures for specific supporting information. GAAP plays a similar role in the accounting process as IFRS. It covers the financial reporting and accounting process. However, it takes a rules-based approach to this process. Consequently, it provides less room for different interpretations of the standards provided.
The primary objective of GAAP is to improve the clarity, comparability, and consistency of financial information. It helps govern the world of accounting according to general rules and guidelines. Similarly, it seeks to standardize assumptions, definitions, and methods in accounting. Since it applies to all companies, these areas become consistent with GAAP usage. However, it only has a limited scope.
Ultimately, GAAP includes standards and principles to ensure a company’s financial statements are complete. Similarly, it emphasizes the comparability and consistency of the information provided in those statements. GAAP makes it easier for investors to extract specific information and analyze it. Similarly, GAAP provides companies with a standardized method to record and report financial transactions.
Why IFRS is better than GAAP? 5 reasons you should know
Both IFRS and GAAP provide a base for companies to record and report financial information. In those terms, they are similar. However, they differ in their scope due to the areas they cover. On top of that, IFRS differs from GAAP due to the accounting standards in question. Nonetheless, many believe IFRS to be better than GAAP.
For those, the top five reasons why IFRS is better than GAAP include the following.
Principles-based Vs. Rules-based
IFRS uses a rules-based approach to accounting, which some accountants believe to be better. Within this approach, IFRS uses the conceptual framework to develop new standards. This framework comes from the Accounting Standard Board’s Framework. Similarly, it helps the IASB create better standards based on the underlying conceptual framework.
However, GAAP uses a rules-based approach to setting an accounting framework. This approach is stricter than the principles-based one used by the IFRS. Similarly, GAAP provides accounting standards that companies must follow. This approach is also called the ‘Cookbook’ approach. Most experts believe this approach is rigid and does not allow flexibility.
Focus on investors
One of the most significant reasons why IFRS is better than GAAP is its focus on investors. IFRS promises more accurate, timely, and comprehensive financial statements. Similarly, it ensures investors that this information will be relevant to their decisions. Consequently, it helps new and small investors by making the reporting standards. IFRS removes the need to understand the underlying principles while making information more comparable.
IFRS is also more investor-friendly due to its broader application and adaptation. It includes harmonized and standardized reporting standards which do not require additional analysis. On top of that, it reduces the differences between reporting standards between various jurisdictions. While GAAP also promises parts of those aspects, it is not as investor-friendly.
The conformity to IFRS has significantly improved the comparability of financial statements worldwide. More specifically, in the EU, it has achieved substantial results. Companies using the IFRS have also attracted more attention due to the ease of comparison in their financial statements. One aspect that helps in this regard also includes its broad adaptation and convergence.
GAAP also provides some comparability. However, this process is only applicable between companies within the US. Outside, these companies have little chance of attracting investors. The primary reason for it is the lack of comparability with companies outside the US. Only investors who understand the differences between GAAP and IFRS can compare those companies.
Better access to foreign markets and investments
IFRS provides companies better access to foreign markets and investments. Usually, the mergers and acquisitions process involves various challenges. One of those includes aligning the accounting process with the other companies. However, if companies use IFRS, these challenges decrease. The broad adoption of IFRS in the EU and other countries helps in this regard.
Investors are also more likely to prefer investing in companies that use IFRS. GAAP can also help in this regard. However, only investors within the US can invest in those companies. Foreign investors will need to obtain a basic understanding of GAAP before investing in US-based companies. This point also relates to the focus IFRS places on investors and their needs.
IFRS is also more relevant compared to GAAP. Several reasons contribute to this aspect. Usually, new IFRSs reflect on the economic substance of financial transactions more than legal form. It helps companies and their stakeholders get a true and fair view of those transactions. Similarly, IFRS reflects gains and losses promptly. Consequently, it makes IFRS more reliable and credible than GAAP.
Similarly, specific financial statements prepared under the IFRS are more useful to decision-making. These statements are more consistent and provide relevant information compared to GAAP. On top of that, IFRS prevents various manipulative accounting procedures. GAAP is rules-based and can allow for more leeway if a specific rule does not exist to process a transaction.
IFRS and GAAP are two accounting and financial reporting frameworks. While GAAP only applies in the US, IFRS has a broader scope. Consequently, it makes IFRS more preferable for companies and stakeholders. Most experts believe the IFRS to be better than GAAP. Some of the reasons to support that belief are available above.