Companies report their financial statements to allow users to make well-informed decisions. This process falls under the scope of accounting standards.
Usually, companies get those standards from a body that regulates the accounting process. While IFRS is the most prevalent accounting standard, some companies also use GAAP. In the US, GAAP is the only applicable accounting standard.
The IFRS is more prevalent in other parts of the world. Currently, over 140 countries use the IFRS. However, the US has only emphasized using the GAAP standards.
Some other countries have also adopted a version of the GAAP standards. However, those standards differ from the ones used in the US. Furthermore, those companies have only used GAAP to cater to the needs of investors from the US.
The IFRS comes from the International Accounting Standards Board (IASB). The IASB regulates the process for developing and maintaining those standards. Similarly, it works with various national bodies to help create and promote the IFRS worldwide. However, it has not achieved the same results in the US. The primary reason for it is the alternative in the form of GAAP.
GAAP uses a different standard than the IFRS. While these involve several discrepancies, they also agree on various accounting treatments. The difference between GAAP and IFRS creates issues for investors who are active in the global market. Most investors wonder if the US will adopt IFRS since GAAP cannot apply to other jurisdictions. Before discussing that, however, it is crucial to understand what GAAP is.
What are Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles, or GAAP refers to a group of accounting standards. These standards include the details, complexities and legalities of business and corporate accounting. Usually, these standards only apply to companies based in the US. However, other countries have also adopted a customized version of the GAAP standards. For those countries, IFRS is still the primary standard for accounting.
GAAP includes a set of rules and procedures that govern corporate accounting and financial reporting in the US. Also known as US GAAP, it contains comprehensive accounting practices that guide companies on various transactions. However, these standards do not provide leniency in how companies treat those transactions. GAAP follows a rules-based approach to setting standards compared to the IFRS, which uses a principles-based approach.
The US GAAP comes from the Financial Accounting Standards Board (FASB). Furthermore, the Governmental Accounting Standards Board (GASB) also plays a role in developing them. Usually, the former dictates the process for entities involved in financial reporting. The latter, in contrast, creates standards for governmental bodies and nonprofits. In the US, public companies must follow GAAP standards when reporting their activities.
GAAP provides an alternative to the IFRS in the US. However, it also creates issues for investors active in the worldwide market. On top of that, GAAP also makes it more challenging for companies in the US to be part of acquisitions and mergers. Nonetheless, the discrepancies between GAAP and IFRS have become lesser due to efforts from both sides. Some differences still exist between the two, though.
Overall, GAAP includes several accounting standards and common industry usage. They come from the FASB and GASB for many years. In the US, GAAP is the primary accounting standard. Those entities use GAAP to organize their financial information into accounting records. Similarly, it helps them summarize those records into financial statements.
What is the Importance of Generally Accepted Accounting Principles (GAAP)?
GAAP allows companies to follow a strict set of standards. Therefore, they have little room to manipulate accounts and show a favourable picture in the financial statements. Consequently, companies can report a more accurate financial position and performance. This feature also protects investors from any material misstatements in the financial statements. GAAP removes any leniency in the accounting process for various transactions.
GAAP also allows investors to compare and evaluate companies. It enforces a consistent and comparable approach to accounting. Consequently, investors can obtain financial statements from various companies and compare them. Similarly, it allows them to determine which company is faring better. By removing the accounting differences in financial treatments, GAAP enables better comparisons.
GAAP also allows companies to gain valuable insights into their practices and performance. Similarly, it minimizes the risk of errors in the financial reporting process. It achieves that by having various checks and safeguards against erroneous financial reporting. Consequently, it makes the underlying financial statements more reliable and accurate. These statements can be helpful in both internal and external analysis.
GAAP standardizes the overall process to prepare financial statements. It establishes various rules, regulations, and assumptions that companies must adhere to during the process. Similarly, it specifies when and how companies must comply with specific accounting standards. Consequently, it ensures that all companies follow similar guidelines when disclosing financial transactions. The process also becomes more standardized due to the existence of GAAP.
Overall, GAAP is highly critical for companies in the US. For public companies, following these standards is compulsory. Other companies outside the US may also use these standards. However, it is not mandatory to do so. GAAP provides all the benefits of following standards during the accounting process. Apart from those, it can also have other specific advantages.
Will the US Adopt IFRS?
IFRS has reached a global audience with its broad adoption throughout the world. Most companies use these standards to prepare and report their financial statements. Therefore, it has become a global standard for investors and companies. However, the US has emphasized using its standards through GAAP. It has created some issues for companies with a global presence and foreign investors.
Currently, the US has not expressed any opinion on adopting IFRS as the accounting standard for its companies. It feels GAAP is appropriate and sufficient for its needs. Similarly, GAAP also uses a rules-based approach compared to the principle-based approach from IFRS. This approach is stricter and provides less leeway for companies to manipulate their accounts. The US feels this approach enforces a reliable and accurate financial accounting process.
Another issue with adopting IFRS is the cost and effort involved in the process. Currently, all companies operating in the US use the GAAP standards. If the US decides to change that requirement to IFRS, companies must adjust their financial statements accordingly. These widespread changes can create many issues and disrupt their economy. At the time, adopting the IFRS is challenging.
Nonetheless, the US has realized the need for similar accounting standards. Therefore, it has chosen to converge GAAP standards with the IFRS. This process tackles the issues that come with adopting IFRS. Despite this decision, there are still many differences between both. On top of that, convergence does not guarantee consistency throughout the process.
In summary, the US does not plan to adopt the IFRS for its companies anytime soon. Despite ideas about combining these standards, nothing has changed. Currently, the US intends to use GAAP as its primary accounting standard for companies. However, companies within the US may choose to report their accounts under GAAP and IFRS.
Conclusion
GAAP includes accounting standards that dictate the financial reporting process. These standards apply to financial transactions and financial statements. However, they are only applicable in the US. The rest of the world has chosen IFRS as the primary accounting standard for the financial report. This difference has created issues for companies and investors. However, the US does not intend on adopting IFRS anytime soon.