Accounting is often referred to as the “language of business.” It’s one of the most fundamental business skills, capable of revealing key insights into a company’s financial health and potential, and driving strategic decision-making that leads to new ventures and investment opportunities.
For professionals in non-accounting roles, understanding what’s behind an organization’s numbers can be immensely valuable. Knowing how to analyze financial statements can improve your ability to communicate results and boost collaboration with colleagues in more numbers-focused positions.
If you want to further your accounting knowledge, it’s critical to understand the standards that guide how companies record transactions and report finances. Here’s a look at the two primary sets of accounting standards—GAAP and IFRS—and how they compare.
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Accounting standards are critical to ensuring a company’s financial information and statements are accurate and can be compared to the data reported by other organizations.
The two main sets of accounting standards followed by businesses are GAAP and IFRS.
- GAAP, also referred to as US GAAP, is an acronym for Generally Accepted Accounting Principles. This set of guidelines is set by the Financial Accounting Standards Board (FASB) and adhered to by most US companies.
- IFRS stands for International Financial Reporting Standards. These principles are dictated by the International Accounting Standards Board (IASB) and followed in many countries outside the US.
Deciding which set of standards to use depends on whether your company operates in the US or internationally. Work is being done to converge GAAP and IFRS, but the process has been slow going.
The Key Differences Between GAAP vs. IFRS
While GAAP and IFRS share many similarities, there are several contrasts, beyond the regions in which they’re applied. Here are four key differences between GAAP and IFRS.
1. The Balance Sheet
The way a balance sheet is formatted is different in the US than in other countries. Under GAAP, current assets are listed first, while a sheet prepared under IFRS begins with non-current assets.
The two standards also dictate different approaches to ordering categories on the balance sheet. GAAP calls for accounts to be listed in the order of liquidity—or how quickly and easily they can be converted to cash. The items are arranged in descending order (most liquid to least liquid): current assets, non-current assets, current liabilities, non-current liabilities, and owners’ equity.
Under IFRS, the order is reversed (least liquid to most liquid): non-current assets, current assets, owners’ equity, non-current liabilities, and current liabilities.
2. The Cash Flow Statement
A company’s cash flow statement is also prepared differently under GAAP and IFRS. This is most acutely seen in how interest and dividends are classified.
GAAP prescribes that interest paid and interest received should be classified as operating activities, while international standards are a bit more flexible. Under IFRS, a firm can choose its own policy for classifying interest based on what it considers to be appropriate. Interest paid can be placed in either the operating or financing section of the cash flow statement, and interest received in the operating or investing sections.
The same goes for dividends. GAAP specifies that dividends paid be accounted for in the financing section, and dividends received in the operating section. When following IFRS standards, companies have a choice of how they categorize dividends. Dividends paid can be put in either the operating or financing section, and dividends received in the operating or investing section.
To summarize, here’s a detailed breakdown of how the two standards differ in their treatment of interest and dividends.
3. Asset Revaluation
When an asset experiences a reduction in value due to market or technological factors—which in turn, causes it to fall below its current value in a company’s account—it’s classified as a loss on impairment. While impairment is often permanent, an asset’s value can increase after this loss has been recognized if the elements that caused it no longer exist.
GAAP and IFRS handle this ensuing rise in value differently. The rules of GAAP do not allow for an asset’s value to be written back up after it’s been impaired. IFRS standards, however, permit that certain assets can be revaluated up to their original cost and adjusted for depreciation.
4. Inventory Valuation Methods
GAAP and IFRS contrast in how they handle inventory valuation, too. Three methods that companies use to value inventory are FIFO, LIFO, and weighted inventory.
- FIFO stands for First In First Out. This inventory valuation method follows the natural flow of inventory, assuming that the first items in inventory (i.e. the oldest) are the first sold.
- LIFO, or Last In First Out, takes the opposite approach of FIFO. Under this method, the last items to arrive in inventory (i.e. the newest) are assumed to be the first sold.
- Weighted average looks at the weighted average cost of items remaining in inventory at the time of an associated sale, which yields a figure that can then be used to value ending inventory and the related cost of goods sold.
In the US, under GAAP, all of these approaches to inventory valuation are permitted, while IFRS allows for the FIFO and weighted average methods to be used, but not LIFO.
The Value of Accounting Knowledge
There are some key differences between how corporate finances are governed in the US and abroad. Understanding GAAP and IFRS guidelines can be an asset, no matter your profession or industry. By furthering your knowledge of these accounting standards through such avenues as an online course, you can more effectively analyze financial statements and gain greater insight into your company’s performance.
Do you want to take your career to the next level? Explore our online finance and accounting courses, which can teach you the key financial concepts you need to understand business performance and potential. To get a jumpstart on building your financial literacy, download our free Financial Terms Cheat Sheet.
