What the @$#! Are GAAP and IFRS?

Relax. Let me explain — Have you ever compared nutrition facts between two grocery products? Although it’s getting better, it continues to be a challenge as each company measures and labels their “suggested servings” and other nutritive facts differently. It can be even more confusing when comparing the financial statements of companies, which is why “generally accepted accounting principles” (or, “GAAP”) was set up. By regulating and unifying what financial information is communicated, and how it is communicated, it is easier for investors, analysts, consumers, and law-makers to review a company to make financial decisions.

You’ve probably heard of GAAP, but you may not know about its international “cousin”, the International Financial Reporting Standards (“IFRS”). If you plan on investing in a company, knowing about both of these systems is important.

An Overview of GAAP and IFRS

GAAP has been an ongoing development of procedures and best practices that has developed and codified by auditors over the years. It includes basic concepts like pre-determining a common currency and using that currency uniformly in all communication; it includes far more complex ideas, too. When comparing one American company to another, it is a useful tool. But what if you want to compare an American company with a company in another country? Although GAAP is generally a US-based system, similar ideas and principles have been adopted by countries all around the world, but there are differences.

This is where the IFRS comes in. Like GAAP, IFRS is a set of codified best practices that are being adopted globally so that companies from one country can more easily be compared with companies from another country. Similarly, IFRS recommends specific procedures and policies and uniform definitions. While GAAP solved national financial uniformity, IFRS solves international financial uniformity.

How will it affect the business?

Many countries currently have their own form of GAAP. However, with pressure by governments to become internationally competitive, more and more countries are mandating a switch from their local GAAP policies to the international IFRS policies. Note that countries may require or permit use of IFRS reporting, while some companies do not permit it. A few examples: China does not permit IFRS reporting (although Hong Kong requires it). Japan does not permit it now but is expected to converge their GAAP and IFRS policies by 2011. The US does not permit IFRS reporting now but expects to phase it in between now and 2014 and phase out GAAP by 2016. For more information about what the usage of IFRS in the country where your investment target is operating, visit http://www.iasplus.com/country/useias.htm.

So, if you are investing in a company that needs to deliver reports to a country, such as a country that it is doing business in, make sure you know what accounting principles they are using, AND the accounting principles they plan to use soon. It might not hurt to adopt both accounting practices now if it seems like the country will be phasing one system out and the other in.

“What The @$#!” case closed.

References:

• An updated list of all countries that require, permit, or do not permit use of IFRS
• Deloitte produces a helpful section on its website to help IFRS newbies understand and implement IFRS into their accounting practices.
• The International Accounting Standards Board (IASB) is the body that introduced and maintains the IFRS.