Without accounting standards, businesses could easily skew their financial results to make themselves look more successful. It would also be much harder to compare how different companies are performing.
Here’s where generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) come in. These two sets of guidelines—one American and one international—are what most companies follow when preparing financial statements. With these accounting standards in place, investors can be sure businesses are accurately reporting their finances. In turn, businesses are able to make informed decisions about where to invest their money.
Learn more about the differences between GAAP vs. IFRS in this guide.
What are generally accepted accounting principles (GAAP)?
Generally accepted accounting principles (GAAP) is the accounting standard set by the Financial Accounting Standards Board (FASB) for the Securities and Exchange Commission (SEC) in the United States. It’s a rule-based system all domestic and Canadian publicly traded companies must follow when filing financial statements. The purpose of GAAP is to help investors analyze financial data and compare different companies to make informed financial decisions.
What are International Financial Reporting Standards (IFRS)?
International Financial Reporting Standards (IFRS) are the accounting standards set by the International Accounting Standards Board (IASB). It’s a set of guidelines followed by 15 of the G20 countries. China, India, and Indonesia do not follow IFRS accounting standards but have similar standards, while Japan allows companies to follow IFRS standards if they choose.
GAAP vs. IFRS: What are the differences between GAAP and IFRS?
While GAAP and IFRS both pertain to how financial documents are structured and filed—and they both often include comprehensive income reporting—there are significant differences.
When thinking about the difference between IFRS and GAAP, the two main distinctions are:
- Enforcement: GAAP is rule-based, meaning publicly traded US companies are lawfully required to follow its directives. On the other hand, IFRS is standard-based, meaning no one is required to follow its guidelines—though it’s recommended. As a result, the theoretical framework and principles of IFRS leave more room for interpretation and sometimes require lengthy disclosures on financial statements.
- Source and scope: GAAP is US-based, while IFRS is used worldwide. The IASB, which sets IFRS, is globally influential; its accounting standards are adapted to accounting rules in countries worldwide. The only exception is the US, where the SEC requires American companies to use GAAP when preparing their financial statements.
There are other notable differences in how GAAP and IFRS handle specific elements of various financial documents, including these six things:
1. Inventory valuation methods
The process of figuring out how much your inventory is worth is called inventory valuation.
There are three standard accounting methods for inventory valuation:
- The first in, first out (FIFO) method, which assumes the first (or oldest) items in your inventory will be the first to sell.
- The last in, first out (LIFO) method, which assumes the last (or newest) items in your inventory will be the first to sell.
- The weighted average method, which uses the amount earned from selling a portion of your inventory to determine the value of the remaining portion.
Here are the differences between IFRS and GAAP when it comes to inventory valuation methods:
- GAAP: GAAP allows companies to use any of the above three inventory valuation methods. When using FIFO, GAAP uses net asset value to determine inventory valuation. This is calculated as the total value of a company’s assets minus the total value of its liabilities.
- IFRS: IFRS allows the FIFO and weighted average method but does not allow the LIFO method, because LIFO can be manipulated to distort a company’s earnings to lower tax liability. When using FIFO, IFRS uses net realizable value. This considers how much an asset might generate when sold, minus an estimate of costs, fees, and taxes associated with the sale.
2. Cash flow statement
A cash flow statement is a financial statement that shows precisely how cash and cash equivalents enter and exit a business over a specific reporting period.
GAAP and IFRS handle cash flow statements differently, particularly in how they classify interest and dividends:
- GAAP: Interest paid and received, as well as received dividends, are all listed under the operating section, while dividends paid are listed in the financing section.
- IFRS: All interest and dividends can be listed under the operating or financing section.
3. Balance sheet
A balance sheetis a financial statement that summarizes a company’s assets, liabilities, and shareholder equity at a given point in time. It’s essential to know how to organize your balance sheet so your investors and other interested parties can quickly and accurately read it.
GAAP and IFRS differ in how categories are arranged on a balance sheet.
- GAAP: Requires assets in order of liquidity, with the most liquid assets listed first—that is, current assets, non-current assets, current liabilities, non-current liabilities, and owners’ equity.
- IFRS: Suggests putting assets in the opposite order of liquidity, with the least liquid assets listed first—that is, non-current assets, current assets, owners’ equity, non-current liabilities, and current liabilities.
4. Asset revaluation
The value of a company’s assets may fluctuate over a given period. When that happens, they need to be reevaluated (i.e., reappraised). Asset revaluation is crucial because it can help you save for replacement costs of fixed assets once they’ve run through their useful lives. It also gives investors a more accurate understanding of your business. Plus, asset revaluation can reduce your debt-to-equity ratio, which can paint a healthier financial picture of your company.
GAAP and IFRS have different approaches to asset revaluation.
- GAAP: Only allows the revaluation of fair market value for marketable securities (i.e., investments and stocks).
- IFRS: Allows for the revaluation of more assets, including plant, property, and equipment (PPE), inventories, intangible assets, and investments in marketable securities.
5. Inventory write-down reversals
A company’s inventory may lose value over time. For example, an asset may lose value because of market or technological factors, which classifies it as a “loss on impairment.” Both GAAP and IFRS require businesses to write down their inventory as soon as its cost exceeds its net realizable value (i.e., how much the inventory is expected to generate when sold).
While a loss is often permanent, the value of an asset may increase again if the impairing factor is no longer present. GAAP doesn’t allow companies to re-evaluate the asset to its original price in these cases. In contrast, IFRS allows some assets to be evaluated up to their original price and adjusted for depreciation.
6. Development costs
In accounting, development costs are the internal costs of developing intangible assets—assets with no physical form, like patents, intellectual property, and client relationships. GAAP considers these intangible assets expenses, while IFRS allows companies to capitalize and amortize them over multiple periods. Your accounting standard, therefore, determines where on your financial documents you must list intangible assets, which affects your balance sheet’s final record.
Which is better: GAAP vs. IFRS?
It depends on the context. Generally speaking, IFRS is more widely used globally and is better for companies that operate in multiple countries. If your business has international operations or plans to expand globally, IFRS offers an easier transition. Using IFRS can also make it easier to get foreign investors or enter into international partnerships.
GAAP is more focused on the US and is better for companies that operate only in the US. In fact, it’s often required for compliance. The Securities and Exchange Commission (SEC) mandates US-based companies must comply with GAAP, which is especially important for publicly traded companies.
GAAP vs. IFRS FAQ
What is the difference between IFRS and GAAP?
GAAP stands for generally accepted accounting principles, which are the generally accepted standards for financial reporting in the United States. IFRS stands for International Financial Reporting Standards, which are a set of internationally accepted accounting standards used by most of the world’s countries.
The key differences between GAAP and IFRS include:
- GAAP is a framework based on legal authority while IFRS is based on a principles-based approach.
- GAAP is more detailed and prescriptive while IFRS is more high-level and flexible.
- GAAP requires more disclosures while IFRS requires fewer disclosures.
- GAAP is more focused on the historical cost of assets while IFRS allows for more flexibility in the valuation of assets.
Why is IFRS not used in the US?
IFRS (International Financial Reporting Standards) is not used in the US because the US government has not adopted it as the official accounting standard. Instead, the US uses its own set of generally accepted accounting principles (GAAP). The US government has indicated it is considering adopting IFRS, but has yet to do so.
What is the difference between GAAP and IFRS in inventory?
GAAP and IFRS have some different requirements when it comes to inventory:
- Under GAAP, inventory must be valued at the lower of cost or market value, while IFRS requires inventory to be valued at the lower of cost or net realizable value.
- GAAP does not allow for any inventory write-downs, whereas IFRS does.
- GAAP requires inventory be valued using a specific cost flow assumption (such as FIFO or LIFO) while IFRS does not have such a requirement.
Can US companies use IFRS?
Yes, US companies can use IFRS. US companies can use both GAAP and IFRS. Using IFRS is more appealing if a US company operates internationally.
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