Generally accepted accounting principles, better known as GAAP, are what provide the foundation for public, nonprofit and sizable small private company accounting in the United States. International financial reporting standards, more often referred to as IFRS, provide the accounting basis for publicly traded companies globally. The Securities and Exchange Commission has stated its intention to move to usage of IFRS in the future, so governing bodies around the world have been working to converge the requirements.
The International Accounting Standards Board, or IASB, sets the standards for and governs IFRS. IFRS, as an alternative to GAAP, is a methodology guided by published standards and principles that accountants in foreign countries use to prepare financial statements for public companies. Currently, IFRS focuses on large or public companies. However, in the IASB's efforts to make IFRS the true global standard, it is considering changes to facilitate use of IFRS by small companies.
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Unlike IFRS, which is governed solely by the IASB, two entities set the standards for and govern GAAP. The Financial Accounting Standards Board, or FASB, which focuses on public companies, is the primary governing body. The American Institute of Certified Public Accountants, or AICPA, which focuses on smaller private companies, provides significant input and involvement from the private company perspective. Because of the dual involvement, GAAP has standards that are fairly straightforward for both public companies and small private companies. Companies and their CPAs use GAAP to both prepare and audit company financial statements.
Simplicity and Accounting Advantages
IFRS has fewer than 3,000 pages of rules and standards compared to the more than 25,000 pages that GAAP uses. IFRS follows two main principles for revenue recognition, while GAAP has step-by-step, often industry-specific methodology for recognizing revenue. Companies must expense research and development costs under GAAP, but can capitalize those costs in some situations under IFRS. This cost capitalization strengthens the income statement and balance sheet. IFRS enables companies to portray a stronger balance sheet by allowing companies to report the fair market value of assets less accumulated depreciation. GAAP only allows the reporting of cost less accumulated depreciation.
Converting to IFRS for financial statement preparation allows U.S. companies to readily compare their financial statements to those of their foreign counterparts who already use IFRS. Public companies and global medium-sized companies commonly already use IFRS to prepare the financial statements of foreign subsidiaries. After convergence, these companies can use IFRS company-wide, reducing or eliminating the amount of duplicated accounting efforts required.
Advantages to Small Companies
While some of the advantages of IFRS over GAAP apply primarily only to larger or public companies, IFRS can provide advantages to smaller companies. Small companies that seek investment from foreign investors may more readily appeal to these investors by presenting them with accounting and financial information in a format they easily understand. Small companies that already have a foreign investor, especially a corporate investor who must use IFRS, are able to provide financial statements that the investor no longer needs to convert from GAAP to IFRS.