Level 1 CFA® Exam:
IFRS vs US GAAP
Balance Sheet Presentation
As you know both IFRS and U.S. GAAP require that the balance sheet distinguishes between:
- current and non-current assets, and
- current and non-current liabilities.
Remember that current and non-current categories should be reported separately.
Also, note that U.S. GAAP requires current assets to be shown before long-lived assets and current liabilities – before non-current liabilities. According to IFRS, no such requirement exists. What is more, usually in financial statements prepared according to IFRS non-current assets are shown before current assets.
We should also mention here one exception considering the requirement of distinguishing current from non-current assets and current from non-current liabilities. According to the so-called liquidity-based presentation, which is allowed only under IFRS, assets and liabilities are presented in order of liquidity and no differentiation between current and non-current is demanded.
Fair value under IFRS is the amount at which an asset could be exchanged or a liability settled in an arm’s length transaction between knowledgeable and willing parties.
Under U.S. GAAP, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
Now a few words about the measurement of inventory.
Inventories are measured at the lower of cost and net realizable value under IFRS, which means that whichever of these two is lower – this is assumed as the measure of inventories.
How do we obtain the net realizable value?
Net realizable value (NRV) is computed as the estimated selling price less (the sum of estimated costs of completion and estimated costs of sale).
Under U.S. GAAP inventories are measured at the lower of cost or market. By market we mean the market value and we define it as equal to the current replacement cost. However, we should remember that the market value cannot be greater than NRV and lower than NRV less normal profit margin.
If the NRV or market value of inventory is lower than the inventory carrying amount, we write down, that is reduce, the value of the inventory. And here comes a thing to remember:
- Under U.S. GAAP, reversals of write-downs are not allowed. What does it mean? It means that if we write down the value of inventory, we cannot bring it back to the old carrying amount at a later date even if the fair value of inventory increases.
- Remember, though, that under IFRS reversals of write-downs are allowed. It means that we can restore the value of previously impaired inventory.
Let’s now say a bit about inventory valuation methods, which are called:
- cost formulas under IFRS and
- cost flow assumptions under U.S. GAAP.
IFRS allow 3 cost formulas, namely:
- specific identification,
- weighted average cost, and
- FIFO (first-in, first-out).
U.S. GAAP additionally allow LIFO (last-in, first-out). Thus, under U.S. GAAP there are 4 cost flow assumptions allowed, namely:
- specific identification,
- weighted average cost,
- FIFO, and
- LIFO.
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The first difference between U.S. GAAP and IFRS arises from the initial recognition of long-term debt in the balance sheet.
According to IFRS, the costs related to the issuance of a bond (for example legal fees, commissions, and so on) are included as part of bonds payable. So, if for example sales proceeds are equal to USD 100 million and the issuance costs are equal to USD 2 million, then we will debit cash for USD 98 million and the bond payable will be initially recognized at USD 98 million.
Under U.S. GAAP, the costs related to the issuance of a bond are not included as part of bonds payable but – instead – they are treated as a deferred asset amortized over the life of the bond. It means that if for example sales proceeds are equal to USD 100 million and the issuance costs are equal to USD 2 million, then the bond payable will be initially recognized at USD 100 million and we will debit cash and deferred charge for USD 98 million and USD 2 million, respectively.
Another difference between the accounting standards arises when measuring a long-term debt in subsequent periods. If the company uses the amortized cost approach, it can use 2 methods to amortize the discount and the premium. These are:
- the effective interest rate method, or
- the straight-line method.
The latter is allowed only under U.S. GAAP.
Long-Term Contracts
Long-term contracts are contracts that last for more than one year. An example of a long-term contract can be a contract for constructing a building. In this kind of contract, revenue is usually recognized in more than one period. The revenue recognition methods for long-term contracts are:
- percentage-of-completion method, and
- completed contract method.
However, the latter is allowed under U.S. GAAP only.
So, both types of accounting standards allow to use percentage-of-completion method, but in some circumstances, namely, when the outcome of a contract cannot be measured reliably, their approaches are different.
Under IFRS, when the outcome of a contract cannot be measured reliably and it is probable that costs will be recovered, revenue in a given period can be recognized in the amount of costs incurred in this period. So, the profit is recognized after all costs are recovered.
Under U.S. GAAP, when a reliable estimate of total costs cannot be determined until the contract is finished, the completed contract method is used. This means that no revenue and costs are recorded until the very last period of the contract.
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| Item | IFRS | U.S. GAAP |
|---|---|---|
| interest received | operating or investing activities | operating activities |
| interest paid | operating or financing activities | operating activities |
| dividends received | operating or investing activities | operating activities |
| dividends paid | operating or financing activities | financing activities |
| taxes paid | mainly operating activities but a portion of tax expense can be allocated to investing or financing activities if it can be directly assigned | operating activities |
As you can see IFRS are less restrictive. Both interest received and dividends received can be classified as operating or investing activities. U.S. GAAP allow to classify them as operating activities only.
Under IFRS, interest paid and dividends paid are classified as operating or financing activity, but according to U.S. GAAP interest paid is an operating activity, and the dividend paid is a financing activity.
Have a look at the taxes paid. U.S. GAAP always classify them as operating activities, but under IFRS a portion of tax expense can be allocated to investing or financing activities if it can be directly assigned there.
You should also know that under IFRS, bank overdrafts are part of cash equivalents. However, under U.S. GAAP, bank overdrafts are not cash or cash equivalents and are included in financing activities.
As for the methods of creating a cash flow from operations, both U.S. GAAP and IFRS allow direct and indirect method. Both types of accounting standards encourage using the direct method.
However, under U.S. GAAP if the direct method is used the reconciliation of net income to operating cash flow must be provided. By the way, remember that even though both standards encourage the direct method, a vast majority of companies use the indirect method.
- IFRS allow 3 cost formulas: specific identification, weighted average cost, and FIFO (first-in, first-out).
- Under U.S. GAAP there are 4 cost flow assumptions allowed: specific identification, weighted average cost, FIFO, and LIFO.
- Under U.S. GAAP, an impairment loss of an asset held for use cannot be reversed.
- Under IFRS, impairment loss can be reversed both for assets held for use and assets held for sale.
- The straight-line method to amortize the bond discount or premium is allowed only under U.S. GAAP.
- The equivalent of the capital lease under U.S. GAAP is called a finance lease under IFRS.
- The completed contract method is allowed under U.S. GAAP only.
- Under IFRS, classifying any income or expense item as extraordinary is not allowed.
- Under IFRS, interest received and dividends received can be classified as operating or investing activities. U.S. GAAP allow to classify them as operating activities only.