Study: What are US GAAP and IFRS and how do they benefit management, investors and creditors?
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Slide 1 (:13s)
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Welcome to Introduction to Accounting for a User’s Perspective. What are US GAAP and IFRS and how do they benefit management, investors and creditors?
Slide 2 (:38s)
Links to an external site.What are US GAAP and IFRS? As noted in a prior video, US GAAP stands for United States Generally Accepted Accounting Principles (US GAAP
Links to an external site.) and IFRS
Links to an external site. stands for International Financial Reporting Standards (IFRS). Some people refer to IFRS as IGAAP but IFRS is the official term for it. US GAAP and IFRS provide US and international, rules and guidance for the preparation of general purpose financial statements for external use.
Slide 3 (:31s)
Links to an external site. US GAAP has been developed by a few different standard setters over the past several decades. The current standard setter of US GAAP for private companies is the Financial Accounting Standards Board (FASB)
Links to an external site.. Legally, the current standard setter of US GAAP for public companies is the Securities Exchange Commission (SEC
Links to an external site.). But the FASB still plays a role in the development of US GAAP for public companies.
Slide 4 (:40s)
Links to an external site. Effectively, although the SEC has ultimate legal authority for the creation of US GAAP for public companies, it has asked the FASB to help by proposing new standards, which the SEC can choose to either accept or reject. The SEC also creates its own standards, which become part of US GAAP for public companies. Therefore, in the United States we have two sets of US GAAP:
1) US GAAP for public companies as issued by the FASB and modified by the SEC
2) US GAAP for private companies as issued by the FASB with no modifications
Slide 5 (1m:24s)
Links to an external site. The most recent iteration of US GAAP for private companies is the FASB Accounting Standards Codification (ASC)
Links to an external site. issued in July 2009. In it, all previously issued accounting standards have been consolidated and organized by topic into one set of standards using standard code numbers. For example, in the past, if you wanted to know what US GAAP for inventory was, you might have had to go to several different standards, from several different, and sometimes conflicting, sources. Now all US GAAP for private companies is located in one location reducing the time it takes to find answers. Now, if you want to know what current US GAAP for inventory is, you can just look up code 300 for assets, then 330 for inventory and you have it. In the ASC, each major accounting topic has its own ASC code. The topics included in the ASC are noted below:
100 General Principles
200 Presentation of Financial Statements
300 Assets
400 Liabilities
500 Equity
600 Revenue
700 Expenses
800 Broad Transactions
900 Industry
Don’t worry, I will not test you on these topic numbers, they are provided here to help you get a feel for the organization of US GAAP as located in the ASC. If you would like to learn more about the ASC, feel free to watch the following 8 minute 45 second video from Jeff Sailor seminars
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Slide 6 (:26s)
Links to an external site. One benefit for management of well-organized US GAAP found in the ASC is that management can more quickly access the accounting standards they need in order to prepare US GAAP-compliant general purpose financial statements thus improving their compliance. This has made the job of preparing the financial statements more efficient (i.e. it saves time) and more effective (i.e. it gets it right).
Slides 7-8 (1m:00s)
Links to an external site. Just like technology, which evolves over time to meet user’s needs, US GAAP also constantly evolves as new issues arise and user’s needs change.
For example, prior to 1987, one of the standards included in US GAAP required companies to produce a report describing the companies’ sources and uses of funds. In other words how did the companies receive funds during the year such as cash, marketable securities Links to an external site., and accounts receivable Links to an external site. and what did they do with them? However, in 1987, based on user’s demands and an appropriate due process by the FASB, the FASB issued Financial Accounting Standard 95 which required companies to issue a different statement that focuses solely on increases and decreases in cash. This new statement is called the statement of cash flows Links to an external site..
Slide 9 (:48s)
Links to an external site. Over time, when no official US GAAP exists, companies tend to migrate toward accounting for new transactions in the same manner, which, without guidance from the FASB or the SEC, effectively becomes “generally accepted”. This migration toward a “generally accepted accounting standard” becomes the unofficial US GAAP until the FASB/SEC (for US private or public companies respectively) or the IASB (for international private and public companies) issue an official standard on the topic and create the official US GAAP. During this waiting period, management’s process of preparing financial statements can tend to be less efficient and less effective.
Slide 10 (:40s)
Links to an external site. The most common GAAP for international issuers (i.e. public companies) is IFRS. The International Accounting Standards Board (IASB) is currently responsible for developing IFRS. Formerly, the International Accounting Standards Committee (IASC
Links to an external site.) developed the standards. In countries where IFRS have been adopted, companies that are financial institutions, such as banks, or whose securities trade publicly, must use full IFRS, regardless of the company’s size. Click here to see a current IFRS adoption by country report from pwc
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Slide 11 (:35s)
Links to an external site. Because full IFRS is quite extensive and complex and would be difficult for non-public companies, especially small ones, to comply with, the IASB created a scaled down, less complex version of IFRS, called IFRS for Small and Medium-sized Entities (SMEs). So, like US GAAP, IFRS has full IFRS for public companies and IFRS for SMEs for private ones.
Slide 12 (:25s)
Links to an external site. To help eliminate accounting and reporting differences, the FASB and IASB have often worked together to create new standards and to converge old standards. Some industry observers hope that someday US GAAP and IFRS will converge into a single set of standards to be accepted and used throughout the world thus improving the efficiency and effectiveness of capital markets.
Slide 13 (:18s)
Links to an external site.How does US GAAP benefit investors and creditors? All else being equal, investors and creditors who fully understand US GAAP are more efficient and effective when making investing and lending decisions. Why is that true?
Slide 14 (:36s)
Links to an external site. How do US GAAP and IFRS help make investors and creditors more efficient? First, users can find the applicable GAAP faster, because it is well-organized and in one location. Second, users can compare the financial statements
Links to an external site. of two different companies more quickly if both companies are measured using the same standards, such as US GAAP. Third, users can analyze companies earlier because they won’t need to waste time translating financial statements from one country’s GAAP into that of another.
Slide 15 (:36s)
Links to an external site. How do US GAAP and IFRS help make investors and creditors more effective? Investors and creditors who fully understand US GAAP will better understand their potential investees’ and borrowers’ financial positions, results of operations and cash flows than someone who doesn’t. This heightened understanding will help them avoid misinterpreting key financial statement information thus helping them make more effective investing and lending decisions. Warren Buffett certainly knows US GAAP and uses that knowledge to invest more effectively.
Slide 16 (1m:05s):
Links to an external site. An example of how a standard unit of measure can improve efficiency and effectiveness can be illustrated by the following sign, “SALE! $200 for either A) 100 liters of gasoline OR B) 30 gallons of gasoline.” Clearly for someone who does not know how to convert metric measurements (liters) into imperial measurements (gallons), this SALE! sign causes the customer’s decision process to be inefficient and ineffective. It is inefficient because the customer must now the take time to convert the gasoline prices into one common unit of measurement, such as gallons. It is ineffective because if the customer is unable to convert the prices to a common unit of measurement, the customer will simply have to guess which one is better. However, if the sign had simply read “SALE! $200 for either A) 26.417 gallons, or B) 30 gallons, the driver could have efficiently and effectively chosen option B as the better alternative.
Slide 17 (:42s)
Links to an external site. The investing and lending world faces the same comparability challenge as the gasoline purchasing world does. For example, Hyundai Motor Company
Links to an external site. uses Korean International Financial Reporting Standards (K-IFRS) to prepare its general purpose financial statements but Ford Motor Company
Links to an external site. uses US GAAP. Investors who want to compare Hyundai to Ford will need to either translate Hyundai’s financial statements into US GAAP and compare the two using US GAAP, or translate Ford’s financial statements into K-IFRS and compare the two using K-IFRS.
Slide 18 (:48s)
Links to an external site. What is really unusual about the US public markets is that the SEC currently allows international-based companies to submit their financial statements according to IFRS or US GAAP, but US-based companies must submit their financial statements according to US GAAP. These two different standards reduce investors’ and creditors’ ability to efficiently and effectively compare the results of international and US-based companies. The SEC is aware of this lack of comparability and is currently considering whether to allow US-based companies to use IFRS, but no final decision has been made. Until such decision is made, the inefficiencies and ineffectiveness caused by having different standards will continue.
Slides 19-20 (1m:05s):
Links to an external site. In summary, US GAAP and IFRS are two similar, but different sets of accounting standards that US and international companies follow when preparing their general purpose financial statements. Both US GAAP and IFRS have a private GAAP for non-public companies (US GAAP and IFRS for SMEs) and a public GAAP for public companies (US GAAP as modified by the SEC and IFRS). IFRS is used by many international companies throughout the world and can be used by international corporations in the United States that are subject to SEC regulations. By having a standard GAAP for company management to follow, management can become more efficient and effective in preparing their external financial statements. By having a standard GAAP that company’s must follow when issuing their external financial statements, investors and creditors can be more efficient and effective in making investing and lending decisions.