Why do the accounting systems of different countries differ?

Generally accepted accounting principles, formally designated in the United States as GAAP, vary from country-to-country, and no universally accepted accounting recording and publishing system currently exists. The GAAP are a combination of procedures and standards utilized by a company when generating its financial statements. Both authoritative standards, determined by policy boards, and the most widely used and accepted means of writing and publishing accounting information are joined to create GAAP. These standards are required of companies so an investor can have some basic consistency among the financial statements of companies for comparison. Covered under the GAAP are such things as classification of items on the balance sheet, share measurements and recognition of revenue.

The international financial reporting standards, or IFRS, are a list of principles that address the way particular transactions, procedures and various events should be indicated in a company’s financial statements. These principle-based standards are put out by the London-based International Accounting Standards Board, or IASB, and are sometimes confused with the older international accounting standards, or IAS, which were replaced by the IFRS in 2000. These standards are used by the United Kingdom and member countries of the European Union, as well as a number of other countries.

Controversy has almost inevitably arisen when one country adopts another country’s accounting methods. Part of the reason it is so difficult to generate one set of universally accepted accounting standards is the basis on which the standards are set. The GAAP utilized in the U.S. are rules-based, while the IFRS are principles-based. The two differing fundamental approaches make it difficult to reconcile standard practices. Despite the difficulties posed, a basic, universally accepted means of documenting and publishing accounting information is sought on an ongoing basis.

Companies that solely operate in the United States generally prepare financial statements that are in accordance with U.S. Generally Accepted Accounting Principles (GAAP). However, most of the rest of the world is subject to International Financial Reporting Standards (IFRS). While there is significant overlap between the two systems, there are marked differences. Understanding the differences between U.S. GAAP and IFRS can help you make sure that your company's books are in order as you branch out overseas.

Principles vs. Rules

1. The major difference between U.S. GAAP and IFRS is their differing philosophy with regard to how regulations should be constructed. IFRS accounting regulations reflect a principles-based approach where there are less bright-line rules and more qualitative guidance. Supporters of this approach argue that companies should be looking at the nature of a transaction, not arbitrary cutoffs. U.S. GAAP often takes a rules-based approach where companies classify transactions based upon numerical cutoffs. Lease accounting is a good example of the difference in philosophy. Under U.S. GAAP, a company is required to capitalize any lease when the lease contract is for greater than 75 percent of the economic life of the asset. However, under IFRS the guidance requires capitalization when the lease is for a "major part" of the economic life of the asset.

Inventory

1. Last-in, first-out (LIFO) inventory is commonly used by U.S. companies to lower tax liabilities. By expensing inventory that is purchased most recently first, as prices rise companies reduce net income. However, as companies expand overseas, they may run into trouble. LIFO inventory is not allowed under IFRS. Companies that wish to do business in other countries should first check to see if an audit under that country's accounting regulations is required by statute. If so, companies that have adopted LIFO inventory should consider the costs of complying with this regulation before moving into the foreign market. For smaller businesses, the costs of compliance may outweigh the benefits of expansion.

Extraordinary Items

1. Extraordinary items are defined by U.S. GAAP as gains and losses that are both unusual and infrequent in nature. Small business owners should recognize that this is a pretty onerous criteria. For example, losses related to Hurricane Katrina were not considered to meet the criteria, as hurricanes are common, particularly in the Southeast. However, when the criteria are met, U.S. GAAP and IFRS have differing presentation requirements. U.S. GAAP allows for extraordinary items to be broken out and displayed as net income. This allows investors to easily remove the effect of these items from the company's income figure. However, IFRS financial statements do not allow this treatment and include extraordinary items above the net income figure in the statement of income.

Development Costs

1. An important difference between U.S. GAAP and IFRS exists for small business owners involved in research and development. Under U.S. GAAP, research and development costs are generally expensed as incurred. However, under IFRS certain development costs may be capitalized. Small business owners should take note that like other parts of IFRS, capitalization guidance is principles-based. As such, small business owners with significant development costs should anticipate spending a fair amount of time working with their accountant as to the whether or not their company's specific activities constitute costs that should be expensed or capitalized.

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