GAAP Worked Great, Why Change Things?
By Mike Morley

The following is an excerpt from Mike Morley’s latest book “IFRS Simplified”

GAAP has worked great up to now, why change things?

Although North American publicly traded companies are presently preparing their financial statements according to Generally Accepted Accounting Principles (GAAP), this is quickly changing. Canada is moving to IFRS based statements effective January 1, 2011, and the chairman of the SEC announced a roadmap to achieve IFRS compliance In the USA by 2015. Even companies that are not legally required to comply with IFRS will feel strong pressure to adapt to the new worldwide standards. This is especially true of private companies wanting to merge with large public firms and companies that are suppliers to international IFRS compliant firms.

GAAP has been with us for many years and is not being abandoned. GAAP will continue to be used for some time after the official switch to IFRS. So what’s the difference between GAAP and IFRS?

GAAP is rules based while IFRS is principles based. What this means is that IFRS provides more flexible ‘guidelines’ for choosing what to include (and what to leave out) of the financial statements while GAAP imposes more rigid rules. IFRS requires more judgment decisions on the part of the accountants, but provides more flexibility to explain unique situations.

Another important difference between GAAP and IFRS is that GAAP measures assets at ‘historical cost’ (the original purchase price of the asset), while IFRS can measure assets in terms of their potential future benefits for the company. For example, a painting originally purchased for $1000 to decorate the lobby of a building, but which is now appraised at more than $100,000 would under GAAP, continue to be recorded at its original $1000 cost, while under IFRS the value of the asset would be increased to reflect its fair market value, thus making the increase in the value of the company visible to the investor. Investors have been demanding this changeover in order to be able to more easily compare international investing opportunities.

Summary

• GAAP is rules based while IFRS is principles based.
• IFRS introduces a new way of thinking about financial statements by introducing guidelines rather than strict rules in choosing accounting policies. Judgment decisions will have to be made every day about how to account for financial transactions, deciding on the value of assets, and how to report revenue.
• GAAP measures assets at ‘historical cost’ while IFRS can measure assets in terms of their potential future benefits.
• ‘Publicly Accountable Enterprises’ must comply. These are companies that ‘hold assets in a fiduciary capacity’, in other words, companies that hold public money ‘in trust’
• The deadline for comparative IFRS financial statements for ‘Publicly Accountable Enterprises’ in the USA is January 1, 2015 and January 1, 2011 in Canada.