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Summary: In many countries, company accounting must comply with International Financial Reporting Standards (IFRS). Find out more about them here.
International Financial Reporting Standards (IFRS)
The International Financial Reporting Standards (IFRS) are a set of accounting standards and best practices. These standards are set by the International Accounting Standards Board (IASB), a body within the not-for-profit public interest organization the IFRS Foundation. The purpose of these standards is to create an international language for accounting practices that can be understood everywhere. The standards tell companies how to practice their accounting and how to report on their finances to the public in a way that’s most effective and widely understood. Currently, over 140 jurisdictions, including the European Union (EU) have adopted the IFRS, though the US uses a different standard called the Generally Accepted Accounting Principles (GAAP).
These standards are of particular importance to all publicly traded companies in the jurisdictions where they’ve been adopted. The main purpose of these standards is to provide investors and creditors with accurate and reliable information about a business entity’s financial health so they can make good decisions about how to interact with it.
Key Principles of IFRS
The IFRS is guided by a conceptual framework that holds accurate financial reporting as essential for investors and creditors. This information helps them understand how an entity’s resources are being managed, the value of the entity, and the income they can expect from the entity in the future. The conceptual framework for the IFRS states that the data in financial reports should be relevant and faithfully representative of the entity’s situation. It also states that reports should be comparable, verifiable, understandable, and reported in a timely fashion to be useful for stakeholders.
Companies release IFRS financial statements which include the following components:
- Balance sheet
- Profit and loss statement
- Equity change statement
- Cash flow statement
- Descriptions of accounting policies
- Comparative information from the previous reporting period
In the U.S., the GAAP is the standard established by the Financial Accounting Standards Board (FASB). This accounting standard has been adopted by the U.S. Securities and Exchange Commission (SEC) and used by companies registered in the U.S. The GAAP and IFRS have enough differences that the staff of the SEC issued a statement in 2012 that the move to the IFRS wouldn’t be feasible. It has not yet reversed this position. Among the main differences between the IFRS and GAAP are:
- IFRS is principles-based, while GAAP is rules-based.
- Under IFRS, inventory that is written down can later be reversed, while reversals are prohibited under GAAP.
- Valuation of inventory following Last In, First Out (LIFO) is prohibited under IFRS but is allowed under GAAP and provides tax advantages.
- Discontinued operations are defined differently. Under IFRS, discontinued operations are components that have been disposed of or held for sale or represent separate lines of business. Discontinued operations under GAAP are assets or components that have been discontinued or planned to be discontinued and only have to be reported if they will have a major impact on a company’s operations.
Benefits and Challenges of IFRS Adoption
There are plenty of advantages to implementing the IFRS. These include:
- Widespread adoption: Over 140 jurisdictions already require organizations to follow the IFRS for their financial reporting. This represents the majority of the world’s markets and helps investors understand financial statements by entities the world over. It means that IFRS adherence is a key element of international compliance.
- Global comparability: Much like the International Organization for Standardization (ISO) helps organizations around the world compare physical standards, the IFRS helps investors and creditors compare companies around internationally.
- International Mergers & Acquisitions: A global accounting standard helps companies assess other entities around the world, facilitating international expansion and M&As.
- Increased transparency: Following the IFRS principles can make financial reporting more transparent and thus make a company more credible and trustworthy. This, in turn, can attract greater investment.
At the same time, there are always going to be disadvantages and limitations to any system. Among the challenges for the IFRS are:
- Implementation challenges: Implementing a new system means retraining accounting staff, creating new procedures, and using new computing systems. These costs and resistance to change can make implementing the IFRS system challenging.
- Principles-based: The IFRS lays out principles but not strict rules. While this allows for some flexibility in accounting, it can also enable organizations to use different accounting methods, which may be confusing.
- SEC regulations: In the US, the SEC requires companies to follow GAAP. If they want to align with IFRS to be comparable to foreign firms, they may have to implement two parallel accounting systems, which would be costly.
Future of the IFRS
While the SEC had planned a roadmap to bring the US in line with the IFRS by 2014, it later reversed this decision. These systems seem set to exist in parallel for the foreseeable future. At the same time, IFRS is expanding around the world. It is already mandatory in over 140 countries and is the predominant standard for accounting in over 166 countries. The ease of comparison of entities across borders will likely encourage more jurisdictions to adopt the IFRS in the future.
Importance of the International Financial Reporting Standards
The IFRS has become key in international accounting, whether carrying out your accounting at home or outsourcing it offshore. By following the same standards, entities can attract and compete for funding from investors around the world. IFRS makes accounting comparable, transparent, and understandable to investors everywhere.
FAQ
The IFRS helps to make financial reporting more transparent, comprehendible, verifiable, and timely. Most especially, it helps investors and creditors review a company’s financial statements and make informed decisions about whether to interact with them or not.
Over 140 countries worldwide have adopted IFRS as a principles-based accounting standard. Only the US and select firms abroad follow GAAP, which is stricter and rules-based. Written inventory can be reversed under IFRS but not under GAAP. Discontinued operations also have different definitions and reporting rules.
