Revenue Recognition: U.S. GAAP vs. IFRS

Similarities and Differences

Companies and corporations in the world use two major accounting principles. For example, in the United States, many firms employ the Generally Allowed Accounting Principles, which is also known as GAAP. International companies apply the International Financial Report Standards (IFRS). GAAP and IFRS have some similarities and differences in the manner in which they treat revenues recognition. There are a number of dissimilarities and a few resemblances between GAAP and IFRS with regard to accounting for liabilities. GAAP dictates that liabilities should be reported, depending on the order of liquidity, whereas IFRS needs liabilities to be reported in the reverse order of liquidity (Murphy, 2012). GAAP permits the use of both the straight-line method and the effective interest rate method in interest expenses reports, while IFRS only consents the use of an effective interest rate method. IFRS has exceptional guidelines when it comes to contingent liabilities which are not present when it comes to GAAP. Each of the systems has particular requirements in connection with providing reports for liabilities and assets, these requirements can give rise to small variations in the financial results. However, both IFRS and GAAP have very comparable fair value definitions and similar techniques of valuation, such as cost approach, the income approach, and the hierarchy of fair value.

U.S. GAAP vs. IFRS

In 2014, FASB and IASB gave a convergent standard approach to revenue recognition. The two accounting bodies have recognized the fact that GAAP and IFRS had a different approach to revenue recognition (Brodersen & Pysh, 2014). GAAP entails a collection of standards, given by FASB, EITF, AICPA and SEC with an effort to create an effective revenue standard. There are specific industrial differences in how GAAP and IFRS handle revenue recognition. The U.S. GAAP, for example, uses Vendor Specific Objective Evidence of mean value, in order to establish the selling price of a commodity. In the United States, for instance, telecommunication companies pay activation fees, similar to that of cable television. The U.S. GAAP principle governing the two mentioned sectors differs, resulting in different timing of the revenue recognition for similar economic services. IFRS entails no guidelines on the specific industry needs. IFRS is so broad in nature, yet it is applied across all industries and service providers. More specific differences between GAAP and IFRS are highlighted below.

Contingent Pricing

On the one hand, the U.S. GAAP works on a fixed pricing criterion. The approach creates a scenario, in which contingent figures are not acknowledged to be revenue, until the point where the contingency is cleared. On the other hand, IFRS, as a principle, considers the probability of economic advantage, arising from any transactions coming into the company and the capability to evaluate the said revenue, in addition to contingent revenue. Time is, therefore, of the essence in determining revenue recognition under IFRS, where such timing is always earlier.

Revenue Recognition

Under the U.S. GAAP, revenue is handled in two major ways. Revenue can either be achieved or achievable. In addition to this, revenue can also be earned. The principle identifies revenue to involve an exchange process. Revenue should not be identified as revenue until a time when a transaction is complete. There are detailed concepts under GAAP that explain the straightforward principles that govern revenue recognition. IFRS, on the other hand, identifies the two major revenue standards that govern revenue businesses. Such revenue transactions are put in four main units – sales of goods, delivery of services, client’s use of a firm’s assets and contracts.

Under IFRS, the criteria for revenue recognition lies in the assumption that the economic advantages tagged to a transaction will benefit a given company and the costs of such transactions can be measured in a most reliable manner. The concept of software revenue recognition is also of great importance in these two accounting procedures. Under the U.S. GAAP, there is a need to separate the VSOE of fair value, in order to differentiate various software components of a contract. The desire to separate these elements rises above the standard fair value threshold of the U.S. GAAP.

Contingent Consideration

It is important to note that revenue could be noticed earlier, using the IFRS principle. In such cases, there are two elements that are associated with the said revenue. Under the U.S. GAAP even when services have already been given to clients, SEC principle insists that revenue associated with contingent consideration cannot be identified as revenue until such a time that the contingency is arbitrated. Evidently, it appears inappropriate to accept revenue that lies on a probable factor in approval. Under IFRS, however, it is only the probability of benefits getting into a company and the ability to measure the expected revenue that matters in its recognition. In more specific terms, IFRS dictates that once the economic gains would benefit an entity and the value of revenue is measurable then such revenue would be recognized. Revenue recognition would only be postponed if other revenue criteria were not initially fulfilled.

The Problem with Having Two Different Standards for ‘RR’ in the Global Arena

Financial entities around the world have raised concerns over the use of different accounting principles in handling accounting decisions in terms of profit and loss management. Issues of concern to the global community include revenue recognition, tax, interest rates, and general customer relation in regard to service delivery. Most capital markets around the world use the U.S. GAAP, which is a creation of the Financial Accounting Standards Board (FASB) and IFRS, which was made by the International Accounting Standards Board (IASB). Both GAAP and IFRS withhold accounting principles, aimed at cushioning potential investors from possible relative risks. Analysts around the world have viewed these two systems as being opposed to each other (Pawsey, Brown, & Chatterjee, 2013). The UK accounting model is based on a number of principles, whereas the U.S. model is more tied to rules.

On the one hand, the United States has SEC as its ruling agency. The UK, on the other hand, is governed by the Financial Services Authority. The regulations of FSA are backed up by a set of rules that are considerably flexible and easily adapt (Needles, Powers, & Crosson, 2011). The SEC as an organization operates on a set of rules that are backed up by numerous regulations that might not be so easy to implement. The decision of a company in the world to use international accounting standards thus lies with the institutions that formulate and carry out such laws. As a result of the usual transformation and evolution in the accounting framework in every country in the world, there is a need to change different international accounting principles, in order to bring a sense of comparable reporting of accounts. There have been numerous steps, aimed at harmonizing the different standards at varying levels of accountability. Harmonization of accounting standards has taken place at national, regional and even global levels (Brodersen & Pysh, 2014). The relative risk, associated with the different standards of reporting, has affected many entities that participate in global business, as well as a foreign stock exchange. Companies out of the U.S. prefer to report their financial transactions in accordance with the IFRS. Such countries also develop their domestic version of the GAAP. So many businesses are not amused by the evident difference in the accounting standards worldwide.

Advantages and Disadvantages

There are advantages and disadvantages, associated with the use of two different accounting principles in the world. The first advantage of using different accounting standards is that such standards will attract foreign investors. Stock exchanges all over the world accept statements prepared in domestic GAAP and a few versions of the GAAP inclusive of the United States. Second, when a company is listed on an international stock market, the income is more likely to increase if such a stock market is reputable. According to Murphy (2012), a drug Company in Switzerland had increased income in 2008 due to its listing on the NYSE. The major disadvantage of operating along with two different accounting principles is that it does not give consistency in terms of returns. The same Swiss Company named Novartis had a net income of $4.1 billion with IFRS, as opposed to $ 2.8 billion with GAAP reporting (Murphy, 2012). This sense of fluctuation is likely to drive away investors who are willing to buy offers from such firms. The difference in Novartis turnover sales from the two standards can also damage its market standings globally.

IV. Where Are We Headed?

On the one hand, the Financial Accounting Standards (FASB) has the responsibility of generating standards for financial accounting that directs the way non-governmental organization prepare their financial reports in the United States. On the other hand, the IASB, an association delegated with the responsibility of setting standards liable for ensuring that capital markets of the world have a mutual method for formulating financial reports. In recent times, the IASB and the FASB have declared new standards of accounting that focus on the creation of a single foundation of GAAP, in relation to the measurement of fair value (Pawsey et al., 2013). The paper discusses the measures taken by both IASB and FASB to move to fair value measurement for financial instruments. It further discusses depreciation, revaluation of plant assets, the difference between development expenses and development costs, the definition of the contingent liability, in accordance with IFRS and, finally, provides a brief description of similarities and differences between International Financial Reporting Standards (IFRS) and GAAP with regard to accounting for liabilities.

The majority of countries in Europe listed on the NYSE prefer to use the GAAP. According to a study by Esther Ortiz (2005), numerous foreign and international firms opted for the principles of the IASB. Germany, for example, has an increasing number of its companies listed on the NYSE, which published most of the reports using either IFRS or the UNITED States’ GAAP. Germany even went ahead to create its own version German GAAP for the listed Companies. This option in Germany means a bigger threat to the international business community. In the year 2000, the SEC gave its concept release, known as the international accounting standards, which are aimed at converging different accounting standards globally. In addition, the SEC release, aimed at establishing a regular framework for financial reporting for different businesses in the world. Several critics claimed that the structure of SEC publication was too complex and, therefore, too hard to implement. The IASC, in particular, considered SEC as a threat to its original accounting principles. IASC was restructured into IASB with the aim of coming up with a more inclusive accounting body, aimed at creating a platform of accounting standards acceptable to different nations. Currently, different European nations have come together to form unions that are aimed at strengthening the members economically and socially (Brodersen & Pysh, 2014). The members of the European Union, for example, have worked towards formulating financial empires based on similar accounting principles. Member states of the EU have not, however, come up with a common agreement on which set of accounting standards to adopt. Australia and Canada, for example, use the GAAP, whereas other members, such as Switzerland have opted for the IFRS (Brodersen & Pysh, 2014). The biggest achievement of the IASB early 2000 was the proclamation by the European Commission that EU members should adopt IFRS by the end of 2006. There is a success for IASB, since most EU states use IFRS, thus increasing cross-border trade. It is worth noting that many EU members adopted the IFRS but still use their domestic standards for financial reporting. There is a great dilemma on which accounting principles the world should use. Great economies, like the United States and the European Union, have always advocated for the IFRS. Otherworld economies believe that a convergent approach would be more appropriate in handling the accounting dilemma. Through the Norwalk Agreement, FASB and IASB are able to make the amendments to their initial standards and create common standards to encourage international trade. As a result of the harmonization of the two sets of standards more international companies have been listed on NYSE. The nonreconciliation principle also played a role in ensuring that many international companies are able to file their financial reports freely. The world is headed to a point where carrying out business becomes easier. Companies from different parts of the world can operate businesses in a free manner without the fear of having to conform to the United States’ GAAP. With no major restrictions on financial reporting standards, cross-border trade is bound to increase.

General Concerns that Need to Be Reviewed by the IASB Committee

There are certain general concerns that the IASB needs to take into consideration. The existence of numerous accounting principles in a global market hinders smooth business operations. When companies operate in different financial reporting grounds, the noble accounting procedures might lack consistency, and the possible investors might shy from putting their money in very promising or already established firms.

FASB came up with a new System of Codification for Accounting Standards. In the system, accounting for fair value is categorized as Topic 820. The System of Codification founded a new definition of fair value that was standard and universal (Zeff, 2005). Moreover, the topic made available a method for the determination of liabilities and assets fair value by the application of inputs hierarchy. On the one hand, the codification system equally required the use of techniques for value determination that was in line with traditional approaches and offered fundamental guidelines for disclosure. On the other hand, the IASB published an exposure summary on the measurement of fair value in 2009 and was expected to give the ultimate standard later. The approaches have differed given that the boards of GAAP and IFRS have different projects, hence, they cannot focus on the basis of measurement of each other’s standard. The difference between liabilities, assets, and instruments of equity that are measured has also led to a difference in the approaches.

IASB should try to harmonize various accounting principles for domestic and international companies to be able to operate in a cohesive and common ground. There should be a review of both the GAAP and IFRS with the aim of formulating an inclusive accounting body that enhances competition among global companies in a fair manner. There has been a number of efforts, aimed at harmonizing various accounting standards and regulations across the world. The first effort was the creation of the Norwalk Agreement. The agreement was between the U.S. standard-setting agency and the international governing council. The most recent step towards the harmonization of financial principles was the formation of the European Union. Under the Norwalk Agreement, FASB and IASB vowed to form a compatible standard that would bring harmony within the accounting sectors across the world. The main aim of the agreement was to eliminate all the hindrances that would make it difficult for European companies to be listed on the NYSE. Major communities in the world financial sector were in favor of a convergent approach to accounting standards in the world. There was a need to reduce the number of difficulties experienced during cross-border trades.

With FASB working in harmony with IASB, most of multinational financial reporting is bound to go in a smooth way. In addition, the merger of these two iconic bodies will hopefully reduce the fears and costs that are associated with foreign trade. When countries all over the world apply a common accounting principle international business becomes easier. It is worth noting that accounting, just like any other noble profession in the financial world, should operate along with well-designed standards. Such standards or principles should be clear and applicable both locally and internationally. The GAAP and IFSB, therefore, need to come up with consultative principles that are inclusive and tolerant to different world markets. The GAAP should be observed by all accounting figures in the world but it should also allow the views of other stakeholders all over the world in order to form a fair playing field for businesses. The formation of the European Union was a big step in the right direction. Its aim was to bring about harmony in terms of trade and other world emerging issues in the region. Financial institutions in the world should form communities with interest in everyone coming, as the first motivation. Selfishness in terms of currency control and manipulation of member communities should not be encouraged in the current financial environment. Accounting standards must focus on creating harmony among divergent standards.

FASB came up with a new System of Codification for Accounting Standards. In the system, accounting for fair value is categorized as Topic 820. The System of Codification founded a new definition of fair value that was standard and universal (Zeff, 2005). Moreover, the topic made available a method for the determination of liabilities and assets fair value by the application of an inputs hierarchy. On the one hand, the codification system equally required the use of techniques for value determination that was in line with traditional approaches and offered fundamental guidelines for disclosure. On the other hand, the IASB published an exposure summary on the measurement of fair value in 2009 and was expected to give the ultimate standard later. The approaches have differed, given that the boards of GAAP and IFRS have different projects, hence they cannot focus on the basis of measurement of each other’s standard. The difference of liabilities, assets, and instruments of equity that are measured have also led to a difference in the approaches.

Conclusions Reached by the IASB Committee

There are certain observations that the IASB has reached concerning international accounting standards. The recent move to create the International Financial Reporting Standards Foundation in 2013 led to the formation of the Accounting Standards Advisory Forum. This forum has worked to increase the integration among different pacesetters in the accounting field. The forum also advises IASB, as it develops and improves the IFRS. ASAF has a committee of twelve members, and FASB is one of them. Membership of FASB in ASAF is an effort by the United States to converge GAAP and the IFRS. IASB has worked on the international convergence of accounting standards with the aim of making financial reporting a standardized affair.

Would the Outcome Look Like the U.S. GAAP?

There is no doubt that the IASB has put a lot of efforts aimed at improving international accounting standards. The dilemma of financial reporting, emerging from the existence of two different financial reporting systems, makes the whole process very complicated. The final accounting principle to be released by the IASB later would be a merger and harmonization of GAAP, IFRS, and other internationally accepted accounting principles reviewed by the Accounting Standards Advisory Forum. The result of convergence and harmonization would not be very different from GAAP since it must observe the general accounting principle.