The differences between the General Accepted Accounting Principles and the International Financial Reporting System affect many aspects of business. The changes of these accounting rules show future losses due to the fact that businesses have to pay for training employees and converting accounting software, but the United States is still going through with the conversion. The United States looks to make these rule changes in order to have comparable financial statements with business, greater market liquidity, and lower cost of capital. The rule change benefits multinational companies as well. The multinational companies will eliminate business expenses that multinational companies pay to report their financial statements in several different accounting standards. Though there are advantages, they may not be as important as some may propose.
The willingness to have comparable financial statements has become more of a need because the economy has gone more global and companies have become more multinational. With comparable financial statements, investors can see business from all over the world on the same plane. Over the years, trade has increased; cross-border investments and integration of markets are easier with lower cost of capital and greater market liquidity. Having the comparable information, would allow for companies to allocate their capital more effectively.
However, some suggest that having one standard does not mean that there is going to be comparability. Though countries may have the same standards, the standards may be enforced differently across the world. There are about 113 countries that are currently using the International Financial Reporting System, but 29 of those countries have added some of their own standards, defeating the purpose of having one worldwide accounting standard.
The International Financial Reporting System has been said to have less specific rules that are made for guidance purposes. The General Accepted Accounting Principles have strict guidelines to follow that do not need interpretation. The International Financial Reporting System standards that are left for interpretation cause some concern. There are concerns that the new standards could leave more room for financial fraud because the rules can be interpreted in different ways.
One difference in rules between the two standards is the way a business would keep track of inventory. The Generally Accepted Accounting Principles currently allows companies to record inventory in several different ways. The two main ways are LIFO and FIFO. The LIFO method assumes that the inventory most recently purchased is sold first and the remaining inventory has already been purchased. The FIFO method assumes that the inventory purchased first is sold first and the remaining inventory will be sold in later periods. The International Financial Reporting System tries to limit the options of recording inventory by only not allowing the LIFO method. Though that may be a benefit in comparability for some, others are worried about the issues it creates with companies having a higher tax due to the inventory method. The high tax can change a company’s financial standing and bargaining power.
The conversion of standards is cost saving for multinational companies. Before the conversion of standards can be cost saving, the companies have to take into account the cost of transitioning from the International Financial Reporting System to the General Accepted Accounting Principles. These costs involve preparation, certification, dissemination of reports, and opportunity costs. Businesses will have to update their computer systems and accounting processes, train employees, hiring specialists to train the employees, and change the documents to the International Financial Reporting System. The cost saving opportunity given by the change in standards is only beneficial to the multinational companies. The cost saving comes with the multination companies that can go from having two or three different financial statements to only having one. The smaller companies that have been only using the General Accepted Accounting Principles will not receive a cost benefit from the switch to IFRS in the short run. There may be cost savings in the long run but the smaller companies may not last long enough to receive the benefit due to the cost of the conversion.
There is little argument that the United States General Accepted Accounting Principles are a very high standard and have superior enforcement of the standards. Before Europe switched to the International Financial Reporting system, it was under the United States Generally Accepted Accounting Principles. The European accounting firms felt that switching to the Generally Accepted Accounting Principles would make their financial conditions and financial statements more credible. By being more accurate in their information, the firms hoped to gain more trust from their stakeholders.
One major reason that Europe had switched to the United Sates Generally Accepted Accounting Principles is because GAAP prevented companies from using hidden reserves. Hidden Reserves is when a company takes money and puts it in an expense account. This money is supposed to be saved in case there are future losses in the company. The money that is saved would be used in the future to cover up poor performances. The Generally Accepted Accounting Principles prevents companies from doing such fraud, which makes companies show more truthful reports of how a company is actually financially performing.
There are also some unknown risks that no one can predict. The adoption of The International Financial Reporting System has mixed evidence across the world. The Generally Accepted Accounting Principles has been proven to work over the years. There is already little argument that the Generally Accepted Accounting Principles have superior enforcement and great quality of standards. There are a lot of similarities between the two accounting standards, which may mean that the cost of transitioning to the International Financial Reporting System outweighs the benefits.
The Generally Accepted Accounting Principles have proven to work in the United States Economy. On the other hand, the International Financial Reporting System has not been tested in an economy such as the United States. Therefore, a switch in standards may lead to some variables that cannot be predicted and unknown complications.
Although there are some favorable reasons as to why the United States would make the conversion to the International Financial Reporting system, there are some complications that go with the change in standards. The idea of creating a global accounting standard may be closer, but there are still countries that have differences in their accounting standards due to different enforcements. There is also uncertainty of whether there will be a cost benefit. There are a lot more multinational companies due to the global market and they may benefit from the transition, while small companies may not. Some also wonder whether the quality of the accounting system in the United States will remain at a high standard with the International Financial Reporting System. The main concerns about the transition of accounting standards are the unknown risks, which raise the hesitation among the United States companies. Although there are some complications in the transition, it is believed by some that the United States Accounting Board should be able to monitor the change and bring the best for the companies and financial investors to make educated business decisions.
The ultimate goal is to have the best available accounting system for investors to make appropriate business decisions. Whether one believes that it is the Generally Accepted Accounting Principles or the International Financial Reporting system, all people involved in this situation wants to be able to understand the financial information in order to make that important educated business decisions. Both the Generally Accepted Accounting Principles and International Financial Reporting System attempt to do so, they just do so in different ways.
Each method has been somewhat successful in the countries they have been implemented in. The main concern with the United States is how we are going to implement the International Financial Reporting System with such problems like the cost of the switch to the International Financial Reporting System, will the rules of the International Financial Reporting System coincide with the fraud rules of the United States, and how well the United States accountants will pick up on the transition of rules. There is no evidence that the International Financial Reporting System has not been a success set of standards. Each Standard controls certain aspects of accounting well, but in different forms. Each standard has their positives and negatives of recording the financial situations of a business.
The problems that have been stated before when switching from the Generally Accepted Accounting Principles to the International Financial Reporting System such as; costs, credibility, and inventory can be summed up in the financial statements. The main one is the income statement. There are two main differences in the reporting that change what the investors may be looking for or how correct the numbers on the financial reporting might be. The income statement and the recording of revenue have major differences between the accounting systems and affect the way investors should interrupt the financial reporting.
For instance, the two accounting systems record a business’s income through an income statement, but there are differences in the two. The International Financial Reporting System has no format for the income statement. They allow the entity to express the expenses and income in a way that the entity sees fit. It could either be in a traditional income statement or in a note form. However, there are some requirements as to what has to be on the income statement. It has to have the businesses revenue, finance costs, post tax income, tax expenses and the profit or loss for that period of time.
The Generally Accepted Accounting Principles have the same function that an income statement would have with the International Financial Reporting System. However, the Generally Accepted Accounting Principles has a format that the businesses have to follow in order to record the business’s profit or loss. One can report the income statement in the single step form or the multiple step form. A single step income statement categorizes all the expenses that a business has and deducts the expenses from the income that the business had generated in that period. A multiple step income statement shows how much the business paid in order to receive the goods that they sold. Then the company shows that other expenses and income as a component of the profit or loss.
While both systems show key components in the income statement for investors in the business, both could improve on some issues that investors might have with the income statement. The fact that the International Financial Reporting system does not have a set format for an income statement may give some trouble for investors because there could be differences in the income statements from business to business. The lack of format and categories could also lead to business under the International Financial Reporting System being able to hide expenses or income to make their business look more profitable than it might actually be.
The Generally Accepted Accounting Principles attempts to avoid the problems that the International Financial Reporting System might have by using the formats and categories. However, this might lead to information on the income statement that the investors might not need. The International Financial Reporting system gives the basic information that tells an investor whether or not a business is profitable or not.
Revenue is also recognized differently which leads to differences in the accounting systems when it comes to costs, inventory, and credibility. Revenue recognition by the International Financial Reporting System is based off of whether or not the product that is sold or going to be sold is going to create an economic benefit. In order to know if a company is going to get an economic benefit, a company has to be able to be measured reliably.
In the Generally Accepted Accounting Principles, the price of the product has to be fixed and collectability is assured. A company also has to know without a doubt that an agreement exists between the company and the buyer. The exchange of goods and currency must have occurred in order for the business to recognize the revenue. On the other hand, all a company has to do to recognize revenue under the International Financial Reporting System is make sure the entity has transferred to the buyer the significant risks and rewards of obtaining the product.
There may not be a perfect solution for recognizing revenue but there both these methods create issues. The International Financial Reporting System has a credibility issue because it is stated that companies can hide revenue until the next period to make the next period look better or it can hide expenses and wait until they have enough income to cover the expenses.
The Generally Accepted Accounting Principles way of recognizing revenue causes problems for entities as well. They have to wait so long to recognize the revenue that the company may look less profitable than it actually. Though there may be more credibility with this method, inventory may be misjudged.
Each accounting system has its own positive and negative feedback. The main concerns have to do with inventory, credibility, and cost to perform the tasks necessary to provided correct financial information. Whether it’s the businesses’ income statement, recognize revenue, fraud or training employees, the main goal is to have the best available accounting system.
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