Deference between GAAP and IAS for recognition of Liabilities

Framework Structure

The U.S. Generally Accepted Accounting Principles (GAAP) and the International Accounting Standards (IAS) — also known as the International Financial Reporting Standards (IFRS) — both serve the same purpose. GAAP and IAS provide a framework of accounting principles that can be used to draft financial statements. GAAP is used within the United States, while IAS has been adopted by many other developed nations. While the organizations that define GAAP and the IAS seek to converge the two standards, there are some significant differences between them. The U.S. Securities and Exchange Commission has found 29 specific areas of difference in application between GAAP and IFRS. However, the broad points of comparison concern the way in which the two frameworks are structured, how financial statements are presented, the definitions of assets and liabilities, and revenue recognition.
The best way to think of GAAP is as a set of rules that accountants follow. Each country has its own GAAP, but on the whole, there aren’t many differences between countries – interpretations might vary from country to country, but everyone tends to agree that a company can’t simply make up billions of dollars’ worth of revenue and put it on its books. Every country, in turn, influences the other countries that follow GAAP.

Recognition of Liabilities

Under GAAP, liabilities are defined in terms of “probability;” liability is something that represents a probable future economic benefit or loss. GAAP defines probability as something that can be reasonably expected based on the circumstances. IAS also uses probability to determine when an liability should be added to a business’s balance sheet, but does not define what constitutes “probable.” The IAS also requires that before liability can be recognized, the item’s value must be reliably measurable.
Classification of Liabilities
The classification of debts under GAAP is split between current liabilities, where a company expects to settle a debt within 12 months, and noncurrent liabilities, which are debts that will not be repaid within 12 months. With IFRS, there is no differentiation made between the classification of liabilities, as all debts are considered noncurrent on the balance sheet.

Other Implication about Liability

The guidance in relation to non-financial liabilities (e.g., provisions, contingencies, and government grants) includes some fundamental differences with potentially significant implications. For instance, a difference exists in the interpretation of the term “probable.” IAS defines probable as “more likely than not,” but US GAAP defines probable as “likely to occur.” Because both frameworks reference probable within the liability recognition criteria, this difference could lead companies to record provisions earlier under IAS than they otherwise would have under US GAAP. The use of the midpoint of a range when several outcomes are equally likely (rather than the low-point estimate, as used in US GAAP) might also lead to increased or earlier expense recognition under IAS.

IAS does not have the concept of an ongoing termination plan, whereas severance is recognized under US GAAP once probable and reasonably estimable. This could lead companies to record restructuring provisions in periods later than they would under US GAAP.

As it relates to reimbursement rights, IAS has a higher threshold for the recognition of reimbursements of recognized losses by requiring that they be virtually certain of realization, whereas the threshold is lower under US GAAP. The following table provides further details on the foregoing and other selected current differences.

Recognition of Provision

Impact
GAAP
IAS

Differences in the definition of “probable” may result in earlier recognition of liabilities under IAS. The IAS “present obligation” criteria might result in delayed recognition of liabilities when compared with US GAAP

A loss contingency is an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur. An accrual for a loss contingency is required if two criteria are met: (1) if it is probable that a liability has been incurred and (2) the amount of loss can be reasonably estimated. Implicit in the first condition above is that it is probable that one or more future events will occur confirming the fact of the loss.

The guidance uses the term “probable” to describe a situation in which the outcome is likely to occur. While a numeric standard for probable does not exist, practice generally considers an event that has a 75 percent or greater likelihood of occurrence to be probable.

A contingent liability is defined as a possible obligation whose outcome will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events outside the entity’s control.

A contingent liability is not recognized. A contingent liability becomes a provision and is recorded when three criteria are met: (1) a present obligation from a past event exists, (2) it is probable that an outflow of resources will be required to settle the obligation, and (3) a reliable estimate can be made.

The term “probable” is used for describing a situation in which the outcome is more likely than not to occur. Generally, the phrase “more likely than not” denotes any chance greater than 50 percent.

Financial liabilities and equity
Under current standards, both US GAAP and IAS require the assessment of financial instruments to determine whether either equity or financial liability classification (or both) is required. Although the IAS and US GAAP definitions of a financial liability bear some similarities, differences exist that could result in varying classification of identical instruments.

As an overriding principle, IAS requires a financial instrument to be classified as a financial liability if the issuer can be required to settle the obligation in cash or another financial asset. US GAAP, on the other hand, defines a financial liability in a more specific manner. Unlike IAS, financial instruments may potentially be equity-classified under US GAAP if the issuer’s obligation to deliver cash or another financial asset at settlement is conditional. As such, US GAAP will permit more financial instruments to be equity-classified as compared to IAS.

Oftentimes, reporting entities issue financial instruments that have both a liability and an equity component. Such instruments are referred to as compound financial instruments under IAS and hybrid financial instruments under US GAAP. IAS requires a compound financial instrument to be separated into a liability, and an equity component. Notwithstanding convertible debt with a cash conversion feature, which is accounted for like a compound financial instrument, hybrid financial instruments are evaluated differently under US GAAP. Unless certain conditions requiring bifurcation of the embedded feature(s) are met, hybrid financial instruments are generally accounted for as a financial liability or equity instrument in their entirety. The accounting for compound hybrid financial instruments can result in significant balance sheet presentation differences while also impacting earnings.

Written options are another area where US GAAP and IAS produce different accounting results. Freestanding written put options on an entity’s own shares are classified as financial liabilities and recorded at fair value through earnings under US GAAP. Under IAS, such instruments are recognized and measured as a financial liability at the discounted value of the settlement amount and accreted to their settlement amount. SEC-listed entities must also consider the SEC’s longstanding view that written options should be accounted for at fair value through earnings.

In addition to the subsequent measurement differences described above, the application of the effective interest method when accreting a financial liability to its settlement amount differs under IAS and US GAAP. The effective interest rate is calculated based on the estimated future cash flows of the instrument under IAS, whereas the calculation is performed using contractual cash flows under US GAAP.

Reference

“Hearst Newspaper “ (2017 ). GAAP vs IAS. Retrieved from
http://smallbusiness.chron.com/gaap-vs-ias-35636.html

“Intuit Limited” (2017). Top 10 Differences Between IFRS and GAAP Accounting. Retrieved from
https://www.firmofthefuture.com/content/top-10-differences-between-ifrs-and-gaap-accounting/

Rob Renaud (2017) Investopedia Web site Retrieved from
http://www.investopedia.com/ask/answers/05/iasvsgaap.asp

James G. Kaiser (2014, Semtember, 01). IFRS and US GAAP: Similarities and differences. Retrieved from
https://www.pwc.com/us/en/issues/ifrs-reporting/publications/assets/ifrs-and-us-gaap-similarities-and-differences-2014.pdf

“dummies” (n.d.), Comparing U.S. GAAP AND IFRS ACCOUNTING SYSTEM, Web site Retrieved from

Comparing U.S. GAAP and IFRS Accounting Systems

Gary Laskar, (n.d.), Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). Web site Retrieved from

Comparing and Contrasting International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP)

“A Securities and Exchange Commission Staff Paper” (2011, November,11). A Comparison of U.S. GAAP and IFRS. Web site Retrieved from
https://www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-paper-111611-gaap.pdf

Selim Reza