Generally accepted accounting principles (GAAP) provide the financial accounting rules, such as the timing and amount of revenue recognition, that U.S. public companies must adhere to when preparing financial statements. However, to standardize the accounting rules on an international basis, the International Accounting Standards Board (IASB) provides a separate body of accounting rules known as the international financial reporting standards (IFRS), which provides its own guidelines on how all companies must recognize revenue each fiscal period.
Which Rules Apply
For U.S. public companies that are subject to the authority of the Securities and Exchange Commission (SEC), financial statements must adhere to GAAP, which the SEC views as the authority on financial reporting standards. However, as of 2007, foreign companies that are also subject to SEC regulation may prepare financial statements in accordance to IFRS. Approximately 120 other countries either allow or require companies to report revenue in accordance with IFRS.
Sale of Goods
There are slight differences in the rules governing when a company can report the sale of goods as revenue under GAAP and IFRS. Pursuant to GAAP, a company can only recognize revenue once delivery of the goods occurs, meaning that all risks and rewards of ownership over the goods transfers from the seller to the buyer. GAAP also requires that recognition of revenue not occur until the price of the goods is fixed and collection of the payment is reasonably assured. The revenue recognition rules under IFRS employ similar principles, but rather than just a transfer of the risks and rewards of ownership, the buyer must have control over the goods before the seller can recognize the revenue. Moreover, the revenue the seller anticipates collecting need not be fixed, but it must be able to be measured reliably.
Deferral of Receivables
Most large businesses must use an accrual method of accounting under IFRS and GAAP. This means that companies will report revenues prior to collection of payments at the time of posting a receivable for it. However, under IFRS, the accounting principles view all receivables as a financing agreement, and therefore, you must calculate the present value of each receivable. In other words, companies must reduce the revenue that relates to receivables using an imputed rate of interest that represents the cost of having to wait for payment. Under GAAP, the rules don’t view all receivables in the same way and only requires a present value calculation in a very limited number of circumstances.
Construction Contract Revenue
Pursuant to both IFRS and GAAP, businesses that earn revenue from long-term construction activities can recognize a portion of the revenue that relates to a contract each reporting period. However, under GAAP, companies are able to use the completed contract method to account for revenue, which defers recognition of revenue until the contract is complete. In contrast, IFRS doesn’t allow for the completed contract method. Instead, companies that satisfy certain criteria can use the percentage-of-completion method or report revenue equal to the costs it recovers each period prior to completing the contract.
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