Advantages and Disadvantages of IFRS compared to GAAP

By Anna Jordan

1. Advantages of IFRS compared to GAAP reporting standards

1.1 Focus on investors

One of the significant advantages of IFRS compared to GAAP is its focus on investors in the following ways:

  1. The first factor is that IFRS promise more accurate, timely and comprehensive financial statement information that is relevant to the national standards. And the information provided by financial statements prepared under IFRS tends to be more understandable for investors as they can understand the financial statement without the necessity of other sources which makes investors more informed
  2. This also helps new or small investors by making the reporting standards simpler and better quality as it puts small and new investors in the same position with other professional investors as it was impossible under the previous reporting standards. This also helps to reduce the risk for new or small investors while trading as professional investors can not take advantage due to the simple to understand nature of financial statements.
  3. Due to harmonization and standardization of reporting standards under IFRS, the investors do not need to pay for processing and adjusting the financial statements to be able to understand them, thus eliminating the fees of analysts. Therefore, IFRS reduces the cost for investors.
  4. Reducing international differences in reporting standards by applying IFRS, in a sense removes a cross border takeovers and acquisitions by investors.

Based on information mentioned above, it can be assumed that because higher information quality reduces both the risk to investors from buying and owning shares and the risk to less informed investors due to wrong selection due to lack of understanding, it should lead to reduction in firms cost of equity capital.

This on one hand should increase the share prices, and on the other should make new investments by firms more attractive.

Moreover, the following points mark additional advantages of IFRS compared to GAAP


1.2 Loss recognition timeliness

Recognising the loss immediately is one of the key features of IFRS as it is not only the benefit for the investors, but also for the lender and other stakeholders within the company.

The increased transparency and loss recognition of IFRS, usually increases the efficiency of contracting between companies and their management, which also enhances the corporate governance.

With increased transparency as promised by IFRS, the lenders also benefit from IFRS as it makes it compulsory for the companies recognize the loss immediately.

This timelier loss recognition of IFRS, triggers the issues as when the companies face economic losses, it will be known to the stakeholders of other potential investors. Timelier loss recognition also enables the company review its book values of assets and liabilities, earnings, equity.


1.3 Comparability

The convergence to IFRS has improved the comparability of financial statements in the EU. This has been achieved through having the same reporting standard under a single market, the EU.

As all companies, preparing their consolidated financial statements, have been reporting underone reporting standard have improved the comparability not only for investors, but also all stakeholders who use the financial statements.

Another reason that has contributed to the overall success of the IFRS adoption has been due to the transition period, as more than 8000 listed companies in the EU adopted it in the same year.

However, there has been an argument about the lack of efficiency and comparability of IFRS. The following is the arguments against the lack of comparability and consistency of IFRS:

Due to the strong national identity of IFRS reports, as the main effects of IFRS has been on how companies recognize, measure and disclose items. And the companies have adopted an approach which minimized the changes from previous national standards which reduced the ability to compare the financial statements across an industry.

The extensive judgement has been required under IFRS due to the absence of industry related guidance which created gaps and inconsistencies in the IFRS reporting standards. And this is another reason for the lack of comparability and inconsistency

And companies are not confident that the IFRS is adequate for the purposes of communicating their performance to the financial markets, as GAAP reporting standards tended to be more detailed which could provide more detailed information

Another factor that shows the lack of comparability and inconsistency is because the IFRS reporting standards are more complicated than the national accounting standards (UK), therefore, it may become a process of following the complex mechanism but does not necessarily promote the performance of the companies.


1.4 Standardization of accounting and financial reporting

The most mentioned factor about the advantages of IFRS has been the standardization of financial reporting which eventually improves the comparability of financial statements in major financial markets. This also removes the trade barrier, as this was one of the key factors as why the EU has been trying to adopt single reporting standards.


1.5 Improved consistency and transparency of financial reporting

This factor can also be mentioned as one of the crucial advantages of converting to IFRS as it makes the EU member countries to be consistent not only on macroeconomic aspects, but also on financial reporting which improves relationship between investors and companies among member countries.


1.6 Better access to foreign capital markets and investments

As thousands of companies in Europe and other joining countries across the world has already created a huge base for IFRS adoption, it also improves the companies to access to financial markets by having the financial statements prepared under one reporting standards.

One of the main reasons for converting from previously used GAAP to new IFRS was for improving comparability in international financial markets, thus increasing the focus on investors. And this has been mainly achieved and still going to be achieved as more and more countries around the world have been converting to IFRS from their national reporting standards as mentioned during the interview.


1.7 Improved comparability of financial information with global competitors

The comparability of financial statements under IFRS will be improved only if the adoption of IFRS expands including more countries. However, the comparability of financial statements get worse if the same country uses two different sets of reporting standards, thus IFRS and national reporting standards.

Due to the gap between the market and book values, the local stock market gets adversely affected when the IFRS is applied in line with other national reporting standards.

Moreover, there has been no significant achievement in terms of usefulness and improved comparability of financial statements in the short term which is mainly due to the fact that the IFRS reporting standards is fairly new  as a reporting standard and the harmonization has not fully been achieved yet by all EU member countries. And it is hoped that the usefulness and improved comparability of IFRS may be achieved in the medium-long term.

In order to assure the comparability of financial statements, all companies should follow the same rules by adopting IFRS. Private and small and medium sized, unconsolidated statements can be prepared under IFRS which further improves the comparability and consistency of financial statements. And eventually, the adoption of IFRS by all countries around the world gives even more increased usefulness and comparability of financial statements.


1.8 Relevance

And the relevance of the IFRS can be mentioned as a substantial advantage due to the following reasons:

  • The new IFRS reflects on economic substance more than legal form. This helps the companies and other stakeholders to have true and fair view of the companies’ transactions.
  • The way IFRS reflects to gains and losses in a timely manner puts IFRS in a more reliable and credible position than the GAAP in terms of reporting standards
  • The balance sheets prepared under IFRS tends to be more useful due to its layout and the consistency, and the level of complexity compared to GAAP that tended to be more detailed
  • The manipulation by managers by creating hidden reserves is not allowed any more under new IFRS, so less manipulative and more shareholders oriented

Moreover, other benefits as mentioned during the interview are cost saving with new IFRS especially for multinational corporations. However, before companies can start enjoying the cost savings, they have to spend considerable amount of money as a transitional costs.


Advantages and Disadvantages of IFRS

2. Disadvantages of IFRS compared to GAAP reporting standards

The most noteworthy disadvantage of IFRS relate to the costs related to the application by multinational companies which comprise of changing the internal systems to make it compatible with the new reporting standards, training costs and etc.

The issue of regulating IFRS in all countries, as it will not be possible due to various reasons beyond IASB or IASC control as they can not enforce the application of IFRS by all countries of the world.

Issues such as extraordinary loss/gain which are not allowed in the new IFRS still remain an issue

Another major disadvantage of converting to IFRS makes the IASB the monopolist in terms of setting the standards. And this will be strengthened if IFRS is adopted by the US companies. And if there is competition, such IFRS vs. GAAP, there is more chance of having reliable and useful information that will be produced during the course of competition.

The total cost of transition costs for the US companies will be over $8 billion and one off transition costs for small and medium sized companies will be in average $420,000, which is quite a huge amount of money to absorb by companies.

And even though the companies and countries are incurring huge transitional costs, the benefits of IFRS can not be seen until later point due to the fact that it takes some years for the harmonization and to have sufficient years of financial statements to be prepared under IFRS to improve consistency.

They key problem in conversion to IFRS that has stressed with high importance is the use of fair value as the primary basis of asset and liability measurements. And the interviewers think that this principle will bring increased volatility as the assets are reported.

And another disadvantage of IFRS is that IFRS is quite complex and costly, and if the adoption of IFRS needed or required by small and medium sized businesses, it will be a big disadvantage for SMEs as they will be hit by the large transition costs and the level of complexity of IFRS may not be absorbed by SMEs.

And moreover, one of the aims of European Union from applying and standardizing the reporting standards was to increase the international comparability of financial statements; however, only over 7000 listed companied adopted IFRS from 2005, there were still more than 7000,000 SMEs in EU, which preferred their national version of reporting standards. This contradicts the aim of the EU and partly of IFRS in implementing single international reporting standards.

Category: Finance