What is IFRS and why?

You’ve probably heard that the accounting of companies adheres to IFRS standards. Its use is growing tremendously and is already regulated in more than 150 countries worldwide. But what exactly is the meaning of IFRS? What is the difference between the IFRS standards and the US GAAP (Generally Accepted Accounting Principles)? And, when and for whom is compliance mandatory?

Meaning IFRS

IFRS stands for ‘International Financial Reporting Standards’ and includes all accounting agreements and standards that companies must comply with. The purpose of the IFRS is to produce a uniform financial language for companies from different countries.

IFRS therefore determines how companies must report their financial data. The IFRS is based on a number of accounting principles that accountants must adhere to. Within the European Union, these standards are already mandatory, but countries outside the EU are also starting to accept and enforce IFRS instead of their own. Think for example of Brazil, Turkey, India, South Korea, and Australia.

Research shows that the transition from local standards to IFRS has had a positive impact on companies (European Commission, 2015; Australian Accounting Standards Board, 2016). However, one point of criticism is the effort and costs associated with the transition. The IFRS should also be able to set clear rules to avoid fraudulent earnings management.

History IFRS

The IASB (International Accounting Standards Board) developed the IFRS standards in 2001 for a clearer and more equal form of reporting, previously known as the IAS (International Accounting Standards). The main cause was rapid globalization. Companies nowadays do business with each other worldwide, so it is necessary to be able to speak one general financial ‘language’ with each other.

In 2002, the European Union decided that from 2005 onwards, all listed companies within the European Union must comply with the standards of IFRS. The meaning of IFRS pretends that these standards apply to the whole world, but initially it was only for the European Union. More and more countries outside the European Union have joined in and in 2022, 167 countries are already using these standards, a number that continues to grow.

Structure of the IFRS organization

Changes or additions to standards are made through all departments within the structure of the IFRS Foundation and the IASB. These departments consist of:

• The IFRS Foundation oversees all other departments. They assign roles to people, check effectiveness, and they provide enough capital.
• The IASB, which produces the enforceable standards for international financial reporting. In other words, the IASB makes the final standards of IFRS.
• The Advisory Council advises the IASB on technical issues.
• The IFRS Interpretations Committee assists the IASB in adapting and discussing issues within the IFRS standards.

There is also the Monitoring Board, which keeps an eye on everything and ensures that the entire process runs according to the correct legislation.

Differences between IFRS and US GAAP

But why are so many countries now switching to IFRS standards? The main reason for countries that are still switching is of course because the majority of them already use these standards. This makes it simpler for international companies and investors. But, the organization has become so big for more reasons, some of which I will mention below.

First of all, it is based on principles, rather than rules. This makes it a lot less strict than the local GAAP.

Second, turnover is recorded when a certain value (or part thereof) is delivered. It is therefore possible that part of the agreement has already been paid, but another part has not yet been paid. In that case, you already book the completed part as revenue. As a result, your revenue figure is more representative of what is going on in reality. In many GAAPs, you are not allowed to book revenue until the entire agreement has been fulfilled.

Under IFRS, you can only calculate your inventory using the FIFO (First In First Out) method. This contrasts with the US GAAP, where the LIFO (Last In First Out) method is also permitted. Read in this blog post why the LIFO method is prohibited. The bottom line is that this does not give a transparent and accurate picture of the real situation.

For example, there are other features of the IFRS standards that differ from the US GAAP, about which proponents and opponents can discuss endlessly.

IFRS and GAAP do not recognize some concepts such as EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortisation), even though it is widely used by investors and is therefore often reflected in companies’ financial statements.

Which companies have to adhere to IFRS?

Since 2005, all listed companies in the European Union have been required to comply with the accounting principles of IFRS. As a small to medium-sized company, you are therefore not obliged to carry out your reporting in accordance with these standards. It is advisable to do this so that if – if you have ambitious plans – and you are ever listed on the stock exchange, nothing has to change.

As a ‘small’ entrepreneur, you hardly have to deal with this yourself. Certainly not if you outsource your bookkeeping, you can read more about it here. Your accountant will make sure that everything is done according to the rules and you will probably never hear the word ‘IFRS’ mentioned.

The standards can sometimes be difficult for accountants because something is often adjusted or added. So, accountants should always know the most recent principles and often get a refresher course.

Conclusion

Thus, the creation of the IFRS by the IASB was with the aim of generating a unified financial ‘language’ for companies around the world. The main difference with US GAAP is that it focuses on broader principles, rather than stricter rules.

Many countries now use all these standards and it is actually more a question of when than if, IFRS will become the global framework for financial reporting. This will mainly depend on America, which I don’t see switching so soon since they don’t (yet) see the ‘usefulness’ of a transition that will take time and effort.

Check out my explanation of the new lease standard IFRS 16 – Leases, which was introduced in 2019.