Mind the GAAP: Understanding GAAP Alternatives
Companies of all sizes are required to prepare financial statements for internal and external stakeholders. In the U.S., Generally Accepted Accounting Principles (GAAP) has been the most popular accounting framework for decades, but it’s not the only option. Three alternatives – two based on international standards and one new option in the U.S. – could provide companies with simpler financial reporting obligations.
What is GAAP?
Generally Accepted Accounting Principles (GAAP) has often been referred to as the gold standard of reporting frameworks. Public companies have historically been required to follow it, and it’s commonly been used by privately held companies as well. Some private U.S. businesses with international trade use dual reporting, which means they prepare financial statements according to GAAP and another financial reporting framework.
More recently, there have been some additional GAAP pronouncements from the Financial Accounting Standards Board (FASB), such as revenue recognition and the new lease accounting standard. Both changes have required companies to put forth a significant amount of work to comply with the new standards. Complexities like these add extra time and cost to comply with GAAP.
Although the organization may still need to comply with GAAP according to its Board of Directors or financial covenants, there are other high-quality accounting frameworks that can maintain compliance while reducing the overall amount of work involved.
Alternatives to GAAP: IFRS
One of the more recent sets of accounting rules released is IFRS, or International Financial Reporting Standards. The International Accounting Standards Board (IASB) developed IFRS, and the IFRS Foundation monitors compliance. It came out in 2003 as an alternative to US GAAP. IFRS is essentially the international version of GAAP.
It was initially meant to be a global set of accounting standards that countries around the world could use, thus increasing universal conformity. Around 160 global jurisdictions have adopted IFRS for both publicly listed and privately held companies.
The standard encompasses many of the same changes in accounting rules like GAAP. It also has a revenue recognition standard and a lease accounting standard that almost mirrors GAAP; however, these standards are options for publicly listed companies in other countries to use.
One of the biggest differences between GAAP and IFRS is that GAAP is rules-based whereas IFRS is principles-based. That means that US companies adhering to GAAP must comply with a set of detailed rules when developing financial statements. International and U.S. private companies that choose to adopt IFRS instead use a set of guidelines. This can result in uncertainty and potentially more disclosures; however, it’s generally an easier standard to follow.
There are also differences in how some costs are recognized. GAAP uses both last-in-first-out (LIFO) and first-in-first-out (FIFO) methods for inventory costing, while IFRS uses only first-in-first-out (FIFO), for example. Historically, there are also differences in how research and development (R&D) costs are recognized. That can cause financial statements under IFRS to appear more profitable when there are significant R&D costs compared to GAAP.
These changes can mean financial statements between the two standards look quite different. There is still a considerable amount of overlap between GAAP and IFRS, however.
Alternatives to GAAP: IFRS for SMEs
The International Financial Reporting for Small and Medium Enterprises (IFRS for SMEs) is available to for-profit companies that issue financial statements to an outside user. IFRS views this framework as “an accounting framework for entities that are not of the size nor have the resources to use full IFRS. In the [US], the term ‘SME’ would encompass many private companies.”
Outside users can include funding agencies, banks, sureties, and similar organizations. Publicly listed companies cannot use IFRS for SMEs. Generally, users of these types of financial statements are more concerned with shorter-term cash flows, liquidity, how the balance sheet looks, interest coverage, and whether the business is solvent. Full IFRS is more detailed and complex and even though it is less complex than GAAP, small to mid-size entities may still find full IFRS compliance too cost prohibitive.
IFRS for SMEs is a set of more simplified accounting rules. Since IFRS for SMEs was first issued in 2009, there has been one update in 2015, and the rules have stayed the same ever since. Just like IFRS, this set of accounting rules is considered GAAP. For companies, this means if they issue financial statements in the U.S., the covenants and requirements for both IFRS and IFRS for SMEs are the same as U.S. GAAP for financial statement purposes.
Some of the key differences between U.S. GAAP and IFRS for SMEs include:
- Simpler disclosures
- Inventory costing method only allows FIFO
- Goodwill is amortized over ten years at most
- Depreciation is based on components
- Simplified approach to income tax accounting
- Cost accounting for financial assets and liabilities is different
AICPA recognizes both IFRS and IFRS for SMEs as alternatives to GAAP, though there are other non-GAAP financial reporting methods that may also be available to private companies.
Alternatives to GAAP: FRF for SMEs
Another accounting standard that is becoming more popular is the Financial Reporting Framework for Small and Medium Enterprises (FRF for SMEs) which was released in 2013. This standard works well for a company if it does not have a requirement to report under U.S. GAAP. Private companies without bank debt and whose covenants don’t require GAAP financial statements can use it. The standard uses a blended approach from traditional accounting methods with accrual income tax methods.
It is a simple framework that only has a few deviations from U.S. GAAP. These deviations don’t require companies to comply with new lease accounting or revenue recognition standards. It is essential to note the framework will not keep a company in compliance with GAAP rules. Yet, it’s a good solution for those with few reporting requirements that don’t have to be GAAP-compliant.
The SEC has said it plans to move away from GAAP and align more closely with IFRS, but adoption has been slow. Whether a company is looking for alternative financial reporting methods now or will need to become familiar with IFRS should GAAP become obsolete in the U.S., it’s a good idea to know what those alternatives are and how they could impact the financial statements.
Let’s talk about GAAP alternatives
While GAAP has been the standard in U.S. financial reporting for years, there are high-quality alternatives that private companies can consider if they’re looking for ways to simplify their accounting – and GAAP alternatives may help with the new lease accounting standard – leading lease accounting thought leaders Tom Groskopf and Matt Rosen break it down in this on-demand event. We also built a lease accounting toolkit for you. If you have questions about GAAP alternatives or need assistance with a financial reporting concern, we’re here to help. Contact us to set up a free consultation with one of our financial reporting pros.