Compare and Contrast Essay on GAAP and IFRS and Their Impact on Financial Statements

Published: 2021-07-16 17:34:32
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GAAP and IFRS vary widely on its effects on financial statements. Firstly, GAAP is rule-based meaning that financial statements are only interpreted using a particular rule. On the other hand, IFRS is principle-based such that there is a potential of interpreting financial statements in different ways leading to extensive disclosure of financial statements. Secondly, the methodology used in assessing financial statements varies between GAAP and IFRS. GAAP focuses most on the literature of the statements while IFRS emphasizes on reviewing facts pattern (Sedki, Smith & Strickland, 2014).

The effects on the statement of income vary between the two as IFRS does not segregate extraordinary items while GAAP shows the items below the income statement. The model of financial statements is unique in each case. GAAP employs risks and reward model while IFRS prefers control model. Lastly, GAAP uses LIFO and FIFO in their inventories while IFRS cannot use LIFO (Sedki, Smith & Strickland, 2014). This will significantly affect the reporting of inventories in a company.

Accounting Treatments

Before a company releases financial statements, an adjustment has to be done to make them complete and to reflect the accrual method of accounting. The adjusting entries involve accrued revenues and expenses, deferred revenues and expenses and depreciation expense. Accounting treatments help in rectifying cases such as failure of accounting software to process all financial transactions of the company (Porter, 2012). It further corrects data computed by accounting software like errors in expenses and revenues.

The AMASON has listed prepaid expenses on its financial statements. The company pays their expenses before incurring them and is deferred to an asset account until costs are used up. Prepaid expenses paid in advance includes insurance, subscriptions, and rent. These services are expenses which the company would not avoid in future thus necessary to pay in advance to avoid lateness. It also brings savings to the company in case of the rise of their rate in future.

On the other hand, prepaid expenses benefit the company due to tax deductions. This is because the tax rules say that you cannot deduct the prepaid expense in the current year (Porter, 2012). However, prepaid expenses have led to significant losses to the company. Some prepaid expenses were made like subscriptions which the company did not benefit from the services. Another adverse impact is increasing the number of adjusting journal entries on the companys balance sheet making it complicated.

Straight Line Depreciation Method and Its Importance

The AMASON Company uses straight-line method of depreciation. This is a simple and most common method, and it involves calculating depreciation subtracting salvage value of an asset from the purchase price and dividing it by the total productive years of the asset (Ackermann, Fochmann & Wolf, 2016). The company chose this method because of e of its profit effect. The profits can be easily analyzed because each same year amount of expenses are deducted meaning profit will also be comfortably analyzed. The method allows a reduction in profit but not cash flow and comparisons of profits in different years can be seen.

Another importance of this method is the accurate value of the companys assets. The assets are depreciated up to net scrap value thus facilitating full depreciable cost over the useful life of the asset (Ackermann, Fochmann & Wolf, 2016). The method is useful for firms assets whose life can be accurately estimated and where the asset has consistently been used in the firm.

Memo

To: CEO

From: AMASON Controller

Topic: Advantages and Disadvantages of Transitioning From GAAP to IFRS

The AMASON company transition from GAAP to IFRS has numerous advantages to the firm. Firstly, IFRS offers a more accurate, timely and comprehensive financial statements which are relevant according to national standards (Sedki, Smith & Strickland, 2014). Secondly, it helps the company by improving the quality standards in the financial statements and making them easy to understand. Lastly, there is a reduction of international differences in reporting standards thus removing cross border takeovers in the case of changing management of the company.

However, IFRS can be a disadvantage to the company. The company can incur huge costs from changing international systems to make it compatible with new reporting standards. IASB wont be able to control the application of IFRS of many companies thus causing extraordinary losses to the company due to logistical issues. Another limitation is a reduction of reliable information to companies due to lack of competition between GAAP and IFRS. IFRS is also expensive and more complex (Sedki, Smith & Strickland, 2014). The huge transitional cost can impact negatively on the revenue of the company.

Memo

To: CEO

From: AMASON Controller

Topic: Effects of Bankruptcy of Customer on Accounts Receivable.

In this case, the customer had purchased merchandise from the AMASON Company on credit which increases the accounts receivable balance. Due to bankruptcy, the customer would not be able to pay for the sales in future and will be forced to either return the goods or fail if they have utilized them. This will ultimately reduce the accounts receivable balance of the company causing loss of revenue.

Moreover, accounts receivable of more than $100,000 will impact on the cash flow negatively. Payment for labor and inventory had already been incurred when providing goods to the customer. Possible failure to pay for the commodities due to bankruptcy will actually lead to short of money in the company. Other possible long-term effects include effects on the net worth. Short of money will force the company to take a loan and incur more financial charges (Duru, Ekwe & Okpe, 2014).

References

Ackermann, H., Fochmann, M., & Wolf, N. (2016). The Effect of Straight-Line and Accelerated Depreciation Rules on Risky Investment Decisionsan Experimental Study. International Journal of Financial Studies, 4(4), 19.

Duru, A. N., Ekwe, M. C., & Okpe, I. I. (2014). Accounts receivable management and corporate performance of companies in the food & beverage industry: evidence from Nigeria. European Journal of Accounting Auditing and Finance Research, 2(10), 34-47.

Porter, J. C. (2012). How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co. Issues in Accounting Education, 27(2), 493-524.

Sedki, S. S., Smith, A., & Strickland, A. (2014). Differences and similarities between IFRS and GAAP on inventory, revenue recognition, and consolidated financial statements. Journal of Accounting and Finance, 14(2), 120.

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