Comparisons of Financial Ratios between IFRS and GAAP US Companies
Many countries around the globe use the International Financial Reporting Standards (IFRS) as their preferred approach when it comes to financial reporting for their companies. Another financial reporting method that is commonly used is Generally Accepted Accounting Principles, also known as GAAP. However, GAAP is used for companies in the United States of America only. According to Bao et al., these two methods have some similar features and others that are not so much as they highlighted in their research that was published in 2010. The US Securities and Exchange proposed converting to IFRS from US GAAP on November 14, 2008. Compulsory transition will take effect in 2014 but companies are allowed to switch voluntaliry from 2010. This paper is therefore a way to educate the companies on all they need to know by comparing these two accounting standards. The paper is therefore a summary of the comparisons of the current ratio, asset turnover ratio and debt-asset-ratio as studied by Bao et al.
The IASB (International Standards Accounting Board) aims to develop understandable, high-quality and IFRAS general purpose financial statements. Financial statements that are made according to IFRS have advantages such as, transparency, improved comparability and quality in addition to accounting labor. Te reduction in cost makes this switch a welcome change by companies in the US. In this research the researchers looked to investigate the difference in reporting property plant and equipment, inventory, development cost and intangible assets and wanted to find the effects of the said items on inventory turnover ratio, debt-asset-ratio, return on assets and current ratio. Sample companies used in the research were from germany, Australia, Italy, france, USA and the UK. All the other countries with the exception of the US use IFRS while USA uses US GAAP.
When it comes to inventory accountability, three methods are employed, last in-last out (LIFO), first out-first-in (FIFO) and weighted-average cost method. Since companies in America use GAAP therefore all thsese methods are used by its companies. Almost all other countries use IFRS and as such they cannot use LIFO method. The two methods also show their differences when it comes to costing formulas and inventory reversal write-doms. As much as they differ in many ways, they are also similar in a few ways for inventory costing. For instance, in order for an inventory to be ready for sale, all direct costs must be included in the inventory expenses, this includes overhead and the exclusion of all selling costs and costs from most general administration. Although most firms use FIFO, majority of the companies use atleast more than just a single cost flow assumption when trying to find an inventory’s price. When determining the price of an inventory, fair value has become a vital tool as opposed to historical cost. According to the Bao et al, several studies had been carried out to determine the changes in several measures of return and liquidity through examining reports from companies in countries that use IFRS. They indicated that there were positive differences on assets return and an increase in market liquidity cost of capital of the firms upon the introduction of IFRS, however these changes decreased over time.
According to Bao et al, Inventory can be classified as a part of current assets and as such when the is a higher inventory value there is an increase of the numerator of current ratio and a lower inventory value decreases the numerator of current ratio. The study found out that firms under IFRS have a higher current ratio compared to those that use GAAP. Also companies that use IFRS have a lower inventory turnover ratio than in GAAP. The asset turnover ratio is also lower in IFRS firms, and that is also the case when it comes to asset return ratio and debt-to-asset ratio which are also significantly lower in IFRS firms than in GAAP firms.
According to the research, firms from countries that use IFRS have a considerably higher current ratio, a considerably lower debt-asset-ratio and a considerably lower asset turnover ratio. However, inventory turnover ratio was not confirmed here as they used a wrong sign in writing the t-value. IFRS companies’ inventory turnover is significantly higher compared to companies that use US GAAP, despite the fact that most of the companies using US GAAP use LIFO in their assumption of their cost flow when determining inventory. But according to earlier studies done when there were cases of rising costs, firms that use LIFO are supposed to have values that are smaller for inventory and cost of sold goods to be greater. To explain this abnormality Bao et al, (2010) stated that this can be attributed to the difference in size between the two samples. Also it can be because companies from the sample countries in Australia and Europe could possibly have fewer inventories in relation to costs of sold goods or the amount of sales and that could distort the LIFO effect.
After analyzing the statistics collected it showed that current ratio is considerably higher, asset turnover ratio is considerably lower and debt-asset-ratio is considerably lower as well. The research therefore, confirms that asset turnover ratio, current ratio and debt-to-asset-ratio together classify companies into the sample groups used successfully because of the significance of the X2 values. And most importantly the three ratio’s coefficients are significant.
The article believes that theoretically the requirements of IFRS would mean a higher inventory value and consequently total assets. Results from the tests were consistent and they indicated that companies from countries that have adopted IFRS have a lower asset turnover ratio, lower debt-to-assets ratio and a higher current ratio compared to the others. On the other hand, inventory turnover ratio as well as return asset ratio showed no noteworthy difference between US GAAP firms and IFRS firms. The paper provides preliminary proof of the differences between US GAAP and IFRS firms by using the selected ratios. The differences can be attributed to how both standards work in applying accounting treatments for the ratios selected. It can also be as a result of other factors that were not accounted in this article. Based on the research IFRS should clearly be the future of accounting in the United States. Those looking to invest in overseas companies now understand these differences and can make better and informed decisions. Now we can finally wait for the harmonization of the two bodies knowing how they both compare.