Reporting mechanics and standards - IFRS vs US GAAP basics

Learning Outcomes

This article explains the essential IFRS versus US GAAP reporting mechanics that CFA Level 1 candidates must know for the financial reporting and analysis syllabus, including:

• The role of financial reporting standards, standard-setting bodies, and regulatory authorities in promoting transparency, comparability, and decision-useful information
• Key conceptual contrasts between principles-based IFRS and rules-based US GAAP, and how these differences influence recognition and measurement choices
• Practical differences in recognition, measurement, and presentation for major items such as inventories, development costs, property, plant and equipment (PPE), and intangibles
• Differences in cash flow statement classification (especially for interest, dividends, taxes, and bank overdrafts) under IFRS and US GAAP and their effect on reported cash flow from operations
• The impact of these differences on reported earnings, asset values, equity, and commonly tested ratios, plus typical analyst adjustments used to improve cross-company comparability
• How LIFO vs FIFO, capitalization vs expensing, revaluation vs historical cost, and impairment write-down and reversal rules can systematically bias profitability, liquidity, solvency, and cash-flow-based metrics
• How to interpret disclosures such as LIFO reserves, R&D and development cost breakdowns, and revaluation reserves when comparing IFRS and US GAAP reporters in an exam context

CFA Level 1 Syllabus

For the CFA Level 1 exam, you are required to understand reporting mechanics and standards, with a focus on the following syllabus points:

• Explaining the objective and importance of financial reporting standards in analysis and valuation
• Describing the roles of standard-setting bodies (IASB and FASB) and regulatory authorities
• Summarizing core conceptual differences between IFRS and US GAAP
• Comparing selected recognition, measurement, and presentation differences (e.g., inventory, development costs, PPE, cash flow statement)
• Describing implications of these differences for financial analysis and the need for caution when comparing companies using different frameworks

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which pair correctly matches the standard-setter with the framework and typical orientation?
   1. IASB – US GAAP – rules-based
   2. IASB – IFRS – principles-based
   3. FASB – IFRS – principles-based
   4. FASB – US GAAP – principles-based
2. Which statement about inventory accounting is most accurate?
   1. Both IFRS and US GAAP permit LIFO and FIFO
   2. IFRS permits LIFO, but US GAAP does not
   3. US GAAP permits LIFO and FIFO; IFRS does not permit LIFO
   4. Neither IFRS nor US GAAP permit LIFO
3. How are reversals of inventory write-downs treated?
   1. Allowed under both IFRS and US GAAP if justified
   2. Prohibited under both IFRS and US GAAP
   3. Allowed under US GAAP, prohibited under IFRS
   4. Allowed under IFRS, generally prohibited under US GAAP
4. Which statement best describes the treatment of development costs?
   1. Both IFRS and US GAAP require capitalization of all research and development
   2. IFRS generally expenses all research and development; US GAAP capitalizes development costs
   3. IFRS capitalizes qualifying development costs; US GAAP generally expenses research and development
   4. IFRS and US GAAP both require capitalization of development costs once a project starts

Introduction

International comparability of financial statements is essential for analysts. A large proportion of listed companies report under either:

• IFRS (International Financial Reporting Standards), used in most jurisdictions outside the United States; or
• US GAAP (Generally Accepted Accounting Principles), used by most US-listed companies.

Understanding where these systems are similar and where they differ is a recurring CFA Level 1 topic, particularly because differences can materially affect reported profit, asset values, and key ratios such as return on assets (ROA), current ratio, and cash flow from operations.

Key Term: IFRS (International Financial Reporting Standards)
A globally recognized set of accounting standards issued by the International Accounting Standards Board (IASB), emphasizing broad principles, faithful representation, and the use of professional judgment.

Key Term: US GAAP (Generally Accepted Accounting Principles)
A framework of accounting standards and guidance developed by the Financial Accounting Standards Board (FASB) in the United States, often characterized by detailed, prescriptive requirements.

Key Term: Rules-based standards
Accounting standards that provide detailed rules and specific guidance for many scenarios, limiting flexibility in application.

Key Term: Principles-based standards
Accounting standards based on broad principles and concepts, requiring preparers to exercise judgment to achieve a fair presentation of economic reality.

A classic exam theme is how the principles-based approach of IFRS and the more rules-based orientation of US GAAP affect:

• Which costs are capitalized versus expensed
• How inventories and long-lived assets are measured
• How cash flows are classified into operating, investing, and financing activities

Key Term: Substance over form
Concept under IFRS requiring that the economic substance of a transaction be reflected in the accounts, even if it differs from its legal form.

These frameworks are not only technical rulebooks. They reflect conceptual views about what “useful information” is and how to balance relevance, reliability, and comparability. For exam purposes, you need to be able to link high-level concepts (such as relevance and faithful representation) to concrete accounting choices (such as revaluing PPE or capitalizing development costs).

Key Term: Financial reporting standards
Authoritative rules and guidance governing how transactions and events must be recognized, measured, presented, and disclosed in financial statements.

Key Term: Conceptual framework
A system of interrelated objectives and fundamentals that underlies financial reporting standards and provides guidance when no specific standard applies.

Key Term: Qualitative characteristics of financial information
Attributes that make financial information useful, including fundamental characteristics (relevance, faithful representation) and enhancing characteristics (comparability, verifiability, timeliness, understandability).

At Level 1, the focus is on knowledge and comprehension:

• Being able to state what each framework allows or prohibits
• Understanding the direction of the effect on income, assets, equity, and ratios
• Recognizing when analyst adjustments are needed to compare companies fairly

The Purpose and Structure of Financial Reporting Standards

Financial statements provide information about a company’s financial position, performance, and cash flows. To make this information useful for investors, creditors, and other users, companies must follow recognized reporting standards.

Key Term: Standard-setting body
An independent organization that develops accounting standards (for example, the IASB for IFRS and the FASB for US GAAP).

Key Term: Regulatory authority
A government or public agency (such as the US SEC) that has legal power to require, monitor, and enforce the use of specified accounting standards.

Standard-setting bodies such as the IASB and FASB are private-sector organizations, but they gain authority when regulatory authorities in each jurisdiction require companies to use their standards for financial reporting.

Key Term: IASB (International Accounting Standards Board)
The independent standard-setting body that issues IFRS.

Key Term: FASB (Financial Accounting Standards Board)
The independent US body that develops and maintains US GAAP.

Both the IASB and FASB publish conceptual frameworks that:

• State the objective of financial reporting (to provide useful information to existing and potential resource providers)
• Identify qualitative characteristics (relevance, faithful representation, comparability, verifiability, timeliness, understandability)
• Provide guidance for recognition and measurement when detailed standards do not exist

Key Term: Going concern assumption
The assumption that an entity will continue in operation for the foreseeable future and has neither the intention nor the need to liquidate or significantly curtail its activities.

Key Term: Accrual basis of accounting
Accounting basis in which transactions are recognized when they occur (and not when cash is received or paid), so revenues and expenses are matched to the period in which they are earned or incurred.

These fundamental assumptions apply under both IFRS and US GAAP and are frequently mentioned in exam questions about the preparation of financial statements.

Roles of Standard Setters vs Regulators

The CFA curriculum distinguishes clearly between who writes the standards and who enforces them:

• Standard setters (IASB, FASB)

  • Typically private, not-for-profit bodies
  • Members include experienced accountants, auditors, analysts, and academics
  • Follow a due process that usually includes:
    • Identifying and prioritizing issues
    • Research and consultation (often involving national standard setters)
    • Issuing an exposure draft for public comment
    • Considering comments and issuing final standards
  • Do not themselves have legal enforcement power

• Regulators (for example, SEC in the US, securities regulators in other countries)

  • Have legal authority to:
    • Specify which standards must be used (e.g., US GAAP or IFRS)
    • Require public companies to file financial statements
    • Review filings and enforce compliance through sanctions or penalties
  • Sometimes issue their own interpretative guidance (for example, US SEC Staff Accounting Bulletins)

For example, in the United States:

• The SEC recognizes the FASB as the primary standard setter for US GAAP.
• However, the SEC legally retains the power to set standards and can override FASB in rare cases.

In IFRS jurisdictions:

• National law or securities regulators typically require listed companies to use IFRS.
• The IASB’s standards become binding only once incorporated into local regulation.

For exam purposes, you need to:

• Distinguish clearly between the standard-setting role (IASB, FASB) and the enforcement role (regulators).
• Understand that analysts must monitor both new standards and regulatory changes because both can change reported numbers and ratios.

Standard Setters and Approach

Although the IASB and FASB work together and many newer standards (for example, revenue recognition and leases) are largely converged, important differences remain, especially in older areas of the standards.

• IFRS

  • Issued by the IASB, based in London
  • Generally described as principles-based
  • Strong emphasis on substance over form and the use of professional judgment
  • Allows alternative models (e.g., cost or revaluation for certain non-current assets) when this improves relevance

• US GAAP

  • Issued by the FASB, based in the United States
  • Often characterized as rules-based
  • Provides more detailed guidance and bright-line criteria
  • Aims to reduce diversity in practice by limiting preparer discretion

In practice, both systems use a mix of principles and rules and both require judgment. For exam purposes, however, you should know that IFRS is typically framed as more principles-based, whereas US GAAP is often portrayed as more detailed and rule-oriented.

Key Conceptual Differences

These conceptual differences drive many of the specific mechanical differences discussed below. They also help explain why IFRS sometimes permits multiple acceptable treatments (for example, cost vs revaluation model), while US GAAP often prescribes one specific approach.

Major Reporting Mechanics and Treatment Differences

Although convergence has reduced some differences, several high-yield areas remain where IFRS and US GAAP diverge. These areas commonly appear in Level 1 questions.

The most testable topics include:

• Inventory methods and write-downs
• Development costs and R&D
• Property, plant and equipment (PPE) and impairment
• Cash flow statement classification (interest, dividends, taxes, bank overdrafts)
• Reversals of impairments and write-downs

Before looking at these in detail, it is helpful to define a few key measurement concepts.

Key Term: Carrying amount
The amount at which an asset or liability is recognized on the balance sheet, after deducting accumulated depreciation, amortization, and impairment losses where applicable.

Key Term: Net realizable value (NRV)
The estimated selling price of an asset in the ordinary course of business, minus the estimated costs of completion and the estimated costs necessary to make the sale.

Key Term: Lower of cost and net realizable value (LCNRV)
A measurement rule requiring inventory to be carried at no more than its original cost or its NRV, whichever is lower.

Inventory: Methods and Write-Downs

Key Term: FIFO (First-in, first-out)
An inventory costing method that assumes the earliest goods purchased are the first to be sold; ending inventory reflects more recent costs.

Key Term: LIFO (Last-in, first-out)
An inventory costing method that assumes the latest goods purchased are the first to be sold; ending inventory reflects older costs.

Key Term: Weighted average cost method
An inventory method that values units at the average cost of all units available during the period.

Key Term: Inventory write-down
A reduction of the carrying amount of inventory to the lower of cost and net realizable value (IFRS) or cost and market/net realizable value (US GAAP).

Key Term: LIFO reserve
The cumulative difference between inventory reported under LIFO and the amount that would have been reported under FIFO; disclosed under US GAAP when LIFO is used.

Inventory cost formulas

• US GAAP

  • Permits:
    • FIFO
    • Weighted average cost
    • LIFO
    • Specific identification (for unique, non-interchangeable items)
  • Many industrial and retail companies historically used LIFO because it often reduces taxable income in periods of rising prices.

• IFRS

  • Permits:
    • FIFO
    • Weighted average cost
    • Specific identification
  • Explicitly prohibits LIFO.

In periods of rising prices:

• LIFO (US GAAP only)

  • Uses the most recent (higher) costs in COGS.
  • Results:
    • Higher COGS
    • Lower gross profit and net income
    • Lower ending inventory (older, cheaper layers remain)
    • Lower taxable income and lower income taxes

• FIFO (IFRS and US GAAP)

  • Uses older (lower) costs in COGS.
  • Results:
    • Lower COGS
    • Higher gross profit and net income
    • Higher ending inventory (more recent, higher-cost units)

Thus, in an inflationary environment, a US GAAP LIFO company will usually report:

• Lower earnings
• Lower inventory and current assets
• Lower equity (because retained earnings accumulate more slowly)
• Different profitability and liquidity ratios compared to a FIFO company with identical physical flows

This is a classic exam setup when comparing a US GAAP LIFO firm with an IFRS FIFO firm.

Lower of cost and market / NRV

Both IFRS and US GAAP require an inventory write-down when the recoverable amount of inventory falls below cost, but the details differ.

• IFRS

  • Inventory is measured at the lower of cost and NRV.
  • NRV is explicitly defined (estimated selling price minus costs of completion and selling costs).

• US GAAP

  • For most inventory, measurement is at lower of cost and NRV, converged with IFRS.
  • For some inventory (especially where LIFO or retail method is used), older guidance refers to lower of cost or market, where “market” is a replacement cost constrained between NRV (ceiling) and NRV minus a normal profit margin (floor). For Level 1, focus on the lower of cost and NRV idea.

A write-down is recognized as an expense (usually in COGS or a separate line such as “inventory obsolescence”) and reduces inventory on the balance sheet.

Write-down reversals

• IFRS

  • If the reason for a prior write-down no longer applies (for example, selling prices have increased or inventory has become less damaged), a reversal is required, up to the original write-down amount.
  • The reversal is recognized as a reduction of expense in the income statement in the period of reversal.

• US GAAP

  • Reversal of inventory write-downs is prohibited, even if prices recover.

This difference means:

• IFRS earnings can include “gains” from reversing earlier write-downs.
• US GAAP earnings cannot show such gains; the initial loss is permanent.

For analysis, this affects:

• Earnings volatility
• Comparability of gross margin trends over time
• Interpretation of one-off gains in IFRS reporters

Key Term: LIFO liquidation
Reduction in inventory quantity for a firm using LIFO, causing older, cheaper inventory layers to be included in COGS and temporarily boosting gross profit and net income.

Under US GAAP, a LIFO liquidation can distort profitability because:

• Old low-cost layers enter COGS.
• COGS decreases and profit increases, even if selling prices and current replacement costs have not changed.
• The effect is often disclosed in the notes; analysts should treat it as non-recurring.

Analyst adjustments using the LIFO reserve

The LIFO reserve allows an analyst to approximate FIFO values for a US GAAP LIFO company:

• Adjust inventory to FIFO:

  $$\text{FIFO inventory} = \text{LIFO inventory} + \text{LIFO reserve}$$

• Approximate FIFO COGS for the period:

  $$\text{FIFO COGS} \approx \text{LIFO COGS} - \Delta(\text{LIFO reserve})$$

Where $\Delta(\text{LIFO reserve})$ is the increase in the reserve during the period (ending reserve minus beginning reserve).

Adjusting inventory and COGS to a FIFO basis improves comparability between:

• US GAAP LIFO reporters and
• IFRS FIFO reporters (and US GAAP companies that use FIFO or weighted average).

This adjustment also affects:

• Profitability ratios (gross margin, net margin, ROA, ROE)
• Liquidity ratios (current ratio, quick ratio)
• Leverage ratios (debt-to-equity) through changes in equity.

Development Costs and Intangible Assets

Key Term: Research costs
Expenditures aimed at obtaining new knowledge or understanding, with no specific, commercially viable product yet identified.

Key Term: Development costs
Expenditures incurred after research when a project is in development and is directed toward a specific, identifiable product or process that may generate future economic benefits.

Key Term: Capitalization
Treating an expenditure as an asset to be recognized on the balance sheet and then allocated to expense over time.

Key Term: Expensing
Recognizing an expenditure as an expense in the income statement in the period it is incurred.

Under both frameworks, research costs are generally expensed as incurred. The main difference relates to development costs.

IFRS treatment

Under IFRS, internally generated intangible assets are split into research and development phases:

• Research phase

  • All costs are expensed when incurred.

• Development phase

  • Requires capitalization as an intangible asset when specific criteria are met, including:
    • Technical feasibility of completing the asset
    • Intention to complete and use or sell it
    • Ability to use or sell it
    • Probable future economic benefits (existence of a market or internal usefulness)
    • Availability of adequate resources to complete the project
    • Ability to reliably measure the expenditure

Once capitalized, development costs are:

• Recorded as an intangible asset
• Amortized over their useful life
• Tested for impairment when indicators of loss in value exist

This treatment applies to many software development projects, pharmaceutical development after technical feasibility, and other technology projects.

US GAAP treatment

Under US GAAP:

• General rule: Most research and development (R&D) costs are expensed as incurred.
• Exceptions: Some specific guidance permits capitalization in narrow cases, for example:
  • Certain software development costs for software to be sold to customers (after technological feasibility is established)
  • Certain internal-use software development costs in later stages

For CFA Level 1, the key point is:

• Treat US GAAP as generally expensing R&D.
• Treat IFRS as capitalizing qualifying development costs.

Impact on financial statements and ratios

Capitalizing development costs (IFRS) versus expensing them (US GAAP) has important consequences:

• In the capitalization period (early years):

  • IFRS company:
    • Reports an intangible asset on the balance sheet
    • Recognizes only amortization (if any) of prior capitalized costs in the income statement
    • Shows higher net income than if it had expensed all costs
    • Shows higher total assets and higher equity
  • US GAAP company (expensing all R&D):
    • Recognizes full cost as expense in the income statement
    • Shows lower net income
    • Shows lower total assets and equity

• In later periods:

  • IFRS company:
    • Records amortization expense on the capitalized intangible
    • This reduces profit in those periods
  • US GAAP company:
    • Has no further expense related to those past R&D costs (they were already expensed)

Consequences for analysis:

• Earnings trends may differ:
  • IFRS firm appears more profitable in high-development years and less profitable later.
• Asset and equity levels differ:
  • IFRS firm shows larger asset base and equity.
• Ratio implications:
  • ROA and ROE may appear lower under IFRS in later years due to a larger denominator.
  • Asset turnover ratios may also differ.

When comparing an IFRS company that capitalizes development costs with a US GAAP peer that expenses them:

• Adjusting for capitalization vs expensing is often difficult because detailed data may be limited.
• Analysts should at least interpret profitability and asset-based ratios with caution.

Property, Plant, and Equipment (PPE) and Impairment

Key Term: Property, plant and equipment (PPE)
Tangible long-lived assets used in the production or supply of goods or services (for example, land, buildings, machinery).

Key Term: Cost model
A measurement approach in which assets are carried at historical cost minus accumulated depreciation and accumulated impairment losses.

Key Term: Revaluation model
A measurement approach under IFRS that allows certain long-lived assets to be carried at fair value, with changes in fair value recognized in equity or profit depending on the direction of the change.

Key Term: Impairment loss
A write-down recognized when an asset’s recoverable amount falls below its carrying amount on the balance sheet.

Key Term: Recoverable amount
Under IFRS, the higher of an asset’s fair value less costs of disposal and its value in use (present value of future cash flows expected from the asset).

Key Term: Other comprehensive income (OCI)
Items of income and expense not recognized in profit or loss but recorded directly in equity, such as some revaluation gains and certain actuarial gains and losses.

Key Term: Revaluation surplus
The equity reserve arising from upward revaluations of PPE or eligible intangibles under IFRS, recorded in OCI.

Measurement after initial recognition

• Initial recognition (both frameworks)
  PPE is initially measured at cost, which includes:

  • Purchase price (net of discounts)
  • Directly attributable costs (e.g., site preparation, delivery, installation, testing)
  • Initial estimates of dismantling and site restoration obligations

• Subsequent measurement

  • IFRS

    • Allows a choice, by class of assets, between:
      • Cost model
      • Revaluation model for certain classes (e.g., land and buildings, some intangible assets with active markets)
    • Under the revaluation model:
      • PPE is carried at fair value at the revaluation date, less subsequent depreciation and impairment.
      • Upward revaluations:
        • Recognized in OCI and accumulated in a revaluation surplus within equity (unless reversing a previous downward revaluation taken through profit and loss).
      • Downward revaluations:
        • First reduce any existing revaluation surplus for that asset (in OCI), then excess is recognized as a loss in profit and loss.

  • US GAAP

    • Generally restricts PPE to the cost model.
    • Upward revaluations of PPE are not permitted.
    • Assets remain at depreciated historical cost unless impaired.

This means IFRS balance sheets may show PPE closer to current fair value (for entities using the revaluation model), whereas US GAAP PPE is typically at depreciated historical cost, potentially understating asset values in inflationary environments or rising property markets.

Depreciation

Although depreciation methods and estimates are not themselves a major IFRS–US GAAP difference, they affect comparability:

• Both frameworks allow:
  • Straight-line methods
  • Accelerated methods
  • Units-of-production or usage-based methods
• Both require:
  • Estimates of useful life
  • Estimates of residual (salvage) value
  • Periodic review of these estimates

Different choices can cause significant differences in:

• Depreciation expense
• Net PPE
• Profitability ratios
• Measures of asset age (e.g., accumulated depreciation / gross PPE)

The CFA curriculum expects you to recognize that management has discretion here and that analyst judgment is needed when comparing companies, even within the same framework.

Impairment and reversals (non-financial assets)

Both IFRS and US GAAP require an assessment for impairment when there are indicators that an asset may be impaired (for example, market value declines, adverse changes in technology or regulation, poor performance of the cash-generating unit).

• IFRS impairment approach

  • For an individual asset or cash-generating unit (CGU), compare carrying amount with recoverable amount (the higher of fair value less costs of disposal and value in use).
  • If carrying amount > recoverable amount:
    • Recognize an impairment loss for the difference.
  • Reversals:
    • For assets other than goodwill, if recoverable amount increases in a later period:
      • Impairment loss must be reversed, up to the carrying amount that would have existed had no impairment been recognized (taking into account normal depreciation).
      • Reversal is recognized in profit or loss.

• US GAAP impairment approach (long-lived assets held for use)

  • Follows a two-step process:
    • Step 1 – Recoverability test:
      • Compare carrying amount with the sum of undiscounted expected future cash flows.
      • If carrying amount ≤ sum of undiscounted cash flows → no impairment.
    • Step 2 – Measurement (if not recoverable):
      • Impairment loss = carrying amount − fair value.
  • Reversals:
    • Impairment losses for long-lived assets held for use are not reversed if fair values subsequently increase.

Practical implications:

• US GAAP may delay recognizing impairment losses (because cash flows are not discounted in the recoverability test).
• IFRS may recognize impairments earlier (because recoverable amount uses discounted cash flows or fair value).
• IFRS earnings can include gains from impairment reversals (except for goodwill), whereas US GAAP earnings cannot.

Cash Flow Statement Classification

Key Term: Cash flow from operating activities
Cash flows related to the entity’s principal revenue-generating activities (for example, cash received from customers, cash paid to suppliers and employees).

Key Term: Cash flow from investing activities
Cash flows related to acquiring and disposing of long-term assets and investments (for example, purchases of PPE, proceeds from sale of equipment).

Key Term: Cash flow from financing activities
Cash flows related to obtaining or repaying capital (for example, issuing or repurchasing shares, borrowing or repaying debt, paying dividends).

Key Term: Cash equivalents
Short-term, highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of changes in value, usually with original maturity of three months or less.

Key Term: Direct method (cash flow statement)
Method of presenting operating cash flows that shows major classes of gross cash receipts and payments (such as cash received from customers, cash paid to suppliers).

Key Term: Indirect method (cash flow statement)
Method of presenting operating cash flows that starts with net income and adjusts for non-cash items and changes in working capital to derive cash flow from operations.

Under both IFRS and US GAAP, cash flow statements classify cash flows as operating, investing, or financing. However, IFRS provides more flexibility in classifying certain items.

Interest, dividends, and taxes: classification differences

Key differences commonly tested:

Thus, an IFRS company may report higher or lower cash flow from operations (CFO) than a US GAAP company with identical economics, depending on classification policy.

• Taxes paid

  • IFRS: Generally classified as operating, but a portion may be allocated to investing or financing if specifically associated with those activities (for example, tax on a gain from selling PPE could be shown in investing).
  • US GAAP: Typically treated as operating cash flows; allocation to investing or financing is not permitted.

• Bank overdrafts

  • IFRS: Certain overdrafts that are repayable on demand and form a key part of an entity’s cash management may be included as part of cash and cash equivalents.
  • US GAAP: Bank overdrafts are usually classified as financing liabilities, not cash equivalents.

These classification options affect common cash flow-based metrics such as:

• Cash flow from operations (CFO)
• Free cash flow (CFO − capital expenditures)
• Cash interest coverage
• CFO-based valuation multiples

Under both frameworks:

• Companies may use either the direct or indirect method for reporting operating cash flows.
• IFRS encourages the direct method; US GAAP also encourages it, but in practice most companies use the indirect method.
• Under US GAAP, if the direct method is used, a separate reconciliation of net income to CFO (indirect reconciliation) must be provided. IFRS also requires a reconciliation if the direct method is used.

Summary of Selected Differences

The following table summarizes several high-frequency exam topics:

Exam tip: When you see a question about “which company will report higher CFO / net income / total assets,” immediately consider IFRS vs US GAAP, inventory method (LIFO vs FIFO), capitalization vs expensing of development costs, and whether PPE is revalued.

Application to Analysis and Comparisons

Standard-setter priorities and detailed rules affect how economic events appear in financial statements. Analysts comparing companies across borders must adjust—or at least mentally adjust—for these differences.

Inventories (LIFO vs FIFO; write-downs)

• US GAAP LIFO firms in rising price environments will show:
  • Higher COGS → lower gross margin and net income
  • Lower ending inventory and lower current assets
  • Lower retained earnings and equity

This affects:

• Profitability ratios:

  • Gross margin (gross profit / sales)
  • Net profit margin
  • ROA and ROE

• Liquidity ratios:

  • Current ratio (current assets / current liabilities)
  • Quick ratio (excluding inventories)

• Solvency ratios:

  • Debt-to-equity (because equity is lower under LIFO)

Using the LIFO reserve, an analyst can restate a US GAAP LIFO company’s inventory and COGS to a FIFO basis to improve comparability with IFRS firms.

Inventory write-downs and their reversals also affect analysis:

• IFRS companies may show:
  • Lower COGS in periods when prior write-downs are reversed
  • Higher inventory and equity after reversals
• US GAAP companies:
  • Cannot reverse write-downs, so previous losses remain in COGS history

When you see an IFRS company reporting a gain or reduced COGS due to reversal of inventory write-downs, you should consider:

• Whether this gain is sustainable
• Whether it distorts trend analysis of margins

Development costs and intangibles

IFRS capitalization of development costs leads to:

• Higher intangible assets
• Higher income in development periods, lower income in later periods due to amortization

When comparing an IFRS company that capitalizes development costs with a US GAAP peer that expenses them, the IFRS firm may appear:

• More profitable (higher margins) during periods of heavy development activity
• Less profitable later when amortization expense is significant
• To have lower asset turnover (sales / total assets) because of a larger intangible asset base

Analytical considerations:

• If R&D is a major driver of future growth, the IFRS capitalization can make near-term earnings look “better” but also increases the risk of future impairments if projects fail.
• US GAAP expensing gives a more conservative earnings pattern in early years but avoids later amortization.

PPE revaluation

IFRS companies using the revaluation model may report:

• Higher PPE and equity (revaluation surplus in OCI)
• Lower ROA and ROE (because total assets and equity are larger)
• Different leverage ratios:
  • Debt-to-equity ratio looks lower when equity includes large revaluation reserves

Analysts need to distinguish performance differences from measurement differences:

• A US GAAP and an IFRS company might have identical operations.
• The IFRS company could appear less profitable (lower ROA) because its assets are carried at higher, revalued amounts.
• However, the IFRS company might look less leveraged because equity includes revaluation surplus.

When revaluation increments are large:

• Consider looking at ratios both including and excluding revaluation surplus if the information is disclosed.
• Recognize that revaluation gains in OCI do not directly inflate net income, but they affect comprehensive income and equity.

Cash flow classification differences

Classification options under IFRS can significantly affect reported CFO:

• An IFRS company classifying interest paid as financing will show:

  • Higher CFO than a US GAAP firm with identical cash flows (since interest is excluded from CFO under IFRS in this policy choice).
  • Lower cash flows from financing.

• Similarly, an IFRS company may classify dividends received as investing, which reduces CFO relative to a US GAAP company that classifies them as operating.

Analytical implications:

• When comparing CFO-based metrics (such as cash interest coverage or CFO margin), always:
  • Check the cash flow statement notes for classification policies.
  • Consider reclassifying interest and dividends to a common basis (usually treating both interest and dividends as operating) for comparability, if sufficient data is available.

Worked Example 1.1

A Singapore-listed company (using IFRS) and a US-listed peer each report inventory and COGS in their statements. Both faced rising raw material prices during the year. The US-listed company uses LIFO; the IFRS company uses FIFO. Which company is likely to show lower net income, all else equal?

Answer:
The US-listed company is likely to show lower net income. Under LIFO, the most recent (more expensive) inventory costs are recognized in COGS, leading to higher COGS and lower profit in a period of rising prices. FIFO, used by the IFRS company, assigns older (cheaper) costs to COGS, lowering COGS and increasing profit. This is a classic LIFO vs FIFO exam scenario.

Worked Example 1.2

A UK-based company reporting under IFRS capitalizes eligible software development costs once technical feasibility is demonstrated. A US competitor reporting under US GAAP expenses all such costs as R&D when incurred. In a year when development spending is high, how will this affect profitability ratios and total assets?

Answer:
In the development year, the IFRS reporter will typically show:

• Higher net income and higher profit margins, because only amortization of capitalized costs (if any) is expensed, not the full cash outlay.
• Higher total assets, due to the capitalized development intangible.
  In later years, the IFRS firm will have higher amortization expense, reducing profit relative to the US GAAP firm, which has no remaining development cost to expense. ROA and ROE comparisons must consider this timing difference in expense recognition.

Worked Example 1.3

A US company reports under US GAAP and uses LIFO for all its inventory. It discloses:

• Inventory (LIFO) = 80,000
• LIFO reserve = 20,000
• Current liabilities = 45,000

A competitor reporting under IFRS uses FIFO and has:

• Current assets (all on a FIFO basis) = 300,000
• Current liabilities = 150,000

Compare the current ratios of the two companies on a FIFO basis.

Answer:
First compute Company A (IFRS, FIFO) current ratio:

• Current ratio = 300,000 / 150,000 = 2.0
  For the US GAAP LIFO company (Company B), adjust inventory to FIFO:
• FIFO inventory = 80,000 (LIFO) + 20,000 (LIFO reserve) = 100,000
  If the only current asset is inventory, then:
• Adjusted current assets (FIFO basis) = 100,000
• Current ratio (FIFO basis) = 100,000 / 45,000 ≈ 2.22
  On a LIFO basis, the US company appears less liquid than the IFRS peer. After adjusting to FIFO, it actually appears more liquid (2.22 vs 2.00). This illustrates why analysts often adjust LIFO inventories using the LIFO reserve for comparability.

Worked Example 1.4

Two companies are identical except for their cash flow classification policy. Both have:

• Cash received from customers: 1,000
• Cash paid to suppliers and employees: 700
• Interest paid: 60
• Dividends paid: 40
• No investing cash flows in the period

Company X reports under US GAAP. Company Y reports under IFRS and classifies interest paid and dividends paid as financing cash flows. Compute CFO for each company.

Answer:
For Company X (US GAAP):

• CFO = cash received from customers − cash paid to suppliers and employees − interest paid
• CFO (US GAAP) = 1,000 − 700 − 60 = 240
• Cash flows from financing include dividends paid of 40.

For Company Y (IFRS, interest and dividends as financing):

• CFO = 1,000 − 700 = 300 (interest paid and dividends paid are excluded from CFO)
• Cash flows from financing = interest paid 60 + dividends paid 40 = 100

The companies have identical cash flows, but Company Y reports higher CFO (300 vs 240) because of classification choices allowed under IFRS. An analyst comparing CFO must adjust for this if possible.

Worked Example 1.5

An IFRS company uses the revaluation model for its land. The land originally cost 500 and has never been depreciated. At the revaluation date, fair value is 800. Later, fair value falls to 720. How are these changes recognized under IFRS, and how would US GAAP treat the same changes?

Answer:
Under IFRS:

• Initial upward revaluation:
  • Carrying amount increases from 500 to 800.
  • The 300 gain is recognized in OCI and accumulated in a revaluation surplus within equity. It does not affect profit in that period.
• Subsequent decrease in fair value from 800 to 720:
  • A 80 decrease is recognized as a loss in OCI, reducing the revaluation surplus (because the decrease reverses part of a previous upward revaluation).
  • If the decrease were larger than the remaining revaluation surplus, the excess would be recognized as a loss in profit and loss.
    Under US GAAP:
• Upward revaluation from 500 to 800 is not permitted; land continues to be carried at cost (500) unless impaired.
• The later decrease to 720 would not be recognized, because GAAP does not allow upward revaluation in the first place, and the asset is not considered impaired (fair value still exceeds historical cost).
  As a result, IFRS shows land at 720 and includes a revaluation surplus in equity; US GAAP shows land at 500 and no revaluation surplus, affecting ROA and leverage ratios.

Convergence and Ongoing Differences

The IASB and FASB have converged the standards in several major areas (notably revenue recognition and leases), reducing some cross-framework differences. However, the areas emphasized in this article—inventory (including LIFO and write-down reversals), development costs, PPE revaluation, impairment reversals, and cash flow classification—remain important sources of divergence.

Key points for analysts:

• Reconciliation between IFRS and US GAAP numbers is no longer generally required for cross-listed companies.
• Published financial statements may not provide enough detail to fully adjust for all differences.
• Analysts must:
  • Read the accounting policies and notes carefully.
  • Recognize where reported numbers are not directly comparable.
  • Adjust when possible (for example, using LIFO reserves or separately disclosed R&D and development cost breakdowns).
  • Exercise caution when specific adjustments cannot be made due to limited disclosures.

Monitoring developments in standards is also important:

• New standards can change:
  • Recognition and measurement (e.g., new impairment models)
  • Classification (e.g., lease liabilities now on balance sheet)
  • Disclosure requirements
• For Level 1, you are not expected to know the detailed content of every new standard, but you should be aware that:
  • IFRS and US GAAP continue to move closer in many areas.
  • Some differences are structural (like the LIFO prohibition under IFRS) and are likely to remain.

Key Point Checklist

This article has covered the following key knowledge points:

• IFRS (issued by IASB) and US GAAP (issued by FASB) are the dominant global financial reporting frameworks.
• Standard-setting bodies write the standards; regulatory authorities (such as the SEC) adopt and enforce them in their jurisdictions.
• Both IASB and FASB use conceptual frameworks emphasizing relevance and faithful representation, supported by enhancing qualitative characteristics (comparability, verifiability, timeliness, understandability).
• IFRS is generally principles-based with strong emphasis on substance over form; US GAAP is more rules-based with detailed guidance.
• Both frameworks assume going concern and use the accrual basis of accounting.
• US GAAP permits LIFO, IFRS does not; LIFO vs FIFO can materially affect COGS, profit, inventory, and liquidity ratios, especially in periods of rising prices.
• US GAAP LIFO users disclose a LIFO reserve, which analysts can use to approximate FIFO inventory and COGS for comparability.
• Inventory is measured at the lower of cost and net realizable value; IFRS allows reversal of certain inventory write-downs, whereas US GAAP prohibits reversals.
• IFRS capitalizes qualifying development costs as intangible assets; US GAAP generally expenses R&D, affecting the timing of profit recognition and asset levels.
• IFRS allows PPE (and some intangibles) to be measured using a revaluation model, while US GAAP largely restricts measurement to depreciated historical cost.
• IFRS and US GAAP both require impairment write-downs of long-lived assets, but IFRS uses a recoverable amount based on discounted cash flows and allows reversals (except for goodwill), while US GAAP often uses an undiscounted recoverability test and prohibits reversals.
• IFRS provides flexibility in classifying interest, dividends, taxes, and bank overdrafts in the cash flow statement; US GAAP is more restrictive, especially for CFO.
• These differences can significantly impact profitability, liquidity, solvency, and cash-flow-based ratios, so analysts must consider them in cross-company and cross-border comparisons.
• Where disclosures permit (LIFO reserves, R&D breakdowns, revaluation reserves), analysts should perform adjustments or at least interpret ratios with these differences in mind.

Key Terms and Concepts

• IFRS (International Financial Reporting Standards)
• US GAAP (Generally Accepted Accounting Principles)
• Rules-based standards
• Principles-based standards
• Substance over form
• Financial reporting standards
• Conceptual framework
• Qualitative characteristics of financial information
• Standard-setting body
• Regulatory authority
• IASB (International Accounting Standards Board)
• FASB (Financial Accounting Standards Board)
• Going concern assumption
• Accrual basis of accounting
• Carrying amount
• Net realizable value (NRV)
• Lower of cost and net realizable value (LCNRV)
• FIFO (First-in, first-out)
• LIFO (Last-in, first-out)
• Weighted average cost method
• Inventory write-down
• LIFO reserve
• LIFO liquidation
• Research costs
• Development costs
• Capitalization
• Expensing
• Property, plant and equipment (PPE)
• Cost model
• Revaluation model
• Impairment loss
• Recoverable amount
• Other comprehensive income (OCI)
• Revaluation surplus
• Cash flow from operating activities
• Cash flow from investing activities
• Cash flow from financing activities
• Cash equivalents
• Direct method (cash flow statement)
• Indirect method (cash flow statement)