GAAP vs. IFRS: Adjusting Entries - Online Tutor, Practice Problems & Exam Prep

Understanding the differences between GAAP and IFRS is crucial for accounting practices. Both frameworks require accrual-basis accounting and the periodicity assumption, necessitating adjusting entries. A key distinction lies in IFRS's fair value principle, which can alter long-term asset valuations and affect depreciation calculations. Additionally, while GAAP differentiates between expenses and losses, IFRS categorizes both as expenses. This knowledge is essential for navigating the accounting cycle and ensuring accurate financial reporting.

GAAP vs. IFRS: Adjusting Entries

Alright, now let's talk about some of the key differences between GAAP and IFRS when it comes to adjusting entries. Adjusting entries have been a big focus of this unit, so let's go ahead and talk about how IFRS could have some differences here. Remember, GAAP, this is what we focus on in this course. We focus on the U.S. laws, generally accepted accounting principles. They're set by FASB, the Financial Accounting Standards Board, who create GAAP. Internationally, the international standards are set by the International Accounting Standards Board, and those are called IFRS, the International Financial Reporting Standards. Okay? So let's go ahead and see what some of these key differences and similarities for the adjusting entries are. Let's start here with the similarities.

First, accrual accounting is required. That means we need adjusting entries, right? When we do accrual accounting, that's why we were doing these adjusting entries, compared to cash basis accounting where we only focus on cash. So we do the accrual basis of accounting in both GAAP and IFRS, and we use the Periodicity Assumption. This Periodicity Assumption, it's another reason why we make our adjusting entries, right? Remember, Periodicity means that we're breaking up an indefinite timeline. The company doesn't stop to produce financial statements, no, it keeps running and running. But we break it up into artificial time periods, usually a year, so that we can do our reporting. And we do the same thing in IFRS, right? We're going to have to break up time, so that we can do our financial reporting. Usually in years, right? We'll show our balance sheet at the end of the year. We'll show our income statement for a period of time. We show these same statements, but it's just that the time doesn't actually stop for this reporting, right? Time keeps going. The business keeps running. But we're breaking it up just to be able to report this information. Okay? And revenue recognition rules, the ones that we discussed in this chapter, they're generally the same, especially when we talk about the things we talk about in this course. They're going to be the same; the rules for revenue recognition. Okay?

Now some of the key differences, we've talked about this before. The use of the fair value principle by IFRS, okay? This can change the value of long-term assets. So we talked about depreciation and depreciating our long-term assets. So you can imagine if we're revaluing these assets, well, it's going to affect our depreciation calculations based on what the value of the asset is. Okay? In GAAP, we don't do any of these revaluations of our long-term assets. So our depreciation calculations are going to be quite simple, okay? IFRS allows these changes in valuation, and that could change how we calculate depreciation. We don't need to get into details in this course, we're not going to be calculating depreciation under IFRS rules and seeing these revaluations. However, the methods that we use for calculating depreciation, they are going to be generally the same. It's just the fact of this fair value principle adjusting the value of the asset that can affect the calculation. Okay?

And now under IFRS, another big difference here is what they call an expense. Okay? So under GAAP, we have two things. In GAAP, we have expenses, which are things that happen in the normal course of business. But then we have things that are outside the normal course of business. So if we lose money outside the course of business, GAAP calls that a loss. We will have losses outside the normal course of business. Okay? So that could be something like we have a piece of stock. We have a share of stock that we have as an investment, and we sell it, but we lost money on that sale. Well, that would be a loss from the standpoint of GAAP, but from IFRS, they would also call that an expense. Okay? So it's just a little difference in terminology, and it's not really that big of a deal here. Alright? So that's about it for adjusting entries. Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What are the key differences between GAAP and IFRS in terms of adjusting entries?

GAAP and IFRS both require accrual-basis accounting and the periodicity assumption, necessitating adjusting entries. However, a key difference is IFRS's use of the fair value principle, which can alter long-term asset valuations and affect depreciation calculations. GAAP does not allow revaluation of long-term assets, making its depreciation calculations simpler. Additionally, GAAP differentiates between expenses (normal business activities) and losses (outside normal business activities), while IFRS categorizes both as expenses. Understanding these differences is crucial for accurate financial reporting and navigating the accounting cycle.

How does the fair value principle under IFRS affect adjusting entries?

The fair value principle under IFRS allows for the revaluation of long-term assets, which can change their recorded value on the balance sheet. This revaluation affects depreciation calculations, as the depreciation expense is based on the updated asset value. In contrast, GAAP does not permit revaluation of long-term assets, resulting in more straightforward depreciation calculations. This difference in asset valuation and depreciation can lead to variations in financial statements between IFRS and GAAP.

Why is accrual accounting required under both GAAP and IFRS?

Accrual accounting is required under both GAAP and IFRS because it provides a more accurate representation of a company's financial position and performance. Unlike cash basis accounting, which only records transactions when cash changes hands, accrual accounting recognizes revenues and expenses when they are earned or incurred. This method aligns with the periodicity assumption, which breaks down an indefinite timeline into artificial periods (usually a year) for reporting purposes. Adjusting entries are necessary to ensure that revenues and expenses are recorded in the correct period, providing a clearer financial picture.

How do GAAP and IFRS differ in their treatment of expenses and losses?

Under GAAP, expenses and losses are treated differently. Expenses are costs incurred during the normal course of business, while losses are costs that occur outside the normal business activities, such as selling an investment at a loss. In contrast, IFRS does not differentiate between expenses and losses; both are categorized as expenses. This difference in terminology and classification can affect how financial statements are interpreted and compared between companies using GAAP and those using IFRS.

What is the periodicity assumption, and why is it important for adjusting entries?

The periodicity assumption is the concept of dividing an indefinite timeline into artificial time periods, usually a year, for financial reporting purposes. This assumption is crucial because it allows businesses to prepare periodic financial statements, providing stakeholders with timely and relevant information. Adjusting entries are necessary under this assumption to ensure that revenues and expenses are recorded in the correct period, reflecting the true financial performance and position of the company. Both GAAP and IFRS require the periodicity assumption, making it a fundamental aspect of accrual accounting.