Why is it important for companies to comply with GAAP IFRS in preparation of their financial statements?

IFRS or International Financial Reporting Standards refers to a globally-accepted set of accounting and financial reporting guidelines for preparing and presenting financial statements. It ensures uniformity in accounting practice that makes financial records comparable across different reporting entities worldwide. Over the years, it has emerged as the new world standard in accounting.
Table of Contents Show

Understanding IFRS
Objectives of IFRS
Uses of IFRS
Importance of IFRS
Frequently Asked Questions (FAQs)
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Source: IFRS (wallstreetmojo.com)

It was first published in the year 2003. It was designed by the International Accounting Standards Board (IASB) and is adopted by more than 144 jurisdictions and countries worldwide, including the European Union. The U.S. government, however, uses the U.S. Generally Accepted Accounting Principles (GAAP) system of accounting rules. Before IFRS, the International Accounting Standards (IAS) were in regulation.

The full form of IFRS is the International Financial Reporting Standards. It is a unique set of rules and regulations followed worldwide for recording financial transactions of a business entity. At present, it is adopted by 144 jurisdictions.
In June 2003, its first copy was published by IASB. IASB is a board of finance and accounting experts with responsibility for designing and issuance of the standards.
IFRS is often confused with IAS (International Accounting Standards), which were in practice before. IFRS superseded IAS.
The U.S. government doesn’t follow IFRS and has its own rules and protocols called U.S. Generally Accepted Accounting Principles (GAAP). Both standards are effective and serve the same purpose. However, there is always a comparison of IFRS vs GAAP.

Understanding IFRS

The purpose of financial statementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more is to provide information on a company’s financial performance and position to help current or prospective stakeholdersA stakeholder in business refers to anyone, including a person, group, organization, government, or any other entity with a direct or indirect interest in its operations, actions, and outcomes.read more make reliable financing decisions. It is a company’s primary means of communication with them.

So, the information presented in the records should be relevant, reliable, accurate, and comparable. To ensure it, companies started observing regionally accepted accounting standards. However, comparing different companies across countries became difficult due to a lack of uniformity in their accounting guidelines. As a result, companies had to prepare several sets of financial statements for different jurisdictions.

With the emergence of multinationals having a presence in multiple countries, the need for a global accounting framework gained momentum. It gave rise to the formation of IASB. The IASB is an independent group with hybrid experts in finances, auditing, accounting standards, and education. The task of board members is to issue and publish financial accounting standards.

The IASB was created with the sole purpose of designing an international financial reporting system that will ensure smooth processing, interpretation, and comprehension of financial statements, business transactionsA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.read more, and foreign investmentsForeign investment refers to domestic companies investing in foreign companies in order to gain a stake and actively participate in the day-to-day operations of the business, as well as for essential strategic expansion. For example, if an American company invests in an Indian company, it will be considered a foreign investment.read more. IASB introduced IAS and later IFRS that laid down a framework of universally recognized principles for accountingAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts.read more.

The IFRS establishes accounting standards and practices that every company adhering to it must observe. It is a rule book that must be followed while recording business transactions in the books of accounts. Also, as it yields transparency and consistency in financial reportingFinancial reporting is a systematic process of recording and representing a company’s financial data. The reports reflect a firm’s financial health and performance in a given period. Management, investors, shareholders, financiers, government, and regulatory agencies rely on financial reports for decision-making.read more, governments use it to regulate direct and indirect foreign investments.

It is accepted worldwide as it facilitates the free flow of capital. In other words, any U.S. investor will be more confident to invest in, suppose, an Indian company after scrutinizing its financial records prepared in conformity with this accounting standard. This is because following the internationally-approved standards eliminate accounting risks associated with such investments.

However, note that the U.S. government enforces GAAPGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more on their companies. Therefore, there is often a widespread debate on IFRS vs US GAAPThe International Accounting and Standards Board (IASB) issued IFRS, whereas GAAP is given by the Financial Accounting Standards Board (FASB). Though attempts are being made to bring about convergence, it becomes essential to be considerate when evaluating financial statements under the different frameworks.read more when it comes to compliance. IFRS is lengthy and flexible compared to GAAP. As it is principle-based, its rules are open to multiple interpretations. However, both IFRS and GAAP serve a common objective of uniformity and openness in maintaining financial statements.

Objectives of IFRS

International Financial Reporting Standards represents an international financial reporting system and serves multiple purposes. Some of its significant goals in the financial world are as follows:

#1- Create a Common Law

One of its key objectives is to ensure that common law is introduced and adopted by as many jurisdictions and countries as possible to bring everyone on the same page. It ensures that everyone follows the same guidelines and adopts a universal way of reporting business activities.

#2 – Aid analysis

It helps stakeholders in analyzing a company’s performance and interpreting its financial position. For example, corporations and governments use these standards to make credible financial statements. It aids in categorizing and reporting financial data with accuracy and consistency. Such financial records promote better comprehension and help decision-making.

#3 – Assist in preparation of reliable financial records

By following International Financial Reporting Standards, the data presented in the books of accounts are likely to be accurate, reliable, uniform, and appropriate within the bounds of its rules. The high quality of financial records assists investors in making informed economic decisions.

#4 – Ensure comparability, transparency, and flexibility in reporting

The consistency in reporting accounting practicesAccounting practice is a set of procedures and controls used by an entity's accounting department to keep track of accounting records and entries. Other reports are generated based on accounting records, such as financial statements, cash flow statements, fund flow statements, payroll, tax workings, payment and receipts statements, and so on, and they form the basis of the auditor's reliance while auditing the financial statements.read more enables easy comparison of the financial records of compliant companies across nations. Such comparisons allow investors to identify risks and opportunities before investing. As a result, it promotes foreign trade and investment.

Also, it requires full disclosureFull Disclosure Principle is an accounting policy backed by GAAP and IFRS, asking the management of an organization to disclose every relevant and material financial information to creditors, investors and any other stakeholder who depend on the financial reports and decision-making process.read more of all relevant information to its stakeholders. However, being principle-based, the rules are not very rigid and allow companies to adapt to them in their own way.

Uses of IFRS

This standard is a multi-layer set of rules and guidelines prepared like a blueprint to follow in accounting. Its main uses are as follows:

#1 – Financial Tool

The International Financial Reporting Standards bring efficiency, accuracy, and data transparency to serve public interests for growth, trust, and sustainability of the world economyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. For example, the International Organization of Securities Commissions (IOSCO) is working with the IFRS to set up a new body by November 2021 to postulate mandatory global standards on climate change in company disclosures. The IOSCO will also eliminate any errors or conflicts by going interoperable with the global baseline.

#2 – Principles and Guide

The companies run their whole business and represent their financial data and information as per the IFRS accounting principles. If they fail to do so, they may be penalized for it. Hence, it assures the trustworthiness of a company.

The standards help investors make wise decisions regarding their investment by providing a clear picture of company reports and financial statements. It is possible because of its singular and universal language, making it easy to comprehend.

#4 – Improves Economy

Globally, investors are more open to investing in companies with IFRS-compliant financial records. Again, it is because such reports are presumed to be authentic, easily understandable, and comparable. This credibility opens the economy to foreign investment and thereby paves the way for economic progress.

Importance of IFRS

It is treated as an international accounting standard and holds great importance for many countries and the world economy. Here is its significance:

#1 – Transparency

It encourages transparency and accountability of financial statements prepared by companies, small firms, and government agencies. As a result, it minimizes the margin of error and manipulation of any holdings and irregularities of funds, transactions, and balances. Besides, it also motivates consistency and clarity of work.

#2 – Uniformity and Comprehensive

The International Financial Reporting Standards are developed to set uniformity in the presentation and understandability of statements. When everyone follows and recognizes the standards, it becomes easy for companies and agencies to follow a common law that helps world economies compare their growth comprehensively. Also, it is easy to read for everyone.

#3 – Security and Flow

It helps track the flow of transactions, records funds information, and works towards attaining a security level for direct and indirect foreign investments across nations. This accounting standard is essential when we are dealing with significant assets or getting into heavy transactions.

#4 – Accountability

It strengthens accountability by bridging the gap of incompetent financial reporting. If not complied with it, the companies may face penalties. For example, last year, the Johannesburg Stock Exchange fined a sugar firm Tongaat Hulett Ltd. Its financial statements, account reports, and other information details did not comply with IFRS and were incorrect.

Frequently Asked Questions (FAQs)

When was IFRS introduced?

International Accounting Standards Board (IASB) is a body formed to create IFRS in 2001. In June 2003, its first principles were developed and issued by it.

The IFRS are based on what?

It is based on standard accounting principles and procedures accepted and adopted by 144 jurisdictions. It is a guide on reporting financial statements and data that is understandable and comparable with one another.

What are IFRS and its purpose?

IFRS full form is International Financial Reporting Standards. As the name suggests, its purpose is effective, efficient, and accurate reporting of financial statements using standard accounting principles to ensure transparency, consistency, growth, and interest of public services.