fundamental similarities and differences between U.S. GAAP and IFRS

 fundamental similarities and differences between U.S. GAAP and IFRS

Undeniably, the adoption of IFRS across the world remains one of the financial reporting issues of the 21st Century. Today, the majority of publicly-traded companies have adopted IFRS as the foundation or guideline for their financial reporting. Similarly, there has been a debate between the FASB and the IASB to converge the U.S. GAAP with IFRS. As a result, the acceptance of such convergence aimed to help auditors, financial analysts, and accountants understand the essential components of financial reporting. This paper describes the fundamental similarities and differences between U.S. GAAP and IFRS with a focus on employee benefits and share-based payments in the financial statements.

It is essential to note that the identification of employee benefits differs across entities depending on the accounting standards applied. By definition, employee benefits are all forms of benefits that an employee receives from an entity in exchange for the services offered. The employers can record direct and indirect interests in the P&L account by dividing the funds for employees into either direct payments or provisions for benefit plans after retirement. In the financial reporting, employees’ benefits are reported as either liabilities or expenses depending on the commitments by employers. Under the IAS, it is the moral commitment of the employer to fulfill the benefits to employees by incurring the financial costs associated with the same. The Council of International Accounting Standards Board issued the IFRS to describe the procedures that employers should follow to report employee benefits on their financial statements. In other words, IFRS prescribes the specific obligation of the employer to disclose and report the said benefits.

Under these standards, the entity should recognize employee benefits as a liability when an employee offers a service whose payments will come in future dates. An organization should report employee benefits as an expense when the company consumes the economic benefits from the service provided by an employee in exchange for the payments.

The types of Employee Benefits

Short-term or immediate benefits are employee benefits payable within twelve months of the accounting period from the time the employees rendered the service. An entity should recognize such payments as an accrued expense or a liability upon deducting the already paid amount. However, employee benefits become an asset or prepaid expense if the amount paid exceeds the undiscounted value of the profits. Such transfers result in cash refund or reduction in future payments. Employee benefits can be expenses if the benefits are included in the costs of an asset. Financial benefits to employees include salaries, wages, social security contributions, holiday or sickness pay, and bonuses, among other benefits.

On the other hand, non-financial benefits include healthcare and educational programs, among other services provided by the entity to the employee. Employee benefits after retirement are transfers payable after the completion of employment. They include pensions, lump-sum pension payments, life, and sickness insurance. An entity should discount all termination benefits that are due more than 12 months after the balance sheet date. Firms should recognize these compensation benefits as a liability and an expense when such claims comply with the labor laws or internal regulations.

Employee Benefits: Comparison between US GAAP and IFRS

Under the IFRS, there is a lack of recognition between special and other termination benefits. Such compensation benefits become a liability and expense when the entity demonstrates its commitment to pay for the same. In other words, the firm only recognizes termination benefits when such claims comply with the relevant internal regulations and labor laws. Conversely, the US GAAP recognizes exclusive termination benefits when an entity communicates to such plans to employees. In this regard, the US GAAP encourages entities to identify and estimate liability up to cover the time when the employees rendered their services beyond the minimum retention period. It gives firms to use reasonable and probable estimations to recognize contractual termination benefits entitled to employees. In other words, the US GAAP considers termination benefits as employee benefits when an entity terminates the contract before the reasonable retirement date or when an employee accepts voluntary redundancy in exchange for those benefits. An employer should treat optional termination benefits as a liability and an expense when the employee agrees with the monetary consideration.

The IFRS permits firms to recognize actuarial gains and losses directly in equity such claims occur. These are fixed payments or defined contributions that a firm incurs in post-employment plans. Noteworthy, the company does not have a constructive obligation to make additional payments to the employee if the fund for employee benefits fails to hold sufficient assets to remit amounts for services rendered by all employees in both the current and prior periods. On the other hand, the US GAAP requires that an entity must recognize all actuarial gains and losses in equity when they rise. An entity’s legal obligation is to pay a limited amount in line with its contributions to the fund. In other words, employees should bear the actuarial and investment risk incurred during a period when the company received such services.

Moreover, the IFRS does not permit the recycling of actuarial gains and losses in the P&L recognized as equity in the previous accounting period. On the contrary, the US GAAP reclassifies actuarial gains and losses arising from other comprehensive income. It acknowledges these amounts in the P&L account as net benefit costs in a given accounting period.

The IFRS uses the present value criterion to calculate the value of actuarial gains and losses. It curtails any unrecognized actuarial gains and losses from the previous accounting period. Similarly, the US GAAP reduces unrecognized actuarial gains and losses by detailing differences between the present and fair value of the benefits from the past service costs. In other words, both standards curtail gains and losses when the entity announces and demonstrates its commitments to pay the employee benefits. Both IFRS and US GAAP recognize a probable actuarial loss when there are reasonable estimates that curtailment will occur. Similarly, both the standards recognize a curtailment gain when an employer terminates employment contracts of the relevant employees or when there is an amendment to the suspension plan, and the employer demonstrates commitments to pay.

Share-Based Payments

Although both IFRS and US GAAP share standard guidelines for share-based payments at a conceptual level, there are significant differences between the two standards at the application level. IFRS and US GAAP differ in the way the two approaches report compensation awards as a liability or equity. As a result, the rating of such claims may contribute to different compensation costs due to volatility effects on earnings and balance sheets. Under the IFRS, an entity should settle the awards in equity or cash, whereas US GAAP separates awards as equity and liability. Besides, IFRS allows companies with grants of more than 25% annually for four years to recognize expenses faster than US GAAP.

Under IFRS, companies have more significant variability between periods when accounting for the deferred income tax before the tax deduction. The degree of variability affects the issuance of the stock price. On the other hand, companies using the US GAAP experience higher volatility after receiving their tax deduction due to the difference between the actual tax benefits and estimated deferred taxes recognized.

The IFRS accounts for all arrangements for both employees and non-employees regarding the share-based payments. In this regard, IFRS has a broader definition of an employee than in the US GAAP guidelines. Under the US GAAP, stock compensation helps evaluate awards for non-employee to determine the compensation costs. It defines an employee as either equity and liability-classified. The US GAAP guidelines allow companies, primarily non-public entities, to employee the fair value or the calculated-value method to measure stoke-based awards when it is impossible to estimate the price of stock due to market volatility. The US GAAP also guides non-public companies to measure stock-based awards by using either the fair-value or the intrinsic-value method. Entities should record transactions between employers and employees, indicating the dates when the employees rendered the services to the company. Such services are measured at fair value. IFRS does not give non-public entities such alternatives but instead requires the use of the fair-value method all the time regardless of the circumstances.