similarities and differences between U.S. GAAP and IFRS

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.

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 labour 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 labour 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 experience 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.

Toyota Motor Corporation: IFRS

Employee Benefits. Toyota Motor Corporation is a multinational company that manufactures automotive around the world. The company has over 364,445 employees worldwide and, and it remained one of the largest firms by revenue in 2019. The company uses IFRS to recognize employee benefits plans such as post-employment plans. Toyota industries use lump sum and pension payment approach to provide for employee retirement benefits. The amount of compensation awards depends on the employees’ final salary, grades, and years of service, among other terms.

Toyota industries determine employees’ contributions by using actuarial calculations to estimate salaries and wages. The industry complies with internal and relevant regulations in defining the defined benefit pension plan. In other words, Toyota complies with all the applicable laws on the eligibility of the pension agreement. Employees’ consent validates the compensation agreements upon approval by the Ministry of Labor, Health, and Welfare. The company engages entrusted institution such as pension management to design and recognize contributions to the pension plan. Such pension management institution plays a fiduciary role in the management of assets according to the agreement.

The company operates retirement benefit plans in line with relevant laws in Japan and local laws and regulations outside the domestic market. In 2017, a change in the company’s defined benefit scheme resulted in a decline of JP ¥ 14,370 million in the present value of the said plan. As a result, the company had a weighted-average obligation duration of 15.6 and 18.3 years in Japan and foreign markets, respectively, in the accounting period of 2018.

Over the long-term, Toyota Industries’ policy aims to secure profits by recognizing acceptable risks within the defined benefit pension agreement. Such systems result in attainment of basic earnings that enable Toyota to maintain the sound operation into the future. Under pension finance, the company ensures that the actual earnings rate must exceed the expected price in calculating future contribution. For instance, the company contributed JP¥ 6,021 million and JP¥ 7,091 million to the defined contribution pension plan for 2017 and 2018 fiscal years, respectively.

Share-Based Payments. In Japan, the Companies Act stipulates that a firm can incorporate more than half of the payment for issuing equity into capital stock, while the remaining into capital surplus. The company should include the incorporated capital surplus in capital reserve. Noteworthy, shareholders can resolve to incorporate the capital reserve into capital stock in their general meeting. The company authorized 1,100,000,000 shares in the 2018 fiscal year. The same ACT also stipulates that 10% of the surplus should be accumulated as retained earnings or capital reserve following the distribution of a dividend of surplus. The company should do the same until the capital reserve, and retained earnings reach 25% of capital. The appropriation of accumulated retained earnings helps compensate for losses. However, a resolution by shareholders during the general meeting may reduce retained earnings. The calculation of the distributable amount depends on retained earnings and statutory capital surplus as may be stipulated by generally accepted accounting standards in Japan. It is essential to note that Toyota does not include legal retained earnings and statutory capital reserve in the distributable amount.

Toyota Industries pay income on taxes such as the sufficient statutory tax and enterprise tax amounting to 31.1% for the 2018 fiscal year. Outside Japan, the subsidiaries pay rent and other taxes based on regulations in their locations. For instance, the deferred tax assets and liabilities decreased by JP¥218 million and JP ¥ 15,896 million in the consolidated financial statement of 2018, respectively. In the same period, income taxes in the P&L consolidated statements reduced by JP¥16,073 million while other comprehensive income declined by JP ¥431 million.

General Motors Company: US GAAP

General Motors Corporation is a typical company that uses the GAAP in preparing its financial statements. The employee benefits plan significantly contribute to the current fixed income securities and equity. The consolidated financial statements reveal that defined benefit pension plans depend on interest rates and the performance of such assets in the future. The defined benefits plan also depend on changes in regulations and relevant laws. The company uses the discounted rates to pay for compensation awards when the actual returns are lower than the expected value of returns on such assets. Therefore, GM Corporation uses assumptions to estimate future contributions to pension plans. Market liquidity may affect future contributions due to changes in investment policy. Defined benefit plans are affected by these factors; thus, the company funds its obligation as benefits when it pays such for the services rendered. Changes in local legal authorities affect the compensation for non-U.S. programs, policies that may compel the company to contribute more funds.

Dividends are paid quarterly on common stock according to the resolution of the board of directors. The payment of such dividends depends on changes in financial and business conditions, liquidity, capital, and earnings requirements, among other factors. Retained shares are paid upon warrants and insurance of common stock. Shareholders approved incentive plans that authorize stock appreciation rights and options to selected employees and non-employee. In 2018, the company recorded $7.3 billion in tax expense and $2.3 billion in deferred tax assets. The restructuring of its subsidiaries outside the United States resulted in charges of $460 million.

The relevance of IFRS from the Investor’s Perspective

IFRS is relevance to investors because it will improve efficiency of human capital in line with the international standards. In this regard, the measures aim to strengthen the accountancy profession as well as ensuring compliance to address managerial discretion. In doing so, IFRS improves investors’ confidence by addressing their concerns about international standards. Implementation of IFRS provides greater transparency in economic models and profitability because of homogeneity of financial information.

Conclusion

Employee benefits and share-based payments remain one of the items that international practice continues to monitor in an attempt to compel entities to address the ever-rising issues on the same. These accounting standards ensure that companies comply with their by correctly calculating the compensation benefits and reporting them in the financial statements. Unlike US GAAP, IFRS shows greater prudence because it requires faster recognition of actuarial losses to reduce the likelihood of surpluses in the financial statements. It also ensures greater transparency by compelling organizations to public employee benefits in line with moral and legal obligations. US GAAP’s use of discount rates on actuarial liabilities results in a reduction of the present value of commitments that the firm should pay to employees.