GAAP vs. IFRS: Adjusting Entries: Videos & Practice Problems

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.

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.

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.

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.

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.