When a foreign-owned company expands its business operations in the U.S., one of the early decisions is selecting an accounting standard for financial reporting. Although the foreign parent might require the U.S. company to report on a certain standard for consolidation with global operations, this could be inconsistent with reporting in the United States. The accounting standard commonly used in the U.S. is generally accepted accounting principles (GAAP), a rules-based system. Interestingly, GAAP is not the required accounting standard for U.S. companies. Contrast this with various statutory reporting systems in countries outside the United States. In addition, many countries require companies to follow the International Financial Reporting Standards (IFRS), a principles-based set of accounting standards.
Like other countries, U.S. businesses also have an annual income tax reporting responsibility. This requires taxpayers to follow separate rules and regulations prescribed by the U.S. Department of the Treasury. From a financial reporting perspective, this is referred to as the income tax basis of accounting (Tax Basis). Because many small companies are not required to maintain their accounting on GAAP, but they are required to file an income tax return annually, management teams can alternatively choose to follow Tax Basis for their financial reporting. Whether a business chooses an accounting standard based on rules, principles, or tax regulations, financial reporting must still be meaningful. However, the outcome of reporting can sometimes vary greatly based on the chosen standard.
Common Differences in Accounting: GAAP, IFRS, & Tax Basis
The theoretical differences between GAAP, IFRS, and Tax Basis often result in inconsistent accounting for certain transactions and presentation of reporting. The following are a few common examples:
- Inventory
- GAAP: There are three main forms of inventory: first-in, first-out (FIFO); last-in, first-out (LIFO); and weighted average cost (WAC).
- IFRS: This permits the use of FIFO and WAC but doesn’t permit the use of LIFO.
- Tax Basis: Multiple inventory methods are available, including the direct expensing of inventories for small companies.
- Fixed Asset
- GAAP: Recorded at historical cost and subject to depreciation. The value of fixed assets cannot increase.
- IFRS: Initially recorded at historical cost, this is later changed to fair value. Fair value is re-evaluated year-over-year and can increase the value of fixed assets.
- Tax Basis: This is similar to GAAP regarding historical costs without increasing values, but there are different considerations of repairs versus capitalization and significantly different methods of recording depreciation.
- Balance Sheet
- GAAP: Current assets are listed first under GAAP and arranged in order of liquidity.
- IFRS: Noncurrent assets are listed first under IFRS and arranged in order of least liquid to most liquid.
- Tax Basis: Regulatory requirements for regarded entities on Schedule L; follows a similar ordering arrangement as GAAP.
Although the decreased regulation for statutory reporting in the U.S. can relieve the compliance burden, the lack of consistency can result in unexpected outcomes for the users of its financials. Therefore, an entity should carefully consider which accounting standard to adopt and consistently use.
Other Accounting System Considerations in the U.S.
The core of a company’s accounting system and reporting starts with its chart of accounts (COA). Similar to the flexibility in choosing a financial reporting standard, U.S. businesses are not required to use a prescribed COA. Therefore, a well-structured COA is key for international inbound businesses to facilitate meaningful reporting. Consideration should be given to its financial reporting standard, but specific emphasis should be placed on the end users of its financials to establish an effective COA.
If the users are primarily stakeholders in the U.S., then businesses can choose a COA consistent within their industry. However, end users typically include the management team of the foreign parent, so a mapping would be required to cross-walk the U.S. reporting for the foreign parent’s management team more efficiently. Alternatively, end users can elect to use the foreign parent’s COA, eliminating the need for mapping.
Once a COA is chosen, another component of the accounting system is the standard for invoicing. The U.S. does not have stringent statutory requirements for invoicing. In fact, there are no specific regulations mandating particular information that must be included on an invoice, e.g., value-added tax (VAT) numbers, no electronic reporting mandate, and no specific numbering system. The following information on invoices should be included to aid in proper documentation and tax compliance:
- Company name and address
- Customer name and address
- Invoice date
- Description of goods or services
- Amount due, including any applicable sales taxes
- Currency
- Payment terms
Conclusion
The selection of an accounting standard for financial reporting is an important decision for U.S. inbound companies. Once chosen, consideration must also be weighed when designing the COA and invoicing system. You may want to consider management needs, access to capital markets, third-party stakeholders, and financial and regulatory transparency when making these decisions. If you have any questions or need assistance, please reach out to the Outsourced Accounting Services team at Forvis Mazars, and be sure to check out the other articles in our Launching a Foreign-Owned Business Entity in the U.S. series.
