Increased globalization lies at the heart of developing the existing international accounting standards. Companies are increasingly venturing internationally and must standardize their operation for efficiency and stakeholder accountability. Therefore, governments and multinational organizations use International Financial Reporting Standards (IFRS) to remove the technical barriers to global trade (Turlington et al., 2020). Most countries, especially in Europe, have adopted the IFRS as it provides a standardized language for communicating financial information. The U.S. primarily uses the rules-based standards, Generally Accepted Accounting Principles (GAAP), but there are efforts to adopt the IFRS. The paper will examine the implications of applying GAAP and IFRS in two companies dealing with similar products, specifically automobiles. While GAAP and IFRS are good financial reporting standards, the former appears easier for investors to interpret as it allows comparability and contains clarification notes.
Companies are obliged by law to report their financial operations and can apply GAAP or IFRS standards. GAAP typically applies to firms operating within the U.S., while companies headquartered outside the country adhere to the IFRS financial reporting system. More than 140 countries, especially in Europe, Asia, and the South American region, have adopted the IFRS reporting standards (Barth et al., 2018). The Financial Accounting Standards Board (FASB) developed the GAAP, which governs the financial accounting and reporting processes in the U.S. The International Accounting Standards Board (IASB) issues the IFRS principles governing multinational companies’ financial reporting and accounting.
Part 1: Comparison of Two Companies’ Financial Reporting Processes
The comparison will involve two related companies, one operating in the U.S. under GAAP rules, and the other headquartered outside the U.S., applying IFRS principles. Volkswagen and Tesla automobile companies constitute the point of comparison in the paper, with the former applying IFSR and the latter the GAAP system. Volkswagen is a German car manufacturer headquartered in Wolfsburg, Germany. It has a long history of producing automobiles for the common folk in Germany. The company used to apply GAAP-based standards but has since shifted to IFRS. On its part, Tesla is a US-based electric car manufacturer headquartered in Austin, Texas. It applies the GAAP system in accounting and reporting its financial data.
A close study of the 2022 financial reports for the two companies exhibits significant differences. First, Volkswagen uses an IFRS reporting system with no specified income statement format. It uses the functional income statement, which presents the line items by activity performed, such as manufacturing and administrative expenses. The company labels the section as “Statement of Comprehensive Income.” The item presented on the income account includes profit after tax (1.819B Euros), Items that will not be reclassified to profit or loss (189 million Euros), net of tax (49 million Euros), all culminating in a total comprehensive Income of 1.869B Euros (Volkswagen, 2022). It also compares the 2022 figures with those of 2021.
In Tesla’s case, it presents its income statement in a standardized format and minimum line items. Its income statement has revenues ($8.142B), including line items such as automotive sales, leasing, regulatory credits, energy generation, and services (Tesla, 2022). The statement contains an item identified as cost of revenues & Gross margins. It indicates the expenditures within the year and leads to a gross profit of $20.853 billion (Tesla, 2022). Also, the financial statement includes comparative figures for 2020 and 2021.
The balance sheet is the second item that exhibits a contrast in the financial reporting of the two companies. Volkswagen, which uses the IFRS system, lists assets in increasing order of liquidity. In other words, it starts with non-current assets and then moves down to the current. On its part, Tesla, which uses GAAP, lists the current assets first before non-current ones. Third, the statement of Cash flows differs between the two companies. In Volkswagen, the interest paid and received are placed as line items under the “profit before tax” heading. The same items are placed under “Operating expenses.” While GAAP specifies the placement of interest paid and received under Operating Expenses, IFSR exhibits flexibility on the two items allocation.
While GAAP and IFRS differ significantly, they have some similarities. First, the overall framework of the financial statement is similar in both cases. It contains objectives, accounting characteristics, and elements (Alsharari, 2016). Also, both Volkswagen and Tesla’s financial statements use similar items, such as balance sheets, statements of cash flow, and income statements. They follow the same guidelines regarding cash and cash equivalents. Finally, they follow the same accrued-based approach.
Tesla’s financial statements are easier to understand, and investors can use the information as the basis of their future decision-making processes concerning the company. Its primary attraction is the accompanying notes which clarify specific items that may be unclear to the stakeholder. Also, it has specific terms and items that must be included. The manager will easily use the information in the Tesla financial statement to inform future company strategies.
Part 2: International Factors Affecting Automobile Production
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Economic Factors
The COVID-19 global pandemic had a significant impact on the automotive industry. The boundary closure interfered with supply chain efficiencies, cutting the supply of labor and materials to the companies (Eldem et al., 2022). Also, the cut in the supply lines hindered the sales of the company products, significantly reducing its profitability. Further, social distancing rules affected labor supplies implying that companies could not produce vehicles.
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Political Factors
International conflicts between major trade partners such as China and the U.S. may impact the vehicle’s production and sales. The tariff conflict between the two countries may have affected the procurement of raw materials and the export of finished products.
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Environmental Factors
Tesla is known for producing electric cars and parts with a minimum environmental impact, compared to Volkswagen, which mainly makes hydrocarbon-powered vehicles. Tesla sells its carbon points to companies such as Volkswagen, increasing its profitability, while the latter experiences a reduction in its revenue. Therefore, environmental concerns affect vehicle production.
Part 3: Compliance and Regulatory Issues
Environmental issues are prominent drivers of government compliance and regulatory practices in the automotive industry. The concerns over companies’ carbon footprints have encouraged governments to develop strict regulations on vehicle manufacturers to ensure an increase in the production of electric vehicles with a minimal carbon footprint. Tesla benefits significantly from such regulations and incentives. Also, many states in the U.S. specify that vehicle manufacturers must produce a certain percentage of electric cars. If they are unable, they purchase carbon credit from other companies. Tesla benefits significantly as it experiences excess electric vehicle production (Isidore, 2021). However, Volkswagen struggles to ensure compliance with government carbon regulations and standards. Shifting from traditional oil-combustion engines to environmentally safe electric ones will be time-consuming and cost-intensive.
Conclusion
Companies’ Financial reporting is a critical legal requirement by the government, with the GAAP system being more easily understandable than the IFRS. The IFRS is an international financial reporting system used by companies in most countries outside the U.S. Companies headquartered in the U.S. use the GAAP system. The GAAP financial reporting system is easier to understand as it uses a strict format with all the line items specified. Also, it has notes, which provide further clarity on some of the items on the financial statement.
References
Alsharari, N.M. (2016). Management accounting relevance: Practice, variance and current research agenda introduction. Journal of Humanities and Social Sciences,14(1), 1–33. DOI:10.36394/jhss/14/1/14
Eldem, B., Kluczek, A., & Bagiński, J. (2022). The COVID-19 impact on supply chain operations of automotive industry: A case study of sustainability 4.0 based on sense–adapt–transform framework. Sustainability, 14(10), 5855. MDPI AG. Retrieved from http://dx.doi.org/10.3390/su14105855
Isidore, C. (2021). Tesla’s dirty little secret: Its net profit doesn’t come from selling cars. CNN. Retrieved from https://edition.cnn.com/2021/01/31/investing/tesla-profitability/index.html
Tesla. (2022). TESLA, INC. Annual report on form 10-k for the year ended December 31, 2022 index. United States Securities and Exchange Commission. Retrieved from https://ir.tesla.com/_flysystem/s3/sec/000095017023001409/tsla-20221231-gen.pdf
Turlington, J., Fafatas, S., & Oliver, E. G. (2020). Is it US GAAP or IFRS? Understanding how R&D costs affect ratio analysis. Business Horizons, 62(4), 427-436.
Volkswagen. (2022). Volkswagen financial services: Annual report 2022, IFRS. Volkswagen Financial Services. Retrieved from https://www.vwfs.com/en/investor-relations/volkswagen-financial-services-ag/annual-reports.html
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