Accounting Standards
GAAP vs IFRS Differences That Change Underwriting
US GAAP and IFRS produce different reported EBITDA, leverage and asset values for the same business. The differences that most often change underwriting conclusions are lease accounting, capitalization of development costs, LIFO inventory, impairment reversals, revaluation of fixed assets and cash flow classification of interest. Underwriters should restate borrowers to a common basis before comparing metrics or applying thresholds.
Why do GAAP and IFRS differences matter in credit and valuation?
Underwriting thresholds such as maximum leverage, minimum coverage and valuation multiples are usually calibrated on a particular accounting basis. When a borrower reports under a different framework, the same economics can produce materially different ratios. A lender comparing two companies, one under US GAAP and one under IFRS, may conclude that one is less levered or more profitable when the difference is purely accounting. Cross-border acquisitions, foreign subsidiaries and multinational peer sets all raise this issue regularly. The risk is greatest when thresholds are applied mechanically without checking the basis.
The two frameworks have converged in many areas, including revenue recognition and much of business combinations. Meaningful differences remain, and some of them sit precisely in the metrics lenders and buyers rely on most. The practical goal is not to master every technical difference but to know the handful that move EBITDA, debt and asset values, and to restate figures to a common basis whenever a comparison or covenant depends on them. Restatement is often approximate, but it is far better than ignoring the issue.
Which differences change EBITDA?
Leases are the largest. IFRS 16 removes nearly all rent from operating expenses, replacing it with depreciation and interest, while ASC 842 keeps operating lease cost within EBITDA. For a lease-heavy business, IFRS EBITDA can be substantially higher than US GAAP EBITDA for identical operations. Development costs are another: IFRS requires capitalization of development expenditure once specific criteria such as technical feasibility and intent to complete are met, whereas US GAAP generally expenses research and development, with exceptions for software.
Other differences are smaller but still relevant. Classification of certain items as operating or non-operating can vary with presentation choices that IFRS permits more flexibly. Government grants may be presented as deferred income or netted against assets under IFRS, which shifts amounts between EBITDA and depreciation. Capitalized borrowing costs follow broadly similar principles but differ in detail. Each difference should be identified from the accounting policy notes and quantified where material. Small differences can still matter when a borrower is close to a covenant threshold or when a valuation multiple magnifies the effect on enterprise value.
- Leases: IFRS 16 single model raises EBITDA versus ASC 842 operating leases
- Development costs: capitalized under IFRS when criteria are met, generally expensed under US GAAP
- Grants and presentation choices: can shift amounts between operating and non-operating lines
Which differences change the balance sheet?
LIFO inventory is permitted under US GAAP but prohibited under IFRS. In periods of rising costs, LIFO reports lower inventory and higher cost of goods sold, reducing both assets and earnings relative to FIFO or weighted average methods. The LIFO reserve disclosure allows conversion. Impairment reversals are another: IFRS permits reversal of impairment losses on assets other than goodwill when conditions improve, while US GAAP prohibits reversals for assets held and used. This can make IFRS asset values more volatile in both directions.
IFRS also allows property, plant and equipment and certain intangibles to be carried at revalued amounts, and investment property may be measured at fair value with changes in profit or loss. US GAAP generally requires historical cost. Revaluation increases equity and asset values and can make asset-based covenants and loan to value comparisons look stronger than under cost accounting. Underwriters relying on book values for collateral or tangible net worth should confirm the measurement basis and, where possible, rely on independent appraisals.
How does cash flow classification differ?
US GAAP requires interest paid and interest received, as well as dividends received, to be classified in operating activities, with dividends paid in financing. IFRS allows choices: interest paid may be operating or financing, and interest and dividends received may be operating or investing, provided the policy is applied consistently. A company under IFRS that classifies interest paid as financing will report higher operating cash flow than an identical US GAAP company, which affects ratios built on operating cash flow.
Combined with IFRS 16 lease classification, these choices can produce substantially higher reported operating cash flow under IFRS. Underwriters using cash flow from operations in coverage ratios, or comparing cash conversion across peers, should reclassify interest and lease principal consistently. The simplest approach is to build cash available for debt service from EBITDA, taxes, capex and working capital directly, rather than relying on reported operating cash flow subtotals that depend on classification choices. That approach also makes comparisons across frameworks far more straightforward.
How should underwriters restate for comparability?
Start by reading the accounting policy notes and identifying which differences apply. Quantify each using disclosures: lease notes for rent and lease liabilities, development cost notes for capitalization and amortization, inventory notes for LIFO reserves, and asset notes for revaluations and impairment reversals. Then restate EBITDA, debt and equity to the basis used for the underwriting thresholds. Document each adjustment so that reviewers can follow the path from reported to restated figures. Where disclosures are insufficient to quantify a difference, ask management for a reconciliation and note any remaining uncertainty in the credit memo.
Credit agreements should specify the accounting basis for covenant calculations and address future changes in standards, often through frozen GAAP provisions or a requirement to negotiate in good faith. When a borrower switches frameworks, for example after acquisition by a foreign parent, covenants may need to be reset. Underwriters should also confirm that management reporting and the audited statements use the same framework, since monthly reporting packages sometimes follow local rules that differ from the annual audited financial statements. Reconciling the two at least annually helps avoid surprises at covenant test dates and makes discrepancies visible early, when they are easier to resolve.
Restating an IFRS borrower to a US GAAP basis
- IFRS-reported EBITDA = $36.0 million. In the year, the company spent $10.0 million on development, of which $6.0 million met IFRS capitalization criteria and was capitalized.
- Under US GAAP, the $6.0 million would be expensed, so restated EBITDA = 36.0 - 6.0 = $30.0 million (amortization of previously capitalized costs sits below EBITDA under IFRS and drops out on restatement).
- Leases: IFRS EBITDA excludes $4.0 million of rent that would be operating lease cost under ASC 842. Restated EBITDA = 30.0 - 4.0 = $26.0 million.
- Funded debt = $90.0 million. IFRS-basis leverage including $15.0 million of lease liabilities = 105.0 / 36.0 = 2.92x.
- US GAAP-basis leverage excluding operating lease liabilities = 90.0 / 26.0 = 3.46x.
- At an 8.0x EBITDA multiple, the $10.0 million EBITDA difference implies an $80.0 million valuation gap driven entirely by accounting.
How underwriters apply this
- Restate borrowers and peers to one accounting basis before applying leverage limits or valuation multiples.
- Quantify lease and development cost effects on EBITDA from policy notes and disclosures.
- Convert LIFO inventory using the LIFO reserve and confirm the measurement basis of fixed assets used as collateral.
- Build cash available for debt service directly rather than relying on operating cash flow subtotals.
- Specify the accounting basis and treatment of future standard changes in the credit agreement.
Frequently asked questions
Is IFRS EBITDA always higher than US GAAP EBITDA?
Not always, but it frequently is for lease-intensive businesses and for companies that capitalize development costs under IFRS. Other differences can move in either direction. The direction and size depend on the business, so each borrower should be analyzed individually using its policy notes rather than applying a general rule.
Can a company use LIFO under IFRS?
No. IFRS prohibits LIFO. Companies reporting under IFRS use FIFO or weighted average cost. US GAAP permits LIFO, and companies that use it disclose a LIFO reserve, which allows analysts to convert inventory and cost of goods sold to a FIFO basis for comparison with IFRS reporters.
What is frozen GAAP in a credit agreement?
A frozen GAAP provision fixes covenant calculations to accounting rules in effect at a set date, so later changes in standards do not alter compliance without the parties agreeing. It protects both borrower and lender from accounting-driven covenant swings, though it requires the borrower to maintain reconciliations between current reporting and the frozen basis.
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