U.S. GAAP vs. IFRS in Valuation and Financial

ModelingWho Wants to Read 545-Page Reports from

the Big 4 Firms?

U.S. GAAP vs. IFRS: Confusion

This is a revised/updated version of a much older video in this channel because some key accounting rules have changed.

U.S. GAAP vs. IFRS is a confusing topic because you can find 545-page reports from the Big 4 firms that are also completely useless!

U.S. GAAP vs. IFRS: Confusion

Many of these reports discuss points like FIFO vs. LIFO for inventory, the reversals of write-downs and impairments, fair value revaluations, etc.

These points are all true, but they’re also irrelevant for valuation and financial modeling!

U.S. GAAP vs. IFRS: Our Approach

So, we’re going to take these 545-page reports and turn them into a short tutorial that focuses on the key pointswhile cutting out the fluff.

Main topics: Accounting, projecting the three statements, and valuation/DCF analysis.

Outline for This Tutorial:

• Part 1: Differences on the Financial Statements 3:07

• Part 2: How to “Convert” IFRS Cash Flow Statements 8:14

• Part 3: Leases, Valuation Multiples, and the DCF Analysis 14:45

• Part 4: More Advanced Topics 21:31

Part 1: Differences on the Financial Statements

• Income Statement and Balance Sheet: Largely the same, but some items have slightly different names (e.g., “Turnover” rather than “Revenue”)

• U.S. GAAP Cash Flow Statement: U.S.-based companies almost always start with Net Income (after-tax profits) and adjust it by adding back non-cash items like Depreciation

• IFRS Cash Flow Statement: Companies might start with Operating Income or Pre-Tax Income or something else – or they might use the Direct Method and record only cash inflows and outflows!

Part 1: Differences on the Financial Statements

• IFRS Cash Flow Statement: Items tend to be in more “random” locations, such as Dividends and Interest showing up in Cash Flow from Operations for EasyJet

• Leases: Did a whole separate video on this one, but under IFRS, companies split the Operating Lease Expense into “Interest” and “Depreciation” elements; under U.S. GAAP, it’s just a simple Rental Expense

• So: Be very careful when comparing U.S. and non-U.S. companies because of this last point

Part 2: Cash Flow Statement Conversion

• EasyJet provides a good example of why many IFRS Cash Flow Statements are problematic…

• Problem #1: We can’t link the CFS and BS because there are no changes in Accounts Receivable, Accounts Payable, etc.

• Problem #2: “Cash Generated from Operations” doesn’t match anything on the Income Statement

• Problem #3: Why are Dividends in Cash Flow from Operations?

• Problem #4: Net Interest and Taxes are also within CFO

Part 2: Cash Flow Statement Conversion

• Solution: Find a “reconciliation” in the filings that shows the bridge between Net Income or Operating Income and “Cash Generated from Operations” and swap that in

• And: Start the CFS with Net Income, include this bridge, and adjust for items like Deferred Taxes and anything else that doesn’t line up

Part 3: Leases and Valuation/DCF Analysis

• SHORT VERSION: Refer to our previous tutorial on IFRS 16 and Operating Leases, which explains the financial statements and valuation multiples

• U.S. GAAP: If you count Operating Leases as a Debt-like item in the Enterprise Value calculation, you need to pair Enterprise Value with EBITDAR to exclude the Rental Expense

• IFRS: Depreciation already includes part of the Lease Expense, so you normally count Operating Leases as a Debt-like item in the Enterprise Value calculation (you could also adjust Depreciation and remove the Lease Element…)

Part 3: Leases and Valuation/DCF Analysis

• Comparing U.S. and International Companies: You should use TEV Including Operating Leases / EBITDAR

• Why: No need for “adjustments” or special cases or special multiples, and the name clearly states the purpose

• DCF: It’s easiest to deduct the full Lease Expense in Unlevered Free Cash Flow for both IFRS and U.S. GAAP

• U.S. Companies: This is easy because the Lease Expense is a simple cash line item on the Income Statement → Already fully deducted within Cash Flow from Operations

Part 3: Leases and Valuation/DCF Analysis

• IFRS Companies: If you start with EBIT (Operating Income) to calculate UFCF, then:

• Interest Element of Lease Expense: You must find and deduct this in the NOPAT calculation

• Depreciation Element of Lease Expense: You must remove this from the “normal” Depreciation when adding back Depreciation

• Why: It’s easiest to deduct the full Lease Expense here so that you don’t have to factor in Operating Leases as a source of capital later in the analysis… or include them in the TEV bridge

Part 4: More Advanced Topics

• Main Issue: Most of the other differences do not affect your day-to-day work in projecting and valuing companies

• Example: LIFO vs. FIFO for Inventory – yes, U.S. GAAP allows both, while IFRS allows only FIFO… but so what?

• You’ll never have enough information to “adjust” a company’s Inventory or COGS; this difference just means that direct U.S.-to-International comparisons are not that useful

• Or: Taxes and Stock-Based Compensation; DTA changes continuously under IFRS, but only once under U.S. GAAP

Part 4: More Advanced Topics

• But: Again, so what? It doesn’t affect the company’s net cash flows, and you rarely “project” the exercise of SBC

• Pensions: Different components may be deductible, which could affect the taxes in a model…

• But: This one depends more on the specific country than the accounting system – need to look up whether pension contributions, the service cost, etc., are deductible in the country

• Bottom Line: Most of these differences are not that relevant for projecting cash flows and valuing companies

Recap and Summary

• Part 1: Differences on the Financial Statements

• Part 2: How to “Convert” IFRS Cash Flow Statements

• Part 3: Leases, Valuation Multiples, and the DCF Analysis

• Part 4: More Advanced Topics