The SEC recently released a proposal that could lead to required use of International Financial Reporting Standards (IFRS) by U.S. publicly traded companies in 2014. According to experts, the question is not if the U.S. will require the hospitality industry to change to IFRS but when.
As a result, major accounting firms are advising their clients to begin planning for IFRS adoption now as the process is complicated and will affect many areas of the business including the tax, treasury, IT, investor relations and financial reporting functions.
There are many advantages to adoption of IFRS including better access to international capital, combined with potential cost savings for companies with subsidiaries in foreign countries. Over 100 countries currently require or permit the use of IFRS for financial reporting. The European Union made IFRS mandatory for member countries in 2005. Companies in industries using IFRS as the basis of financial reporting more than any other set of standards would be eligible to elect to use IFRS beginning with SEC filings in 2010.
IFRS is considered principles-based as opposed to the Generally Accepted Accounting Principles (GAAP) (the standard framework of guidelines for financial accounting used in the United States), which is rules-based. The US GAAP has become a burdensome compliance problem due to the volume of standards and pronouncements generated by several standard-setting bodies including the FASB, AICPA, EITF and SEC. For every possible financial transaction, the US standard setters attempt to create a rule instructing preparers and auditors how to account for, and disclose it in their financial statements. Over the years, this process had led to the equivalent of a very complex rules series comprising over 25,000 pages of instructions with which all must comply.
By comparison, the IFRS guidelines are contained in 2,000 pages. Accountants are given latitude to use their professional judgment to account for a financial transaction, and to report the substance of a transaction over its form, rather than meeting the requirements of the immense rule book under US GAAP. The simplification underlying this concept is a major driving force behind the acceptance of IFRS as the global accounting language.
US standard setters, and the International Accounting Standards Board (IASB), signed a memorandum of understanding called the Norwalk Agreement, and are in the process of bringing to convergence the US GAAP and IFRS to help reduce their differences. However, many such differences still exist. A potential investor reviewing financial statements for a company in identical accounting periods and using the widely divergent standards of the two systems, could see a difference in reported profit in the tens or hundreds of millions of dollars resulting from the different conceptual and reporting methods. These differences could have a negative effect upon investor understanding, and thus upon their choice of investment vehicles. US companies do not want to be at a disadvantage in competing for access to global capital and these are the major reasons the SEC and US interests are urging mandatory adoption of IFRS in the US.
Briefly, some areas of specific difference that exist that for the hospitality industry include reporting of fixed assets. Under IFRS there is a fair value option but under US GAAP fixed assets must be reported using historical cost. In valuing inventory under IFRS, LIFO is prohibited, but permitted under US GAAP. The gain on sale and leaseback (operating lease) which occurs when an owner sells a hotel to obtain cash but still controls it is reported immediately under IFRS but is deferred over the lease term under US GAAP.
Interest cost on a hotel loan must be capitalized under US GAAP but can be expensed under IFRS. A hotel holding company is required to consolidate entities based on majority voting rights in US GAAP but under IFRS the standard is control which leads to differences in reported profit.
Other differences include impairment of assets such as when a hotel or restaurant is no longer meeting cash flow projections and its carrying value must be reduced through a charge to income, stock option accounting, and business combinations (hotel acquisitions).
In subsequent editions of the Cayuga Hospitality Review, we will provide updates on the IFRS/US GAAP convergence issues as they affect the hospitality industry, and we will document the progress toward adoption of IFRS by US issuers that will be determined by the changes in the US political administration and its regulatory regime.
About the Author
Blair Vago is a former member of Cayuga Hospitality Consultants.