New revenue recognition principles have been issued and replace nearly all existing guidance under US generally accepted accounting principles (GAAP), effective beginning in 2018 (2019 for non-public companies). While the impact to hotels is not expected to be significant, hotels should review a few specific revenue streams to ensure accounting practices remain compliant with the new required accounting principles, including recognition of breakage on gift card sales, accounting for loyalty programs, and gross/net recognition of revenue from third party sales. With the extensive use of OTAs (online travel agencies) required in the current market to stay competitive and fill hotel rooms, substantially all hotels will need review their accounting treatment over these third-party sales, considering the new standards.
To determine whether revenue from OTA sales should be recorded at the gross amount (paid by guest) with an offsetting commissions expense, or at the net amount received from the third party (received by hotel, net of OTA fees), hotels must determine whether they are the principal or the agent in the transaction. Determining principal/agent classification requires the hotel to look at who controls the good/service before it is transferred to the customer, and whether the hotel is providing the good/service (principal) or arranging for it to be provided by another party (agent).
The following questions can be used as a guide to determine if the hotel controls the good/service, and is therefore the principal in the transaction:
- Who is primarily responsible for fulfilling the promise to provide the good/service to the guest (guest satisfaction)?
- Who has inventory risk (unsold rooms)?
- Who establishes pricing?
The above provide indicators of who the controlling party is, but should be evaluated by the hotel along with the terms and conditions of various contracts to determine who has control of the good/service sold to the customer. OTAs may have some flexibility in pricing the room to generate additional sales but still be considered the agent in the transaction when looking at the contract in whole.
In most cases, hotels are responsible for providing the hotel room, bear the loss of unsold rooms (inventory risk), and set prices for the rooms sold by OTAs, and therefore, considered to be the principal in the transaction. While this likely will not impact sales where the guest pays the hotel directly, rather than to the OTA at booking, it may impact how a hotel records sale paid directly to the OTA by the guest. If the hotel has determined they are the principal in the transaction, revenue should be recorded at the gross amount paid to the OTA by the guest along with an expense for amounts paid or withheld by the OTA.
Aside from the impact on classification of revenue and expense on hotel’s profit and loss statement, this may impact various taxes (state and local) and fees (e.g., management fees, bonus, commission) that use revenue as a base for calculation. Hotels should review their OTA contracts and current accounting practices to evaluate if any changes will be needed to implement the new accounting standards. If changes to how these transactions have recorded is determined to be necessary, we recommend evaluating the impacts to various revenue-based taxes and fees, and making any adjustments needed in those areas to avoid negative impacts to the hotel’s bottom line.
For more information, please contact Audit and Managed Accounting Services Senior Manager, Shelley Oswald.