Starting on 1 January 2018, there will be several changes to the accounting and financial reporting standards that will impact the hotel industry. Owners and operators need to prepare now to ensure these accounting changes don’t negatively impact their bottom lines.
One of the changes to the accounting standards is on revenue recognition—specifically how revenues from online travel agencies should be recognized. Currently, there are two models for the treatment of OTA revenues in the hotel industry:
Retail model: Guest makes the reservation via the OTA but pays the hotel upon stay; hotel remits commission to the OTA. Currently, the hotel recognizes revenue as the gross amount of cash collected (i.e. the total room rate), offset by a commission expense to the OTA. Revenue recognized through this model is typically recorded on a “gross” basis.
Merchant model: Guest makes the reservation via the OTA and pays the OTA up-front; the OTA remits cash, net of their commission to hotel. Currently, the hotel recognizes revenue as the net amount of cash received (i.e. the total room rate less the OTA commission). Revenue recognized through this model is typically recorded on a “net” basis, which means a lower amount of revenue is recognized than under the “gross” basis.
So how is OTA revenue recording changing, and why does this matter? Based on the new revenue recognition standard developed by the Financial Account Standards Board, the factors that previously determined “gross” or “net” revenue recognition have been changed. The new standard requires the party who is the principal in the sales transaction to record the revenue on a “gross” basis.
How is the principal determined? An entity is the principal in a transaction if it controls the good or service before that good or service is transferred to the customer. Indicators to consider when determining if an entity has control may include:
- Who is primarily responsible for the promise to provide the good or service?
- Who has the inventory risk?
- Who has discretion in establishing the pricing of the transaction?
Since the hotel is primarily responsible for providing the stay, the OTA does not take any inventory risk, and the price of the hotel room is largely determined by the hotel, the new accounting standard would indicate that revenue recognized from the retail model and merchant model should be both recorded on a “gross” basis.
This is potentially significant to hotels, as this will increase the amount of costs which are calculated as a percentage of revenues (for example, credit card fees, management and franchise fees, and sales taxes). In addition, a sales tax difference that may be created because of this change is not recoverable from the OTA. Therefore, this accounting change will reduce the hotel’s bottom line.
Review your OTA agreement
To determine if revenue should be recognized on a “gross” or “net” basis, one needs to understand what flexibility the OTA has to discount the room rate, charge additional fees to a guest or combine the room night in a package with other goods or services (flight, rental car) under the merchant model. This is critical because under the new revenue recognition standard, if there is any uncertainty as to what the customer is being charged, then the revenue will be recognized on a “net” basis.
If your OTA agreement does not provide latitude for the OTA to discount their price and receive less commissions without the hotel’s approval or to make the room night part of a package transaction, or if the OTA is restricted from charging an additional booking fee or service charge to the guest, then all revenue recognized under the merchant model will be recorded on a “gross” basis, whereas previously this would have been recorded on a “net” basis.
The financial management committee for the American Hotel & Lodging Association will be issuing detailed guidance this fall that will further explain the changes to the revenue recognition standard and how hotels should approach this issue. In the meantime, we encourage all hotel operators and owners to understand the details of their OTA agreements.
Cindy Braak is a Senior Vice President, Finance Business Partner at Marriott International (NYSE:MAR). She is a graduate of the School of Hotel, Motel, and Restaurant Management from Michigan State University.
Raymond D. Martz is the Chief Financial Officer for Pebblebrook Hotel Trust (NYSE:PEB). He is a graduate of the School of Hotel Administration at Cornell University and a MBA from Columbia University. Cindy and Ray serve as the Co-Chairs on AHLA’s Financial Management Committee. The AHLA’s Financial Management Committee supports the overall goals and objectives of the American Hotel & Lodging Association by providing superior financial management expertise on issues of common interest to owners and operators of hotels.
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