27 Mar ASC 606 – Hotel IndustryReading Time: 23 minutes
Table of Contents
- Background Information.
- Transition Approach.
- Policy Details.
- Step 1 – Identify the contract with a customer.
- Step 2 – Identify the performance obligations in the contract.
- Step 3 – Determine the transaction price.
- Step 4 – Allocate the transaction price.
- Step 5 – Recognize revenue as performance obligations are satisfied.
- Presentation of statement of financial position.
- Case Study.
Revenue is an important point of concern to the users of Financial Statements in assessing an entity’s Financial Performance and Position.
Accounting Standard Codification (ASC) 606 – Revenue from Contract with Customers is an Industry-wide revenue recognition guidance which has been formulated by the Financial Accounting Standard Board (FASB). This was a joint task by Financial Accounting Standard Board (FASB) and International Accounting Standard Board (IASB) to clarify the principles for Revenue Recognition and to develop common revenue standard for U.S. GAAP and IFRS.
ASC 606 will be applicable across all the industries and aid in recognizing revenue from all the types of transactions, except those transactions which are covered by more specific guidelines (for example – Insurance Contract or Leasing Contract).
We will be discussing revenue recognition guidelines for the hotel industry.
ABC Hotel is a heritage 5-star luxury hotel consisting of 560 rooms and 44 suites. The hotel has acquired an image trademark It is the first building in the country to get intellectual property rights protection for its architectural design. It caters to high-end clients and hosts high tea parties, corporate dinners, business conferences. The hotel is part of a premium chain of hotels and has a presence in about 12 countries across 4 continents.
The hotel mainly offers the following products/services:
- All day dining
- Business Centre
- Fitness Centre
- Specialty Restaurants
- Holiday Packages
ASC 606 was effective for the Company beginning January 1, 2018, with early adoption permitted. The guidance allows for two transition methods.
a. Full retrospective adoption:
b. Modified retrospective application:
The Hotel elected to apply the ‘modified retrospective method’ with the following practical expedient as provided by the new standard and as applicable:
For contracts that were modified before the beginning of the earliest reporting period presented, the Company will not restate the contract for those contract modifications. Instead, the Company will reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented.
Revenue Recognition Framework
The Hotel recognizes revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the Hotel expects to be entitled in exchange for those goods and services.
Depending on the circumstances, the guidance may be applied on a contract-by-contract basis, or the practical expedient described in ASC 606-10-10-4 of using the portfolio approach may be followed.
The portfolio approach allows an entity to apply the guidance to a portfolio of contracts with similar characteristics so long as the result would not differ materially from the result of applying the guidance to individual contracts.
The Hotel will decide whether to apply the portfolio approach on a case-by-case basis as appropriate. The Hotel’s approach to applying each of these steps is discussed in detail throughout the remainder of this section.
3.1 IDENTIFY THE CONTRACT(S) WITH CUSTOMER
STEP 1 of the revenue recognition model requires the Hotel to identify the contract(s) with a customer. This section discusses the steps to determine whether a contract exists and specific considerations that may impact that determination. Each contract will need to go through this evaluation.
Per ASC 606-10-25-1, the five criteria for identifying a contract are as follows:
a. The parties have approved the contract and are committed to perform.
- Sales directly to end customers
- A signed purchase agreement. Or
- A standard purchase order of the form normally issued by the customer, supporting the customer’s commitment to receive and pay for products and/or services specified in the quotation and/or contract, which is approved by the Hotel’s legal and finance department.
- Sales to distributors and resellers (channel partners)
- A signed contract accepted by the Hotel (which is approved by both Legal and Finance) and the channel partner.
- A purchase order from the channel partner.
- The Hotel does not consider the contract approved until both parties have executed the documents. Such execution is deemed to have occurred as of the last signature date.
- The approved contracts described above must be executed before the end of the accounting period in which revenue is to be recognized and be provided to the order entry location by midnight Pacific time. Faxed documents will not be considered received unless they are legible and complete.
- Contracts, in general, are reviewed and executed by the Legal Team. All non-standard contracts should be reviewed by the Revenue Team and approved by the VP of Finance prior to being executed.
b. Each party’s rights are identifiable:
Rights should all be documented in writing within the terms and conditions of the approved contracts described above.
c. Payment terms are identifiable:
The hotel is obligated to perform the services ordered by the customer and agreed to by the hotel. The customer is also obligated to pay the hotel the prices for agreed goods and services. The hotel’s bills are payable immediately upon receipt of the bill without any deduction, unless other payment terms and conditions are expressly agreed.
d. The contract has commercial substance:
When the risk, timing, or amount of the Hotel’s future cash flow is expected to change as a result of the contract. Generally, an executed contract is evidence of commercial substance.
e. The collection is probable based on the customer’s ability and intent to pay:
The amount deemed collectible may be less than the contractual price: The collectability assessment only applies to consideration associated with goods or services to be transferred during the non-cancellable term of the contract. The Hotel’s contracts with its customers are usually non-cancellable. Generally, the Hotel will not enter into an arrangement for which the collectability criterion is not met.
Customers’ and Channel Partner’s creditworthiness will be assessed at the outset of an arrangement through a background check.
Combination of contracts
The Hotel combines two or more contracts entered into at or near the same time, same location and with the same customer and end user, and accounts for the combined contracts as a single arrangement if one or more of the following criteria outlined in ASC 606-10-25-9 are met:
a. The contracts are negotiated as a package with a single commercial objective.
b. The amount of consideration to be paid in one contract depends on the price or performance of the other contract.
c. The goods and services promised in the contracts (or some goods or services promised in each of the contracts) are a single performance obligation.
In the event that the Hotel enters into multiple contracts with a customer, the Hotel will evaluate the considerations above to determine whether the contracts should be accounted for together or as separate contracts.
The Hotel may enter into a transaction with a customer whereby the appliance, maintenance and support, and professional services are on different purchase orders. Such transactions will be combined as a single arrangement under ASC 606 if the contracts meet the criteria above.
Customers may subsequently add additional products or services that were not included in the original contract. In general, such transactions are not deemed to be separate contracts that should be combined for accounting purposes but rather the Hotel will consider whether such contracts are a modification to the original contract (see the Contract Modifications section below for further discussion).
A contract modification exists when there is a change in the scope and/or the price of a contract. Upon approval of a change in an existing contract, it is accounted for as a separate contract, a termination of the existing contract and creation of a new contract, or as part of the existing contract.
A contract modification is accounted for as a separate contract (prospective treatment) when both of the following criteria are met:
The additional goods and services are distinct from the goods and services in the original arrangement; and,
The amount of consideration expected for the added goods and services reflects the standalone selling price of those goods and services.
A contract modification that does not meet the above criteria is considered a change to the original contract and is accounted for as either the termination of the original contract and the creation of a new contract, or as a continuation of the original contract, depending on whether the remaining goods or services to be provided after the contract modification are distinct from the goods or services transferred to the customer on or before the date of the modification.
A modification is accounted for on a prospective basis, or said differently, a termination of the existing contract and creation of a new contract, if the goods and services subject to the modification are distinct from the other goods and services provided within the original contract but the consideration does not reflect the standalone selling price of those goods or services.
A modification is accounted for as a continuation of the original contract if the goods or services added or removed are not distinct from the goods and services already provided; such modifications are accounted for on a cumulative catch-up basis. This scenario is considered to be rare.
Once a contract modification has been determined to be either a separate contract, a termination of the existing contract and creation of a new contract, or as part of an existing contract, the Hotel will recognize revenue for the contract consistent with the above policies.
Changes to existing SOWs will be evaluated as contract modifications, including changes to the nature of the professional service and the purchase of additional hours of professional services.
3.2 IDENTIFY THE PERFORMANCE OBLIGATIONS
Step 2 of the revenue recognition model requires the Hotel to identify performance obligations and whether the promises to transfer either goods or services are distinct performance obligations. This section discusses the requirements and provides conclusions for our general performance obligations in our contracts with customers. Each contract will need to go through this evaluation.
ASC 606-10-25-14 states that at contract inception an entity shall assess the goods or services promised in a contract with a customer and shall identify, as a performance obligation, each promise to transfer to the customer either:
a. A good or service (or a bundle of goods or services) that is distinct;
b. A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer.
A good or service is distinct if both of the following criteria are met:
a. Capable of being distinct – the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer
b. Distinct within the context of the contract – the promise to transfer the good or service is separately identifiable from other promises in the contract
In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable, the objective is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs.
The Company’s revenue transactions may include a combination of the following:
The policies below illustrate additional considerations of the Hotel when identifying performance obligations in the contract.
Determination of whether the item is immaterial in the context of the contract and therefore not considered for revenue recognition purposes
Standard user charges requirements for, say Wi-Fi services, may be immaterial in the context of a contract based on the following considerations:
i. The Hotel does not have a specified invoice amount pertaining to the promise of providing Wi-Fi services.
ii. ii. The Effort to provide Wi-Fi services is generally minimal. The required service is typically inherent to or achieved with minimal modification to the existing Wi-Fi installation in the hotel.
Series of distinct goods or services
The Hotel’s contracts contain promises to deliver a distinct series of services that are substantially the same. If the distinct series of services meet both of the criteria below, they are considered to be a single performance obligation:
i. Each distinct service in the series that the Company have promised to transfer to the Company’s customer would meet the criteria of a performance obligation satisfied over time
ii. The same method would be used to measure the Company’s progress toward complete satisfaction of the performance obligation to transfer each distinct service in the series to the Company’s customer.
A stand-ready obligation represents a service of ‘standing ready’ to provide goods or services or of making goods or services available for a customer to use as and when the customer decides. The appropriate measure of progress to apply to a stand-ready obligation that is satisfied over time might vary from one type of stand-ready obligation to another. Although the Hotel is obligated to provide these services throughout the term of the contract, the pattern of benefit to the customer may or may not be consistent throughout the term of the contract.
Examples of such stand ready obligations would be in-room dining service and laundry service.
3.3 DETERMINE THE TRANSACTION PRICE
Step 3 of the revenue recognition model requires the Company to determine the transaction price for the contract. This section discusses the potential transaction price components and how they may increase or decrease the overall transaction price. Each contract will need to go through this evaluation.
The Company considers the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which the Company expects to be entitled in exchange for transferring goods or services to a customer, excluding amounts collected on behalf of third parties such as sales taxes. The following items are taken into consideration when determining transaction price and are discussed in further detail throughout this section.
+ Fixed Consideration (includes consideration related to performance obligations and activation fees)
+ Estimated Variable Consideration
─ Contingent Amounts (unless no revenue reversal is probable)
─ Consideration Payable to the Customer
± Significant Financing Component
─ Amounts Collected on Behalf of Third Parties
When determining the transaction price, the Company assumes that the goods or services will be transferred to the customer based on the terms of the existing non-cancellable contract and does not take into consideration the possibility of the contract being cancelled, renewed, or modified. The Company also considers the effects of the following:
Variable consideration (and the constraint)
Forfeitures, refunds, rights of return, price concessions, payments contingent on future events, and similar items give rise to variable consideration which, in turn, affects the transaction price for an arrangement. The Hotel will determine how much variable consideration can be included in the overall transaction price at contract inception. This determination is comprised of the following two steps:
a. Estimate the amount of variable consideration;
b. Determine whether any of the estimated amount is subject to a probable revenue reversal (this concept is referred to as “the constraint” in the literature).
ASC 606-10-32-8 suggests two alternatives to use (be consistently applied throughout the life of the contract) when estimating the amount of variable consideration:
a. The expected value method:
Sum of probability-weighted amounts in a range of possible consideration amounts
b. The most likely amount method:
The single most likely amount in a range of possible consideration amounts
Variable consideration may include amounts that could be refunded, returned, or uncollected from customers or resellers, rebates in the form of cash or credits provided to resellers for meeting certain sales targets, booking targets, etc., credits to end-users, price concessions, incentives, performance bonuses, penalties, usage-based fee, price protection, time and materials contracts, usage overages on subscription contracts, or other similar items.
In case of a hotel, variable consideration would be the amount refunded to a customer if he cancels the booking within the window provided by the hotel
The Hotel may provide infrequent concessions to certain customers in order to keep customer loyalty to the hotel intact. These concessions typically result in free or reduced price maintenance and support services /extension of payment term
Under ASC 606, concessions are generally viewed as any post-execution change to the original agreement between the Hotel and the customer that increases the customer’s rights or the Hotel’s obligations. Concessions may impact the determination of performance obligations and/or transaction price and could be considered a contract modification. As such, concessions should be considered throughout the five-step revenue recognition framework. Discussion of concessions is placed in the transaction price section of the policy as transaction price is frequently impacted by concessions.
Concessions may take many forms and include, but are not limited, to the following:
a. Accepting returns that are not required under the terms of the original arrangement;
b. Reducing the arrangement fee or extending the terms of payment; or
c. Increasing the deliverables or extending the customer’s rights beyond those in the original transaction, without an appropriate increase in fees
The Hotel will assess whether to include estimated concessions in the transaction price on a contract-by-contract basis when and if concessions are expected to be provided. As of the date of this policy, the Hotel does not have a history of granting concessions and, as such, estimated concessions will not be included in the transaction price.
The Consideration payable to a customer
The Hotel evaluates consideration payable to a customer to determine whether the amount represents a reduction of the transaction price, payment for distinct goods or service, or a combination of the two. Consideration payable that does not exceed the fair value of distinct goods or services shall be accounted for as a purchase from suppliers. Consideration payable that exceeds the fair value of distinct goods or services shall be accounted for as a reduction to the transaction price with the remainder accounted for as a purchase from suppliers. If the Hotel cannot reasonably estimate the fair value of goods or services received from the customer, then it will account for all consideration payable to the customer as a reduction of the transaction price at the later of when the Hotel recognizes revenue for the transfer of the related goods or services and the Hotel pays or promises to pay the consideration.
The Hotel excludes all taxes assessed by governmental authorities from the measurement of transaction price as allowed by ASC 606-10-32-2A as the taxes collected by the Hotel are levied against its customers. The Company is considered an agent for the governmental authority and therefore the taxes collected are not included in the transaction price.
3.4 ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATION IN THE CONTRACT
Step 4 of the revenue recognition model requires the Hotel to allocate the transaction price to the performance obligations in the contract. This section discusses how standalone selling prices are determined and how transaction price will be allocated using the standalone selling prices or other appropriate methods. Each contract will need to go through this evaluation.
Allocating transaction price to performance obligations
The Hotel allocates a portion of the total transaction price to each performance obligation based on the relative stand-alone selling price (SSP) of each performance obligation. The amount allocated, therefore, represents the amount of consideration to which the Hotel expects to be entitled in exchange for providing the goods or services included in the performance obligation. SSP is determined at the inception of the contract for each performance obligation.
Once the Hotel has determined the transaction price, a portion of the total transaction price is allocated to each performance obligation in a manner depicting the amount of consideration to which the Hotel expects to be entitled in exchange for transferring the goods or services to the customer (the “allocation objective”). The first step is to determine the SSP of each performance obligation. Once the SSPs have been determined, the second step is to allocate the transaction price based on the performance obligations’ relative SSPs.
However, in some cases, a discount or variable consideration may be allocated to one or more, but not all, performance obligations in the contract. See discussion of these cases in sections. Allocating variable consideration, and Discount Allocation, below.
SSP is determined at the inception of the contract for each performance obligation. After contract inception, no reallocation of transaction price is made to reflect subsequent changes in SSPs.
Determining standalone selling prices
The following shows the Company’s decision-making process for selecting a standalone selling price:
SSP is the price at which the Company would sell a promised good or service separately to a customer. The best evidence of SSP is an observable SSP, which is the “price of a good or service when the entity sells that good or service separately in similar circumstances to and to similar customers” per ASC 606-10-32-3.
The Hotel considers SSP to be a range of prices. The Company will apply judgment in determining what constitutes an appropriate SSP range. Any such range will be established based on an analysis that maximizes observable inputs and supports an assertion that any price within that range would be a valid pricing point if the performance obligation were sold on a stand-alone basis.
Determining observable SSP
The Company first concludes whether an observable SSP exists. An observable SSP is the price of a good or service when the entity sells that good or service separately in similar circumstances and to similar customers. The Company conducts a regular analysis to determine whether various services have an observable SSP. If an observable SSP exists, it is used for allocation purposes. If there is a relatively narrow range of observable prices, then a stated contract price within that range is an acceptable SSP. The Company considers observable SSP to exist when (a) 80% of contract prices for a separately-sold service to be within 15% of an estimated SSP, and (b) there are a sufficient amount of observed contracts to reasonably estimate SSP.
Determining SSP based on historical prices
If the Company does not have an observable SSP then, the Company next assesses whether products have an estimated SSP by considering its historical pricing. Historical prices include both (a) observed in transactions within the last twelve months, and (b) standalone and non-standalone transactions.
The Company considers historical SSP to exist when (a) 60% of contract prices for a separately-sold service to be within 25% of an estimated SSP, and (b) there are a sufficient number of observed contracts to reasonably estimate SSP.
- Determining SSP for low-coverage products
If the historical standalone selling price is not available after disaggregating the product revenue family, Management reviews the specific item and makes its best estimate of SSP. This analysis may consider the following:
a. Adjusted market assessment
Prices based on SSP of similar goods or services or SSP observed in another market, and adjusted for known differences in functionality, markets, etc.
b. Expected cost plus a margin
Prices based on a forecast of the expected costs plus an appropriate margin for the service.
c. Combined method
Prices established for a bundled (combined) performance obligation based on combining SSP of individual goods or services included in the bundle, and adjusting for the effect of bundling, as appropriate. The Hotel does not believe it will utilize this method.
The following table outlines the Company’s distinct performance obligations and the method that is most frequently used to establish SSP:
Frequency of updating the SSP analysis
The Hotel estimates SSP on an annual basis, or as needed when standard discounts are updated or new products are introduced in the market. On a quarterly basis, the Company will revise its estimate of SSP if there is a material change in the SSP.
Allocating variable consideration
Variable consideration may be attributable to:
i. All of the performance obligations in a contract—including amounts that could be refunded, returned, or uncollected from customers or resellers, rebates in the form of cash or credits provided to resellers for meeting certain sales targets, booking targets, etc., credits to end-users, price concessions, incentives, performance bonuses, penalties, price protection, or other similar items;
ii. One or more, but not all, of the performance obligations in a contract—including time and materials contracts, and usage-based fees; and
iii.One or more, but not all, of the distinct goods or services, promised in a series of distinct goods or services that forms part of a single performance obligation—including usage overages on subscription contracts.
The Hotel will allocate variable amounts, along with subsequent changes to such amounts, entirely to one or more, but not all performance obligations when both of the following criteria are met:
i. The variable payment terms relate specifically to the entity’s efforts to satisfy the performance obligation; and
ii. Allocating the variable amount of consideration entirely to the performance obligation is consistent with the allocation objective when considering all of the performance obligations and payment terms in the contract.
3.5 RECOGNIZE REVENUE WHEN (OR AS) THE ENTITY SATISFIES A PERFORMANCE OBLIGATION
Step 5 of the revenue recognition model requires the Hotel to recognize revenue when (or as) it satisfies a performance obligation, which is determined by the transfer of control to the customer. This section discusses potential impacts to the timing of the transfer of control, the types of transfer of control and the likely recognition method for the Hotel’s various performance obligations. Each contract will need to go through this evaluation.
The Hotel recognizes revenue when (or as) it satisfies a performance obligation by transferring promised goods or services to its customers. The good or service is considered transferred when the customer gains control of the good or service. Control of an asset refers to the ability to direct the use of and obtain substantially all of the remaining benefits from the asset. Control also means the ability to prevent other entities from directing the use of, and receiving the benefit from, a good or service. If control transfers over time, revenue will be recognized over time in a manner depicting The Hotel’s performance in transferring control of the good or service. If control transfers at a point in time, revenue will be recognized at that point.
Per ASC 606-10-25-27, transfer of control occurs over time if one of the following criteria is met:
a. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs
b. The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced
c. The entity’s performance does not create an asset with an alternative use to the entity (e.g., the ability to sell the asset to a different customer), and the Hotel has an enforceable right to a proportionate amount of payment if the customer were to terminate the contract. Generally, our professional services meet this condition as (i) the nature of our professional services are generally customized to our customer’s specific requests and needs, and (ii) these services are not transferable to other customers (i.e., they provide value to the Hotel.
The customer receives and consumes the benefits as the entity performs if another entity would not need to substantially re-perform the work completed to date to satisfy the remaining obligations. The fact that another entity would not have to re-perform work already performed indicates that the customer receives and consumes the benefits throughout the arrangement.
If a performance obligation is not satisfied over time it is satisfied at a point-in-time.
Per ASC 606-10-25-30, indicators of transfer of control that would likely result in point-in-time revenue recognition include:
a. The Hotel has a present right to payment for the asset
b. The customer has legal title to the asset
c. The Hotel has transferred physical possession of the asset
d. The customer has the significant risks and rewards of ownership of the asset
e. The customer has accepted the asset.
The following table summarizes how the Company transfers control for each performance obligation based on the above guidance.
Once the determination of how control is transferred, the method for measuring progress of satisfying a performance obligation must be selected. For performance obligations satisfied over time, a company may select either an output method or input method as provided under ASC 606.
PRESENTATION ON THE STATEMENT OF FINANCIAL POSITION
The Hotel will present a contract liability or a contract asset in its statement of financial position when either party to the contract has performed. The Hotel performs by transferring goods or services to its customers, and the customer performs by paying consideration to the Hotel. Unconditional rights to consideration will be separately presented as receivables. A right to consideration is unconditional if only the passage of time is required before payment becomes due.
Obligations to transfer goods or services to a customer for which the Hotel has received consideration, or for which an amount of consideration is due from the customer, will be presented as contract liabilities. It is noted that in extremely rare situations, customers contracts contain a right to right to terminate for convenience, where amounts paid by the customer are refundable. In these situations, the customer has paid for future goods or services, but because of the termination clause an agreement does not exist and thus the Hotel does not have an obligation to transfer goods or services except as the customer requests (i.e. doesn’t terminate). The amount of consideration received for which the Hotel is not currently obligated is not considered a contract liability, but rather will be classified as a customer deposit and included in Other Liabilities.
Rights to consideration in exchange for goods or services that the Hotel has transferred to a customer when that right is conditional on something other than the passage of time will be presented as a contract asset. The Hotel will not net receivables with contract liabilities.
Based on the above considerations and in reference to various requirements of the guidance, a typical transaction can be molded as below:
Let us assume that a customer books a hotel for 5 days at $600 per day which includes room rentals as well as allied services such as swimming pool, gymnasium, yoga etc. He uses the restaurant service, car rental service and the business centre for a day each.
Step 1: Identify the contract with the customer
The contract is mutually agreed upon between the customer and the hotel. Terms of payment are defined in the contract. Also, the payment is enforceable as well as collectible from the customers.
The Hotel combines two or more contracts entered into at or near the same time, same location and with the same customer or end user, and accounts for the combined contracts as a single arrangement. In this case, the contract entered with the customer for 5 days will be considered as a single contract with the customer.
Step 2: Identifications of Performance obligations (PO)
For Room Rentals and allied services: Over time recognition from the check-in date.
For Restaurant Services: Point in Time on availment of service.
For Car Rental Services: Point in Time on availment of service.
For Hiring of business Centre: Point in Time on availment of service.
(The reasons for choosing the method of recognition viz overtime or point in time have been mentioned above in Point 3.5 above)
Step 3: Determine the transaction price
The hotel is a premium 5-star hotel.
It is assumed that the transaction price is based on cost plus profit. It also considers the goodwill attached to the name of the Hotel while charging its customers
Transaction price as per contract is
For Room Rentals and allied services: $ 3,000/-
For Restaurant Services: $ 100/-
For Car Rental Services: $ 200/-
For Hiring of business Centre: $ 300/-
Step 4: Allocation of Transaction Price
Based on Relative Standalone Selling price the allocation of Transaction price would be as below:
Relative Standalone Selling Price has been determined using the market rates of restaurants of the similar category.
Step 5: Recognition of Revenue
Recognition schedule over 5 days
Excerpts of Notes to the financial statement:
Item X.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Critical Accounting Policies
Note (Y) Summary of Significant Accounting Policies
The hotel derives revenue from providing accommodation, renting of banquet halls and related facilities, restaurants, fitness centre, holiday packages and safari packages that it provides. It also gets its revenue from various corporate packages that it offers.
At contract inception (i.e. from the time of checking in), the Hotel assesses the goods and services promised in its contracts with customers and identifies a performance obligation for each promise to transfer to the customer a good or service (or bundle of goods or services). The Hotel recognizes revenue when or as it satisfies a performance obligation by transferring control of a product or service to a customer.
Once the Hotel has determined the transaction price, the total transaction price is allocated to each performance obligation proportionate to the estimated selling prices for the good(s) or service(s) transferred to the customer (the “allocation objective”). If the allocation objective is met at contractual prices, no allocations are made. Otherwise, the Hotel allocates the transaction price to each performance obligation identified in the contract on a relative standalone selling price basis.
In order to determine the standalone selling price of its promised goods or services, the Hotel conducts a regular analysis to determine whether various goods or services have an observable standalone selling price. In determining the observable standalone selling price, the Hotel requires that a substantial majority of the standalone selling prices for a good or service fall within a reasonably narrow pricing range. If the Hotel does not have a directly observable standalone selling price for a particular good or service, then the Hotel estimates a standalone selling price by reviewing external and internal market factors including, but not limited to, pricing practices including historical discounting, major service groups, and the geographies in which the Hotel offers its products and services. The determination of the standalone selling price is made through consultation with and approval by the Hotel’s management.
Difficulties in Applying the guidance
Understanding bundle information
Hotel management contracts are often complex contracts involving incentive fees, gross/net considerations, guarantees, and multiple goods or services. Entities need to exercise judgment and use historical data to determine the amount of fees and consideration they believe they will receive from their contracts. These management contracts must be considered carefully to determine when specific goods or services should be bundled together or when they are distinct.
Understanding revenue recognition pattern of each class of service.
A major source of revenue for many hotels is the money they receive from their guests. Because hotels provide their customers with numerous goods or services (e.g., room stays, food, housekeeping, use of amenities), it is often difficult for hotels to determine how to account for their various performance obligations. It is important for hotels to determine which goods and services are distinct and which need to be bundled. While there may be exceptions, once a hotel determines which goods or services are distinct and which should be bundled the hotel should be able to apply that same determination to a majority of their contracts.
Many hotel chains have loyalty programs that allow customers to earn points through staying at certain hotels and spending money at hotel stores and restaurants. These loyalty programs incentivize customers to frequent particular hotel chains and to stay more often. These points can be redeemed for different rewards such as free hotel stays or merchandise. Currently, many companies are applying a cost accrual method to account for the loyalty points they are issuing to customers that allows the points to be expensed. However, under the new revenue model companies may need to account for the loyalty points as performance obligations which will lead to deferred revenue rather than expenses. For this reason, and others that will be discussed below, the new revenue standard will lead to many possible changes in the accounting for loyalty program points that hospitality companies will need to be aware of.
Hotels should follow the guidance found in ASC 606-10-55-42 when accounting for loyalty program points. Per the standard, when a customer receives a point, they are receiving the right to purchase additional goods or services in the future at a discount, or for free—a right that the customer would not have received without entering into the contract. If the company determines the customer is receiving a material right, then the company must account for the points provided as a separate performance obligation. This will often result in the allocation and deferral of revenue related to the material right. Companies should consider the relevant transactions with the customer, historical facts, and quantitative and qualitative factors when determining if the option to buy additional goods or services is a material right.
Constraining Estimates of Variable Consideration
Before it can include any amount of variable consideration in the transaction price, an entity must consider whether the amount of variable consideration is required to be constrained.
That is, to include variable consideration in the estimated transaction price, an entity has to conclude that it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur once the uncertainty related to the variable consideration is resolved. Under this evaluation, which is known as the variable consideration constraint, the estimate of variable consideration is reduced until it reaches an amount that can be included in the transaction price that, if subsequently reversed, would not result in a significant reversal of cumulative revenue recognized. When there is significant uncertainty about the ultimate pricing of a contract, entities should not default to constraining the estimate of variable consideration to zero.
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