In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, later codified as Accounting Standards Codification (ASC) Topic 606. This major overhaul of revenue recognition (effective for fiscal years starting after December 15, 2017 for public companies) affects almost every industry, and the hospitality industry is no exception.
The complex contractual arrangements between hospitality companies, hotel franchisors, and guests create many complexities with revenue recognition. Due to the various franchising and leasing agreements, management agreements, and services provided to guests that may be involved in a single contract as part of a hotel stay, many of the five steps of revenue recognition may be complicated.
The AICPA and the major accounting firms have assembled industry task forces to research the industry-specific accounting issues within ASC 606, and we will draw from the guides they have published as we provide a brief explanation of the key issues the hospitality industry faces when applying ASC 606. For more information on any of these issues, see:
- AICPA: Revenue Recognition: Audit and Accounting Guide
- Deloitte: New revenue standard issued: Potential challenges in the travel, hospitality, and leisure industry
- EY: Hospitality Insights 2016
We will also provide references to other RevenueHub articles for more detailed explanations of related ASC 606 topics. For general information on the basics of revenue recognition, see our RevenueHub article, The Five-Step Method.
The following are the issues that companies in the hospitality industry commonly face:
1. Franchise revenue arrangements
Many hospitality companies generate revenue through franchising arrangements with hotel owners. As part of the franchising arrangements, hospitality companies agree to provide numerous goods and services. For example, the company may agree to arrange services for hotel guests, employ hotel staff, or provide marketing and other back office support. It may be difficult to determine when a good or service is distinct or should be bundled with other performance obligations because of the variety of related goods and services hospitality companies provide as part of franchising arrangements. When making this determination companies should assess whether a customer could benefit from the good or service they are providing on its own or if it must be accompanied by other goods and/or services to provide economic benefit.
Franchising arrangements often include amounts of payment that vary depending on certain tasks being performed or results being accomplished. For example, revenues received by a hospitality company from a franchisee may vary depending on the performance of the property. It is important for hospitality companies to determine the amount of variable consideration they believe they will receive from each contract using historical data and current expectations.
The guidance related to the specific issues arising from franchise revenue arrangements has been released by the AICPA and can be found in the AICPA Guide: Revenue Recognition. The following RevenueHub articles may provide additional assistance: Identifying Promised Goods & Services, Distinct Within the Context of the Contract, Distinct Goods or Services: Case Studies, Series of Distinct Goods or Services
2. Hotel management service arrangements
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.
The guidance related to the specific issues arising from hotel management service arrangements can be found in the AICPA Guide: Revenue Recognition. The following RevenueHub articles may provide additional assistance: Distinct Within the Context of the Contract, Distinct Goods or Services: Case Studies, Series of Distinct Goods or Services, Principal/Agent Considerations (Gross vs Net)
3. Revenue arrangements with guests of leased and owned hotels
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, house keeping, 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.
The guidance related to the specific issues arising from hotel management service arrangements can be found in the AICPA Guide: Revenue Recognition. The following RevenueHub articles may provide additional assistance: Identifying Promised Goods & Services, Distinct Within the Context of the Contract, Distinct Goods or Services: Case Studies, Series of Distinct Goods or Services
4. Loyalty programs
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.
Companies 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.
It is important for entities to know the stand-alone selling price of the performance obligations to determine the transaction price of the contract. If the entity determines that the loyalty points provided to customers represent a distinct performance obligation, then the entity will need to estimate the stand-alone selling price of the points. ASC 606-10-55-44 through 45 provides guidance about estimating the standalone selling price of an obligation if it is not readily available:
If the standalone selling price for a customer’s option to acquire additional goods or services is not directly observable, an entity should estimate it. That estimate should reflect the discount that the customer would obtain when exercising the option, adjusted for both of the following:
1. Any discount that the customer could receive without exercising the option
2. The likelihood that the option will be exercised
If a customer has a material right to acquire future goods or services and those goods or services are similar to the original goods or services in the contract and are provided in accordance with the terms of the original contract, then an entity may, as a practical alternative to estimating the standalone selling price of the option, allocate the transaction price to the optional goods or services by reference to the goods or services expected to be provided and the corresponding expected consideration.
According to the above guidance, if an entity has provided a customer with a material right to acquire future goods or services there is an alternative to estimating the standalone selling price of the material right. Under the alternative, the entity should estimate the amount of consideration it expects to receive as part of the contract, including the amount it will receive when the customer exercises the future right to purchase, and allocate that amount of consideration to the various performance obligations. They will do this by subtracting the value of the goods or services the entity is presently obligated to transfer to the customer from the total amount of consideration they expect to receive. The amount left over after that subtraction will be the amount that is allocated to the material right to purchase goods or services in the future for free or at a discount.
The guidance related to the specific issues arising from loyalty programs has been released by the AICPA and can be found in the AICPA Guide: Revenue Recognition. The following RevenueHub articles may provide additional assistance: Identifying Promised Goods & Services, Standalone Selling Prices
Royal Caribbean Cruises Ltd. SEC Correspondence
Royal Caribbean Cruises Ltd. is a global cruise holding company that offers rewards to guests through loyalty programs. In response to an SEC comment letter dated May 14, 2019, Royal Caribbean Cruises Ltd. described its approach to identifying the points awarded to guests as separate performance obligations and allocating the transaction price (i.e. cost of a cruise ticket) to the cruise and the loyalty points.
Royal Caribbean Cruises Ltd. first assessed the goods and services promised within the cruise ticket contract to identify performance obligations to guests according to ASC 606-10-25-14:
“A key consideration was whether certain loyalty program benefits, obtained by purchasing a cruise ticket contract, constituted a ‘material right,’ and therefore a performance obligation that required an allocation of the transaction price (i.e. cost of a cruise ticket) between the cruise and the loyalty benefits in accordance with ASC 606.”
Two benefits categories were analyzed in this comment letter:
1. Complimentary Cruise Benefit: a guest can earn a complimentary cruise after completing a specific number of cruises.
2. Various Tiered Status Benefits: benefits of loyalty programs, including discounts on stateroom upgrades, internet service, spa services, laundry, specialty restaurants, food and beverage items, and other discount coupons (“tiered status benefits”).
For the Complimentary Cruise Benefit, Royal Caribbean Cruises Ltd. determined that:
“the complimentary cruise benefit is a material right requiring allocation of the transaction price (i.e., cost of a cruise ticket) in accordance with ASC 606-10-25-14 and ASC 606-10-55-353 through 356.” Given the immateriality of the redemption rate and associated value of the complimentary cruise benefit to the consolidated financial statements, Royal Caribbean Cruises Ltd. has not accounted for this benefit separately from the cruise ticket.
For the Various Tiered Status Benefits, Royal Caribbean Cruises Ltd. determined that the various other status benefits are sellable on a standalone basis and should be analyzed as to whether they represent separate performance obligations under ASC 606. The company concluded that the tiered status benefits do not constitute a material right and a separate performance obligation. This conclusion was reached because of the marketing and advertising attributes of the tiered status benefits. Royal Caribbean Cruises Ltd. stated that
“guests who have not earned status obtain similar tiered status benefits through our customary promotional programs, which we consistently use to attract new customers and incentivize future sales. In addition, we do not separately sell tiered status, the benefits offered under our loyalty programs do not result in losses on anticipated future cruise to be taken by the guests and tiered status under our loyalty programs is not transferable to others.”
This resulted in the conclusion that tiered status under our loyalty programs should be accounted for as a marketing incentive. Therefore, Royal Caribbean Cruises Ltd. has not accounted for these tiered status benefits as a separate performance obligation upon adoption of ASC 606.
Natural Grocers by Vitamin Cottage, Inc. SEC Correspondence
Natural Grocers by Vitamin Cottage, Inc. is a grocer that specializes in organic produce. In its correspondence with the SEC on August 10, 2022, the company explains how it recognizes revenue for its customer loyalty program.
Natural Grocers references ASC 606-10-55-42 through 45, stating that the company:
“assesses the number and dollar value of points earned and redeemed, and accounts for the loyalty points as a separate obligation, resulting in revenue being deferred until the loyalty points are either redeemed or expire. The Company considers historical redemption rates, or breakage, for loyalty points in its analysis.”
In the letter, the SEC asked Natural Grocers why it did not include a more detailed disclosure on this revenue recognition procedure. Natural Grocers quotes one of the criteria in ASC 606-10-15-30 that exempts a company from disclosure:
“the performance obligation is part of a contract that has an original expected duration of one year or less.”
Because the loyalty points expire after one year, the performance obligation relating to the points does not go beyond one year. Thus, the company did not have to disclose this revenue recognition procedure.
5. Contract costs
Companies are required to capitalize and amortize incremental costs the entity incurred to obtain (e.g., sales commissions) and fulfill a contract. The costs of obtaining a contract are recognized as an asset if the entity expects to recover them. There is a practical expedient that allows entities to immediately expense the costs if they would have been fully amortized in one year or less. The entity should only capitalize and amortize the costs to fulfill a contract if (1) the costs relate directly to a specific contract, (2) the costs generate or enhance resources that will be used to satisfy performance obligations in the future, and (3) the entity expects to recover the costs. The costs capitalized by the entity should be amortized as the entity transfers the goods or services designated in the contract to the customer. While there are industry specific contract costs that should be considered in the hospitality industry, the guidance above will generally be the guidance that entities should apply.
The guidance related to the specific issues arising from contract costs has been released by the AICPA and can be found in the AICPA Guide: Revenue Recognition. The following RevenueHub articles may provide additional assistance: Costs to Fulfill a Contract
It is likely that many other issues and questions will arise for hospitality entities as entities adopt ASC 606. This article serves as a base reference point for your research into some of the focal issues anticipated by industry experts. Similar industry-specific issues, discussions, and resources are available on the RevenueHub site for major industries identified by the AICPA. Click on the following link for a list of these articles: Industry-Specific Issues.