Common ASC 606 Issues: Hospitality Entities

After years of debate, revision, and refinement, ASC 606 is finally coming into effect. The Financial Accounting Standards Board (FASB) released its initial major Accounting Standards Update (ASU) about revenue recognition in May of 2014—ASU 2014-09—and has since received thousands of comments and issued six subsequent ASUs on the topic. This major overhaul of the revenue recognition framework—formerly ASC 605—takes effect for fiscal years beginning after December 15, 2017 for all public entities, certain not-for-profits, and certain employee benefit plans.

 

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 related to ASC 606, and we will draw from the guides they have published to give you an idea of some of the issues you should expect. For more information on any of these issues, see:

We will also provide references to other Revenue Hub articles for more detailed explanations of Accounting Standards Codification (ASC) 606 topics. See our Revenue Hub article The Five-Step Method for more general information. 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 specific guidance related to the specific issues arising from hotel management service arrangements has not yet been released by the AICPA. However, the following RevenueHub articles may be of 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 specific guidance related to the specific issues arising from hotel management service arrangements has not yet been released by the AICPA. However, the following RevenueHub articles may be of 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 specific guidance related to the specific issues arising from hotel management service arrangements has not yet been released by the AICPA. However, the following RevenueHub articles may be of 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. 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.

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 specific guidance related to the specific issues arising from hotel management service arrangements has not yet been released by the AICPA. However, the following RevenueHub articles may be of assistance: Identifying Promised Goods & Services, Standalone Selling Prices

5. Contract costs

Under the new standard, companies will be 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 specific guidance related to the specific issues arising from hotel management service arrangements has not yet been released by the AICPA. However, the following RevenueHub articles may be of assistance: Costs to Fulfill a Contract

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Author Morgan Hunsaker

Morgan grew up in Tokyo, Japan, and has also lived in Thailand, Hong Kong, and Provo, Utah. When Morgan is not studying accounting he can be found playing or watching sports. He is a lifelong Utah Jazz fan and watches at least one Jazz game every week.

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