11/27/2009 Hotel Industry Overview - August 2007…

Hote l Industry Ov erview - August 2007 - Accounting Principle s

LMSB-04-0807-054

"This document is not an official pronouncement of the law or the position of the Service and cannot be used, or
cited, or relied upon as such."

Accounting Principles

The lodging industry was reportedly one of the first industries to develop “definitive standards to provide specific
guidance to accountants and operators. The standards evolved because uniform ity of layout and presentation were,
and are, still not stressed under U.S.

Generally Accepted Accounting Principles (GAAP).” [3] ; Those standards were and are contained in the Uniform
System of Accounts for the Lodging Industry (USALI), which is published by the American Hotel and Motel
Association. [4]

While the accounting profession may not have seen fit to develop GAAP standards specifically applicable to the
lodging industry, the USALI has been widely adopted within the industry. Although there is no requirement that a
lodging operator use the USALI, the degree of com pliance with this time-tested, turnkey system is substantial. The
prim ary reason for widespread adoption of the USALI has been comparability. Lodging operators tend to use
financial statem ent data generated by competitors as a benchm ark against which to measure their own operations.
If comparability is lacking, then there are no benchmarks.

Additionally, while the system was developed for use within the United States, many hotel operators around the
world have adopted the USALI.

Financial statements prepared for external users, are based on GAAP. In addition to other items commonly found in
most financial statements, lodging industry financials are likely to report on such items as China, Glassware, Silver,
Linen, and Uniform s (CGSLU), and the House Bank.

The USALI is a highly departmentalized system of accounting, and includes Departmental Statements of Incom e.
There are two main department classifications in a hotel: operating and overhead. The operating (revenue-
producing) departments include rooms, food and beverage, telecomm unications, and similar departm ents. The
overhead departm ents include administrative and general, data processing, hum an resources, transportation,
marketing, guest entertainm ent, energy costs, and property operation and maintenance.

The USALI itself provides for up to 30 departmental statem ents, which include, in addition to those already
mentioned: telecom munications, garage and parking, golf shop, golf pro shop, guest laundry, health center,
swim ming pool, tennis, tennis pro shop, other operated departments, rentals and other incom e, human resources,
inform ation services, security, franchise fees, managem ent fees, rent, property taxes and insurance, interest
expense, depreciation and amortization, income taxes, house laundry, salaries and wages and payroll taxes and
em ployee benefits.

The principal differences between a hotel’s transactions and internal control and those of other businesses are
found in the revenue cycle. Room revenue is the m ost important source of income to a hotel. The front desk is the
center of the hotel’s operation and the place where the guest ledger, which summ arizes and accum ulates all
charges to guests using the hotel facilities, is m aintained. Some of the functions performed by front desk personnel
are registering guests, recording room revenue, recording food and beverage and other guest charges, checking
out guests, and settling guests’ bills. There are num erous articles and books that further explain the hotel
business. For more inform ation, refer to Montgomery’s Auditing by O’Reilly,Vincent M., et al., Twelfth Edition. new
York: Wiley, 1998.

Montgomery’s Auditing recomm ends the following substantive tests for room revenue for financial statement
purposes:

Review reconciliations of rooms occupied per the front desk to the housekeeper’s daily inspection report or
the exception report
Com pare the room rate charged on the guest folio with that on the guest registration and room rack for a
selected number of folios
Trace room charges to guest folios and compare with established rates
Trace cash receipts to the cashier’s report and the cash receipts journal

Montgomery’s Auditing recomm ends the following for revenue deductions (allowances):

Determine that adjustm ents (credits) made to guests’ accounts in connection with overcharges, disputed
charges or rate changes were properly approved
Review supporting documentation for propriety
Trace credit postings to individual guest folios

From a tax audit standpoint, the available descriptions of hotel operations would seem to suggest considerable
opportunity for manipulation of both revenue and expenses. Room rates vary considerably depending on a variety of
factors - e.g., group rates versus individual rates, etc. The occupancy rate would appear to be another area of
potential concern.

While these concerns may not be overly great in the case of publicly traded com panies who have to undergo an
audit in the post Sarbanes-Oxley atm osphere, there may be of considerable concern with non-publicly traded
companies.

Additionally, one of the newest areas that is gaining significance in the industry is the barter transaction. A barter
transaction occurs when a property agrees to provide accomm odation and/or other services in exchange for external
services, for exam ple advertising. While USALI recognizes barter transactions as executory contracts that do not
need to be recorded in the financial statements until service is provided or received, it suggests that to provide m ore
complete information for decision-making, the internal records reflect the transaction by recording an asset and a
liability at the tim e the barter transaction is negotiated. The value assigned to this transaction should be a
conservative average of the m arket rate for sim ilar accom modations or services at the property, per the USALI. [5]

When services are provided by the property, revenues are recorded and charged to the barter liability. On the other
side, the expense is offset against the barter asset account when the service is received. For external reporting
purposes, USAL suggests that the asset and liability accounts be netted and reflected as a current asset or liability.
This will result in revenues and expenses associated with the barter transaction being reported in different periods .
[6]

Ratio analysis, in general, com prises the same types of ratios used in almost any industry. However, there are a
few industry specialized ratios peculiar to hotels and/or restaurants of which one should be aware.

Average Room Rate = Room s Revenue divided by Paid Room s Occupied.

Average Food Check = Total Food Revenue divided by Number of Covers. Covers refer to guests served in
the food operation during the period.

A key recent addition is RevPar, which stands for Revenue per Available Room. It is calculated as either: Room s
Revenue divided by Rooms Available for Sale, or as Room s Revenue divided by Rooms Available. The USALI
expresses a preference for the second computation because “[t]he purpose of the ratio is to determine whether the
inventory of rooms is being managed optimally. Therefore, the denominator should also include rooms out of order
and tem porary house use rooms.” [7]

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