Effective January 1, 2018, several new accounting standards became mandatory for the hospitality industry in the U.S. The most important of these standards concerns revenue recognition, and more concretely how hotels recognize revenues from online travel agents (OTAs).
The new accounting standards require the entity designated as the principal in the sales transaction to record the revenue on a gross basis. The principal controls the good or service before that good or service is transferred to the customer. In the current hotel – OTA relationship, the hotel is the principal, since it is the entity responsible for providing accommodations to the guest. The price of the hotel room sold by the OTAs is determined and enforced by the hotel via rate parity clauses in the agreements with the OTAs, so that the OTAs do not take any inventory risks.
These new standards stem from The Financial Accounting Standards Board’s (FASB) revised guidelines for recording revenue. A private, non-profit organization, FASB is the ultimate accounting standard setting institution in the United States. Its primary purpose is to establish and improve generally accepted accounting principles (GAAP) within the United States in the public’s interest.
The FASB’s Accounting Standards Codification (“ASC”) 606 contains these new revenue recognition standards, effective 1 January 2018 for public companies, and no later than 31 December 2019 for all other companies. The new accounting guidelines clarify how revenue should be recognized for goods and services. Additionally, the American Hotel & Lodging Association’s Financial Management Committee has followed suit and issued guidance on the new revenue recognition standards’ effect on the hotel industry.
The Financial Management Committee, too, has provided a modification to the Uniform System of Accounts (USALI) related to gross versus net revenue accounting, incorporating the new revenue recognition standards.
How is OTA revenue being recognized today?
There are two prevailing OTA business models that affect how revenues are being recognized at the present:
Agency/Retail Model: The guest reserves the hotel with the OTA but pays at the hotel. This is the traditional travel agency commission model: the hotel collects the face value of the reservation (room rate + local taxes), recognizes this gross amount as revenue, and pays the OTA a commission, which is recorded as COGS (Cost of Goods Sold). The new standards will not affect this agency model.
Merchant Model: The guest both reserves and pays for hotel accommodations with the OTA. In turn, the OTA deducts its commission from the gross amount collected and pays the hotel the net amount (room rate minus commission). The hotel recognizes this net amount as revenue, and the OTA commission does not get recorded as COGS and in any way in the hotel’s profit and loss (P&L). Currently, recognizing revenue from the OTAs as “net” inevitably lowers ADRs and RevPARs, but the true effect remains “hidden,” since net OTA revenue is bundled with gross revenue (direct and OTA). The new standards call for the “gross” OTA revenue to be recognized in the property P&L and not the net as it is done currently, and the commission collected from the OTAs to be recognized as COGS.
How will the new OTA revenue recognition standards affect the industry?
The new OTA recognition standards will have a negative impact on hotels that are overly reliant on the OTA Merchant Model. This will result in:
