06.07.2018 | Berdon Industry Insights
In an ideal world, most hotels would prefer only direct bookings, but this is neither possible nor always preferable in the age of Online Travel Agencies (OTAs). OTA’s and hotel companies have co-existed for many years in a mutually beneficial relationship. Hotels provided OTA’s with the opportunity to market a broad array of rooms to consumers at a low cost to the hotel and OTA’s helped hotels increase bookings on unused inventory. However, over the past couple of years, OTA’s have increased in their online hotel reservation market share and have raised the commissions charged to the hotels to list rooms.
Strike and Counterstrike
In June 2017, the American Hotel & Lodging Association (AHLA) launched the “Search Smarter” campaign to help increase consumer awareness about the risks and hazards of booking a hotel reservation through an OTA. This is one of the latest attempts of the hotel industry to fight back against the OTA’s.
Fees are typically 10% to 30% of the room revenue. As an incentive to book directly through the hotel and avoid these fees, some hotels offer discounts to loyalty members and free Wi-Fi among other perks. OTA’s have noticed and taken action. Some have pushed certain hotels to the bottom of searches or removed descriptive details, such as available amenities, out of certain listings.
While the hotels and OTA’s fight this out, the consumer is also affected. In a new survey commissioned by AHLA and conducted by Morning Consult, 23% of consumers report being misled by third-party traveler resellers on the phone or online, translating to 28.5 million hotel stays and $5.2 billion in fraudulent and misleading hotel booking transactions in 2017.
Accounting Consequences in Play
In addition to the impact this conflict is making on all involved, there are some accounting issues, brought on by regulation, that may complicate matters even further:
There are currently two models to record OTA revenue:
- Merchant model. Guest books through the OTA and pays the OTA directly. The OTA then pays the hotel net of any commission. Revenue is recognized on a net basis.
- Retail/Commission/Agency model. Guest books through the OTA and pays directly to the hotel. The hotel then pays a commission to the OTA. Revenue is recognized on a gross basis, with a corresponding entry to commission expense.
However, the way OTA revenue is recorded under these models will change with the new revenue recognition standard developed by the Financial Accounting Standard Board (FASB). In May 2014, FASB issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The effective date for this change in revenue recognition differs for public and nonpublic organizations. Public organizations should apply the new revenue standard to annual reporting periods beginning after December 15, 2017, and nonpublic organizations for annual reporting periods beginning after December 15, 2018.
Know Your Terms, Recording Revenue
The new standard requires the principal of the transaction (as opposed to the agent) to record revenue on a gross basis. The agent would recognize revenue in the amount of any fee or commission for arranging the good or service. For OTA’s and hotels, the first step in properly applying the new revenue standard is to determine who the principal and agent is under the following definitions:
- Principal – provides the specified good or service and controls the good or service before it is transferred to a customer.
- Agent – arranges for that good or service to be provided by the other party.
Other considerations to determine which party is the principal, or has control of the good or service include:
- Which party is primarily responsible for fulfilling the promise to provide the specified good or service?
- Which party has the inventory risk?
- Which party has discretion in establishing the price for the specified good or service?
Based on these considerations, under the new revenue recognition standard, the hotel likely would be the principal under the merchant and agency models. Therefore, under both models, revenue would now be recorded on a gross basis. These considerations may be more or less relevant in assessing control depending on the conditions in the OTA contract. If there is uncertainty as to what the customer is being charged, then revenue would be recognized on a net basis. For example, the customer may purchase a hotel room, flight, and rental car all in one package under the merchant model and costs for each service cannot be identified. A proper review of the applicable terms of the OTA contract is integral in determining the proper treatment of a transaction.
Both the hotel and OTA need to determine who is the principal within these arrangements and then report the transactions accordingly. The manner in which these transactions are reported will also have a direct effect on the hotel’s calculation of average daily rate (ADR), revenue per available room (RevPAR), and potentially management and franchise fees due to the operator that are based on gross revenues. Understanding the OTA contract and assessing the effect its terms have on the new revenue recognition standards is critical for hotel operators.
The financial management committee for the AHLA issued detailed guidance that further explains the changes to the revenue recognition standard and how hotels should approach this issue. In addition, the financial management committee modified the Uniform System of Accounts for the Lodging Industry (USALI) relating to gross vs. net accounting for revenues when incorporating the new revenue recognition standards. The AHLA encourages all hotel operators and owners to understand the details of their OTA agreements prior to the effective date.
If you have questions about OTA’s, their impact on the hospitality market, or how the new revenue standard will impact your business, contact your Berdon advisor.
Berdon LLP, New York Accountants