Hotel management agreements

What does a hotel management company promise?

The manager promises to operate the hotel throughout the contract: hiring and directing staff, setting room rates, managing sales and marketing, and running the hotel to the brand's standards. Each day of management is substantially the same and transferred in the same way, so IFRS 15 treats it as a series of distinct services, one performance obligation satisfied over time. The owner, who receives the benefit of the management as it is provided, is the manager's customer. See hospitality accounting.

How are base and incentive fees recognised?

Both fees are variable consideration. Because they relate to the management service of a particular period, IFRS 15 allows them to be allocated entirely to that period rather than estimated over the whole contract. Base fees, often 2% to 4% of total hotel revenue, are recognised each month as the hotel earns its revenue. Incentive fees, typically a percentage of profit above an owner's priority return, are often measured annually: in interim periods, the manager recognises the amount earned to date only to the extent it is highly probable there will be no significant reversal when the annual result is known. See variable consideration.

Hotel management agreements: a year of fees

A management company runs a hotel under a 20-year agreement. It receives a base fee of 3% of total hotel revenue and an incentive fee of 10% of gross operating profit above the owner's priority return of US$ 8 million. To win the contract, it paid the owner key money of 2 million. It employs the hotel's staff, whose costs of 12 million the owner reimburses. This year the hotel earns revenue of 50 million and gross operating profit of 15 million.

The manager's fee revenue is 2.1 million. The key money is not an expense or an intangible asset: it is a payment to the customer, so it is held as an asset and released against fee revenue over the 20-year term, and tested for recoverability if the hotel underperforms. Because the manager employs the staff and controls their work, it is the principal for those services and reports the 12 million reimbursement as revenue, with the same amount of staff costs, which adds a large amount to revenue but nothing to profit.

How are performance guarantees treated?

Managers sometimes guarantee owners a minimum profit, paying any shortfall. Payments under such a guarantee are consideration payable to the customer, so expected payments reduce fee revenue, estimated as variable consideration. Where the guarantee could require payments larger than the fees, the manager also considers whether the contract is onerous or whether part of it is a financial guarantee. Guarantees are a key judgement in hotel managers' accounts because hotel profits can fall sharply in a downturn.

What other costs and income arise?

Incremental costs of obtaining a management contract, such as fees to brokers that arise only if the contract is signed, are capitalised under IFRS 15 and amortised over the contract if recoverable. Charges to hotels for shared services, such as reservations systems and group marketing, are usually recognised gross where the manager controls those services. Termination fees received when an owner ends a contract early are recognised when the termination is agreed, and any unamortised key money for that contract is written off. Timeshare developers that manage resorts face similar questions; see timeshare revenue. See contract costs.

How does the hotel owner account for the agreement?

The owner is the principal in sales to guests, so it reports all of the hotel's revenue and costs, including the staff costs it reimburses, and records the base and incentive fees as an expense. Key money it receives is not income on receipt: it is in substance a reduction of the cost of the management services, deferred and released over the contract term. The hotel building is the owner's property, plant and equipment. See hotel property and depreciation.

How does US GAAP differ?

ASC 606 gives the same answers, and the largest US hotel groups report cost reimbursement revenue gross alongside their base, franchise and incentive fees, which is why their reported revenue is far larger than their fee income. Key money and similar contract acquisition payments to owners are amortised as a reduction of revenue. See hotel franchise fees.

This guide is general information. It is not tax or legal advice for your situation.