Hotel property and depreciation

Is a hotel investment property?

IAS 40 defines investment property as property held to earn rentals or for capital appreciation. A hotel whose owner sells rooms and services to guests is different: IAS 40 itself says that an owner-managed hotel is owner-occupied property, because the services provided to guests are significant to the arrangement as a whole. The same usually applies when the owner hires a management company but keeps the operating risks and rewards. A hotel leased to an operator for a mostly fixed rent, where the owner is a passive investor, is investment property in the owner's accounts. See property, inventory or investment property and hospitality accounting.

Why depreciate hotel property by component?

IAS 16 requires each part of an item of property, plant and equipment with a cost that is significant in relation to the total to be depreciated separately. A hotel's parts have very different lives: the frame and envelope may last 50 years or more, lifts, heating, ventilation and air conditioning 15 to 25 years, interior fit-out around 10 years, and furniture, fixtures and equipment, known as FF&E, around 5 to 8 years. Depreciating them separately gives a truer charge and lets refurbishments be capitalised as replacements of specific components. See component depreciation.

Hotel property: depreciating a new hotel by component

An owner opens a new hotel that cost US$ 100 million, including land of 20 million. It splits the rest into four components, each depreciated straight-line with no residual value.

Depreciation by component is 3,450 thousand a year, compared with 2,000 thousand if the 80,000 thousand building were depreciated as one asset over 40 years. The difference is mostly the furniture, fixtures and equipment and the interiors, which will be replaced long before the building is. The owner also spent 1,500 thousand on training staff, marketing the opening and a launch event before the hotel opened. IAS 16 does not allow costs of opening a new facility, introducing a new service or training staff to be included in the asset's cost, so these are expensed as incurred.

How are refurbishments treated?

Hotels follow refurbishment cycles: soft refurbishments every few years replace carpets, soft furnishings and furniture, and major renovations replace bathrooms, building services and public areas. When a refurbishment replaces a component, its cost is capitalised and the carrying amount of the replaced part is derecognised, with any remaining balance recognised as a loss. Where the replaced part was not depreciated separately, its cost can be estimated from the cost of the replacement. Day-to-day repairs and maintenance are expensed. See IAS 16 property, plant and equipment.

What is the FF&E reserve?

Management and franchise agreements usually require the owner to set aside a percentage of hotel revenue, often around 3% to 5%, in a reserve to fund replacements of furniture, fixtures and equipment. The reserve is cash, often in a separate account, not an expense or a provision: nothing is charged to profit or loss when money goes into it. Spending from it is capitalised or expensed according to its nature. The reserve may be restricted cash, which affects how it is presented and disclosed.

How are linen, china and other operating equipment treated?

Practice varies for small operating equipment such as linen, china, glassware and uniforms. Many hotels capitalise the initial stock as equipment depreciated over a short life and expense replacements, while others treat them as consumables expensed when put into use. Either approach is acceptable if applied consistently and the amounts are not material to the hotel's results.

Can hotels be carried at fair value?

Yes, under the IAS 16 revaluation model, applied to the whole class of land and buildings. Hotels are usually valued as trading businesses using cash flow projections, so the valuation must be adjusted to separate out furniture and equipment and any intangible value from the brand or operator. Revaluation increases go to other comprehensive income, and depreciation is then based on the revalued amount. See the revaluation model.

How does US GAAP differ?

ASC 360 requires cost, with no revaluation option, and permits but does not require component depreciation, so many US owners use broader asset groups. Start-up and pre-opening costs are expensed under ASC 720-15, as under IFRS. Impairment of hotels uses an undiscounted cash flow recoverability test before measuring the loss; see hotel impairment. See IAS 16 and US GAAP compared and hotel management agreements.

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