The basic principles – Hotel-Online

David Lund | July 15, 2019

By David Lund

Accounting was a trade that had a global language just like carpentry or plumbing. There were universal rules that applied and these principles were exactly the same in the hotel business. It was good news. Accounting principles are universal. The way accounting is done around the world is a direct by-product of these principles:

“Accounting principles are the rules and guidelines that companies must follow when reporting financial data. The common set of US accounting principles is generally accepted accounting principles (GAAP).

These principles are the very foundation on which the business community relies to ensure the relevance and meaning of financial reporting. These principles existed before the advent of the accounting profession; much like gravity had always been there for the plumber. In this chapter, I have reviewed some basic processes, most related to the hotel world.

I teach them to my non-financial leaders as business principles; I deliberately forget the accounting connotation.

The why of what we did.

They link day-to-day activities to hotel business so that leaders can understand why we do what we do a certain way. It’s a powerful thing. It is no longer me who invents work for you. There is a rhyme and a reason for everything we do. For many non-financial executives, this is the key to letting go of their resistance to getting on board with their numbers.

The principle of correspondence

The number one principle on which the entire hotel accrual accounting system is based is the “match principleâ€. This principle dictates to match income with expenses to determine profitability during the accounting period. It also means that the exchange of money and its timing have no relation to the financial results (P&L).

The accrual accounting system is used by most hotels; only very small inns and guesthouses (B & Bs) used the cash accounting system. The treasury system provides that income and expenses are realized at the same time as money is exchanged. Hotels use the principle of matching and accrual accounting for a more accurate picture of profit or loss.

The hotel business is a retail business and every day the property management system is closed just like the point of sale systems and in turn the sales are known. Collecting money for sales is irrelevant for recording revenue volume. Knowing the month’s income for the month is the place to start. Now close the books and determine the costs for the same period. This is where things get a bit tricky. The monthly calendar was not designed to handle weekly or bi-weekly payroll, so we still need to post the missing payroll until the end of the month and also undo the posting from the previous month. Along with expenses, be sure to account for items that were delivered or provided, but no invoices were received.

The whole process around the matching principle is designed to get an accurate picture of what happened with income and expenses in a specific month or year.

This principle is the juice that makes the month-end closing process fun. For example, has everything been done during the month? was the end of the month clean? It could also be the area where some people may turn a blind eye to what should be included (accumulated) for the sole purpose of improving results. This is a serious offense and not an error. Carrying out these actions can lead to a lot of problems.

The principle of materiality

Another very important principle, especially for hotels, is the principle of materiality. What is important for financial reporting and how does it dictate how it is handled? What has been “represented†in the balance sheets via the processes? What was omitted and why?

One hundred percent of what was consumed, payroll and expenses were included in the income statement. It became difficult with the balance sheet and how to directly charge what was purchased or put it in an inventory or prepaid account.

The principle of materiality dictates the processing. In the hospitality world, the terms tequila, filet mignon, and toilet paper have helped show the distinction. For this example, tequila and netting were important items in the business, but not toilet paper. That didn’t mean toilet paper wasn’t important. When it was necessary, it was important. It just wasn’t important, so the accounting treatment was different. Tequila and filet were sold, while toilet paper was used.

Tequila and filet were assets that could easily turn into profits. These items were a bit expensive and required locked storage. Therefore, the physical accounting and inventory of these items represented the remaining value on a balance sheet at the end of the month. Along with toilet paper, it was recorded as an expense as it was purchased, skipping the balance sheet. It did not count at the end of the month but was considered consumed when purchased.

Many, many items are treated the same as toilet paper in the hospitality industry simply because they weren’t considered materials.

The principle of the commercial entity

This principle dictates that, unless it is a sole proprietorship, the assets of the business and all rights to use those assets are separate and distinct.

For example, if Henry Ford was still alive and CEO of the Ford Motor Company, the cars installed on the factory assembly line belonged to the shareholders of the Ford Motor Company and not to Henry Ford.

The assets and liabilities of the company are segregated and kept separate from its officers, principles and employees. This principle also means that only transactions directly relating to the business are recorded in the books of the company. We hear from time to time in the public how executives use certain corporate assets like jets to transport their families on vacation. Company assets are not managerial assets and therefore should not be treated as such. This is also an area where the allegation of abuse of power causes problems for some people.

The principle of full disclosure

This principle is necessary because of the financial statements. The numbers only give part of the financial picture, more specifically, what has happened financially to date.

Any forward-looking event likely to have a significant impact on the company must be disclosed in writing to shareholders and stakeholders. Items such as pending lawsuits, union affairs, competition, environmental issues, pending law changes, insurance claims and more. Anything that can have a negative effect on the future stability and profits of the company should be disclosed.

These are represented in the activity reports in the form of footnotes to the financial statements. In the case of the hotel, the monthly hotel management commentary, property report or managers report is the instrument of full disclosure. It is designed to include anything that “could†negatively impact future profits, as well as more information about what happened during the current reporting period. In addition, the commentary includes detailed information on market conditions and future business prospects.

Basically, investors and all stakeholders need to know what’s going to happen in the future, or at least as much information as possible to make the best possible decisions for financial stability.

The principle of conservatism

This principle states that the financial statements must fairly and prudently represent the current financial position of the company. The principle is to never overestimate income and never underestimate expenses.

For example, a tenant might prepay rent for a year, but 100% of the income from that payment will not apply to the income statement that month, but instead will take 1/12 and apply it each month. Another example was the cancellation fee. Sales contracts could include such an agreement with a customer and if this clause were to apply, revenue would not be recognized until paid.

On the other hand, all possible negative activities should be captured that affect the reporting period. For example, the hotel had not yet received the electricity bill for the month and the books had to be closed; err on the side of accumulating the largest consumption to date rather than the smallest.

If you are aware of an ongoing litigation, plan now for possible and probable future expenses with a liberal estimate of exposure.

The essence of the precautionary principle is that information is communicated in a way that minimizes negative future financial results today and does not take any risk that future expenses resulting from a current situation will not materialize. Bad things have been reported and it was not assumed that anything positive would happen unless it has already happened.

The principle of objectivity

The principle of objectivity states that we must prove every financial transaction in the company. It might sound a little wrong, but it isn’t. For each sale there was a display, a room price, a restaurant ticket, a bar bill, a banquet check. For each purchase, there was a purchase order, receipt, invoice, and paycheck. For each hour worked, there is a schedule, a time card and a payroll.

All in all, this principle statement of evidence is necessary to substantiate everything. When transactions move from transaction to books, this also applies. A manager could not just invent transactions and record them; backup must prove entry. For example, the maintenance manager may want to accumulate for an emergency plumbing repair that occurred on the 30th of the month. There is no invoice, so a work order estimate or purchase order that describes the problem, location and estimated cost is required.

The principle of consistency

The last business principle to write about is the principle of consistency. It means following a consistent process from period to period in the financial world. If the process needs to be changed, the necessary people are informed through the principle of full disclosure.

For example, if changes are needed in an inventory method. In the past, the “first in, first out†(FIFO) method was used to measure the value of beverage inventories. Then it was decided that the most efficient way to measure value in the future was to use a weighted average cost. Disclosure of the change is required in the month the change was made, so that business stakeholders can see and understand the difference due to the change in accounting policies.

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Enough about accounting principles for now, remember that the hotel industry, like all businesses, needs structure. The structure needs principles that support the foundation. These processes make it possible to produce coherent and relevant financial information.

Teaching them to my leaders meant that they understood the why. This creates the buy-in needed for non-financial leaders to participate in the game.