The basic principles (part 1)
Accounting was a trade that had a global language much like carpentry or plumbing. There were universal rules that applied and these principles were exactly the same in the hotel business. That was good news. Accounting principles are universal. The way in which accounting is done throughout 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 U.S. accounting principles is the Generally Accepted Accounting Principles (GAAP).”
These principles are the very foundation that the business world relies on to ensure the relevance and meaning of financial information. These principles existed before the advent of the accounting profession; much like gravity had always been there for the plumber. In this chapter, I reviewed a few basic processes, the ones most relative to the hotel world. I teach these to my non-financial leaders as business principles; I purposely leave out the accounting connotation.
The why for what we did.
They connect the everyday activities to the business of hotels so leaders can understand why we do what we do a certain way. This is powerful stuff. It’s no longer me making up work for you. There is a rhyme and a reason for everything we do. For many non-financial leaders, this is the key to dropping their resistance to getting on board with their numbers.
The Matching Principle
The number one principle that the entire hotel accrual accounting system is built on is the “matching principle.” This principle dictates matching revenues with expenses to determine profitability within the accounting period. It also means the exchange of money and its timing has no relevance to the financial (P&L) results.
The accrual accounting system is used by most hotels; only very small inns and bed and breakfasts (B&Bs) used the cash system of accounting. The cash system calls for revenues and expenses to be realized at the same time the money is exchanged. Hotels use the matching principle and accrual accounting for a more accurate picture of the profit or loss.
The hotel business is a retail business and every day the property management system is closed off, as is the point of sale systems and, in turn, sales are known. Collecting the cash for sales is irrelevant to recording the volume of revenue. Knowing revenues in the month for the month is the starting point. Now close the books and determine the costs for the same period. This is where things get a little tricky. The monthly calendar was not designed to handle weekly or bi-weekly payroll, so we always need to accrue for the payroll missing until the end of the month and also reverse the previous month’s accrual. With expenses, be sure to accrue for items that were delivered or provided, but no invoice was received.
The entire process around the matching principle is designed to get an accurate picture of what happened with revenues and expenses in a specific month or year.
This principle is the juice that makes the month-end closing process fun. For instance, did everything get done in the month; was the month close a clean one? It could also be the area where some people can turn a blind eye to what should be included (accrued) with an eye only to improving results. This is a serious offense and is not an error. Perpetrating these actions can lead to a lot of trouble.
The Materiality Principle
Another very important principle, especially for hotels, is the materiality principle. What is material to financial reporting and how does that dictate how it is treated? What got “represented” on balance sheets via the processes? What was omitted and why?
One hundred percent of what was consumed, payroll and expenses were included on the profit and loss statement. It got tricky with the balance sheet and how to either directly expense what was bought or put it into an inventory or pre-paid account.
The materiality principle dictates the treatment. In the hotel world, the terms tequila, tenderloin and toilet paper helped to show the distinction. For this example, the tequila and tenderloin were material items in the business, but toilet paper was not. That was not to say the toilet paper was not important. When it was needed, it was important. It was just not material and therefore the accounting treatment was different. Tequila and tenderloin were sold, while toilet paper was used.
Tequila and tenderloin were assets that can readily turn into profits. These items were somewhat expensive and required storage under lock and key. Therefore, the material accounting and inventory of these items represented the remaining value on a balance sheet at month end. With the toilet paper, it was recorded as an expense as it was purchased, skipping the balance sheet. It did not count at month end but was treated as consumed when bought.
Many, many items are treated the same as toilet paper in the hotel business simply because these were not deemed as material.
To be continued…
David Lund – The Financial Coach
Helping Hotel Teams and Leaders with Financial Coaching and Educational workshops
Contact David at (415) 696-9593.
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