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Accounting implications of COVID-19 for hotels

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Wall Street COVID-19 continues to have a significant impact on companies within the hotel industry –a potentially irreversible one for many entities. As entities in the industry look to report their financial results for fiscal-year end and interim periods for many businesses, company leaders should pay special attention to the accounting implications related to financial reporting resulting from COVID-19. We highlight a few of these considerations below.

First, companies should evaluate the impact that COVID-19 may have on revenue recognition. Hotel owners and operators should consider the appropriate accounting treatment for applying changes in loyalty programs and cancellation policies, as well as any impact specific to advanced deposits received for future events or room blocks. In many cases, determining the appropriate accounting for loyalty programs based on historical trends will require a significant amount of estimation and judgment as these trends may no longer be relevant. The decline in hotel usage from COVID-19 could have a significant impact on these trends and needs to be considered, along with changes to the loyalty programs, in evaluating the accounting for these programs now and in the future.

In addition, hotel owners and operators and hotel management companies should evaluate accounting implications related to modifications or amendments to management agreements. Specifically, businesses should examine the impact of COVID-19 on terms within executed management agreements, as management and incentive fees are traditionally calculated as a percentage of total revenues or as a percentage of net operating income or gross profit. Hotel owners may also have long-term contracts with vendors that include incentives or discounts directly related to volumes of purchases. Given the significant decline in hotel occupancy throughout the United States and globally, achieving minimum volume thresholds may no longer be realistic. Management should consider any impact related to a company’s inability to meet these thresholds. In addition to contracts with vendors, companies should also consider the impact of COVID-19 on terms within existing long-term lease agreements for equipment, real property, or other items. Changes in lease agreements will need to be evaluated to ensure appropriate accounting treatment, specific not only to the balances of assets and liabilities recorded on the balance sheet, but also to the amount and timing of expense recognition within the statement of operations.

Another area of focus relates to possible asset impairment charges, as described in-depth in our New Developments Summary, “COVID-19: Accounting and financial reporting considerations.” Impairment charges might be necessary for hotel property assets that are currently not being used at or near previous capacity or are idle given canceled meetings or events. Consideration should be given to whether there is a change in long-term projections of occupancy in hotel rooms and event space. Management’s timely identification of potential impairment charges is critical, because in addition to the direct impact on financial reporting, these charges could play a significant role in debt covenant compliance, liquidity projections, and in some cases the ability of an entity to continue as a going concern. Fluid communication with lenders, owners, and investors is of utmost importance to identify and mitigate pitfalls in meeting debt covenants or investor expectations.

In many cases, companies may find it necessary to consider modifications to agreements with lenders, vendors, and management companies. Management will likely need to place an increased focus on the budget process to ensure forecasts have been appropriately adjusted for ongoing COVID-19-related impacts, given the significant disruption that many companies within the hotel industry have experienced over the last eight months. As it relates to financial reporting, management should also be prepared to evaluate events that occur subsequent to the balance sheet date to ensure the impact of these events has been appropriately accounted for and / or disclosed within the entity’s financial statements.

COVID-19 has also given rise to an increase in certain operating expenses. Examples include an increase in payroll costs, given workforce turnover, and elevated expenses to ensure appropriate sanitation. This applies not only to additional supplies, but also increased employee training to ensure compliance with updated company policies for cleanliness of rooms, restaurant and bar areas, and event spaces. Companies will need to evaluate the potential impact of these expenses on management and incentive fees. The classification of these expenses will also need to be an area of focus for management to ensure that these additional costs are presented in accordance with accounting standards. Hotel owners and operators may also face challenges in navigating insurance claims associated with business interruption or litigation that may arise around alleged COVID-19 outbreaks among employees or guests staying on properties.

Finally, companies that operate in the hotel and lodging space will face many decisions as to how to navigate and properly capitalize on tax benefits that are available from the CARES Act, including various provisions that provide business tax relief such as the Employee Retention Credit, modifications of the limitation of losses on pass through entities, and changes to the tax implications surrounding qualified improvement property. Since its issuance, there have been continuing changes to the CARES Act and given the fluidity of this regulatory action, companies need to ensure they have the appropriate advisors in place to maximize cost savings and navigate the government regulations. Benefits from the CARES Act can vary by company structure and it is critical to ensure that management has the tools and resources to effectively and efficiently take the appropriate measures to maximize all opportunities to reduce costs both in the short term and in the future. Many companies have experienced short-term benefits from taking out Paycheck Protection Program (PPP) loans, however, companies will need to evaluate future impacts regarding ability to meet the forgiveness criteria for PPP loans to ensure such benefits are realized long-term.

In summary, the impact of these considerations will vary based on the underlying facts and circumstances specific to an individual company, but our experience has shown that many hotel and lodging entities will experience a financial statement impact from one or more of the issues noted above.

Contact:

Lauren SpegalLauren Spegal
Partner
Hospitality & Restaurants
Charlotte office
T +1 704 632 6979