Hospitality Accounting

3rd Edition

Steven M. Bragg

Table of Contents

Chapter 1 – Introduction to Hospitality Accounting ...... 1 Learning Objectives ...... 1 Introduction ...... 1 Characteristics of the Hospitality Industry ...... 1 Hotel Organizational Structure...... 2 The Controller Job Description ...... 3 Decisions Requiring Accounting Information ...... 4 Financial and Managerial Accounting ...... 5 The Structure of this Book ...... 6 Summary ...... 8 Review Questions ...... 9 Review Answers ...... 10

Chapter 2 – The System of Accounting ...... 11 Learning Objectives ...... 11 Introduction ...... 11 Financial Accounting Basics ...... 11 Accounting Frameworks ...... 12 Accounting Principles ...... 13 The Accounting Cycle ...... 14 Accounting Transactions ...... 15 Types of Transaction Cycles ...... 15 Source Documents...... 16 Double Entry Accounting ...... 16 The Accounting Equation ...... 17 Journal Entries ...... 19 The Accruals Concept ...... 20 The Chart of Accounts...... 20 Major Journal Entries ...... 22 The Ledger Concept ...... 23 Posting to the General Ledger ...... 24 General Ledger Overview ...... 24 The Trial Balance ...... 25 The Trial Balance Format ...... 26 The Extended Trial Balance ...... 27 The Realization Concept ...... 28 Accrual Basis of Accounting ...... 28 Cash Basis of Accounting ...... 29 Converting Cash Basis to Accrual Basis Accounting ...... 29 Summary ...... 30 Review Questions ...... 31 Review Answers ...... 32

Chapter 3 – The Financial Statements ...... 33 Learning Objectives ...... 33 Introduction ...... 33 Income Statement Overview ...... 33 The Single-Step Income Statement ...... 35 The Multi-Step Income Statement ...... 36 The Multi-Period Income Statement ...... 37 Hospitality Income Statement Format...... 37 The Balance Sheet...... 39 The Common Size Balance Sheet ...... 42 The Comparative Balance Sheet ...... 43

Table of Contents

The Statement of Cash Flows ...... 44 The Direct Method ...... 45 The Indirect Method ...... 47 Limitations of the Financial Statements ...... 47 Summary ...... 48 Review Questions ...... 49 Review Answers ...... 50

Chapter 4 – Receivables and Payables Accounting ...... 51 Learning Objectives ...... 51 Introduction ...... 51 Accounting for Accounts Receivable ...... 51 Accounting for Deposits ...... 53 Accounting for Cash Sales ...... 53 Remitting Sales Taxes ...... 54 The Accounts Receivable Aging Report ...... 55 Accounting for Bad Debts ...... 55 Direct Write-Off Method ...... 55 Allowance for Doubtful Accounts ...... 56 Accounting for Accounts Payable ...... 57 Accounting for Petty Cash ...... 59 Petty Cash Transfer Form ...... 60 Petty Cash Voucher ...... 60 Petty Cash Book ...... 61 The 1099 Vendor ...... 62 Summary ...... 63 Review Questions ...... 65 Review Answers ...... 66

Chapter 5 – Payroll Accounting ...... 67 Learning Objectives ...... 67 Introduction ...... 67 Employee Time Tracking ...... 67 Gross Pay Calculations ...... 68 Hourly Rate Plan ...... 68 Overtime...... 69 Tips ...... 70 Types of Payroll Taxes ...... 71 Social Security Tax ...... 71 Medicare Tax ...... 72 Unemployment Taxes ...... 72 Income Tax Withholdings ...... 73 Benefits and Other Deductions ...... 75 Net Pay ...... 76 Remitting Payroll Taxes ...... 76 Types of Tax Deposit Schedules ...... 76 Monthly Deposit Schedule ...... 77 Semiweekly Deposit Schedule ...... 78 Federal Unemployment Deposit Schedule ...... 78 Remittance Method...... 78 The Form 941 Quarterly Federal Tax Return ...... 79 State Tax Remittances...... 79 Payments to Employees ...... 80 The Payroll Register ...... 81 Form W-2 ...... 82 Payroll Journal Entries ...... 83 Types of Payroll Journal Entries ...... 83

ii Table of Contents

Primary Payroll Journal Entry ...... 84 Accrued Wages ...... 85 Manual Paycheck Entry ...... 85 Employee Advances ...... 86 Accrued Vacation Pay ...... 86 Tax Deposits ...... 87 Summary ...... 87 Review Questions ...... 89 Review Answers ...... 90

Chapter 6 – Inventory Accounting ...... 91 Learning Objectives ...... 91 Introduction ...... 91 The Periodic Inventory System ...... 91 The Perpetual Inventory System ...... 92 The Physical Inventory Count ...... 93 Inventory Cost Layering Overview ...... 95 The First In, First Out Method ...... 96 The Last In, First Out Method ...... 97 The Weighted Average Method ...... 98 Estimating Ending Inventory ...... 99 Gross Profit Method ...... 99 Retail Inventory Method ...... 100 Cost of Food Consumed ...... 101 Cost of Sales Account Classifications ...... 101 Summary ...... 101 Review Questions ...... 102 Review Answers ...... 103

Chapter 7 – Fixed Asset Accounting ...... 105 Learning Objectives ...... 105 Introduction ...... 105 What are Fixed Assets? ...... 105 Fixed Asset Classifications ...... 106 Accounting for Fixed Assets ...... 107 The Capitalization Limit ...... 107 The Base Unit ...... 108 The Initial Measurement of a Fixed Asset ...... 109 The Purpose of Depreciation ...... 109 Depreciation Concepts ...... 109 Accelerated Depreciation ...... 110 Sum-of-the-Years’ Digits Method ...... 111 Double-Declining Balance Method ...... 111 Straight-Line Method ...... 112 Units of Activity Method ...... 112 MACRS Depreciation ...... 113 The Depreciation of Land ...... 115 The Depreciation of Land Improvements ...... 115 Depreciation Accounting Entries ...... 115 Accumulated Depreciation...... 116 Asset Derecognition ...... 116 Abandoned and Idle Assets...... 117 Asset Disposal Accounting ...... 118 Summary ...... 119 Review Questions ...... 120 Review Answers ...... 121

iii Table of Contents

Chapter 8 – Interest Capitalization ...... 123 Learning Objectives ...... 123 Introduction ...... 123 Overview of Capitalized Interest ...... 123 When to Capitalize Interest ...... 124 The Interest Capitalization Period ...... 124 The Capitalization Rate ...... 125 Calculating Interest Capitalization...... 126 Summary ...... 127 Review Questions ...... 128 Review Answers ...... 129

Chapter 9 – Debt Accounting ...... 131 Learning Objectives ...... 131 Introduction ...... 131 Basic Debt Accounting ...... 131 The Amortization Schedule ...... 133 Reconciling the Debt Account ...... 133 Summary ...... 134 Review Questions ...... 135 Review Answers ...... 136

Chapter 10 – Income Taxes ...... 137 Learning Objectives ...... 137 Introduction ...... 137 Sole Proprietorship Taxes ...... 137 Partnership Taxes ...... 140 C Corporation Taxes ...... 143 S Corporation Taxes ...... 145 Tax Reduction Strategies for Small Businesses ...... 148 Summary ...... 149 Review Questions ...... 150 Review Answers ...... 151

Chapter 11 – Other Accounting Topics ...... 153 Learning Objectives ...... 153 Introduction ...... 153 Startup Costs ...... 153 Advertising Costs ...... 153 Gift Cards ...... 154 Summary ...... 157 Review Questions ...... 158 Review Answers ...... 159

Chapter 12 – Controls ...... 161 Learning Objectives ...... 161 Introduction ...... 161 The Proper Balance of Control Systems ...... 161 The Nature of Risk ...... 163 Control Principles ...... 163 The Failings of Internal Controls ...... 164 Preventive and Detective Controls...... 165 Manual and Automated Controls ...... 165 Constructing a System of Controls ...... 166 Common Fraud Risk Factors ...... 166 Hospitality Industry Risk Characteristics ...... 167 Hospitality Industry Fraud ...... 168 Specific Controls ...... 169

iv Table of Contents

Controls for the Small Organization ...... 175 Summary ...... 175 Review Questions ...... 176 Review Answers ...... 177

Chapter 13 – Pricing Methodologies...... 179 Learning Objectives ...... 179 Introduction ...... 179 Price Elasticity of Demand...... 179 Cross Price Elasticity of Demand ...... 181 Pricing Perception ...... 181 Market-Based Pricing ...... 182 Dynamic Pricing ...... 183 Pricing Segmentation ...... 183 Day-to-Day Pricing Tactics ...... 185 Cost Markup Pricing (Meals) ...... 186 Investment-Based Pricing (Room Rates) ...... 187 Hubbart Formula (Room Rates) ...... 188 Hubbart Formula (Meal Pricing) ...... 190 Menu Engineering ...... 190 Contribution by Meal Period ...... 192 Discounting of Room Rates ...... 193 Room Revenue Yield Analysis ...... 194 Price Increase Considerations ...... 195 Nonprofit Pricing ...... 196 Summary ...... 196 Review Questions ...... 197 Review Answers ...... 198

Chapter 14 – Ratio and Trend Analysis ...... 199 Learning Objectives ...... 199 Introduction ...... 199 Interpretation of Financial Statements ...... 199 Horizontal Analysis...... 200 Vertical Analysis...... 201 Current Ratio ...... 202 Quick Ratio ...... 203 Accounts Payable Turnover Ratio ...... 204 Accounts Receivable Turnover Ratio ...... 204 Inventory Turnover Ratio ...... 205 Fixed Asset Turnover Ratio ...... 205 Sales to Working Capital Ratio ...... 206 Debt to Equity Ratio ...... 207 Fixed Charge Coverage ...... 207 Net Profit Ratio...... 208 Return on Net Assets ...... 208 Hotel Operating Ratios ...... 209 Paid Occupancy Percentage ...... 209 Complimentary Occupancy Percentage ...... 209 Average Occupancy per Room ...... 210 Average Room Rate ...... 210 Revenue per Available Room ...... 211 Revenue per Available Customer ...... 211 Hotel Market Share ...... 212 Restaurant Operating Ratios ...... 212 Seat Turnover ...... 212 Average Food Service Check ...... 213

v Table of Contents

Ratio of Beverage to Food Revenue ...... 213 Food Cost Percentage ...... 214 Beverage Cost Percentage ...... 214 Labor Cost Percentage ...... 214 Limitations of Ratio Analysis ...... 214 Summary ...... 215 Review Questions ...... 216 Review Answers ...... 217

Chapter 15 – Cost Concepts ...... 219 Learning Objectives ...... 219 Introduction ...... 219 The Economics of Cost Management ...... 219 What is Cost? ...... 220 Basic Cost Types ...... 220 Fixed Costs ...... 220 Variable Costs ...... 221 Mixed Costs...... 221 Step Costs ...... 223 Differential Costs ...... 223 Discretionary Costs...... 224 Committed Costs ...... 224 Sunk Costs ...... 224 The Cost Allocation Conundrum ...... 225 Advantages of Cost Management...... 225 Summary ...... 226 Review Questions ...... 227 Review Answers ...... 228

Chapter 16 – Cost-Volume-Profit Analysis ...... 229 Learning Objectives ...... 229 Introduction ...... 229 Contribution Margin ...... 229 Breakeven Point...... 230 Margin of Safety ...... 232 Cost-Volume-Profit Analysis ...... 233 Cost-Volume-Profit Cautions ...... 235 Sales Mix ...... 236 Summary ...... 237 Review Questions ...... 238 Review Answers ...... 239

Chapter 17 – Operations Budgeting ...... 241 Learning Objectives ...... 241 Introduction ...... 241 The Advantages of Budgeting ...... 241 The Disadvantages of Budgeting ...... 242 The Operations Budget ...... 243 The Operations Budget Format ...... 243 Revenue Projections ...... 244 Expense Projections ...... 246 The Flexible Budget ...... 247 Formulation of the Budget ...... 247 The Long-Range Budget ...... 249 Variance Analysis ...... 249 Types of Variances ...... 250 Selling Price Variance ...... 251

vi Table of Contents

Sales Volume Variance...... 251 Purchase Price Variance ...... 251 Material Yield Variance ...... 252 Labor Rate Variance ...... 252 Operating without a Budget ...... 252 Summary ...... 254 Review Questions ...... 255 Review Answers ...... 256

Chapter 18 – Capital Budgeting ...... 257 Learning Objectives ...... 257 Introduction ...... 257 Overview of Capital Budgeting ...... 257 Time Value of Money ...... 257 Present and Future Value Tables ...... 259 Cost of Capital Derivation ...... 261 Cost of Debt ...... 261 Cost of Preferred Stock...... 261 Cost of Common Stock ...... 261 Weighted Average Cost of Capital ...... 262 Net Present Value Analysis ...... 262 Terminal Value ...... 264 Internal Rate of Return ...... 265 Incremental Internal Rate of Return ...... 265 Profitability Index ...... 266 Breakeven Analysis...... 266 Payback Method ...... 267 Real Options ...... 269 Capital Expenditure Proposal Analysis ...... 270 Information Recordation ...... 271 Separate Spreadsheet ...... 271 Separate General Ledger / Subledger Accounts ...... 271 Separate Accounting Module ...... 272 Summary ...... 272 Review Questions ...... 273 Review Answers ...... 274

Chapter 19 – The Lease or Buy Decision ...... 275 Learning Objectives ...... 275 Introduction ...... 275 The Lease Arrangement ...... 275 The Lease or Buy Decision ...... 275 Leasing Concerns ...... 276 Leasing Advantages...... 277 Summary ...... 277 Review Questions ...... 278 Review Answers ...... 279

Chapter 20 – Cash Management ...... 281 Learning Objectives ...... 281 Introduction ...... 281 The Difference between Net Income and Cash Flow ...... 281 The Bank Reconciliation ...... 282 The Daily Bank Reconciliation ...... 283 The Cash Forecast...... 284 The Short-Term Cash Forecast ...... 284 The Medium-Term Cash Forecast...... 287

vii Table of Contents

The Need for Cash Concentration ...... 287 Cash Sweeping ...... 289 The Zero Balance Account...... 289 Multiple Sweep Arrangements ...... 289 Sweeping Rules...... 290 Sweep Costs ...... 290 Summary ...... 290 Notional Pooling ...... 291 Notional Pooling Problems ...... 291 Notional Pooling Costs...... 291 Summary ...... 291 Cash Concentration Best Practices ...... 292 Cash Concentration Alternatives ...... 292 Accounting for Cash Concentration Transactions ...... 293 Investments ...... 293 Accounting for Investments—Dividends and Interest Income ...... 296 Stock Dividends and Stock Splits ...... 296 Noncash Dividends ...... 297 Summary ...... 297 Review Questions ...... 298 Review Answers ...... 299

Chapter 21 – Working Capital Management ...... 301 Learning Objectives ...... 301 Introduction ...... 301 The Cash Conversion Cycle ...... 301 Accounts Receivable Enhancements ...... 302 Credit Enhancements ...... 302 Billing Enhancements ...... 303 Collection Enhancements ...... 303 Accounts Receivable Policies ...... 305 Inventory Enhancements ...... 305 Inventory Policies ...... 306 Accounts Payable Enhancements ...... 306 Terms Renegotiation ...... 306 Early Payment Discounts ...... 306 Payment Processing Frequency ...... 307 Accounts Payable Policies ...... 307 Summary ...... 308 Review Questions ...... 309 Review Answers ...... 310

Glossary ...... 311

Index ...... 317

viii