Revenue recognition is an important and widely adopted formal accounting principle that governs how and when earnings are recognised in financial reports. In particular, it deals with situations where there is a clear separation between payments being received and goods and services actually being delivered – or, to use the official accounting speak, ‘realised and earned’.
This might sound like a very dry and technical piece of accounting jargon with limited relevance to the day-to-day realities of businesses in the travel and tourism industry. But technical though it may be, it’s actually pretty important.
Travel and tourism is a perfect example of an industry where separation between transactions and provision of goods and services is commonplace. Whether it’s buying airline tickets or putting a deposit down on a package holiday or place to stay, payments are made to effectively enter into a contract for the provision of a service perhaps months down the line – which is when the revenue is ‘realised’.
According to internationally recognised accounting standards like IFRS 15, such revenue should be accounted for at the point where it is realised, not necessarily when cash is received – though, as with all such things, there are exceptions and qualifications.
And if this is straying into dry and technical territory again, there are very good reasons why this rule is in place. For one, it provides consistency and transparency across all operators, making it difficult to do things like ‘hide’ revenue to minimise tax liabilities, or shift earnings around to make a company’s financial situation look better than it actually is to investors, shareholders and creditors.
Importantly, this is also good business practice. Having a clear, consistent view of the true financial position of your business is an essential foundation for making sound business decisions.
When is an obligation satisfied?
Good practice though it might be, the travel and tourism industry also throws up some unique challenges that make revenue recognition particularly tricky. Some of this boils down to the handling of performance obligations, which in accounting terms means the contractual ‘promise’ made to deliver a specific service. Realisation of revenue is linked to when a performance obligation is satisfied, which in turn relates to when a promised good or service is transferred to the customer.
With something like an airline ticket, this is straightforward – the obligation is satisfied at the moment the ticket is sent to the customer. But not all performance obligations have such a neat, specific moment of satisfaction. Take a two-week stay in a hotel, for example. Is the point of satisfaction the moment when the booking is confirmed? Or when the keys are handed over? Or is it instead ‘satisfied’ over the duration of the two-week stay?
Things are further complicated by what are known as variable considerations, or uncertainties in what the final transaction price might be at the point of transaction due to various contingencies. In the travel and tourism industry, common examples include the practice of no-fee cancellations in hotel bookings. The hotel operator has to account for a reservation at one price, knowing that the booking could be cancelled and re-booked at a later date when, for reasons of optimising occupancy rates versus revenue, the unit price might have changed.
Similarly, airlines and travel agents are often subject to paying out compulsory refunds and rebates caused by travel delays that affect the actual transaction price.
Finally, all of the above is multiplied in the case of package bookings that might roll flights, accommodation, transportation and other services into one. Determining the individual performance obligations and variable considerations of different services within these bundles can pose a major challenge for revenue recognition.
Speak to an expert
More than 200 businesses in the travel and tourism industry trust Xeinadin’s experience and expertise in their industry to help them navigate these and other challenges that financial management throws up. Contact our team today to get on board with them.
