HOSPITALITY MANAGEMENT
ACCOUNTING
CHAPTER 1
BASIC FINANCIAL
A C C O U N T I N G R E V I EW
Introduction
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
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Accounting has been developed to accumulate,
maintain, and provide financial information
regarding internal business transactions.
In this chapter we will discuss and use basic
accounting principles and procedures common to a
manual system.
Computerized systems incorporate all of the
fundamental accounting principles of the manual
system.
Accounting Principles


A common language has developed from the
practice of accounting with its own set of rules or
assumptions, commonly called principles and
concepts.
It is important to have a good understanding of
each of these principles and concepts to be able to
interpret financial information correctly.
Accounting Principles (Contd.)

1.
2.
3.
4.
5.
These assumptions include the following:
Business entity principle
Monetary unit principle
Going concern principle
Cost principle
Time period principle
6. Conservatism principle
7. Consistency principle
8. Materiality principle
9. Full disclosure principle
10. Objectivity principle
11. Matching principle
G E N E R A L LY A C C E P T E D
AC C OU NTI N G PR I N C I PLE S

Accounting is not a static system; it is a dynamic
process that incorporates generally accepted
accounting principles (GAAP) that evolve to suit
the needs of financial statement readers, such as
business managers, equity owners, creditors, and
governmental agencies with meaningful,
dependable information.
BUSINESS ENTITY PRINCIPLE
From an accounting, if not from a legal, point of view,
the transactions of a business entity operating as a
proprietorship, partnership, or corporation are
considered to be separate and distinct from all
personal transactions of its owners.
Only the effects to assets, liabilities, ownership equity,
and other transactions of the business entity are
entered to the organization’s accounting records. The
ownership’s personal assets, debts, and expenses are
not part of the business entity.
MONETARY UNIT PRINCIPLE

The assumption of the monetary unit principle is
that the primary national monetary unit is used for
recording numerical values of business exchanges
and operating transactions.
GOING CONCERN PRINCIPLE

the going concern principle makes the assumption
that a business entity will remain in operation
indefinitely. This continuity of existence assumes that
the cost of business assets will be recovered over
time by way of profits that are generated by
successful operations. The balance sheet values for
long-lived assets such as land, building, and
equipment are shown at their actual acquisition cost.
Since there is no intention to sell such assets, there is
no reason to value them at market value.
COST PRINCIPLE

The assumption made by the monetary concept is
tied directly to the cost principle, which requires the
value of business transactions be recorded at the
actual or equivalent cash cost.
TIME PERIOD PRINCIPLE


The time period principle requires a business entity
to complete an analysis to report financial condition
and profitability of its business operation over a
specific operating time period.
An accounting year, or fiscal year, is an account
period of one year. A fiscal year is for any 12
consecutive months and may or may not coincide
with a calendar year that begins on January 1 and
ends on December 31 of the same year.
CONSERVATISM PRINCIPLE

A business should never prepare financial
statements that will cause balance sheet items such
as assets to be overstated or liabilities to be
understated, sales revenues to be overstated, or
expenses to be understated. Situations might exist
where estimates are necessary to determine the
inventory values or to decide an appropriate
depreciation rate. The inventory valuation should be
lower rather than higher. Conservatism in this
situation increases the cost of sales and decreases
the gross profit.
CONSISTENCY PRINCIPLE

The consistency principle was established to ensure
comparability and consistency of the procedures and
techniques used in the preparation of financial
statements from one accounting period to the next.
MATERIALITY CONCEPT

Theoretically, items that may affect the decision of
a user of financial information are considered
important and material and must be reported in a
correct way. The materiality concept allows
immaterial small dollar amount items to be treated
in an expedient although incorrect manner.
FULL DISCLOSURE PRINCIPLE


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Financial statements are primarily concerned with a past
period. The full disclosure principle states that any future
event that may or will occur, and that will have a material
economic impact on the financial position of the business,
should be disclosed to probable and potential readers of
the statements. Such disclosures are most frequently made
by footnotes. For example,
a hotel should report the building of a new wing, or the
future acquisition of another property.
A restaurant facing a lawsuit from a customer who was
injured by tripping over a frayed carpet edge should
disclose the contingency of the lawsuit.
OBJECTIVITY PRINCIPLE

This objectivity principle requires a transaction to
have a basis in fact. Some form of objective
evidence or documentation must exist to support a
transaction before it can be entered into the
accounting records. Such evidence is the receipt for
the payment of a guest check or the acceptance of
a credit card, or billing a house account that
supports earned sales revenue.
MATCHING PRINCIPLE

The matching principle reinforces the accrual basis
of accounting. Assets are consumed to generate
sales revenue inflows; outflows of assets are
identified as operating expenses. The matching
principle requires that for each accounting period
all sales revenues earned must be recognized,
whether payment is received or not. It also requires
the recognition of all operating expenses incurred,
whether paid or not paid during the period.
End-of-period Adjusting Entries
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
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At the end of an operating period, adjustments are made
to recognize all sales revenue earned. This might be sales
revenue not yet recorded or sales revenue that was earned
but will not be received until sometime in the new accounting
period.
Adjustment must also be made to recognize expenses not
yet recorded or expenses that were incurred in the current
period but not expected to be paid until sometime in the
new operating period.
Adjusting entries are needed to ensure that correct amounts
of sales revenue and expenses are reported in the income
statement, and to ensure that the balance sheet reports the
proper assets and liabilities.
Adjusting Entries (contd.)

1.
2.
Adjusting entries are also used for items that, by their
nature, are normally deferred. These consist of two
types of adjustments:
The use or consumption of an asset and recognition of it
as an expense. This type of adjustment typically
adjusts supplies, prepaid expenses, and depreciable
assets.
The reduction of a liability and recognition of revenue.
This adjustment concerns the recognition of unearned
revenue as being recognized as earned.
DISCUSSION QUESTIONS
1.
2.
3.
4.
5.
Explain the major difference between cash and accrual
accounting.
In what way can a business manager use accounting
information?
Using examples, give a short description of five accounting
principles or concepts using examples.
Discuss why adjusting entries are necessary at the end of
each operating period are made before the end-ofperiod financial statements are prepared.
A hotel shows office supplies such as stationery on its
balance sheet as a $500 asset, even though to any other
hotel these supplies might have a value only as scrap
paper. Which accounting principle or concept justifies this?
Chapter 2
UNDERSTANDING FINANCIAL
STATEMENTS
The INCOME STATEMENT AND
The BALANCE SHEET

Although the balance sheet and the income
statement are treated separately in this chapter,
they should, in practice, be read and analyzed
jointly. The relationship between the two financial
statements must always be kept in mind. This
relationship becomes extremely clear when one
compares the definition and objective of each
statement.
The Balance Sheet

The purpose of the balance sheet is to provide at a
specific point in time a picture of the financial
condition of a business entity relative to its assets,
liabilities, and ownership equity. By category, each
individual account, by name and its numerical
balance, is shown at the end of a specific date,
which is normally the ending date of an operating
period.
The Income Statement


The purpose of the income statement is to show
economic results of profit motivated operations of a
business over a specific operating period.
The ending date of an operating period indicated
in the income statement is normally the specific date
of the balance sheet.
The Income Statement (contd.)


Most hospitality operations are departmentalized, and the
income statement needs to show the operating results
department by department as well as for the operation as a
whole. Exactly how such an income statement is prepared
and presented is dictated by the management needs of
each individual establishment.
As a result, the income statement for one hotel may be
completely different from another, and income statements
for other branches of the industry (resorts, chain hotels, small
hotels, motels, restaurants, and clubs) will likely be very
different from each other because each has to be prepared
to reflect operating results that will allow management to
make rational decisions about the business’s future.
REVENUE
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Revenue is defined as an inflow of assets received in
exchange for goods or services provided.
In a hotel, revenue is derived from renting guest rooms,
while
in a restaurant, revenue is from the sale of food and
beverages.
Revenue is also derived from many other sources such
as catering, entertainment, casinos, space rentals,
vending machines, and gift shop operations, located on
or immediately adjacent to the property.
Expenses


Expenses are defined as an outflow of assets
consumed to generate revenue.
The accrual method requires that expenses be
recorded when incurred, not necessarily when
payment is made.
DEPARTMENTAL CONTRIBUTORY
INCOME


The term departmental contributory income is used
in this text and shows departmental revenue minus
its direct costs to arrive at income before tax.
By matching direct expenses with the various
revenue-producing activities of a department, a
useful evaluation tool is created.
Departmental Contributory Income

The departmental income statement provides the
basis for an effective evaluation of the
department’s performance over an operating
period. In general, the format in condensed form of
a departmentalized operation is shown below
Departmental sales revenue
$580,000
Departmental Expenses
(464,000)
Departmental Contributory Income 116,000
Departmental Contributory Income (Contd.)


If departmental managers are to be given authority
and responsibility for their departmental
operations, they need to be provided with more
accounting information than revenue less total
expenses.
In other words, expenses need to be listed item-byitem, otherwise department heads will have no
knowledge about which expenses are out of line,
and where additional controls may need to be
implemented to curb those expenditures.
Sample Income Statement
Understanding the Income Statement



As you review the sample departmental income
statement, take particular note of the following:
(1) each revenue division is identified;
(2) the cost of employee meals is deducted from the
cost of sales. The cost of employee meals is the actual
cost of the food, and no sales revenue was generated
or received from those meals. The term net food cost
implies that all necessary adjustments to cost of food
sales have been made, and represent the actual cost
incurred to produce the sales revenue. Cost of
employee meals became a part of the employee
benefits reported as a departmental expense.
Understanding the Income Statement (contd.)

Income before fixed charges is an important line on
an income statement because it measures the
overall efficiency of the operation’s management.
The fixed charges are not considered in this
evaluation because they are capital costs resulting
from owning or renting the property (that is, from
the investment in land and building) and are thus
not controllable by the establishment’s operating
management.
Control over inventory
The control of inventory for sale is important for a number of reasons:




If inventories are not known, the possibility exists that inventory may
run out and sales will stop. This situation will certainly create
customer dissatisfaction.
If inventories are in excess of projected needs, spoilage may occur,
creating an additional cost that could be avoided.
If inventories are maintained in excess of the amount needed,
holding excess inventories will create an additional cost such as
space costs, utilities costs, and inventory holding costs.
If inventories are maintained in excess of the amount needed, the
risk of theft is increased and, therefore, the cost of stolen inventory
is higher.
Valuation of Inventory
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
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There are several inventory valuation methods, of
which we will discuss four.
Specific item cost
First-in, first-out
Last-in, first-out
Weighted average cost
Adjustments to the cost of sales
In most food and beverage operations it is necessary to adjust
cost of sales—food before it can be accurately labeled net
food cost. Here are some possible adjustments:
 Interdepartmental transfers: For example, in a restaurant,
some items like eggs, fruits, etc. might be purchased and
received in the kitchen and recorded as food purchases that
are later transferred to the to the café shop for use there. In
the same way, some purchases might be received by the
café shop (and recorded as beverage purchases) that are
later transferred to the restaurant. A record of transfers
should be maintained so at the end of each month, both
food cost and beverage cost can be adjusted to ensure they
are as accurate as possible.
Adjustments to cost of sales (contd.)

Employee meals: Most food operations allow certain
employees, while on duty, to have meals at little or
no cost. In such cases, the cost of that food has no
relation to sales revenue generated in the normal
course of business. Therefore, the cost of employee
meals should be deducted from cost of food used.
Employee meal cost is then transferred to another
expense account. For example, it could be added to
payroll cost as an employee benefit.
Adjustments to cost of sales (contd.)

Promotional expense: Restaurants sometimes provide
customers with complimentary (free) food and/or
beverages. This is a beneficial practice if it is done for
good customers who are likely to continue to provide
the operation with business. The cost of promotional
meals should be handled in the same way as the cost of
employee meals. The cost should not be included in cost
of sales—food or cost of sales—beverage because,
again, the food and/or beverage cost will be distorted.
The cost should be removed from food cost and/or
beverage cost and be recorded as advertising or
promotion expense.
RESPONSIBILITYACCOUNTING
A hospitality business with several departments, each with the
responsibility for controlling its own costs and with its department head
accountable for the departmental profit achieved, is practicing what is
known as responsibility accounting.
Responsibility accounting is based on the principle that department
heads or managers should be held accountable for their performance
and the performance of the employees in their department.
There are two objectives for establishing responsibility centers:
1. Allow top-level management to delegate responsibility and authority
to department heads so they can achieve departmental operating
goals compatible with the overall establishment’s goals.
2. Provide top-level management with information (generally of an
accounting nature) to measure the performance of each department in
achieving its operating goals.
Responsibility Accounting (contd.)
Within a single organization practicing responsibility accounting,
departments can be identified as cost centers, revenue centers, profit
centers, or investment centers.
A cost center is one that generates no direct revenue (such as the
maintenance department). In such a situation, the department manager
is held responsible only for the costs incurred.
Some establishments also have revenue centers. These departments
receive sales revenue, but have little or no direct costs associated with
their operation. For example, a major resort hotel might lease out a
large part of its floor space to retail stores. The rent income provides
revenue for the department, all of which is profit.
A profit center is one that has costs but also generates revenue that is
directly related to that department. The rooms department is an
example where the manager is responsible for generating revenue
from guest room sales.
The Balance Sheet
Importance of Balance Sheet
The balance sheet is important because it can provide information
about matters such as the following:
 A business’s liquidity, or ability to pay its debts when they have to
be paid.
 How much of the operation’s profits has been retained in the
business to help it expand and/or reduce the amount of outside
money (debt) that has to be borrowed.
 The breakdown of assets into current, fixed, and other, with details
about the amount of assets within each of these broad categories.
 The business’s debt (liabilities) relative to owners’ equity. In general,
the greater the amount of debt relative to equity, the higher is the
operation’s financial risk.
Balance Sheet Limitations
There are some aspects of a business that the balance sheet
may not disclose.
For example:
 True value - Because transactions are recorded in the value
of the dollar at the time the transaction occurred, the true
value of some assets on the balance sheet may not be
apparent.
 Goodwill - if a business was started from scratch, and has a
good location compared to its competitors, and/or a good
reputation and faithful clientele, and/or a superior work
force with good morale, it is probably worth far more than
the balance sheet assets show, simply because the goodwill
built up is not reflected on the balance sheet.
Balance Sheet Limitations (Contd.)


Employee investment - Another value similar to goodwill
that is not shown on a business’s balance sheet is the
investment in its employees. This investment is the time and
money spent on recruiting, training, evaluating, and
promoting motivated individuals. Obviously, it is difficult to
assign a value to these human resources, but nevertheless,
they are assets to any hospitality business.
Judgment calls - Many items recorded on balance sheets
are a matter of judgment or estimate. For example, what is
the best depreciation method and rate to use, and what is
the best of several available methods for valuing
inventories? There are no absolute answers to these
questions. For this reason, a balance sheet may not reflect
the correct value for all assets.
Balance Sheet Limitations (Contd.)

Changing circumstances - Balance sheets also reflect
the financial position of a business at only one moment
in time. However, the business is constantly changing,
and, therefore, the information on the balance sheet is
constantly changing. These changes will not be shown
until another balance sheet is produced a month or
more later. If a balance sheet shows a healthy cash
position at one time, and a week later most of that cash
was spent on new furniture, the balance sheet will
reveal nothing about the impending use of most of the
cash available.
Problems
The Purple Rose Restaurant has the following food cost
information for a given month. Calculate the food cost
of sales and net food cost of sales for March. The
following information is provided:
 Food inventory, March 1 $2,428
 Food inventory, March 31 1,611
 Food purchases, March
8,907
 Employee meals cost
209
 Promotional meals cost
278
Exercise
Cindy’s Restaurant has three revenue divisions with direct costs and average monthly
figures given in the following information:
Dining Room
Banquet Room
Beverages
Sales revenue
$202,000
$108,000
$90,000
Cost of sales
81,000
41,000
28,000
Wages and salaries 64,455
34,795
12,000
Other direct costs
18,640
8,960
1,600
The restaurant also has the following indirect, undistributed costs:
 Administrative and general expenses $13,000
 Marketing expenses
9,000
 Utilities expense
6,000
 Property operation and maintenance 12,000
 Depreciation expense
14,000
 Insurance expense
2,000
a. Prepare a consolidated contributory income statement showing each
of the three divisions side by side for comparison. Do not allocate
indirect costs.
b. Allocate the indirect costs to the divisions and prepare a
departmental income statement for each division. Administrative,
general, and marketing costs are allocated based on sales revenue.
The remaining indirect costs are allocated based on square footage
used by each division:
Dining 2,400 sq. ft.
Banquet 3,000, sq. ft.
Beverage 600 sq. ft.
c. After allocating the indirect costs, would you consider closing any of
the divisions? Why or why not?
Exercise
George Jarvis purchased a trailer park on January 1,
0004. It is now March 31. George has no accounting
training but has kept a record of his cash receipts and
cash payments for the three months (see next page):
As Mr. Jarvis’s accountant, you discover the following
additional information:
a. The building has an estimated life of 20 years and
straight-line depreciation is used.
b. The office equipment has a five-year life with a tradein value of $500.
c. The insurance was prepaid on January 1 for the entire
year.
Chapter 4
Ratio Analysis
Ratio Analysis
Ratio analysis in the simplest terms is the
comparison of two figures, numerical dollar
values or quantity values. Ratio analysis
allows an evaluation of balance sheet items
in conjunction with some income statement
information to determine various
relationships between selected items.
RATIO COMPARISONS
RATIO COMPARISONS
Ratios are used to help a business entity evaluate financial and
economic results of profit-oriented operations over a given accounting
period. A ratio standing alone is simply a number and appears to
have little value, in that the ratio does not directly show favorable or
unfavorable results.
For example, a restaurant’s food inventory turnover of four times per
month may appear good, but until the turnover ratio is compared with
some standard, such as the average turnover ratio in the restaurant
industry for that type of restaurant, its true value cannot be
determined.
For a ratio to have meaning, it must be comparable to a standard or
an established base ratio. A standard ratio could be an industry
average.

USERS OF RATIOS
Generally, three broad groups of people are interested in
the evaluation of ratios:
 internal operating management, current and potential
creditors, and the organization’s owners.
Management has the responsibility of safeguarding the
assets, controlling costs, and maximizing profit for the
business operation. Ratio evaluation is a major technique
used by management to monitor the operation’s
performance against predetermined standards to
determine if the operating budget objectives are being
achieved.
Users of Ratios (Contd.)
Creditors of a business operation have an equity claim to
the assets of the operation.
Creditors loan money or extend trade credit to the
business operation. As such, creditors are normally
interested in certain ratios that may indicate the level of
safety of their loaned funds or trade credit. In addition,
existing and potential creditors use certain ratios to
estimate their potential risk of future loans the business
operation may need. In some cases, a creditor may
require the borrower to maintain a specified level of
working capital, a specific level of current assets greater
than current liabilities.
Users of Ratios (Contd.)
The ownership of a business operation can use
certain ratios to measure such items as their
return on investment, the risk level of their
investment, or to estimate the probability of
success of future operations.
RATIO CATEGORIES
Current liquidity ratios. The primary purpose of
liquidity ratios is to identify the relationship between
current assets and current liabilities; thus, liquidity
ratios provide the basis for an evaluation of the
ability of a company to meet its current obligations.
Liquidity ratios that provide a direct analysis of
current and quick assets in relation to current liabilities
are the current ratio (or the working capital ratio)
and the quick ratio (or acid test ratio).
RATIO CATEGORIES (Contd.)
Profitability ratios. Resources and assets are made
available to management to conduct sales-revenuegenerating operations, and the profitability ratios
show management’s effectiveness in using the
resources (assets) during operating periods.
profitability ratios to be discussed are return on
assets, profit to sales ratio, return on ownership equity,
return on total investment, and earnings per share.
RATIO CATEGORIES (Contd.)
Activity ratios. Activity or turnover ratios
indicate how well the managers are using assets.
Inventory turnover ratio shows the relationship
between inventories held for resale and the cost of
sales over an operating period. In addition, the
average days of inventory for resale on hand can be
determined. Working capital turnover that measures
the effectiveness of using working capital and fixed
asset turnover that measures the effectiveness of using
fixed assets are also explained.
RATIO CATEGORIES (Contd.)
Operating ratios. The final category to be discussed
includes analysis of items that are oriented primarily to
food, beverage, and rooms operations. Operating ratios
are generally summarized on the manager’s daily or
weekly report. This chapter concludes with a discussion on
financial leverage, or, simply put, the use of debt to
obtain capital. Basically, there are two sources of
obtaining operating capital—assuming long-term debt or
increasing ownership equity by selling additional
ownership rights.
Financial leverage is the term used to describe the use of
debt, rather than equity financing to increase the return
on ownership equity.