IFRS 15 adopted, full retrospective method, hotels, agency and principal, franchise fees, disaggregation of revenue

InterContinental Hotels Group PLC – Half year report – 30 June 2018

Industry: leisure

  1. Adoption of new accounting standards

IFRS 15

With effect from 1 January 2018, the Group has adopted IFRS 15 ‘Revenue from Contracts with Customers’ which introduces a new five-step approach to measuring and recognising revenue from contracts with customers. Under IFRS 15, revenue is recognised at an amount that reflects the consideration to which an entity expects to be entitled in exchange for transferring goods or services to a customer.

The Group has elected to apply the full retrospective method in adopting IFRS 15.

Prior to adoption of IFRS 15, the Group’s revenue was primarily comprised of fee-based revenue from franchise and management contracts, and hotel revenue in owned and leased properties. The recognition of these revenue streams is largely unchanged by IFRS 15:

  • Franchise and base management fees are charged as a percentage of underlying revenues in the hotels and are treated as ‘variable consideration’ under IFRS 15. These fees are recognised as the underlying hotel revenues occur, provided there is no expectation of a subsequent reversal of the revenue.
  • Incentive management fees are generally charged based on the hotel’s profitability or cash flows, and are recognised over time when it is considered highly probable that the related performance criteria will be met, provided there is no expectation of a subsequent reversal of the revenue.
  • Hotel revenue in owned and leased properties includes rooms revenue and food and beverage sales, which is recognised when the rooms are occupied and food and beverages are sold.

The key changes resulting from the adoption of IFRS 15 are as follows:

  1. Core IHG adjustments

a) Managed and franchised hotel cost reimbursements

Under IFRS 15, the provision of employees to managed hotels is not considered to be a service that is distinct from the general hotel management service. Reimbursements for the cost of the IHG employees working in managed hotels are therefore shown as revenue with an equal matching cost, and no profit impact. Certain other costs relating to both managed and franchised hotels are also contractually reimbursable to IHG and where IHG is deemed to be acting as principal in the provision of the related services, the revenue and cost are shown on a gross basis under IFRS 15. Under previous accounting policies, no revenue or matching cost was recognised.

b) Initial application and re-licensing fees

Under previous accounting, application and re-licensing fees were recognised as revenue when billed as the monies received are not refundable and IHG has no further obligations to satisfy. Under IFRS 15, there is a requirement to consider whether the payment of these fees transfers a distinct good or service to the customer that is separate from the promise to provide franchise services. As this is not the case, IFRS 15 requires initial application and re-licensing fees to be recognised as services are provided, over the life of the related contract. The spreading of these fees results in an initial reduction to revenue and operating profit, and the recognition of deferred revenue on the statement of financial position, reflecting the profile of increased amounts received in recent years.

c) Contract costs

Contract costs related to securing management and franchise contracts were previously charged to the income statement as incurred. Under IFRS 15, certain costs qualify to be capitalised as the cost of obtaining a contract and are amortised over the initial term of the related contract. This change results in an initial increase to operating profit and the capitalisation of contract costs on the statement of financial position.

d) Amortisation of amounts paid to hotel owners to secure management contracts and franchise agreements (‘key money’)

Under previous accounting, key money payments were capitalised as intangible assets and amortised over the life of the related contracts. Under IFRS 15, these payments are treated as ‘consideration payable to a customer’ and therefore recorded as a contract asset and recognised as a deduction to revenue over the contract term. This change results in a reduction to revenue, no change to operating profit, and the reclassification of key money on the statement of financial position from intangible assets to contract assets.

In the statement of cash flows, these contract acquisition costs are reclassified from investing activities to cash flow from operations.

e) Owned hotel disposals subject to a management contract

Under previous accounting, when hotels were sold and the Group retained management of the hotel, the consideration recognised included both the cash received and the fair value of the management contract which was capitalised as an intangible asset and subsequently amortised to the income statement. This accounting was governed by the ‘exchange of assets’ criteria included in IAS 16 ‘Property, Plant and Equipment’ and IAS 38 ‘Intangible Assets’. IFRS 15 specifically includes property sales in its scope and results in the sales consideration being recorded at the fair value of the encumbered hotel, which generally will be equivalent to the cash received. This change results in the derecognition of historic intangible asset balances and a lower amortisation charge in the income statement.

f) Other adjustments

Other adjustments, which are immaterial, include re-assessments of IHG’s role as principal in other revenue transactions and the treatment of payments under performance guarantees as a reduction to the transaction price within management contracts.

  1. System Fund adjustments

The Group operates a System Fund (the Fund) to collect and administer cash assessments from hotel owners for the specific purpose of use in marketing, the guest reservation systems and hotel loyalty programme. The Fund also receives proceeds from the sale of loyalty points under third-party co-branding arrangements. The Fund is not managed to a profit or loss for IHG, but is managed for the benefit of hotels in the System with the objective of driving revenues for the hotels. Consequently, under previous accounting these revenues and expenses were not recorded in the Group income statement.

Under IFRS 15, an entity is regarded as a principal if it controls a service prior to transfer to the customer. As marketing and reservations expenses primarily comprise payroll and marketing expenses under contracts entered into by the Group, management has determined that the Group controls these services. Fund revenues and expenses are therefore recognised on a gross basis in the Group income statement. Assessment fees from hotel owners are generally levied as a percentage of hotel revenues and are recognised as those hotel revenues occur.

In respect of the loyalty programme (IHG Rewards Club), the Group has determined that the related performance obligation is not satisfied in full until the member has redeemed the points at a participating hotel. Accordingly, revenue related to loyalty points earned by members or sold under co-branding arrangements is deferred in an amount that reflects the stand-alone selling price of the future benefit to the member. As materially all of the points will be redeemed at IHG managed or franchised hotels owned by third parties, IHG is deemed to be acting as agent on redemption and therefore recognises the related revenue net of the cost of reimbursing the hotel that is providing the hotel stay. The deferred revenue balance under IFRS 15 is significantly higher than the points redemption cost liability that was recognised under previous accounting resulting in an increase in the Group’s net liabilities.

Management has also determined that in addition to the performance obligation for the redemption of points, co-branding arrangements contain other performance obligations including marketing services and the right to access the loyalty programme. Revenue attributable to the stand-alone selling price of these additional services is recognised over the term of the co-branding arrangement. Certain travel agency commission revenues within the Fund will be recognised on a net basis, where it has been determined that IHG acts as agent under IFRS 15.

Under previous accounting, any Fund short-term timing surplus or deficit was carried in the Group statement of financial position within working capital. Under IFRS 15, the in-year Fund surplus or deficit is recognised in the Group income statement. Both the current accounting treatment and the change on applying IFRS 15, and the equivalent US GAAP standard, are consistent with current and expected future practice across the hotel industry. The Fund surplus of $158m at 31 December 2017 has been derecognised resulting in a reduction in the Group’s net liabilities.

IHG also records an interest charge on the outstanding cash balance relating to the IHG Rewards Club programme. In 2017 these interest payments totalled $7m (6 months to 30 June 2017: $3m), and were recognised as interest income for the Fund and interest expense for IHG. The System Fund also benefits from the capitalisation of interest related to the development of the next-generation Guest Reservation System, which totalled $6m in 2017 (6 months to 30 June 2017: $3m). As the Fund is now included on the Group income statement, these amounts are included in the reported net Group financial expenses for 2017.

The System Fund accounting changes result in an increase in recorded revenue and a change to reported profits. However, since the Group’s agreement with the IHG Owners Association is that the Fund is not managed to a gain or loss for IHG, any in-year profit or loss resulting from Fund activity is excluded from the calculation of underlying operating profit and adjusted earnings per share as there is an agreement to spend these funds for the benefit of hotels in the System.

The impact of adopting IFRS 15 and other presentational changes (see note 3) on previously reported line items in the Group financial statements is set out on the following pages.

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  1. Segmental Information

With effect from 1 January 2018, an internal reorganisation resulted in the formation of a new operating segment, Europe, Middle East, Asia & Africa (EMEAA), bringing together the former segments of Europe and Asia, Middle East & Africa (AMEA). Kenneth Macpherson, previously CEO of Greater China, has been appointed CEO of the new EMEAA region. By bringing together two strong, established regions, there will be an increased focus on growth through increased agility and effectiveness.

Following this reorganisation, the management of the Group’s operations, excluding Central functions, is organised within three geographical regions:

  • Americas;
  • Europe, Middle East, Asia & Africa (EMEAA); and
  • Greater China.

These, together with Central functions, comprise the Group’s four reportable segments. Each of the geographical regions is led by its own Chief Executive Officer.

No operating segments have been aggregated to form these reportable segments.

Central functions include costs of global functions including technology, sales and marketing, finance, human resources and corporate services; central revenue arises principally from technology fee income.

Management monitors the operating results of the geographical regions and Central functions separately for the purpose of making decisions about resource allocation and performance assessment. The System Fund is not viewed as being part of the Group’s core operations as IHG is unable to profit from its activities. As such, its results are not regularly reviewed by the Chief Operating Decision Maker and it does not constitute an operating segment under IFRS 8.

Segmental performance is evaluated based on operating profit or loss and is measured consistently with operating profit or loss in the Consolidated Financial Statements, excluding exceptional items. Group financing activities and income taxes are managed on a group basis and are not allocated to reportable segments.

Comparatives have been restated for IFRS 15 (note 2) and presentational changes (note 3) to show segmental information on a consistent basis.

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  1. Disaggregation of revenue

The following tables present Group revenues disaggregated by type of revenue stream and by operating segment:

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