“All happy families resemble one another; each unhappy family is unhappy in its own way.”
It is not our intention here to suggest that business is an unhappy undertaking but it is true that every business is unique. It is the great variation that one finds in the operation of businesses that makes it almost impossible to teach complete business skills from a book or in a classroom; there is no substitute for front-line experience specific to the industry you are interested in.
Having said that, from the bookkeeper’s perspective there are certain commonly encountered transactions that arise in businesses that operate in similar industries. Our purpose here is to review some of these and how these impact the accounting records.
We will mention those commercial enterprises that have special sales tax accounting rules to consider.
The hospitality industry encompasses hotels, motels and similar providers of short-term accommodation, the restaurant industry and tourism. In North America, with the recent dramatic growth in gaming and its close association with the operation of hotels and restaurants, gaming is often treated as part of the hospitality industry.
Many hospitality industry enterprises provide both accommodation and food services. Because of the significant differences in the types of information to be provided, such organizations will typically establish branch or departmental accounting to report these activities separately.
Example - Hospitality Departments
A large urban hotel might have the following departments set up in its general ledger, with sub-departments listed below: RoomsFacilitiesEntertainmentRoom chargesMeeting roomsLobby barTelephone / fax / internetRestaurantNight clubMini-barCatering Room serviceRoom service
Separate departments are typically not set up for functions which are shared. However, in the example above, the facilities department which accounts for restaurant operations, could charge the rooms operation for meals or serve as the profit centre for such services.
A restaurant is really just a retail outlet, selling food and drink. Inventory management (the inventory is perishable) and payroll accounting are the major bookkeeping functions. Because restaurants often deal with substantial amounts of cash, cash management and control are important operational issues.
Every restaurant and bar experiences a certain amount of loss of stemware and china through breakage. As such items are replaced they are often simply expensed to a breakage expense account. It is not unusual to set up a breakage reserve to which actual replacement costs are charged.
Example - Accruing Breakage
A restaurant budgets for $2,000 a month of losses due to breakage. Every month the following entry is booked: Dr: Breakage loss expense$2,000 Cr: Reserve for breakage (balance sheet account) $2,000 As stemware and china are replaced, the replacement cost is charged to the reserve. In a month in which $3,500 of china is purchased, the entry is (ignoring sales taxes): Dr: Reserve for breakage$3,500 Cr: Cash / accounts payable $3,500 The balance in the reserve account is a measure at any given time on how actual breakage losses measure up against budget.
Where a restaurant accounts for breakage using the accrual system described above, adjustment must be made in determining income for income tax purposes:
GST and retail sales taxes apply to virtually all sales through a restaurant. Prepared foods that are sold for take-out are taxed in the same manner as meals consumed on premises.
The most profitable component in the operation of a hotel or similar establishment is the rooms operation. Indeed, most hotels provide meeting rooms, food service, entertainment, fitness facilities, etc. solely for the purpose of encouraging guests to stay in their rooms.
Having said that, it is normal for such a business to set up internal departments to track the various sources of revenue that a rooms operation will generate: the rooms themselves; telephone services (these tend to have very high margins); Internet services (if there is charge); in-room service, including mini-bar and pay-per-view television. The underlying accounts need to be set up to keep track of both revenues and related costs.
Most rooms are provided with a set of consumable items – soap, shampoo, mouthwash, shoe brushes, toilet paper, tissues, a morning newspaper, stationery, etc. – which the occupant is expected to use. Most operators budget a fixed amount per room night (such as $4.00/night) for the cost of such items, and do not bother to inventory them. Rather, periodically the cost of consumable supplies used is measured against the budget.
As with breakage for a restaurant, a hotel will often account for consumables by accruing the cost to a reserve and charging outlays to the reserve accrued.
Even though expenditures on consumables would normally be expensed, an adjustment is normally required for income tax purposes, as reserves are not generally deductible. The hotel will add back (deduct) any increase (decrease) in the amount of the reserve and deduct only the actual expenditure on consumables.
In addition to consumables, most rooms operations will experience ‘shrinkage’ – the slow but inevitable disappearance of linens and perhaps even larger items with the passage of time.
It is possible to perform an inventory of each room that is occupied on a daily basis as room service tidies the room, and many operations do this. Unless the loss is particularly large, the cost of replacing the inventory is simply expensed as part of the rooms’ operation charges.
Accommodation charges attract GST.
The ways in which the provinces tax accommodation charges vary. In some jurisdictions there is a specific hotel tax levied on accommodation charges; in others they are subject to regular retail sales tax; there may also be a municipal levy on the room charge.
The reference material published by each province should be consulted.
The tourism industry arranges travel, accommodation and like services for travel within Canada, for Canadians traveling outside Canada and for non-residents visiting Canada.
The major accounting issues arise in determining whether GST is to be applied to the operator’s charges. The rules are rather complex.
As would be expected, any charge for travel within Canada attracts GST. A charge for travel outside Canada, as it does not represent consumption in Canada, is zero-rated. Our GreenLearning article “Sales Taxes in Canada” provides a more detailed description of the application of the tax in general.)
The devil (as is usually the case) is in the detail. Separate rules are provided for assessing the tax status of travel that does not include air travel and travel that does. When traveling by air, ‘Canada’ becomes the ‘taxation area’ – Canada, the United States (other than Hawaii) and the islands of St. Pierre and Miquelon.
Because these rules are complex and not always intuitive, it is vitally important that they be well understood by those in charge of arranging for and billing international travel arrangements.
It is not unusual for the tourist industry to bundle together accommodation, travel and other services in a package. The package may include some services that are fully taxable and others that are zero-rated. The vendor of the package is required to assess the taxable component and charge GST (or HST) only that portion.
The vast majority of enterprises operating in the educational services field are not-for-profit entities. The bookkeeping issues specific to not-for-profits are discussed in detail in our GreenLearning article “Not For Profit Accounting”.
For-profit educational institutions are really retailers of a service and face no particularly complex bookkeeping issues.
Retail sales taxes generally do not apply to services and, particularly, do not apply to educational services.
There are very complex provisions which apply to govern the GST status of educational services.
The general rule is that any charge for an educational service provided by a school authority, university or public college that leads to certification in a defined program of education is exempt from GST. However, many of the related services that such institutions provide (cafeterias, book stores, merchandise, etc.) are taxable in the normal manner.
Depending of the level of activity, the number of courses offered and the sophistication of those doing the invoicing, it will likely make sense to associate sales tax codes in any computerized bookkeeping system with particular courses or programs.
Example - Using Sales Tax Codes
A public college offers the same art appreciation course in three separate streams. The course is offered to second-year students enrolled in the four-year fine arts degree program. The course is also offered to anyone who cares to follow a five-course program leading to a certificate in cultural studies. Finally, anyone can take the course singly for personal interest. The supply to the degree-program students is exempt because it is part of a degree program. The supply to those taking the certificate in cultural studies is also exempt because it is part of a program that involves two or more courses, provided only that the program has been approved by the appropriate board of the college. The individual course should be taxed. The college has assigned three codes to the course. The first four digits identify the course, the last two digits indicate which program it belongs to and assign a sales tax code. The first two are exempt; the last is taxable.
There are many different types of business that are described as ‘real estate’, including brokerages, real estate developers, rental accommodation providers, commercial property providers and so on.
Partnerships and joint ventures are probably more commonly encountered in the real estate industry than in any other (with the possible exception of natural resource exploration). This reflects two facts: real estate development and ownership often brings together two or more parties on a project-by-project basis; and, the participants commonly want to flow through the financial and tax reporting for the undertaking.
Thus, the bookkeeping issues reviewed in our GreenLearning article “Partnerships & Joint Ventures” are commonly encountered in dealing with real estate.
Owners of Real Estate
In most businesses it is usual to report current assets and current liabilities separately from non-current assets and long term liabilities, respectively. This is not true in reporting for entities that own real estate. The concept of short-term means something quite different to a business whose underlying assets have a life cycle measured in decades. Therefore, most real estate businesses do not present long- and short-term disclosures in their financial statements.
GST accounting is the primary source of complexity in bookkeeping for rental accommodation. The general rule is that any charge for such accommodation is exempt so that GST is not charged and the enterprise cannot recover any of the GST it pays.
These exempting provisions generally turn on the period for which the property is leased (it must be 30 days or more to be exempt) or the rental charge (it is exempt if under $20 a day, no matter how long the property is rented for). The exempting provisions carry over to related laundry facilities and parking.
Commercial Real Estate
Enterprises that build commercial real estate typically build it to own it and rent it out. While individual properties may, of course, be bought and sold most such enterprises are not in the business of building properties for sale.
There is an exception: the design-build trade. Design-build developers are businesses which build commercial property to the specification of a particular user. A manufacturing company, for example, may need a new plant but will have little or no experience in development. The company may choose to contract with a design-builder who constructs the property to specification and hand it over on a turn-key basis.
The design-build trade is really a type of contracting, and project cost accounting becomes particularly important. This was discussed in detail in our GreenLearning article “Construction Accounting”.
Where properties are built for ownership and long-term rental, the key issue becomes capturing capital costs during construction and including them in the cost of the project.
Most commercial leases allow the landlord to recover operating costs from the tenants. Such leases are referred to as ‘net leases’ and they allow the landlord to pass on to the tenant that tenant’s share of the property’s operating costs. In contrast, a lease which provides only for base rent and does not permit the landlord to recover operating costs is called a ‘gross lease’.
Some of the more common recoverable operating expenses that an owner can recover in a net lease are listed below. The precise items that are to be paid by the tenant are specified in a written lease.
There can be significant amounts of bookkeeping involved in tracking costs and recovering them from tenants. This complexity arises because it is rare indeed for all tenants in a particular property to have the same commercial arrangement, so that the landlord is required to calculate and bill each tenant’s participation separately.
Example - Cost Recoveries
A commercial property landlord has a property in which it has two tenants. Tenant A entered into the lease in 2012 and pays $14.00 a foot for 10,000 feet, plus its share of cost increases from 2012. Tenant B entered into the lease in 2014 and pays $15.00 a foot for 5,000 feet plus is share of cost increases from that year. Each lease provides the landlord with a fee of 15% of recoveries. Total recoverable costs in 2012 were $18,000; in 2014 were $19,200; and in the current year are $21,300. The recoveries in the current year are calculated as follows: ABTotal recoverable costs$21,300$21,300Less: base year(18,000)(19,200)Net$ 3,300$ 2,100Share - 10,000 / 15,000$ 2,200 Share - 5,000 / 15,000 $ 700 The entry to record the recoveries is: Dr: Accounts receivable$ 3,501.75 Cr: GST collected on revenue $ 166.75Cr: Tenant recoveries (a revenue account) $ 2,900.00Cr: Management fee income $ 435.00
Even where all tenants contribute to cost recoveries, the portion of the actual costs they cover will typically vary because participation is usually based on increases in costs from the ‘base’ year in which the lease is entered into. This concept is demonstrated in the following example.
It is not usual for the lease to call for the landlord to add a fee to the amount of the expense recovery billed, which compensates the landlord for the extra costs involved in preparing the cost recovery billing.
GST is added to the billing (where the landlord is a registrant) based on the rate that is applicable to the province in which the building is located – 15% in Newfoundland and Labrador, New Brunswick, PEI and Nova Scotia; 13% in Ontario; 5% elsewhere.
Many real estate businesses own both commercial and residential property.
While bookkeeping for the operations does not create any new issues, issues will arise on the allocation of GST paid on costs that relate to both types of activity. The allocation of tax paid by an enterprise making both taxable and exempt supplies is discussed in detail in our GreenLearning article “Sales Taxes in Canada”.
There are a couple of GST issues that can be important to those in the commercial property business.
First, any amount billed under a lease to a commercial tenant is treated as rent and is subject to tax, even if it is calculated with respect to an outlay that is otherwise exempt. For example, a landlord may recover from its tenants the landlord’s cost of insurance. While the insurance premium paid by the landlord did not attract GST, the on-billing does as the insurance loses its nature and is treated simply as additional rent.
Second, where real property is sold to a registrant in a taxable supply (which would include all sales of commercial property) a special rule precludes the vendor from charging GST. Rather, the purchaser is required to self-assess tax and, presuming the property continues to be used in making taxable supplies, can claim an offsetting input tax credit at the same time. This rule effectively relieves the parties from having to remit tax on the sale and claim back an input tax credit.
New Home Builders
A new home builder is very much like a general contractor and the issues that were discussed in detail in our GreenLearning article “Construction Accounting” are generally relevant. There is one aspect of accounting for the builder of a new home that is unique, however, and that is the accounting for GST on the sale of such a home.
The New Homes Rebate
The exempting provisions that apply to the sale or rental of residential real estate only apply to the sale of a home if it is used; the sale of a new home is taxable. A home is considered to be ‘new’ for these purposes if it is newly constructed and has never been occupied or, if it was previously occupied, it has been substantially renovated since its last occupancy.
The GST was introduced as a replacement for the old Federal Sales Tax which applied to manufactured goods. The FST did not apply to the sale of land and the application of the GST to land sales was a new tax on land. In response to lobbying from the home-building industry, the GST includes a provision which is effectively designed to rebate back to the purchaser of a new home the GST that has been paid on its purchase that relates to the value of the land. Since the land price is almost never broken out on the sale of a new home, an arbitrary measure of this tax is calculated and given back to the home purchaser as a new homes rebate.
Example - New Home Rebate
Andrew purchases a new home for $212,000 in a province where the GST rate is 5%. The builder will charge Andrew GST of 5% of $212,000 = $10,600. Andrew is entitled to apply for a new homes rebate of the lesser of 36% of the tax paid $3,816.00 and $7,560.00. Andrew will submit his rebate application and, in due course, receive a cheque for $3,816.00.
The requirement that GST has to be paid up front on the purchase of a home and then the purchaser applies for a rebate creates a cash flow problem for the purchaser. In recognition of this, the purchaser is allowed to assign the GST rebate, to which he or she is entitled, to the builder. The builder can then reduce the cash required by the amount of the rebate.
Example - Assignment of New Home Rebate
Andrew assigns his rebate to the vendor of the home. The home builder collects $218,784 from Andrew – the sales price of $212,000, plus the gross GST due of $10,600 less the new homes rebate of $3,816. When it files its GST return, the builder remits $6,784 – the gross GST of $10,600 less the rebate of $3,816. This is recorded by the builder as follows: Dr: Cash$ 218,784 Dr: GST new homes rebate receivable$ 3,816 Cr: Sales $ 212,000Cr: GST collected on sales $ 10,600
It is not possible to inventory all the special bookkeeping issues that arise in the various forms of business enterprise the bookkeeper will encounter.
In this GreenLearning article we have attempted to survey some issues that relate to a few selected industries.
We can assist you with advice and reporting as it relates to these various business issues for Hospitality, Tourism and Real Estate - we can also assist with you many other types of industry accounting. If you don't see your industry as it relates to your small business in Canada, just ask! Here at Green Quarter Consulting - Accounting and Bookkeeping Services for Small Businesses in White Rock South Surrey, Vancouver, Langley and Surrey BC, we assist Small Business Owners with analyzing transactions, sources of income and your tax risks and how they relate to your specific business strategy. Learn more about our Greenstamp CFO Services here.