There is a lot of buying and selling going on right now. So this week I want to touch on a slightly different topic- settlement statements. Specifically prorations. If you are purchasing a hotel, you will likely see prorations on your closing statement. It’s important to understand them and receive all the appropriate backup from the seller for those numbers. It’s also important to know going in that they can get messy.
First of all, prorations just mean certain expenses are prorated to make sure the buyer and seller both pay for their portion of the expense. For example, the seller may have paid for a one year contract for services that the buyer will continue to benefit from. So, if the hotel is sold on July 1, the cost of 6 months of that expense may be added to the purchase price.
Usually, prorations raise the purchase price because the buyer is agreeing to purchase an expense that the seller has prepaid.
Property taxes are the most common proration for a home or hotel purchase, so most people are familiar with that one. It could impact the purchase price in either direction depending on whether they are prepaid or paid the following year.
On a residential purchase, taxes and insurance may be the only prorated items. The “prorations” section can become quite detailed for a hotel purchase though if the buyer has detailed records of their prepaids and the seller agrees to purchase.
The Guest Ledger is often included in the proration section of your settlement statement. Advanced Deposits could be listed as well. Advanced Deposits would have the opposite impact as the others, and decrease the purchase price though. In that case, the buyer is going to have to offer services that the seller received payment for.
The buyer may also be purchasing inventory on the settlement statement.
The bottom line is, if you’re purchasing, you need to make sure you understand all the items on the closing statement and that you receive backup for all of it so that it can be properly recorded on your Balance Sheet (and expensed at the right time).
If you’re purchasing the Guest Ledger or Advanced Deposits, make sure that is the exact balance that comes over when the PMS switches to your account.
If you’re purchasing inventory, make sure you agree to the count and that you receive the product.
If you are purchasing prepaids (including any taxes and insurances), make sure that you receive copies of all the invoices so that you know when and how to expense them, and what vendor agreements you are essentially inheriting.
I think because these items make up such a small percentage of the purchase price, they often get lost in the shuffle. They are overlooked because they don’t seem material at the time.
However, if you don’t receive backup, it could hold up your accountant's ability to record the purchase, and ultimately, you may have to write-off the entire balance.
So that’s your little note about prorations this week! Let me know if you have any questions.