Question

Compensation to a customer when overbooking happens is an expense, right?

A friend of mine that booked a hotel on a site, notified her that there was an overbooking. The site compensated her by giving her a 5 start hotel instead. Compensating her by upgrading her hotel. The site probably paid the amount left that needed to be paid. In order to compensate my friend, right? This cost would go into the site's expense cost?

Answer 1

Overbooking is done to avoid the loss of revenue in case of cancellation of order. Organization generally assumes that there would be certain percent of bookings that would be cancelled by any reason. So to avoid loss of income in the event of cancellation, the organization overbooks, that is accepting orders more than the capacity or availability.

Overbooking is to be accounted by using marginal costing approach. Means, marginal cost of overbooking and marginal revenue from accepting one order(which was expected to cancel, but accepted) is compared.

In the given question, compensation is paid by a site to a customer due to overbooking by paying excess amount to customer due to shifting her at five star hotel.

If we compare revenue and cost room by room (Means for a single customer) then certainly, this compensation is an expense for the site as marginal cost is more than marginal revenue, as the site has to pay to a customer more than what is received from booking a room of its own hotel.

If we compare the total revenue and total cost for all overbookings, then it is possible that marginal revenue is more than marginal cost, if overbooking is less and and accepting of rooms of its own hotel is full according to the capacity of hotel. That is, if there is possibility of 10% cancellation of rooms, so site accepts offers equal to 10%, but overbooking is only to the extent of say, 4%, then the marginal revenue is more than marginal cost, that is by 6%. In this case, it will not result in expense, due to marginal costing approach.