1. Company Information and Significant Accounting Policies

   Company Information.

      Choice Hotels International, Inc. and subsidiaries (together "the Company") is in the business of hotel franchising. As of December 31, 2002, the Company had franchise agreements with 4,664 open hotels and 474 hotels under development in 48 countries and territories under the following brand names: Comfort, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites and Flag.

   Principles of Consolidation.

     The consolidated financial statements include the accounts of Choice Hotels International, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

     On July 1, 2002, the Company acquired a controlling interest in Flag Choice Hotels ("Flag"). Flag, based in Melbourne, Australia, is a franchisor of hotels in Australia, Papua New Guinea, Fiji and New Zealand. The results of Flag have been consolidated since that date.

   Revenue Recognition.

     The Company accounts for initial franchise fees in accordance with Statement of Financial Accounting Standards ("SFAS") No. 45, "Accounting for Franchise Fee Revenue." The Company enters into franchise agreements committing to provide franchisees with various marketing services, a centralized reservation system and limited rights to utilize the Company's registered tradenames and trademarks. These agreements typically have an initial term of twenty years with provisions permitting franchisees to terminate after five, ten, or fifteen years under certain circumstances. In most instances, initial franchise fees are recognized upon execution of the franchise agreement because the initial franchise fee is non-refundable and the Company has no continuing obligations related to the franchisee. The initial franchise fee related to executed franchise agreements which include incentives, such as future potential rebates, are deferred and recognized when the incentive criteria are met or the agreement is terminated, whichever occurs first.

     Royalty fees, which are typically based on a percentage of gross room revenues of each franchisee, are recorded when earned. Reserves for uncollectible royalty fees are charged to bad debt expense and are included in selling, general and administrative expenses in the accompanying consolidated statements of income.

     The Company generates partner services revenues from hotel industry vendors. Partner services revenues are generally earned based on the level of goods or services purchased from endorsed vendors by hotel owners and hotel guests who stay in the Company's franchised hotels. The Company accounts for these revenues in accordance with Staff Accounting Bulletin No. 101, ("SAB 101") "Revenue Recognition." SAB 101 provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The Company recognizes partner services revenues when the services are performed or the product delivered, evidence of an arrangement exists, the fee is fixed and determinable and collectibility is probable. SAB 101 requires the Company to defer the recognition of partner services revenues related to upfront fees. Such upfront fees are generally recognized over a period corresponding to the Company's estimate of the life of the arrangement.

     The Company's franchise agreements require the payment of franchise fees, including marketing and reservation fees, which are used exclusively by the Company for expenses associated with providing franchise services such as national marketing, media advertising, central reservation systems and technology services. The Company is contractually obligated to expend the marketing and reservation fees it collects from franchisees in accordance with the franchise agreements; as such, no income or loss to the Company is generated. As described below, the Company changed its presentation of marketing and reservation revenues and expenses to a gross basis during the fourth quarter of 2001.

   Presentation of Marketing and Reservation Revenues and Expenses.

     The Company revised its presentation of marketing and reservation revenues during the fourth quarter of 2001 to comply with Emerging Issues Task Force ("EITF") Issue No. 99-19 "Reporting Revenue Gross as a Principal versus Net as an Agent." The Company had previously presented these revenues net of related expenses on its consolidated statements of income. EITF 99-19 requires that these revenues be recorded gross and accordingly, the Company has revised its financial statement presentation for all periods presented. In addition, net advances from and repayments related to marketing and reservation activities have been reclassified to present these activities as cash flows from operating activities for all periods presented. These revisions had no effect on the net income or cash flows reported during the periods revised.

   Credit Risk and Exposure.

     Substantially all of the Company's trade receivables as well as the receivable for marketing and reservation fees are due from hotel franchisees. However, the Company considers its credit risk associated with trade receivables and the marketing and reservation fees minimal due to the dispersion of the Company's receivables across a large number of geographically diverse franchisees.

     The Company records bad debt expense which is included in selling, general and administrative expenses in the accompanying consolidated statements of income based on its assessment of the ultimate realizability of receivables considering historical collection experience and the economic environment. When the Company determines that an account is not collectible, the account is written-off to the associated allowance for doubtful accounts. Bad debts have historically been minimal.

   Advertising Costs.

     The Company expenses advertising costs as the advertising occurs in accordance with American Institute of Certified Public Accountants, Statement of Position 93-7, "Reporting on Advertising Costs". Advertising expense was $41.8 million, $55.1 million and $48.4 million for the years ended December 31, 2002, 2001, and 2000, respectively. The Company includes advertising costs in marketing and reservation expenses on the accompanying consolidated statements of income.

   Cash and Cash Equivalents.

     The Company considers all highly liquid investments purchased with a maturity of three months or less at the date of purchase to be cash equivalents. As of December 31, 2002 and 2001, $5.0 million and $8.6 million, respectively, of book overdrafts representing outstanding checks in excess of funds on deposit have been classified in accounts payable in the accompanying consolidated balance sheets.

   Capitalization Policies.

     Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Major renovations, replacements and interest incurred during construction are capitalized. Upon sale or retirement of property, the cost and related accumulated depreciation are eliminated from the accounts and the related gain or loss is recognized in the accompanying consolidated statements of income. Maintenance, repairs and minor replacements are charged to expense as incurred.

   Impairment Policy.

     The Company evaluates the impairment of property and equipment and other long-lived assets, including franchise rights and other definite-lived intangibles, in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 states that an impairment of long-lived assets has occurred whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured based on net, undiscounted expected cash flows. Assets are considered to be impaired if the net, undiscounted expected cash flows are less than the carrying amount of the assets. Impairment charges are recorded based upon the difference between the carrying value of the asset and the fair value. The Company did not record any impairment on long-lived assets during the three years ended December 31, 2002.

     The Company evaluates the impairment of goodwill in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," which requires goodwill to be assessed on at least an annual basis for impairment using a fair value basis. Because the Company operates in one reporting segment in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" and related interpretations, the fair value of the Company's total assets are used to determine if goodwill may be impaired. According to SFAS No. 142, quoted market prices in active markets are the best evidence of fair value and shall be used as the basis for the measurement if available. The Company did not record any impairment of goodwill in 2002, 2001 or 2000 based on assessments performed by the Company.

     The Company evaluates the collectibility of notes receivable in accordance with SFAS No. 114, "Accounting by Creditors For Impairment of a Loan". SFAS No. 114 states that a loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. The Company reviews outstanding notes receivable on a periodic basis to ensure that each is fully collectible by reviewing the financial condition of its debtors. If the Company concludes that it will be unable to collect all amounts due, the Company will record an impairment charge based on the present value of expected future cash flows, discounted at the loan's effective interest rate. The Company did not record any impairment charges related to notes receivable during the years ended December 31, 2002 or 2001. During the year ended December 31, 2000, the Company recorded $7.6 million of impairment losses related to its subordinated term note to Sunburst Hospitality Corporation (see Note 7).

   Deferred Financing Costs.

     Debt financing costs are deferred and amortized, using the effective interest method, over the term of the related debt. As of December 31, 2002 and 2001, deferred financing costs were $2.1 million and $2.7 million, respectively, and are included in other non-current assets on the accompanying consolidated balance sheets.

   Investments.

     The Company accounts for its investments in the common stock of Choice Hotels Scandinavia ("CHS") in accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities" and SFAS No. 130 "Reporting Comprehensive Income." The Company accounts for its investment in Choice Hotels Canada, Inc. ("CHC") in accordance with Accounting Principles Board Opinion ("APB") No. 18 "The Equity Method of Accounting for Investments in Common Stock."

   Derivatives.

     SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," establishes accounting and reporting standards for derivative instruments, including derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 requires the recognition of the fair value of derivatives in the balance sheet, with changes in the fair value recognized either in earnings or as a component of other comprehensive income dependent upon the hedging nature of the derivative. SFAS No. 133 also states that any deferred gain on previous hedging activity does not meet the definition of a liability, due to a lack of expected future cash flows and therefore should be included in comprehensive income. Except for the Flag put option discussed in Note 11, the Company has no derivative financial instruments.

   Stock-based compensation.

     The Company accounts for its stock-based employee compensation plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense related to fixed employee stock options is recorded only if on the date of grant the fair value of the underlying stock exceeds the exercise price. The Company adopted the disclosure only requirements of SFAS No. 123, "Accounting for Stock-Based Compensation," which allows entities to continue to apply the provisions of APB Opinion No. 25 for transactions with employees and to provide pro forma net income disclosures as if the fair value based method of accounting, described in SFAS No. 123, had been applied to employee stock option grants.

     The Company's stock option plans are described more fully in Note 14. No compensation expense related to the Company's stock option plans was reflected in net income for the three years ended December 31, 2002, as all options granted under those plans had an exercise price equal to market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of SFAS No. 123.

	Years Ended December 31,
		2002			2001			2000
	(In thousands, except per share amounts)
Net income, as reported		$60.8			$14.3			$42.4
Total stock-based employee compensation expense determined under    fair value method for all awards, net of tax effects		(2.6)			(3.0)			(3.9)
Pro forma net income		$58.2			$11.3			$38.5
Earnings per share:
Basic-as reported		$1.55			$0.32			$0.80
Basic-pro forma		$1.48			$0.25			$0.72
Diluted-as reported		$1.52			$0.32			$0.80
Diluted-pro forma		$1.45			$0.25			$0.73

     Effective January 1, 2003, the Company adopted, in accordance with SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure," the fair value based method of accounting for stock option awards granted on or after January 1, 2003.

   Notes Receivable.

     From time to time, the Company provides financing to franchisees for property improvements and other purposes in the form of interest free notes. The notes typically have a term of 10 years and are forgiven and amortized over that time period if the franchisee remains in the system in good standing. As of December 31, 2002 and 2001, other assets included $5.0 million and $1.8 million, respectively, of these notes. Amortization expense related to the notes was $0.4 million, $0.1 million and $35,000, respectively, for the years ended December 31, 2002, 2001 and 2000.

   Income Taxes.

     Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the financial statements or income tax returns. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted rates expected to apply to taxable income in the years in which those differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

   Earnings per Share.

     Basic earnings per share excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share, assumes dilution and is computed based on the weighted-average number of common shares outstanding after consideration of the dilutive effect of stock options.

   Use of Estimates.

     The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States and require management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.