3. Summary of Significant Accounting Policies

Revenue Recognition and Promotional Allowances

Gaming revenue is the aggregate net difference between gaming wins and losses, with liabilities recognized for funds deposited by customers before gaming play occurs, for chips and “ticket-in, ticket-out” coupons in the customers’ possession, and for accruals related to the anticipated payout of progressive jackpots. Progressive slot machines, which contain base jackpots that increase at a progressive rate based on the amounts played, are charged to revenue as the amount of the jackpots increase.

Food, beverage and other revenue, including racing revenue, is recognized as services are performed. Racing revenue includes the Company’s share of pari-mutuel wagering on live races after payment of amounts returned as winning wagers, its share of wagering from import and export simulcasting, and its share of wagering from its off-track wagering facilities.

Revenue from the management service contract for Casino Rama is based upon contracted terms and is recognized when services are performed.

Revenues are recognized net of certain sales incentives in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605-50, “Revenue Recognition—Customer Payments and Incentives.” The Company records certain sales incentives and points earned in point-loyalty programs as a reduction of revenue.

The retail value of accommodations, food and beverage, and other services furnished to guests without charge is included in gross revenues and then deducted as promotional allowances. The estimated cost of providing such promotional allowances is primarily included in food, beverage and other expense.

The amounts included in promotional allowances for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	(in thousands)
Rooms	$	8,426	$	8,993	$	16,497	$	18,312
Food and beverage	26,794		31,232		53,392		63,722
Other	2,471		2,944		4,733		5,721
Total promotional allowances	$	37,691	$	43,169	$	74,622	$	87,755

The estimated cost of providing such complimentary services for the three and six months ended June 30, 2014 and 2013 are as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	(in thousands)
Rooms	$	2,530	$	3,121	$	5,240	$	6,360
Food and beverage	18,482		21,119		37,354		43,098
Other	1,471		1,383		2,801		3,027
Total cost of complimentary services	$	22,483	$	25,623	$	45,395	$	52,485

Gaming and Racing Taxes

The Company is subject to gaming and pari-mutuel taxes based on gross gaming revenue and pari-mutuel revenue in the jurisdictions in which it operates. The Company primarily recognizes gaming and pari-mutuel tax expense based on the statutorily required percentage of revenue that is required to be paid to state and local jurisdictions in the states where or in which wagering occurs. In certain states in which the Company operates, gaming taxes are based on graduated rates. The Company records gaming tax expense at the Company’s estimated effective gaming tax rate for the year, considering estimated taxable gaming revenue and the applicable rates. Such estimates are adjusted each interim period. If gaming tax rates change during the year, such changes are applied

prospectively in the determination of gaming tax expense in future interim periods. Finally, the Company recognizes purse expense based on the statutorily required percentage of revenue that is required to be paid out in the form of purses to the winning owners of horse races run at the Company’s racetracks in the period in which wagering occurs. For the three and six months ended June 30, 2014, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of operations, were $223.2 million and $442.6 million, respectively, as compared to $267.0 million and $549.0 million for the three and six months ended June 30, 2013, respectively.

Rental Expense related to the Master Lease

As of June 30, 2014, the Company leases from GLPI real property assets associated with 17 of the Company’s gaming and related facilities used in the Company’s operations. The rent structure under the Master Lease, which became effective November 1, 2013, includes a fixed component, a portion of which is subject to an annual 2% escalator if certain rent coverage ratio thresholds are met, and a component that is based on the performance of the facilities, which is prospectively adjusted, subject to certain floors (i) every 5 years by an amount equal to 4% of the average change to net revenues of all facilities under the Master Lease (other than Hollywood Casino Columbus and Hollywood Casino Toledo) during the preceding five years, and (ii) monthly by an amount equal to 20% of the change in net revenues of Hollywood Casino Columbus and Hollywood Casino Toledo during the preceding month.

In April 2014, an amendment to the Master Lease was entered into in order to amend certain provisions relating to the Sioux City property. Per the amendment, upon ceasing gaming operations at Argosy Casino Sioux City due to the termination of its gaming license, the annual rent will be reduced by $6.2 million (see Item 6.Exhibit 10.4). On July 30, 2014, the Company closed its facility in Sioux City, Iowa.

The Master Lease is commonly known as a triple-net lease. Accordingly, in addition to rent, the Company is required to pay the following, among other things: (1) all facility maintenance; (2) all insurance required in connection with the leased properties and the business conducted on the leased properties; (3) taxes levied on or with respect to the leased properties (other than taxes on the income of the lessor); and (4) all utilities and other services necessary or appropriate for the leased properties and the business conducted on the leased properties. At the Company’s option, the Master Lease may be extended for up to four five-year renewal terms beyond the initial 15-year term, on the same terms and conditions.

Total rental expense under the Master Lease was $104.6 million and $208.9 million for the three and six months ended June 30, 2014, respectively.

Long-term asset related to the Jamul Tribe

On April 5, 2013, the Company announced that, subject to final National Indian Gaming Commission approval, it and the Jamul Indian Village (the “Jamul Tribe”) had entered into definitive agreements to jointly develop a Hollywood Casino-branded casino and resort on the Jamul Tribe’s trust land in San Diego County, California. The definitive agreements were entered into to: (i) secure the development, management, and branding services of the Company to assist the Jamul Tribe during the pre-development and entitlement phase of the project; (ii) set forth the terms and conditions under which the Company will provide a loan or loans to the Jamul Tribe to fund certain development costs; and (iii) create an exclusive arrangement between the parties. The proposed $360 million development project will include a three-story gaming and entertainment facility of approximately 200,000 square feet featuring over 1,700 slot machines, 50 live table games, including poker, multiple restaurants, bars and lounges and a partially enclosed parking structure with over 1,900 spaces. In mid-January 2014, the Company announced the commencement of construction activities at the site and it is anticipated that the facility will open in mid-2016. The Company may, under certain circumstances, provide backstop financing to the Jamul Tribe in connection with the project and, upon opening, will manage and provide branding for the casino and resort.

In accordance with this project and the related agreements, the Company has a note receivable with the Jamul Tribe for $29.5 million and $7.0 million at June 30, 2014 and December 31, 2013, respectively, which is included in Other Assets within the condensed consolidated balance sheets. Collectability of the note receivable will be derived from the revenues of the casino operations once the project is completed. Based on the Company’s current progress with this project, the Company believes collectability of the note is highly certain. However, in the event that the Company’s internal projections related to the profitability of this project and/or the timing of the opening are inaccurate, the Company may be required to record a reserve related to the collectability of this note receivable.

Earnings Per Share

The Company calculates earnings per share (“EPS”) in accordance with ASC 260, “Earnings Per Share” (“ASC 260”). Basic EPS is computed by dividing net income applicable to common stock by the weighted-average number of common shares outstanding during the period. Diluted EPS reflects the additional dilution for all potentially-dilutive securities such as stock options and unvested restricted shares.

At June 30, 2014, the Company had outstanding 8,624 shares of Series C Preferred Stock and at June 30, 2013, had outstanding 12,050 shares of Series B Redeemable Preferred Stock (“Series B Preferred Stock”). The Company determined that both classes of preferred stock qualified as a participating security as defined in ASC 260 since these securities participate in dividends with the Company’s common stock. Under ASC 260, a security is considered a participating security if the security may participate in undistributed earnings with common stock, whether that participation is conditioned upon the occurrence of a specified event or not. In accordance with ASC 260, a company is required to use the two-class method when computing EPS when a company has a security that qualifies as a “participating security.” The two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is included in the computation of basic EPS using the two-class method. Under the two-class method, basic EPS for the Company’s common stock is computed by dividing net income applicable to common stock by the weighted-average common shares outstanding during the period. Diluted EPS for the Company’s common stock is computed using the more dilutive of the two-class method or the if-converted method.

Since the Company reported a net loss for the three months ended June 30, 2013, it was required by ASC 260 to use basic weighted-average common shares outstanding, rather than diluted weighted-average common shares outstanding, when calculating diluted EPS for the three months ended June 30, 2013. In addition, since the Company reported a loss from operations for the three months ended June 30, 2013, the Series B Preferred Stock was not deemed to be a participating security for the three months ended June 30, 2013, pursuant to ASC 260 as the Series B Preferred Stock is not obligated to participate in the losses of the Company. The basic weighted-average common shares outstanding for the three months ended June 30, 2013 were 78,306,436.

The following table sets forth the allocation of net income for the three months ended June 30, 2014 and the six months ended June 30, 2014 and 2013 under the two-class method:

	Three Months Ended June 30,		Six Months Ended June 30,
	2014		2014		2013
	(in thousands)
Net income	$	4,176	$	8,713	$	53,091
Net income applicable to preferred stock	414		866		9,983
Net income applicable to common stock	$	3,762	$	7,847	$	43,108

The following table reconciles the weighted-average common shares outstanding used in the calculation of basic EPS to the weighted-average common shares outstanding used in the calculation of diluted EPS for the three months ended June 30, 2014 and the six months ended June 30, 2014 and 2013:

	Three Months Ended June 30,	Six Months Ended June 30,
	2014	2014	2013
	(in thousands)
Determination of shares:
Weighted-average common shares outstanding	78,458	78,189	77,932
Assumed conversion of dilutive employee stock-based awards	1,800	1,903	3,058
Assumed conversion of restricted stock	54	97	92
Diluted weighted-average common shares outstanding before participating security	80,312	80,189	81,082
Assumed conversion of preferred stock	8,624	8,624	22,850
Diluted weighted-average common shares outstanding	88,936	88,813	103,932

Options to purchase 935,147 shares were outstanding during the three and six months ended June 30, 2014, but were not included in the computation of diluted EPS because they were antidilutive. Options to purchase 10,638,637 shares were outstanding during the three months ended June 30, 2013, but were not included in the computation of diluted EPS because they were antidilutive since the Company reported a loss from operations for the three months ended June 30, 2013. Options to purchase 99,625 shares were outstanding during the six months ended June 30, 2013, but were not included in the computation of diluted EPS because they were antidilutive.

The following table presents the calculation of basic EPS for the Company’s common stock (in thousands, except per share data):

	Three Months Ended June 30,		Six Months Ended June 30,
	2014		2014		2013
Calculation of basic EPS:
Net income applicable to common stock	$	3,762	$	7,847	$	43,108
Weighted-average common shares outstanding	78,458		78,189		77,932
Basic EPS	$	0.05	$	0.10	$	0.55

The following tables present the calculation of diluted EPS for the Company’s common stock (in thousands, except per share data):

	Three months ended June 30,		Six months ended June 30,
	2014		2014

Calculation of diluted EPS using two-class method:
Net income applicable to common stock	$	3,762	$	7,847
Diluted weighted-average common shares outstanding before participating security	80,312		80,189
Diluted EPS	$	0.05	$	0.10

	Six months ended June 30,
	2013

Calculation of diluted EPS using if-converted method:
Net income	$	53,091
Diluted weighted-average common shares outstanding	103,932
Diluted EPS	$	0.51

Stock-Based Compensation

The Company accounts for stock compensation under ASC 718, “Compensation-Stock Compensation,” which requires the Company to expense the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. This expense is recognized ratably over the requisite service period following the date of grant.

The fair value for stock options was estimated at the date of grant using the Black-Scholes option-pricing model, which requires management to make certain assumptions. The risk-free interest rate was based on the U.S. Treasury spot rate with a term equal to the expected life assumed at the date of grant. Expected volatility was estimated based on the historical volatility of the Company’s stock price over a period of 5.45 years, in order to match the expected life of the options at the grant date. Historically, at the grant date, there has been no expected dividend yield assumption since the Company has not paid any cash dividends on its common stock since its initial public offering in May 1994 and since the Company intends to retain all of its earnings to finance the development of its business for the foreseeable future. The weighted-average expected life was based on the contractual term of the stock option and expected employee exercise dates, which was based on the historical and expected exercise behavior of the Company’s employees. The Company granted 916,522 stock options during the six months ended June 30, 2014.

The Company’s cash-settled phantom stock unit awards (“PSUs”), which vest over a period of four to five years, entitle employees and directors to receive cash based on the fair value of the Company’s common stock on the vesting date. The PSUs are accounted for as liability awards and are re-measured at fair value each reporting period until they become vested with compensation expense being recognized over the requisite service period in accordance with ASC 718-30, “Compensation—Stock Compensation, Awards Classified as Liabilities.” The Company has a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its PSUs of $3.4 million and $6.8 million at June 30, 2014 and December 31, 2013, respectively.

For the Company’s stock appreciation rights (“SARs”), the fair value of the SARs is calculated during each reporting period and estimated using the Black-Scholes option pricing model based on the various inputs discussed below. The Company’s SARs, which vest over a period of four years, are accounted for as liability awards since they will be settled in cash. The Company has a liability, which is included in accrued salaries and wages within the condensed consolidated balance sheets, associated with its SARs of $10.3 million and $11.4 million at June 30, 2014 and December 31, 2013, respectively.

In connection with the Spin-Off of GLPI, the Company’s employee stock options and SARs were converted into two awards, an award in Penn with an adjusted exercise price and an award in GLPI. The number of options and SARs and the exercise price of each converted award were adjusted to preserve the same intrinsic value of the awards that existed immediately prior to the Spin-Off. As such, no incremental compensation expense was recorded as a result of this conversion. In addition, holders of outstanding restricted stock awards and PSUs received an additional share of restricted stock or PSUs in GLPI common stock at the Spin-Off so that the intrinsic value of these awards were equivalent to those that existed immediately prior to the Spin-Off. The unrecognized compensation costs associated with GLPI restricted stock awards, GLPI PSUs, GLPI stock options and GLPI SARs held by Penn employees will continue to be recognized on the Company’s financial statements over the awards remaining vesting periods.

Stock-based compensation expense for the three and six months ended June 30, 2014 was $2.5 million and $5.1 million, respectively, as compared to $5.4 million and $11.7 million for the three and six months ended June 30, 2013, respectively. The decrease is primarily due to the fact that certain members of Penn’s executive management team transferred their employment to GLPI following the Spin-Off.

For PSUs held by Penn employees, there was $13.1 million of total unrecognized compensation cost at June 30, 2014 that will be recognized over the grants remaining weighted average vesting period of 2.60 years. For the three and six months ended June 30, 2014, the Company recognized $1.2 million and $2.6 million, respectively, of compensation expense associated with these awards, as compared to $2.2 million and $5.0 million for the three and six months ended June 30, 2013, respectively. Amounts paid by the Company for the three and six months ended June 30, 2014 on these cash-settled awards totaled $0.1 million and $6.0 million, respectively, and for the three and six months ended June 30, 2013 totaled $0.1 million and $3.7 million, respectively.

For SARs held by Penn employees, there was $9.2 million of total unrecognized compensation cost at June 30, 2014 that will be recognized over the awards remaining weighted average vesting period of 2.60 years. For the three and six months ended June 30, 2014, the Company recognized ($0.2) million and $0.1 million, respectively, of compensation expense associated with these awards, as compared to $0.9 million and $3.7 million for the three and six months ended June 30, 2013, respectively. The reason for these declines was due to a drop in the stock prices of GLPI and Penn common stock during 2014. Amounts paid by the Company for the three and six months ended June 30, 2014 on these cash-settled awards totaled $0.7 million and $1.2 million, respectively, and for the three and six months ended June 30, 2013 totaled $0.6 million and $1.3 million, respectively.

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model at June 30, 2014 and 2013:

	2014		2013

Risk-free interest rate	1.68	%	1.08	%
Expected volatility	44.80	%	46.27	%
Dividend yield	—		—
Weighted-average expected life (years)	5.45		6.57

Segment Information

The Company’s Chief Executive Officer, who is the Company’s Chief Operating Decision Maker as that term is defined in ASC 280, “Segment Reporting” (“ASC 280”), measures and assesses the Company’s business performance based on regional operations of various properties grouped together based primarily on their geographic locations. In January 2014, the Company named Jay Snowden as its Chief Operating Officer and the Company decided in connection with this announcement to re-align its reporting structure. Starting in January 2014, the Company’s reportable segments are: (i) East/Midwest, (ii) West, and (iii) Southern Plains.

The East/Midwest reportable segment consists of the following properties: Hollywood Casino at Charles Town Races, Hollywood Casino Bangor, Hollywood Casino at Penn National Race Course, Hollywood Casino Lawrenceburg, Hollywood Casino Toledo and Hollywood Casino Columbus. It also includes the Company’s Casino Rama management service contract and the Mahoning Valley and Dayton Raceway projects in Ohio, which the Company anticipates completing in the third quarter of 2014, as well as the Plainville project in Massachusetts which the Company expects to open in the second quarter of 2015. It also previously included Hollywood Casino Perryville, which was contributed to GLPI on November 1, 2013.

The West reportable segment consists of the following properties: Zia Park Casino and the M Resort, as well as the Jamul development project, which the Company anticipates completing in mid-2016.

The Southern Plains reportable segment consists of the following properties: Hollywood Casino Aurora, Hollywood Casino Joliet, Argosy Casino Alton, Argosy Casino Riverside, Argosy Casino Sioux City, Hollywood Casino Tunica, Hollywood Casino Bay St. Louis, Boomtown Biloxi, and Hollywood Casino St. Louis, and includes the Company’s 50% investment in Kansas Entertainment, LLC (“Kansas Entertainment”), which owns the Hollywood Casino at Kansas Speedway. It also previously included Hollywood Casino Baton Rouge, which was contributed to GLPI on November 1, 2013.

The Other category consists of the Company’s standalone racing operations, namely Beulah Park, Raceway Park, Rosecroft Raceway, Sanford-Orlando Kennel Club, and the Company’s joint venture interests in Sam Houston Race Park, Valley Race Park, and Freehold Raceway, as well as the Company’s 50% joint venture with the Cordish Companies in New York. It also previously included the Company’s Bullwhackers property, which was sold in July 2013. If the Company is successful in obtaining gaming operations at these locations, they would be assigned to one of the Company’s reportable segments. The Other category also includes the Company’s corporate overhead operations which does not meet the definition of an operating segment under ASC 280.

The prior year amounts were reclassified to conform to the Company’s new reporting structure in accordance with ASC 280. See Note 9 to the condensed consolidated financial statements for further information with respect to the Company’s segments.

Other Comprehensive Income

The Company accounts for comprehensive income in accordance with ASC 220, “Comprehensive Income,” which establishes standards for the reporting and presentation of comprehensive income in the consolidated financial statements. The Company presents comprehensive income in two separate but consecutive statements. The net of tax changes in accumulated other comprehensive income by component were as follows (in thousands):

	Foreign Currency			Available for sale securities			Total

Other comprehensive income (loss):
Balance at December 31, 2012	$	1,628		$	1,394		$	3,022
Foreign currency translation adjustment	(999		)	—			(999		)
Unrealized holding losses on corporate debt securities	—			(98		)	(98		)
Realized gain on redemption of corporate debt securities	—			(1,296		)	(1,296		)
Ending balance at June 30, 2013	$	629		$	—		$	629

Balance at December 31, 2013	$	383		$	—		$	383
Foreign currency translation adjustment	(81		)	—			(81		)
Ending balance at June 30, 2014	$	302		$	—		$	302

Fair Value of Financial Instruments

The following methods and assumptions are used to estimate the fair value of each class of financial instruments for which it is practicable to estimate:

Cash and Cash Equivalents

The fair value of the Company’s cash and cash equivalents approximates the carrying value of the Company’s cash and cash equivalents, due to the short maturity of the cash equivalents.

Long-term Debt

The fair value of the Company’s Term Loan B component of its senior secured credit facility and senior unsecured notes is estimated based on quoted prices in active markets and as such is a Level 1 measurement. The fair value of the remainder of the Company’s senior secured credit facility approximates its carrying value as it is variable rate debt and as such is a Level 2 measurement.

The estimated fair values of the Company’s financial instruments are as follows (in thousands):

	June 30, 2014				December 31, 2013
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	251,299	$	251,299	$	292,995	$	292,995
Financial liabilities:
Long-term debt
Senior secured credit facility	735,110		735,628		748,777		748,150
Senior unsecured notes	300,000		284,250		300,000		297,000