A key component to the success of a brand is marketing and advertising, which makes it a crucial part of running a successful franchised concept. Marketing and advertising funds are instrumental in most franchised concepts and are primarily funded through the receipt of funds from franchisees based on a percentage of their revenue, as defined by the franchise disclosure document (FDD) or franchise agreement (also known as advertising revenue). Marketing and advertising expenditures are typically the franchisor’s responsibility, who must spend the funds on allowable expenses as defined by the FDD or franchise agreement. Typically, allowable expenses include system-wide advertising that supports the brand as a whole and can include expenses related to maintaining, administering, directing, preparing, and producing advertising, including various media methods, marketing agency costs, public relations expenses, and expenses related to the use of internal marketing personnel.
It is important to maintain quality reporting and provide transparency to your franchisees for the brand’s overall success and to reduce the risk of conflict and potential litigation with franchisees. Below are a few reminders and best practices that could help maintain marketing and advertising funds.
- Include specific details and clear guidelines in the FDD related to:
- How advertising funds are collected and how funds can be used
- Consider being clear regarding whether affiliated or company-owned locations are paying into the marketing and advertising fund, and consider risks associated with these decisions.
- Ensure it is clearly stated which, if any, internal costs related to overhead expenses and/or administrative expenses for maintaining the marketing and advertising fund can be offset against the marketing and advertising funds received.
- Consider setting up a separate trial balance or general ledger company to track related revenues and expenses to ensure funds are not co-mingled. This also creates a clear record of transactions specific to the marketing and advertising fund.
- Ensure proper segregation of funds by setting up a separate bank account specific to marketing and advertising fund contributions and disbursements it aids in clarity in ensuring fund revenues and expenses are not co-mingled.
- Create a regular cadence in communicating with the franchisees to ensure transparency around the following:
- Understanding of funds being collected
- Internal and external uses of the funds
- General marketing and advertising plans taking place
- Strategy around underspending or overspending in various years (if applicable per the terms of the FDD)
These communications with franchisees can take place during annual meetings and more frequently if desired.
Reporting considerations
In accordance with Accounting Standards Codification Topic 606 (ASC 606), franchisors should apply the five-step process to ensure proper treatment and classification of related revenues and expenses. Depending on the verbiage used in the related FDD and franchise agreements, generally, a franchisor would conclude that the agreement’s marketing and advertising fund component is not distinct from the franchise rights as advertising benefits the brand as a whole versus the individual franchisee or location under the agreement.
Next, a franchisor should consider if they are the principal or agent in relation to the marketing and advertising fund. Typically, we see the franchisor meet the definition of principal, as the franchisor typically controls vendor selection, marketing and advertising plan development, and determining the terms of the collection of the advertising funds. Once it is determined that the franchisor is a principal in the arrangement, the franchisor should record advertising revenue received as a component of revenue and expenses disbursed as a component of expenses on their income statement.
Maintaining proper records surrounding a marketing and advertising fund is crucial for proper accounting, ensuring compliance with the FDDs and franchise agreements, and maintaining transparency with franchisees.
If you have questions on any of the topics listed above, please contact your GBQ advisor.
