Article written by:
Anna Markin, CPA, MBA
Manager, Assurance & Business Advisory Services

FASB Listened to Franchisors and Proposed “Practical Expedient” to Recognition of Initial Franchise Fees

This practical expedient is still in the proposed stage with FASB; however, FASB voted 4 to 3 to finalize on December 9, 2020. As a result, we anticipate a final standard in early 2021. 

After receiving numerous complaints from franchisor entities regarding the complexity of applying Accounting Standards Codification (ASC) Topic 606, FASB has issued a proposed Accounting Standards Update (ASU), Franchisors—Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient. This new practical expedient will allow franchisors that are not public business entities (i.e. most private companies) to account for pre-opening services provided to a franchisee as a single performance obligation if the services are in line with the services listed within the guidance, and they meet certain other conditions.

Highlights

In a typical franchise agreement, the franchisee pays an initial franchise fee to the franchisor to use the branded concept and receives assistance with pre-opening activities. The previous revenue recognition standard (ASC 952) allowed franchisors to recognize initial fees after certain conditions were satisfied, typically upon store opening. However, ASC 606 guidance significantly affected the analysis for franchisors, requiring a determination of whether these pre-opening services were “distinct” from the franchise license and, therefore, a separate performance obligation. In many franchising arrangements, it is difficult to assert that such pre-opening services are distinct under existing guidance within ASC 606, resulting in initial franchise fees recognized over the term of the contract. If this proposed guidance realizes issuance, the practical expedient will simplify the guidance that franchisors have to assess the performance obligation for the pre-opening services. Under the new guidance, pre-opening services include the following:

  • Assistance in the selection of a site
  • Assistance in obtaining and preparing facilities for their intended use, including related financing and architectural and engineering services, and lease negotiations
  • Training the franchisee’s personnel or the franchisee
  • Preparation and distribution of manuals and similar material about operations, administration, and record-keeping
  • Bookkeeping, information technology, and advisory services, including setting up the franchisee’s records and advising the franchisee about income, real estate, and other taxes and/or local regulations affecting the franchisee’s business
  • Inspection, testing, and other quality control services

Franchisors are also required to assess ongoing fees and the relationship of those fees to ongoing services. Specifically, franchisors can only account for pre-opening services as a single, current performance obligation if (1) it is probable that the continuing fees in the agreement would be sufficient to cover the franchisor’s continuing costs plus a reasonable profit, and (2) the pre-opening services fall within the list mentioned above.

Disclosure

If elected to apply, franchisors must disclose that the practical expedient has been adopted to ensure users of the financial statements can compare results to those of a public company franchisor or a private company franchisor that has not elected the practical expedient.

Effective date

For those entities that have not yet adopted ASC 606, the proposed ASU allows for an option of modified retrospective transition or full retrospective transition and the effective date of annual reporting periods beginning after December 15, 2019, and interim reporting periods within annual reporting periods beginning after December 15, 2020.

If an entity has already adopted ASC 606, the amendments in the proposed ASU would be effective in interim and annual periods ending after December 15, 2020 with early application permitted. For these entities, the ASU would be applied retrospectively to the date ASC 606 was adopted.

You can count on GBQ to keep up with these and other changes.  Contact us for further details or for any questions you may have.

 

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