Audit + Accounting: Summing It All Up

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Franchisor revenue recognition relief

Recently, the FASB issued an update to U.S. accounting standards that will be some relief to franchisors by providing an avenue for earlier revenue recognition for initial franchise fees. Many franchisors found it difficulty to support the identification of distinct performance obligations within a franchise agreement under the new revenue recognition standard guidance (Topic 606). Accordingly, many franchisors recognized initial franchise fees ratably over the term of the agreement. Under ASU 2021-02, the FASB has now provided a practical expedient where franchisors who enter into a franchise agreement may account for the following pre-opening services as distinct from the franchise license:

  1. Assistance in the selection of a site
  2. Assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, and engineering services, and lease negotiation
  3. Training of the franchisee’s personnel or the franchisee
  4. Preparation and distribution of manuals and similar material concerning operations, administration and record keeping
  5. Booking, information technology and advisory services, including setting up the franchisee’s records and advising the franchisee about income, real estate and other taxes or about regulations affecting the franchisee’s business
  6. Inspection, testing and other quality control programs

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If using this practical expedient, you must apply the guidance in Topic 606 to determine whether the pre-opening services are distinct from one another. Alternatively, you may make an accounting policy election to account for the pre-opening services as a single performance obligation. Either way, this will provide earlier revenue recognition for a portion of the initial franchise fee as the pre-opening services are performed individually, if distinct, or as a whole, if the accounting policy election is made.

However, one of the difficulties with this is the need to determine standalone selling prices associated with each of the distinct pre-opening services or the bundle of services if the accounting policy election is made. For most franchisors, these services are not offered to franchisees individually or as a package with a stated selling price. Therefore, the standalone selling price is not observable. Accordingly, you will need to estimate the standalone selling price, using observable inputs, when available. This may be an exercise that you will need to go through once upon adoption of the practical expedient and will not need to change regularly, unless there is a change in the nature of the pre-opening services being performed or a change in other market factors.

After recognition of revenue upon satisfaction of these pre-opening performance obligations, any remainder will be recognized over the term of the license agreement. For example, assume the initial franchise fee is $50,000 and it is determined that the standalone selling price of the pre-opening services is $15,000. You would recognize $15,000 of revenue upon satisfaction of the pre-opening performance obligations. The remaining amount of $35,000 would be recognized ratably over the term of the franchise agreement.

For companies that have not yet adopted the Topic 606, this practical expedient can be applied in connection with its adoption. If Topic 606 has already been adopted, this amendment is effective for interim and annual periods beginning after December 15, 2020. However, earlier application is permitted. When applying this practical expedient, it must be applied retrospectively to the date Topic 606 was adopted.

If you have any questions, don’t hesitate to contact a Henry+Horne professional adviser.

Jonathan Poppel, CPA