February 04, 2021 | Legal News
FASB PROVIDES RELIEF TO FRANCHISORS REGARDING ASC 606
In January 2021, the Financial Accounting Standards Board addressed franchisors’ concerns and issued an amendment to its former Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) on implementing GAAP Accounting Standard 606.
Prior to the amendment, to complete the five steps of revenue recognition under ASC 606, a franchisor was required to (a) determine whether the franchisor’s pre-opening obligations under the franchise agreement included any obligation that was distinct from the grant of franchise rights, and, if so, (b) analyze the stand-alone selling price of such pre-opening performance obligations in order to determine the timing and amount of revenue recognition. To avoid the hefty cost and complexity associated with those determinations and analyses, many franchisors presumed that their pre-opening service obligations would not be distinct from the grant of franchise rights and that the initial franchise fee would, therefore, always be recognized over the entire franchise term. That, of course, had a tremendous negative impact on the franchisor’s financials statements.
To eliminate some of the negative impacts of Topic 606, FASB has now simplified step 2 of the five-step revenue recognition model under ASC 606 (namely, identifying the franchisor’s pre-opening performance obligations under the franchise agreement) by identifying the following list of pre-opening services that would be considered distinct from the grant of franchise rights:
- assistance in the selection of a site;
- assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, and engineering services, and lease negotiation;
- training of the franchisee and its personnel ;
- preparation and distribution of manuals and similar material concerning 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 or about regulations affecting the franchisee’s business; and
- inspection, testing, and other quality control programs.
[see FASB, Accounting Standards Update, No. 2021-02 January 2021 at p. 9]
It is important to note that the guidance in the amendment applies only to the relationship between the initial franchise fee and the franchisor’s pre-opening services and does not extend to development fees, renewal fees, or transfer fees. If a franchisor elects to apply the above guidance, it is required to make certain disclosures in its financial statements. The new guidance also does not modify the remainder of Topic 606, such as determining whether the pre-opening services are distinct from one another, recognizing revenue received from franchisees, allocating the transaction price, etc.
Most franchisors, regardless of whether or not they have adopted ASC 606, can benefit from FABS’s latest pronouncement as it allows retrospective adoption or retrospective implementation, as applicable. As franchisors gear towards preparing for the upcoming renewal season, they should work with their franchise counsel and their auditors to take advantage of this timely guidance from FASB.