By 2019, the FASB Accounting Standards Codification® Topic 606 (“ASC 606”), will impact virtually all franchisors and how they recognize revenue. Under ASC 606, franchisors will have to begin deferring recognition of some or all of the up-front franchise fee revenues they receive over the life of a franchise agreement. Practically speaking, this means that even for non-refundable initial fees received from franchisees, franchisors will have to “recognize” a portion of those fees over the full term of the agreement instead of doing so immediately.
The new FASB rule marks a significant shift in how initial franchise fee revenue can be recognized. Under prior rules, franchisors enjoyed the ability to recognize the initial franchise fee paid at the beginning of the relationship. That is no longer the case. Under the new rules, how and when that revenue is recognized could affect how state regulators, lenders, prospective franchisees, and potential investors view the financial strength, viability, and/or profitability of a franchisor. As a result, it is important for franchise companies to consult with accounting and legal counsel to determine how ASC 606 will affect their financial statements in 2019 and beyond.
Under ASC 606, franchisors could benefit from carefully analyzing how initial franchise fees are actually used, and then clearly delineating the portions of those fees used to perform up-front services to the franchisee, and the portions intended for goodwill. Where the franchisor can demonstrate that a portion of the up-front fee will be used to pay for or fund a specific initial performance obligation that it must provide under the franchise agreement, then it will be able to recognize that revenue early in the relationship.
Given that these rules will take effect in 2019, a prudent franchisor should begin planning now by consulting with its bookkeeper or accountant to determine how it can begin allocating its initial franchise fees to maximize the company’s ability to recognize initial fee revenue early in the relationship. Some of the categories of service or assistance by a franchisor that may make revenue eligible for early recognition include, among other possible categories:
* Assistance in Site Selection
* Assistance with Lease Negotiation
* Initial Training Program
* Equipment and Supplies
* Access to Vendor Programs
* Initial Supply of Advertising Materials
* Broker Commission Payments
Once your accountant and you decide how to structure recognition of your initial franchise fee, it will usually be a good idea to revise portions of your franchise agreement and franchise disclosure document to be consistent with your plans.
The devil is in the details, and successfully implementing early revenue recognition will oftentimes depend on how the franchisor plans to do (and does) business. If your bookkeeper or accountant and you need help in determining how, when, and under what circumstances these rules can be used to allow you to recognize more of the initial franchise fee you receive earlier, please contact a member of Howard & Howard’s Franchise Practice Group.