As usual, there’s much to think about at the start of a new year. If you’re a franchisor, revenue recognition should be top of mind as you plan for 2019. That’s because on January 1, 2019, the Financial Accounting Standards Board’s new revenue recognition rules went into effect for private companies (the rules went into effect for public companies on January 1, 2018). Technically known as “FASB ASC Topic 606, Revenue from Contracts with Customers,” these new rules could significantly alter how you recognize initial franchise fees.
What changes can franchisors expect?
The previous FASB rules required franchisors to recognize initial franchise fees upon substantial performance of their obligations to the franchisee, which generally resulted in recognition upon the opening of the unit. The new rules, however, may require franchisors to recognize these fees over the term of the franchise agreement, or when certain performance obligations are met. For instance, instead of recognizing a $50,000 increase in revenue at a new store’s opening, the franchisor must now recognize the amount over a period of what could potentially be several years.
What about performance obligations?
A performance obligation is a contracted agreement to provide a distinct good or service to a customer. In the event of a franchise unit opening, performance obligations might include site selection, equipment, manuals, training, and, of course, the use of the franchisor’s intellectual property (e.g., its trade name).
Theoretically, a franchisor could recognize a portion of the initial franchise fee upon the completion of each activity—in accordance with the franchise agreement, of course. But this is where it gets tricky. Other than equipment, performance obligations related to opening a unit will not likely be considered distinct. This is because they provide little or no benefit without intellectual property.
What should you do now?
First, be sure you understand the aforementioned FASB rules. Then, it’s a good idea to review your contracts to identify any performance obligations related to the initial opening of a unit. Next, determine which performance obligations are distinct and when each distinct performance obligation is typically completed. Generally, performance obligations are either completed at a point in time or over the course of time, the latter of which will likely be the case if the performance obligation involves the use of intellectual property.
Act now to start 2019 off on the right foot.
As you can see, the new revenue recognition rules could dramatically change the way you recognize your initial franchisee fees. Taking time to get acquainted with the rules and the details of your contracts as soon as possible could help you avoid unnecessary process changes and headaches. If you have questions about how you might be impacted, please give us a call, and we’ll help you sort it out.
Contact your PWB advisor today.