As we highlighted in a previous blog, the Financial Accounting Standards Board (“FASB”) new rule on revenue recognition requires a franchisor to recognize revenue from the sale of a franchise (i.e. the initial franchise fee) over the term of the franchise agreement. The problem is that this reduces the franchisor’s initial revenue, which makes the franchisor appear (in its financial statements) to be a weaker company.
The good news is that there is an exception to the above rule: the franchisor can recognize the value of distinct goods and/or services when those goods and services are delivered to the franchisee. So what constitutes a distinct good or service? The FASB guidelines highlight two key examples: initial training and site selection assistance. Other pre-opening activities may also qualify, if they satisfy certain requirements. Once distinct goods and services have been determined, the franchisor must then fix a value to each using one of three accepted valuation methods. Ultimately, that value can be recognized upfront; the balance of the initial franchise fee is then amortized over the term of the franchise agreement.
A franchisor that is aware of the new rule can make changes to its franchise model to recognize more revenue upfront. Without a guided approach, a franchisor may find itself amortizing much of the initial franchise fee during the entirety of the term of the franchise agreement.
Although this blog focuses on franchisors, the new FASB rule also applies to non-franchisors. If you have any questions about the impact of the new FASB rule on your business, please contact us.