Recently, FASB released an Accounting Standards Update (ASU) specific to franchisors that aren’t public business entities to allow for an optional practical expedient when identifying performance obligations in a franchise contract.
FASB ASC 606 & revenue recognition: What’s changed?
Qualified franchisors that adopt ASU 2021-02, which adds Subtopic 952-606, will now be allowed to account for certain, predefined, preopening services as distinct from the franchise license. This election could simplify the process of determining which preopening services are distinct from the franchise right, which allows some portion of the initial franchise fee to be recognized earlier in the franchise relationship (instead of over the term of the franchise agreement). Below are two critical distinctions:
1. Certain services can be recognized separately
The predefined, preopening services covered by Subtopic 952-606 include assistance with site selection, franchisee personnel training, advisory services, such as establishing bookkeeping procedures and advising on tax and regulatory matters, as two examples, among others.
2. Policy election for treatment of preopening services may be treated as a single performance obligation
The ASU also allows entities to make an accounting policy election to treat the defined preopening services collectively as a single performance obligation. Otherwise, the entity must determine whether the preopening services are distinct from one another.
Careful consideration should be given to this policy election and the impact it will have on Step 5 of the revenue recognition model — determining whether the related revenue is recognized at a point in time or over time as the preopening services are provided. If the election is made to bundle services together that would have been recognized at different points in time or have different patterns of recognition if accounted for separately, it could make selecting the appropriate recognition pattern difficult for a single performance obligation, which consists of multiple preopening services.
What hasn’t changed under ASC 606?
All other steps of the revenue recognition model remain unchanged, including the requirement to allocate the transaction price to distinct performance obligations and to determine stand-alone selling prices to be used as the basis for that allocation.
Franchisors will still be required to allocate a portion of the initial franchise fee to the preopening services, whether they’re treated as separate performance obligations or bundled as a single performance obligation under the accounting policy election. The allocation must be based on the estimated stand-alone selling price of the services, which may be challenging to determine since data supporting the fair value of the preopening services might not be readily available.
This allocation may be challenging even if the policy election is made to bundle the preopening services as a single performance obligation, since it will likely still require a franchisor to measure the fair value associated with each preopening service and then aggregate those amounts to arrive at the amount that will be allocated to the single performance obligation.
Effective dates
If a franchisor has not yet adopted Topic 606, the ASU is effective for annual reporting periods beginning after Dec. 15, 2019. Modified retrospective transition or full retrospective transition is allowed.
If a franchisor has already adopted Topic 606, the ASU is effective for annual reporting periods beginning after Dec. 15, 2020; however, early application is permitted. Once adopted, the guidance should be applied retrospectively to the date Topic 606 was initially adopted.
Qualified nonpublic franchisors have a lot to consider with respect to Subtopic 952-606. In particular, determining stand-alone selling prices of preopening services and the appropriate timing of revenue recognition, whether as single or bundled performance obligations, can be challenging.
Still have questions about how to implement ASC 606 or whether and how to adopt the practical expedient for preopening services? As always, feel free to give us a call.
