The adoption of new revenue recognition in ASC Topic 606, Revenue from Contracts with Customers, introduced added complexity in the accounting for pre-opening services for franchisors. In particular many private company franchisors found it challenging to evaluate whether pre-opening services offered to franchisees were distinct services and should be accounted for separately or should be combined with the franchise license for accounting purposes.
A franchisor that could not establish that pre-opening services were distinct under the new revenue recognition guidance would recognize all revenue, including any upfront fees, over the term of the license. In contrast, franchisors had generally recognized upfront fees upon store opening under the prior guidance. In order to address the cost and complexity of evaluating whether pre-opening services are distinct the Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2021-02, Franchisors—Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient.
Accounting Under the Practical Expedient
A franchisor that is not a public business entity (i.e. a private company) can elect to account for the following pre-opening services as distinct:
- 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’s personnel or the franchisee
- 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
- Inspection, testing, and other quality control programs.
The franchisor may also elect to account for the above list as either a single performance obligation, or apply the guidance in ASC Topic 606 to determine, which if any, of the services are distinct from each other (i.e. evaluate if they should be accounted for as more than one performance obligation).
A franchisor making the election may offer additional pre-opening services that are not included in the pre-defined list. In those instance, the franchisor would continue to consider whether the additional services are distinct to determine if those additional services are separate performance obligations.
The practical expedient does not alleviate the requirements to allocate the transaction price of the contract between each performance obligation in the contract. A franchisor will continue to have to evaluate the standalone selling price of each performance obligation identified, including the pre-opening services accounted for as a performance obligation under this practical expedient, in order to allocate the transaction price.
Franchisors that are public business entities and private company franchisors not utilizing this practical expedient are not permitted to apply the practical expedient by analogy.
Disclosure and Effective Date
A franchisor electing to use the practical expedient is required to disclose the use of the practical expedient and, when applicable, the election to account for the pre-opening services as a single performance obligation.
For franchisors that have already adopted ASC Topic 606, ASU 2021-02 is effective for periods ending after Dec. 15, 2020 (i.e. calendar year end Dec. 31, 2021). However, the ASU may be elected early and applied to financial statements for Dec. 31, 2020 that have not yet been made available for issuance. For a franchisor that previously adopted ASC Topic 606, the adoption of the practical expedient is required to be applied retrospectively.
Franchisors that have not yet adopted ASC Topic 606 should adopt ASU 2021-02 at the same time as the adoption of ASC Topic 606. A franchisor that is first adopting ASC Topic 606 applies the guidance under either the modified retrospective method or the full retrospective method.
For More Information
For more information about accounting issues to watch for in 2021, please contact Mark Winiarski of MHM’s Professional Standards Group or another member of our team.
Published on February 02, 2021
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