Skip to content
FASB

FASB Proposes Alternative to Simplify Reporting of Initial Franchise Fees

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

By Denise Lugo

The FASB on September 21, 2020, issued a proposal that would give privately owned franchisors an accounting alternative for reporting initial franchise fees – earnings gleaned for helping franchisees set up shop.

Franchisors have said current revenue recognition rules require them to delay for up to 20 years the full recognition of initial franchise fees, sums that are used to defray incurred expenses.

The board proposal aims to lower cost and simplify the performance obligation analysis that is required under Topic 606, Revenue from Contracts with Customers, a text of the guidance states.

Specifically, private franchisors would get a practical expedient that would permit them to account for pre-opening services provided to a franchisee as a single separate performance obligation “if the services are consistent with those included in a predefined list within the guidance and they meet certain other conditions.” A practical expedient is an alternative aimed at producing a more cost effective way of achieving the same or a similar accounting objective.

Under the proposal, a franchisor would be required to assess the ongoing fees and the relation of those fees to ongoing services. A franchisor would be precluded from applying the expedient if it is not probable that continuing franchise fees will cover the continuing cost of services plus a reasonable profit.

The board said the proposal would simplify two objectives of Topic 606: identifying performance obligations and allocating consideration in the contract.

Companies that have not yet adopted Topic 606 would get the transition option and newly deferred effective date that standard allows. Meaning, that guidance allows for an option of modified retrospective transition or full retrospective transition and an effective date of annual reporting periods beginning after December 15, 2019, and interim reporting periods within annual reporting periods beginning after December 15, 2020.

For companies that have already adopted the revenue standard, the proposed changes would apply to interim and annual periods beginning after December 15, 2020. Early application would be permitted. The guidance would be applied retrospectively to the date Topic 606 was adopted.

Companies have until November 5 to submit comments to the provisions, published as Proposed Accounting Standards Update (ASU) No. 2020-600Franchisors—Revenue from Contracts with Customers (Subtopic 952-606)—Practical Expedient.

Botosan, Schroeder, Buesser Dissent

Three members dissented to the proposal. FASB members Christine Botosan, Harold Schroeder, Gary Buesser wrote a joint dissent, stating the changes would violate the core principles of Topic 606, and wouldn’t improve U.S. GAAP.

The board members said the proposal would apply a one-size-fits-all approach that violates the core principle in Topic 606 that states “an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services” provided by the entity.

Among other reasons, the dissent states that the changes are not sufficiently beneficial to justify the costs.

The board members suggest the use of an option as an alternative path, believing it would be less costly and would offer a more faithful representation of typical franchise arrangements. “If cost reduction is the primary concern, the least costly alternative would be to provide an option to defer the revenue recognition of all [initial franchise fees] and amortize the deferred amount into revenue on a straight-line basis over the term of the contract,” they wrote.

Franchisors Seeking Simplicity

The changes are being proposed to address concerns raised by the franchising sector. Privately owned franchisors that started audits of their 2019 annual financial statements observed that it was costly and complex to justify not deferring initial franchise fees, despite analyses performed by some franchisors that were intended to support their view that a portion of pre-opening services is distinct from the franchise license, a board explanation states.

Additionally, some private franchisors appeared to presume that the initial franchise fee would always be recognized over the license term rather than applying the Topic 606 model to identify performance obligations.

The board initially placed the topic on its research agenda to evaluate how to reduce the costs and complexity related to applying Topic 606 to initial franchise fees and how to improve the application of the guidance to achieve accounting results more consistent with the objective of Topic 606.

In July 2020, the board decided to move the project from the research agenda to its technical agenda and to pursue a private company practical expedient. The board voted in July to issue the proposal. (See FASB Agrees by Narrow Majority to Propose Alternative for Reporting Initial Franchise Fees in the July 23, 2020, edition of Accounting & Compliance Alert.)

For in-depth analysis of the FASB’s revenue recognition standard, please see Catalyst: US GAAP — Revenue Recognition, also on Checkpoint.

Additional analysis of the revenue standard can be found on Checkpoint in the Accounting and Auditing Update Service and the SEC Accounting and Reporting Update Service [SARU No. 2014-21] (June 2014): Special Report: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements.

 

This article originally appeared in the September 22, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.

Subscribe to our Checkpoint Daily Newsstand email to get all the latest tax, accounting, and audit news delivered to your inbox each weekday. It’s free!

More answers