By Denise Lugo
The FASB on January 28, 2021, published an accounting workaround to give privately-owned franchisors a simpler way to account for revenues gleaned for helping franchisees to set up shop.
The standard introduces a practical expedient to Topic 606, Revenue from Contracts with Customers, to allow private franchisors to immediately recognize as revenue a portion of upfront fees they charge for pre-opening services.
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 amendment, initial franchise fees can be recognized as a single performance obligation if they are consistent with those included in a predefined list in the guidance.
For companies that have not yet adopted Topic 606, the standard applies to annual periods after December 15, 2019, and interims within annual periods after December 15, 2020. For those that have adopted the standard, it is effective for annual and interim periods after December 15, 2020. Early application is permitted.
Nitty Gritty of the Change
The narrow rules were issued as Accounting Standards Update (ASU) No. 2021-02, Franchisors—Revenue from Contracts with Customers (subtopic 952-606): Practical Expedient.
ASU No. 2021-02 amends revenue recognition rules to reduce the cost and complexity of applying step two – identifying performance obligations in Topic 606 to preopening services for franchisors. Step 2 of the revenue model requires companies to determine whether goods or services transferred to customers are separate performance obligations. Some accountants have said that this part of the model is difficult and costly for franchisors to apply.
The amendments will reduce the cost and complexity of applying Topic 606 to pre-opening services for privately owned franchisors, the board said. Additionally, for private companies “ applying the practical expedient directionally will result in accounting outcomes generally consistent with the intent of Topic 606 for those entities and will counter biases that appear to have emerged in practice,” a text of the guidance states.
Three Board Members Dissent
The standard was not endorsed by the full board. Three of the seven board members—Christine Botosan, Harold Schroeder, and Gary Buesser—wrote a joint dissent to state that the new rules will not improve U.S. GAAP and the expected benefits do not justify the costs.
Among other reasons for their dissent is that “applying a one-size-fits all approach violates the core principle of Topic 606 in paragraph 606-10-10-2, which states that “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 or services” provided by the entity.”
Tackling the rules generated more controversy than the board planned, some accountants observed.
“The proposed ASU was described as providing nonpublic franchisors with a practical expedient in applying ASC 606 to pre-opening services,” Scott Ehrlich, president of Mind the GAAP, LLC, said. “Our view was that the proposed ASU instead provided an exception – that could only be applied by a small subset of companies, that, is nonpublic franchisors – to some of the foundational principles of ASC 606.”
The new rules would introduce divergence in applying Topic 606 amongst public and nonpublic franchisors, as well as for similar transactions across various industries, Ehrlich also said. “This outcome would contradict one of the main reasons why ASC 606 was promulgated,” he said.
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 January 29, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.
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