For general context, the Financial Accounting Standards Board (FASB), issued Accounting Standard Codification 606, Revenue Recognition (“ASC 606”) on May 28, 2014 which originally required non-public franchisors to adopt a new GAAP-compliant accounting revenue standard for annual reporting periods beginning after December 15, 2018. The new standard of accounting will require franchisors to delay by spreading out, the recognition of revenue on their balance sheets, often over a period of years. It would affect initial fees, such as the initial franchise fee, received by franchisors when they sign franchise agreements with new franchisees.
However, as a result of the COVID-19 pandemic, FASB last year deferred the effective date for implementing ASC 606. Now, it becomes effective for franchisors’ annual reporting periods beginning after December 15, 2019 and interim reporting periods within annual reporting periods beginning after December 15, 2020. That means for many franchisors, the audited annual reports they include in their 2021 FDD will need to comply with the ASC 606 revenue standard.
Another development to ASC 606 centers around a “practical expedient” –a proposed amendment to the original text of ASC 606 that was introduced on September 21, 2020. The practical expedient is intended to reduce the cost and complexity of applying ASC 606 to preopening services associated with initial franchise fees. If it becomes effective, franchisor could rely on the practical expedient to immediately account for and recognize revenues corresponding to certain preopening services provided to a franchisee as a single performance obligation. To rely on the practical expedient, a franchisor would be required to assess the ongoing fees and the relation of those fees to ongoing services. A franchisor however, 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.
As the end of the year approaches and franchisors begin to prepare their audited year-end financials, we encourage our franchisor clients to discuss ASC 606 with their accountants and how it may impact their GAAP-compliant financial statements for 2020. We at Carter & Tani will monitor the progress FASB’s proposed practical expedient and keep our franchisor clients informed of any developments in the future.