Does your franchise recognize fees from franchisees when a new location opens?
Before FASB adopted the new revenue standard, this was the most common way for
franchisors to recognize initial franchise fees. Under the new revenue recognition standards, which take effect for private companies in January 2019, franchisors will need to reconsider whether this approach is still appropriate for them.
Separate Distinct Services
What pre-opening services are included in the franchise contract? If the franchisor provides services such as location scouting, training, or any other services that the franchisee could benefit from, and are separately identified in the contract, these services should be considered as distinct services. If the franchisee would be likely to purchase the same services elsewhere were the services not included in the franchise agreement, they are likely to be distinct services for revenue recognition purposes.
Determine Transaction Price
After identifying the distinct services they provide to the franchisee, the franchisor then determines a “standalone” price – a price that the franchisor would charge if these services were to be sold separately. There are a variety of ways this price may be determined. FASB guidance doesn’t specify any particular method for making the determination, but says that the price could be determined by referring to competitor prices for similar services, or adding an appropriate margin to the expected costs of the services.
Allocate Selling Prices
You may determine that none, some, or all of the pre-opening services are distinct. If some or all of the pre-opening services can be separately identified, then a portion of the initial franchise fee should be allocated to those services.
At last, it’s time to recognize revenue. Revenue is recognized as the performance obligations are met. If the pre-opening services are considered distinct, the determined price for these services should be recognized as the services are provided. If there are no distinct pre-opening services, and the franchise agreement is simply for the use of the franchisor’s intellectual property, then recognition of the fees should be spread out over the life of the franchise contract. If the combined standalone price of pre-opening services is equal to or greater than the franchise fee, then the entire fee should be recognized as the services are performed.
Franchise agreements vary widely. As a result, there is no one-size-fits-all solution for recognizing franchise revenue. For more information on how your franchise can adapt to the changing revenue standards, please contact one of our industry experts at (714) 569-1000.