This article, "FASB Issues Practical Expedient for Private Franchisors Applying Topic 606," originally appeared on MossAdams.com.

Summary provided by MaterialAccounting.com: This article explains FASB’s standards update regarding how private company franchisors apply Topic 606. 

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2021-02, Franchisors—Revenue from Contracts with Customer (Subtopic 952-606): Practical Expedient, to provide a practical expedient that is intended to simplify how private company franchisors analyze certain activities when determining their performance obligations in a franchise agreement.

The practical expedient permits certain preopening services listed within the guidance to be accounted for as distinct from the franchise license. The practical expedient is only applicable for franchisors that aren’t public business entities.

Accounting Considerations for Initial Franchise Fees

During the implementation of ASU 2014-09, Revenue from Contracts with Customers (Topic 606), concerns were raised about the cost and complexity of applying Topic 606 to determine the amount and timing of revenue recognition for initial franchise fees, especially for franchisors that are start-ups or that have a small number of franchise units.

The initial franchise fee is typically paid in a lump sum to a franchisor in exchange for establishing a franchise relationship, along with varying levels of preopening services, such as training and site selection. Prior to the adoption of Topic 606, the initial franchise fee was typically recognized when the franchise location opened—in accordance with the industry-specific guidance in Topic 952, Franchisors.

In comparison, under current guidance in Topic 606, franchisors are required to determine if the preopening activities are separate performance obligations. The standalone selling price of each performance obligation must also be assessed to determine the timing and amount of revenue recognition.

Practical Expedient for Preopening Services

The amendments introduce Subtopic 952-606, Franchisors—Revenue from Contracts with Customers.

Intended to reduce the cost and complexity for franchisors applying Topic 606, Subtopic 952-606 provides a new practical expedient that permits private company franchisors to account for preopening services provided to a franchisee as distinct from the franchise license if the services are consistent with those included in a predefined list within the guidance.

If the practical expedient is elected, the following preopening services may be accounted for as distinct from the franchise license—in accordance with ASC 952-606-25-2:

  • Assistance in the selection of a site
  • Assistance 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 amendments also allow private company franchisors to make an accounting policy election to recognize the preopening services as a single performance obligation.

Scope of the Practical Expedient

The practical expedient applies to entities within the scope of Topic 952 that aren’t public business entities. The guidance in Topic 952 applies to all entities that meet the definition of a franchisor, which is the party that grants business rights (the franchise) to the party (the franchisee) that will operate the franchised business.

Disclosure Requirement

Disclosure is required if the practical expedient is elected or if the accounting policy election to recognize the preopening services as a single performance obligation is applied.

Effective Dates of ASU 2021-02

For private company franchisors that haven’t yet adopted Topic 606, the amendments are effective for annual reporting periods beginning after December 15, 2019, and interim reporting periods within annual reporting periods beginning after December 15, 2020. The amendments should be adopted concurrently with Topic 606 using the same transition method.

For private company franchisors that have adopted Topic 606, the amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. Early adoption is permitted, and the amendments should be applied retrospectively to the date Topic 606 was adopted.

We’re Here to Help

For more information on how the practical expedient could affect your business, contact your Moss Adams professional.