Franchisor Revenue Recognition Simplified

A Summary of FASB’s ASU No. 2021-02, Franchisors – Revenue from Contracts with Customers Practical Expedient

By Christopher F. Terrigino

In January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2021-02, Franchisors – Revenue from Contracts with Customers Practical Expedient in order to simplify the application of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), as it is applied to initial franchise fees paid by a franchisee to a franchisor. ASU No. 2021-02 does not apply to public business entities.

Specifically, ASU No. 2021-02 was issued to reduce the cost and complexity of implementing revenue recognition guidance under FASB Topic 606 to the pre-opening services provided by a franchisor. The first key provision allows a franchisor to adopt a practical expedient (i.e., shortcut) when following revenue recognition standards that allows for certain pre-opening services to be accounted for as distinct from the franchise license in a franchise agreement.

These services are:

  1. Assistance in the selection of a site.
  2. Assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, and engineering services, and lease negotiation.
  3. Training of the franchisee’s personnel or the franchisee.
  4. Preparation and distribution of manuals and similar material concerning operations, administration, and recordkeeping.
  5. 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.
  6. Inspection, testing, and other quality control programs.

Being a franchisor, defined in ASC 952-10-20 as the party who grants business rights (the franchise) to the party (the franchisee) who will operate the franchised business, is required to qualify for use of the practical expedient.

The second key provision allows the franchisor to make an accounting policy election to treat the pre-opening services as a single performance obligation. This will result in all pre-opening costs being combined and recognized as revenue at the same time based on the franchisor recognition policy. An organization will now have only two performance obligations to consider: the franchise license and the pre-opening costs.

For example, a company enters a contract with a customer to grant a franchise license to open and operate a franchise store. Under the contract terms, the company is responsible for assisting the customer in finding a store location, assisting in preparing the facilities, and training personnel. The company receives a payment of $50,000 from the customer when the contract is signed, plus the right to receive 6% of the customer’s sales over the term of the agreement. If the requirements are met to use the practical expedient, a portion of the $50,000 payment is allocated to the pre-opening activities, and the rest is allocated to the licensing agreement.

The franchisor is required to disclose when they have elected to use the practical expedient and the accounting policy election to recognize the pre-opening activities as a single performance obligation. These disclosures would be made in the company’s notes to their financial statements.

The amendments in ASU No. 2019-02 are effective in interim and annual periods beginning after December 15, 2020, and early application is permitted. If multiple periods are presented, these changes should be applied on a retrospective basis. It is expected that adoption of these changes will make the recordkeeping easier for nonpublic franchisors. 

If you would like more details on this topic, please review the extended article in the link below.

Are you a franchisor? One of your most important duties is to hire a qualified independent public accountant with the necessary experience and expertise to ensure that your company is getting the best advice available. Rivero, Gordimer & Company has been assisting organizations with their tax and accounting needs for 40 years, and we want to assist you, too. For further information or assistance, contact Christopher F. Terrigino, call our office at 813-875-7774 to schedule a meeting, or visit our website for more information.

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