Revenue Recognition Update: Important Changes for Franchisors

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The impact of the new revenue recognition standard will be felt across all businesses, but franchisors in particular. The new standard will have a profound impact on franchisor financial statements, and franchisors who have not been in business for many years will be especially hard hit. With an effective date of Jan. 1, 2018 for public companies and Jan. 1, 2019 for private companies, the time to comply is now.

Old vs. new guidance

Current accounting standards require franchisors to recognize revenue from initial franchise fees when they have substantially performed all the services required to earn the initial franchise fee. For the vast majority of franchisors, this was traditionally upon opening of the franchise location.

The new standard introduces new accounting rules for licensing of symbolic intellectual property (IP), which includes franchise rights. Under the new guidance, revenue from licensing of symbolic IP is recognized over time using a measure of progress that reflects the franchisor’s pattern of performance. In other words, revenue is recognized over the term of the franchise agreement.

The impact here is that previously recognized initial franchise fee and area developer fee revenue will be reversed and deferred on franchisor financial statements once the standard is in effect. While certain costs will be reversed and deferred as well to match the new recognition requirement for revenue, this is going to result in the reversal of previous profits of franchisors, which will also reduce their equity balances.

Newer franchisors that haven’t been in operation for long could be particularly hard hit because their concepts are new and they often spend a considerable amount to develop the company brand and market the franchise concept. Under the current standard, as the franchisor develops more franchisee locations, revenue would help offset the impact from these expenses on equity. Now, with franchise and area developer fee revenue being spread out over the term of the franchise agreement, it will take much longer to recover these expenses.

How to proceed

Get with your accountant right away. You’ll need to discuss the upcoming changes and modify the tracking schedules for deferred franchise fees and related costs so these amounts are amortized to revenue and expensed over time, rather than when a franchise location opens. In addition, you may need to accumulate additional information related to each franchise location to determine the adjustment that will be needed and to properly account for revenue and costs on a go forward basis once the standard takes effect in 2019. You do have the potential to defer taxes for one year on advance fees received, but you will need to file for a change in accounting method.

Within the new standards, there are 5 steps outlined for revenue recognition. Be sure to check those out and reach out to us with any questions you have about this critical changes.

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