By Denise Lugo
The FASB on July 22, 2020, voted 4 to 3 to propose an industry-specific alternative for how privately-owned franchisors are to report initial franchise fees, lump sums they depend on to defray expenses.
The board plans to propose an accounting alternative to simplify the performance obligation analysis that is required under Topic 606, Revenue from Contracts with Customers, an area franchisors have a hard time figuring out.
Specifically, the proposal would create Subtopic 952-606, Franchisors—Revenue from Contracts with Customers, in the GAAP codification to narrowly focus on initial franchise fee reporting, according to FASB discussions.
The proposal will be issued in early September with a 45-day comment period.
“I actually see this practical expedient as driving the results closer to the intention of [Topic] 606,” FASB Chairman Richard Jones said. “In my mind, I think that improves the adoption of 606,” he said.
Jones said providing a practical expedient is consistent with the approach that the board has taken in the past for private companies, recognizing that they have a different cost-benefit equation associated with their financial reporting. “To me this meets that criteria. The fact that it’s bringing a closer application to 606 for this industry, at the same point in time a reduction in cost, so for those reasons I am supportive,” he said.
Topic 606, which was issued in 2014, replaced hundreds of pieces of industry-specific guidance with a principles-based, five step model for reporting revenues earned from customer contracts.
The proposal will enable franchisors to presume that initial services are a distinct performance obligation, board discussions indicated. This means that rather than evaluating each pre-opening service to see if it is distinct from the franchise license, the franchisor can account for the services as distinct if they are included in a predefined list of initial services.
The change would allow franchisors to more easily make conclusions about whether pre-opening services are distinct, and whether a portion of the initial franchise fee can be recognized upfront.
Board Sharply Split
Board members Harold Schroeder, Gary Buesser, and Christine Botosan argued the case for financial statement users against financial statement preparer and auditor views held by Jones, board Vice Chair James Kroeker, and FASB members Susan Cosper and Marsha Hunt.
Schroeder and Buesser, the two investor voices, and Christine Botosan, the academic, who lost their bid to drop the project, said the proposal would create industry-specific rules that Topic 606 was developed to eliminate. Most importantly, they said, the resulting information would not give financial statement users beneficial information.
All three will write dissents on the potential changes.
“I don’t think there are sufficient benefits in this particular case, and I don’t think there are any benefits to the users of financials including the regulators who’ve been cited in the past,” Schroeder said. “And I think the information that will result from this could actually be misleading,” he said.
Buesser, a big supporter of Topic 606, said having a five-step model that is applied to every company globally for the most important line item in the financial statement had been a huge win for GAAP. “Essentially what the franchisors want – they want revenue recognition upfront as it was under [Topic] 605,” he said. “There are other industries who want it over time – I don’t think we can arbitrate that on a continual basis and I think once you open the door to this, I’m not sure how you turn back.”
Board members that won the debate – Jones, Kroeker, Cosper, and Hunt – felt the argument posed by franchisors that Topic 606 was too costly and complex for an initial franchise free scenario was valid, stating the private company change is in line with what the board typically does. The resulting information would provide meaningful accounting rules, they said.
“I do think this is a great example of learning from a public company adoption,” said Kroeker. “Unfortunately very late in the process I think we thought we had some solutions – they just weren’t achieving the cost reduction that we anticipated so I think this does learn from public company adoption, I think this is what we ought to be doing – where there are more cost effective ways for private companies to adopt in or apply the standard going forward through an expedient, we should do those,” he said.
Kroeker said that if more companies request other practical expedients to make standards more cost effective, “I’m happy about that.”
“I would encourage people to look at other areas where they believe there are cost effective ways to accomplish the more consistent outcome and please send those to us,” he said, pointing to prior board exemptions on sales tax and shipping rules as examples.
Franchisors Say Old Rules Were Clear Cut
The topic came to the board about three years ago after private companies raised questions about the timing of revenue recognition under Topic 606 for initial franchise fees. The project had been on the board’s research agenda, and the board’s recent deferral of the revenue standard came in part so that it could further study an accounting solution.
The initial franchise fee is a sum paid to a franchisor in exchange for establishing a franchise relationship, along with the provision of some initial services. This fee typically is paid in a lump sum to the franchisor when a franchise agreement is signed, a FASB handout explains.
Before the adoption of Topic 606, under Topic 952, Franchisors, the initial franchise fee was recognized when the franchise location opens. Under the guidance in Topic 606, the franchisor determines if the pre-opening activities contain any distinct goods or services in order to determine the appropriate timing of revenue recognition.
Private company franchisors expressed concern about the cost and complexity of applying the Topic 606 guidance to initial franchise fees, the handout states. They also expressed concern about the accounting outcome of deferring some or all of the initial franchise fee over the franchise license term.
For in-depth analysis of the FASB’s revenue recognition standard, please see Catalyst: US GAAP—Revenue Recognition, also on Checkpoint.
Additional analysis of the revenue standard can be found on Checkpoint in the Accounting and Auditing Update Service and the SEC Accounting and Reporting Update Service [SARU No. 2014-21] (June 2014): Special Report: Comprehensive Coverage of the New U.S. GAAP Revenue Recognition Requirements.
This article originally appeared in the July 23, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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