As part of franchise disclosures, franchisors are required to disclosure financials. The financials included in the franchise disclosure document [FDD] must be prepared in accordance with U.S. GAAP standards, which are set by the Financial Accounting Standards Board [FASB].
GAAP Standards were recently updated by the FASB. One of the changes called into question how franchisors recognized initial franchise fees in their financials. Instead of being able to include and recognize the entire initial franchise fee as revenue, franchisors would have to amortize the initial franchise fee over the life of the franchise agreement.
Per an article in Franchise Times:
There were a lot of changes (which you can read about here) but one of the trickiest was how initial franchise fee revenue was to be recognized……So instead of being able to take those funds into income in year one, to be spent on site selection help, training, equipment or anything else, it looked as if most of the fee revenue would have been recognized over time, which wouldn’t have been consistent with how franchisors work in practice. http://www.franchisetimes.com/news/December-2017/FASB-Clarifies-Confusing-Revenue-Recognition-Language/
This would hit hard against the franchisor’s financials in year one. Franchisor revenues would be lower at a time when the cost to franchisors for startup cost for such things as training, site selection, and prospect franchisee vet are highest. As a result, there would a lower bottom line for franchisors on paper and higher hard cost.
The FASB is giving a little relief. A quote of staff issued FASB highlighted in the Franchise Times states:
One of the most prevalent questions from the franchising industry involves determining whether or not pre-opening activities constitute a distinct performance obligation. Under current GAAP, franchisors generally recognize the initial fee when the location opens and recognize the subsequent royalty stream over time. Because industry-specific GAAP exists, franchisors historically have not had to assess whether the pre-opening services are a separate deliverable. In making this determination under the new standard, the first step for the franchisor is to determine if the pre-opening activities contain any distinct services. If none of the pre-opening services are distinct, then the initial fee would be part of the transaction price for the combined performance obligation of the license and services and, thus, recognized over the entire license period. http://www.franchisetimes.com/news/December-2017/FASB-Clarifies-Confusing-Revenue-Recognition-Language/
For a link to the full link to the FASB handout. Visit the link above.
Franchisor financials are big deal. Franchisor financials matter when prospective franchises consider the brand. And, it is used by state examiners to determine if initial fees must be deferred or escrowed or alternatively a surety bond is required.