Forget the new federal tax laws. Take a look at the new rules on revenue recognition issued by the Financial Accounting Standards Board (FASB) now going into effect.
On January 1, 2018, new FASB rules on revenue recognition went into effect for public companies. The rules will be in effect for all other corporate entities on January 1, 2019. The big issue for franchisors is that the new FASB rules set a new standard for revenue recognition that could significantly impact how franchisors recognize revenue derived from initial franchise fees, training fees, equipment, inventory and the ongoing royalties that they collect. FASB, by the way, is an independent, private sector, not-for-profit organization established in 1973 that establishes financial accounting and reporting standards for public and private companies following Generally Accepted Accounting Principles (GAAP).null
How should franchisors recognize income?
Journalist Nicholas Upton, reporting on the new rule in a recent issue of Franchise Times, says going forward, franchisors will have to split licensing fees into two distinct categories:
- Functional, such as a license to use software; and
- Symbolic, where the value of the license is in the brand and support provided by the franchisor.
This is a departure from convention, says Upton, noting that prior to the new rules, most franchisors typically recognized the payment of an initial franchise fee immediately, or in the case of training, etc., when the related support was provided. The timing of revenue recognition was most often interpreted by franchisors as an ability to recognize income when the franchisee opened for business.
No more lump sum revenue recognition?
Nope. Be prepared for a slower process because the new FASB standard may require franchisors to recognize initial franchise fees (and other initial fees) as revenue derived over the period of the entire franchise agreement. So, Upton says, instead of realizing a revenue increase of, say, $40,000 at each franchisee opening, the franchisor may have to amortize that $40,000 fee over ten years, or whatever the term of the franchise agreement.
What does slower revenue recognition mean for franchisors?
Slower revenue recognition means slower revenue streams for franchisors. Complying with the new FASB rule could significantly impact a franchisor’s financial statements, essentially reporting reduced revenue.
Revenue reduction (due to this slowdown) could, in turn, lead some franchise registration states to impose new financial assurance requirements on franchisors seeking registration or renewal. Moreover, these requirements could significantly reduce needed revenue generated by franchise fee payments and/or increase operating costs connected to posting a bond or escrowing franchise fees depending on whether a franchisor catalogs specific licensing fees as either functional or symbolic.
Why planning for the FASB now matters
The new FASB rule does not go into effect for non-public companies until January 1, 2019. Nonetheless, franchisors should review the new rules with their franchise counsel and auditors now! This is particularly important for those franchisors currently updating their franchise documents for renewal and registration in early 2018.
Why should you prepare for FASB?
You should prepare now for the FASB rule going into effect next year because in franchising, as in all business management, knowledge is power. So be informed. Talk with your franchise attorney about the new FASB rules. Still got questions? Feel free to email them to me, Julie Lusthaus at [email protected] and let’s talk.