Reporting Initial Franchise Fees: How the Changes May Affect You

The Financial Accounting Standards Board (FASB) and Internal Accounting Standards Board (IASB) have recently issued a new rule, ASC 606, which has been generating some buzz. The new rule will have an impact on the revenue recognition reporting for franchisors. This article discusses the speculations of the new rule and how its adoption could affect franchisors, franchisees, and their future profitability.

The New Rule

ASC 606 will change the way franchisors will report initial franchise fees (IFFs) on their financial statements. Its purpose is to require franchisors to spread the IFF over the life of the contract instead of recognizing the entire lump sum as revenue up front. For example, if you sell a franchise today for a five-year contract with an initial franchise fee of $25,000, you get to recognize that entire amount as revenue upon the opening of the franchise. With the new rule in place, you will have to report $5,000 each year over the life of the contract, five years.

The rule is set to take effect this year for publicly traded companies, and next year, 2019, for private companies. Those who will remain unaffected by this change include ones that collect periodic royalties once a franchise unit is in operation and franchises that are royalty self-sufficient.

How will this affect my franchise?

One possible effect of this change could be related to the profitability of your franchise. If you use IFFs to sustain your franchise at a profitable level, this new rule could bring you from a “profitable” franchisor to an “unprofitable” franchisor, when looking at your financial statements. How do you explain this unattractive status to potential franchisees?

The new rule has the possibility not only to affect your ability to generate business with franchisees but could potentially scare off future vendors and suppliers. With an “unprofitable” financial record, it could be difficult to attract qualified partners and attractive deals from suppliers. If people can’t see the value in your business, why should they decide to work with you?

Ways to lessen the impact

There are a few different ways you can offset the effect of the new rule in a justifiable way.

Become royalty self-sufficient

For starters, get your franchise to become royalty self-sufficient, and fast. The quicker this is accomplished, the lesser the effect you will see on your income statement.

Pre-opening obligations

You could also boost your revenue stream by recognizing pre-opening obligations on your financial statements. These could include activities such as on-site guidance and training. Your advisor will be able to help you recognize these opportunities.

Prove its worth

As discussed earlier, with an “unprofitable” income statement, it may be hard for franchisees, vendors, suppliers, and advisors to recognize the potential of your franchise. One way to mitigate this is to open up a unit yourself to demonstrate the investments worth.

In summary, the new revenue reporting rule isn’t expected to have a substantial effect. Although it may present challenges for some, there are ways in which to lessen its impact. Consulting with an advisor could be beneficial to you and the future of your franchise.