The FASB issued ASU 2021-02 (“ASU”) to provide franchisors that are not public business entities with a practical expedient to account for certain pre-opening services as distinct from the franchise license when identifying performance obligations under Topic 606.
During the implementation of ASU 2014-09, private company stakeholders in the franchise industry raised concerns with the FASB about the cost and complexity associated with identifying performance obligations related to pre-opening services provided in a franchise agreement, as well as determining the amount and timing of revenue recognition for initial franchise fees. The initial franchise fee is an upfront payment typically paid in a lump sum to a franchisor in exchange for establishing a franchise relationship, along with the provision of varying levels of pre-opening services to the franchisee.
Under legacy industry-specific guidance in Topic 952, Franchisors, the initial franchise fee was recognized when the franchisor had delivered the promised pre-opening services, which was typically when the franchise location opened. Under the five-step revenue model in Topic 606, the franchisor is required to determine whether the pre-opening activities represent distinct performance obligations and, if so, to evaluate the standalone selling prices for those performance obligations in order to determine the timing and amount of revenue recognition. Many stakeholders expressed concerns about the level of effort required in applying this guidance by private company franchisors, especially for franchisors that are startups or that have fewer resources for applying the general requirements. Moreover, the FASB became aware that some private company franchisors incorrectly presumed that no pre-opening services are distinct from the franchise license and therefore the initial franchise fee would always be recognized over the license term, rather than applying the general requirements in Step 2 of the revenue model to identify performance obligations.
Therefore, the FASB has decided to simplify the evaluation of whether pre-opening activities are distinct from the related franchise right by franchisors that are not public business entities. View the final ASU.
- As a practical expedient, franchisors that are not public business entities may account for the following pre-opening services as distinct from the promise to grant the franchise license:
- Assistance in the selection of a site.
- Assistance in obtaining and preparing the facilities for their intended use, including related financing, architectural, engineering, and lease negotiation services.
- Training of the franchisee’s personnel or the franchisee.
- Preparation and distribution of manuals and similar material concerning operations, administration, and record keeping.
- Bookkeeping, information technology, and advisory services, including setting up the franchisee’s records and advising the franchisee about income, real estate, and other taxes or about regulations affecting the franchisee’s business.
- Inspection, testing, and other quality control programs.
- Franchisors that elect to use the practical expedient may elect an accounting policy to account for the bundle of pre-opening services as a single performance obligation, instead of evaluating whether each of the pre-opening services is distinct.
- Franchisors electing to use the practical expedient or making the accounting policy election should disclose that fact.
- Application of this guidance directly or by analogy is prohibited for all other entities.
- If a franchisor elects not to apply the practical expedient or the pre-opening services in the arrangement do not qualify for the practical expedient, the franchisor shall apply the general guidance on identifying performance obligations in ASC 606-10-25-14 through 25-22.
Effective Dates and Transition:
Franchisors that have not yet adopted Topic 606 should follow the existing transition provisions and effective date in ASC 606-10-65-1.
For franchisors that have already adopted Topic 606, the amendments are effective for interim and annual periods beginning after December 15, 2020. Early application is permitted. For those entities, the amendments should be applied retrospectively to each prior period by means of a cumulative-effect adjustment to the opening retained earnings as of the date Topic 606 was adopted.
 Franchisors—Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient.
 Revenue from Contracts with Customers (Topic 606).
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