Start now to meet new rule from FASB
Big changes are coming to the accounting department, but few companies have done much about new Financial Accounting Standards Board (FASB) rules. Dubbed revenue from contracts with customers, the handful of new rules will change things for restaurant franchisors especially.
The new rule creates a universal standard instead of a patchwork of industry-specific guidance. Within that guidance, the standard splits licensing fees into two distinct categories: functional, which covers things like software; and symbolic, where franchising generally will fall, as the value isn’t in the tool itself but in the brand and support.
Companies have been slow to adopt standards that go into effect for public companies in January 2018 and for private companies in January 2019. In a recent survey from Ernst & Young, 14 percent of respondents said they hadn’t yet started doing anything, and 70 percent said they were not finished.
To get the industry up to speed, BDO National Assurance Partner Angela Newell coauthored an executive summary on the new standard. She said franchisors that fall under the symbolic license will have to change how they recognize franchisee fees in financial statements—from right when the store opens to over the life of the contract.
“There was some industry guidance for franchisors that allowed them to recognize that upfront franchise fee when the related efforts were complete, which most people interpreted when the store opened,” said Newell. “The new standard requires the revenue for the symbolic license to be recognized over the period of benefit from the licensee standpoint. Basically that’s going to be the term of the franchise agreement.”
So instead of a $40,000 revenue bump with every franchisee grand opening, for example, franchisors must now amortize that fee over 10, 15 or 20 years—however long the franchise term covers. For fast-growing brands, that may alter the revenue line dramatically and investors may not understand what happened at first blush.
But there are ways around the standard for brands that still want to see revenue up front.
“The new guidance does have some language about identifying distinct performance obligations; what that really asks is, are you providing any services that are distinct or separate from the franchise right themselves,” said Newell.
“If recognizing some revenue up front is really important, they might consider renegotiating or restructuring franchise agreements such that they may take less up front but what they do take up front really only relates to the types of goods and services that can be separately identified.”
In practice, a brand might look at real estate help as an opportunity for upfront recognition. Since quality real estate is not typically brand specific (in other words, many brands could work at the same location), fees associated with real estate guidance could be recognized as soon as the lease is signed.
Franchisors under a private-equity umbrella may especially be pushed to get as many of those tangential items recognized up front as firms look to keep Generally Accepted Accounting Principles (GAAP) revenue as high as possible for their ownership term. For others, it may amount to a lot of work with little payoff.
“The reality is that the upfront fees are not that much compared to the royalties that you get,” said Newell. “So I’m not sure how much of a benefit it is to go back and work on renegotiating and changing things just to recognize a relatively small amount upfront. But that’s something franchisors need to think about.”
Showing the work is critical under the new rules. That’s a big change for accountants. “The new standard adds a large number of disclosures, so the accountants out there are going to be writing a lot of footnotes,” said Newell.
‘No bright line’
The new footnote requirements are in part due to the universal coverage of the new standard. To demonstrate the why and the how of results and recognitions, CFOs must essentially show their work in the footnotes.
That’s one of the downsides of a principles-based standard, Newell said. “There’s no bright line. It’s all facts and circumstances.” This new standard will require more disclosures, not only about the numbers but what the thought process is.
“It can be a big change,” she added. “If you look at most financial statements in the restaurant space the disclosures are minimal. Even for franchisors, it’s two or three sentences.”
Newell said that’s one thing that many companies are glossing over as they prepare to adopt the new standard, but it’s a critical thing to think about early on. Luckily companies have a few months before the standard goes into effect, and private companies have an additional year to prepare (and learn from the public company efforts).
“They’ve got a bit of time. The challenge is really that if they want to revisit their negotiation process for their franchise rights … they’d want to start doing that now,” said Newell. If a company’s investors or bankers look at EBITDA (gross earnings) or “something else that includes revenues that will be impacted, they want to start having those conversations sooner rather than later so they aren’t caught with unexpected consequences.”