The math that counts – accounting and finance for franchisors
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Once a franchise relationship is in place, it’s time to get to work – and whether the franchise sells shoes or makes hamburgers or offers in-home medical care, the common work of all franchise systems is to make money. Among other things, this means someone has to do the accounting.
Both the franchisor and the franchisee have accounting related needs. Some of those needs are the same, and some are unique to one side or the other. This responsibility requires careful coordination between franchisors and franchisees, including a clear agreement as to who does what and how. Who manages the systems and labor that franchise accounting requires? Who chooses the technology platform, and according to what specifications? What are the audit rights of both parties? What service levels are committed to by each party?
There is no single perfect solution. There is risk when accounting responsibilities lie with the franchisees, because their methods and their financial capabilities may not be sufficient. There is a risk when the franchisor takes on the burden, because doing so many franchisee books at once can make it harder to peer into any one item in detail or satisfy any unique reporting demands from the franchisees. Either way, it’s a heavy lift for someone.
Recently, rule changes from the Financial Accounting Standards Board (FASB) have made the accounting question even more complex, for franchisors in particular.
One rule changes the way a franchisor is allowed to recognize the receipt of a franchise fee as revenue. For one thing, the recognition can’t take place until the franchisee opens for business – previously, it happened when the payment changed hands. A change with even greater potential impact is that a franchisor must amortize the franchise fee in equal portions over the lifespan of the franchise. So, for example, if an agreement carries a fee of $20,000 and a 10-year lifespan, the franchisor can recognize only $2,000 per year as revenue.
In real life, franchisors count on that fee money early in a relationship, when they spend it on startup costs. While they still receive the initial franchise fee cash up front, the new accounting creates some complexities. Keeping some of the revenue classified as unearned may dilute the apparent financial health of a franchise organization, which might affect its ability to grow or obtain credit. This can raise challenges for dealmakers as they get into the financing of deals.
Late in 2017, FASB heard these concerns from franchisors and issued a “clarification” that will allow them to recognize fee revenue when “pre-opening services” such as training and site selection take place.
FASB has also worked with international authorities to change the standards for leasing – and leasing of real property and equipment is an important facet of the franchise relationship. The main effect of this complex new approach is that the assets and liabilities associated with a lease would be recognized earlier, and would appear on the balance sheet instead of as operating items.
Beyond complex accounting rule changes, there are a multitude of activities that have to occur relative to franchise accounting, just to produce the books. Store operations result in a myriad of transactions on an ongoing basis, and performing the correct accounting and related financial reporting is a critical need that requires time, resources and collaboration.
What do these changes and ongoing needs mean for individual franchisors? That’s likely a case-by-case determination. But the common thread is that accounting requires a careful, professional eye. Recent advances in digital technology may put that kind of sophistication within the reach of more franchisors. More, but not all. Who will handle the books? Both parties should approach that question with information, a long-term view, and unhurried analysis of the options.
Kevin Lane - Principal, Franchise Advisory Services Leader
Deloitte & Touche LLP
With over 20 years of professional experience in advisory services, Kevin has served in a variety of leadership and technical roles over the course of his career. In recent years, he completed an overseas assignment in South America, repatriating to the United States in 2013 to the Dallas/Fort Worth area. Kevin now serves a variety of Consumer & Industrial Products (C&IP) clients throughout the U.S. in meeting their risk and compliance objectives. His areas of focus include compliance, third-party risk, and operations. In addition to leading advisory teams for select C&IP accounts, Kevin serves as Deloitte Advisory’s leader for its Franchisor Advisory Services initiative. Learn more about Kevin and connect with him here