Franchisors entering into franchise agreements with customers often perform varying levels of pre-opening activities, such as training or assisting the customer in site selection and preparation. In many cases, franchisors will charge their customers a nonrefundable upfront fee, or initial franchise fee, related to these activities. As discussed in RR 8.4
, no revenue should be recognized upon receipt of an upfront fee, even if it is nonrefundable, if the fee does not relate to the satisfaction of a performance obligation. Accordingly, a franchisor will need to assess whether pre-opening activities transfer a good or service to the franchisee and if so, whether that good or service is distinct from other goods and services in the contract, including the franchise license.
In January 2021, the FASB issued ASU 2021-02
, Franchisors—Revenue from Contracts with Customers (Subtopic 952-606)
, which applies to nonpublic entities (that is, all entities other than public entities, as defined) that are franchisors, as defined within ASC 952
. ASU 2021-02
includes a practical expedient that permits a nonpublic franchisor to account for certain pre-opening services identified in ASC 952-606-25-2
as distinct from the franchise license in a franchise agreement. Reporting entities outside the scope of ASU 2021-02
should not apply the guidance by analogy.
As a practical expedient, when applying the guidance in Topic 606, a franchisor that enters into a franchise agreement may account for the following pre-opening services as distinct from the franchise license:
- Assistance in the selection of a site
- Assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, and engineering services, and lease negotiation
- 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.
The practical expedient only applies to identifying the performance obligations in a franchise agreement and does not amend other aspects of the revenue guidance. For example, a franchisor will need to determine the standalone selling price of the pre-opening services and any other distinct goods or services in the contract (including the franchise license) and allocate the transaction price in accordance with the guidance discussed in RR 5
. As a result, the amount allocated to the pre-opening services could differ from the amount of the initial franchise fee. A nonpublic franchisor that elects the practical expedient will apply the guidance in the revenue standard on identifying performance obligations (RR 3
) to determine whether multiple pre-opening services are distinct from one another. Alternatively, franchisors applying the practical expedient can make an accounting policy election to account for all pre-opening services as a single performance obligation.
If the franchisor performs services that are not included in the list of pre-opening services in ASC 952-606-25-2
, the practical expedient cannot be applied to those services. That is, franchisors cannot apply the practical expedient to other pre-opening services by analogy. For services not subject to the practical expedient, the franchisor should apply the guidance in the revenue standard on identifying performance obligations (RR 3
) to determine whether the services are distinct from other promises in the contract, including the franchise license.
The practical expedient should be applied consistently to contracts with similar characteristics and in similar circumstances. Similarly, the accounting policy to account for pre-opening activities as a single performance obligation should be applied consistently. Nonpublic franchisors must disclose the use of the practical expedient and, if elected, the accounting policy to treat certain pre-opening services as a single performance obligation.
If a nonpublic franchisor has not yet adopted ASC 606
, the existing transition provisions and effective date in ASC 606-10-65-1
are applicable, which allows for a modified retrospective or a full retrospective adoption. If a nonpublic franchisor has already adopted ASC 606
, the practical expedient should be applied retrospectively to the date ASC 606
was adopted. The guidance is effective in interim and annual periods beginning after December 15, 2020 and may be early adopted.