IFA continues to work with key stakeholders ahead of approaching deadlines for public and private companies.

By Aaron Chaitovsky, CFE, and Dean Heyl, CFE

The Financial Accounting Standards Board (FASB) is the independent, private-sector, not-for-profit organization that establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow Generally Accepted Accounting Principles and is recognized by the U.S. Securities and Exchange Commission as the designated accounting standard setter for public companies.
 
Starting with reporting periods beginning after Dec. 15, 2017 (which equates to Jan. 1, 2018 for public entities with a Dec. 31 year-end) for public companies and after Dec. 15, 2018 for private companies, those entities that license intellectual property, including franchisors, will have to recognize the revenue from certain initial fees in a new manner. With regard to licensing, the FASB Section 606 codification focuses on the treatment and understanding of the license right to be used by the customer. The conclusion reached was that the licensing arrangement afforded to a franchisee represents a right for the franchisee to “access” the intellectual property versus a “right to use.” Based on the conclusion reached in the codification (and the Accounting Standards Updates) and some other assumptions, it was determined that the correct treatment of the initial franchise fee would be for the franchisor to record the fee as being earned over the term of the underlying agreement and not, as per the current treatment in FASB ASC 952, when substantially all of the material obligations that the franchisor has to the franchisee, have been completed.
 
There are still scenarios that need clarification with regard to the “simple application of the new standard,” and therefore IFA is seeking clarification for the following reason: the reality that the typical franchise arrangement is not similar to a standard licensing arrangement. A franchise arrangement differs in that the initial franchise fee often covers the expenses of selling, training and assisting in the opening of the franchise location. The ongoing royalty fee is in essence the fee paid for the “use” of or “accessing” of the brand. The initial franchise fee is actually used for the direct and identifiable expenses incurred by the franchisor in selling a franchise and in many instances, exceeds the initial fee collected. Typically, the initial franchise fee is not based on any future activity by the franchisee, but rather a fixed and determined amount paid up front. The ongoing royalty fee, however, is based on the sales by the franchisee at the time and is for access to the intellectual property as it is being used by the franchisee.
Additionally, there are a number of situations not addressed in the new revenue recognition requirements, for example:
 
• A franchisee is sold multiple units of the franchise concept for a certain sum, however, each location can only be opened after the franchisee signs the then-current franchise agreement, an event to take place in the future.
 
• A fee paid for a development agreement, reserving a territory to be used for a certain number of individual franchises and whose development agreement quite often is modified and extended as the years continue.
 
• Fees paid for a master franchise agreement whereby the franchisor quite often has no involvement in the eventual franchise and their right to access the intellectual property.
 
• Other modifications of the agreements initially signed, that may affect both the future and existing franchise units.
 
Specifically identified costs incurred in selling a franchise, such as the sales commission. The amortization period will need clarity to address deferred cost treatment in the following circumstances:
 
• Per Accounting Standards Codification 340, criteria for deferral and subsequent amortization is based on the expectation of recovering the costs over a future period, benefitting a future period; or enhancing the future intellectual property.
 
• Dealing with impairment of the deferred costs should the franchise sell or transfer.
 
• Understanding the broker’s role once the franchise is sold (with regard to any future involvement with the franchisee during the term of the agreement).
 
IFA is also seeking clarity and guidance regarding the required retrospective statements under the following circumstances:
 
• Some franchise agreements carry as much as a 30-year-term and will have to be restated for any unused portion of the initial fee.
 
• Most active franchisors may not have the capability of reconstructing the franchise system and determining when and which units were sold, transferred, closed and if sales commissions were paid and the amount.
 
 
Representatives of IFA have been speaking with the Securities and Exchange Commission, FASB and Capitol Hill staff on the above issues and will keep members updated on progress.
 
Aaron Chaitovsky, CPA, CFE, is practice leader, franchising accounting and consulting practice for Citrin Cooperman.​ Dean Heyl, CFE, is Vice President of Government Relations and Tax Counsel for the Internationaal Franchise Association.

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