Historically, franchise brands have been allowed to immediately recognize the initial franchise fees earned from incoming franchisees, which average $36,000, when all material services or conditions relating to the sale have been substantially performed or satisfied. For small business, “emerging brands,” the recognition of this income is critical to the financial stability of entrepreneurs who are beginning to grow their business.
In 2019, private companies were required to comply with the Financial Accounting Standards Board (FASB)’s new ASC 606 revenue recognition standards, requiring franchise brands to amortize their initial fees over the life of the franchise contract. For example, if a franchise brand receives $36,000 from a new franchise owner, the brand would have to amortize the fee over the ten-year agreement, providing the brand with only $3,600 in cash per year.
In 2018, IFA worked directly with FASB to clarify the rules for franchisors and allow for the recognition of a portion of initial franchise fees, such as for site selection and training. However, it has now come to our attention that the majority of our emerging brands have been unable to recognize a portion of their initial franchise fees, and for those who have found some success, the process has been overly burdensome, requiring hundreds of hours of analysis and significant resources to achieve minimal success. There is also a significant cash flow issue that is critical to the survival of small business emerging brands.
In our continued discussions with FASB, we emphasized the need for permanent relief for private sector franchisors, in particular. On April 21, 2020, IFA submitted a public comment in support of FASB’s proposed Accounting Standards Update to allow an extra year to implement Topic 606 for private franchisors while the Board evaluates a simplified process to reduce costs for small businesses and income derived from initial franchise fees.IFA is also continuing to discuss this ongoing issue with our allies in Congress and the Administration. On May 12, 2020, Congressman Brad Sherman, Chairman of the Investor Protection and Capital Markets Subcommittee, led a bipartisan letter to FASB in support of allowing private franchisors the ability to immediately recognize a portion of the their initial franchise fees.
The economic impact of ASC 606 is serious. As a result of ASC 606, franchisors will suffer from reduced assets and greater liabilities, resulting in a lower net worth on their balance sheet. Franchisors that show a negative net worth in their audited financials often face impound conditions (escrow requirements) in certain franchise registration states, as well as additional questions from franchisee prospects regarding the strength of the system.
According to the franchise research firm FRANData, 930 franchise brands will be at serious risk of bankruptcy or closure within the first three years of the new revenue recognition standards going into effect if relief isn’t provided. The associated 104,098 franchise small business locations will face closure, causing approximately 1.1 million job losses.
See below for more information about certain activities with FASB and the Congress, and direct any questions to Suzanne Beall, Vice President of Government Relations & Public Policy and Counsel, at email@example.com.
- IFA Technical Inquiry to FASB Regarding ASC 606
- CEO Letter to U.S. Congress Requesting Relief
- U.S. House Small Business Committee Letter to FASB
- FASB Educational Staff Paper for Private Franchisors
- U.S. House Small Business Committee Letter to PCAOB
- IFA Letter in Support of the Responsible Accounting Standards Act
- IFA Comment Letter in Support of ASU No. 2014-09
- Chairman Brad Sherman Letter to FASB