Rule ASC 606
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board recently jointly issued rule ASC 606 known as “Revenues From Contracts With Customers”. ASC 606 has the potential to dramatically change the franchise industry. In a nutshell, this new rule governs when the franchise fee can be recognized (from an accounting perspective) by a franchisor.
ASC 606 provides that the franchise fee cannot be recognized by the franchisor when the franchisor’s initial obligations to the franchisee are met, as has been the custom. Under ASC 606 the franchisor must recognize the monies paid in the franchise fee over the life of the franchise rights. In other words, if the franchise term is ten years, then the franchise fee must be recognized in their financial statements over a 10 year period of time. This means that if a franchisor is paid $50,000 for a franchise fee for a franchise term of 10 years, the franchisor may only recognize one-tenth of that in the first year, or $5,000.
What is the likely impact of ASC 606? It is hard to determine.
For franchisors ASC 606 will likely mean that their audited financial statements will reflect far less revenues. It may also mean that incentives to sell franchises rapidly to obtain hundreds of franchise fees will be less important than opening up franchises and garnering the revenue from royalties and product sales from the franchisees. It seems to me that if a franchisor cannot immediately recognize the revenue from the franchise fee, there is less motivation to grow rapidly. Another question is what happens with multi-unit development fees? How will these be treated? Clearly this can prolong the time when franchisors can recognize the fees.
The impact of ASC 606 on consultants is even less clear. Will franchisors now want to pay the fees owed to consultants over the term of the franchise agreement? Clearly payment over 5 or 10 years would make a tremendous impact on consultants. On the other hand, maybe franchisors will continue to pay the consultants in the same manner as they were paid prior to ASC 606, ignoring the fact that from the franchisor’s accounting perspective the funds are not recognized.
ASC 606 will become effective for audited financial statements of publicly held companies on December 15, 2017 and privately held companies on December 15, 2018.