The new revenue recognition standard becomes effective on January 1, 2018 for public companies. Private companies can choose to adopt the new model early, but have an additional year to comply. With the clock ticking until implementation, are you ready?

On May 28, 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASC 606), which provided new guidance for recognizing revenue for contracts with customers. The standard is poised to change the way franchisors recognize their revenue. 

Under current revenue guidance, a franchisor would recognize the revenue from the initial franchise fee upon evidence of completion of all initial obligations (training, site selection, etc.). Generally, the opening of the store was the best indication that these obligations had been satisfied. The royalty, of course, is recognized as the restaurant’s sales took place over the period the restaurant‘s operation.

However, ASC 606 indicates that the franchise right is a distinct performance obligation that transfers over time, and therefore, any portion of the initial franchise fee that is allocated to the franchise right should be recognized over the course of the contract term. This conclusion results from the fact that the franchise license derives its value from the past and ongoing activities of the franchisor, such as branding and marketing activities. The royalty, of course, is recognized as the restaurant operates and the sales occur.

In most cases, the upfront franchise fee—and by extension, any area development fees—will now generally be recognized over the term of the franchise license. However, the new standard retains the requirement to defer any broker fees paid in relation to entering into the franchise license, and requires them to be amortized generally over the same period.