A franchise agreement generally stipulates that the franchisor will be paid an initial franchise fee in a lump sum in exchange for establishing a franchise relationship, along with the provision of varying levels of pre-opening support, such as training or site selection. When implementing Topic 606, Revenue from Contracts with Customers, of the Financial Accounting Standards Boards’ (FASB) Accounting Standards Codification (ASC), private-company franchisors expressed concerns about the level of effort required to account for initial franchise fees due to the complexity in determining whether pre-opening activities include any separate performance obligations.

To address these concerns, the FASB recently issued Accounting Standards Update (ASU) 2021-02, Franchisors – Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient. This ASU provides a practical expedient in ASC 952-606-25-2 that permits a franchisor that is not a public business entity that enters into a franchise agreement to account for the following pre-opening services provided to a franchisee 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

If a franchisor elects to use the practical expedient in ASC 952-606-25-2, it is required to disclose that fact. Also, if a franchisor elects this practical expedient, it must apply the guidance in ASC 606-10-25-19 through 25-22 to determine whether the pre-opening services are distinct from one another, unless it makes an accounting policy election to account for the pre-opening services as a single performance obligation. A franchisor that makes the accounting policy election to account for the pre-opening services as a single performance obligation must disclose that fact.

If a franchisor elects not to apply the practical expedient in ASC 952-606-25-2 or if the services performed are not included in the list in ASC 952-606-25-2, the franchisor is required to apply the ASC 606 guidance on identifying performance obligations.

For an entity that has not yet adopted ASC 606, ASU 2021-02 is effective for annual reporting periods beginning after December 15, 2019 and interim reporting periods within annual reporting periods beginning after December 15, 2020. For an entity that has adopted ASC 606, ASU 2021-02 is effective for interim and annual periods beginning after December 15, 2020. Early application is permitted.