Revenue recognition for franchisors: You’re on your way. Now what?
The new revenue recognition standard is effective in 2018 for public business entities and in 2019 for all other entities. With implementation of the new revenue recognition standard well underway for many organizations, best practices have emerged to avoid headaches during the transition process. For those in the franchising industry, these best practices can offer valuable insight into how to go about meeting the deadline efficiently and effectively.
Revenue recognition for franchisors
The major steps franchisors should take to implement the new standard include:
- Assign staff to be experts in understanding the new revenue recognition model.
- Identify distinct performance obligations in your franchise agreements and typical costs associated with obtaining the franchise agreements.
- Determine the GAAP change.
- Evaluate the impact of the GAAP change on financials, processes and systems, and operational/performance metrics.
- Determine the transition approach.
- Educate key stakeholders.
- Execute necessary changes.
Considering the magnitude of the changes and the number of franchisees in many franchisors’ systems, it’s easy for executives to feel as though the road to implementation will by rocky. However, lessons learned from those planning to early adopt can make it much easier to get through to the finish line.
Now is the time for action. Continuing to move ahead ensures that you have the resources you need to meet the deadline.
Best practices by implementation phase
Here, we’ll look at the typical phases of the implementation process and examples of how franchisors can overcome challenges encountered:
- The initiation phase (steps 1-4)
- Challenge: The new ASC 606 requires an extensive inventory of contracts and close examination of relevant terms. While your franchise agreements are likely similar from franchisee to franchisee, it can be time-consuming to identify all of the obligations owed to the franchisee by the franchisor. This is especially true if the terms of a contract can vary by franchisee.
- Best practice: Start by grouping similar agreements and identifying agreement-specific terms that could result in unique forms of revenue recognition. Segregating these outliers can facilitate applying the new revenue recognition rules to the majority of more homogenous contracts and terms. In addition to franchise agreements, you will also want to consider key terms in area development and master franchise agreements.
- The gap and impact analysis phase (steps 5-8)
- Challenge: Franchisors must understand and quantify the changes to their balance sheets and income statements as a result of applying the rules in the new revenue recognition standard. And, even where those changes are not significant, the new disclosure requirements mean that additional analysis and new information is needed.
- Best practice: Keep in mind that a major distinction between the new principles-based standard and the previous rules-based standard lies in the supporting documentation provided to explain an organization’s revenue recognition process. Develop and maintain comprehensive documentation from start to finish to avoid a lengthy catchup exercise near the end of the process. And review the additional disclosures made by early adopters and publicly-held franchisors in their quarterly filings to determine whether your planned disclosures are in line with others in the industry.
- The implementation phase (step 9)
- Challenge: Financial statements need to change at the beginning of the period that you adopt the new standard. It could take a long time to finalize necessary changes to processes and systems and get the right data into the financial statements. Restating prior periods can add even more time to the process.
- Best practice: Ensure that system revisions are online at the beginning of the year to uncover any challenges to reporting the information needed for the first full set of financial statements. And, if you are planning to restate prior periods, start your process even sooner. Performing a “dry run” of the closing process is a great way to confirm that you are ready to go live.
Best practices: Human capital
With the deadline for implementation getting closer, the most important step is to ensure that you’ve established an implementation team. Remember that those who will be most involved in the transition process also have daily responsibilities that will need to be addressed. As the deadline nears, the people in your organization with specialized knowledge about institutionalized processes, systems, and procedures could be short on time. Consider adding temporary staff with the skills to perform administrative activities that your implementation team may not have time to address. Lightening the load for your core team will allow you to conduct a smoother and drama-free implementation project with a higher likelihood of success.
Consider adding temporary staff with the skills to perform administrative activities that your implementation team may not have time to address.
Best practices: Financial statement impacts
- Even if the timing and amount of your revenue doesn’t change significantly as a result of applying the new standard, you will still need to disclose important decisions made and methods and analysis used to produce the revenue presented in your financials. Your financial statements will look different to you and your readers. In the new principles-based rules for revenue recognition, the focus will be on explaining how you arrived at a number, rather than on the number itself, in an effort to promote more consistent information available to financial statement users.
- There may be financial statement users who you want to alert of the changes in presentation. Identify which account balances could be impacted, and review important agreements, such as financing arrangements, that could rely on your account balances. For example, could your debt covenants be affected by the change? If so, you should contact your bank and work with them to make sure that those covenants are reset upon implementation.
Other best practices for franchisors
- Any franchise agreements or relevant terms that are substantially similar can be grouped and evaluated together as a “portfolio”. Rather than analyzing each agreement individually, this approach can save time and effort if agreements and terms are similar enough. Consider whether the terms of your FDD and standard franchise agreement change significantly year over year, or if unique terms are negotiated for certain franchisees.
- A franchisor’s transaction price is typically easy to determine (i.e. the initial franchise fee and ongoing royalties); however, determining when and how that transaction price should be recognized — a crucial decision in the new revenue recognition framework — can require special attention. Value may or may not ultimately be ascribed to training services, site selection and evaluation, and goods or equipment provided if they don’t meet the definition of a distinct performance obligation under the new standards.
- Franchisors will also need to consider the impact on customer loyalty programs, advertising funds, gift cards, and product sales to franchisees. The key terms and obligations under such programs will need to be carefully identified and reviewed for changes resulting from the new standards.
Franchisors will also need to consider the impact on customer loyalty programs, advertising funds, gift cards, and product sales to franchisees.
You’re on your way. Now what?
Of all the advice we could offer to franchisors implementing the new revenue recognition standard, perhaps the most important is this: Don’t let your momentum lag. Keep going!
The deadline may be quickly approaching, but it’s certainly still possible to effectively prepare for the change. As you complete each phase, keep your momentum going by quickly continuing on with the next one. If you keep going, you’ll give your team the opportunity to make it through any unexpected roadblocks and still meet the deadline. And, if you need any help along the way, Plante Moran’s national franchise team is here to help.