New Financial Rule May Affect Brokers
While it’s still too early to determine the exact impact on franchise brokers of the updated revenue recognition accounting rule, compensation changes could be coming. ASC 606, the joint rule issued by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), redefines when and how most franchisors must recognize initial franchise fees on their balance sheet from when they are received and stretch them out over the life of the franchise agreement. (See page 25 for more details.)
For example, if an initial franchise fee is $10,000 for a 10-year franchise agreement, revenue must now be recognized as $1,000 per year for 10 years. The same holds for multi-unit development: franchisors will no longer recognize all initial franchise fees as revenue when the first location opens its doors, but rather when each location opens.
“Effectively, what this new regulation is doing is potentially reducing the equity balance of the franchisor,” says franchise attorney Charles Internicola, managing partner and founder of The Internicola Law Firm.
The new revenue recognition standards take effect this year for large, publicly traded companies, and in 2019 for private companies. The FASB has clarified that multiple pre-opening performance obligations, such as site guidance and training provided to help new franchisees launch, can be recognized as revenue when the services are provided.
Whether or not franchisors will attempt to spread out the fees owed to brokers and consultants over the term of the franchise agreement, there already is talk of pushback from the broker community if they do. This could negatively affect franchisor-broker relationships, but it’s still too early to tell and both sides have an interest in working it out so the deals–and the commissions–continue to flow.
Don Daszkowski, founder of the International Franchise Professionals Group, doesn’t believe that franchise consultants will or should be affected by the new accounting regulations. “Franchise consultants’ commissions are based on a percentage of the franchise fee, but these commissions should be looked at as marketing dollars to the franchisor,” he says.
For example, he says, “If a franchisor spends $15,000 in marketing dollars to a franchise portal to recruit a new franchisee, they cannot ask the franchise portal to amortize their marketing spend over a 10-year period. A consultant’s commissions should be treated the same way.”
“This is very much something that is a wait-and-see to see how this progresses,” says Internicola. “State regulators haven’t modified any of their requirements based on these new accounting recognition policies, so we don’t know if we can get movement from the states. This is definitely a fluid situation.”
Published: April 14th, 2018