Income Wreck-ognition Roundup
Hey there, if you’re a franchisor and believe you will be adversely affected by the income recognition rule changes, please reply to this email with your contact information so I can keep you informed and get a count of franchisors affected by the change, and complete IFA’s Income Recognition Survey.
By this point, I’m sure you’re familiar with my series on income recognition, as well as former IFA Chair Shelly Sun’s presentation at this year’s annual IFA Convention. I hope these have prompted all franchisors to reach out to their respective auditors to get a sense of how much of their initial franchise fee can be recognized upon opening, or, conversely, how much must be amortized over the term of the franchise and what the net effect will be on the company’s capitalization. If you missed it, check out a recap of my prior articles on Income Wreck-ognition, and be sure to review the FASB clarifying document.
All income not recognized in the present year becomes a liability on the financial statement, which threatens capitalization, state registrations and compliance with loan covenants, and may also impact valuations. There are presentation opportunities that may help to explain or mitigate the impact of a large deferred revenue line item. Help regulators identify this quickly by ensuring that deferred revenues for initial franchise fees is a separate line item on your balance sheet.
The rules and guidance provided by FASB, the governing body responsible for auditing standards, are subjective. Your auditor will engage in a five-step process to determine what dollar amount of your initial franchise fee may be recognized up-front.
Shelly Sun shared that BrightStar Healthcare can likely recognize the value of separate performance obligations (such as certain training) upfront, representing 76% of BrightStar’s initial franchise fee, but lamented that the cost of developing the supporting documentation took over 500 hours. Some other large franchisors have indicated that they would like likely recognize the value for distinct performance obligations representing 60% of the initial franchise fee after spending considerable funds in long and protracted discussions with their auditor.
Our experience hasn’t been nearly so bright. Auditors are all over the board, and it’s hard to imagine that they’re all applying a uniform set of rules.
As it stands, this change will severely, adversely affect many of our clients and extended members of our franchise family – who will be lucky to recognize 20 to 30% of their initial franchise fee upfront, and who lack the resources to invest hundreds of man-hours or tens of thousands of dollars in documenting distinct performance obligations and their associated values.
At the recently concluded IFA Convention, Shelly Sun shared FRANdata’s estimate that, without relief, 930 brands are at risk of bankruptcy or closure in three years, with more than 104,000 physical locations at risk of closure and 1.1 million jobs at stake.
The IFA’s government relations team is once again intervening to seek further guidance from FASB, and to ask Congress to help mitigate the auditing rule’s impact on emerging franchisors at a meeting with congressional leaders on February 26. See today’s article on Bloomberg discussing congressional interest in this matter.
To be effective, Shelly and the IFA need your data. If you are an emerging franchisor who has been active in selling over the past few years, this is your issue. Please contact your auditor, and if you are adversely affected, please share your circumstances with me and Suzanne Beall, IFA’s Vice President for Government Relations, so she and Shelly can share your experience with FASB, Congress and Administration officials. When you obtain your actual numbers, please provide IFA and Suzanne your information by clicking here, and until then, reply to this email so I can monitor your progress.
As you may have also seen, we are dedicating a portion of the programming at our upcoming 2020 Franchise UnConference in Park City to an Income Wreck-ignition Roundup for collaboration among franchisors, auditors, PE firms and others coping with this change. Please join other members of the franchise family in this last chance opportunity to share successful strategies to maximize income recognition and methods and tools to sell over a deteriorated financial statement. For more information on UnConference or the Roundup, please reach out to Antonia.