Most franchisors’ annual franchise registration renewal deadlines are a few months away. Nevertheless, franchisors should contact their accountants now regarding a new revenue recognition rule issued by the Financial Accounting Standards Board (FASB) that affects financial reporting for franchisors.

Under the new FASB rule, revenue from initial franchise fees cannot be recognized until the franchisor performs obligation(s) separate and distinct from the intellectual property (IP) license granted to franchisees. Revenue from services that are not separate and distinct from the IP license cannot be recognized immediately,but must be recognized pro-rata, over the term of the franchise agreement. Franchisors must distinguish performance obligations that are separate and distinct from the IP license granted to franchisees, and assess their value compared to the value of services not separate and distinct from the license to use the marks and system.

As an example, a typical franchisor might provide franchisees with an in-person classroom training program and an on-site training program before and just after opening for business.

Training can include topics like business management, accounting, record keeping, banking, payroll, opening and closing, efficient operation, cleanliness, vendor relationships, buying procedures, and information on starting and operating the type of business in the franchisor’s system. Delivering this training would likely be a performance obligation separate and distinct from the IP license granted to the franchisee. This is because the franchisee could use this training to operate a business without use of the franchisor’s brand. If the franchisor determines the standalone sales price for this training is $5,000, that amount could be recognized as revenue when the training is completed.

On the other hand, training could also include topics like use of the franchisor’s distinctive brand-specific operating procedures, merchandise and services, brand-specific routines, methods, techniques, and the like. This would likely not be a performance obligation separate and distinct from the IP license granted to the franchisee. This is because this training could not be used separate and apart from the franchisor’s system. If the franchisor determines the standalone sales price for this training is $10,000, that amount could be recognized as revenue only on a pro-rata basis spread over the term of the franchise agreement.

One effect of the new rule is to require franchisors defer recognition of substantial amounts of initial franchise fee revenue. By planning now, positive steps can be taken to mitigate the impact of the new rule, allowing franchisors to reduce the portion of initial fee revenue for which recognition must be deferred. Therefore, franchisors are encouraged to discuss the new rule with their accountants now.

Read: FASB Financial Reporting for Franchisors’ Rule Memo