As we have worked with some of our 200 brands, we have noticed a pattern among auditors – the pattern being that there is no pattern. The more parochial firms categorically reject the concept of recognizing any income upfront and require the entire initial fee to be amortized. Others seem to go through the appropriate exercise: the franchisor and auditor looking line-by-line at the components of initial fee and segregating performance obligations that are unrelated to the trademark license for recognition in the present year. However, we’re seeing vastly different treatment by audit firms of these items in arriving at the recognizable portion.
A large part of our practice lately has been to advocate for franchisors with their auditors, prior to the audit being issued. In our opinion, the opportunities for recognition revolve around the treatment of: (i) training unrelated to the brand; and (ii) real estate and site selection.
This is a macro issue for the franchise industry and affects all franchisors. We are collecting data to determine the size of the problem and the number of affected systems hoping to provide education, or potentially approaching FASB for additional clarification and guidance for the auditors of franchise companies.
Franchisors’ Call to Action
Before the New Year, ask your accountant where you will stand at the end of 2019 (or your fiscal year) because of income recognition rule changes, and what percentage of your initial franchise fee or development fees your brand will have to amortize for 2019.
A capital deferral problem can be solved on the financial statements by making a capital infusion of the negative amount at any time before the end of your fiscal year (for most franchisors, this is December 31). While many shortfalls will probably be difficult or impossible to recapitalize with a third-party investor, the ability to reflect the equity infusion in your 2019 audit expires on December 31. After that point, it won’t get picked up until the 2020 audit in April 2021 – state examiners will no longer accept an unaudited interim statement to demonstrate a capital infusion in order to get registered. So if capital infusion is your fix, you need to do it by year-end.
We can’t organize any effort to deal with these collective issues if we don’t know about you. Please help us make sure your brand is represented – complete the minute-long INCOME WRECK-ognition survey here.
These changes may cause successful and active franchisors to be put in the red based on an accounting rule, which, alone, doesn’t accurately depict the quality of the franchisor, or the economic opportunity represented by the franchise.
To counteract an inaccurate depiction, brands are poring over their POS and loyalty data to demonstrate brand equity with their customer base, and developing robust Item 19 financial performance representations to demonstrate that the underlying business opportunity remains sound. Our attorneys are highly skilled in preparing comprehensive FPRs that can highlight and demonstrate the strength of your brand, and are ready to assist. Don’t hesitate to contact our team.