What is the significance of pre-opening activities being 'distinct' for Bombs Away's accounting practices?
Bombs_Away Franchise · 2024 FDDAnswer from 2024 FDD Document
Specifically for franchisors, The Financial Accounting Standards Board (FASB) has issued an Accounting Standards Update (ASU) to ASC 606, Franchisors—'Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient' in 2021 which provides a new practical expedient that permits private company franchisors to account for preopening services provided to a franchisee as distinct from the franchise license if the services are consistent with those included in a predefined list within the guidance. The Company has elected to adopt this new standard.
Unearned Revenue
The Company's primarily performance obligation under the franchise agreement mainly includes granting certain rights to access the Company's intellectual property and a variety of activities relating to opening a franchise unit, including initial training and other such activities commonly referred to collectively as "pre-opening activities", which are recognized as a single performance obligation. The Company expects that certain pre-opening activities provided to the franchisee will not be brand specific and will provide the franchisee with relevant general business information that is separate and distinct from the operation of a company-branded franchise unit. The portion of pre-opening activities that will be provided that is not brand specific is expected to be distinct as it will provide a benefit to the franchisee and is expected not to be highly interrelated or interdependent to the access of the Company's intellectual property, and therefore will be accounted for as a separate distinct performance obligation. All other pre-opening activities are expected to be highly interrelated and interdependent to the access of the Company's intellectual property and therefore will be accounted for as a single performance obligation, which is satisfied by granting certain rights to access the Company's intellectual property over the term of each franchise agreement.
Source: Item 21 — FINANCIAL STATEMENTS (FDD page 35)
What This Means (2024 FDD)
According to Bombs Away's 2024 Franchise Disclosure Document, the distinction of pre-opening activities has a significant impact on how the company recognizes revenue. Specifically, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) that allows Bombs Away, as a private company franchisor, to account for pre-opening services separately from the franchise license itself, provided these services meet certain criteria. Bombs Away has elected to adopt this new standard.
For Bombs Away, this means that if certain pre-opening activities are not brand-specific and offer general business information separate from the Bombs Away franchise operation, they are considered 'distinct'. This distinction allows Bombs Away to recognize revenue for these activities as a separate performance obligation when the services are rendered. This is because these activities are expected to benefit the franchisee independently and are not highly interrelated or interdependent with access to Bombs Away's intellectual property.
Conversely, pre-opening activities that are highly interrelated and interdependent with access to Bombs Away's intellectual property are treated as a single performance obligation. Revenue from these activities is recognized over the term of the franchise agreement, essentially as the franchisee gains access to Bombs Away's intellectual property. This accounting treatment affects the timing of revenue recognition for Bombs Away, potentially impacting its financial statements and reported income in different periods.
For a prospective Bombs Away franchisee, this accounting practice may not have a direct, immediate impact on their day-to-day operations. However, understanding how the franchisor recognizes revenue can provide insight into the franchisor's financial health and stability. It also highlights the importance of the initial franchise fee and what services are included, as the allocation of this fee impacts when Bombs Away recognizes revenue. Franchisees may want to inquire about the specific pre-opening activities considered 'distinct' and how they benefit the franchisee separately from the Bombs Away brand.