What is the significance of pre-opening activities being 'highly interrelated' for Bombs Away's accounting practices?
Bombs_Away Franchise · 2024 FDDAnswer from 2024 FDD Document
valuated to ensure that these criteria are met prior to recognition of revenue.
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 degree to which pre-opening activities are interrelated significantly impacts how the company recognizes revenue. Specifically, Bombs Away distinguishes between pre-opening activities that are brand-specific and those that are not.
If pre-opening activities are not brand-specific and provide general business information, Bombs Away accounts for these as a separate, distinct performance obligation. This means the company recognizes revenue ratably as these services are rendered. However, if the pre-opening activities are considered 'highly interrelated and interdependent' to the access of Bombs Away's intellectual property, they are bundled together and accounted for as a single performance obligation.
In practice, this means that Bombs Away recognizes the revenue associated with these interrelated activities over the term of the franchise agreement, essentially spreading the revenue recognition out over the life of the agreement. This accounting treatment reflects the idea that the franchisee's benefit from these activities is intrinsically linked to their ongoing access to the Bombs Away brand and its associated intellectual property. This distinction is important for franchisees to understand, as it affects how Bombs Away's financial performance is reported and how the initial franchise fees are accounted for.