What is the significance of pre-opening activities being 'highly interrelated' for Chocolate Bash franchisees?
Chocolate_Bash Franchise · 2024 FDDAnswer from 2024 FDD Document
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.
The Company estimates the stand-alone selling price of pre-opening activities using an adjusted market assessment approach. The Company will first allocate the initial franchise fees and the fixed consideration, under the franchise agreement to the standalone selling price of the training services that are not brand specific and the residual, if any, to the right to access the Company's intellectual property. Consideration allocated to pre-opening activities, which are not brand specific are recognized ratably as those services are rendered. Consideration allocated to pre-opening activities included under Accounting Standards Update (ASU) to ASC 606, Franchisors—'Revenue from Contracts with Customers (Subtopic 952-606): Practical Expedient' is recognized when the related services have been rendered.
Source: Item 21 — FINANCIAL STATEMENTS (FDD page 38)
What This Means (2024 FDD)
According to Chocolate Bash's 2024 Franchise Disclosure Document, the classification of pre-opening activities as 'highly interrelated' has a specific accounting implication for how Chocolate Bash recognizes revenue. When pre-opening activities are considered highly interrelated and interdependent to the access of Chocolate Bash's intellectual property, they are treated as a single performance obligation. This means that Chocolate Bash recognizes the revenue associated with these activities over the term of the franchise agreement, essentially as the franchisee continues to have the right to use Chocolate Bash's brand and systems.
This accounting treatment contrasts with pre-opening activities that are not brand-specific, such as general business training. These non-brand-specific activities are considered a separate performance obligation. Chocolate Bash recognizes revenue for these distinct activities as they are rendered. This distinction is important because it affects the timing of when Chocolate Bash can recognize revenue from the initial franchise fees.
For a prospective Chocolate Bash franchisee, this means that a portion of the initial franchise fee is not immediately recognized as revenue by Chocolate Bash but is instead recognized over the life of the franchise agreement. This accounting practice reflects the ongoing support and brand access that Chocolate Bash provides to its franchisees. The FDD indicates that Chocolate Bash estimates the stand-alone selling price of pre-opening activities using an adjusted market assessment approach and allocates the initial franchise fees accordingly.