What is the relationship between the initial franchise fee and the unearned revenue for a Chocolate Fish Coffee franchise?
Chocolate_Fish_Coffee Franchise · 2024 FDDAnswer from 2024 FDD Document
turities of three months or less when purchased.
Revenue Recognition
Revenues are primarily derived from franchise fees (one-time and recurring monthly fees). In accordance with Accounting Standards Codification (ASC) Topic 606, Revenue will be recognized when persuasive evidence of an arrangement exists, delivery has occurred, or services have been rendered, the seller's price to the buyer is fixed or determinable, and collectability is reasonable assured. The determination of whether fees and fixed or determinable and collection is reasonable assured involves the use of assumptions. Arrangement terms and customer information are evaluated 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 2022 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.
Source: Item 21 — FINANCIAL STATEMENTS (FDD page 41)
What This Means (2024 FDD)
According to the 2024 Franchise Disclosure Document, Chocolate Fish Coffee recognizes revenue from franchise fees, which include both one-time and recurring monthly fees. The company adheres to Accounting Standards Codification (ASC) Topic 606 for revenue recognition, meaning revenue is recognized when there is persuasive evidence of an arrangement, delivery has occurred, or services have been rendered, the price is fixed or determinable, and collectability is reasonably assured. This involves making assumptions to determine if these criteria are met before recognizing revenue.
Chocolate Fish Coffee estimates the stand-alone selling price of pre-opening activities using an adjusted market assessment approach. The initial franchise fees and fixed consideration under the franchise agreement are allocated to the stand-alone selling price of training services that are not brand specific, with any residual amount allocated to the right to access the company's intellectual property. The consideration allocated to these pre-opening activities is recognized ratably as the services are rendered.
The portion of the franchisee fee not allocated to pre-opening activities is recorded as Unearned Revenue. This unearned revenue will be recognized over the term of the franchise agreement. This means that Chocolate Fish Coffee does not recognize the entire initial franchise fee as revenue immediately. Instead, a portion is recognized as services are provided upfront, and the remaining portion is recognized gradually over the life of the franchise agreement, reflecting the ongoing value and support provided to the franchisee.
For a prospective Chocolate Fish Coffee franchisee, this accounting treatment means that the initial franchise fee covers both immediate services like training and the ongoing right to use the Chocolate Fish Coffee intellectual property. The allocation of the fee and the recognition of unearned revenue over time aligns the revenue recognition with the delivery of services and the value provided throughout the franchise term. This is a common practice in franchising, as it reflects the long-term relationship and support that the franchisor provides.