How does Crab N Spice's accounting treatment of pre-opening activities affect its financial statements?
Crab_N_Spice 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.
The remaining franchisee fee not allocated to pre-opening activities are recorded as Unearned Revenue and will be recognized over the term of the franchise agreement.
Source: Item 21 — FINANCIAL STATEMENTS (FDD pages 40–50)
What This Means (2024 FDD)
According to Crab N Spice's 2024 Franchise Disclosure Document, the company's accounting treatment of pre-opening activities affects its financial statements through revenue recognition and the classification of unearned revenue. Crab N Spice recognizes that its primary performance obligation under the franchise agreement includes granting rights to its intellectual property and various pre-opening activities such as initial training. These activities are considered a single performance obligation. However, some pre-opening activities that are not brand-specific and provide general business information are treated as separate, distinct performance obligations.
Crab N Spice estimates the stand-alone selling price of pre-opening activities using an adjusted market assessment approach. The initial franchise fees and fixed consideration 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. Consideration allocated to these non-brand-specific pre-opening activities is recognized ratably as the 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.
The remaining franchisee fee not allocated to pre-opening activities is recorded as Unearned Revenue and is recognized over the term of the franchise agreement. This accounting treatment ensures that Crab N Spice recognizes revenue in accordance with accounting principles generally accepted in the United States of America (US GAAP), matching the revenue recognition with the delivery of services and access to intellectual property over the life of the franchise agreement. This approach affects the timing of revenue recognition and the presentation of unearned revenue on Crab N Spice's balance sheet.