What accounting standard does Extreme Art Studio use for revenue recognition?
Extreme_Art_Studio Franchise · 2024 FDDAnswer from 2024 FDD Document
The Company's revenues consist of initial franchise fees, royalties and marketing fees based on a percentage of gross revenues, and product sales. Upon inception, the Company adopted ASC 606, Revenue from Contracts with Customers. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the considerations expected to be received for those goods or services. In implementing ASC 606, the Company evaluated all revenue sources using the five-step approach: identify the contract, identify the performance obligations, determine the transaction price, allocate the transaction price, and recognize revenue. For each franchised location, the Company enters into a formal franchise agreement that clearly outlines the transaction price, which includes an initial fee and ongoing fees, and the Company's performance obligations.
Upon evaluation of the five-step process, the Company has determined that royalties and marketing fees from locations operated by a franchisee, which are based on a percentage of gross revenue, are to be recognized at the time the underlying sales occur. Product sales are recognized upon shipment. In allocating the transaction price and recognizing the revenue associated with initial franchise fees, the Company has elected to adopt the practical expedient for private company franchisors outlined in ASC 952-606, Franchisors—Revenue from Contracts with Customers. The practical expedient allows franchisors to account for pre-opening services as a single distinct performance obligation. These pre-opening services include the following:
- Assistance in the selection of a site
NOTES TO THE FINANCIAL STATEMENTS December 31, 2023
- Assistance in obtaining facilities and preparing the facilities for their intended use, including related financing, architectural, and engineering services, and lease negotiation
- Training of the franchisee's personnel or the franchisee
- Preparation and distribution of manuals and similar material concerning operations, administration, and record keeping
- Bookkeeping, information technology, and advisory services, including setting up the franchisee's records and advising the franchisee about income, real estate, and other taxes about local regulations affecting the franchisee's business
- Inspection, testing, and other quality control programs
As of December 31, 2023, the Company has not collected initial franchise fees and has not determined the amount to be allocated to the pre-opening services.
Source: Item 21 — FINANCIAL STATEMENTS (FDD page 49)
What This Means (2024 FDD)
According to Extreme Art Studio's 2024 Franchise Disclosure Document, the company adopted ASC 606, Revenue from Contracts with Customers, upon inception. This standard dictates that revenue is recognized when control of promised goods or services is transferred to a customer, reflecting the consideration expected to be received for those goods or services.
For Extreme Art Studio, this means applying a five-step approach to evaluate all revenue sources: identifying the contract, identifying performance obligations, determining the transaction price, allocating the transaction price, and recognizing revenue. The company enters into a formal franchise agreement for each franchised location, which outlines the transaction price, including initial and ongoing fees, and the company's performance obligations.
Specifically, royalties and marketing fees, which are based on a percentage of gross revenue from franchisee-operated locations, are recognized when the underlying sales occur. Product sales are recognized upon shipment. For initial franchise fees, Extreme Art Studio has elected to adopt the practical expedient for private company franchisors outlined in ASC 952-606, Franchisors—Revenue from Contracts with Customers, which allows them to account for pre-opening services as a single distinct performance obligation. These pre-opening services include site selection assistance, help with facilities, training, manuals, bookkeeping, IT, advisory services, and quality control programs.
As of December 31, 2023, Extreme Art Studio had not yet collected initial franchise fees and had not determined the amount to be allocated to pre-opening services. This approach to revenue recognition ensures that Extreme Art Studio's financial reporting aligns with current accounting standards and provides a clear picture of when and how revenue is earned.