IFRS 15 and Franchise Arrangements: Implications for Revenue Recognition

Posted In | Finance | Accounting Software | Revenue Recognition

With the advent of the International Financial Reporting Standard (IFRS) 15, "Revenue from Contracts with Customers," significant changes in revenue recognition practices have rippled across numerous industries, including the world of franchising. This standard provides a comprehensive model for entities to apply in recognizing revenue arising from contracts with customers. In this article, we delve into the potential impacts and unique implications of IFRS 15 for franchise arrangements and revenue recognition.

 

1. IFRS 15 and Franchise Arrangements

IFRS 15 utilizes a five-step approach for recognizing revenue: identifying the contract, identifying performance obligations, determining the transaction price, allocating the transaction price to performance obligations, and recognizing revenue when (or as) performance obligations are satisfied.

In the context of franchise arrangements, these steps could be interpreted as follows:
 

  1. Identifying the Contract: This would typically be the franchise agreement signed between the franchisor and franchisee, which outlines the terms and obligations of both parties.
     

  2. Identifying Performance Obligations: In a franchise arrangement, performance obligations can include the provision of initial franchise rights, ongoing services such as marketing and training, and delivery of goods or other services.
     

  3. Determining the Transaction Price: The transaction price in a franchise arrangement can include an initial franchise fee, ongoing royalty fees, advertising fees, and other potential payments.
     

  4. Allocating the Transaction Price: The transaction price must be allocated to each distinct performance obligation based on their standalone selling prices. For instance, the franchise fee might need to be allocated between the initial franchise right and other services provided.
     

  5. Recognizing Revenue: Revenue should be recognized when (or as) each performance obligation is satisfied. For franchisors, this could involve recognizing revenue at a point in time (such as when the franchise right is granted) or over time (such as providing ongoing support services).
     

2. Challenges and Implications for Franchise Arrangements
 

  1. Distinct Performance Obligations: Franchisors often offer a mix of distinct goods or services, which may present challenges when identifying separate performance obligations.
     

  2. Allocation of Transaction Price: Allocating the transaction price to performance obligations based on their standalone selling prices can be complex, especially when observable prices are not available for every obligation.
     

  3. Franchisee-Related Promises: Some franchise agreements include promises related to future actions (like a pledge to open additional outlets). Determining when these performance obligations are satisfied and how to recognize the related revenue may be challenging.
     

  4. Ongoing Support Services: Determining the appropriate method to recognize revenue from ongoing support services, which are typically delivered over the franchise term, may require judgement.
     

3. Best Practices
 

  1. Thorough Review of Contracts: Franchisors should thoroughly review their franchise agreements to clearly identify performance obligations and accurately allocate the transaction price.
     

  2. Sound Estimation Methods: When standalone selling prices are not directly observable, franchisors must develop sound estimation methods to allocate the transaction price to the performance obligations.
     

  3. Effective Systems and Controls: Franchisors need robust systems and controls to track and monitor their performance obligations, changes in transaction prices, and the satisfaction of performance obligations over time.
     

  4. Seek Expert Advice: Given the complexity of IFRS 15, franchisors may find it beneficial to seek advice from financial reporting and accounting experts, especially during the initial implementation phase.

 

While IFRS 15 brings challenges to the franchise industry, it also provides an opportunity for franchisors to enhance the clarity and transparency of their revenue recognition practices. By understanding the unique implications of the standard and adopting best practices, franchisors can successfully navigate the complexities of IFRS 15, ensuring accurate and compliant financial reporting.