What ASC 606 means for the restaurant industry

The new revenue recognition standard issued in 2014 is finally here. ASC 606: Revenue from Contracts with Customers will affect nearly every company in America — including restaurants.

It replaces multiple pieces of revenue recognition guidance with one overarching principles-based standard that any company in any industry could apply to its revenue transactions, converging for the most part with the international standards.

“One downside is that it’s a one-size-fits-all, which we all know doesn’t always work as well as customized guidance might,” says Angela Newell, national assurance partner with the BDO Dallas office.

In the restaurant space, franchisors are going to feel the change the most.

Smart Business spoke with Newell about the new revenue recognition standard and its impact on restaurants.

What changes will the restaurant space see?

The new standard will result in a significant change in the accounting for upfront franchise fees and area development fees charged by franchisors.

Franchisors typically recognize franchise fees when a franchise opens. Under the new standard, franchisors will likely defer that upfront franchise fee and recognize it over the franchise term, which can be 10 or more years, putting the fee on the balance sheet and amortizing it into revenue over the period. The thought is that the value to the franchisee doesn’t end when the store opens, it continues over the life of that franchise agreement. Going forward, franchisors will report a deferred revenue liability on their balance sheet. This new liability needs to be communicated to stakeholders.

While franchisees and owner/operators aren’t expected to experience the same far-reaching changes, they may have to make changes to the accounting for their gift cards and loyalty programs.

Everyone — franchisees, franchisors and owner/operators — will have to comply with additional footnote disclosures. They need to ensure they have access to the information and then be prepared to report it regularly.

When do the new rules go into effect?

The new standard is effective for calendar year-end public companies on Jan. 1, 2018. Private companies get an extra year. Calendar year-end private companies won’t have to adopt until Jan. 1, 2019.

What should companies do now?

Many restaurant companies, especially smaller private companies, haven’t spent much time on this, because it’s not effective for them until 2019. While restaurants are impacted less than some, the change may be painful because they’re not used to dealing with complicated revenue recognition.

Start by making sure you understand the standard and what it entails for your company. Accounting firms have published short implementation guides that help explain the impact. Even if the standard isn’t effective for you until 2019, plan ahead and, to the extent you can, do a dry run to work the kinks out. If your company uses systems to account for franchise revenues, make sure the system can handle the new accounting rules. No matter how easy it seems, it takes a while to get those changes pushed through an IT system and tested. If you’ve never needed such a system, it may be time to think about one in order to add efficiency.

Some franchisors are thinking about their current structure and whether or not there’s a business case for changes, such as shorter franchise agreements or a different fee.

Franchisors also should consider how this may impact their external metrics. Financial statement changes need to be communicated to investors, owners, private equity, lenders or even a management team with bonuses connected to earnings. If debt covenants are tied to EBIDTA metrics, EBIDTA in the current period obviously goes down when revenues are deferred. The new standard has been well-publicized, though, so it shouldn’t be a surprise to most lenders.

In addition, a new leasing standard is effective for public companies in 2019 and for private companies in 2020, under which lessees must put all of their leases on their balance sheet. This change will be even more impactful than the changes to revenue accounting. If companies need to talk to their lenders about the impact the new revenue standard will have on debt covenants, consider including a discussion of the new leasing standard, as it will be easier to address the impact of both at once.

Insights Accounting is brought to you by BDO USA, LLP