June 15, 2020
The Financial Standards Accounting Board (FASB) is doing their part to help restaurants and retailers alike as the industry continues to navigate challenges created by the COVID-19 pandemic. While targeted changes in FASB’s latest Accounting Standards Update (ASU) respond to specific concerns this industry is facing, the final updates provide accounting relief for all industries.
Accounting Changes during COVID-19
To date, FASB has provided accounting relief related to the timing of the adoption of two significant and new standards, ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as amended by subsequent ASUs (collectively, ASU 2014-09) and ASU 2016-02, Leases (Topic 842), as amended by subsequent ASUs (collectively, ASU 2016-02); as well as simplifying how to account for COVID-19 related lease concessions.
Revenue Recognition for Franchisors
In June 2020, FASB issued ASU 2020-05: Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842). Concurrent with adapting operations to the COVID-19 chaos, many in the franchise industry have also been working to adopt the newest revenue recognition guidance in their financial statements.
ASU 2014-09 has significantly impacted many franchisor stakeholders, specifically as it relates to the recognition of initial franchise fees. Initial franchise fees historically have been paid in upfront, single lump sum payments upon execution of the franchise agreements.
Under legacy generally accepted accounting principles, the initial franchise fees were generally recognized fully into revenues upon the opening of the franchise location. Under the new guidance, ASU 2014-09, generally, the timing of the revenue recognition for all or the majority of the initial franchise fees is required to be deferred over the term of the franchise agreement.
The impact of deferring the revenues over the term of the franchise agreement is expected to be significant to the franchisor’s financial statements. Furthermore, certain estimates and accounting policy elections that are required of management during the adoption period have proven very costly for those early adopters, specifically from a time perspective. Therefore, in April, FASB initially proposed a deferral of the required adoption date of this standard for all franchisors that are not public business entities.
However, during the proposal period for this standard, FASB reviewed many comments which indicated the costs associated with the adoption of ASU 2014-09 was not limited to the franchisor industry. In response to the feedback received in the comment period, FASB adjusted the final ruling in ASU 2020-05 to allow for entities (not just those in the franchise industry) that have not yet issued their financial statements (or made financial statements available for issuance) to defer the adoption of ASU 2014-09 for an additional year. Those entities may elect to adopt the guidance for the annual reporting period beginning after December 15, 2019.
Lease Accounting Effective Date Extended
Another significant accounting standard required to be adopted by private companies in 2020 is ASU 2016-02. The adoption of ASU 2016-02, which requires a change in existing lease accounting, including requiring lessees to recognize most leases on their balance sheets, has also proven time-consuming and costly to those who have already adopted the standard. Many organizations have realized that the dedicated resources necessary to adopt ASU 2016-02 is directly related the number of leases existing at the organization. Therefore, restaurants and retailers found themselves significantly impacted by this new standard. By issuing ASU 2020-05, FASB deferred the effective date by one year for entities in the “all other” category and public not-for-profit entities that have not yet issued their financial statements (or made financial statements available for issuance).
Accounting for COVID-19 Lease Concessions
In addition to the deferral of the effective date for these two significant accounting standards, FASB also responded to the impact COVID-19 is having on the accounting and financial burdens of restaurants and retailers that have been forced to close their doors during quarantines and shutdowns.
As a result of evaporating revenues, required store closures, and lack of traffic, some restaurants and retailers have negotiated deferrals, reductions or complete abatements of monthly rental payments from their landlords. Current guidance under generally accepted accounting principles could make the application of these concessions complex both for the lessees and the lessors.
Therefore, while not limited to the franchise industry, but in response to the challenges the industry is facing, the FASB staff published a Q&A recently. The published Q&A says it was acceptable for entities to make an accounting policy election to account for the aforementioned COVID-19 related lease concessions, consistent with how concession would be accounted for under current lease guidance (Topic 842, Leases or Topic 840, Leases) as though enforceable rights and obligations for those concessions existed.
By making this policy election, the entity will not have to analyze each individual lease contract to determine whether enforceable rights and obligations for concessions exist in the contract and can elect to apply or not apply the lease modification guidance to those lease contracts.
Generally, this will allow the entity to take the benefit of an abatement in the period in which the concession is made, and not spread it over the remaining lease term. Similarly, if a deferral is received, the benefit can be recognized in the period of deferral, and account for the deferred payments as variable lease payments at that time. The FASB staff further stated that material concessions either granted or received and the related accounting effects should be disclosed in the financial statements.
Adopting Accounting Standards on Time
Windham Brannon is here to help. We can guide you through Revenue Recognition adoption, Lease Standard adoption, and accounting for situations brought about by COVID-19.
For further guidance, particularly with lease and revenue recognition standards, please contact your Windham Brannon advisor or email [email protected] or [email protected] to start the conversation today.
