revenue changes for franchisors - bkd · revenue changes for franchisors . 6 . model or only for...

Revenue Changes for Franchisors



2

Table of Contents INTRODUCTION ..................................................................................................................................................... 4

PORTFOLIO APPROACH .......................................................................................................................................... 5

STEP 1: IDENTIFY THE CONTRACT WITH A CUSTOMER ........................................................................................... 6

COMBINING CONTRACTS ................................................................................................................................................. 7

STEP 2: IDENTIFY PERFORMANCE OBLIGATIONS IN A CUSTOMER CONTRACT ....................................................... 7

IMMATERIAL ITEMS......................................................................................................................................................... 8 MATERIAL RIGHT ......................................................................................................................................................... 10

Loyalty Programs ................................................................................................................................................ 10 SERIES PROVISION ........................................................................................................................................................ 11

STEP 3: DETERMINE THE TRANSACTION PRICE ..................................................................................................... 12

VARIABLE PRICING & CONSTRAINT .................................................................................................................................. 12 SIGNIFICANT FINANCING COMPONENT ............................................................................................................................. 13 NONCASH CONSIDERATION ............................................................................................................................................ 14

STEP 4: ALLOCATE THE TRANSACTION PRICE TO PERFORMANCE OBLIGATIONS .................................................. 14

LOYALTY PROGRAMS ..................................................................................................................................................... 14 ALLOCATING DISCOUNTS ............................................................................................................................................... 15

STEP 5: RECOGNIZE REVENUE .............................................................................................................................. 17

PERFORMANCE OBLIGATIONS SATISFIED OVER TIME ............................................................................................................ 18 CONTROL TRANSFERRED AT A POINT IN TIME ..................................................................................................................... 18 LICENSING & RIGHTS TO USE INTELLECTUAL PROPERTY ........................................................................................................ 18

Sales-Based or Usage-Based Royalties................................................................................................................ 19

OTHER ITEMS ....................................................................................................................................................... 21

PRINCIPAL VERSUS AGENT CONSIDERATIONS ..................................................................................................................... 21 CUSTOMER'S UNEXERCISED RIGHTS – "BREAKAGE" ............................................................................................................ 24 CONTRACT COSTS ......................................................................................................................................................... 25

Incremental Costs of Obtaining a Contract ......................................................................................................... 25 Costs to Fulfill a Contract .................................................................................................................................... 25

REVENUE PRESENTATION .................................................................................................................................... 26

SALES TAXES ............................................................................................................................................................... 26

DISCLOSURES ....................................................................................................................................................... 27

DISAGGREGATION OF REVENUES ..................................................................................................................................... 27 CONTRACT BALANCES ................................................................................................................................................... 28 REMAINING PERFORMANCE OBLIGATIONS ........................................................................................................................ 29

ADOPTION ........................................................................................................................................................... 30


3

CONCLUSION ....................................................................................................................................................... 31

CONTRIBUTOR ..................................................................................................................................................... 31


4

Introduction Revenue recognition will change with the adoption of Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes most industry-specific guidance and adds significant disclosures. Implementation is a significant undertaking for entities across all industries. Franchisors face additional challenges due to the variety of revenue streams and extent of changes to current guidance and practice. The effect on each company will vary depending on existing income streams, customer base and current estimation methodologies and accounting elections. This paper focuses on those items in the new model that will have the greatest effect on franchisors. U.S. Securities and Exchange Commission (SEC) filings for public entities1 after initial adoption indicate the biggest changes will be:

Initial franchise fees. Under Accounting Standards Codification (ASC) 606, these will now be recognized over the term of the agreement rather than upfront on opening or when a renewal agreement becomes effective.

Incentive management fees. Currently, many companies recognize the amount that would be due if the management contract was canceled at the end of the reporting period. Under ASC 606, incentive management fees would be recognized to the extent that it is probable a significant reversal will not occur, which could be later than current practice. This is likely to primarily affect interim reporting.

Contract assets and liabilities. This is a new concept for most industries other than construction. Under ASC 606, reclassification from a contract asset to a receivable is contingent on fulfilling performance obligations—not on invoicing a client. As a result, the point at which a contract asset is reclassified as a receivable may be different than the time of invoicing.

Advertising fund contributions. Many franchisors recognize these amounts as a reduction to advertising expenses. Under ASC 606, franchisors may be required to recognize the funds on a gross basis, with advertising fund fees included in revenue and the related advertising expense included in operating expenses.

Loyalty programs. Many programs currently recognize points or benefits on a gross basis at issuance along with an accrual of the expected future cost. Under ASC 606, benefits are recognized at redemption, net of any reimbursement to a third party. Fees received in excess of the estimated liability for loyalty programs may be considered a contract liability.

Contract acquisition costs. Depending on current practice, certain costs related to management and franchise contracts may be recognized over the term of the contracts as a reduction to revenue, instead of as amortization expense.

Breakage. For companies that issue gift cards, the timing of when a company can derecognize a contract liability and recognize revenue may change depending on current accounting practice.

Presentation of sales taxes. The standard creates a new accounting policy election to present sales taxes collected from customers on a net basis. In general this is current practice for most companies; however, to continue under ASC 606, an entity must make this accounting policy election.

Additional disclosures. These are needed around the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

1 A public entity is defined as any one of these: • A public business entity • A not-for-profit entity that has issued—or is a conduit bond obligor for—securities traded, listed or quoted on an exchange or over-the-counter market • An employee benefit plan that files or furnishes financial statements to the SEC


5

Even if timing or revenue recognition does not change, disclosure and internal controls and systems will.

Portfolio Approach For larger franchisors with a sizable volume of contracts, the Financial Accounting Standards Board (FASB) recognized the challenges of applying ASC 606 on a contract-by-contract basis and provided a practical expedient. Franchisor entities can apply the practical expedient if the portfolio has similar characteristics and the entity reasonably expects that the effects will not differ materially from applying the guidance to individual contracts. Because this is a practical expedient and not a requirement, an entity can choose to apply it to certain types of contracts and use it on an individual contract basis for others. The expedient is available for all aspects of the

Effective DatesRevenue Recognition

(ASC 606)

Public Entities1

Annual and interim reporting periods

beginning after December 15, 2017

All OthersAnnual reporting periods

beginning after December 15, 2018, and subsequent

interim periods

Dunkin’ Brands Group, Inc. 1Q 2018 10-Q

The Company expects the adoption of the new guidance to change the timing of recognition of initial franchise fees, including master license and territory fees for our international business, and renewal fees. Currently, these fees are generally recognized upfront upon either opening of the respective restaurant or when a renewal agreement becomes effective. The new guidance will generally require these fees to be recognized over the term of the related franchise license for the respective restaurant, which we expect will result in a material impact to revenue recognized for initial franchise fees and renewal fees. The Company does not expect this new guidance to materially impact the recognition of royalty income. Additionally, rental income is outside the scope of this new guidance, and therefore will not be impacted.

The Company also expects the adoption of this new guidance to change the reporting of advertising fund contributions from franchisees and the related advertising fund expenditures, which are not currently included in the consolidated statements of operations. The Company expects the new guidance to require these advertising fund contributions and expenditures to be reported on a gross basis in the consolidated statements of operations. … However, we expect such contributions and expenditures to be largely offsetting and therefore do not expect a significant impact on our reported net income.

Extended Stay America, Inc. 1Q 2018 10-Q

Adoption of ASC 606 had no impact to the recognition of revenue in the Company’s unaudited condensed consolidated financial statements. The Company recognized no cumulative effect adjustment upon adoption. Adoption of the standard resulted in enhanced revenue-related disclosures that provide information with respect to the Company’s analysis of certain contracts, significant judgments and the disaggregation for owned hotel room revenues by booking source and length of guest stay. …

Although ASC 606 is not expected to have a material impact to the Company’s ongoing net income, the Company implemented changes to its processes and procedures related to revenue recognition and the control activities within them. These included the development of new policies based on the five-step model, training and ongoing contract review procedures with respect to the validation of information used in financial statement disclosures.

Dunkin’ Brands Group, Inc. 1Q 2018 10-Q

Additionally, the Company is in the process of implementing new accounting systems, business processes, and internal controls related to revenue recognition to assist in the application of the new guidance.


6

model or only for certain steps. In establishing portfolios, entities will need to use judgment to determine the size, composition and number of portfolios. Each organization is unique, and portfolios will depend on the customer base and accounting system capabilities. Entities should consider the experience with and homogeneity of the portfolio to ensure the data is useful to predict an expected outcome. The standard does not mandate a specific approach in assessing materiality if using the portfolio approach will produce a different outcome than applying the guidance on an individual contract basis. An entity must demonstrate—in a reasonable manner, using some form of objective and identifiable information—why it expects the two approaches will not differ materially.

Step 1: Identify the Contract with a Customer In the hospitality industry, the customer and the contract terms are easily identifiable. The new revenue standard defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations.” Accounting for contracts with customers under the new model only begins when all the following criteria are met:

Step 1: Identify

contract with customer

Step 2: Identify

performance obligations

Step 3: Determine transaction

price

Step 4: Allocate

transaction price

Step 5: Recognize revenue

Disclosures


As a practical expedient, the Company elected to apply its contract review to portfolios of contracts with similar characteristics as the Company expects the effects of applying these contracts on a portfolio basis compared to an individual basis would not have a material impact to the Company’s unaudited condensed consolidated statement of operations. … The Company applies a portfolio approach in its review of contracts or performance obligations that have similar characteristics. Contract portfolios reviewed include:

(i) Rooms sold on-site at the property, through the Company’s call center and website

(ii) Rooms sold by the Company’s sales team

(iii) Rooms sold by traditional and online travel agents, including merchant and opaque arrangements

Commercial substance

Collectible Contract Approval and commitment

Identifiable rights, obligations and payment terms


7

Combining Contracts Contracts entered into at or near the same time with the same customer (or related parties) should be combined if one or more of the following criteria are met:

Contracts are negotiated together with a single commercial objective

Pricing interdependencies exist between contracts

Goods or services in the contracts represent a single performance obligation (see Step 2 – Identify Performance Obligations)

When the standard was first issued, companies were concerned with how this requirement would affect the hospitality industry. The American Institute of CPAs (AICPA) Hospitality Entities Revenue Recognition Task Force (task force) addressed this issue.

Step 2: Identify Performance Obligations in a Customer Contract Under ASC 606, performance obligations and fulfillment of them determine revenue recognition. Properly identifying the performance obligations will be time-consuming but critical because these determinations drive the pattern of revenue recognition and financial statement disclosures. A performance obligation is a promise to transfer goods or services to a customer that can be explicitly identified in a contract or implied by customary business practices, published policies or specific statements. This is complicated as franchise arrangements contain multiple elements, e.g., licensing of intellectual property, access to reservation systems and marketing.

Both of the following criteria must be met for a promised good or service to be considered distinct and a separate performance obligation:

Capable of being distinct because the customer can benefit from the good or service on its own or with other readily available resources

Distinct within the contract’s context—the good or service to the customer is separately identifiable from other promises in the contract. The following indicators would be used to evaluate if a good or service is distinct within the contract’s context:

• Significant integration services are not provided • The goods are not highly interdependent or interrelated • The good or service does not significantly modify or customize another good or service promised

in the contract

The task force concluded that goods and services purchased by the customer on a standalone basis—separate from the hotel reservation—are distinct promised goods and services that should be accounted for as separate contracts. However, for package hotel reservations, depending on the specific facts and circumstances, the hotel owner may identify multiple performance obligations—one for the hotel reservation and one for each type of ancillary service—because the hotel regularly sells these items separately.


When a reservation is made, the Company deems that the parties have approved the contract in accordance with customary business practices and are committed to perform their respective obligations. At such time, each party’s rights regarding the services to be transferred are identified, payment terms for services to be transferred are specified, the contract has commercial substance and, in most instances, it is probable the Company will collect substantially all consideration to which it will be entitled in exchange for services.


8

Companies must use judgment in determining which promises represent distinct performance obligations. When a promise is not considered distinct, it is bundled with other promises until the bundle constitutes a distinct performance obligation. Franchisors often will conclude that certain activities, e.g., pre-opening activities or the administration of an advertising fund, do not constitute distinct performance obligations and are bundled together as a symbolic license. This will be a significant judgment and will depend on the unique facts and circumstances for each franchise arrangement. In many cases, it is likely that other than equipment, the activities undertaken by the franchisor either will not represent promised goods or services because they are essentially setup activities or will not be considered distinct promised goods or services because, without the license of the IP, they provide little to no benefit on their own (or together with other readily available resources) or they cannot be separately identifiable from the license of the IP.

Immaterial Items FASB did not expect entities to identify significantly more performance obligations than the deliverables identified under current guidance. However, concerns arose since the standard’s basis for conclusions noted the current SEC guidance on inconsequential or perfunctory items was intentionally not carried forward into ASC 606. A subsequent amendment in ASU 2016-10 permits entities to disregard promises deemed to be immaterial in the contract’s context. In addition, such items would not be required to be aggregated and assessed for materiality at the entity level for auditing purposes.

The AICPA task force concluded that the separate components of providing a hotel accommodation, e.g., room, toiletry items, housekeeping and amenities, are not distinct within the context of the contract as they are all highly dependent and interrelated as part of the obligation to provide the lodging facility.

Marriott International, Inc. 1Q 2018 10-Q

For our managed hotels, we have performance obligations to provide hotel management services and a license to our hotel system intellectual property for the use of our brand names. …

For our franchised hotels, we have a performance obligation to provide franchisees and operators a license to our hotel system intellectual property for use of certain of our brand names. …

We provide hotel design and construction review quality assurance (“Global Design”) services to our managed and franchised hotel owners, generally during the period prior to a hotel’s opening or during the period a hotel is converting to a Marriott brand (the “pre-opening period”). As compensation for such services, we may be entitled to receive a one-time fixed fee that is payable during the pre-opening period of the hotel. As these services are not a distinct performance obligation, we recognize the fees on a straight-line basis over the initial term of the management or franchise agreement within the “Owned, leased, and other revenue” caption of our Income Statements. …

Under our Loyalty Programs, we have a performance obligation to provide or arrange for the provision of goods or services for free or at a discount to Loyalty Program members in exchange for the redemption of points earned from past activities. …

We have multi-year agreements for our co-brand credit cards associated with our Loyalty Programs. Under these agreements, we have performance obligations to provide a license to the intellectual property associated with our brands and marketing lists (“Licensed IP”) to the financial institution that issues the credit cards, to arrange for the redemption of Loyalty Program points … and to provide free night certificates to cardholders.


9


The Company provides a specific room type which includes free WiFi, grab and go breakfast, access to on-site laundry facilities and parking. In evaluating its performance obligation, the Company bundles obligations in addition to the room with the obligation to provide the guest the room itself as the additional items are not distinct and separable since the guest cannot benefit from the additional amenities without the consumed room night. The hotel’s obligation to provide the additional items or services are not separately identifiable from the fundamental contractual obligation (i.e., providing the room and its contents). … The Company and the guest agree upon a fixed rate at the time of booking; therefore, the sales price is identifiable and allocated to the Company’s single performance obligation.

Hyatt Hotels Corporation 1Q 2018 10-Q

Systemwide services—We provide sales, reservations, technology, and marketing services on behalf of owners of managed and franchised properties. The promise to provide systemwide services is not a distinct performance obligation because it is attendant to the license of our IP. Therefore, the promise to provide systemwide services is combined with the license of our IP to form a single performance obligation. …

Hotel management agreement services—We provide hotel management agreement services, which form a single performance obligation that qualifies as a series, under the terms of our management agreements.

Loyalty program administration—We administer a loyalty program for the benefit of the Hyatt portfolio of properties owned, managed, franchised, or licensed by us. Under the program, members earn loyalty points that can be redeemed for future products and services. Points earned by loyalty program members represent a material right to free or discounted goods or services in the future. The loyalty program has one performance obligation that consists of marketing and managing the program and arranging for award redemptions by members. …

Room rentals and other services provided at owned and leased hotels—We provide room rentals and other services to our guests, including but not limited to spa, laundry, and parking. These products and services each represent individual performance obligations. …

Under our franchise agreements, we also receive initial fees from third-party hotel owners. The initial fees do not relate to a distinct performance obligation and, therefore, are combined with the royalty fees and recognized through management, franchise, and other fees over the expected customer life, which is typically the initial term of the agreement.


10

Material Right A contract may contain an option to acquire additional goods or services. A separate performance obligation could exist if the option provides a material right to the customer that it would not receive without entering into that contract. Material right obligations must be separately valued to allocate part of the transaction price to those specific performance obligations. Management judgment will be required in making this determination. The identification of a material right affects the pattern of revenue recognition in Step 5.

Loyalty Programs

Many companies have loyalty programs that allow customers to earn points from various activities. Points can be redeemed for different rewards, such a free hotel stay or other third-party merchandise. Currently, many companies apply a cost accrual method to account for the loyalty points they are issuing to customers. Under ASC 606, loyalty points should be accounted for as a separate performance obligation if they provide the customer with a material right. This often will result in the allocation and deferral of revenue related to the material right.

Hilton Worldwide Holdings Inc. 1Q 2018 10-Q

We identified the following performance obligations in connection with our management and franchise contracts:

• Intellectual Property ("IP") licenses grant the right to access our hotel system IP, including brand IP, reservations systems and property management systems.

• Hotel management services include providing day-to-day management services of the hotels for the property owners.

• Development services include providing consultative services (e.g., design assistance and contractor selection) to the property owner to assist with the construction of the hotel prior to the hotel opening.

• Pre-opening services include providing services (e.g., advertising, budgeting, e-commerce strategies, food and beverage testing) to the property owner to assist in preparing for the hotel opening.


11

Series Provision The series provision is a concept introduced in ASU 2014-09 and does not exist in current generally accepted accounting principles (GAAP). The series provision requires goods or services to be accounted for as a single performance obligation in certain instances, even though the underlying goods or services are distinct. A series of distinct goods or series should be accounted for as a single performance obligation if they are substantially the same, have the same pattern of transfer and both of the following criteria are met:

Each distinct good or service in the series represent a performance obligation that will be satisfied over time

The entity would measure its progress toward satisfaction of the performance obligation using the same measure of progress for each distinct good or service in the series

Entities will need to determine whether a single performance obligation is created in this manner to appropriately allocate variable consideration and apply the guidance on contract modification and changes in transaction price. This provision prevents an entity from having to allocate the transaction price on a relative standalone selling price basis to each increment of a distinct service in repetitive service contracts. If the nature of the promise is the delivery of a specified quantity of a service, the evaluation should consider whether each service is distinct and substantially the same. If the nature of the entity’s promise is the act of standing ready or providing a single service for a period of time, the evaluation likely would focus on whether each time increment—rather than the underlying activities—is distinct and substantially the same. The underlying activities may vary within a day and from day to day, but that should not prevent an entity from concluding the service is distinct and substantially the same.


Points earned by loyalty program members represent a material right to free or discounted goods or services in the future. …

We administer the loyalty program for the benefit of the Hyatt portfolio of properties owned, operated, managed, franchised, or licensed by us during the period of their participation in the loyalty program. The loyalty program is primarily funded through contributions from eligible revenues from loyalty program members, and the funds are used for the redemption of member awards associated with the loyalty program and payment of operating expenses.

The costs of operating the loyalty program, including the estimated cost of award redemption, are charged to the participating properties based on members' qualified expenditures. The revenues received from the properties are deferred, and revenue is recognized as loyalty points are redeemed, net of redemption expense, through revenues for the reimbursement of costs incurred on behalf of managed and franchised properties. Operating costs are expensed as incurred through costs incurred on behalf of managed and franchised properties. …

The loyalty program has one performance obligation that consists of marketing and managing the program and arranging for award redemptions by members. The costs of operating the loyalty program are charged to the properties through an assessment fee based on members’ qualified expenditures. The assessment fee is billed and collected monthly, and the revenue received by the program is deferred until a member redeems points. Upon redemption of points at managed and franchised properties, we recognize the previously deferred revenue through revenues for the reimbursement of costs incurred on behalf of managed and franchised properties, net of redemption expense paid to managed and franchised hotels, as we are an agent in the transaction.


12

Step 3: Determine the Transaction Price Revenues are recorded at the transaction price, which is the amount the entity expects to be entitled to and which may be net of amounts paid on behalf of others, discounts and allowances, as applicable. To determine the transaction price, an entity would consider the terms of the contract, its customary business practices and the effects of the time value of money, noncash consideration and consideration payable to the customer. Consideration may include fixed amounts, variable amounts or both.

Transaction Price

Total Amount of Consideration to Which an Entity Expects to Be Entitled

Variable consideration

Constraining estimates of variable

consideration

Significant financing Noncash consideration

Consideration payable to a

customer

Variable Pricing & Constraint ASC 606 requires that variable consideration be included in the transaction price if it is probable subsequent changes in the estimate would not result in a significant reversal of revenue. This concept is commonly referred to as the “constraint.” Entities should perform a qualitative assessment that takes into account the likelihood and magnitude of a potential revenue reversal. The ASU provides factors that could indicate an estimate of variable consideration is subject to significant reversal, e.g., susceptibility to factors outside the entity’s influence, a long period before uncertainty is resolved, limited experience with similar types of contracts, practices of providing concessions or a broad range of possible consideration amounts. This estimate would be updated in each reporting period to reflect changes in facts and circumstances. When the transaction price includes a variable amount, an entity must estimate the variable consideration by using either an “expected value” (probability-weighted) approach or “most likely amount” approach, whichever is more predictive of the amount to which the entity expects to be entitled.


Each of the identified performance obligations related to management and franchise revenues is considered to be a series of distinct services transferred over time. While the underlying activities may vary from day to day, the nature of the promises are the same each day, and the property owner can independently benefit from each day's services.

Franchise arrangements often include payments that vary depending on certain tasks being performed or results being accomplished. It is important for hospitality companies to determine the amount of variable consideration they believe they will receive from each contract using historical data and current expectations.

Domino’s Pizza, Inc. 1Q 2018 10-Q

The Company also offers profit sharing rebates and volume discounts to its supply chain customers. Obligations for profit sharing rebates are calculated each period based on actual results of its supply chain centers and are recognized as a reduction to revenue. Volume discounts are based on annual sales. Each period, the Company estimates the amount that will be earned and records a reduction to revenue.


13

Significant Financing Component Contract terms may explicitly or implicitly provide the entity or the customer with favorable financing terms. The transaction price should reflect a selling price as though the customer had paid cash at the time of transfer and should be adjusted to reflect the time value of money if there is a significant financing component. An entity should consider the following:

If the consideration would differ substantially if the customer paid cash promptly under typical credit terms

Expected length of time between delivery of goods or services and receipt of payment

The interest rate in the contract and prevailing market interest rates

ASU 606 makes an exception for certain differences between the promised consideration and the cash selling price of the goods or services. A contract would not be considered to have a significant financial component if the difference stems from a reason other than financing to either the customer or contractor and the difference is proportional to the reason for the difference. As a practical expedient, an entity would not reflect the time value of money if the period between customer payment and transfer of goods or services is one year or less. This also would apply to contracts greater than one year if the period between performance and the corresponding payment for that performance is one year or less. Disclosure is required if this practical expedient is elected.


Franchise and management fees are based on a percentage of hotel revenues and, as a result, fees vary from period to period. Due to the fact that a portion of fees associated with a typical hotel management agreement are expected to be categorized as variable consideration, the estimate of the transaction price associated with these fees is determined in accordance with guidance on variable consideration and constraining estimates of variable consideration. In the event that fees include variables that extend beyond the current period, the Company uses the most likely amount method to determine the amount of revenue to record based on a reasonable revenue forecast for the applicable hotel. The Company does not expect to have constraining estimates, as hotel revenue is obtained monthly and used to calculate the fees.


Hotel management agreement services … In exchange for providing these services, we receive variable consideration in the form of management fees, which are comprised of base and incentive fees. Incentive fees are typically subject to the achievement of certain annual profitability targets, and therefore, we apply judgment in determining the amount of incentive fees recognized each period. Incentive fees revenue is recognized to the extent it is probable that we will not reverse a significant portion of the fees in a subsequent period. We rely on internal financial forecasts and historical trends to estimate the amount of incentive fees revenue recognized and the probability that incentive fees will reverse in the future.


Incentive fees are generally based on a percentage of a hotel's operating profits and in some cases may be subject to a stated return threshold to the property owner, normally over a one-calendar year period (the "incentive period"). Incentive fee revenue is recognized on a monthly basis, but only to the extent the cumulative fee earned does not exceed the probable fee for the incentive period.


14

Noncash Consideration Noncash consideration refers to contracts that include promises of consideration in a form other than cash, e.g., equity, advertising, etc. If a customer promises consideration in a form other than cash, an entity would measure the noncash consideration at fair value at contract inception to determine the transaction price. If a reasonable estimate of fair value of the noncash consideration cannot be made, the entity would use the estimated selling price of the promised goods or services, similar to current accounting standards.

Step 4: Allocate the Transaction Price to Performance Obligations An entity would allocate the transaction price to performance obligations based on the relative standalone selling price of separate performance obligations. The best evidence of standalone selling price would be the observable price for which the entity sells goods or services separately. In the absence of separately observable sales, the standalone selling price would be estimated by using observable inputs and considering all information reasonably available to the entity. Several approaches could be used—adjusted market assessment, cost plus margin or residual value. The new standard does not specify how to determine the standalone selling price.

Loyalty Programs If customer loyalty points represent a distinct performance obligation, a company will need to estimate the standalone selling price of the points. If the standalone selling price for loyalty points is not directly observable, an


Application, initiation and other fees … are typically fixed and collected upfront and are recognized as revenue over the term of the franchise contract. We do not consider this advance consideration to include a significant financing component, since it is used to protect us from the property owner failing to adequately complete some or all of its obligations under the contract. …

We do not adjust the promised amount of consideration for the effects of a significant financing component when we expect, at contract inception, that the period between our transfer of a promised good or service to a customer and when the customer pays for that good or service will be one year or less, which it is in substantially all cases. Additionally, we do not typically include extended payment terms in our contracts with customers.

Yum! Brands, Inc. 1Q 2018 10-Q

Additionally, from time-to-time we provide non-refundable consideration to franchisees in the form of cash or other incentives (e.g. cash payments to incent new unit openings and free or subsidized equipment). The Company’s intent in providing such consideration is to drive new unit development or same-store sales growth that will result in higher future revenues for the Company. Under Legacy GAAP, these payments were recognized when we were obligated to make the payment and were presented as either a reduction to Franchise and property revenues, if cash was provided directly to the franchisee, or as Franchise and property expenses, if cash was not provided directly to the franchisee. Upon adopting Topic 606, such payments are capitalized as assets and amortized as a reduction in Franchise and property revenues over the period of expected cash flows from the franchise agreements to which the payment relates.


Franchise fees are reduced by any consideration paid or anticipated to be paid to incentivize hotel owners to enter into franchise contracts.


15

entity should estimate it. That estimate should reflect the discount the customer would obtain when exercising the option, adjusted for both of the following:

Any discount the customer could receive without exercising the option

The likelihood that the option will be exercised

If a customer has a material right to acquire future goods or services and those goods or services are similar to the original goods or services, an entity may—as a practical alternative to estimating the standalone selling price of the option—allocate the transaction price to the optional goods or services by reference to the goods or services expected to be provided and the corresponding expected consideration.

Allocating Discounts Discounts for a bundle of goods or services would be allocated to all performance obligations unless all of the following criteria are met, in which case the entire discount would be allocated to one or more (but not all) separate performance obligations:

The entity regularly sells each good or service or each bundle of goods or services in the contract on a standalone basis

The entity regularly sells on a standalone basis bundles of distinct goods or services at a discount to the standalone selling prices of the goods or services in each bundle


When points are earned by Hilton Honors members, they are provided with a material right to free or discounted goods or services in the future upon accumulation of the required level of Hilton Honors points. Points may be redeemed for the right to stay at participating properties, as well as for other goods and services from third parties. … As the points are issued to a Hilton Honors member, the property or affiliated partner pays Hilton Honors based on an estimated cost per point for the costs of operating the program, which include marketing, promotion, communication and administrative expenses, as well as the estimated cost of award redemptions.

We record liabilities for the payments received from participating hotels and program partners. Amounts equal to the estimated cost per point of the future redemption obligation are included in the liability for guest loyalty program and any amounts received in excess of the estimated cost per point are included in deferred revenues in our consolidated balance sheets. We engage outside actuaries to assist in determining the fair value of the future redemption obligation using statistical formulas that project future point redemptions based on factors that include historical experience, an estimate of points that will eventually be redeemed, which includes an estimate of "breakage" for points that will never be redeemed, and the cost of reimbursing properties and other third parties in respect to other redemption opportunities available to members. When points are issued as a result of a stay at our owned or leased hotel, we recognize a reduction in owned and leased hotel revenues, since we are also the guest loyalty program sponsor. For the Hilton Honors fees that are charged to the participating properties, we allocate the fees to the material right created by Hilton Honors points issued using the variable consideration allocation guidance, since the fees are directly related to the issuance of Hilton Honors points to the Hilton Honors member and Hilton's efforts to satisfy the future redemption of those Hilton Honors points.

The transaction prices for the Hilton Honors points are reduced by the expected payments to the third parties that will provide the free or discounted room or service using the actuarial projection of the cost per point. The remaining transaction price is then further allocated to the points that are expected to be redeemed, adjusting the points that are issued for estimated breakage, and recognized when those points are redeemed. While the points are outstanding, both the estimate of the expected payments to third parties (cost per point) and the estimated breakage are reevaluated, and the amount of revenue recognized when each point is redeemed is adjusted so that the final amount allocated to the material right is reflective of the amount retained for providing all of the free or discounted goods and services, net of the payments to third parties and points not redeemed.


16

The observable selling prices from those standalone sales provide evidence of the performance obligations to which the entire discount belongs


If a guest enters into a package including multiple goods or services, the fixed price is allocated to each distinct good or service based on the stand-alone selling price for each item. …

In exchange for the products and services provided, we receive fixed and variable consideration that is allocated between the performance obligations based upon the relative stand-alone selling prices. Significant judgment is involved in determining the relative stand-alone selling prices, and therefore, we engaged a third-party valuation specialist to assist us. …

Co-branded credit card—We have a co-branded credit card agreement with a third party and under the terms of the agreement, we have various performance obligations: granting a license to the Hyatt name, arranging for the fulfillment of points issued to cardholders through the loyalty program, and awarding cardholders with free room nights upon achievement of certain program milestones. The loyalty points and free room nights represent material rights that can be redeemed for free or discounted services in the future. …

We utilized a relief from royalty method to determine the revenue allocated to the license, which is recognized over time. We utilized observable transaction prices and adjusted market assumptions to determine the stand-alone selling price of a loyalty point and we utilized a cost plus margin approach to determine the stand-alone selling price of the free room nights.


The majority of our performance obligations are a series of distinct goods or services, for which we receive variable consideration through our management and franchise fees or fixed consideration through our owned and leased hotels. We allocate the variable fees to the distinct services to which they relate applying the prescribed variable consideration allocation guidance, and we allocate fixed consideration to the related performance obligations based on the present value of the allocated variable cash flows. …

Although the transaction prices of room rentals, goods and other services are generally fixed and based on the respective room reservation or other agreement, an estimate to reduce the transaction price is required if a discount is expected to be provided to the customer. For package reservations, the transaction price is allocated to the performance obligations within the package based on the estimated standalone selling prices of each component. On occasion, the hotel may also provide the customer with a material right to a free or discounted good or service in conjunction with a room reservation or banquet contract (e.g., free breakfast and free room night for every four nights booked). These material rights are considered separate performance obligations to which a portion of the transaction price is allocated based on the estimated standalone selling prices of the good or service, adjusted for the likelihood the hotel guest will exercise the right. …

The co-brand license fee is allocated between two performance obligations based on their estimated standalone selling prices: (i) an IP license using the relief-from-royalty method; and (ii) material rights for free or discounted goods or services to the credit card customers using a cost plus method based on an evaluation of other third-party administrators.


17

Step 5: Recognize Revenue Under ASC 606, an entity recognizes revenue when (or as) a performance obligation is satisfied by transferring a promised good or service to a customer. For performance obligations satisfied at a point in time, the associated revenue would be recognized at that point in time. For performance obligations satisfied over time, an entity must choose a recognition method that best depicts the transfer of goods or services. Deciding the appropriate recognition pattern may require significant management judgment. Conclusions will depend on a company’s unique facts and circumstances and should be properly documented for an auditor’s and/or regulator’s review.

Recognize revenue when

control transfers

Over timeInput or output

progress measure

Point in time Determine when control transfers


We have multi-year agreements for our co-brand credit cards associated with our Loyalty Programs. Under these agreements, we have performance obligations to provide a license to the intellectual property associated with our brands and marketing lists (“Licensed IP”) to the financial institution that issues the credit cards, to arrange for the redemption of Loyalty Program points as discussed in the preceding paragraph, and to provide free night certificates to cardholders. We receive fees from these agreements, including fixed amounts that are primarily payable at contract inception, and variable amounts that are paid to us monthly over the term of the agreements, based on: (1) the number of free night certificates issued and redeemed; (2) the number of Loyalty Program points purchased; and (3) the volume of cardholder spend. We allocate those fees among the performance obligations, including the Licensed IP, our Loyalty Program points, and free night certificates provided to cardholders based on their estimated standalone selling prices. The estimation of the standalone selling prices requires significant judgments based upon generally accepted valuation methodologies regarding the value of our Licensed IP, the amount of funding we will receive, and the number of Loyalty Program points and free night certificates we will issue over the term of the agreements. We base our estimates of these amounts on our historical experience and expectation of future cardholder behavior. We recognize the portion of the Licensed IP revenue that meets the sales-based royalty criteria as the credit cards are used and the remaining portion of the Licensed IP revenue on a straight-line basis over the contract term. In our Income Statements, we primarily recognize Licensed IP revenue in the “Franchise fees” caption, and we recognize a portion in the “Cost reimbursement revenue” caption. We recognize the revenue related to the Loyalty Program points as discussed in the preceding paragraph. We recognize the revenue related to the free night certificates when the related service is provided. If the free night certificate redemption involves a managed or franchised property, we recognize revenue net of the redemption cost, as our performance obligation is to facilitate the transaction between the Loyalty Program member and the managed or franchised property.


18

Performance Obligations Satisfied over Time An entity transfers control over time if any of the following criteria are met:

The customer receives and consumes the benefits of the entity’s performance as the entity performs, e.g., a cleaning service

The customer controls the asset as it is created or enhanced by the entity’s performance (could be tangible or intangible)

The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date

Control Transferred at a Point in Time Performance obligations that do not meet any of the three criteria for being satisfied over time should be accounted for at a point in time. When control over an asset is transferred at a single point in time, an entity would recognize revenue by evaluating when the customer obtains control. An entity would use judgment in determining when control has been transferred, considering the following indicators:

The entity has a present right to payment

The customer has legal title

The customer has physical possession

The customer has the significant risks and rewards of ownership

The customer has accepted the asset

Licensing & Rights to Use Intellectual Property Licensing refers to granting a customer the right to use—but not own—intellectual property (IP). Examples include patents, trademarks, software, franchises and motion pictures. Licensing arrangements have a variety of forms—term-based or perpetual, exclusive or nonexclusive—and payment terms can be fixed, variable, upfront or installment. An entity must first determine if the license is distinct from other goods or services in the

The AICPA task force concluded that hotel room-only reservations are performance obligations satisfied over time as the hotel guest simultaneously receives and consumes the benefits provided by the hotel. Most ancillary goods or services do not meet the criteria to be a performance obligation recognized over time.


Spa and fitness revenue is recognized at the point in time the products or services are provided to the customer.


Material rights for free or discounted goods or services to hotel guests are satisfied at the earlier point in time of either when the material right expires or the underlying free or discounted good or service is provided to the hotel guest. …

We satisfy our performance obligation related to points issued under the Hilton Honors guest loyalty program at a point in time when points are redeemed for a free good or service by the Hilton Honors member.


19

arrangement. For licenses that are not distinct, an entity would combine the license with other goods and services in the contract and recognize revenue when it satisfies the combined performance obligation.

If a license is distinct, an entity would assess the nature of the promise before applying the revenue recognition model to license arrangements. Entities should classify IP in one of two categories:

Functional IP – This IP has significant standalone functionality. Because functional IP has significant utility independent of the licensor’s past or ongoing activities, and the functionality is not changing because of the licensor’s ongoing activities, the license is satisfied at the point in time the IP is made available for the customer’s use. If the functionality is expected to change, and the customer will be required or compelled to use the latest version of the IP, revenue for the license would be recognized over time.

Symbolic IP – This IP is without significant standalone functionality. The benefit from licenses of symbolic IP depends on continuing support and maintenance of the IP. For example, a license to a sports team’s name and logo typically would have limited residual value if the team stops playing games, e.g., Hartford Whalers or Tampa Bay Devil Rays. Symbolic IP grants the customer an access right that is satisfied over time as the entity fulfills its promise to both:

• Grant the customer’s right to use and benefit from the IP • Continue to support and maintain the IP

Franchise rights are considered symbolic IP and revenue would be recognized over time using a measure of progress that reflects the franchisor’s performance in providing those rights. In general, the franchise rights are provided evenly over the contract term and—except for sales-based royalties—the franchisor recognizes consideration allocated to the rights on a straight-line basis over the contract term or longer, if a renewal option constitutes a material right.

Sales-Based or Usage-Based Royalties

FASB has provided a narrow exception to the variable consideration criteria for IP licenses when there is a sales-based or usage-based royalty. An entity should recognize revenue for such a transaction only when the later of the following events occurs:

Subsequent sale or usage

Satisfaction of performance obligation

An entity would not be required to split a royalty into the portion subject to the royalty exception and the portion that is not. The sales-based royalty constraint would be applied to the overall royalty stream when the sole or predominant item within the arrangement is the license of IP. Otherwise, the general constraint on variable consideration would apply to the entire arrangement. Minimum guarantees can affect the recognition of sales- or usage-based royalties:

Functional IP – A minimum guaranteed amount of sales- or usage-based royalties should be recognized at the point in time the entity transfers control. Any royalties above the fixed minimum would be recognized at the later of when the sale or usage occurs or when the performance obligation is satisfied.

Symbolic IP – Various recognition approaches could be acceptable for minimum guarantees in licenses of symbolic IP, which require revenue to be recognized over time.


20


Royalty revenues are based on a percentage of franchise sales and are recognized when the items are delivered to or carried out by franchise customers. Domestic franchise fee revenue primarily relates to per-transaction technology fees that are recognized as the related sales occur. …

Store opening fees received from international franchisees are recognized as revenue on a straight-line basis over the term of each respective franchise store agreement, which is typically 10 years. Development fees received from international master franchisees are also deferred when amounts are received and are recognized as revenue on a straight-line basis over the term of the respective master franchise agreement.


The timing and amount of revenue recognized related to continuing fees was not impacted by the adoption of Topic 606 based on the application of the sales-based royalty exception within Topic 606.


At our owned and leased hotels, we have performance obligations to provide accommodations and other ancillary services to hotel guests. … We generally satisfy the performance obligations over time, and we recognize the revenue from room sales and from other ancillary guest services on a daily basis, as the rooms are occupied and we have rendered the services. …

For our franchised hotels, we have a performance obligation to provide franchisees and operators a license to our hotel system intellectual property for use of certain of our brand names. As compensation for such services, we are typically entitled to initial application fees and ongoing royalty fees. Our ongoing royalty fees represent variable consideration, as the transaction price is based on a percentage of certain revenues of the hotels, as defined in each contract. We recognize royalty fees on a monthly basis over the term of the agreement as those amounts become payable. Initial application and relicensing fees are fixed consideration payable upon submission of a franchise application or renewal and are recognized on a straight-line basis over the initial or renewal term of the franchise agreements.


21

Other Items

Principal Versus Agent Considerations If other parties are involved in providing goods or services to a customer, a company must determine whether it is acting as a principal or agent. This distinction is important because it determines if revenue is recognized on a gross or net basis. Distinguishing between principal and agency roles requires significant judgment and is a challenge even under current guidance.

If an entity obtains control of goods or services from another party before transfer to the customer, the entity’s performance obligation is to provide the goods or services, meaning the entity is acting as a principal and would recognize revenue at the gross amount collected from the customer. If an entity does not obtain control of the goods or services from another party before transfer to a customer, the entity is acting as an agent and would recognize revenue at the net amount, such as a fee or commission. A principal can control a service—even when another party actually performs the service—if it can direct that party to perform the service for the customer on its behalf, e.g., an entity that provides office maintenance services, but subcontracts with another party to perform the services instead of using its own employees. The indicators in ASC 606 may be more or less relevant or persuasive to the control assessment, depending on the facts and circumstances.


We satisfy the following performance obligations over time: the license of Hyatt’s symbolic IP, hotel management agreement services, administration of the loyalty program, and the license to our brand name through our co-branded credit card agreement. Each of these performance obligations is considered a sales-based royalty or a series of distinct services, and although the activities to fulfill each of these promises may vary from day to day, the nature of each promise is the same and the customer benefits from the services every day.

For each performance obligation satisfied over time, we recognize revenue using an output method based on the value transferred to the customer. Revenue is recognized based on the transaction price and the observable outputs related to each performance obligation. …

Within our management agreements, we have two performance obligations: providing a license to Hyatt’s IP and providing management agreement services. Although these constitute two separate performance obligations, both obligations represent services that are satisfied over time, and Hyatt recognizes revenue using an output method based on the performance of the hotel. Therefore, we have not allocated the transaction price between these two performance obligations as the allocation would result in the same pattern of revenue recognition. …

Owned and leased hotels revenues are derived from room rentals and services provided at our owned and leased properties and are recognized over time as rooms are occupied and when services are rendered. … In relation to the loyalty program, a portion of our owned and leased hotels revenues is deferred upon initial stay as points are earned by program members at an owned or leased hotel, and revenues are recognized upon redemption at an owned or leased hotel.


The Company uses an output method based on performance completed to date (i.e. management services performed) to determine the amount of revenue to recognize on a daily basis as services associated with the respective franchise and management fees are earned over time.


22


Revenues generated from owned and operated hotels that use the travel agent distribution channel involve a third party. Regardless of the basis on which the Company is compensated (i.e., gross or net), the Company is responsible for fulfilling the promise to provide hotel service (i.e. the performance obligation) to the guest and retains inventory risk. The Company does not have full discretion in establishing the guest’s price for the room and, in almost all instances, does not have access to the room rate charged to the guest. Since the Company controls the inventory and hotel services provided, and because the third party intermediaries are not required to consume or guarantee room night consumption, the Company has concluded that it is the principal in these transactions. As such, the Company is required to gross-up amounts received from these third party intermediaries such that revenue should equal the price charged to the guest. Third party intermediaries that pay the Company directly typically charge the guest additional fees, blend the room offering with other offerings at amounts which, to the Company, are not allocable, and may adjust the price without hotel approval. As such, the Company is unable to calculate the rate charged to the guest. Since any gross-up estimate the Company would make has significant uncertainty that ultimately would not be resolved, despite its role as principal, the Company records the net amount paid by third party intermediaries as room revenues in the accompanying unaudited condensed consolidated statements of operations.


23


Hotels commonly enter into arrangements with online travel agencies, trade associations, and other entities. As part of these arrangements, Hyatt may pay the other party a commission or rebate based on the revenue generated through that channel. The determination of whether to recognize revenues gross or net of rebates and commission is made based on the terms of each contract. …

Cost reimbursement model

Third-party hotel owners are required to reimburse us for all costs incurred to operate the systemwide programs with no added margin. The reimbursements are recognized over time within revenues for the reimbursement of costs incurred on behalf of managed and franchised properties. We have discretion over how we spend program revenues and, therefore, we are the principal with respect to the promise to provide systemwide services.

Expenses incurred related to our sales, reservations, technology, and marketing programs are recognized within costs incurred on behalf of managed and franchised properties. The reimbursement of systemwide services is billed on a monthly basis based upon an annual estimate of costs to be incurred and are recognized as revenue commensurate with incurring the cost. To the extent that actual costs vary from estimated costs, a true-up billing or refund is issued to the hotels. Any amounts collected and not yet recognized as revenues are deferred and recognized as contract liabilities. Any costs incurred in excess of revenues collected are recognized as receivables.

Fund model

Third-party hotel owners are invoiced a systemwide assessment fee primarily based on a percentage of hotel revenues on a monthly basis. We recognize the revenues over time as services are provided through revenues for the reimbursement of costs incurred on behalf of managed and franchised properties. We have discretion over how we spend program revenues and, therefore, we are the principal with respect to systemwide services. Expenses related to the sales, reservations, technology, and marketing programs are recognized as incurred through costs incurred on behalf of managed and franchised properties. Over time, we manage the systemwide programs to break-even, but the timing of the revenue received from the owners may not align with the timing of the expenses to operate the programs and, therefore, the difference between the revenues and expenses may impact our net income. …

The revenues allocated to loyalty program points and free night awards are deferred and recognized upon redemption, net of redemption expenses, as we are deemed to be the agent in the transaction. We are responsible for arranging for the redemption of promotional awards, but we do not directly fulfill the award night obligation, except at owned and leased hotels. Therefore, we are the agent for managed and franchised hotels and we are the principal with respect to owned hotels.


24

Customer’s Unexercised Rights – “Breakage” “Breakage” refers to money received from prepaid cards but never redeemed by consumers. There is current diversity in practice in how card issuers classify prepaid card transactions. Under ASC 606, if an entity expects to be entitled to a breakage amount for a liability resulting from the sale of a prepaid stored-value product, the entity would derecognize the amount related to the expected breakage in proportion to the pattern of rights expected to be exercised by the card holder only to the extent it is probable that a significant reversal of the recognized breakage amount will not subsequently occur. If an entity does not expect to be entitled to a breakage amount for prepaid stored-value products, the entity shall derecognize the amount related to breakage when the likelihood of the customer exercising its remaining rights becomes remote.

FASB also made consequential amendments to ASC 405-20-40, Extinguishments of Liabilities, to ensure consistent treatment going forward. Entities would be required to disclose the methodology used and significant judgments made in calculating breakage. The prepaid liability would be subject to the disclosure requirements for financial liabilities in Topic 825, Financial Instruments, but entities are excluded from the fair value disclosure requirements.


Domestic franchise advertising revenues … are primarily comprised of contributions from Domino’s Pizza franchisees to the Domino’s National Advertising Fund Inc. (“DNAF”), the Company’s not-for-profit subsidiary that administers the Domino’s Pizza system’s national and market level advertising activities. …

Although these revenues are restricted to be used only for advertising and promotional activities to benefit franchised stores, the Company has determined they are not performance obligations associated with the franchise advertising contributions received by DNAF that are separate from its domestic royalty payment stream and as a result, these franchise contributions and the related expenses are presented gross in the Company’s condensed consolidated statement of income. …

The Company has also determined that ASC 606 requires a gross presentation on the consolidated statement of income for franchisee contributions received by and related expenses of DNAF, the Company’s consolidated not-for-profit subsidiary. … Under prior accounting guidance, the Company had presented the restricted assets and liabilities of DNAF in its consolidated balance sheets and had determined that it acted as an agent for accounting purposes with regard to franchisee contributions and disbursements. As a result, the Company historically presented the activities of DNAF net in its statements of income and statements of cash flows.

Upon the adoption of ASC 606, the Company determined that there are not performance obligations associated with the franchise advertising contributions received by DNAF that are separate from our domestic royalty payment stream and as a result, these franchise contributions and the related expenses are presented gross in the Company’s consolidated statement of income and consolidated statement of cash flows. While this change will materially impact the gross amount of reported franchise revenues and expenses, the impact will generally be an offsetting increase to both revenues and expenses such that the impact on income from operations and net income is not expected to be material.


25

Contract Costs In conjunction with the new standard’s release, FASB also amended ASC 340, Other Assets and Deferred Costs. Outside of guidance on accounting for long-term construction contracts and certain industry-specific guidance, U.S. GAAP previously did not address the accounting for the cost of obtaining and fulfilling customer contracts—an accounting policy election determined whether such costs were capitalized or expensed. Only SEC registrants are required to disclose their policy for capitalized costs.

Incremental Costs of Obtaining a Contract

An entity would capitalize incremental costs of obtaining a contract if the costs are recoverable. Incremental costs are those that would not have been incurred if the contract had not been obtained, e.g., sales commissions. Cost an entity incurs regardless of whether it obtains a contract would be expensed as incurred. As a practical expedient, an entity can expense these incremental costs if the amortization period of those costs would be one year or less, i.e., the contract term or earnings process is not greater than a year. An entity must disclose if this practical expedient is elected.

Costs to Fulfill a Contract

If the costs incurred in fulfilling a contract are not within the scope of other guidance, e.g., inventory, property, plant and equipment or capitalized software, an entity would recognize an asset only if the costs meet all of the following criteria:

They directly relate to a contract or a specific anticipated contract, e.g., direct labor or materials

They generate or enhance resources that would be used to satisfy performance obligations in the future

They are expected to be recovered

Certain costs are expensed as incurred, such as most general and administrative costs and the cost of wasted materials and labor not reflected in the contract price. If an entity cannot distinguish the fulfillment costs that relate to future performance obligations from the costs that relate to past performance obligations, the entity would expense these costs as incurred.


The revenue recognized each period includes an estimate of breakage for the loyalty points that will not be redeemed. Determining breakage involves significant judgment, and we engage third-party actuaries to estimate the ultimate redemption ratios used in the breakage calculations and to estimate the amount of revenue recognized upon redemption. Changes to the expected ultimate redemption assumptions are reflected in the current period.


The amount of revenue we recognize upon point redemption is impacted by our estimate of the “breakage” for points that members will never redeem. We estimate such amounts based on our historical experience and expectations of future member behavior. We recognize revenue net of the redemption cost within our “Cost reimbursement revenue” caption on our Income Statements, as our performance obligation is to facilitate the transaction between the Loyalty Program member and the managed or franchised property or program partner.


We engage outside actuaries to assist in determining the fair value of the future redemption obligation using statistical formulas that project future point redemptions based on factors that include historical experience, an estimate of points that will eventually be redeemed, which includes an estimate of "breakage" for points that will never be redeemed, and the cost of reimbursing properties and other third parties in respect to other redemption opportunities available to members.


26

Revenue Presentation Any income streams that are not in ASC 606’s scope must be separately identified on the income statement.

Sales Taxes As originally issued, ASU 2014-09 required amounts collected on behalf of third parties, e.g., some sales taxes, to be excluded from the transaction price. Entities would have to evaluate taxes collected in multiple jurisdictions to determine if a tax is levied on the entity or customer. FASB reconsidered, and a subsequent amendment created an accounting policy election to present sales taxes collected from customers on a net basis. An entity not making this accounting policy election would apply the new revenue standard—as originally issued—in determining if those taxes should be included in the transaction price. Most franchisors have indicated they will exclude sales-based taxes collected on behalf of third parties from the transaction price.

Companies should consider new or enhanced processes, controls and systems for identifying and accounting for capitalized contract costs.


We incur certain costs to obtain and fulfill contracts with customers, which we capitalize and amortize on a straight-line basis over the initial, non-cancellable term of the contract. We classify incremental costs of obtaining a contract with a customer in the “Contract acquisition costs and other” caption of our Balance Sheets, the related amortization in the “Contract investment amortization” caption of our Income Statements, and the cash flow impact in the “Contract acquisition costs” caption of our Statements of Cash Flows. We classify certain direct costs to fulfill a contract with a customer in the “Other noncurrent assets” caption of our Balance Sheets, and the related amortization in the “Owned, leased, and other-direct” caption of our Income Statements.


We did not incur significant costs to obtain a contract and generally any costs are expensed as incurred, as the amortization period would be less than one year.


27

Disclosures Companies in all industries that have early adopted the new revenue standard have found this area to be more challenging than initially anticipated. The new revenue standard provides significant relief for nonpublic entities and less focus on quantitative disclosures. In most cases, additional data will need to be collected and additional monitoring and record-keeping will be required. BKD has prepared a separate white paper on the new required disclosures that applies to all industries, “Revenue Recognition: New Disclosures.”

Disaggregation of Revenues When determining how to disaggregate revenue for disclosures, an entity should consider how investors, regulators and lenders use the information to evaluate the entity’s financial performance. Public entities must disaggregate revenue in meaningful categories. Entities must disclose sufficient information to enable users to understand the relationship between the amounts from this disclosure and those reported for segment reporting purposes if they are different.


We are required to collect certain taxes and fees from customers on behalf of governmental agencies and remit these back to the applicable governmental agencies on a periodic basis. We have a legal obligation to act as a collection agent. We do not retain these taxes and fees and, therefore, they are not included in our measurement of transaction prices. We have elected to present revenue net of sales taxes and other similar taxes. We record a liability when the amounts are collected and relieve the liability when payments are made to the applicable taxing authority or other appropriate governmental agency.


Sales taxes related to these sales are collected from customers and remitted to the appropriate taxing authority and are not reflected in the Company’s condensed consolidated statements of income as revenue.


We are required to collect certain taxes and fees from customers on behalf of governmental agencies and remit these back to the applicable governmental agencies on a periodic basis. We do not include these taxes in determining the transaction price.


Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue transaction and collected from a customer are excluded from revenue under both Legacy GAAP and Topic 606.

Understand nature, amount,

timing and uncertainty of revenue and cash flows

Revenue Disaggregation

Contract Balances

Performance Obligations

Significant Judgments

Contract Costs

https://www.bkd.com/article/2017/05/revenue-recognition-new-disclosures


28

Contract Balances A contract asset or contract liability is generated when either party to a contract performs and is required to be reported in the financial statements. When an entity satisfies a performance obligation by delivering promised goods or services, the entity has earned a right to consideration and has a contract asset. When the customer performs first, e.g., prepayment, the entity has a contract liability.

The disclosure requirements have been developed to allow financial statement users to understand the relationship between the revenue recognized and changes in the overall balances of an entity’s total contract assets and liabilities during a particular reporting period.

Nonpublic entities may elect to only disclose qualitative information about how economic factors affect the nature, timing and uncertainty of revenue and cash flows.

This is a new concept for most industries, other than construction. Under existing guidance, when revenue is recognized but not yet billed, an entity records an asset for unbilled accounts receivable. After an invoice is sent to the customer, the related balance is reclassified as billed accounts receivable. Under ASC 606, reclassification from a contract asset to a receivable is contingent on fulfilling performance obligations—not on invoicing a client. As a result, the point at which a contract asset is reclassified as a receivable may be different than the time of invoicing.

Nonpublic entities may elect to only disclose the opening and closing balances of receivables, contract assets and contract liabilities from contracts with customers, if not otherwise separately presented or disclosed.


Our payments from customers are based on the billing terms established in our contracts. Customer billings are classified as accounts receivable when our right to consideration is unconditional. If our right to consideration is conditional on future performance under the contract, the balance is classified as a contract asset. … due to the profitability hurdles in the contract, incentive fees are considered contract assets until the risk related to the achievement of the profitability metric no longer exists. Once the annual profitability hurdle has been met, the incentive fee receivable balance will be reflected within accounts receivable.

Our contract assets were $21 million and insignificant at March 31, 2018, and December 31, 2017, respectively. At March 31, 2018, the contract assets were included in receivables, net. As our profitability hurdles are generally calculated on a full-year basis, we expect our contract asset balance to be insignificant at year-end.

Payments received in advance of performance under the contract are classified as contract liabilities and recognized as revenue as we perform under the contract.


29

Remaining Performance Obligations Only public entities are required to disclose information about remaining performance obligations and the amount of the transaction price allocated to such obligations, including an explanation of when they expect to recognize the amounts in their financial statements. This requirement applies to all performance obligations and is not limited to performance obligations with corresponding contract balances.


We record a receivable when we have an unconditional right to receive payment and only the passage of time is required before payment is due. We record deferred revenue when we receive payment, or have the unconditional right to receive payment, in advance of the satisfaction of our performance obligations related to franchise application and relicensing fees, Global Design fees, credit card branding license fees, and our Loyalty Programs.

Current and noncurrent deferred revenue increased by $85 million, from $685 million at December 31, 2017, to $770 million at March 31, 2018, primarily as a result of our revenue recognition activity described above in the “Performance Obligations” caption. The increase was primarily attributed to a $96 million increase related to our credit card branding licenses and a $9 million increase related to franchise application and relicensing fees, partially offset by an $8 million decrease related to Global Design activity.

Our current and noncurrent Loyalty Program liability increased by $327 million, from $4,940 million at December 31, 2017, to $5,267 million at March 31, 2018, primarily reflecting an increase in points earned and consideration from our credit card agreements, partially offset by revenue recognized of $425 million that we had deferred at December 31, 2017.


Contract assets relate to incentive management fees for which the period of service has passed, but for which our right to consideration is conditional upon completing the requirements of the incentive fee period. Contract assets are included in other current assets in our consolidated balance sheets and are transferred to accounts receivable when our right to consideration becomes unconditional.

Contract liabilities relate to:

(i) Advance consideration received from hotel owners at contract inception for services considered to be part of the contract performance obligations, such as management or franchise contract application, initiation, renewal and other fees;

(ii) Advance consideration received for certain indirect reimbursements, such as system implementation fees; and

(iii) Amounts received when points are issued under Hilton Honors, but for which revenue is not yet recognized, since the related points are not yet redeemed.

Contract liabilities related to advance consideration received for fees, excluding Hilton Honors, and certain indirect reimbursements are recognized as revenue over the term of the related contract. Contract liabilities related to amounts received for Hilton Honors are recognized as revenue at the point in time when the points are redeemed for a free good or service by the Hilton Honors member, which typically occurs within two years of points issuance. Contract liabilities are included in deferred revenues in our consolidated balance sheets.

Nonpublic companies are exempt from this requirement.


30

Adoption Entities must adopt the new revenue standard using either a full or modified retrospective approach with multiple practical expedients offered to provide transition relief. Under the full retrospective approach, entities would apply the new revenue standard as if it had been in effect since the inception of all customer contracts. Under the modified approach, the cumulative effect of initial application is recognized in opening retained earnings at the adoption date. For franchisors, SEC filings indicate both approaches have been used. Companies that chose a modified approach include Sonic, Extended Stay America and McDonald’s. Companies that chose or will choose a full restatement include Marriott, Hyatt, Hilton and Dunkin’ Donuts.

Each approach has relative benefits, costs and complexities. There is no “one size fits all” solution—it will depend on each company’s specific facts and circumstances and which factors are most relevant. Some entities may consider comparability to peers or between reporting periods to be most relevant while others may prioritize the cost of implementation. In other cases, an entity may consider comparability most important but determine the retrospective method is not feasible because it cannot make the necessary system changes in the required time frame at a reasonable cost.

Most entities took advantage of the available practical expedients on transition.


When we adopted ASU 2014-09, we applied the following expedients and exemptions, which are allowed by the standard, to our prior period Financial Statements and disclosures:

- We used the transaction price at the date of contract completion for our contracts that had variable consideration and were completed before January 1, 2018.

- We considered the aggregate effect of all contract modifications that occurred before January 1, 2016, when:

(1) identifying satisfied and unsatisfied performance obligations;

(2) determining the transaction price; and

(3) allocating the transaction price to the satisfied and unsatisfied performance obligations.

- We did not:

(1) disclose the amount of the transaction price that we allocated to remaining performance obligations; or

(2) include an explanation of when we expect to recognize the revenue allocated to remaining performance obligations.


31

Conclusion The adoption of this ASU will be complex and likely will require significant hours to correctly implement. The effect on each company will vary depending on existing revenue streams, accounting elections and estimation methodologies. Companies will need to redraft accounting policies under the new principles and update internal controls for the increases in management’s judgments.

BKD can help educate your team, provide implementation tools and assist with analysis and documentation. If you would like assistance complying with the new revenue recognition standard, contact your trusted BKD advisor. BKD has prepared a library of BKD Thoughtware® on revenue recognition issues. Visit our revenue recognition page to learn more.

Contributor Anne Coughlan Director 317.383.4000 [email protected]


We have not retrospectively restated for management and franchise contracts modified before January 1, 2016 for the contract modifications. Instead, we have reflected the aggregate effect of all contract modifications when identifying the satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price. The estimated effect of applying this practical expedient is to use a longer period over which to straight line any fixed consideration either received from the customer or paid to the customer, since all fees will be amortized over the full contract term beginning on the date of initial execution, rather than amortizing fees received upon contract modifications prospectively from the contract modification date. We do not anticipate that this effect is material given the insignificance of the fixed consideration compared to the overall consideration we expect to earn over the term of the contract. …

As part of the adoption of ASU 2014-09, we elected not to disclose the amount of the transaction price allocated to the same remaining performance obligations, … as of December 31, 2017 or provide an explanation of when we expect to recognize that amount as revenue.

https://www.bkd.com/resource/2018/08/revenue-recognition

mailto:[email protected]

revenue changes for franchisors - bkd · revenue changes for franchisors . 6 . model or only for...

Documents