As originally adopted by FASB in early 2003, FIN 46 gave accountants a license to apply a complex quantitative and qualitative analysis to business relationships involving equity investment, debt, and contractual ties, to determine who was in charge of a VIE and who was the most likely party to suffer the greatest cumulative losses or realize the most residual gain.  FIN 46 was written so broadly that basic contractual relationships – including, most significantly, virtually all franchise arrangements – were drawn into the interpretation.

The potential consequences of FIN 46 as initially adopted posed an accounting nightmare:  Franchisors dictating financial statement principles to franchisees;  franchisees sharing the most intimate details of their individual businesses with franchisors and their accountants; CEOs and CFOs of public franchisors who are required to provide certifications under the Sarbanes-Oxley Act taking on personal liability for the integrity of the accounting records and internal controls over financial reporting of perhaps thousands of franchised businesses over which neither they nor the public franchisors had responsibility.

Balance sheet impacts mainly include accounts receivable and fixed assets and current and long-term liabilities.  If the franchisor sold products to its franchisees, inventories will surely be affected.  Even such items as deferred taxes will be touched by consolidation.  Line items from the top to the bottom of the operating statement, including critical measuring sticks such as revenue, gross margin, OSG&A, and net operating income, can be affected.  Thus, the business relationship currency, the increased costs, and the financial statement impact warranted franchisor attention to FIN 46.

The International Franchise Association staff, assisted by counsel and interested IFA members, took action.  Through white papers, comments submitted to FASB, meetings, and hearings they brought the looming crisis to the attention of FASB, the Securities and Exchange Commission, and members of U.S. Congress.  The results of this effort were positive.  First, a staff interpretation (FSP 46‑8) was issued to officially recognize some of the points that the franchise community made.  That interpretation provided a bit of relief.  Then, on the morning of December 24, 2003, as a Christmas present to the franchise world and others, FASB issued FIN 46R.  For FASB, the R stands for revised.  For the franchise world, the R stands for relief.  That relief, however, is not complete.  While it is less likely that most franchisors will have to consolidate under FIN 46 as revised (FIN 46R) than under the initial draft, under FIN 46R, franchisors and franchisees still did not fully escape the consolidation issue.  An analysis is required to determine whether and, if so, how FIN 46R might apply.

How FIN 46R Works