Franchise Accounting

A franchise agreement involves the granting of business rights by the franchisor to a

franchise that will operate the franchise outlet in certain geographical location. Four
types of franchising arrangements have evolved:

 Manufacturer retailer,
 Manufacturer wholesaler,
 Service sponsor-retailer, and
 Wholesaler-retailer

PFRS 15 on Franchise Arrangements identifies two sources of revenue.

 Sale of initial franchises and related assets or services. and
 Continuing fees bused on the operations of franchises.

Performance obligations relate to

 Right to open a business
 Use of trade name or other intellectual property or the franchisor
 Continuing services, such as marketing help. training, and in some Cases
supplying inventory and inventory management

Franchisors commonly charge an initial franchise fee and continuing franchise fees
1. Initial franchise fee (payment! for establishing the relationship and providing some
initial services).
2. Continuing franchise fees received
a. In return tor continuing rights granted by the agreement
b. For providing management training, advertising and promotion, legal
assistance, and other support.

Initial Franchise Fee

Franchise agreements vary but usually involve an initial payment (called an initial
franchise fee) by the franchisee and ongoing payments of continuing franchise fees.
For the initial franchise foe, the franchisor {the party who grants business rights under the
franchise} normally provides the franchisee (the party who operates the franchised
business) with the following services:
1. Assistance in site selection
a. Analyzing location
b. Negotiating lease
2. Evaluation of potential income
3. Supervision of construction activity
a. Obtaining financing
b. Designing building
c. Supervising contractor while building
4. Assistance in the acquisition of signs. fixtures, and equipment
5 Provision of bookkeeping and advisory services
a. Setting up franchisee’s records
b. Advising on income real estate, and other taxes
c. Advising on local regulations of the franchisee;’s business
6. Provision of employee and management training
7. Provision of quality control

Continuing Franchise Fee (Royalty Fee)

Continuing franchise fees (royalty fee) are received in return for the continuing rights by
the franchise agreement and for providing such services as management training,
advertising and promotion, quality control, budgeting and other accounting services,
legal assistance, and other support
Continuing fees (royalty fee) should be reported as revenue when they are earned
(over time) and receivable from the franchisee, unless a portion of them has been
designated for a particular purpose, such as providing a specified amount for building
maintenance or local advertising. In that case, the portion deferred shall be an amount
sufficient to cover the estimated cost in excess of continuing franchise fees and provide
a reasonable profit on the continuing services (point in time) The continuing fees
(royalty payments), which are typically computed as a percentage of the franchisee’s
sales but can also be a fixed periodic amount, are recognized by the franchisor as
revenue in the same period that the scenes are made by the franchisee.
Occasionally, the continuing franchise fee (royalty payments) is not large enough to
cover the franchisor’s cost of the continuing services provided. However, the initial
franchise fee is unusually large (so in effect it involves a prepayment by the franchisee
for the continuing services.) In such cases the franchisor records a portion of the initial
fee as a liability and amortizes the amount to franchise revenue over the life of the
franchise(over time.)

I – Initial Franchise Fee/Commingled Revenue and Continuing Franchise Fee (Royalty)

Dominador’s Pizza, Inc. enters into a franchise agreement on December 31, 20x7, giving
Doming Corp. the right to operate as a franchisee of Dominador’s Pizza for 5 years.
Dominador’s charges Doming an initial franchise fee of P475,0000 for the right to
operate as a franchisee. Of this amount, P190,000 is payable when Doming Corp. signs
the agreement and the balance is payable in five annual payments of P57,000 each
on December 31.
Consider the following tor allocation of the transaction price at December 31, 20x7:
Rights to the trade name, market area, technical and
proprietary know-how P190,000
Services-training etc. 94,591.50
Machinery and equipments, etc. (costing 95,000) 133,000
Total transaction price P417,591.50

The credit rating of Doming indicates that money can be borrowed at 8%. The present
value of an ordinary annuity of five annual receipts of P7,000 each discounted at 8% is
P227.591.50. The discount of P57.408.50 represents the interest revenue to be accrued
by Dominador's Pizza Inc. over the payment period.
Training is completed in February 1, 20x8. the equipment is installed in February 2, 20x8
and Doming holds a grand opening on February 4, 20x8. On February 4, 20x8, franchise
opens. Dominador's satisfies the performance obligation related to the franchise nights,
training and equipment.
Doming also promises to pay on going royalty payment, of 1% of its annual sales
(payable every January 31 of the following year) and is obliged to purchase products
from Dominador’s at its current standalone selling prices at the time of purchase.
1. How many performance obligations exist in this contract for franchise?
a. 2 c. 4
b. 3 d. 5

2. When should Dominador recognize revenue for the rights (combined) to the trade
name, market area and proprietary know-how which give rise to a single performance
obligation?
a. No transaction c. Point in time
b. No revenue d. Over Time

3. How much revenue (franchise revenue, service revenue and sales revenue -
machinery and equipments) be recognized on December 31, 2017?
a. Zero. c. P133,000.00
b. P 94,591.50 d. 190,000

4. How much revenue (franchise revenue, service revenue and sales revenue —
machinery and equipment) be recognized on February 4 2018?
a. P 94,591.50 c. P190,000
b. P133,000.00 d. P417,591.50
5. How much continuing franchise revenue be recognized on December 31. 20x8.
assuming the sales of P4,987,500 was generated to the first year of operations?
a. Zero c. P190,000
b. P48,875.00 d. P417,591.50

6. How much total franchise revenue (in relation to No. 4 and 5) on December 31, 20x8?
a. P372,366.50 c. P417,591.50
b. P390,673.82 d. P467,466.50

7. In relation to No. 6, the net income on December 31, 2018 amounted to?
a. Zero c. P390,673.82
b. P372,466.50 d. P467,466.50

Recognition of Franchise Rights Revenue Over Time

Depending on the economic substance of the rights, the franchisor may be providing
access to the right rather than transferring control of the franchise rights. In this cases,
the franchise revenue is recognized over time, rather than at a point in time.

II — Initial Franchise Fee/Commingled Revenue

Frozen Delight, Inc. charges an initial franchise fee of 75,000 for the right to operate as a
franchisee of Frozen Delight. Of this amount P25,000 is collected immediately. The
remainder is collected in four equal annual installments of P 12,500 each. These
installments have a present value of P41.402. As part of the total franchise fee, Frozen
Delight also provides training (with a fair value of P2,000) to help franchisees get the
store ready to open. The franchise agreement is signed of April 1, 20x5. Training is
completed, and the store opens on July 1, 20x5.
1. The amount of revenue from training and franchise on April 1, 20x5 to:
a. Zero c. P66,402
b. P64,402 d. P75,000
2. The amount of revenue from training and franchise on July 1, 20x5 to:
a. Zero c. P66,402
b. P64,402 d. P75,000

III- Initial Franchise Fee

Items 1 to 7 are based on the following information: |
Pacific Crossburgers Inc. charges an initial fee of P70 000. Upon the signing of the
agreement (which covers 3 years), a payment of P28,000 is due. Thereafter, three
annual payments of P14,000 are required. The credit rating of the franchisee is such that
it would have to pay interest at 10% to borrow money. The franchise agreement signed
on May 1, 20x5, and the franchise commences operation on July 1, 20x5.

1. The amount of franchise revenue on May 1, 20n5 assuming no future services are
required by the franchisor once the franchise starts operations.
a. Zero. c P62,816
b. P28.000 d. P70,000

2. In relation to No. 1, the amount of franchise revenue on July 1. 20x5.

a. Zero. c P62,816
b. P28.000 d. P70,000

3. The amount of franchise revenue on May 1, 20x5, assuming that the franchisor has
substantial services to perform, once the franchise begins operations to maintain the
value of the franchise.
a. Zero. c P62,816
b. P28.000 d. P70,000
4. In relation to No. 3, the amount of franchise revenue on December 31, 20x5.
a. Zero c. P62,816
b. P13,959 d. P70,000

5. The amount of franchise revenue on May 1, 20x5 assuming that the total franchise
fee includes training services (with a value of P2,400) for the period leading up to the
franchise opening and for two (2) months following opening.
a. Zero. c P62,816
b. P60,416 d. P70,000

6. In relation to No. 5, the amount of franchise revenue on July 1, 20x5:

a. Zero. c P61,616
b. P60,416 d. P63,616

7. In relation to Nos. 5 and 6, the amount of service revenue on September 1, 20x5:

a. Zero. c. P 2,400
c. P1.200 d. P70,000

IV - Initial Franchise Fee

1. TopChop sells hairstyling franchises. TopChop receives P50,000 from a new franchisee
for providing initial training, equipment and furnishings that have a stand-alone selling
price of P50,000. TopChop also receives P30,000 per year tor use of the TopChop name
and for ongoing consulting services (starting on the date the franchise is purchased).
Carlos became a TopChop franchisee on July 1, 20x6, and on August 1, 20x6, had
completed training and was open for business. How much revenue in 20x6 will TopChop
recognize for its arrangement with Carlos?
a. zero c. P65,000 .
b. P10,000 C d. P70,000

2. Pita Pal sells fast-food franchises. Pita Pal receives P75,000 from a new franchisee for
providing initial training, equipment, and furnishings that together have a stand-alone
selling price of 75,000. Pita Pal also receives P36.000 per year for use of the Pita Pal
name and for ongoing consulting services (starting on the date the franchise is
purchased). Rachel became a Pita Pal franchisee on March 1, 20x6, and on May 1,
20x6 Rachel had completed training and was open for business. How much revenue in
20x6 will Pita Pal recognize for its arrangement with Rachel?
a. zero c. 99,000
b. 75,000 d. 105,000
V - Initial Franchise Fee, Continuing franchise Fee and Bargain Purchase
1. On January 1, 20x5 Dairy Treats, Inc. entered into a franchise agreement with a
company allowing the company to do business under Dairy Treats' name. Dairy Treats
had performed substantially all required services by January 1}, 20x5, and the
franchisee paid the initial franchise fee of P840,000 in full on that date. The franchise
agreement specifies that the franchisee must pay a continuing franchise fee of P72,000
annually, of which 20% must be spent on advertising by Dairy Treats. What entry should
Dairy Treats make on January 1, 20x5 to record receipt of the initial franchise fee and
the continuing franchise fee for 20x5?
a. Cash 912,000
Franchise Fee Revenue 840,000
Revenue from Franchise FOS 72,000

b. Cash 912,000
Unearned Franchise Fees 912,000

c. Cash 912,000
Franchise Fee Revenue 840,000
Revenue from Franchise Fees 57,600
Unearned Franchise Fees 14,400
d. Prepared Advertising 14,400
Cash 912,000
Franchise Fee Revenue 840,000
Revenue from Franchise Fees 72,000
Unearned Franchise Fees 14,400

2. Wynne Inc. charges an initial franchise tee of P 1,840,000, with P400,000 paid when
the agreement is signed and the balance in five annual payments. The present value of
the future payments, discounted at 10%, is P1,091,744. The franchisee has the option to
purchase P240,000 of equipment for P192,000. Wynne has substantially provided all
initial services required and collectibility of the payments is reasonably assured. The
amount of revenue from franchise fees:
a. P 400,000. c. P1,491,744.
b. P1,443,744. d. P 1,840,000.

3. Pasta Inn charges an initial fee of P1,600,000 for a franchise. with P320,000 paid when
the agreement is signed and the balance in four annual payments. The present value
of the annual payments, discounted at 10%, is P!.014,000. The franchisee has the right to
purchase P60.000 of kitchen equipment and supplies for P50,000. An additional part of
the initial fee is for advertising to be provided by Pasta Inn during the next five years.
The value of the advertising is P1,000 a month. Collectibility of the payments is
reasonably assured and Pasta Inn has performed all the initial services required by the
contract. How much revenue from franchise fee be recognized when the agreement is
signed?
a. Zero. c. P1,590.000
b. P1,264,000 d. P1,600,000