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p2 1405 Franchise
p2 1405 Franchise
P2.1405-Franchise Accounting
LECTURE NOTES
Some exceptions to the above revenue recognition (b) Collection of the N/R is not reasonably assured:
principles follow: Aside from the two accrual entries in 5(a):
1. If there is a substantial performance and installment
sale method is to be used BUT the franchise cost is not Franchise Revenue 41,941.68
available, only the cash down payment is earned Franchise Cost 25,165.00
revenue and the present value of the note receivable Deferred Gross
unearned revenue. Profit 16,776.68
2. If there is yet no substantial performance but the down
payment is not refundable and if it represents a fair
Deferred Gross Profit 6,177.87
measure of the costs of services already provided by
Realized Gross Profit 6,177.87
the franchisor then the cash down payment is earned
(c) If initial services have not been substantially
revenue and the present value of the note is unearned
performed by franchisor, note receivable is
revenue.
reasonably assured of collection, and the down
payment is not refundable.
Illustrative Entries for Initial Franchise Fees.
Unrealized Franchise
To illustrate, assume on January 1, 2012 Jessie’s Pizza inc.
Revenue 10,000.00
charges an initial franchise fee of P50,000 for the right to
Franchise revenue 10,000.00
operate as a franchise of Jessie’s Pizza. Of this amount,
P10,000 is payable when the agreement is signed, and the
Continuing Franchise Fees
balance is payable in five annual payments of P8,000 each.
Continuing franchise fees are received in return for the
In return for initial franchise fee, the franchisor will help
continuing rights granted by the franchise agreement and
locate the site, negotiate the lease or purchase of the site,
for providing such services as management training,
supervise the construction activity, and provide the
advertising and promotion, legal, assistance, and other
support. Continuing fees should be reported as revenue given that the franchisor will ultimately purchase the
when are earned and received from the franchise, unless outlet, then the initial franchise fee should not be
portion of them has been designated for a particular recognized as revenue but should be recorded as a
purpose, such as providing a specified amount for building liability. When the option is exercised, the liability would
maintenance or local advertising. In that case, the portion reduce the franchisor’s investment in the outlet.
deferred shall be an amount sufficient to cover the
estimated cost in excess of continuing franchise fees an Franchisor’s Cost
amount provide a reasonable profit on the continuing Franchise accounting also involves proper accounting for
services. the franchisor’s cost. The objective is to match related
costs and revenues by reporting them as components of
Bargain Purchases income in the same accounting period. Franchisors should
In addition to paying continuing franchise fees, franchise ordinarily defer direct costs (usually incremental costs)
frequently purchase some or all of their equipment and relating to specific franchise sales for which revenue has
supplies from the franchisor. The franchisor would account not yet been recognized. Costs should not be deferred,
for these sales as it would for any other product sales. however, without reference to anticipated revenue and its
Sometimes, however, the franchise agreement grants realizability5. Indirect costs of a regular and recurring
the franchise the right to make bargain purchases of nature, such as selling and administrative expenses that
equipment or supplies after the initial franchise fee is paid. are incurred irrespective of the level of franchise sales,
If the bargain price is lower than the normal selling price of should be expensed as incurred.
the same product, or if it does not provide the franchisor a
reasonable profit, then a portion of the initial franchise fee Disclosures of Franchisors
should be deferred. The deferred portion would be Disclosure of all significant commitment and obligations
accounted for as an adjustment of the selling price when resulting from franchise agreements, including a
the franchisee subsequently purchases the equipment or description of services that have not yet been substantially
supplies. performed, is required. Any resolution of uncertainties
regarding the collectibility of franchise fees should be
disclosed. Initial franchise fees should be segregated from
Options to Purchase other franchise fee revenue if they are significant. When
A franchise may give the franchisor an option to purchase possible, revenues and costs related to franchisor-owned
the franchisee’s business. As a matter of management outlets should be distinguished from those related to
policy, the franchisor may reserve the right to purchase a franchised outlets.
profitable franchise outlet, or to purchase one that is in
financial difficulty. If it is probable at the time the option is - done -
STRAIGHT PROBLEMS
Problem 1
On January 1, 2013, KITKAT COMPANY entered into a Problem 2
franchise agreement with BROOKLYNNE CORPORATION to On January 2, 2013, CANDY signed an agreement to
sell BROOKLYNNE Products. The agreement provides for an operate as a franchisee of BRUNO, INC. for an initial
initial franchise fee of P7,812,500 payable as follows: franchise fee of P8,750,000 Of this amount, P3,281,250
P4,687,500 cash to be paid upon signing of the contract, was paid when the agreement was signed and the balance
and the balance in four equal annual payments of is payable in five annual payments of P1,093,750
P781,250 to start December 31, 2013. Rose signs 10% beginning December 31, 2013. CANDY signed a non-
interest-bearing notes for the balance. The agreement interest bearing note for the balance. CANDY credit rating
further provides that the franchisor will assist the indicates that she can borrow money at 20% interest for a
franchisee in locating the business site, in designing and loan of this type. The present value of an annuity of P1 at
supervising the construction of the building, and in the 20% for 5 periods is 2.990. The contract includes a
training of management and employees. The agreement continuing franchise fee of 5% of the franchisee’s gross
also provides that franchisee must pay a continuing sales, to be collected monthly.
franchise fee equal to 5% of its monthly gross sales. On
On November 25, 2013, the franchisor substantially
October 31, 2013, the franchisor completed the initial
performed the initial services provided in the contract at a
services required in the contract at a costs of P1,875,000.
cost of P982,835. Indirect cost is P46,875. The franchisee’s
The franchisee commenced business operations on
outlet commenced operations on December 1, 2013. The
November 2, 2013. The gross sales reported to the
gross sales of CANDY for the month of December, 2013 is
franchisor for the months of November and December are
P437,500.
P703,125 and P937,500 respectively.
Required: Prepare journal entries on the books of the
Requirements: franchisor for 2013, assuming (1) collection of the note
1. Assuming that the collection of the notes is reasonably is reasonably assured and (2) collection of the note is
assured, prepare the journal entries in the books of the not reasonably assured.
franchisor for the year 2013.
2. Assuming that the collection of the notes is not
reasonably assured, prepare the journal entries in the
books of the franchisor for the year 2013.
MULTIPLE CHOICE
On January 1, 2012, XEROX SERVICES, INC. signed an required in the contract at a cost of P1,125,000 and
agreement authorizing YOURS TRULY COMPANY to operate incurred indirect costs of P225,000. The franchise
as a franchisee over a 20-year period for an initial commenced business operations on November 3, 2012.
franchise fee of P171,875 received when the agreement The gross sales reported to the franchisor are November
was signed. YOURS TRULY commenced operations On July sales, P115,312.50 and December sales, P133,593.75. The
1, 2012 at which date all of the initial services required of first installment payment was made on due date. Assume
XEROX SERVICES had been performed. The agreement collection of the note is not reasonably assured.
also provides that YOURS TRULY must pay annually to 4. In its income statement for the year ended December
XEROX a continuing franchise fee equal to 5% of the 31, 2012, how much is the net income?
revenue from the franchise. YOURS TRULY’S franchise a. P1,216,068.70 c. P1,059,257.80
revenue for 2012 was P1,375,000. b. P 801,070.31 d. P1,180,757.80
1. For the year ended December 31, 2012, how much
should XEROX record as revenue from franchise fees On January 2, 2012, EXTREME COMPANY signed an
with respect to the YOURS TRULY’S franchise? agreement to operate as a franchisee of BASIC
a. P240,625 c. P154,687.50 PRODUCTS, INC.. for an initial franchise fee of P3,125,000
b. P171,875 d. P 75,625 for 10 years. Of this amount, 40% was paid when the
agreement was signed and the balance payable in four
GREAT DANE, INC., franchisor, entered into a franchise semi-annual payments beginning on June 30, 2012.
agreement with PITBULL COMPANY, franchisee, on July 1, EXTREME signed a non-interest-bearing note for the
2012. The total franchise fees agreed upon is P687,500, of balance. EXTREME’s rating indicates that it can borrow
which P62,500 is payable upon signing and the balance is money at 24% on a loan of this type. Assume that
to be covered by a note payable in four equal annual substantial services amounting to P771,875 had already
installments. The direct franchise cost incurred was been rendered by BASIC PRODUCTS, INC.
P406,250. Indirect franchise expenses of P39,062.50 was 5. If the collection of the note is not reasonably assured,
also paid. The relevant interest rate is 12% and the note is the realized gross profit for the year ended December
reasonably assured of collection. The franchise outlet 31, 2012:
commences its operations on July 25, 2012. a. P1,321,345.50 c. P1,101,069.50
2. Assuming the note payable is interest-bearing, how b. P1,069,031.50 d. P1,338,307.00
much is the net income to be reported in the July,
2012 income statement?
a. P248,437.50 c. P242,187.50 6. On January 1, 2012, ABC signed an agreement to
b. P 96,937.50 d. P 92,187.50 operate a franchise of XYZ for an initial franchise fee of
10M pesos for 10 years. Of this amount P2,000,000
3. Assuming the note payable is non-interest-bearing was paid when the agreement was signed and the
(use two decimal places for the present value factor), balance is payable in four equal annual payments
how much net income is to be reported in the July beginning December 31, 2012. ABC signed a non
2012 income statement? interest bearing note for the balance. ABC’s rating
a. P248,437.50 c. P 96,937.50 indicates that it can borrow money at 24% for a loan
b P242,187.50 d. P 92,187.50 of this type. Present value factor of an annuity of 1 for
four periods at 24% is to 2.4. Assume that the
On January 2, 2012, JELLYFISH, INC. entered into a substantial services amounting to P1,020,000 had
franchise agreement with KOOKIE COMPANY to sell their been already rendered by XYZ. An the additional
products. The agreement provides for an initial franchise indirect franchise cost of P272,000 was also incurred.
fee of P3,515,625 payable as follows: P984,375 cash to be If the collection of the note is not reasonably assured,
paid upon signing of the contract and the balance in five the realized gross profit for the year ended December
equal annual payments every December 31, starting 31, 2012 is:
December 31, 2012. JELLYFISH signs a 15% interest- a. P5,780,000
bearing-note for the balance. The agreement further b. P2,420,800
provides that the franchisee must pay a continuing c. P5,508,000
franchise fee equal to 5% of its monthly gross sales. On d. P2,502,400
October 31 the franchisor completed the initial services