Franchise Accounting

Judith Gabutero
 Introduction

• Franchising is a means of distributing goods or services.

•
• contributes his trade name, products,
A franchise generallycompany's reputation
involves the grant from one
Franchise
party (franchisor) to
• imparts his expertise and on continuing
franchisor
and other party (franchisee), the right
basis provides guidance to sell
and duties
the manner in which the franchisee
on the
Agreement
granting party's goods
or services. must operate his establishment.
-outlines the rights and
• Franchising gives the franchisor the opportunity to distribute responsibilities
his of each party
-describes the marketing
product and or services with minimum investment in the practices to be followed
• provides operating capital and
franchised outlet. Franchisee is able resources
managerial operational to own his business, reapthe contribution of
-details

franchisee
financial rewards andrequired
benefit from
for the the
operation
franchised business
agreement
of the

assistance and guidance from the franchisor The franchisee,

by each0f
way party
-sets certain standards of
operating procedures which
however, must pay for these services, and must be willing bothtoparties agree to perform.
accept the franchisor's control over operations.
 Franchise fees

• Franchise agreement usually requires the franchisee to

make payments, called the franchise fee to the
franchisor in consideration for the reputation, skill,
products, and services contributed by the franchisor.
1. Initial Franchise Fee. This represents initial payment for establishing the
franchise agreement, and for providing certain initial services associated
Types of
with the agreement. The initial franchise fee may be payable immediately franchise fee
in cash or for an extended period of time. The initial services rendered by
the franchisor prior to the opening of the franchisee's operations

2. Continuing Franchise Fee. This represent continues payment to the

franchisor for providing specific future services, such as advertising, and for
the continued use of intangible rights by the franchisee. These fees are
usually based on the operations of franchises.
 Revenue Recognition
1. Initial Franchise Fees. The problem of recognizing revenue with regard to
initial franchise fees, generally results from two issue:
(1) the point at which the fee is to be considered earned; and
(2) the assurance of collectability of any unpaid portion of the fee, if the
total initial franchise fee is not paid in full.
The following accounting principle and procedures are to be used in the
recognition of revenue from the initial franchise fee:
1. Revenue from the initial franchise fee should be recognized on the
consummation of the transaction, which occurs when all material services
or conditions of the sale have been substantially performed. Substantial
performance by the franchisor occurs when the following conditions are
met: a. The franchisor is not obligated in any way (trade practice, law,
intent, or agreement) to refund cash already received or forgive
unpaid debt.
b. The initial services required of the franchisor by contract or
otherwise have been substantially performed.
c. No other material conditions or obligations exist.
 Revenue Recognition
2. Direct franchise costs of initial services rendered by the franchisor shall be
deferred until related revenue is recognized. These costs should not exceed
anticipated related revenue. Indirect costs that occur on a regular basis should
be expensed when incurred.
It is assumed that substantial performance occur when the
franchisee actually commence operations of the franchise. Once substantial
performance is achieved, revenue from the initial franchise fee should be
recognized using the following methods:
1. Accrual basis. This method is used when the initial franchise fee is
collectible over an extended period of time and the collectability of the
unpaid portion of the franchise fee is reasonably assured.
2. Installment method/Cost Recovery method. These methods should be
used in exceptional cases, that is, when the initial franchise fee is
collectible over an extended period and the collectability of the unpaid
portion of the initial franchise fee is uncertain
 Jan. 5, 2016: McDo, Inc. granted a franchise to Mr. A.
De, Jesus to sell McDo products. The Initial franchise
fee (IFF) is P10,000,000.
Feb. to Nov.: McDo, Inc. rendered the following initial
services under the franchise contract: Direct costs of
initial services P2,000,000 ,
Indirect costs of services P50,000.
December 1: The franchisee, Mr. A. De Jesus started
business operations.
Illustration Case 1: The initial franchise fee is paid in full when the
agreement is signed on July 2, 2016. The following entries
would be made by the franchisor during the year 2016:
July 2, 2016 Cash 10,000,000
Deferred Revenue from IFF 10,000,000
To record the receipt of the IFF

Feb. to Nov. Deferred cost of franchise revenue 2,000,000

Franchise expenses 50,000
Cash 2,050,000
To record the payment of franchise costs
 Adjusting entries:
Dec.31 Cost of franchise revenue 2,000,000
Deferred cost of franchise revenue 2,000,000
To adjust cost of franchise revenue.

Dec.31 Deferred revenue from IFF 10,000,000

Revenue from IFF 10,000,000
To recognize fully as revenue the initial franchise fee

Illustration Case 2. The initial franchise fee is payable as follows: P1,000,000

cash when the contract is signed and the balance in five annual
installments payable every December 31, evidenced by a 12
percent promissory note. As discussed earlier, two methods can
be used to record franchise operations if the initial franchise is
payable for an extended period of time. These methods are:
Method 1: Accrual Method. This method is used when the
collectibility of the note is reasonably assured. Under this method
the initial franchise fee is fully recognized as revenue.
 2016
Jan.5 Cash 1,000,000
Notes receivable 9,000,000
Deferred revenue from IFF 10,000,000
To record the initial franchise fee

Feb. to Nov. Deferred cost of franchise revenue 2,000,000

Franchise expenses 50,000
Cash 2,050,000

Illustration To record the cost of services rendered

Dec.31 Cash 2,880,000

Notes receivable 1,800,000
Interest income
(9.000,000 x 12% ) 1,080,000
To record collection of first installment

Adjusting entries:
Dec.31 Cost of franchise revenue 2,000,000
Deferred cost of franchise revenue 2,000,000
To adjust cost of franchise revenue.
 Dec.31 Cost of franchise revenue 2,000,000
Deferred cost of franchise revenue 2,000,000
To adjust cost of franchise revenue

Dec.31 Deferred revenue from IFF 10,000,000

Revenue from IFF 10,000,000
To recognize fully as revenue the initial franchise fee as revenue
on December 31, since the collectibility of the note is reasonable
assured

Illustration The Statement of Comprehensive Income of the franchisor for

the year ended December 31, 2016 will now appear as follows:

Revenue from franchise fee 10,000,000

Cost of franchise revenue 2,000,000
Gross profit 8,000,000
Expenses 50,000
Operating income 7,050,000
Interest income 1,080,000
Net income P 8,130,000
 MULTIPLE CHOICES- COMPUTATIONAL 10-3

On July 1,2016, Ms. Tiam signed an agreement to operate as franchise of Andok's Lechon Manok,
Inc. for an initial franchise fee of P500,000. Of this amount, P100,000 was paid upon signing of the
franchise agreement and the balance evidence by a 12% promissory note is payable in two annual
payments of P200,000 each beginning December 31, 2016. Ms. Tiam commenced operations of the
franchise on November 2, 2016. The first installment was collected on due date. Assuming the
collectibility of the note is reasonably assured, what is the revenue from franchise fee to be
reported by Andok's in its December 31, 2016 statement of comprehensive income?

A. P500,000
B. P 0
C. PI00,000
D. P400,000
 MULTIPLE CHOICES- COMPUTATIONAL 10-6
On July 1,2016, Mr. Roxas signed an agreement to operate as a franchise of HotDog Inc. for an initial
franchise fee of P1,200,000. On the same date, Mr. Roxas paid P400,000 and agree to pay the balance
in four annual payments of P200,000 beginning July 1, 2017. Mr. Roxas can borrow at 14% for a loan of
this type. Present and future value factors are as follows:
Present value of 1 at 14% for 4 periods 0.59
Solution:
Future amount of 1 at 14% for 4 periods 1.69
Present value of an ordinary annuity of 1 at
FV (1,200,000-400,000) 800,000
14% for 4 periods 2.91 PV (200,000 x 2.91) 582,000
On July 1,2016, when the initial franchise fee is received, what is theinterest
Unearned unearned interest
income, income
recorded by HotDog, Inc? July 1,2016 218,000
a. P200,000 c. P 0
b. P218,000 d. P380,000
 MULTIPLE CHOICES- COMPUTATIONAL
10-7

Using the data in 10-6. What is the deferred revenue from franchise fee to be recorded on July 1,
2016 by HotDog, Inc.?

A. P800,000
B. P582,000 Solution:
C. P400,000
D. P982,000
Initial Franchise fee 1,200,000
Unearned interest income 218,000
Deferred Revenue
from Franchise Fee 982,000
 MULTIPLE CHOICES- COMPUTATIONAL 10-10

On December 31,2016. Arce Ice Cream, Inc. authorized Mr. Lee to operate as a Franchise for an initial
franchise fee of P3,000,000. Of this amount Pl,200,000 was received upon signing of the contract, and the
balance by a non-interest bearing note, is due in three annual payments of P600,000, beginning December 31,
2017. The present value on December 31, 2016 of the three annual payments appropriately discounted is
P1,263,900. The collectibility of note is not reasonably assured. On December 31, 2016, Arce Ice Cream, should
record unearned interest income and deferred revenue from franchise fee of:

Unearned Deferred Revenue

Interest Income From Franchise Fee Solution:
Solution:

A. P536,000 P 3,000,000
Initial Franchise fee 3,000,000
B. P536,100 P 2,463,900 FV (3M-1.2M) 1,800,000
Unearned interest income 536,100
C. P 63,900 P 3,000,000 PV 1,263,900
Deferred Revenue
D. P 63,900 P 2,463,000 Unearned interest income 536,100
from Franchise Fee 2,463,900
 MULTIPLE CHOICES- COMPUTATIONAL 10-11

On January 2, 2016, Ms. Rufina got the franchise of Mario's, a known steak house of upscale patronage.
The franchise agreement provided a Pl,000,000 initial franchise fee, payable as follows: P200.000 when
the contract is signed and the balance in four annual installments starting December 31,2016. The
current interest rate is 20%. The present value of an annuity of 1 for 4 periods is P2.5887. Any services
to be rendered in the future is very minimal which will not affect the recognition of revenue from the
initial franchise fee. The agreement further provides a continuing franchise fee of 5 % on gross sales of
the franchise, payable monthly within the first ten days of the following month. The collectibility of the
note is reasonably assured. The franchisee commenced operation on July 1, 2016 and reported gross
sales of P2,000,000 from July to December 31, 2016 What is the revenue from franchise fees to be
reported by Mario's for the year ended December 31, 2016?

a. P1,100,000
b. P 817,740
c. P1,000,000
d. P 300,000