FRANCHISE ACCOUNTING (SPECIAL REVENUE RECOGNITION)

Franchisor Accounting
FRANCHISE REVENUE –
Franchise revenue recognized from two sources:
i. Initial Franchise Fee: sale of initial franchises and related assets or services
ii. Continuing Franchise Fees: based on franchise operations

Initial Franchise Fee/Revenue (IFF)

• Recorded as revenue only when and as the franchisor has established substantial performance:
a) The services obligated to be performed have been so performed
• No obligation to refund any portion of the fee received to date
• Substantial performance of required services
b) Collection of the fee is reasonably assured

• The beginning of operations normally considered the earliest time substantial performance has
occurred

Three conditions to recognize IFF

1. Services – All initial services required under the contract had been performed or substantially
performed.
2. Period of Refund – payment received already expired or non-refundable
3. Collectability – of the note is reasonably assured

CASES Services Refund Collectability Earned/Unearned

1. reasonable expectation of refund and
significant performance by franchisor
required
2. low expectation of refund, minimal
amount of future services to be provided
by franchisor, and collection of the note
reasonably assured
3. no refund, substantial performance by
franchisor required, and collection
reasonably assured
4. if down payment refundable, or
substantial performance by franchisor
required

Continuing Franchise Fees/Revenue (CFF)

• Received in return for continuing rights under the franchise agreement and provision of services
by franchisor
• Reported as revenues when they are earned and receivable from the franchisee
• If an amount is included which is “ear-marked” for a specific purpose e.g. for local advertising, that
amount is deferred

Special Issues
• Franchisor’s Cost
 – Overall objective is to match related costs and revenues
– Direct costs are deferred for any specific franchise sale where revenue has not been
recognized
– Indirect costs, such as selling and administrative expenses, are expensed as incurred

• Bargain Purchase
– When the franchisee may purchase assets at a lower than market price from the franchisor
– Portion of initial franchise fee is deferred if the bargain price is lower than normal selling
price or if franchisor does not make a reasonable profit
– Adjustment to selling price when assets are purchased by the franchisee

• Options to Purchase
– Where the franchisor has the right to purchase the franchisee’s business
– Initial franchise fee recorded as a liability if it is probable that a purchase will occur
– When option is exercised, the liability would reduce the franchisor’s investment

Disclosures of Franchisors
• Full disclosure of all significant commitments and obligations is required
• Description of services yet to be performed is also required
• Initial franchise fees are reported as a separate revenue line item if significant
• Revenues and costs of franchisor-owned outlets should be disclosed separate from the revenues
and costs of franchised outlets

-done-

ILLUSTRATIVE PROBLEMS

Problem 1
On January 1, 2018, Mr. JK entered a franchise agreement with DBM to market their products. The
agreement provides for an initial fee of Php 12, 500, 000 payables as follows: Php 3, 500, 000 to be paid
upon signing of the contract and the balance in five equal annual payments every end of the year starting
December 31, 2018. Mr. JK signs a non-interest-bearing note for the balance. His credit rating indicates
that he can borrow money at 15% interest for a loan of this type. The agreement further provides that the
franchisee must pay a continuing franchise fee equal to 3% of the monthly gross sales. On August 31, the
franchiser completed the initial services required in the contract at a cost of Php 4, 290, 120 and incurred
indirect cost of Php 175, 000. The franchisee commenced business operation on November 30, 2018. The
gross sales reported to the franchiser were Php 1, 800, 000 for December 2018. The first installment
payment was made in due date.
PV? (use three decimal points)
Requirements:
1. Prepare necessary journal entries assuming the note is
a. Interest Bearing: Accrual and Installment Method
b. Non-interest Bearing: Accrual and Installment Method
2. What is the Net Income for the year if:
a. collectability is reasonably assured
b. collectability is not reasonably assured

Problem 2
AB Inc., franchisor, entered franchise agreement with AD Inc., franchisee on July 1, 2018. The initial
franchise fee agreed upon is Php 850, 000, of with Php 150, 000 is payable upon signing and the balance
to be covered by a non-interest bearing note payable in four equal annual instalments. It was agreed that
the down payment is not refundable, notwithstanding lack of substantial performance of services by
franchiser. Probability of collection is unlikely.
The following expenses were incurred:
Initial services:
Direct Cost Php 235, 000
Indirect Cost 64, 000
Continuing Services:
 Direct Cost 23, 900
Indirect Cost 9, 000

The management of AD has estimated that they can borrow loan at the rate of 12%. The franchisee
commenced its operation on July 31, 2018. A continuing franchise fee equal is to 5% of its monthly gross
sales. AD reported gross sales of Php 950, 000 for the month.
PV? (use two decimal)

When AB prepares its financial statements on August 31, 2018, how much is the net income to be
reported?
MULTIPLE CHOICES PROBLEMS

Flapper Jack Inc. sells franchises for an initial franchise fee of P36,000 plus operating fees of P500 per
month. The initial fee covers site selection, training, computer and accounting software, and on-site
consulting and troubleshooting, as needed, over the first five years. On March 15, 2018, Anton signed a
franchise contract, paying the standard P6,000 down with the balance due over 5 years with interest.
1. Assume that at the time of signing the contract, collection of the receivable was assured and that
service obligations were substantial. However, by October 20, 2018, substantially all continuing
obligations had been met. The journal entry required at October 20, 2018 would include a:
a. Credit to franchise fee receivable for P27,000
b. Debit to unearned franchise fee revenue for P36,000
c. Credit to franchise fee revenue for P9,000
d. Debit to unearned franchise fee revenue for P27,000

2. Assume at March 15, 2018, the time of signing the contract, collectability of the receivable was
reasonably assured and there were so significant continuing obligations. The journal entry at signing
would include a:
a. Credit to franchise fee revenue for P36,000
b. Credit to franchise fee revenue for P9,000
c. Credit to unearned franchise fee revenue for P36,000
d. Credit to unearned franchise fee revenue for P27,000

3. Assume at March 15, 2018, the time of signing the contract, collectability of the receivable was
reasonably assured and there were no significant continuing obligations. The journal entry at signing
would include a:
a. Credit to franchise fee revenue for P36,000
b. Credit to franchise fee revenue for P9,000
c. Credit to unearned franchise fee revenue for P36,000
d. Credit to unearned franchise fee revenue for P27,000

MIAH Inc charges an initial franchise fee of P75,000 for the right to operate as a franchisee of MIAH. Of
this amount, P25,000 is collected immediately. The remainder is collected in four equal annual instalment
payments of P12,500 each. These instalments have a present value of P39,623. There is reasonable
expectation that the downpayment may be refunded and substantial future services be performed by MIAH
Inc. The journal entry to record the franchise fee would be:
a. Cash 25,000
Notes receivable 50,000
Unearned interest income 10,377
Franchise revenue 64,623
b. Cash 25,000
Notes receivable 50,000
Unearned interest income 10,377
Unearned franchise revenue 64,623
c. Cash 25,000
Notes receivable 50,000
Unearned interest income 10,377
Unearned Franchise revenue 25,000
Franchise revenue 39,623
 d. Cash 25,000
Notes receivable 50,000
Unearned interest income 10,377
Unearned Franchise revenue 39,623
Franchise revenue 25,000

McDonalds Inc. granted a franchise to Delicious for the Makati area. The franchisee was to pay a franchise
of P250,000, payable in five equal annual installments starting with the payment upon signing of the
agreement. The franchise was to pay monthly 3% of gross sales of the preceding month. Should the
operations of the outlet prove to be unprofitable, the franchise may be cancelled with whatever obligations
owing McDonalds, Inc. in connection with the P250,000 franchise fee waived. The prevailing interest rate
is 14%. The first year generated a gross sale of P1,250,000.

4. What is the amount of unearned franchise fee after the first year of operations?
A. P287,500
B. P145,700
C. P195,700
D. P250,000

MIAH Inc charges an initial franchise fee of P115,000, with P25,000 paid when the agreement was signed
and the balance in five annual payments. The present value of the future payments, discounted at 10% is
P68,234. The franchisee has the option to purchase P15,000 equipment for P12,000. MIAH has
substantially provided all initial services required and collectability of the payments is reasonably assured.
5. How much is the amount of revenue from franchise fees?
A. 25,000
B. 90,234
C. 93,234
D. 115,000

The franchise agreement between Burger Queen and Geri which was signed at the beginning of the year
required a P5,000,000 franchise fee payable P1,000,000 upon signing of the franchise and the balance in
four annual instalments starting at the end of the current year. At the time of the granting of the franchise,
the present value using 12% as discount rate of the four instalments would approximate P1,996,500. The
fees once paid are not refundable. The franchise may be cancelled subject to the provisions of the
agreement. Should there be unpaid franchise fee attributed to the balance of main fee (5,000,000), same
would become due and demandable upon cancellation. Further, the franchisor is entitled to a 5% fee on
gross sales payable monthly within the first ten days of the following month. The Credit Investigation
Bureau rated Geri as AA credit rating. Further the balance of the franchise fee was guaranteed by a
commercial bank. The first year of operations yielded gross sales of P90 million.

6. As of the signing of the franchise agreement, how much is the unearned franchise fee?
A. 6,496,500
B. 4,000,000
C. 1,996,500
D. zero

MIAH Inc. Charges an initial franchise fee of P920,000, with P200,000 paid when the agreement is signed
and the balance in five annual payments. The present value of the future payments, discounted at 10%,
is P545,872. The franchisee has the option to purchase P120,000 of equipment for P96,000. MIAH has
substantially provided all initial services required and collectability of the payments is reasonably assured.

7. What is the amount of revenue from franchise fees?

A. P200,000
B. P721,872
C. P745,872
D. P920,000
PONG entered into a franchise agreement with PING, franchisee, on January 2018. The total sale
agreement was to make a Php 60, 000 down-payments plus two Php 20, 000 annual payments,
representing the value of initial franchise services rendered by PONG. In addition, the agreement required
the franchisee to pay 5% of its gross revenues to the franchisor, this was deemed sufficient to cover the
cost and provide a reasonable profit margin on continuing franchise services to be performed by the
franchisor. The restaurant opens early in 2018.

8. Assuming 10% interest rate is appropriate, how much is PONG’s 2018 total franchise revenue?
A. Php 100, 000
B. Php 94, 710
C. Php 98, 180
D. Php 3, 470

On November 30, 2018, Vanessah Company authorized Marie Corp. to operate as a franchise for an initial
franchise fee of P1, 950, 000. of this amount, P750, 000 was received upon signing the agreement and
the balance, represented by a note, is due in four annual payments starting November 30, 2018. Present
value of P1 at 12% for 4 periods is 0. 6355. Present value of an ordinary annuity is 3. 0374. The period of
refund will elapsed on January 1, 2020. The franchise has performed substantially all of the initial services
have yet to start. Collectability of the note is reasonable certain.
9. How much is the unearned franchise fee on the year ended December 31, 2018?
A. Php 1, 661, 220
B. Php 750, 000
C. Php 911, 220
D. Php -0-

On January 2, BARBIE awarded its first franchise of RTW products to KITTY. The franchise agreement
required Php 200, 000 franchise fee payable Php 50, 000 upon signing of the franchise and the balance
in three annual installments starting the end of the current year. The present value using 12% as discount
rate of the three installment would be approximately Php 82, 160. The fees once paid are not refundable.
The franchise may be cancelled subject to the provision of the agreement. Should there be unpaid
franchise fee attributed to the balance of main free, same need not be paid. Further, the franchisor is
entitled to 3% fee on the gross sale payable monthly within the first ten days of the following month. The
first year of operation yielded gross sales of Php 1, 000, 000. BPI guaranteed the note issued by KITTY.
10. How much BARBIE earn from franchise fees in the first year of KITTY’s operation?
A. Php 162, 160
B. Php 130, 000
C. Php 100, 000
D. Php 30, 000

Hang On restaurant sold a fastfood restaurant franchise to Hold On. The sale agreement, signed on
January 2018 called for a Php 175, 000 down payment plus two Php 87, 500 annually payments
representing the value of initial franchise services rendered by Hang On restaurant. In addition, the
agreement required the franchisee to pay 8% of its gross revenues to the franchisor. The restaurant
opened early in 2018 and its sales for the year amounted to Php 1, 312, 500.
11. Assuming 12% interest rate is appropriate, what is Hong On 2018 total revenue? (PV of annuity 4
decimal places)
A. Php 147, 884
B. Php 427, 884
C. Php 445, 630
D. Php 466, 630

On August 1, 2018, I’m Yours Inc. entered into franchise agreement with You’re Mine franchisee. The
initial franchise fees agreed upon is Php 246, 900, of which Php 46, 900 is payable upon signing and the
balance to be covered by a non-interest bearing note payable in four equal annual installments. The down
payment is refundable within 100 days. You’re Mine Inc. has a high credit rating, thus, collection of the
note is reasonably assured. Out-of-pocket cost of Php 125, 331 and Php 12, 345 were incurred for direct
expenses and indirect expenses respectively. Prevailing market rate is 9%. PV factor is 3. 2397.
12. On the fiscal year ended October 31, 2018, how much will the franchisor recognize?
 A. Php 161, 985
B. Php -0-
C. Php 208, 885
D. Php 3, 645

Jolly Co., franchisor, enters into a franchising agreement with Macdo, franchisee, on June 30, 2018. The
agreement calls for a total franchise fee of P1, 000, 000 of which P100, 000 is payable upon signing of the
contract and the balance is four semi-annual installments. It is agreed that the down payment is non-
refundable notwithstanding lack of substantial performance of services by the franchisor.
13. When Jolly Co. prepares its financial statements as of June 30, 2018, the unearned franchise fee to
be reported is
A. Php -0-
B. Php 100, 000
C. Php 900, 000
D. Php 1, 000, 000

On January 1, 2018, Mr. JM entered into a franchise agreement with VBM to market their products. The
agreement provides for an initial fee of P12, 500, 000 payable as follows: P 3, 500, 000 to be paid upon
signing of the contract and the balance in five equal annual payments every end of the year starting
December 31, 2018. Mr. JM signs a non – interest bearing note for the balance. His credit rating indicates
that he can borrow money at 15% interest for the loan of this type. The agreement further provides that
the franchisee must pay a continuing franchise fee equal to 3% of the monthly gross sales. On August 31,
the franchiser completed the initial services required in the contract at a cost of P 4, 290, 120 and incurred
indirect cost of P175, 000. The franchisee commenced business operations on November 30, 2018. The
gross sales reported to the franchiser were P1, 800, 000 for December 2018. The first installment payment
was made in due date.
14. Assume the collectability of the note is not reasonably assured, the net income for the year ended
December 31, 2018.
A. Php 3, 126, 268
B. Php 3, 201, 268
C. Php 2, 417, 268
D. Php 3, 072, 268

On January 1, 2018, Mr. Dimayuga entered into a franchise agreement with Rey Inc. to sell their products.
The agreement provides for an initial franchise fee of P3, 000, 000 which is payable as follows: P1, 000,
000 cash to be paid upon signing the contract, and the balance in four equal annual installments every
December 31, starting December 31, 2018. Mr Dimayuga signs a non – interest bearing note for the
balance. The credit rating of the franchisee indicates that the money can be borrowed at 10%. The present
value factor of an ordinary annuity at 10% for 4 periods is 3. 1698. The agreement further provides that
the franchisee must pay a continuing franchise fee equal to 5% of its monthly gross sales. Rey incurred
direct cost of P930, 564 and indirect costs of P167, 400. The franchisee started business operations on
July 1, 2018 and was able to generate sales of P1, 240, 000 as of the end 2018. The first installment
payment was made in due date.

15. Assuming that the collectability of the note is not reasonably assured, how much is the net income of
the franchisor for the year ended December 31, 2018.
A. Php 753, 166
B. Php 849, 656
C. Php 911, 656
D. Php 854, 600