FRANCHISE ACCOUNTING

By Via Samantha de Austria

FRANCHISES
Agreement involves the granting of the business rights of the franchisor to a
franchisee.

FRANCHISE FEES
Payment in consideration for the reputation, skill, products and services
contributed by the franchisor.
2 TYPES:
1. Initial Franchise Fee (IFF)
Consideration for establishment the franchise relationship and provision
of initial services.
Recognized only when franchisor makes
substantial performance
No remaining obligation to refund any cash received
Performed all initial services
Commencement of operations by the franchisee
No obligations exist
Collectability is assured = revenue recognized under accrual method
Collectability is not assured = revenue recognized under installment
method
Direct cost deferred; Indirect Cost expensed when incurred

A. IFF- INTEREST-BEARING NOTE (Collectability is assured)

To record the initial franchise fee:
Cash xx
(Down payment)
Notes Receivable xx
(Face Value of
note)
Franchise Revenue xx
(substantially performed)
Unearned Franchise xx
Revenue (no substantial
performance)
To compute net income of franchisor:
Down payment xx
Notes Receivable (at face value) xx
Franchise Revenue xx
Cost of Franchise (xx)
Gross Profit xx
Expenses (indirect costs) (xx)
Operating Income xx
Interest Income (Face value of note x Interest xx
%)
Net Income xx
 B. IFF- INTEREST-BEARING NOTE (Collectability is not assured)
To compute net income of franchisor:
Franchise Revenue xx
Cost of Franchise (xx)
Gross Profit xx
Divided by Franchise Revenue xx
Gross Profit % %
Multiply by Collections
Down payment xx
Installment xx xx
Realized Gross Profit xx
Expenses (indirect costs) (xx)
Interest Income (Face value of note x xx
Interest %)
Net Income xx

C. IFF- NONINTEREST-BEARING NOTE (Collectability is assured)

To record the initial franchise fee:
Cash xx
(Down payment)
Notes Receivable xx
(Face Value of
note)
Unearned Interest Income xx*
Franchise Revenue xx
(substantially performed)
Unearned Franchise xx
Revenue (no substantial
performance)

*Face Value of Notes Receivable xx

Present Value of Notes Receivable
Annual Payment xx
Multiply by PV of annuity of 1 xx (xx)
Unearned Interest Income xx

To compute net income of franchisor:

Down payment xx
Notes Receivable (at present value) xx
Franchise Revenue xx
Cost of Franchise (xx)
Gross Profit xx
 Expenses (indirect costs) (xx)
Operating Income xx
Interest Income (Present value of note x xx
Interest %)
Net Income xx

D. IFF- NONINTEREST-BEARING NOTE (Collectability is not assured)

To compute net income of franchisor:
Down payment xx
Collections
Installment collected xx
Interest Income (PV of note x Interest (xx xx
%) )
Collection as to principal xx
Multiply by gross profit rate %
Realized gross profit xx
Interest income xx
Expenses (indirect costs) (xx
)
Net income xx

2. Continuing Franchise Fee (CFF)

Usually collected at the end of each month from the franchisee
Based on a certain percentage of the monthly sales of the franchisee
Recognized as revenue when received.
Cash xx
Franchise Revenue- xx
CFF

Direct and indirect costs recognized as expense

Franchise expense xx
Cash xx

Illustration:

On January 5, 2013, Mr. Mar Vin signed an agreement to operate as a franchisee of Jolay-
bi, Inc. for an initial franchise fee of P 1,600,000. Of this amount, P 600,000 was paid
when the agreement was signed and the balance payable in five annual payments of P
200,000 beginning December 31, 2013. Mr. Vin signed a non-interest bearing note for
the balance. Mr. Vins credit rating indicates that it can borrow money at 20% interest for
a loan of this type. The present value of an annuity of P1 at 20% for 5 periods is P2.9906.
The contract includes continuing franchise fees of 5% of the franchisees gross sales, to
be collected monthly.
On November 25, 2013, the franchisor substantially performed the initial services
provided in the contract at a cost of P 179, 718. The franchisee commenced operations
on December 1, 2013. The gross sales of Mr. Vin for the month of December is P 80,000.

Journal entries for:

Collection of the note is reasonably assured.
Jan. 5: Cash. ........................................................ 600,000
Notes Receivable..........................................1,000,000
Unearned interest income......................... 401,880
Deferred revenue from F.F......................... 1,198,120

Face value of NR........................................... 1,000,000

Present value (P200,000 x P2,9906)............ __598,120
Unearned interest........................................ 401,880

Nov. 25: Franchise Cost......................................179,718

Cash...................................................... 179,718

Dec. 31:....Cash / AR.............................................. 4,000

Franchise Revenue-CFF......................... 4,000
(P80,000 X 5%)

Cash ........................................................200,000
Notes Receivable.................................. 200,000

Adjusting Entries:
1) Unearned interest income........................ 119,624
Interest income.................................... 119,624
(P598,120 x 20%)

2) Unearned Franchise Revenue...............1,198,120

Franchise Revenue............................... 1,198,120

Collection of the note is not reasonably assured.

(Jan. 5 to Dec. 31 before adjusting entries, the same with the first assumption)

Dec. 31: Adjusting Entries:

1) Unearned interest income..................... 119,624
Interest income........................... 119,624

2) Cost of franchise..................................179,718
Deferred cost of franchise.................... 179,718

3) Deferred revenue from FF....................1,198,120

Cost of Franchise.................................. 179,718
Deferred gross profit Franchise.......... 1,018,402
GPR = 1,018,402 1,198,120 = 85%)

4) Deferred gross profit Franchise..........578,319.60

 Realized gross profit Franchise.......... 578,319.60
(P600,000 + P200,000- P119,624) x 85%

PROBLEMS:

1. Mr. Maik Sy purchased a franchise from Goldilock, Inc. The franchise agreement
provides an initial franchise fee of P4,500,000, payable as follows: P 1,500,000 at the
date of signing, P2,000,000 three months after signing is January 2, 2015. A
continuing fee of 2% of gross sales is also to be paid to the franchisor. Total sales for
the year reported by the franchisee amounts P2,000,000.

Costs associated with the initial franchise fee are as follows:

Title to kitchen equipment, with a cost of P1,500,000, is to be transferred to the
franchisee on the day the agreement is signed. The fair market value of the
equipment is P1,800,000.
An additional P500,000 for initial services are incurred on January18, 2015.

a. Prepare a schedule to determine the timing and amount of revenues through

December 31, 2015.
b. Journal entries for all transactions.

2. On January 2015, Helo Co. purchased franchise with a useful life of 10 years or
P50,000. An additional franchise fee of 3% of franchise operation revenues must be
paid each year to the franchisor. Revenues from franchise operations amounted to
P400,000 during 2015. In its December 2015 balance sheet, what amount should
Helo report as an intangible asset-franchise?

3. Kikiam Co. charges P90,000 for a franchise, with P18,000 paid when the agreement is
signed and the balance in four annual payments. The present value of the annual
payments, discounted at 9% is P58,315. The franchisee has the right to purchase
P20,000 of equipment for P16,000. If collectability of payments is reasonably assured
and substantial performance by Kikiam has occurred, what is the amount of revenue
from franchise fee that should be recognized?

4. On January 20, 2014, Mais Co. signed an agreement to operate as franchise of Sweet
Corn, Inc. for an initial franchise fee of P10,000,000. On the same date, Mais paid
6,000,000 and agreed to pay the balance evidence by a non-interest bearing note in
 four annual payments of 1,000,000, beginning January 20, 2015. The collectability of
the note is not reasonably assured. Mais can borrow at 14% for a loan of this type.
Sweet Corn rendered initial services so that Mais can start their operations. The total
cost of such services is P2,000,000. The franchisor also incurred indirect cost of
P50,000. The franchise agreement further requires the franchisee a continuing fee at
5% of its monthly gross sales. The total sales reported by Mais up to December 31,
2014 is P5,000,000. How much is the net income of Sweet Corn, Inc. for the year
ended December 31, 2015?

5. On January 2, 2014, MCL Co., signed an agreement to operate as a franchisee of VSM

Inc. for an initial franchise fee of P3,125,000 for 10 years. Of this amount, 40% was
paid when the agreement was signed and the balance payable in four semi-annual
payments beginning June 30, 2014. MCL Co. signed a non-interest bearing note for
the balance, and its credit rating indicates that it can borrow money at 24% on the
loan of this type. Substantial services costing P802,500 have been recorded by VSM
Inc. How much is the realized gross profit for year ended December 31, 2014?
Assuming that the collection is not reasonably assured.