AFAR: A Fastrack of Franchise Accounting

Franchise Accounting (A QuickNotes)

A franchise agreement involves the granting of business rights by the franchisor to a franchisee that will operate the franchise outlet in a certain geographical location.

Four types:

     a. Manufacture-Retailer        

     b. Manufacture-Wholesaler         

     c. Service sponsor-retailer

     d. Wholesaler-retailer

Initial Franchise Fee- recorded as revenue only when and as the franchisor makes “substantial performance” of the services it is obligated to perform and collection of the fee is reasonably assured.

The franchisor provides the franchisee with the following services:

1   . Assistance in site location

a.        Analyzing the location

b.       Negotiating the lease

2   . Evaluation of potential income

3   . Supervision of construction income

4   . Supervision of construction activity

a.        Obtaining financing

b.       Designing building

c.        Supervising contractor while building

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 business

6    . Provision of employee and management training

7    . Provision of quality control

Substantial Performance- no remaining obligation to refund any cash received or excuse any non-payment of a note
-performed all the initial services required under the contract general Rule: 90% or more of the services required

3 Conditions to recognize initial franchise fee    a. Services
    b. Period of refund
    c. Collectibility

Journal Entries

   A. Initial Franchise fee-Interest Bearing Note

        1. Performed all material services, the refund has expired,             collectability is assured.

Cash

        N/R

        Franchise Revenue

2.  Refund has expired and collectability of the note is reasonably assured, not substantially performed all material services.
Cash

        N/R

        Unearned Franchise Revenue

Subsequently; when it is performed all services

Unearned Franchise Revenue

        Franchise Revenue

3.       Substantially performed all services and the collectability of the note is reasonably assured, but the refund period has not expired.

Cash

        N/R

        Unearned Franchise Revenue

Subsequently; the refund period has expires

Unearned Franchise Revenue

        Revenue from Franchise

4. Substantially Performed all services, refund period has expired, but the collectability of the note is not reasonably assured but it is used installment method

Cash

        N/R

        Franchise Revenue

        Unearned Franchise Revenue

        
       Subsequently, it recognizes it over a period of time.

        
        Unearned Franchise Revenue

                Franchise Revenue

5. Refund has expired, Substantially performed all services, no basis for estimating the collectability of the note and the recognition of the note as an asset is not unwarranted,so, it uses deposit method, not recognizing the note as an asset

Cash

        Unearned Franchise Revenue

                
        Subsequently, collectability is assured.

               
        Unearned Franchise Revenue

                 Franchise Revenue

     B. Initial Franchise Revenue-Non Interesting Fee

1. Reasonable expectation that the down payment may be refunded, substantial future services remain to be performed
      

      Cash

      N/R

                Unearned Interest Income (Discount on N/R)

                Franchise Revenue

2. If the probability of refunding the initial franchise fee is extremely low, future services to be provided  to the franchisee is minimal, collectability of the note is reasonably is assured, substantial performance has occurred

      Cash

      N/R

                Unearned Interest Income

                Franchise Revenue

3. Initial down payment is not refundable, represents a fair measure of the services already provided, significant amount of services still to be performed, collectability of the note is reasonably assured.

      Cash

      N/R

                Unearned Interest Income

                Franchise Revenue

                Unearned Franchise Revenue

4. Initial down payment is not refundable, and no future services are required by the franchisor, collection of the note is uncertain

   Cash

        Franchise Revenue

*when the collection of the note is extremely uncertain, revenue through gross profit is recognized by means of cash collection using the cost recovery method.

5. Same case in #4 but the initial down payment is refundable or substantial services are yet to be performed.

  Cash

        Unearned Franchise Revenue

Franchisor’s Costs- match related costs and revenues by reporting them as a component of income in the same accounting period.
-ordinarily, defer direct costs
Indirect cost should expense immediately
Continuing Franchise Fees- received in continuing rights granted by the franchise agreement and for providing such service
-it should be reported as revenue when they are earned and receivable from the franchisee unless a portion of them has been designated for a particular purpose

Commingled Revenue- refers to a single initial franchise fee for franchise rights, initial services, tangible property, and equipment. The portion of the fee applicable to these assets is recognized upon transfer of ownership regardless of when the substantial performance of services was made.