FRANCHISE

Franchising is a system whereby one company grants business rights to another

company or individual through a contract to operate a franchised business for a
specified period of time. The company granting the business rights is called the
franchisor, and the company receiving the business rights is called the FRANCHISE.

A franchise generally involves the grant from one party (franchisor) to another
party (franchisee), the right to sell the granting party’s goods or services. Each
party contributes resources.

The franchisor contributes his trade name, products, company’s reputation and
trademarks. He also imparts his expertise and on continuing basis provides
guidance and duties on the manner in which the franchisee must operate his
establishment. The franchisee on the other hand, provides operating capital and
managerial operational resources required for the operation of the franchised
business.

PAS 18 states that franchise fees may cover the supply of initial and subsequent
services, equipment, and other tangible assets, and know-how. Accordingly,
franchise fees are recognized as revenue on a basis that reflects the purpose for
which the fees were charged.

FRANCHISE FEE

Franchise fee is the payment to the franchisor in consideration for the reputation,
skill, products, and services contributed by the franchisor.

1. Initial Franchise Fee – represents the initial payment for establishing the
franchise agreement, and for providing certain initial services. It may be
payable immediately in cash or for an extended period of time.

2. Continuing Franchise Fee – represent continues payment to the franchisor

for providing specific future services such as advertising and for continued
use of intangible rights by the franchisee.

FRANCHISE ACCOUNTING
Substantial performance done?
Period of refund expired?
Collectability assured?
All YES With NO
Franchise fees (Cr) Unearned franchise fees (Dr)

REVENUE RECOGNITION
Initial Franchise Fees

1. Revenue from initial franchise fee should be recognized on the

consummation of the transaction which occurs when all material services
of the sale have been substantially performed.
a. The franchisor is not obligated in any way to refund cash already
received of forgive unpaid debt.
b. The initial services required of the franchisor by contract or otherwise
have been substantially performed or when the franchisee actually
commences operations.
c. No other material conditions or obligations exist.

2. Direct franchise costs of initial services rendered by the franchisor shall be

deferred until related revenue is recognized while indirect costs that occur
on a regular basis should be expensed when incurred.

Once substantial performance is achieved, revenue should be recognized using

the following methods:

Accrual Basis Used when the initial The initial franchisee fee
franchise fee is is fully recognized as
collectible over an revenue.
extended period of time
and the collectivity of
the unpaid portion is
REASONABLY ASSURED

Installment Method Used when the initial Revenue from initial

(Cost Recovery franchise fee is franchise fee is
Method) collectible over an recognized in proportion
extended period of time to cash collections by
and the collectivity of multiplying the
the unpaid portion is collections during the
NOT REASONABLY year by the gross profit
ASSURED rate

Alternative Method

Cash basis of revenue recognition may also be used instead of installment

method. This is usually used when the direct costs of the initial services are minimal
and revenue is recognized as cash is received.
Continuing Franchise Fees

 Usually collected from the franchisee at the end of the month base on
certain percentage of their monthly sales
 Recognized as revenue when actually earned and receivable from the
franchisee
 All indirect costs related to continuing franchise fee are expensed
immediately

Area Franchise Fees

 Percentage of completion method is usually used to determine the

revenue to be recognized because substantial performance of services
rendered by the franchisor is difficult to determine.
 POC is computed by dividing the cost of servicing each individual franchise
by the total costs of all franchise.
 Total initial area franchise fee is multiplied by the POC to determine the
revenue to be recognized.

Continuing Sale of Supplies

 Franchisor usually sells supplies to the franchisee as part of the continuing

services provided in the franchise contract.
 The sale is recorded by the franchisor in the usual manner.

Tangible Assets Included in the Franchise Fee

 Initial franchise fee may include the sale of specific tangible property thus
a portion of the initial franchise fee must be allocated to such tangible
property at its fair market value
 The fair value of the tangible property is recognized as revenue when title
to such property passes to the franchisee, even though substantial
performance has not occurred.

Option to Purchase

 Franchise agreement may include a provision that franchisor has an option

to purchase the franchise business, if granted the initial franchise fee is to
be deferred.
 When option is exercised and the franchisor acquires the franchise business,
the deferred revenue is treated as a reduction from the franchisor’s
investment.