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UNIVERSITY OF THE EAST

CM RECTO, Manila

AC408 - ADVANCED ACCOUNTING PROF. ROEL E.


HERMOSILLA
FRANCHISE ACCOUNTING

ILLUSTRATION OF ENTRIES FOR INITIAL FRANCHISE FEE


Assume that Jollibee Inc. charges an initial franchise fee of P5,000,000 for the right to operate a
franchisee of Jollibee. Of this amount, P1,000,000 is payable when the agreement is signed and the
balance is payable in five annual payments of P800,000 each. In return for the initial franchise fee,
the franchisor will help locate the site, negotiate the lease or purchase of the site supervise the
construction activity, and provide the bookkeeping services. The credit rating of the franchisee
indicates that money can be borrowed at 24%.
1. If there is reasonable expectation that the down payment may be refunded and if substantial
future services remain to be performed by Jollibee Inc., the entry should be:
Cash 1,000,000
Notes Receivable 4,000,000
Discount on Notes Receivable 1,803,680
Unearned Franchise Fee 3,196,320
2. If the probability of refunding the initial franchise fee is extremely low, the amount of future
services to be provided to the franchisee is minimal, collectability of the note is reasonably
assured, and substantial performance has occurred, the entry should be:
Cash 1,000,000
Notes Receivable 4,000,000
Discount on Notes Receivable 1,803,680
Revenue from Franchise Fee 3,196,320
3. If the initial down payment is not refundable, represents a fair measure of the services already
provided, with a significant amount of services still to be performed by the franchisor in future
periods, and collectability of the note is reasonably assured, the entry should be:
Cash 1,000,000
Notes Receivable 4,000,000
Discount on Notes Receivable 1,803,680
Revenue from Franchise Fee 1,000,000
Unearned Franchise Fees 2,196,320
4. If the initial down payment is not refundable and no future services are required by the
franchisor, but collection of the note is so uncertain that recognition of the note as an asset is
unwarranted, the entry should be:
Cash 1,000,000
Revenue from Franchise Fees 1,000,000
5. Under the same conditions as those listed under 4 except that the down payment is refundable or
substantial services are yet to be performed, the entry should be:
Cash 1,000,000
Unearned Franchise Fees 1,000,000
In cases 4 and 5, where collection of the note is extremely uncertain, cash collections may be
recognized using the installment method or the cost recovery method.

ILLUSTRATIVE PROBLEMS
1. Sapphire Inc. franchises its name to different enterprise throughout the country. The franchise
agreement requires the franchisee to make an initial payment of P80,000 on the agreement date
and the balance, covered by a P160,000 noninteresting – bearing note, in four equal annual
payments beginning one year from the agreement date. The franchisor agrees to make market
studies, find a location, train the employees, and perform a few other minor related services. The
initial payment is refundable until the date of opening. The following describe the relationship with
a newly appointed franchisee: (assume an interest rate of 10%).
July 01, ‘8: Entered into franchise agreement.
Aug. 15,‘8: Completed market study at cost of P25,000.
Nov. 10,‘8: Found suitable location; service cost, P10,000.
Jan. 10, ‘9: Completed training of employees; cost, P35,000.
Jan. 15, ‘9: Franchise outlet is opened.

Required:
Give the journal entries in 19-8 and 19-9 record the above transactions, including any adjusting
entry/entries at the 19-8 year-end.
July 01, ‘8: Cash 80,000
Notes receivable 160,000
Discount on notes receivable 33,200
Franchise Accounting Page 2
Deposit on franchise or Unearned Franchise Fees
P80,000 + (P40,000 x 3.17) 206,800

Aug. 15, ‘8: Deferred franchise costs 25,000


Cash 25,000

Nov. 10, ‘8: Deferred franchise costs 10,000


Cash 10,000

Dec. 31, ‘8: Discount on notes receivable 6,340


Interest revenue (40,000 x 3.17) 6,340

Jan. 10, ‘9: Deferred franchise costs 35,000


Cash 35,000

Jan. 15, ‘9: Deposit on franchise 206,800


Franchise revenue 206,800

Franchise costs 70,000


Deferred franchise costs 70,000

July 1, ‘9 Cash 40,000


Notes receivable 40,000

Dec. 31, ‘9 Discount on notes receivable 11,314


Interest income 11,314

2. Jade Enterprises, a franchisor, charges new franchisees a “franchise fee” of P500,000. Of this
amount, P200,000 is payable at the time the agreement is signed and the balance in P100,000
non- interest bearing notes due every year thereafter. Jade agrees to assists in locating a suitable
business site, conduct a market study, supervise construction of facilities, and provide initial
training for employees.
Required:
Assuming an implicit interest rate of 12%, prepare first year entries relating to each of the
following assumptions:
1. Down payment is refundable, but no services have been rendered so far; collection of notes
is reasonably assured.
2. Down payment is nonrefundable, and substantial services, costing P250,000, have been
performed; collections of notes is certain.
3. Down payment is nonrefundable, and substantial services, costing P300,000 have been
performed; collection of notes is doubtful.
4. Same as #3, except cost recovery method will be used.
Case 1: Deposit Method
Cash 200,000
Note receivable 300,000
Discount on notes receivable 59,800
Deposit on franchise 440,200

Case 2: Full Accrual Method


Cash 200,000
Notes receivable 300,000
Discount on notes receivable 59,800
Deposit on franchise 440,200

Deferred franchise costs 250,000


Cash 250,000

Cost of franchise fee revenue 250,000


Deposit on franchise 440,200
Deferred franchise costs 250,000
Franchise fee revenue 440,200

Case 3: Installment Method


Cash 200,000
Notes receivable 300,000
Discount on notes receivable 59,800
Deposit on franchise 440,200

Deferred on franchise 300,000


Cash 300,000
Deposit on franchise 440,200
Deferred franchise costs 300,000
Deferred gross profit on 140,200
Franchise Accounting Page 3
franchise

Deferred gross profit on franchise 63,700


Realized gross profit on 63,700
franchise

Case 4: Cost Recovery Method


First 3 entries in case 3 are also the entries in this method. However, since cash
received (P200,000) is less than the costs incurred (P300,000), no profit will be
realized in this period.

PROBLEMS
I. On January 1, 2009, RCute Company signed an agreement to operate as a franchisee of Perfect
Pizza, Inc. for an initial franchise fee of P1,600,000 for a period of ten (10) years. Of this amount
P600,000 was paid when the agreement was signed and the balance payable in five annual
payments of P200,000 beginning December 31, 2009. RCute signed a non interest- bearing note
for the balance. RCute’s rating indicates that it can borrow money at 20% for a loan of this type.
In return for the initial fee, the franchisor agrees to make market studies, find a location, train the
employees, and perform other related services. The following transactions describe the
relationship with Perfect Pizza, a franchisee:
2009 Jan. 1: Entered into a franchise agreement.
April 1: Completed a market study at a cost of P59,436. Indirect cost of services
(general expenses), P5,000.
May 15: Found suitable location. Service cost of P280,000.
Nov. 15: Completed training program for employees, cost P20,000.
Dec. 20; Franchise outlet opened and business operations started.
Dec. 31: Received the first annual payment.
Required: Prepare all entries on the books of franchisor for 2009, assuming:
1. The collection of the note is reasonably assured.
2. The collection of the note is not reasonably assured.

II. On January 1, 2009, Turquoise Corporation sold a franchise to Mr. D for P10,000,000 for rights to
operate as a franchise of Turquoise Corporation. Terms of the franchise contract are:
a. The initial franchise fee of P1,000,000 is payable in cash, when the contract is signed and
the balance in five equal instalment every December 31, evidenced by a 12% promissory
note.
b. The franchisor will assist in locating the site, supervise construction activity and training of
management and employees.
On December 31, 2009, direct costs of services rendered to the franchisee amounted to
P2,000,000.
Required: Assuming that there is a substantial performance of services required in the
contract and the initial down payment is not refundable to the franchisee, prepare journal entries
for 2009 in the books of the franchisor, if:
1. The collectability of the note is reasonably assured.
2. The collectability of the note is not reasonably assured.

III. On September 1. 2009, Ochie Company entered into franchise agreements with three franchisees.
The agreement required an initial fee payment of P70,000 plus four (4) P30,000 payments due
every 4 months, the first payment due December 31, 2009. The interest rate is 12%. The initial
deposit is refundable until substantial performance has been completed. The following table
describes each agreement.
Services performed Total cost
Probability by Franchiser at Incurred to
Franchisee Full collection December 31, 2009 December 31, 2009
A Likely Substantially P 70,000
B Doubtful 25% 20,000
C Doubtful Substantially 100,000
For each franchisee, identify the revenue recognition method that you would recommend
considering the circumstances. Prepare the journal entries on the books of Ochie Company to
account the franchise. Assume P100,000 was received from each franchisee during the year.

IV. On January 1, 2008, Phil. Foods signed an agreement to operate as a franchisee of Snack
International for an initial franchise fee of P50,000. The amount of P20,000 when the agreement
was signed, and the balance is payable in five annual payments of P6,000 each beginning January
1, 2009. The agreement provides that the down payment is not refundable and that no future
services are required of the franchiser. Phil. Foods’ credit rating indicates that the company can
borrow money at 11% for a loan of this type.
Instructions:
a. How much should Snack International record as revenue from franchise fees on Jan. 1, 2008? At
what amount should Phil. Foods record the acquisition cost of the franchise on Jan. 1, 2008?
Franchise Accounting Page 4
b. What entry should be made by Snack International on January 1, 2008, if the down payment is
refundable and substantial future services remain to be performed by Snack International?
c. How much revenue from franchise fees would be recorded by Snack on January 1, 2008, if:
1. The initial down payment is not refundable, it represents a fair measure of the services
already provided, a significant amount of services is still to be performed by Snack
International in future periods, and collectibility of the note is reasonably assured?
2. The initial down payment is not refundable and no future services are required by the
franchiser, but collection of the note is so uncertain that recognition of the note as an
asset is unwarranted?
3. The initial down payment has not been earned and collection of the note is so uncertain
that recognition of the note as an asset is unwarranted?

MULTIPLE CHOICE
1. On December 31, 2008, Chowqueen, Inc. authorized Mr. Chun to operate as a franchisee for an
initial franchise fee of P150,000. Of this amount, P60,000 was received upon signing the
agreement and the balance represented by a note due in three annual payments of P30,000 each
beginning December 31, 2009. The present value on December 31, 2008, for three annual
payment appropriately discounted is P72,000. According to the agreement, the non- refundable
down payment represents a fair measure of the services already performed by Chowqueen and
substantial future services are still to be rendered. However, the collectibility of the note is not
reasonably assured. Chowqueen’s December 31, 2008, balance sheet unearned franchise fee
from Mr. Chun’s franchise should report as:
a. P132,000 b. P100,000 c. P - 0 - d. P72,000

2. On December 31, 2009, Shabu-Shabu Inc. signed an agreement authorizing Alrene Company to
operate as a franchise for an initial franchise fee of P50,000. Of this amount, P20,000 was
received upon signing of the agreement and the balance is due in three annual payment of
P10,000 each, beginning December 31, 2010. No future services are required to be performed.
Alrene Company’s credit rating is such that collection of the note is reasonably assured. The
present value at December 31, 8 of the three annual payments discounted at 14% (the implicit
rate for a loan of this type) is P23,220. On December 31, 2009, Shabu-Shabu should record
earned franchise fees of:
a. P23,220 b. P43,220 c. P30,000 d. P 0
3. On December 31, 2012, Da Girl Company signed an agreement to operate as franchisee of
Wendy’s for a franchise fee of P80,000. Of this amount, P30,000 was paid upon signing of the
agreement and the balance is payable in five annual payments of P10,000 each beginning
December 31, 2013. The present value of the five payment, at an appropriate rate of interest, is
P56,000 at December 31, 2012. The agreement provides that the down payment is not
refundable and no future services are required of the franchisor. The collection of note receivable
is reasonably certain. Wendy’s Company should report unearned revenue from franchise fee in its
December 31, 2008 balance sheet at:
a. P80,000 b. P30,000 c. P66,000 d. P 0

4. Each of the Yellowwich Pizza Company’s 21 new franchisees contracted to pay an initial franchise
fee of P30,000. By December 31, 2010, each franchise had paid a nonrefundable P10,000 fee and
signed a note to pay P10,000 principal plus the market rate of interest on December 31, 2011,
and December 31, 2012. Experience indicates that five franchisees will default on the additional
payments. What amount of earned franchise fees would Yellowwich Pizza Company report at
December 31, 2010:
a. P400,000 b. P610,000 c. P600,000 d. P530,000
5. Mel’s Pizza Hot, Inc. grants a franchise to Mr. AA for an initial franchise fee of P1,000,000. The
agreement provides that Mel’s Pizza Hot, Inc. has the option within the one year to acquire
franchisee’s business and its seems certain that Pizza Hot, Inc. will exercise the option. On Pizza
Hot, Inc. books, how should the initial franchise fee be recognized?
a. Deferred revenue and to be amortized.
b. Realized revenue.
c. Extraordinary revenue.
d. Deferred revenue and treated as a reduction from Pizza’s investment when the option is
exercise.
6. On Dec. 29, 2009, FIESTA HAT signed a franchising agreement for the operation of an outlet in
Dagupan City by Sombrero Co. The franchising agreement required the franchisee, Sombrero Co.,
to make an initial payment of P200,000 upon signing of the contract and three payments each of
P100,000 beginning one year from the agreement date and yearly thereafter. The franchisor
agrees to prepare market studies, find a suitable location, train employees, and perform some
other related services. The location, train employees, and perform some other related services.
The initial payment is refundable until substantial performance is effected. In 2009, FIESTA HAT
should report franchise fee revenue of:
a. P-0- b. P200,000 c. P125,000 d. P500,000
Franchise Accounting Page 5

7. Jollibee, franchisor, entered into a franchising agreement with Jo Levy, franchisee, on October 31,
2009. The total franchise fee is P500,000, of which P100,000 is payable upon signing of the
agreement with the balance payable in four equal annual installments. The down payment is
refundable in the event the franchisor fails to render stipulated services and, thus far, none has
been performed. When Jollibee prepares its October 31, 2009 financial statements, the franchise
fee revenue to be reported is:
a. - 0 - b. P400,000 c. P100,000 d. P500,000

8. The franchise agreement between Jolly-R and Mr. Chris which was signed at the beginning of the
year required a P500,000 franchise fee payable P100,000 upon signing of the franchise and the
balance in four annual installments starting 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 installments
would approximate P199,650. 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 (P500,000), same would become due and demanable upon
cancellation. Further, the franchisor is entitled to a 5% fee on gross sale payable monthly within
the first ten days of the following month. The Credit Investigation Bureau rated Mr. Chris as AAA
credit rating. Further the balance of the franchise fee was guaranteed by a commercial bank. The
first year of operations yielded gross sales of P9 million. As of the signing of the franchise
agreement, Jolly-R’s unearned franchise fee amounted to
a. P649,650 b. P400,000 c. zero d. P199,650

9. Croley Snack granted a franchise to Eat N Eat for the Ortigas area. Eat N Eat was to pay franchise
fee of P100,000 payable in five equal annual installments starting with the payment upon signing
of the agreement. The franchise was to pay monthly 1% 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 Croley Snack in connection with the P100,000 franchise fee waived.
The first year generated a gross sales of P500,000. Croley Snack earned franchise fee for the first
year amounted to
a. P5,000 b. P25,000 c. P105,000 d. P20,000

10. Kitchenics Inc. awarded its franchise to Wings Co. in Cebu for a total fee of P100,000. Of said
amount, P50,000 was payable upon the signing of the franchise agreement and the balance,
payable in two annual payments of P25,000 each. Kitchenics had been very successful in Metro
Manila with 100 franchisees but Cebu was the first outside Metro Manila. Kitchenics’ agreement
with Wings provided that in the event the first year of operations would result to an operating
loss, the franchising agreement may be cancelled without need of returning any portion of paid
franchise fee and there would be no need to pay any balance of the unpaid franchise fee. The
entry to record the granting of the franchise to Wings was
a Cash P50,000
.
Notes receivable 50,000
Unearned franchise fee P100,000
b Cash 50,000
.
Notes receivable 50,000
Revenue from franchise fee 50,000
Unearned franchise fee 50,000
c No entry
.
d Cash 50,000
.
Notes receivable 50,000
Revenue from franchise fee 100,000

/reh