I. Assume that Thales Company sells a franchise that requires an initial franchise fee of 700,000.

A down payment of 200,000 cash is required, with the balance covered by the issuance of a
500,000, 10% note payable by the franchisee in five equal annual installments. What is the
appropriate journal entry using the following independent scenario:
1. Thales has substantially performed all material services, the refund period has expired
and the collectibility of the note is reasonably assured.
2. The refund period has expired and all the collectability of the note is reasonably assured
but Thales has not substantially performed all material services.
3. Thales has substantially performed all the services and the collectibility of the note is
reasonably assured, but the refund period has not expired.
4. Thales has substantially performed all the services and the refund period has expired but
the collectability of the note is not reasonably assured.
5. The refund period has expired, but Thales has not substantially performed all the
services and there is no basis for estimating the collectability of the note.
Thales does not recognize the note as an asset. Instead it uses a form of deposit method.
6. Thales has earned only 300,000 only from providing initial services, with the
balance being a down payment for continuing services, If the refund period
has expired and the collectibility of the note is reasonably assured.
II. Charles Pizza Inc. charges an initial franchise fee of 500,000 for the right to operate as a
franchisee of Charless Pizza. Of this amount, 100,000 is payable when the agreement is signed
and the balance is payable in five annual payments of 80,000 each. In return for 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 8%. The present value of ordinary annuity of
five annual receipts of 80,000 each discounted at 8% is 319,416.80. The discount of 80,583.20
represents the interest revenue to be accrued by the franchisor over the payment period. What
is the appropriate journal entry using the following independent scenario:
1. If there is reasonable expectation that the DP may be refunded and substantial future
services remain to be performed.
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, collectibility of the note is
reasonably assured, and substantial performance has occurred.
3. The initial DP is not refundable, of which fair services already provided, with a significant
amount of services still to be performed by the franchisor in the future periods and
the collectability of the note is reasonably assured.
4. If the initial DP is not refundable and no future services are required by the franchisor,
but the collection of note is so uncertain that recognition of the note as an asset
is unwarranted.
5. If the initial DP is refundable and substantial services are yet to be performed by
the franchisor, but the collection of note is so uncertain that recognition of the
note as an asset is unwarranted.
III. Lorgie Company charges initial franchise fee of 250,000. Of this, 100,000 is payable in cash
when the agreement is signed, and the remainder is to be paid in four annual installments of
37,500 each. This obligation is evidenced by a 150,000, non-interest bearing note. The
agreement provides that the franchisor will assist in locating the site for a building, conduct a
market survey to estimate potential income, supervise the construction of a building, and
provide initial training for employee. Assume that the franchisee could borrow money at 10%.
Thus, the present value of the four 37,500 payments would be 118,871.25(37,500X3.1699). The
discount of 31,128.75 represents interest to be earned over the payment of period.
1. If the DP is refundable and no services has been rendered at the time the arrangement is
made, and collection on the note is reasonably certain.
2. Initial services are determined to be substantially performed, the refund period has
expired and the collection of the note is reasonably assured. (Full accrual to be used.)