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Accounting for Franchise Operations – Franchisor

(PRFS 15 Revenue from Contract with Customers}

The provisions of PFRS 15 that directly relate to the accounting for franchises can be found on the “licensing
section” of PFRS 15 (PFRS 15.B52-B63). An entity shall apply the specific principles in this section in conjunction
with the general principles that are applicable to all types of contract with customers.

PFRS 15 defines a license as one that “establishes a customer’s rights to the intellectual property on an entity.”
Examples of licenses of intellectual property:
a. Software and technology
b. Motion pictures, music and other forms of media and entertainment
c. Franchises; and
d. Patents, trademarks and copyrights

A franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell
certain products or services, to use certain trademarks or trade names or to perform certain functions, usually
within a designated geographical area.
Franchises are of two types:
1. Contractual arrangement between two private entities or individuals
2. Contractual arrangement between a private entity or an individual and the government (frequently
referred to as license or permits)

Application of the Principles of PFRS 15

I. Identify the contract with the customer


A contract with a customer is accounted for only when all of the following criteria are met:
a. The contracting parties have approved the contract (in writing, orally or implied in customary
business practices) and are committed to perform their respective obligations
b. The entity can identify each party’s rights regarding the goods or services to be transferred
c. The entity can identify the payment terms for the goods or services to be transferred
d. The contract has commercial substance (i.e. the risk, timing or amount of the entity’s future cash
flows is expected to change as a result of the contract and
e. The consideration in the contract is probable of collection. When assessing collectability, the entity
shall consider only the customer’s ability and intention to pay the consideration on due date.
No revenue is to be recognized on a contract that does not meet the criteria above. Any consideration
received from such contract is recognized as liability and recognized only when either of the following
occurred:
i. The entity has no remaining obligation to transfer goods or services to the customer and all, or
substantially all, of the consideration has been received and is non-refundable; or
ii. The contract has been terminated and the consideration received is non-refundable

The entity need not assess the criteria above if they have been met on contract inception unless there is
an indication of a significant change in facts and circumstances, for example, when the customer’s ability
to pay subsequently deteriorates significantly.

II. Identify the performance obligations in the contract

General Principles:
Each promise to transfer the following is a performance obligation to be accounted separately:
a. A distinct good or service (or a distinct bundle of goods or services); or
b. A series of distinct goods or services that are substantially the same and have the same pattern of
transfer to the customer

A promised good or service is distinct if:


a. The customer can benefit from the good or service either on its own or together with other
resources that are readily available to the customer, and
b. The promise to transfer the good or service is separately identifiable from other promises in the
contract

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Customer can benefit
A customer can benefit from a good or service if the good or service could be used, consumed, sold for
an amount that is greater than scrap value or otherwise held in a way that generates economic benefits.
The fact that the entity regularly sells a good or service separately indicates that a customer can benefit
from the good or service on its own or with other readily available resources.

Separately identifiable
A promise to transfer good or service is separately identifiable if the good or services:
a. Is not an output to a combined output by the customer
b. Does not significantly modify other goods or services promised in the contract
c. Is not highly interrelated with other goods or services promised in the contract. For example, the
customer’s decision of not purchasing good or service does not affect the other promised goods or
services in the contract.

Performance obligations include only activities that involves the transfer of a good or service to a
customer. Performance obligations do not include administrative tasks to set up a contract.

Satisfaction of performance obligations


At contract inception, the entity shall determine whether the identified performance obligations will be
satisfied either
a. Over time or
b. At a point in time

A performance obligations is satisfied over time if one of the following criteria is met
a. The customer simultaneously receives and consumes the benefits provided by the entity’s
performance as the entity performs
b. The entity’s performance creates or enhances an asset (e.g. work in progress) that the customer
controls as the asset is created or enhanced.
c. The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.
If the entity cannot demonstrate that a performance obligation is satisfied over time, it is presumed that
the performance obligation is satisfied at a point in time.

Specific Principles: (Licensing’ section)

Promise to grant franchise


Not Distinct Distinct
 Treat all promises in the contract as a  Treat the promise to grant the license as
single performance obligation a separate performance obligation
 Use general principles to determine  Use specific principles to determine if
whether the performance obligation is the promise provides the customer a:
satisfied over time or at a point in time a. Right to access – performance
obligation is satisfied over time.
Revenue is recognized over the license
period.
b. Right to use – performance obligation
is satisfied at a point in time. Revenue is
recognized at the time when the license
is provided.

Promise to grant license is distinct


Right to access Right to use
 The customer cannot direct the use of, and  The customer can direct the use of, and
obtain substantially all of the remaining obtain substantially all of the remaining
benefits from, the license at the point in benefits from, the license at the point in
time at which the license is granted. time which the license is granted.

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 Intellectual Property (IP) changes  Intellectual property (IP) does not change
throughout the license period. throughout the license period.
a. The entity continues to be involved
with the IP; and
b. The entity undertakes activities that
significantly affect the IP.
 May be evidenced by a sales-based royalty
agreement between the entity and the
customer

III. Determine the transaction price

The transaction price is the amount of consideration to which an entity expects to be entitled in
exchange for transferring promised goods and services to a customer, excluding amounts collected on
behalf of third parties (e.g. some sales taxes).

The transaction price is normally the contract price. However, the transaction price may not be equal to
the contract price if the consideration in the contract is affected by any of the following:
a. Variable consideration
b. Constraining estimates of variable consideration
c. The existence of a significant financing component in the contract
d. Non-cash consideration
e. Consideration payable to a customer

The transaction price in a franchise contract is commonly referred to as franchise fees.

Franchise fees refer to payments made by the franchisee to the franchisor in relation to the franchise
right granted by the franchisor. These fees may cover the supply of know-how, initial and subsequent
services, and equipment and other tangible assets.

1. Initial franchise fee – this is the one-off payment made by the franchisee to the franchisor to obtain
the franchise right. It is normally paid at the signing of the franchise agreement and are normally
non-refundable. However, some franchise agreements allow initial franchise fees to be paid over an
extended period of time and provide for the right of refund up to a certain amount.
Initial franchise fees do not normally include cost of initial inventory or furniture and fixtures.

2. Continuing franchise fees – these are the periodic payments made by the franchisee to the
franchisor for the ongoing franchisee support. It is also referred to as royalty fees.

3. Sale of equipment and other tangible assets – in most franchise agreements, the franchisor
provides equipment and other tangible assets to the franchisee for a separate fee.

IV. Allocate the transaction price to the performance obligations

The transaction price is allocated to the performance obligations based on the relative stand-alone
prices of the distinct goods and services.

The stand-alone is the price at which a promised good or service can be sold separately to a customer.

V. Recognize revenue when (or as) performance obligation is satisfied

A performance obligation in the contract is satisfied when the control over a promised good or service is
transferred to the customer.

Revenue is measured at the amount of the transaction price allocated to the satisfied performance
obligation.

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