ReSA ‘The Review School of Accountancy R. Papa Cor. 5. H. Loyola Sts., Sampaloc, Manila ‘# Tel Nos. 734-39-89 & 735-98-07 Advanced Financial Accounting & Reporting PERS 15~Franchise & Consignment dayag/caiga/ngina Revenue from Contracts with Customers — Franchise & Consignment Franchise Accounting A franchise agreement involves the granting of business rights by the franchisor to @ franchisee that wil operate the franchise outle! in cettain qeographicel area or location. Four types of franchising arrangements have evolved, © Manufacturer retailer + Manufacturer wholesale + Service sponsor-retailer. ct © Wholesaler-retailer PERS 15 on Franchise Arrangements icientifies two sources of revenue. ‘+ Sale of inifial franchises and related assets o* services. and = Continuing fees based on the operations of franchises Performance obligations relate © Right to open a business = Use of trade name or other intellectual properly 1 the franchisor + Continuing services, such os marketing help. trong, and in some and inventory management. cases supplying inventory Franchisors commonly charge an initial franchise fee and continuing franchise fees 1. Initial franchise fee {payment for establishing ihe relationship and providing some sn services) 2. Continuing franchise fees 1 . in return for Continuing rights granted by the cai b. For providing management training, adver! other support ing ancl promotion, legal assistance, and Initial Franchise Fee Franchise agreements vary but usually involve an initia! payment (called an initial franchise fee) by the franchisee and ongoing payments of continuing franchise fees. for the initial franchise fee, franchisor {the parly who grants business rights under the franchise} normally provides franchisee {the parly who operates the franchised, busness} with the folowing services 1. Assistance in site selection @. Analyzing location b. Negotiating lease 2. Evaluation of potential income 3. Supervision of construction activity a. Obtaining financing b. Designing building . Supervising contractor while building 4. Assistance in the acquisition af signs. fixtures. and equi 5, Provision of bookkeeping and advisory services «a. Setling up tranchisee’s records b. Advising on income. real estate. an ¢. Advising on local regulations of the franchise's business 6. Provision of employee and management training 7. Provision of quality contro! the other taxes Continuing Franchise Fee (Royalty Fee) Continuing franchise fees (royalty fee) ore received in return for the continuing rights 1° by. the tronchise agreement and for providing such services a: management training. Gdvertising and promotion, quality control. budgeting and other accounting services. .2go! assistance. and other support Continuing fees (toyolty fee) should be reported as revenue when they are earned (overt time) Gnd receivable from the franchisee, unless a portion of them has been designated for a particule’ AFAR-06Advanced Financial Accounting & Reporting Page 2 purpose, such as providing a specified amount for building maintenance or local advertising. in that case, the portion deferred shat be Gn amount sutficien! 1o Cover the estimated cost in excess of continuing tranchise fees and provide: @ reasonable profit on the continuing services [point in une). The conlinuing fees (royalty payments), vihich «re typically computed as a percentage of the hanchisee's sales but can alto be a fixed periodic amount, are recognized by the franchisor as revenue in the same period tha! the saies sre made by the franchisee Occasionally, the continuing franchise’ fee (royalty payments) is no! large enough to cover the franchisors cost of the continuing services provided. Howeve., the initial franchise fee is unusually large (50, in effect ih involves @ prepeyment by the kanchisee for the Continuing services). Ir such Cases. the franchisor record: a portion of the initicr fee as a liability and amortizes the amount to francis [over time) 6 revenue over the lle of the franc | Initial Franchise Fee/Commingled Revenue and Continuing Franchise Fee (Royatty) Bominador’s Piz Inc, enters imo a tranche agement on December 31, 20x7. giving Doming Corp. the right to operate as a tranc £ Dominador’s Pizza for 5 years. Dominador’s charges Doming an inikal hanchise fee vt PA75,000 1 the nght 10 operate as @ franchisee. Of this amount, 190.000 is payable when Doming Corp. signs the agreement, and the balance is payable in five annyal payments of P57,000 each un De 1 Der Consider the following tor allocation of the nansaction price a! Decemiber 31. 20x7, Rights fo the trade name, mawret Gea technic! anu ploptiatary knowhow. Services - Nainng, etc | actinery and equip Total nansaction price etc. teosting, £95,000) 41759150 The credit rating of Doming indicates that money can be borrowed a B%. The present value of an ordinary annuity of five annual receipts of PS7 000 each discounted at 8% is P227,591.50. The discount of 57,408.50 represents the interest revenue to be accrued by Dominador’s Pizza Inc. over the payment period. Training is completed in February |. 2028. the equyrment 6 installed in February 2. 20x8, and Doming holds a grand opening on February 4, 2048, On Feu-vary 4, 20x8, franchise opens. Dominador’'s satlsfies the performance obligation: elated to the ‘anchise tights, taining, and equipment Doming alo promises to pay or January 31 of the following year) and is oblige’ standalone selling prices at the time of purchase: 1. How many performance obligations eyist in ths contract fo a2 a 4 b. 3 da 8 2. When Dominador should recognize revenue ‘or the rights {Combined} to the trade name, market Grea and proprietary know-how which give 1@ 191 ingle performance obligation? a. No transaction Point in Time b. Novevenve a Over Tune Cong WyaHly Payments of 1% of its annual sales payable évery > purchase products from Dominador’s at its current franchise? 3. How much revenue thhanchie revenus, service revenue and soles revenue - machinery end equipments) be recognized on December 31, 4i«?2 a. lero. ©. P133,00000 b. P 9459150 d.P190,000.00 4, How much revenue {franchise revenue. service revenue and sales revenue ~ machinery and equipment) be recognized on February 4 20x8¢ 3. P 974591.50 © 190,000.00 b.P133.000.00 PATS 5D 5, How much continuing franchise revenue be recagnized on December 31, 20x8. assuming the saies Cf P4,987,500 was generated tor Me ‘ss! vear of operations ¢ c Leto c. P199,000.00 b. 48,875.00 d P4i7.591 50 4. How much total franchise reverie lin relation .o Nos 4 and 5} ¢ a. P3/2.466.50 cc. PAI7 591 50 b. P390.674.82 Rab? 466 56 7. Inrelation to No. 6, the net int on DECeMmort 4). 20K8 amounted to# oI = ¥370.6/3.82 D P372,466.50 4 ab) 466 50 AFAR-061 © Advanced Financial Accounting & Reporting page 3 Answers/sohtons: \. b= There ore three pertormance obligations in the contract for franchise: 70 1 - Rights to the trade name, market area, ond proprietary know-how for § yeors are not individuaily distinct. Each one Is not sold separately and cannot be used with other goods oF tervices thot are readily cvaloble to the fronchisee. Combined rights glve tte fo © single pertormance obigation, YO 2. Training services, ond P03. Equipment Note" Mt should be noted that raining (skmiar) xervices end equipment are distinct ond can be sold separately. Commingled Revenue (Polnt in Time ond Over Time) - It rofers 103 single intl franchise fee for franchise right, lial services, tangible property such as supplies and equipment, The portion of the fee applicable to these ansets shall be axed on thek lak valves ond these asteh ore recognized upon transler of ownership regardless when substonfic! Performances of services were made, + Dominador’s cannot recognize revenue for the royalty payments becauie B isnot reasonably assured to be ented to thoae salet-royatly amounts. That lb, these payrants represent varlable consideration (variable consideration lencompostes any amount thal is varable under G contract, including, for example. pertormance bonuses. pence. ‘'scounls. rebates. pice concessions, incenlive: and the customer's righ! to relten products. Variable consideration is Considered to be a component of the rontaction price. Its part of the consideration 10 which on entity expects fo be enti in exchange for ronsterting promised goods or services and therelore should be estimated and included in the transaction price for revenue teeognition puEnwes) Thetetore, Dominador's recognizes revenve for the royalties when (or as) the uncertolnly lt resolved. ‘+ Dominador's promise to stand ready 10 PROVIDE PRODUCTS/SERVICES to the franchisee in the future at a stondtone selling price lt NOT ACCOUNTED for as o SEPARATE PERFORMANCE OBLIGATION (PO) in the contract becouse l DOES NOT PROVIDE Doming wih a material igh! (2 “matedal right” & some ining the customer wouldn't get otherwise, so the: seller & bigoted fo provide it oF it the customer I in effect paying In advance for fuure goods and services such ‘option provides the customer win a “maternal right”, nen the option should be occounted for ax @ separate Performance obligation) Thus, revenue from hose sales ls recorded in the future when the sales are made. 2. ~ Those combined rights (rade name. market areas and proprietory know-how) give re to 2 single performance Cbigation. Dominoda’s satisfies performance obligation af polnt In ime when Doming obtoins CONTROL of the RIGHTS, Tho! f, once Doming begins operating ie store. Dominadcr has no further obigation with respect to these rights. 11 should be noted thot training (amir) services and equipment are dstict and can be sold separately. Dominador's satisfies hose performance obigations (services ond equpmen!) when it ranster the services ond equipment to Domning. 3. @~ Aso! December 31, 20:7. only slgning of agreement and receipts of upton! payment and note were made. Consier the lolowing tor location of ihe transaction pace ot December 31,2087. Righis lo the rade name, marke! creo, technical and propdetary know-how P T9OD0000 Services taining, ete 94.591.50 ‘Machinery and equipmenis, etc (Costing, 95,000). 13300000 Total ransoction price os euceeSTEaEEo Eai391.50 The enities on December 31, 237: Dominadors signs tte agreement and receives upton! payment ond note. ‘Cash ¥90.000.00 Notes receivable 3 reeiaes 785,000.00, ‘Uneamed interes! income (or Discount on notes receivable} 57.4080 Uneamed ttonchise revenue 190,000.00 Uneomed service revenue - taining. etc 9459150 Uneamed soles revenue = machinery and equipments. eic. 13300000 nine Pe Chr Want ts cgpeedt Laced nines ada oS TDowentetwery 1308 0 eye toek nance epen, Donors slius e patenance slim (okt ee) icin to te Senta Roe Winans ana caspenat nl. Denies stein hehe sosgeton eskea a hele wets the Le Ne a eee eroeisalsPali ise ees aaa renee ‘Uneomed franchise revenue 190.000.00 Franchie revenue 190,000.00 Uneamed service revenve - trating. etc. 94591.50 Service revenue - traning. etc. 94,591.50 Unearned soles revenue - machinery anc equipment, ete. 133,00000 Soles revenue - mactinery and equipment, et. 133,000.00 | Cost of goods 301d. eee +98,900.00 | Inventory...» nen 95,900.09 | [As indicated, when Dorring Begins operations, Dominador's Pizo satisfies the performance obligations (point in time) ‘elated fo the franchise rights, raining ond equipment under the franchise ogreement. Tha! is, Dominador’s hat no further obligations related fo these elements of the franchise, 5. b= Dominader’s recognizes revenue for the royatties (continuing fee) when (or a1) the uncertainty I: reroived (over ime), On December 31, 20:8, he continuing ‘.oyatyy) Lonchise tees ‘AcoUnIs receivable (PA.967. 501 x 7 S55 > Franchise revenue... ay 48,875.00 } December 31, 2038: To recotd payment received and \come on nol __ Cosh Noles receivable. 945910 | LUneamed interest income (or Dicount on notes receivable) 1ax0732 | Interest income (P2219) 50 x 8%). 1320732 | "AFAR-06Advanced Financial Accounting & Reporting Page 4 .¢¢ or December 31, 20x8 amounted to P67 466.50 © Therefore. v2 fois! amount of fanchize 1esenve recogn: computed a1 foliows: Fronchise Revenue Pointintime Fetrucey + 20% Init Franchise Fee 41759150 (Overtime) Continuing franchise toe: #4987 599% 1%). 49,875.00 otat franchise revenii 467,466.50 © Therefore. the folol amount of franchise revenue recognited on December 31, 20x8 amounted fo P467. 466.50 (net income of 390,673.82) computed as folows: Franchise Revenue, Pointiniime. february $2008 ‘Over time) ‘Con se oe Ms 293 Total Franchise toverue Par aes 1085 Cost of goods said $5,000.00 Gro prot P72 66.50 ess Operating expenis 90 P 37 abo 5 Adal interes! income 18202.47 Notincome. Piper Recognition of Franchise Rights Revenue Over Time hghts, the anchor may be providing access to the right raihe Depending on the economic subs vin case. fhe fanchise revenue is recognized over time. ra! than transferring contol of the fe man Gt a point in time M1 Initiol Franchise Fee/Commingied Revenue Frozen Delight, Inc. charges an iniict itcnchise: fee of 75,000 tor the right to operate as a franchisee of Frozen Delight. Of this cmount P25,000 is coke. tea immediately. The remainder is collected in four equal annual instalments of 12.500 each. These instalments have @ present valve of P4402. As part of the total franchise fee, Frozen Delight aiv’s provides training (with a fair valve of P2,000) to help franchisees get the store ready to open, Ihe franchise agreement is signed of Aptii 1, 20x5, training is completed. and the store opens on July | 2045: 1 The amount of revenve from irai a Zero. b. P64.402 2. The amount of revenve from taining, anc! a. Zero. . °66,40: b. ‘64,402 @. 75.000 IW ~ initial Franchise Fee lems 1 10 7 are based on the following information: Pacific Crossburgers Inc. charges an initia! fee of P70000. Upon the signing of the agreement (which covers 3 years), a puyrrent of 28,000 is due. Thereafter. three annuci payments of P14,000 are required. The cree’) rating of the franchisee is such that it would hove to pay interest at 10% to bore w tne “ev. The anchise agreement signed on May | 20x5, ond the franchise commences cxzerction on July 1, 20x5, 1. The amount of franchise revenue on May 1, {0x5 eisuming no future services are required by the franchisor once the franchise starts operations 0. Zero. c Persie b. P28.000 79,000 2. Inrelation to No, 1, the amount of franchise revenue on July 1. 20%5. a. Zero. 162414 b. P28,000 2. 70,000 3, The amount of franchise revenue on ‘ny 1, 2945 asseming that the franchisor has substantial services to perform, once the franchise besir operations, to maintain the value of the franchise. a. Tero, © P6216 b. 28,000 . P70,000 4, Intelation to No. 3, the amount of ‘rcrichse revenue on December 31, 20x5. a. Leto. © PARIS bd. PI3.959 Pm AFAR-06Advanced Financial Accounting & Reporting Page 5 The amount of franchise revenue on May |. 20x5 assuming that the total franchise fee includes training services (with a value of P2.400) for the period leading up to the franchise opening and cr two (2) months following opening 2. eto. c. P62816 b. P6016 4. P70,000 relation to No. 5, the amount of franchis revenue on July 1, 20x5: cleo. cc. PBL6I6 b P60.416 1d. P63.616 'n relation to Nos. 5 and 6, the amount of service revenue on September 1, 20x5: ©. Leto, cc. P 2.400 ©. P1200 0. P70,000 Seluton: ‘May 1. 20x5 (Date of Signing) CORR — - 20.000 ‘Notes ReceWable (970,000 - 28.000) : 42.000 - Discount on Notes Receivable /Uneomed interes! income 1P42,000 ~ 2.48685" x PIA, 000) 7.106 Uneomed Franchise Revenue (P28: " snane Re 2}. 20 (oe of Opening Pot nine) ‘Uneomed Franchise Revenve. Franchke Revenue. 3 May 1, 085 ote ofSonina) ‘ih Discount on Notes Receivable /Uneained infereH Income [742,000 ~(2.48685" x P14,000)} ‘Contract Uabilty Granchise) (728,000 + 242006 - P7184). Note: A contact Sabilly 1s generoty roteed 10,03 Uneomed Soles Revenue, Uneamed service Revenue. or any appropriate account te 4 b+ December 31 20:8 Date of Opening = Over Time) (762.8164 3) x 8/12 «713.959 Uneamed Fronchive Revenwe. 13959 ‘ranchise Revenue. 13959 So ‘May 1, 20:5 (Dote of Signing) Cash os se 28,000 ‘Notes Recelvable (770,000 - F28,00%).. 42.000 ‘Discount on Notos Recotvable /Uneomed eorex! Income 7106 17 42,000 ~(2.48685° x ?14,000)) (raining). V - Initial Franchise Fee 1. TopChop sells hairstyling franchises. TopChop receives P50,000 from a new franchisee for providing initial training, equipment and fumishings that have a stand-alone seling price of P50,000. TopChop aso receives P30,000 per yeor for use of the TopChop name and for ongoing consulting services (starfing on the date the franchise is purchased). Carlos became a TopChop franchisee fon July 1, 20x6, and on August 1. 20x6, had completed training and was open for business. How much revenue in 20xé6 will TopChop recognize for its arrangement with Carlos? a. Zero c.— P65,000 b. 10,000 .—P70,000 2. Pita Pal sells fast-food franchises. Pita Pal 1eceives P75,000 from a new franchisee for providing initial training, equipment. and furnishings that together have a stand-alone selling price of 75,000. Pita Pal also receives P36,000 per year for use of the Pita Pal name and for ongoing Consulting services (starting on the date the franchise is purchased). Rachel became a Fita Pal AFAR-06GE (S) Advanced Financlal Accounting & Reporting page 6 franchisee on March 1. 20x6, and on May 1, 20x6 Rachel had completed training and was open for business. How much revenue in: 20x6 will Piic Pal recognize for its arrangement with Rachel? 9. leo cP 99,000 b. P75,000 .—P105,000 \V- Initial Franchise Fee, Continuing franchise Fee and Bargain Purchase 1. On January 1, 20x5 Dairy Treats, Inc. entered into a franchise agreement with a company allowing the company to do business under Dairy Treats's name. Daity Treats had performed substantially ail Fequired services by January 1, 20x5, and the franchisee paid the initial franchise fee of PB40,000 in full on that date. The franchise agreement specifies that the franchisee must pay @ continuing franchise fee of 72.000 annually, of which 20% must be spent on advertising by Dairy Treats. What entry should Dairy Treats make on January 1, 20x5 to fecord receipt of the initial franchise fee and the continuing franchise tee for 20x5¢ COSA en . soe 912,000 Franchise Fee Revenue . een 840,000 Revenve from Franchise FS vss mn 72.000 B. COSR ener ne Sans 912.000 Uneained Franchise Fees... 712.000 ©. Cathe : 912.000 Franchise Fee Revenue 840,000 Revenue from Franchise FEES conn $7,600 Unearned Franchise Fees ne 14.400 4. Prepaid Advertising... . 14,400 COBH sessvenninenmnnnannrnnn 912,000 Franchise Fee Revenue 840,000 Revenue from Franchise Fees conn 72,000 Unearned Franchise Foes — 14.400 2. Wynne inc. charges an initial franchise tee of P 1,840,000, with P400,000 paid when the agreement is signed and the balance in five annual payments, the present value of the future payments, discounted at 10%, is 1,091,744. The franchisee has the option to purchase P240,000 of equipment for P192,000. Wynne has substontially provided al initial services required and collectibilty of the payments is reasonably assured. The amount of revenue from franchise fees: a. P 400,000. ©. PLA9744. b. P1.443,744. d. P1.840,000. 3. Posta Inn charges an initio! fee of P1.600,900 for @ franchise, with P320,000 paid when the ‘agreement is signed and the balance in jour annual payments. The present valve of the annual Payments, discounted at 10%, is P1.014,000. The tranchisee has the night to purchase P60,000 of kitchen equipment and supplies for P50,000. An additional part of the initial fee is tor advertising to be provided by Pasta Inn during the next five years. The value of the advertising is P1,000 0 month. Collectibilty of the payments is reasonably assured and Pasta Inn has performed ali the initiat services required by the contract. How much revenue from franchise fee be recognized when the agreement is signed? 0. Zero. © P1,590,000 b. 1,264,000 4. P1.400,000 Less: Present valve of payments. argain Purchase Option (P60,000-P50,000) - note ‘Advertising (P1,000 x 60 months)... Revenue rom Franchise Fee. Notes Recetvable. ‘Unearned Interest income /Disc un! on Notes Receivable.. Note: Bargain Purchases (Point in Time) In addition to providing services as part of the continuing franchise fee, a franchisor often sells supplies to the franchisee. These saies occur because the franchisor may be able to obtain AFAR-06(as) G29) Advanced Financial Accounting & Reporting Page 7 quantity discounts from manutacturers or wholesalers, or to ensure the quality of the supplies Ine franchisor records these sales and related expenses in the normal manner. In addition to poying continuing franchise fees, tranchisees frequently purchase some or all of ‘helr equipment and supplles from the franchisor. the franchisor would account for these sales 23 it would for any other product sales. sometimes, however, the franchise agreement grants the franchisee the right to make bargain purchases of equipment or supplies after the initial franchise fee is paid. he amount to be deferred shall be either oi the following: + the reasonable profit If indicoled bargain price or option price is lower than the normal selling price of the same product. + oF if dogs not provide the franchisor a reasonable profit, then a portion or the full amount of the initial franchise fee should be deferred and recognize at point in time or at the time the equipment and supplies will be delivered. The deferred portion would be accounted for as an adjustment of the selling price when the ranchisee subsequently purchases the equipment or supplies (point in time). Theories 4. Allrevenue for franchise companies is derived fram @._ assistance for site selection and negotiating lease. 'b. bookkeeping and advisory services c._ sale of initial franchise and continuing toes. d._ advertising and promotion. 5, Franchise fees should be recognized @. on the date the contract was signed. . b. on the date the franchise is opened for business. c. on the date the franchise fee is paid to franchisor. d._when performance obligations are satisfied. 4. Revenve for sales-based royalty payments should be recognized @. when the amount of sales can be determined, b. on the date payment is received by tha franchisor. ©. on the date the performance obligation is satisfied. d. on the date the contract was signed, 7. Franchise revenue are recognized over time it G. franchise rights are transtered at a point in time. b. the franchiso* is providing access to the right rather than transferring contol. c. performance obligations regarding franchise rights are completed when the franchise opens. d._ the franchisee fee is payable upon signing of contract, 8. Types of franchising arangements include ai of the folowing except a. service sponsorsetailer 'b. wholesoler-service sponsor. c. manufacturer-wholesaler. d. wholesoler-etailer. 9. Continuing franchise fees should be recorded by the franchisor ©. asrevenve when uncertainty related fo the variable consideration is resolved. b. asrevenve when received. ¢. in accordance with the accounting procedures specified in the franchise agreement @._asrevenve only after the balance of the initial franchise fee has been collected, 10. Occasionally a franchise agreement gronts the franchisee the right to make future bargain purchases of equipment or supplies. When recording the initial franchise fee. the franchisor should @. increase revenue recognized from the initial franchise fee by the amount of the expected future purchases. b. record a portion of the inifial franchise fee as unearned revenue which willincrease the selling price when the franchisee subsequently makes the bargain purchases. ¢. defer recognition of any revenve from the initial franchise fee until he bargain purchases are made. d. None of these answer choices are conect AFAR-06Advanced Financial Accounting & Reporting Page 8 1. Franchise revenues are recognized over time if @. franchise rights are transfered at a point in time. the franchisee fee is payable upon signing of contract. ¢. performance obligations regarding franchise rights are completed when the franchise opens. 1d. None of these answer choices are comect. 12, Which of the following is not true about accounting for revenue from franchise arangements? @. Franchise arrangements often include a perfomance abiigation for a license as well as for delivery of goods and services. | b. Franchise arrangements typicaly include one or more performance obligations for which revenue is recognized at a point in time. ¢. Franchise anangements typically include one or more performance obligations for which revenve is recognized over a period of time. d. Franchise arrangements typically inciude one performance obligation because the goods end services included in the anangement are not separately identifiable. Consignment Accounting ‘A consignment constitutes the transfer of possession of merchandise without the transfer of tiie from the owner, called the consignor, to another person, called the consignee. The consignee acts as an agent in behaif of the consignor for the purpose of selling the goods for a commission. The shipment of goods to the consignee is not teated as a sale. Although a transfer of goods hos taken place. it is not the intent of either the consignor or the consignee that sale and purchase transactions take place. Tile of the goods remains with the consignor, ond recognition of the sale is deterred until goods are transferred fo a third party by the consignee. The merchandise is cared throughout the consignment as the inventory of the consignor, separately classified as Merchandise Inventory on Consignment. Ii is not recorded as on asset on the consignee’s books. Upon sale of the merchandise, the consignee hos liability for the net amount due the consigner. When an entity delivers its product to a dealer for distributor for sale to end customers. the entity needs to determine whether the contrect s a sale or a consignment rangement Clotovtor tel the product foe customer of distipdernosnot | | hon, tno dealer oF diibulor obtcna Geoeict | control of the product (i.e. after a specified Pra | period of time expires). ‘SALE ~ | The dealer or Recognize revenue whi ‘product is | distributor has shipped or delivered to the dealer or | | obtained control of | distributor (depending on the terms of the I | the product____| contract) |Somsennenr | the - Recognize revenue when the dealer or The following are Indicators of a consignment arrangement: + The entity controls the product untii a specified event occurs, such as the sale of the product toa customer or until a specified period expires The entity can require the retum of the product or transfer the product to another party. The dealer does not have an unconditional obligation to pay the entity for the product (although it might be required to pay a deposit). ‘A common principal-agent relationship involves consignments. in these cases, manufacturers (or wholesale's) deliver goods but retain tile to the goods until they are sold. This specialized method of marketing certain types of products mokes use of an agreement known as a consignment. Under this arangement, the consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer). who is to act as an agent for the Consignor in selling the merchandise. Both Consignor and consignee are interested in selling ~ the former to make a profit or develop a market, the latter to make a commission on the sale. The consignee accepts the merchandise ond agrees to exercise due diligence in caring for and selling it. The consignee remits to the consignor Cash received from customers, alter deducting a sales commission and any chargeable expenses. AYAR-06Gs) (35) Advanced Financial Accounting & Reporting Page ® 1 consignment sales. the consignor uses ¢ modified version of the point-of-sale basis of revenue ‘ogrition. That is, the consignor recognizes revenve only offer receiving notification of the sale and cosh remittance from the consignee. The consignor carries the merchandise as inventory throughout the consignment. separately Classified as inventory (consignment). The consignee does not record the merchandise as an asset on tts Books. Upon sole of the merchandise. the consignee has @ liability for the net amount due to the consignor. -onsignor periodically receives from the consignee report called account sales that shows the merchandise received. merchandise sold. expenses chargentie to the consignment, and the cash remitted. Revenue is then recognized by the consign. Rights and Responsibilities of the Consignee Before goods are transfered on consignment. 0 written agreement should specify clearly the intent of the parties. The agreement should address such issues as the amount and type of the consignee’s expenses 10 be reimbursed by the consignor. how the consignee’s commissions are to be computed, when commissions are to be paid. the credit terms and conditions. if any. to be considered by the consignee in granting credit. and the responsibility for collection of receivables. The agreement should be complete and attempts fo avoid potential points ct confit. For items not provided for in the agreement that resuit in ffigation, the laws of bolment and agency oppy. Accounting by the Consignor The journal entries to be mode on the books of the consignor vary. depending on: * Whether consignment transactions ore recorded in separate ledger accounts for the purpose of determining profits on consignment sales, or are simply combined with the regular account balances, and + Whether c perpetual or periodic inventory systernis used. Because title to the merchandise is held by the consignor but physical possession is neid by the consignee. speciol accounting racords must be maintained by the Consignor for control purposes. No revenue is recognized until a sale is made by the consignee. Upon shipment of the merchandise by the consignor. ar. inventory account is established on tne consignors books to identity the consigned merchandise. Any consignment expenses paid by the Consignor are added fo the invenlay balance o: added costs. The consignee does not make cn entry for receipt of the Inventory in the general ledger: however. memorandum control records usually are kept. Any reimbursable expense paid by the consignee is charged to a receivable account by consignee and added to the inventory balance by the consignor. When a sale is made. consignor recognizes the sale as revenue according 10 one of the revenue recogrition methods, cand the consignee recognizes the commission as revenue on the transaction. ‘Accounting by the Consignor a The journal entries to be made on the books of the Consignor vary. depending on: © Whether consignment transactions are recorded in separate ledger accounts fo: the purpose of determining profits on consignment sales. or are simply combined v. the regular account balances, and + Whether c perpetual or periodic inventory systemis used. Because fille to the merchandise is held by the consignor but physical possession is held by the consignee, special accounting records must be maintained by the consig for control purposes. No revenue is recognized until a sale is made by the consignee. Upon shipment of the merchani« by the consignor, an inventory account is established on the consignor’s books to identity consigned merchandise. ‘Any consignment expenses paid by the consignor are added to the inventoy bolance as Costs. The consignee does not make on entry for receipt of the Inventory in the general however, memorandum control records usually are kept. ‘Any reimbursable expense paid by the consignee is chorged to a receivable account by consignee and added to the inventory balance by the consignox. When a sale is made, consignor recognizes the sale as revenue according to one of the revenue recognition methods, and the consignee recognize: ine commission as revenue on the transaction. AFAR-06Page 10 Consignor’ 1. Consignment transactions recorded: separately - this method determines consignment Profit separate from regular sales. An inventory account called os Inventory on Consignment is used to record transactions in relation to consignment. inventory on Consignment* account is debited for. + Cost of goods shipped on consignment + Expenses related fo consignment incurred by the consignor + Reimbursable expenses related to consignment paid by the consignee. Inventory on Consignment* account is credited for: + Cost of goods returned by the consignee * Cost of consignment sales and expenses relating to consignment. ‘occount tem “conslgnmest-ot marie atemalvel wed when conskmect prof can be caulted separately. 2. Consignment transactions net recorded separately - consignment transactions are treated like @ regular type of sales. Determination of consignment profit is not required because itis ‘already part of the profit of the entire entity. ‘Accounting by the Consignee Accounting procedures established by the consignee must recognize that goods received on consignment are not owned. However, as noted eartier, the consignee must: * Maintain records and controls that permit the identification of: 2. Goods held on consignment cind b. Related receivables and reimbursable expenses, and + Prepare periodic reports. The consignee normally creates’a special account: Consignor Receivable or Consignor Payabie* , Consignee’s 1. Consignment transactions recorded separately - under this method, two accounts ore needed to be maintained in relation to consignment transactions: Consignor receivable* account is: ‘* debited for expenses paid by the consignee but chargeable to the consignor * credited when remittance is made to the consignor Consignor payable* account is: + © redifed for the sales by the consignee * debited when remittance is mace by the consignor ‘account tenn “conalgementtn” maybe atematvety wed when consignment prolt can be cokcloted seperoty. 2. Consignment transactions not recorded separately - consignment transactions are treated like @ regular type of sales. Detemnination of consignment profit is not required because it is Gleady part of the profit of the entire entity. Transactions recorded separately are more convenient on the Consignor and consignee's books to determine the results of operations. The following cotls ond expentes fo the consignment ansactions should corefuly be noted: «Items to be allocated between sold and unsold items: @. Freight cost paid by the consignor upon shipment 'b. Freight and cartages paid by the consignee upon receipt of the shipment ¢. Insurance freight of consigned goods d. Packaging costs of consigned goods fe. Costs and fees such as repairs, installation of devices paid by the consignor and/or consignee related fo the consigned goods. * Hems chargeable to the sold units: Commissions Delivery and installation ‘Advertising Reconditioning on delivered units to customers Insurance in transit to customers Expenses related to returned units delivered seaoga AFAR-06