SPECIAL REVENUE RECOGNITION: FRANCHISE ACCOUNTING

Identify the choice that best completes the statement or answers the question.

____ 1. Cherry, Inc. charges an initial franchise fee of P115,000, with P25,000 paid when the agreement was signed and the balance in
five annual payments. The present value of the future payments, discounted at 10% is P68,234. The franchisee has the option to
purchase P15,000 of equipment for P12,000. Cherry has substantially provided all initial services required and collectability of
the payments is reasonably assured. The amount of the revenue from the franchise fees is:
a. 25,000 c. 93,234
b. 90,234 d. 115,000
____ 2. Jolibi, Inc. enters into an agreement with Ronald’s Co., clothing the later with full authority to operate as its franchisee for a
period of ten years. An initial franchise fee of P275,000, among others, was stipulated in the contract and was promptly paid
during the year 2011.
Assuming that Jolibi was able to perform the initial services during 2011, what is the franchise revenue to be recognized in its
year-end income statement?
a. 0 c. 137,500
b. 27,500 d. 275,000
____ 3. At the beginning of the year, AJD got the franchise of Tony’s, a known steak house of upscale patronage. The franchise
agreement 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 present value using 12% as discount rate, the four installments would
approximate P199,650. The fees once paid are refundable. The franchise may be cancelled subject to the provisions of the
agreement. Should there be unpaid franchise fee attributed to the balance of the main fee (P500,000), same would become due
and demandable upon cancellation. Further, the franchisor is entitled to a 5% fee on gross sales payable monthly within the first
ten days of the following month.
The Credit Investigation of Bureau rated AJD as AAA credit rating. The balance of the franchise fee was guaranteed by a
commercial bank.
The first year of operations yielded gross sales of P9,000,000. Tony’s earned franchise fees for the first year is:
a. 550,000 c. 749,650
b. 450,000 d. 950,000
____ 4. On September 30, 2011, Criselda’s, Inc., received from Ambo P550,000 representing franchise fee. Franchise services were
immediately started by Criselda’s and these were completed on October 31, 2011 at a cost amounting to P330,000. The franchise
fee revenue to be reported by Criselda’s in its October 31, 2011 income statement is:
a. 0 b. 137,500 c. 220,000 d. 550,000
____ 5. Zoe Corporation, sells a franchise for an initial fee of P700,000. A down payment of P200,000 is required, with the balance
covered by a P500,000, 10% note payable in five equal annual installments. If all the material services have been performed and
collectability of the notes is reasonably assured, but the refund period has not yet expired, what journal entry is needed to record
the transaction?
a. Cash 200,000
Notes Receivable 500,000
Franchise Fees 700,000
b. Cash 200,000
Notes Receivable 500,000
Unearned Franchise Fees 700,000
c. Cash 200,000
Notes Receivable 500,000
Franchise Fee 200,000
Unearned Franchise Fees 500,000
d. Cash 200,000
Notes Receivable 500,000
Franchise Fees 500,000
Unearned Franchise Fees 200,000
____ 6. Saisaki Corporation grants a franchise to Mity for an initial franchise fee of P1,000,000. The agreement provides that Saisaki has
the option within one year to acquire franchisee’s business, and it seems certain that Saisaki will exercise this option. On
Saisaki’s books, how should the initial fee be recorded?
a. Deferred and treated as reduction in Saisaki’s investment when the option is exercised.
b. Realized revenue.

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 c. Extraordinary revenue.
d. Deferred revenue to be amortized.
____ 7. Each of Pizza Pie Co.’s 21 new franchisees contracted to pay an initial franchise fee of P30,000. By December 31, 2011, each
franchisee had paid a non-refundable P10,000 fee and signed a note to pay P10,000 principal plus the market rate of interest on
December 31, 2012, and December 31, 2013. Experience indicates that one franchise will default on the additional payments.
Services for the initial fee will be performed in 2011. What amount of net unearned franchise fees would Pizza report on
December 31, 2011?
a. 400,000 b. 600,000 c. 610,000 d. 630,000
____ 8. On September 1, 2011, Cindy Company entered into franchise agreements with two franchisees. The agreements required an
initial fee payment of P700,000 plus four P300,000 payments due every four months, the first payment due December 31,
2011.The market interest rate is 12%. The initial deposit is refundable until substantial performance has been completed. The
following table describes each agreement:
Services Performed Total Costs
Probability of by Franchisor Incurred to
Franchisee Full Collection December 31, 2011 December 31, 2011
A Likely Substantially P700,000
B Doubtful 25% N/A

The present value and future value tables at 4% for four (4) periods were as follows:
Present value of P1 0.8548
Present value of an ordinary annuity of P1 3.6299
Future value of P1 1.1699
Future value of an ordinary annuity of P1 4.2465
What amount of net income is to be reported in 2011, assuming P1,000,000 was received from each franchisee during the year?
Franchisee A Franchisee B
a. P1,088,970 P 0
b. 1,788,970 0
c. 1,132,529 0
d. 1,132,529 43,559
____ 9. On January 2, 2011, RR Enterprises, Inc. authorized XX Company to operate as a franchisee over a twenty-year period for an
initial franchise fee of 60,000 received on signing the agreement. XX started operations on June 30, 2011, by which date RR had
performed all of the required initial services. In its income statement for the six months ended June 30, 2011, what amount
should RR report as revenue from franchise fees in connection with XX franchise?
a. 0 b. 1,500 c. 30,000 d. 60,000
____ 10. On January 3, 2011, PP Services, Inc. signed an agreement authorizing CC Company to operate as a franchisee over a 20-year
period for an initial franchise fee of P50,000 received when the agreement was signed. CC commenced operations on July 1,
2011, at which date all of the initial services required of PP had been performed. The agreement also provides that CC must pay
annually to PP a continuing franchise fee equal to 5% of the revenue from the franchise. CC’s franchise revenue for 2011 was
P400,000. For the year ended December 31, 2011, how much should PP record as revenue from franchise fees in respect of the
CC’s franchise?
a. P70,000 b. P50,000 c. P45,000 d. P22,500
____ 11. The primary issue in accounting for franchise fees is:
I. The timing of revenue recognition (more specifically, initial franchise fees)
II. The assurance of the collectability of franchise fees
III. The commercial viability of the business
a. I only c. I, II and III
b. I and II d. I and III
____ 12. When collectability is reasonably assured, revenue from franchise fee is recognized
a. Under the accrual basis of accounting
b. As cash installments are received
c. evenly over the contract period
d. none of these
____ 13. Direct costs of franchise are
a. Recognized immediately as expense in the period they are incurred.
b. Recognized as expense when the related franchise fee revenue is recognized.
c. Deferred and recognized as expenses at the end of the contract term.
d. Capitalized as cost of inventory of the franchisor and charged as expense when the related goods are
sold.

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____ 14. In the absence of evidence to the contrary, it shall be presumed that substantial performance by the franchisor occurs when
a. The franchise fee is substantially collected.
b. The franchisee commences its operations.
c. Any uncollected franchise fee is probable of collection.
d. All of these.
____ 15. If the franchise agreement provides for the sale of equipment, inventories or other tangible assets at a price lower than that
charged to others or a price that does not provide a reasonable profit on those sales,
a. A service liability is recognized at fair value.
b. A servicing asset is recognized at fair value.
c. Part of the initial fee, sufficient to cover costs in excess of the bargain purchase price and provide a
reasonable profit on the sale, is deferred and recognized over the period the goods are likely to be sold to
the franchisee.
d. a or b.
____ 16. On January 1, 2011, Brownie Delight, Inc. entered into a franchise agreement with a company allowing the company to do
business under Brownie Delight’s name. Brownie Delight had performed substantially all required services by January 1, 2011,
and the franchisee paid the initial franchise fee of P70,000 in full on that date. The franchise agreement specifies that the
franchisee must pay a continuing franchise fee of P6,000 annually, at which 20% must be spent on advertising by Brownie
Delight. What entry should Brownie Delight make on January 1, 2011 to the record the receipt of the initial franchise fee and the
continuing franchise fee for 2011?
a. Cash 76,000
Franchise Fee Revenue 70,000
Revenue from Continuing Franchise Fee 6,000
b. Cash 76,000
Unearned Franchise Fees 76,000
c. Cash 76,000
Franchise Fee Revenue 70,000
Revenue from Continuing Franchise Fee 4,800
Unearned Franchise Fee 1,200
d. Prepaid Advertising 1,200
Cash 76,000
Franchise Fee Revenue 70,000
Revenue from Continuing Franchise Fee 6,000
Unearned Franchise Fee 1,200
____ 17. Nena’s Lechon, Inc. franchiser, entered into franchise agreement with Aling Nena, franchisee, On March 1, 2011. The total
franchise fee is P500,000, of which P100,000 is payable upon signing and the balance in four equal annual installments. The
down payment is refundable in the event the franchiser fails to render services and none thus far had been rendered. When
Nena’s prepares its financial statements on March 31, 2011, the franchise fee revenue to be reported is:
a. P 0 c. P 500,000
b. P 100,000 d. P 400,000
____ 18. Ferragamo’s entered into a franchise agreement with Rusty. As per agreement on July 1, 2011, Rusty is to pay Ferragamo an up-
front franchise fee of P1,000,000 and subsequent annual franchise fees of P50,000 over the next four years. Cost of initial
franchise services rendered by Ferragamo’s during the year is P250,000 which is substantial, and it estimates the cost of
subsequent annual services to be P10,000. Rusty paid the annual franchises fee for 2012, and Ferragamo’s rendered the services
for the year. In its December 31, 2012 Income Statement, the amount of realized franchise fee revenue to be reported by
Ferragamo’s
a. P25,000 c. P250,000
b. P50,000 d. P300,000

19. What determines substantial performance for purposes of recognizing the initial franchise fee?
a. When the franchise actually commence operation.
b. When the franchisee pays the initial franchise fee in full.
c. When the franchisee pays a cash down payment.
d. When the franchisee signs the franchise contract.
20. When the initial franchise fee is not paid in full and the collectability of the note for the balance is reasonably assured, the
method to be used by the franchisor to recognized revenue from the initial franchise fee is:
a. Installment method.
b. Gross profit method.

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 c. Accrual method.
d. Cash basis
21. What costs of initial services are to be deferred by the franchisor?
a. Indirect costs.
b. Direct costs.
c. Period costs.
d. Conversion costs.
22. What conditions are to be met to determine the franchisor’s services are substantially performed?
a. The franchisor is not obligated in any way to refund cash already received or forgive unpaid debt.
b. The initial services required of the franchisor by contact or otherwise have been substantially performed.
c. No other material conditions or obligations exist.
d. All of the above.

Prepared by:

JOHN LYNDON D. RAYOS, CPA

InstructorSPECIAL REVENUE RECOGNITION: FRANCHISE Initial franchise fees are not recognized as revenue until the
ACCOUNTING franchisor makes substantial performance of the required
Answer Section services, and collection is reasonably assured. Since Pizza
Pie has not yet performed the required services, the initial
MULTIPLE CHOICE franchiase fee (21 x 30,000 = P630,000) is reported as
unearned franchise fees at 12/31/11. The estimated
1. ANS: B uncollectible amount (P20,000) normally would be
The revenue from the franchise fee would be as follows: recorded as debit to bad debt expense and a credit to
Cash 25,000 allowance for uncollectible accounts. However, since no
PV of Note 68,234 revenue has yet been recognized, it is inappropriate to
Less: Reasonable profit record bad debt expense. Instead, unearned franchise fees
on sale of equipment is debited, because an unearned revenue should not be
(15,000-112,000) 3,000 recorded when, in effect, no related asset has been
Total Revenue 90,234 received. Therefore, the net unearned franchise fees is
P610,000 (630,000-20,000).
PTS: 1
PTS: 1
2. ANS: D PTS: 1
8. ANS: D
3. ANS: B Franchise Revenue: (FRANCHISE A)
Since the initial franchise fee is refundable, therefore, no Downpayment
amount from the P500,000 initial franchise fee be 700,000
considered as revenue. The only revenue to be recognized PV of Installment (300,000 x 3.6299)
is the cnotinuing franchise fee of P450,000 (5% x 1,088,970
P9,000,000). Total
1,788,970
PTS: 1 Less: Cost of Franchise
700,000
4. ANS: D PTS: 1 Gross Profit
1,088,970
5. ANS: B PTS: 1 Add: Interest Income (1,088,970 x 4%)
43,559
6. ANS: A PTS: 1 Net income
1,132,529
7. ANS: C
FRANCHISE B:

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 Since there is no substantial performance of Revenue from Franchise 70,000
services (only partial collection) rendered it also follows
that the period of refund has not yet been expired and at the PTS: 1
same time there is doubtful of collection. Therefore, no
initial franchise fee is recognized as revenue in 2011. 11. ANS: B PTS: 1
However, because the first payment of P300,000 was 12. ANS: A PTS: 1
made, interest income of P43,559 would be recognized 13. ANS: B PTS: 1
(P1,088,970 x 4%). 14. ANS: B PTS: 1
15. ANS: C PTS: 1
PTS: 1 16. ANS: C PTS: 1
17. ANS: A PTS: 1
9. ANS: D PTS: 1 18. ANS: B PTS: 1
19. ANS: A PTS: 1
10. ANS: A 20. ANS: C PTS: 1
Initial Franchise Fee 50,000 21. ANS: B PTS: 1
Continuing Franchise Fee 20,000 22. ANS: D PTS: 1