Franchise Accounting

Concepts

In franchise accounting, our point of view is the franchisor’s.Therefore, the main focus of this
topic is the recognition of revenue.

Now IFRS 15, recommends a five step model that we will follow in recognizing revenue, to wit:

1. Identify the contract

a. See the provisions of the franchise agreement, to determine the performance
obligation, the transaction price and other terms of the contract.
b. This could be an oral or a written contract.

2. Identify the performance obligations

a. From the franchise agreement, identify the POs, it could be one or more of the
following: (examples not inclusive)
i. Assistance in site selection
ii. Initial training
iii. Assistance with staff recruitment
iv. Advertising and Promotion
v. Delivery of raw materials
vi. Building of stalls

3. Determine the transaction price

a. This is the consideration that will be paid by the franchisee to the franchisor upon
signing the franchise agreement a.k.a the initial franchise fee.
b. See the computation, under templates.

4. Allocate the transaction price to the performance obligations

a. The steps in step 2 and 3 are vital for this fourth step, because the initial
franchise fee shall be allocated to the identified separate performance
obligations.
b. The question is, how should we allocate the initial franchise fee to the POs?
i. IFRS 15 provides that we should allocate transaction price based on the
stand-alone selling price. Now what is the stand-alone selling price?
1. Observable price
a. ito yung price nong product or service kung ibebenta mo
siya separately.
2. If there’s no observable price:
a. Adjusted market approach
b. Expected cost + margin approach
c. Residual method
 i. para magamit mo ang residual method, one of the
following conditions must be met:
1. the entity sells the same good or services in
a broad range of amounts.
2. The entity has not yet established price for
that goods/services or has not been
previously sold in the market on a stand
alone basis.
ii. so dito, i-a-allocate mo muna yung transaction price
sa ibang POs, then yung natira mapupunta sa PO,
kung saan i-a-apply ang residual method.

5. Recognize the revenue

Initial Franchise Fee

● like mentioned in LTCC, dalawa ang method for recognizing revenue, we have :
at a point in time and overtime.
● The general rule to determine kung overtime or at point in time is to see first the
requirements of overtime, then kung hindi man nasatisy, then consider it as a
point in time. The criteria para masabi na ang PO ay satisfied overtime are:
Note : Kahit isa lang ang ma-satisfy
● The customer simultaneously receives and consumes the benefits
provided by the entity’s performance as the entity’s performs (e.g raw
materials)
● The entity’s performance creates or enhances an asset that the customer
controls as the asset is created or enhanced (work in progress, example :
LTCC)
● The entity’s performance does not create an asset with an alternative use
to the entity and the entity has the enforceable right to payment for
performance completed to date.

Kung wala ni isa sa tatlo ang nasatisfy then the PO is said to be satisfied at a point in
time.

For other separate performance obligations in the franchise, the general requirements
above shall be followed. Now as to the license, yung intellectual property itself-- to
determine whether the PO is satisfied overtime or a at a point in time, IFRS 15
specifically provides that the entity should consider whether the promise of granting a
license to the customer is to provide either a :

● right to access or;

● right to use
Kung right to access ang provided : it is satisfied overtime, kung right to use naman : its
at a point in time.

Now, how could we determine if it’s right to access or right to use?

Tingin ka lang sa criteria ng right to access, then kung hindi yun nameet then consider it
as righ to use.

Right to access criteria (all should be met):

1. the contract requires, or the customer reasonably expects, that the entity will
undertake activities that significantly affect the intellectual property to which the
customer has rights
2. the rights granted by the license directly expose the customer to any positive or
negative effects of the entity’s activities.
3. those activities do not result in the transfer of a good or a service to the customer
as those activities occur.

If we are to summarize the criteria, right to access provides the customer the continuous
benefits from the franchise. Now, kung hindi man nameet any one of the criteria, then
what was granted is just right to use, hence recognised revenue at a point in time.

Royalties : Continuing Franchise Fee

● As part of the franchise agreement, the entity may also earn royalty revenue.
Now the recognition of this revenue depends whether there's a subsequent sale
or usage occurs and of course if the performance obligation kung saan all of the
sale based or usage based royalty has been allocated is already satisfied.
● Revenue = Gross sales x percentage
● The costs related to this one are considered as indirect costs.

Interest income
● Interest income is another possible source of revenue in a franchise agreement.
Siyempre magkakaroon neto kung ang payment ng franchisee ay in the form of
promissory note.
● The revenue will be earned thru passage of time.
● The basis of interest is always the present value of the note.
 Templates for Computations:

What is the initial franchise fee?

Downpayment xx

Add : Present Value of the note xx

Initial Franchise Fee xx

*The present value of the note depends whether the note is interest bearing or non interest bearing:
● Interest-bearing = face value
● non-interest bearing = need to calculate the PV factor.

What is the total franchise fee?

Initial Franchise Fee xx

Continuing Franchise Fee xx

Total Franchise Fee xx

What is the total revenue?

Total Franchise Fee xx

Interest income xx

Total Revenue xx
*Crucial sa interest income, kung kailan nag start ang franchise agreement ha, dahil don palang mag iistart ang
accrual ng interest.

What is the net income?

Initial Franchise Fee xx

Less : Direct cost of Franchise* xx

Gross profit from IFF xx

Add : Continuing Franchise Fee xx

Add : Interest Income xx

Total Gross income xx

Less : Indirect Costs** xx

Net Income of the Franchisor xx

*The recognition of direct costs is parallel to the recognition of the initial franchise fee
**The indirect costs are always expensed outright.

PAS 18 : FRANCHISE ACCOUNTING

Just to be safe, it is also significant to know how to account for franchises using the provisions
of the old standard before IFRS 15 - PAS 18. In the context of the board exam, the hint that
you’re going to apply PAS 18 is when you encounter words such as : reasonably assured or not
reasonably assured.

The vital concepts you need to know are :

● When is the recognition of revenue?
● How should the revenue be recognized?

Recognition of Revenue

Under the old standard, the revenue will be recognized when there is already a substantial
performance of the obligation. Now ang question dito ay, kailan natin masasabing meron
nang substantial performance? The table below summarizes the indicators.

Indicators

1 Expressly stated in the problem

2 Franchisee commenced business operations

3 The problem indicates gross sales

4 90% of the initial expected services were rendered.

Now let’s say we could now recognize revenue, the question is…

How should we recognize the revenue?

● As to the manner of recognizing revenue, PAS 18 provides two ways of recognition, (1)
accrual method (2) installment method. Now, kailan mo sila gagamitin?

Accrual method If the collection is reasonably assured

Installment method If the collection is not reasonably assured

Accrual method
● Application lang ‘to ng accrual accounting, so kung na-earn na yung revenue, edi
irecognize mo na. This is actually the method used under IFRS 15, so walang
pinagkaiba as to the manner of recognizing revenue under this method, and that of the
IFRS 15.
Guide in Computation for Accrual Method
C1 C2 C3

Substantial Performance yes yes no

Down Payment (Non-refundable) yes no* no

Initial Franchise Fee yes no** no

Less : Direct cost of Franchise yes no no

Gross profit from IFF yes yes no

Add : Continuing Franchise Fee yes yes*** no

Add : Interest Income yes yes yes

Less : Indirect Costs* yes yes yes

Net Income of the Franchisor

*to know if the down payment is refundable or not, it should be stated in the problem, kung silent
naman always assume na, non-refundable.
**The rationale bakit hindi ka dapat mag recognize ng IFF if the downpayment is refundable
dahil ang basis ng IFF ay yung downpayment, eh possible mo pala siya ibalik, hence it is
conservative to not yet recognize the revenue, consequently the promissory note as well, kasi
kung ang down nga ay hindi makukuha, siyempre yung note rin.

***CFF will always be recognized as long as may substantial performance na, dahil ang
basehan naman ay yung gross sales, while interest is based on the passage of time naman,
and indirect costs are just expensed outright.

Installment method
● Kapag installment method naman, the recognition of revenue is based on the collection,
kaya di talaga ito in accordance with GAAP, but applicable naman ‘to for tax purposes.
So dito, you are to recognize revenue up to the extent of your collection only. Note na
this is only for the initial franchise fee ha. The recognition of CFF and interest is just the
same as how we recognize it in IFRS 15.
 Paano?

Net income
Cash collected down payment + installment collection - interest*

x Gross profit rate 1. IFF - Direct Cost = Gross profit from IFF
2. Gross profit fr. IFF/ IFF 8= Gross profit rate

Gross profit from IFF

Add : CFF Gross profit x percentage

Add : Interest Income Based on the passage of time

Less : Indirect costs always expensed outright

Net income
*interest is deducted if the note is a non-interest bearing note. Why? because the collection from the note is
deemed inclusive of payment of interest.

Guide in Computation for installment method

C1 C2

Substantial Performance yes no

Down Payment (Non-refundable) yes no

Realized Gross profit from IFF yes no

Add : Continuing Franchise Fee yes no

Add : Interest Income yes yes

Less : Indirect Costs* yes yes

Net Income of the Franchisor

Note that the downpayment of the installment method is always “non-refundable”, dahil
ang bait mo naman na installment na nga ang bayad, refundable pa ang down, kaya wala
na yung case 2 don sa accrual method.
 CPA REVIEW SCHOOL OF THE PHILIPPINES
Manila

ADVANCED FINANCIAL ACCOUNTING GERMAN/LIM/VALIX/MARASIGAN

FRANCHISE ACCOUNTING

Part I: Theory of Accounts

1. Under IFRS 15, an asset is transferred to the customer when customer obtains
a. satisfaction
b. possession
c. control
d. recognition

2. When shall an entity recognize revenue from contracts with customers?

a. When it is probable that future economic benefits will flow to the entity and the revenue can be
measured reliably.
b. When or as the entity satisfies the performance obligation.
c. When the entity collected the cash from the customers.
d. When the entity and the customers sign the contracts.

3. What is the accounting treatment of the transaction price when a contract with a customer has
multiple performance obligations?
a. The transaction price shall be recognized as revenue of the most important performance
obligation.
b. The transaction price shall be allocated equally to the different performance obligations.
c. The transaction price shall be allocated to the different performance obligations by reference to
their relative standalone selling prices.
d. The transaction price shall be recognized as revenue only at the end of completion of all
performance obligations.

4. When the stand-alone selling price is not directly observable, an estimate of the stand-alone selling
price is made through maximizing the use of observable inputs. Which of the following is not a
possible estimation approach?
a. Residual approach
b. Adjustment market assessment approach
c. Net realizable value approach
d. Expected cost plus a margin approach

5. Under IFRS 15, a good or service that is promised to a customer 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
b. the entity's promise to transfer the good or service to the customer is separately identifiable from
other promises in the contract
c. Both A and B
d. Neither A nor B

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Part II: Problem Solving

Problem 1
On January 1, 2023, Entity A granted a franchise right to franchisee for the operation of selling
automobile parts. Entity A also granted the franchisee the right to access its trade-name for a period of 10
years. The franchisee is required to pay an upfront non-refundable initial franchise fee of P20,000,000
and a continuing franchise fee of 10% of the annual sales. It is the obligation of Entity A to construct the
franchise stall and to deliver 10,000 units of automobile parts to the franchisee.

Assume the following INDEPENDENT cases:

CASE 1:

Stand-alone selling prices

1. Trade-name P4,000,000
2. Construction of the stall P3,000,000
3. Delivery of 10,000 units of automobile parts Not directly observable

After careful evaluation in the market, the price that a customer is willing to pay for the delivery of
10,000 units of materials was P1,000,000 under the adjusted market assessment approach.

On October 1, 2023, Entity already finished the construction of the stall and as of December 31, 2023,
Entity A only delivered 2,000 units of automobile parts. The franchisee reported sales revenue on
December 31, 2023 in the amount of P4,000,000.

1. Under IFRS 15, what is the revenue recognized pertaining to the delivery of automobile parts?
a. 2,500,000
b. 312,500
c. 0
d. 500,000

2. Under IFRS 15, what is the total revenue from initial franchise fee?
a. 9,000,000
b. 9,400,000
c. 11,000,000
d. 11,400,000

CASE 2:
Stand-alone selling prices
1. Trade-name Not directly observable
2. Construction of the stall Not directly observable
3. Delivery of 10,000 units of automobile parts P4,000,000

The stall had an estimated cost of P4,000,000 with a margin of P6,000,000. Since it is the first time for
Entity A to grant access of its trade-name, Entity A has not yet established a price for that service.

On October 1, 2023, Entity already finished the construction of the stall and as of December 31, 2023,
Entity A only delivered 3,500 units of automobile parts. The franchisee reported sales revenue on
December 31, 2023 in the amount of P1,500,000.

1. Under IFRS 15, what is the amount of transaction price allocated to the performance obligation
trade-name?
a. 6,000,000
b. 10,000,000
c. 12,000,000
d. 0

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2. Under IFRS 15, what is the total revenue from initial franchise fee for the year end December
31, 2023?
a. 12,150,000
b. 14,800,000
c. 12,000,000
d. 1,400,000
3. Under IFRS 15, what is the total revenue for the year end December 31, 2023?
a. 12,150,000
b. 14,950,000
c. 12,000,000
d. 1,550,000

Problem 2
On January 1, 2023, an entity granted a franchise agreement to a franchisee. The contract provided that
the franchisee shall pay an initial franchise fee of P500,000 and on-going payment of royalties equivalent
to 8% of the sales of the franchisee. On January 1, 2023, the franchisee paid down payment of P200,000
and issued a 3-year 12% interest bearing note for the balance payable in three equal annual installments
starting December 31, 2023.
On June 30, 2023, the entity completed the performance obligation of the franchise at a cost of P300,000.
Aside from that, the entity incurred indirect cost of P25,000. The franchisee started operation on July 1,
2023 and reported sales revenue amounting to P50,000 for the year ended December 31, 2023.

Under IFRS 15, what is the net income for the year end December 31, 2023?
a. 239,000
b. 203,000
c. 215,000
d. 179,000

Problem 3
On January 1, 2023, Franchisee entered into a franchise agreement with Franchisor to market their
products. The agreement provides for an initial fee of P2,500,000 payable as follows: P700,000 to be paid
upon signing of the contract and the balance in 5 equal annual payments every end of the year starting
December 31, 2023. Franchisee signs a non- interest bearing note for the balance. His credit rating
indicates that he can borrow money at 15% interest for a loan of this type. The present value of an annuity
of P1 at 15% for 5 periods is 3.352. The agreement further provides that the Franchisee must pay a
continuing franchise fee equal to 3% of the monthly gross sales. On August 31, the Franchisor completed
the initial services required in the contract at a cost of P858,024 and incurred indirect cost of P35,000.
The Franchisee commenced business operations on November 30, 2023. The gross sales reported to the
Franchisor were P360,000 for December, 2023.
1. Assume the collectibility of the note is reasonably assured, what is the net income for the year
ended, December 31, 2023?
a. 843,488
b. 1,024,496
c. 1,205,504
d. 1,240,504
2. Assume the collectibility of the note is not reasonably assured, what is the net income for the
year ended, December 31, 2023?
a. 640,254
b. 278,238
c. 459,246
d. 675,254
END
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