ACCOUNTING FOR SPECIAL TRANSACTIONS

MODULE 8 – ACCOUNTING FOR FRANCHISE OPERATIONS – FRANCHISOR

LEARNING OBJECTIVE :

1. Define a franchise contract

2. Apply the general and specific principles of PFRS 15 in recognizing revenue
from franchise contract .

Introduction :

An entity shall apply the principles set forth under PFRS 15 Revenue from contracts
with customers in accounting for revenues from contracts with customers
regardless of the nature of the contract entered into with a customer except for
lease contracts , insurance contracts , financial instruments and non monetary
exchanges between entities in the same line of business to facilitate sales to
customers .

PFRS 15 supersedes PAS 18 Revenue

Core principle under PFRS 15

An entity recognizes revenue to depict the transfer of promised goods or services to

customers in an amount that reflects the consideration to which the entity expects
to be entitled in exchange for those goods or services .

SUMMARY OF THE REVENUE RECOGNITION PRINCIPLES UNDER PFRS 15

REVENUE RECOGNITION

Step 1 – Identify the contract with the customer

The contract is with a customer and (among other things ) the collectability
of the consideration is probable .

Step 2 – identify the performance obligation in the contract

Each promise to deliver a distinct good or service in the contract is treated as
a separate performance obligation.
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.
Step 3 – Determine the transaction price

The transaction price is the amount that the entity expects to be entitled to in
exchange for satisfying a performance obligation.

Step 4 – Allocate the transaction prior to the performance obligations

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

Step 5 – Recognize revenue when ( or as ) a performance obligation is satisfied .

For performance obligations satisfied overtime , the revenue is recognized as the

entity progresses towards the complete satisfaction of the performance obligation.

For performance obligations satisfied at a point in time , revenue is recognized

when the entity completely satisfies the performance obligation.

Revenue is measured at the amount of transaction price allocated to the

performance obligation satisfied.

LICENSING

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

PFRS 15 defines a license as one that establishes a customer’s rights to the

intellectual property of 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
d. Patents, trademarks and copyrights

FRANCHISE –

A franchise is a contractual agreement 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.

Examples :

1. A Jollibee fast food restaurant

 2. A 711 convenience store
3. A fm radio station
4. Public utility vehicle

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

BETWEEN TWO PRIVATE ENTITIES OR INDIVIDUALS

The franchisor , having developed a unique concept or product, protects its concept
or product through a patent, copyright or trademark or trade name . The franchise
acquires the right to exploit the franchisors idea or product by signing a franchise
agreement.

BETWEEN A PRIVATE ENTITY OR AN INDIVIDUAL AND THE GOVERNMENT

In another type of franchise agreement , a municipality (or other government body)

allows private entities to use public property in performing its services.

Examples are the use of public waterways for a ferry service , use of public land for
telephone or electric lines , use of phone lines for cable tv, use of city streets for a
bus line , or use of airwaves for radio or tv broadcasting . Such operating rights
obtained through agreements with governmental units or agencies , are frequently
referred to as licenses or permits.

Franchises and licenses maybe for a definite period of time or for an indefinite
period of time or perpetual.

APPLICATION OF THE PRINCIPLE OF PFRS 15

Step 1 – 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 ( the risk, timing or amount of the
entity’s future cash flows is expected to change as a result of the contract )
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 recognized on a contract that does not meet the criteria above.
Any consideration received from such contract is recognized as a liability and
recognized as revenue only when either of the following has occurred:
a. 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
b. The contract has been terminated and the consideration received is non
refundable

The entity need not reassess 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 customers ability to pay deteriorates
significantly .

EXAMPLE ;

REASSESING THE CRITERIA FOR IDENTIFYING A CONTRACT

An entity licenses a patent to a customer in exchange for a usage based royalty. At

contract inception, the contract meets all the criteria above (a to e ) and the entity
accounts for the contract with the customer in accordance with the requirements in
PFRS 15 . The entity recognizes revenue when the customers subsequent usage
occurs.

Throughout the first year of the contract , the customer provides quarterly reports
of usage and pays within the agreed upon period.

During the second year of the contract , the customer continues to use the entity’s
patent, but the customer financial condition declines . The customers current access
to credit and available cash on hand are limited. The entity continues to recognize
revenue on the basis of the customers usage throughput the second year. The
customer pays the first quarters royalties but makes nominal payments for the
usage of the patent in quarter 2 to 4 . The entity accounts for any impairment of
the existing receivable in accordance with PFRS9 financial instruments.

During the third year of the contract , the customer continues to use the entity’s
patent . However the entity learns that the customer has lost access to credit and
its major customers and thus the customers ability to pay significantly deteriorates.
The entity therefore concludes that it is unlikely that the customer will be able to
make any further royalty payments for ongoing usage of the entity’s patent . As a
result of this significant change in facts and circumstances , the entity reassess
criteria a to e above and determines that they are not met because it is no longer
probable that the entity will collect the consideration to which it will be entitled .
Accordingly , the entity does not recognize any further revenue associated with the
customers future usage of its patent. The entity accounts for any impairment of the
existing receivable in accordance with PFRS9.

Step 2 – IDENTIFY THE PERFORMANCE OBLIGATION IN THE CONTRACT

General principle :

Each promise to transfer the following is a performance obligation to be accounted

for 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 .

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 benefit. 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 a good or service is separately identifiable if the good or

service :

1. Is not an input to a combined output specified by the customer

2. Does not significantly modify another good or service promised in the
contract
3. Is not highly interrelated with other goods or services promised in the
contract . For example, the customers decision of not purchasing a good or
service does not affect the other promised goods or services in the contract.
Performance obligations include all activities that involve 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 OBLIGATION

At contract inception, the entity shall determine whether the identified performance
obligations will be satisfied either :

a. Overtime
b. At a point in time

A performance obligation 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 (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 )

A contract to grant a license to a customer may include other promises to provide

additional goods or services to the customer whether explicitly stated in the
contract or implied by the entity’s customary business practices. Just like with other
types of contracts, the entity shall apply the general principles in step 2 above to
identify each of the performance obligations in the contract.

PROMISE TO GRANT LICENSE IS NOT DISTINCT

If the promise to grant a license is not distinct from the other promises in the
contract , all the promises are accounted for together as a single performance
obligation .

The entity determines whether the single performance obligation will be satisfied
over time or at a point in time using the general principles above.

Examples of licenses that are not distinct from other goods or services promised in
the contract include the following :
 a. A license that forms a component of a tangible good and that is integral to
the functionality of the good and
b. A license that the customer can benefit from only in conjunction with a
related service (such as an on line service provided by the entity that enables
, by granting a license, the customer to access content. )

PROMISE TO GRANT LICENSE IS DISTINCT

If the promise to grant the license is distinct from the other promises in the
contract , the promise to grant the license is treated as a separate performance
obligation.

The entity determines whether the separate promise to grant the license will be
satisfied over time or at point in time by determining whether the licenses provides
the customer with either :

a. A right to access the entity’s intellectual property as it exists throughput the

license period or
b. A right to use the entity’s intellectual property as it exists at the point in time
at which the license is granted

- If the customer has the right to access the intellectual property as it exists
throughout the license period, the performance obligation is satisfied
overtime. Therefore , the amount of consideration allocated to the promise to
grant the license is recognized as revenue over the license period.
- If the customer has the right to use the intellectual property as it exists at
the point in time at which the license is granted, the performance obligation
is satisfied at a point in time. Therefore , revenue is recognized at the time
when the license is provided.

RIGHT TO ACCESS ;

The customer has the right to access the entity’s intellectual property as it exists
throughout the license period . if the customer cannot direct the use of , and obtain
substantially all of the remaining benefits from, the license at the point in time at
which the license is granted . this is the case if the intellectual property to which
the customer has right changes throughout the license period.

The intellectual property changes throughout the license period if :

a. The entity continues to be involved with its intellectual property and

b. The entity undertakes activities that significantly affect the intellectual
property to which the customer has rights .
 The customer has the right to access the entity’s intellectual property if all of the
following criteria are met :

a. 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 .
b. The rights granted by the license directly expose the customer to any
positive or negative effects of the entity’s activities identified in a above
c. Those activities do not result in the transfer of a good or a service to the
customer as those activities occur.

Although not determinative , the existence of a shared economic interest (for

example a sales based royalty ) between the entity and the customer related to the
intellectual property to which the customer has rights may also indicate that the
customer could reasonably expect that the entity will undertake such activities.

If the customer has the right to access the intellectual property, the promise to
grant a license is a performance obligation satisfied overtime because the customer
will simultaneously receive and consume the benefit from the entity’s performance
of providing access to its intellectual property as the performance occurs.

The entity shall apply an appropriate method to measure its progress towards the
complete satisfaction of that performance obligation to provide access.

RIGHT TO USE

The customer has the right to use the entity’s intellectual property as it exists at
the point in time at which the license is granted if the customer can direct the use
of, and obtain substantially all of the remaining benefits from , the license at the
point in time at which the license is granted . This is the case if the intellectual
property to which the customer has rights will not change.

Any activities undertaken by the entity merely change its own asset , which may
affect the entity’s ability to provide future licenses, however , those activities would
not affect the determination of what the licenses provides or what the customer
controls.

If the customer has the right to use the intellectual property, the promise to grant a
license is a performance obligation satisfied at a point in time .

The entity shall consider the following indicators of transfer of control when
determining the point in time at which the license transfers to the customer.

1. The entity has a present right to payment for the asset.

 2. The customer has legal title to the asset.
3. The entity has transferred physical possession of the asset.
4. The customer has the significant risks and rewards of ownership of the
asset .
5. The customer has accepted the asset .

However , revenue shall not be recognized before the point in time where the
customer is able to use and benefit from the license. For example, if a
software license period begins before an entity provides to the customer a
code that enables the customer to immediately use the software , the entity
would not recognize revenue before that code has been provided .
The following factors shall be disregarded when determining whether a
license provides a right to access or a right to use the entity’s intellectual
property.
a. Restrictions of time, geographical region or use- those restrictions define
the attributes of the promised license, rather than define whether the
entity satisfies its performance obligation at a point in time or overtime .
b. Guarantees provided by the entity that it has a valid patent to intellectual
property and that it will defend that patent from unauthorized use – a
promise to defend a patent right is not a performance obligation because
the act of defending a patent protects the value of the entity’s intellectual
property assets and provides assurance to the customer that the license
transferred meets the specifications of the license promised in the
contract.

SALES BASED OR USAGE BASED ROYALTIES

Regardless of whether the promise to grant a license is not distinct or distinct and
regardless of whether the distinct license provides the customer a right to access or
a right to use the entity’s intellectual property , an entity shall recognize revenue
for a sales based or usage based royalty promised in exchange for a license of
intellectual property only when the latter of the following events occurs :

a. The subsequent sale or usage occurs

b. The performance obligation to which some or all of the sales based or usage
based royalty has been allocated has been satisfied.

An entity is exempt from applying the “ Constraining estimates of variable

consideration “ principle of PFRS 15 when recognizing revenue from sales based or
usage based royalty.

SUMMARY OF PRINCIPLES :
PROMISE TO GRANT LICENSE IS

NOT DISTINCT

- Treat all promises in the contract as a single performance obligation

- Use general principles to determine whether the performance obligation is
satisfied overtime or at a point in time .

DISTINCT

- Treat the promise to grant the license as a separate performance obligation

- Use specific principles to determine if the promise provides the customer a
- a. right to access – performance obligation is satisfied overtime . 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

- The customer cannot direct the use of, and obtain substantially all of the
remaining benefits from , the license at the point in time at which the license
is granted .
- Intellectual property changes throughout the license period.
- a. the entity continues to be involved with the intellectual property
- b. the entity undertakes activities that significantly affect the intellectual
property
- Maybe continued by a sales based royalty agreement between the entity and
the customer.

RIGHT TO USE

- The customer can direct the use of, and obtain substantially all of the
remaining benefits from, the license at the point in time at which the license
is granted .
- Intellectual property does not change throughout the license period.

Step 2 Identify the performance obligations in the contract

Step 3 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 or services to a
customer , excluding amounts collected on behalf of third parties .

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 .

FRANCHISE FEES COME IN THE FORM OF :

1. Initial franchise fee – this is the one off payment made by the franchisee to
the franchisor to obtain the franchise right. Initial franchise fee 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.

The franchise agreement details the responsibilities of both the franchisor and the
franchisee and is usually for a specific length of time (typically 5 to 10 years ) .
Most franchise agreements provide for renewal when they expire.

Aside from consideration for the supply of know how, initial franchise fees may also
cover for the franchisor’s initial services in assisting the franchisee in establishing
the new business.

Examples of initial services provided by the franchisor to the franchisee include the
following :

1. Assistance in site selection, lease negotiations , financing , fitting out of the

premises, and supervision of the construction activity.
2. Initial training in all facets of operating the business.
3. Assistance with staff recruitment and training
 4. Access to preferential purchasing arrangements the franchisor has put in
place.
5. Provision of systems ( accounting, information and quality control)
6. Advertisements and promotion
7. Preparations for and professional execution of the grand opening
8. Initial presence of a trouble shooter for the first few days after the opening.

Initial franchise fees do not normally include costs of initial inventory or furniture
and fixtures.

11. CONTINUING FRANCHISE FEES – these are the periodic payments made by the
franchisee to the franchisor for the ongoing franchise support. Continuing franchise
fees are also referred to as royalty fees and are usually based on a certain
percentage (typically 1 % to 7%) of the franchisee’s sales , but can also be set up
as a fixed amount or on a sliding scale , and are payable in weekly or monthly
arrears.

In some cases . continuing franchise fees may be charged separately for the
following :

a. Management fees – these pay primarily for ongoing franchise support and
are usually calculated as percentage of franchisees sale
b. Training and conference fees
c. Accounting and other special service fees – in some franchises, the franchisor
provides bookkeeping services or maintains the information system of
franchisees. Fees may be charged for these services.
d. Marketing services fund – additional fee may be charged as contribution to
the marketing services fund or advertising fee intended to pay for national
product advertising and marketing activities.
e. Renewal fund – a fund maybe established to cover for the renewal fee of the
franchise when it expires. Contributions to funds are not recognized as
revenue by the franchisor until the earnings process occurs.

Continuing franchise fees are calculated in various ways which may include the
following :

a. Straight payments based on percentage of sales

b. Flat fee payments on weekly or monthly basis
c. Markup on products or services provided

111. SALE OF EQUIPMENT AND OTHER INTANGIBLE ASSETS – in most franchise

agreements , the franchisor provides equipment and other tangible assets to the
franchise for a separate fee. Also, the franchisor may purchase goods centrally and
supplies directly to franchisees. A markup, purchasing or handling fee may be
charged on tangible assets transferred to franchisees.

Step. 4 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 good or services.

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

If there is only one performance obligation in a contract, the transaction price shall
be allocated only to that single performance obligation.

JOURNAL ENTRIES

EXAMPLE 1 RECOGNITION AND MEASUREMENT OF REVENUE

On December 1, 2021, ABC COMPANY enters into a franchise contract with XYZ,
Inc. The franchise provides XYZ Inc. with the right to use ABC’s trade name and
sells ABC’s products for 5 years . The contract requires an initial franchise fee of
120,000 and a continuing franchise fee of 3 % of XYZ’s sales payable at the end of
each month.

The 120,000 initial franchise fee is non refundable and payable in full at contract
inception . ABC Co. as a franchisor, has developed a customary business practice to
undertake the following pre opening activities :

1. Assistance in site selection, lease negotiations , and fitting out of the

premises
2. Initial training in all facets of operating the business.
3. Assistance with staff recruitment and training .
4. Advertisement and promotion.
5. Preparations for and professional execution of the grand opening .

ABC COMPANY does not provide the activities above separately from the
granting of the franchise right.
The new franchise business started operations in December and as of
December 31, 2021 , ABC has no remaining obligation or intent to refund any
of the cash received and all of the services required under the franchise
agreement have been performed.
XYZ INC. reports total sales of 2,000,000 in December 2021.

Requirement :
 Provide the journal entries on December 1, 2021 and December 31, 2021
respectively.

SOLUTIONS :

STEP 2 : Identify the performance obligations in the contract .

The only performance obligation in the contract is the promise to grant the
franchise license.

The additional pre-opening activities associated with the franchise license are not
performance obligations because they do not directly transfer a good or service to
the customer , but rather part of the entity’s promise to grant the license.

Notice that the granting of licenses is included in the examples above. However
preopening activities related to the granting of license are not included in the
examples above.

Moreover, the pre opening activities are in nature , administrative tasks to set up
the franchise contract. Performance obligations do not include administrative tasks
to set up a contract.

Since the promise to grant the license is distinct , the entity shall apply the specific
principles to determine whether the license provides the customer a right to access
or a right to use the entity’s intellectual property.

The existence of a shared economic interest between the entity and the customer
may indicate that the customer could reasonably expect that the entity will continue
to be involved in the intellectual property and will undertake activities that
significantly affect the intellectual property to which the customer has rights.

In such case the intellectual property to which the customer has rights changes
throughout the license period.

Therefore, the franchise provides the customer the right to access the entity’s
intellectual property. Accordingly, the performance obligation is satisfied overtime.

STEP 3 DETERMINE THE TRANSACTION PRICE

The transaction price includes a fixed consideration of 120,000 (initial franchise

fee ) and a variable consideration of 3 % of customer sales ( the continuing
franchise fee)
STEP 4 ALLOCATE THE TRANSACTION PRICE TO THE PERFORMANCE OBLIGATION

Both the fixed and variable considerations are allocated to the sole performance
obligation of granting the franchise license.

STEP 5 RECOGNIZE REVENUE WHEN A PERFORMANCE OBLIGATION IS SATISFIED

Revenue is recognized as follows :

a. For the fixed consideration of 120,000 , the entity applies general principles
of PFRS 15 to determine a measure of progress that best depict the entity’s
performance.
Because the contract provides the customer with unlimited use of the entity’s
intellectual property for a fixed term (5 years) an appropriate measure of
progress maybe a time based method (straight line )
b. For the possible consideration of 3% of sales, the entity recognizes revenue
equal to 3 % of the customer’s sales as those sales occur.

The journal entries are as follows:

Dec. 1, 2021 Cash 120,000

Contact liability 120,000
To record the non refundable initial franchise fee

Contract liability – is an entity’s obligation to transfer goods or services to a

customer for which the entity has received consideration from the customer.
The initial franchise fee is initially recognized as a liability because the
performance obligation is not yet satisfied .

December 31, 2021 Contract liability (120k/5yearsx1/12) 2,000

Revenue 2,000
To recognize revenue from the initial franchise fee
December 31, 2021 Receivable (2,000,000 X 3%) 60,000
Revenue 60,000
To recognize revenue from the continuing franchise
fee (sales based royalty )

Receivable is debited rather than “contract asset “ because ABC Co. has an
unconditional right to the consideration.

Example 2 INTEREST REVENUE AND PROFIT FOR THE YEAR

 On January 1, 2021 ABC CO. enters into a contract with a customer to
transfer a license for a fixed rate of 100,000 payable as follows:
- 20% is payable upon signing of contract
- 80% is represented by a note receivable collectible in 4 equal annual
installments starting December 31, 2021 . The appropriate discount rate
is 12 %.
- The licenses transfers to the customer on January 3, 2022
- During 2021 ABC CO. incurs direct contract costs of 20,000
- Collectability of the note is reasonably assured .
- The license provides the customer with the right to use ABC’s intellectual
property as it exists at the point in time at which the license is granted .

Requirement : Compute for the profits in 2021 and 2022.

SOLUTION :

Step 2 – Identify the performance obligations in the contract.

The only performance obligation in the contract is the promise to transfer the
license .

The performance obligation is satisfied at a point in time because the license

provides the customer the right to use the entity’s intellectual property as it exists
at the point in time at which the license is granted.

STEP 3 DETERMINE THE TRANSACTION PRICE

Cash down payment (100,000 x 20%) 20,000

PV of note receivable

(100kx80% )/4) x PV of ordinary annuity @12% n=4 60,747

Transaction price 80,747

STEP 4 Allocate the transaction price to the performance obligations

The transaction price is allocated to the sole performance obligation of granting the
license.
STEP 5 RECOGNIZE REVENUE WHEN A PERFORMANCE OBLIGATION IS SATISFIED

The transaction price will be recognized as revenue in full on January 3, 2022 when
the license is transferred to the customer.

The profits in 2021 and 2022 are computed as follows :

2021 2022

Revenue - 80,747

Cost of franchise ( 20,000)

Gross profit 60,747

Interest income 7,290 5,764

Indirect costs - -

Profit for the year 7,290 66,511

Amortization table :

Date Collections Interest income Amortization Present value

1.1.21 60,747

12.31.21 20,000 7,290 12,710 48,037

12.31.22 20,000 5,764 14,236 33,801

12.31.23 20,000 4,056 15,944 17.857

12.31.24 20,000 2,143 17,857 0

Computation :

60,747 x 12 % = 7,290

48,037 x 12 % = 5,764
No revenue is recognized in 2021 because the license is not yet transferred to the
customer . No cost of franchise is also recognize as expense . Irrespective of the
satisfaction of the performance obligation in the contract , interest income is
nonetheless recognized because there is passage of time

UNCERTAINTY IN THE COLLECTABILITY OF CONTRACT REVENUE

Contract inception :

If the uncertainty in the collectability of contract revenue arises at contract

inception , the entity does not recognize any revenue from the contract . Any
consideration received is recognized as a liability and recognized as revenue only
when either of the following has occurred.

a. 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 non refundable .
b. The contract has been terminated and the consideration received is non
refundable.

The entity shall continue to assess the contract to determine if the criteria in PFRS
15 are subsequently met.

Example :

On January 1, 2021 ABC Co. enters into a contract with a customer to transfer a
license for a fixed fee of 100,000 payable as follows :

- 20% payable upon signing of contract

- 80% is represented by a note receivable collectible in 4 equal annual
installments starting December 31, 2021 . The appropriate discount rate
is 12 %.
- The license transfers to the customer on January 1, 2021
- ABC COMPANY incurs direct contact cost of 20,000 on January 1, 2021
- On January 1, 2021 ABC Company determines that there is significant
uncertainty as to the collectability of the note.
 - The license provides the customer with the right to use ABC’s intellectual
property a it exists at the point in time at which the license is granted .

SOLUTION :

Step 1 – Identify the contract with the customer

The consideration in the contract is probable of collection is not met, ABC COMPANY
shall not recognize any revenue from the contract. Any consideration received from
the contract is recognized as a liability and recognized as revenue only when either
of the following has occurred :

a. 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
b. The contract has been terminated and the consideration received is non
refundable.

The entry is as follows:

Dec 31, 2021 Cash 20,000

Notes receivable 80,000

Contract liability 80,747

Unearned interest income 19,253

(100,000x20%) t ( 100,000x80%)/4 x PV of ord. annuity @12%,n=4)=80,747

In subsequent periods , ABC Co. shall continue to asses the contract to determine if
the criteria are subsequently met .

If the criteria are subsequently met, ABC CO. shall account for the contract in
accordance with PFRS15 is prospectively . For example if collectability becomes
certain in 2022 ABC CO. shall recognize the contract liability and recognize
revenue from the contract .