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Chapter 6

Appendix 6A Franchises

Prepared by:
Patricia Zima, CA
Mohawk College of Applied Arts and Technology
Franchises

Franchise revenue recognized from two


sources:
Initial Franchise Fee: sale of initial
franchises and related assets or services
Continuing Franchise Fees: based on
franchise operations

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Initial Franchise Fee
Recorded as revenue only when and as the
franchisor has established substantial
performance:
a) The services obligated to be performed have
been so performed
No obligation to refund any portion of the
fee received to date
Substantial performance of required
services
b) Collection of the fee is reasonably assured
The beginning of operations normally considered
the earliest time substantial performance has
occurred
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Initial Franchise Fee Example
Initial franchise fee: $50,000
Down payment: $10,000
Balance: five equal annual instalments
Discount rate: 8%
PV of $8,000 ordinary annuity = $31,942
Difference (40,000 31,942) = $8,058 is interest revenue to
franchisor
Entries if reasonable expectation of refund and significant
performance by franchisor required:
Cash 10,000
Notes Receivable 40,000
Discount on Note 8,058
Unearned Franchise Fees 41,942
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Initial Franchise Fee Example
Initial franchise fee: $50,000
Down payment: $10,000
Balance: 5 equal annual instalments
Discount rate: 8%
PV of $8,000 ordinary annuity = $31,942
Difference (40,000 31,942) = $8,058 is interest revenue to
franchisor
Entries if low expectation of refund, minimal amount of future
services to be provided by franchisor, and collection of the
note reasonably assured:
Cash 10,000
Notes Receivable 40,000
Discount on Note 8,058
Revenue from Franchise Fees 41,942
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Initial Franchise Fee Example
Initial franchise fee: $50,000
Down payment: $10,000
Balance: 5 equal annual instalments
Discount rate: 8%
PV of $8,000 ordinary annuity = $31,942
Difference (40,000 31,942) = $8,058 is interest revenue to
franchisor
Entries if no refund, substantial performance by franchisor
required, and collection reasonably assured:
Cash 10,000
Notes Receivable 40,000
Discount on Note 8,058
Revenue from Franchise Fees 10,000
Unearned Franchise Fees 31,942
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Initial Franchise Fee Example
Entries if no refund of initial down payment, no
performance by franchisor required, and collection
highly uncertain:
Cash 10,000
Revenue from Franchise Fees 10,000

Entries if down payment refundable, or substantial


performance by franchisor required:
Cash 10,000
Unearned Franchise Fees 10,000

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Continuing Franchise Fees

Received in return for continuing rights under


the franchise agreement and provision of
services by franchisor
Reported as revenues when they are earned
and receivable from the franchisee
If an amount is included which is ear-marked
for a specific purpose e.g. for local advertising,
that amount is deferred

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Special Issues
Bargain Purchase
When the franchisee may purchase assets
at a lower than market price from the
franchisor
Portion of initial franchise fee is deferred if
the bargain price is lower than normal
selling price or if franchisor does not make a
reasonable profit
Adjustment to selling price when assets are
purchased by the franchisee
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Special Issues

Options to Purchase
Where the franchisor has the right to
purchase the franchisees business
Initial franchise fee recorded as a liability if
it is probable that a purchase will occur
When option is exercised, the liability
would reduce the franchisors investment

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Special Issues

Franchisors Cost
Overall objective is to match related costs
and revenues
Direct costs are deferred for any specific
franchise sale where revenue has not
been recognized
Indirect costs, such as selling and
administrative expenses, are expensed as
incurred

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Disclosures of Franchisors
Full disclosure of all significant commitments
and obligations is required
Description of services yet to be performed is
also required
Initial franchise fees are reported as a
separate revenue line item if significant
Revenues and costs of franchisor-owned
outlets should be disclosed separate from the
revenues and costs of franchised outlets

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