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
No explicit guidance given in IFRS other than in the illustrative examples
(which are not technically part of the standard)

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

Initial Franchise Fee - Example

Initial franchise fee: P50,000

Down payment: P10,000
Balance: five equal annual installments
Discount rate: 8%

PV of P8,000 ordinary annuity = P31,942

Difference (40,000 - 31,942) = P8,058 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

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

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

Entries if no refund of initial down payment, no performance by franchisor required,

and collection is 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

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

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 //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

Options to Purchase

- Where the franchisor has the right to purchase the franchisee's 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 franchisor's investment

Franchisor's 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

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 outlet