Chapter 8

Accounting for Franchise Operations –

Franchisor

PROBLEM 8-1: TRUE OR FALSE

1. FALSE 6. FALSE
2. FALSE 7. FALSE
3. FALSE 8. FALSE
4. FALSE 9. TRUE
5. FALSE 10. TRUE

PROBLEM 8-2: THEORY & COMPUTATIONAL

1 C 6 A
2 C 7 C
3 B 8 B
4 A 9 B
5 B 10 D
11. B
12. D

13. Solutions:

Step 2: Identify the performance obligations in the contract

There is only one performance obligation in the contract, i.e., the promise to
grant the license.

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.

Analysis:
a. The contract requires ABC Co. to undertake activities that significantly
affect the intellectual property to which the customer has rights (i.e., ABC
Co. is continually involved in developing further the brand).
b. The customer is exposed to any positive or negative effects of those
activities.
c. Those activities do not result in the transfer of a good or a service to the
customer as those activities occur.

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Conclusion:
The license provides the customer the right to access the entity’s intellectual
property as it exists throughout the license period. Therefore, the
performance obligation is satisfied over time.

Step 3: Determine the transaction price

The transaction price is the fixed payment of ₱1,400,000.

Step 4: Allocate the transaction price to the performance obligations

The ₱1,400,000 transaction price is allocated to the single performance
obligation of granting the license.

Step 5: Recognize revenue when (or as) a performance obligation is

satisfied

Since the performance obligation is satisfied over time, the entity recognizes
revenue over the license period by measuring its progress towards the
complete satisfaction of the performance obligation. The entity shall apply the
general principles of PFRS 15 to identify the method that best depicts its
performance in the license.

Because the contract provides the customer with unlimited use of the
licensed characters for a fixed term (i.e., 7 years), the most appropriate
measure of progress may be a time-based method (i.e., straight-line
method).

Journal entries:
Jan. 1, Cash on hand 1,400,000
20x1 Contract liability 1,400,000
to record the non-refundable initial
franchise fee
July 1,
20x1
No entry
Dec. 31, Contract liability (1.4M ÷ 7) x 6/12 100,000
20x1 Revenue 100,000
to recognize revenue from the franchise

PROBLEM 8-3: EXERCISES

1. Solutions:

Requirement (a):
Step 2: Identify the performance obligations in the contract
There is only one performance obligation in the contract, i.e., the promise to
grant the license.

The additional activities associated with the license (i.e., the creation of new
characters and the changes to the images of the characters) do not directly

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transfer a good or service to the customer because they are part of the
entity’s promise to grant a license and, in effect, change the intellectual
property to which the customer has rights.

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.

Analyses:
The problem states the following:
a. “However, newly created characters appear regularly and the images of
the characters evolve over time.”
b. “The contract requires the customer to use the latest images of the
characters.”

From the above statements, we can infer that the intellectual property to
which the customer has rights changes throughout the license period. This is
because new characters are continually created and that the images of the
characters are continually changed. Also, the contract requires the customer
to use the latest images of the characters.

Requirements (b) and (c):

Accordingly, the license provides the customer the right to access the
entity’s intellectual property as it exists throughout the license period.
Therefore, the performance obligation is satisfied over time.

Moreover, the following criteria under PFRS 15 are met:

a. The customer reasonably expects (arising from the entity’s customary
business practices) that the entity will undertake activities that will affect
the intellectual property to which the customer has rights (i.e., the
characters). Those activities include development of the characters and
the publishing of a weekly comic strip that includes the characters.
b. The rights granted by the license directly expose the customer to any
positive or negative effects of the entity’s activities because the contract
requires the customer to use the latest characters.
c. Even though the customer may benefit from those activities through the
rights granted by the license, they do not transfer a good or service to
the customer as those activities occur.

Requirement (d):
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
Since the performance obligation is satisfied over time, the entity recognizes
revenue over the license period by measuring its progress towards the
complete satisfaction of the performance obligation. The entity shall apply the
general principles of PFRS 15 to identify the method that best depicts its
performance in the license.

Because the contract provides the customer with unlimited use of the
licensed characters for a fixed term (i.e., 4 years), the most appropriate
measure of progress may be a time-based method.

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2. Solutions:
Requirement (a):
The only performance obligation in the contract is the promise to grant the
license.

Requirement (b):
The transaction price includes a variable consideration (i.e., sales-based
royalty).

Requirement (c):
The transaction price allocated to the single performance obligation of
granting the license.

Requirement (d):
Regardless of whether the license provides the customer the right to access
or the right to use the entity’s intellectual property, the entity recognizes
revenue as and when the ticket sales occur.

This is because the consideration for the license is a sales-based royalty and
the entity has already transferred the license to the movie to which the sales-
based royalty relates.

3. Solutions:
Requirement (a):
Step 2: Identify the performance obligations in the contract
There is only one performance obligation in the contract, i.e., the promise to
grant the license.

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.

Analyses:
The problem states that “The customer can determine how and when to use
the right without further performance by Pongcuter Co. and does not expect
that Pongcuter Co. will undertake any activities that significantly affect the
intellectual property to which the customer has rights.”

From the statement above, it can be inferred that the intellectual property to
which the customer has rights will not change because the entity does not
undertake activities that significantly affect the intellectual property to which
the customer has rights.

Requirement (a.i):
Therefore, the nature of the entity’s promise in transferring the license is to
provide a right to use the entity’s intellectual property in the form and the

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functionality with which it exists at the point in time that it is granted to the
customer.

Requirement (a.ii):
Consequently, the license is a performance obligation satisfied at a point in
time.

Requirement (b):
Step 3: Determine the transaction price
The transaction price is the fixed fee of ₱1,000,000.

Requirement (c):
Step 4: Allocate the transaction price to the performance obligations
The ₱1,000,000 transaction price is allocated to the single performance
obligation of granting the license.

Requirement (d):
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
Pongcuter Co. recognizes the ₱1,000,000 fee as revenue on April 1, 20x1
when the customer has the ability to use the software.

Requirement (e):
Jan. 1, Cash on hand 1,000,000
20x1 Contract liability 1,000,000

Feb. 1,
20x1
No entry
Apr. 1, Contract liability 1,000,000
20x1 Revenue 1,000,000

4. Solutions:

Step 2: Identify the performance obligations in the contract

The promise to grant the license and the promise to transfer the equipment
are distinct because:
a. The customer can benefit from each promise on their own or together
with other resources that are readily available. (That is, the customer can
benefit from the license together with the equipment that is delivered
before the opening of the franchise and the equipment can be used in
the franchise or sold for an amount other than scrap value.)
b. The license and equipment are separately identifiable.

Moreover, the fact that ABC Co. regularly sells the license and the equipment
separately indicates that a customer can benefit from each of the license and
the equipment on its own or with other readily available resources.

Conclusion:
There are two separate performance obligations in the contract:

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 1. License; and
2. Equipment.

 Since the license is distinct, the entity applies the specific principles to
determine whether the license provides the customer the right to access
or the right to use the entity’s intellectual property.

The problems states that 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. Therefore, the performance obligation of transferring the
license is satisfied at a point in time.

 ABC Co. uses the general principles to identify whether the performance
obligation of transferring the equipment is satisfied over time or at a point
in time.

Since control over the equipment transfers to the customer upon delivery, the
performance obligation is also satisfied at a point in time.

Summary of answers to Requirement (a):

The two separate performance obligations in the contract are as follows:
1. License (satisfied at a point in time)
2. Equipment (satisfied at a point in time)

Requirement (b):
Step 3: Determine the transaction price
The transaction price is sum of the 20% cash down payment and the present
value of the future cash flows from the note receivable. This is computed as
follows:

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

PV of note receivable:
[(100K x 80%) ÷ 4] x PV of ordinary annuity @12%, n=4 60,747
Transaction price 80,747

Requirement (c):
Step 4: Allocate the transaction price to the performance obligations
The transaction price is allocated to the performance obligations in the
contract on the basis of their stand-alone selling prices. The allocation is
done as follows:

Performance Stand-alone Transaction

obligations selling prices Allocation price
(80,747 x
License 38,000 38K/78K) 39,338
(80,747 x
Equipment 40,000 40K/78K) 41,409
Totals 78,000 80,747

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Requirement (d):
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
The ₱41,409 allocated to the equipment will be recognized as revenue on
January 15, 20x1 while the ₱39,338 allocated to the license will be
recognized as revenue on February 1, 20x1.

Requirement (e):

The entry on January 1, 20x1 is as follows:

Jan. 1, Cash on hand 20,000
20x1 Note receivable 80,000
Contract liability 80,747
Unearned interest income 19,253

Jan. 15, Contract liability 41,409

20x1 Revenue 41,409
Jan. 15, Cost of sales 30,000
20x1 Inventory 30,000

The entry on March 1, 20x1 is as follows:

Feb. 1, Contract liability 39,338
20x1 Revenue 39,338

PROBLEM 8-4: CLASSROOM ACTIVITY

1. A
2. A
3. B
4. A
5. D (400,000 ÷ 5) = 80,000 x 1/12 = 6,666.67

PROBLEM 8-5: THEORY

1. D 6. B
2. C 7. A
3. D 8. B
4. B 9. B
5. D 10. D