FRANCHISE
ACCOUNTING
AFAR 1
DEFINITION
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A FRANCHISE is a contractual agreement under which the
franchisor grants the franchisee the right to sell certain products or
services, to use a certain trademarks or trade names or to perform
certain functions, usually within a designated geographical area.
A franchise generally involves the grant from one party (franchisor)
to another party (franchisee), the right to sell the granting party’s
goods or services.
The franchisor should apply the requirements of PFRS 15 in
accounting its income from franchise contracts. PFRS 15 supersedes
PAS 18, Revenue.
Core Principle of 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
FIVE STEP PROCESS
STEP 1: Identify the contract with the customer. The contract is with a
customer and the collectability of the consideration is PROBABLE.
STEP 2: Identify the performance obligations 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.
(b) The promise to transfer the good or service is separately identifiable
from other promises in the contract
determine whether the license provides the customer with either RIGHT
TO ACCESS the entity's intellectual
property or RIGHT TO USE the entity's intellectual property.
FIVE STEP PROCESS
RIGHT TO ACCESS - Performance obligation is satisfied OVER TIME since 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 it is granted.
Thus revenue recognition is OVER THE LICENSE PERIOD.
RIGHT TO USE - Performance obligation is satisfied AT A POINT IN TIME since
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 it is granted.
Thus revenue recognition is AT A POINT IN TIME after satisfaction of
performance obligation."
STEP 3: Determine the transaction price. 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. (e.g. sales tax or VAT)
FIVE STEP PROCESS
Transaction price in a franchise contract is commonly referred to as the franchise fees.
Franchise fees come in the form of:
(1) INITIAL FRANCHISE FEE – payment for establishing the relationship and providing some
initial services. CRITERIA TO RECOGNIZE REVENUE:
S – satisfaction of performance obligation (substantial performance)
P – period of refund has expired (non-refundable) ( if silent)
C – collectibility is reasonably assured ( if silent)
NOTE: (EXCEPTION TO THE RULE ABOVE) Cash received as down payment is
recognized as revenue if non-refundable and represents a fair measure of the services
already rendered by franchisor even though there is no substantial performance.
(2) CONTINUING FRANCHISE FEE (CONTINGENT FRANCHISE FEE) – are fees received (a) in
return for continuing rights granted by the agreement; (b) for providing management
training, advertising and promotion, legal assistance and other support. Continuing
franchise fees (royalty fee) should be reported as revenue when they are earned unless
portion of them has been designated for a particular purpose. (e.g. if it is conditional)
FIVE STEP PROCESS
STEP 4: Allocate the transaction price to the performance obligations.
The transaction price is allocated to the performance obligations on the
RELATIVE STAND-ALONE PRICES of the distinct goods and services.
(Using relative sales value approach or residual approach)
STEP 5: Recognize revenue when (or as) a performance obligation is
satisfied.
For performance obligations satisfied over time, 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 satisfied the performance
obligation. NOTE: Revenue is measured at the amount of transaction
price allocated to the performance obligation satisfied.
REVENUE RECOGNITION METHOD
a. Accrual Basis. This method is used when the initial franchise fee is
collectible over an extended period of time and the collectability of the
unpaid portion of the franchise fee is reasonably assured.
b. Installment method or Cost Recovery Method. This method should
be used in exceptional cases, that is, when the initial franchise fee is
collectible over an extended period and the collectability of the unpaid
portion of the initial franchise fee is uncertain.
ACCOUNTING FOR FRANCHISE COSTS
Franchise accounting
franchisor’s cost.
also
involves
proper
accounting
for
the
The objective is to match related costs and revenues by reporting the as
components of income in the same accounting period.
Franchisors should normally DEFER DIRECT COSTS (incremental costs)
relating to specific franchise sales for which revenue has not yet been
recognized. Deferred until related revenue is recognized. It should not
exceed the anticipated related revenue.
INDIRECT COSTS of a regular and recurring nature, such as selling and
administrative expenses, should be EXPENSED AS INCURRED.
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QUESTIONS?