IV – Franchise Arrangements: Initial Franchise Fee and Continuing Franchise Fee

Dominador’s Pizza Inc. enters into a franchise agreement on December 31, 20x7, giving Dian
Jaycerette the right to operate as a franchisee of Dominador’s Pizza for 5 years. Dominador’s
charges Dian Jaycerette an initial franchise fee of P570,000 for the right to operate as a
franchisee. Of this amount, P228,000 is payable when Dian Jaycerette signs the agreement,
and the balance is payable in five annual payments of P68,400 each on December 31.

The credit rating of Dian Jaycerette indicates that money can be borrowed at 8%. The present
value of an ordinary annuity of five annual receipts of P68,400 each discounted at 8% is
P272,916. The unearned interest income or discount on notes amounted to P69,084 [(P68,400 x
5 years) less P272,916] represents the interest revenue to be accrued by Dominador’s Pizza Inc.
over the payment period.

The transaction price then amounted to P500,916 computed as follows:

Down payment.. . . .. . . . . . . . . . P228,000.00

PV of an ordinary annuity of 8% for 5-years: (P68,400 x3.99). . _272,916.00
Total transaction price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P500,916.00

Consider the following for the allocation of the transaction price on December 31, 20x7:

Rights to the trade name, market area, technical and proprietary P228,000.00
know-how.
Services – training, etc.. . . . . . . . . . . . . . . . . . . . . . . . 113,316.00
Machinery and equipment, etc. (costing, P114,000). . . . . . . . _159,600.00
Total transaction price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P500,916.00

Training is completed in February 1, 20x8, the equipment is installed in February 2, 20x8, and
Dian Jaycerette holds a grand opening on February 4, 20x8. On February 4, 20x8, franchise
opens. Dominador’s satisfies the performance obligations related to the franchise rights,
training, and equipment.

Dian Jaycerette also promises to pay ongoing or continuing fee (royalty payments) of 1% of its
annual sales (payable every January 31 of the following year) and is obliged to purchase
products from Dominador’s at its current stand-alone selling prices at the time of purchase.

Required:
1. Prepare any journal entries to record the revenue arrangement on:
a. December 31, 20x7, the date of signing and receipts of upfront payment.
b. February 1, 20x8, training is completed.
c. February 4, 20x8, franchise outlet opened.
d. December 31, 20x8, ongoing or continuing fee/royalty received.

Answer - Problem IV
1. The entries for the above transactions are as follows:
a. December 31, 20x7: Date of Signing
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228,000.00
Notes receivable (P570,000 – P228,000) . . . . . . . . . . . . . . . . . . . . . . . 342,000.00
Unearned interest income (or Discount on notes receivable) . . 69,084.00
Unearned franchise revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228,000,00
Unearned service revenue – training, etc. . . . . . . . . . . . . . . . . . . . 113,316.00
Unearned sales revenue – machinery and equipments, etc. . . . 159,600.00

b. February 1, 20x8: No entry since outlet not yet opened.

c. February 28, 20x8: Date of Opening

Unearned franchise revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228,000.00
Franchise revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228,000.00
Unearned service revenue – training, etc. . . . . . . . . . . . . . . . . . . . . . 113,316.00
Service revenue – training, etc………………………………………… 113,316.00
Unearned sales revenue – machinery and equipment, etc.. . . . . . . 159,600.00
Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159,600.00
Cost of goods sold. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114,000.00
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114,000.00
2. Determine the following:
a. How many performance obligations exists in this contract?

Answer:
There are three performance obligations in the contract for franchise:
PO 1 - Rights to the trade name, market area, and proprietary know-how for 5 years
are not individually distinct. Each one is not sold separately and cannot be used
with other goods or services that are readily available to the franchisee. Combined
rights give rise to a single performance obligation,

PO 2 - Training services, and

PO 3 - Equipment

Note: It should be noted that training (similar) services and equipment are distinct and
can be sold separately.

Commingled Revenue (Point in Time and Over Time) - It refers to a single initial franchise
fee for franchise rights, initial services, tangible property such as supplies and equipment.
The portion of the fee applicable to these assets shall be based on their fair values and
these assets are recognized upon transfer of ownership regardless when substantial
performances of services were made.

• Dominador’s cannot recognize revenue for the royalty payments because it is not
reasonably assured to be entitled to those sales-royalty amounts. That is, these
payments represent variable consideration (variable consideration encompasses any
amount that is variable under a contract, including, for example, performance
bonuses, penalties, discounts, rebates, price concessions, incentives and the
customer’s right to return products.

Variable consideration is considered to be a component of the transaction price. It is

part of the consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services and therefore should be estimated and
included in the transaction price for revenue recognition purposes)

Therefore, Dominador’s recognizes revenue for the royalties when (or as) the
uncertainty is resolved.

• Dominador’s promise to stand ready to PROVIDE PRODUCTS/SERVICES to the

franchisee in the future at a standalone selling price is NOT ACCOUNTED for as a
SEPARATE PERFORMANCE OBLIGATION (PO) in the contract because it DOES NOT
PROVIDE Dian Jaycerette with a material right

(a “material right” is something the customer wouldn’t get otherwise, so the seller is
obligated to provide it or if the customer is in effect paying in advance for future goods
and services such option provides the customer with a “material right”, then the option
should be accounted for as a separate performance obligation)

Thus, revenue from those sales is recorded in the future when the sales are made.

b. When will Dominador recognize revenue for the rights (combined) to the trade name, market
area and proprietary know-how which give rise to a single performance obligation?

Answer:
Point-in-Time: – Those combined rights (trade name, market areas and proprietary
know-how) give rise to a single performance obligation. Dominador’s satisfies
performance obligation at point in time when Dian Jaycerette obtains CONTROL of the
RIGHTS. That is, once Dian Jaycerette begins operating the store. Dominador has no
further obligation with respect to these rights.
 c. How much revenue (franchise revenue, service revenue and sales revenue – machinery and
equipment’s) be recognized on December 31, 20x7?

Answer:
As of December 31, 20x7, only signing of agreement and receipts of upfront payment and note
were made. Consider the following for allocation of the transaction price at December 31,
20x7.

Rights to the trade name, market area, technical and proprietary know- P 228,000.00
how
Services – training, etc.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113,316.00
Machinery and equipment, etc. (costing, P114,000). . . . . . . . . . . . _159,600.00
Total transaction price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . P 500,916.00

The entries on December 31, 20x7: Dominador’s signs the agreement and receives upfront
payment and note.
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228,000.00
Notes receivable (P570,000 – P228,000) . .. . . . .. . . 342,000.00
Unearned interest income (Discount on notes receivable) 69,084.00
Unearned franchise revenue . . . . . . . . . . . . . . . . . . . . . . 228,000,00
Unearned service revenue – training, etc. . . . . . . . . . . . . . 113,316.00
Unearned sales revenue – machinery and equipment, etc. 159,600.00

Training is completed in February 1, 20x8, the equipment is installed in February 2, 20x8,

and Doming holds a grand opening on February 4, 20x8.

It should be noted that training (similar) services and equipment are distinct and can be
sold separately. Dominador’s satisfies those performance obligations (services and
equipment) when it transfer the services and equipment to Doming.

d. How much revenue (franchise revenue, service revenue and sales revenue – machinery and
equipment) be recognized on February 4, 20x8?

Answer:
P500,916: February 4, 20x8: Franchise opens. Dominador’s satisfies the performance
obligations (point in time) related to the franchise rights, training and equipment. That is,
Dominador’s has no further obligations related to these elements of the franchise. Therefore,
franchise revenue amounted to P500,916.

Unearned franchise revenue . . . . . . . . . . . . . . . . . . . . . . . 228,000.00

Franchise revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 228,000.00
Unearned service revenue – training, etc. . . .. . 113,316.00
Service revenue – training, etc…… 113,316.00
Unearned sales revenue – machinery and equipment, et. 159,600.00
Sales revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159,600.00
Cost of goods sold. . . . . . . . . . 114,000.00
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114,000.00

As indicated, when Doming begins operations, Dominador’s Pizza satisfies the

performance obligations (point in time) related to the franchise rights, training and
equipment under the franchise agreement. That is, Dominador’s has no further obligations
related to these elements of the franchise.

e. How much continuing franchise revenue be recognized on December 31, 20x8, assuming the
sales of P5,985,000 was generated for the first year of operations?

Answer:
P59,850
Dominador’s recognizes revenue for the royalties (continuing fee) when (or as) the
uncertainty is resolved (over time). On December 31, 20x8, the continuing (royalty)
franchise fees:
Accounts receivable (P5,985,000) x 1%). . . . . . . . . . . . . . . . . . 59,850
Franchise revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,850
 December 31, 20x8: To record payment received and interest income on note:
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,400.00
Notes receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,400.00
Unearned interest income (or Discount on notes receivable). . . . 21,833.28
Interest income (P272,916 x 8%). . . . . . . . . . . . . . . . . . . . . 21,833.28

f. How much total franchise revenue [in relation to (d) and (e)] on December 31, 20x8

Answer:
P560,766 .Therefore, the total amount of franchise revenue recognized on December 31,
20x8 amounted to P467,466.50 computed as follows:
Franchise Revenue:
(Point in time, February 4, 20x8):
Initial Franchise Fee............................................................ P 500,916
(Over time)
Continuing franchise fee , P5,985,000 x 1%)..................... 59,850
Total Franchise revenue........................................................... P 560,766

g. In relation to (f), the gross profit on December 31, 20x8 amounted to?

Answer:
P446,766. Therefore, the total amount of franchise revenue recognized on December 31,
20x8 amounted to P467,466.50 (net income of P390,673.82) computed as follows:
Total Franchise revenue (refer to “F)...................................................P 560,766
Less: Cost of goods sold.................................................................. 114,000
Gross profit........................................................................................P 446.766
Less: Operating expenses........................................................... 0.00
P 446,766
Add: Interest income................................................................... 21,833.28
Net income...................................................................................P 468,599.28

h. In relation to (f), the net income on December 31, 20x8 amounted to?

Answer:
P468,599.28 or P468,599. Therefore, the total amount of franchise revenue recognized on
December 31, 20x8 amounted to P467,466.50 (net income of P390,673.82) computed as
follows:
Total Franchise revenue (refer to “F)......................................................P 560,766
Less: Cost of goods sold..................................................................... 114,000
Gross profit...........................................................................................P 446,766
Less: Operating expenses............................................................ 0.00
P 446,766
Add: Interest income...................................................................... 21,833.28
Net income.......................................................................................P 468,599.28
 V - Franchises; Residual Method (refer to Chapter 12 for reference)

Edgardo S. Cabalde Muffler Enterprise sells franchise arrangements throughout the Philippines
and United States. Under a franchise agreement, Edgardo S. Cabalde Muffler receives
P720,000 in exchange for satisfying the following separate performance obligations:
• franchisees have a five-year right to operate as a Edgardo S. Cabalde Muffler Muffler
retail establishment in an exclusive sales territory,
• franchisees receive initial training and certification as a Edgardo S. Cabalde Muffler
Mechanic, and
• franchisees receive a Edgardo S. Cabalde Muffler building and necessary equipment.

The stand-alone selling price of the initial training and certification is P18,000, and P540,000 for
the building and equipment. Edgardo S. Cabalde Muffler estimates the stand-alone selling
price of the five-year right to operate as a Edgardo S. Cabalde Muffler establishment using the
residual approach.

Edgardo S. Cabalde Muffler received P90,000 on July 1, 20x6, from Butch Atianzar and
accepted a note receivable for the rest of the franchise price. Edgardo S. Cabalde Muffler will
construct and equip Butch Atianzar’s building and train and certify Butch Atianzar by
September 1, and Butch Atianzar’s five-year right to operate as a Edgardo S. Cabalde Muffler
establishment will commence on September 1 as well.

Required:
1. What amount would Edgardo S. Cabalde Muffler calculate as the stand-alone selling
price of the five-year right to operate as a Monochrome Muffler retail establishment?

Answer:
Total amount of franchise agreement P 720,000
Less: stand-alone selling price of training (18,000)
Less: stand-alone selling price of building and equipment __(540,000)
Stand-alone selling price of five-year right P 162,000

2. What journal entry would Edgardo S. Cabalde Muffler record on July 1, 20x6, to reflect
the sale of a franchise to Butch Atianzar?

Answer:
As of July 1, 20x6, Edgardo S. Cabalde has not fulfilled any of its performance obligations, so the
entire P720,000 franchise fee is recorded as deferred revenue.
Cash 90,000
Notes receivable 630,000
Deferred revenue 720,000

3. How much revenue would Edgardo S. Cabalde Muffler recognize in the year ended
December 31, 20x6, with respect to its franchise arrangement with Butch Atianzar?
(Ignore any interest on the note receivable.)

Answer:
On September 1, 20x6, Edgardo S. Cabalde has satisfied its performance obligations with respect
to training and certifying Perkins and delivering an equipped Monochrome Muffler building.

Therefore Edgardo S. Cabalde should recognize revenue of P18,000 + P540,000 = P558,000 on

that date.

In addition, by December 31, 20x6, Edgardo S. Cabalde has earned 4 months of revenue
(September – December) associated with the five-year right it granted to Pentagon (Butch
Atianzar),

So Edgardo S. Cabalde should recognize revenue of (P162,000)/5yrs × 4/12= P10,800 associated

with that right.

Total revenue recognized for the year ended December 31, 20x6, is P558,000 + P10,800 =
P568,800.
23. d – the amount of P41,000 Is the nearest answer but the suggested correct answer should be P41,555
(refer to entry below):

Recognition of Franchise Rights Revenue Over Time

Depending on the economic substance of the rights, the franchisor may be providing access to the
right rather than transferring control of the franchise rights.

In this case, the franchise revenue is recognized over time, rather than at a point in time (November
1, 20x7), therefore, the P41,555 is unearned franchise revenue while training (as service) and
equipment (sales of equipment) are separately classified but not as an unearned franchise revenue
(in contrast to PAS 18).

November 1, 20x7: Date of Opening/Franchise Opens: - Rights to trade name (to record revenue
from delivery of franchise rights – point in time/right of use)
Unearned Franchise Revenue ........................... . . . . . . . . . . 41,555
Franchise revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41,555
Cash/down-payment..............................................................P 40,000
PV of Installment payment for two (2) periods:
P30,000 x 1.78326 (PV of an annuity of P1 for 2 periods) 53,498
Total............................................................................................P 93,498
The PV of the elements of revenue of P93,498 should be allocated to:

Rights to trade name: P93,498 x (40,000/90,000)............P 41,555

Training services: P93,498 x (11,500/90,000).................... 11,947
Equipment: P93,498 x (38,500/90,000)............................ 39,996
Total..................................................................................... P 93,498

Franchises often include a license (right of use-point in time), as well as goods and services
transferred at the start of the franchise as well as over the life (right of access-over time) of the
franchise.

A license is said to transfer a right of use if the seller’s activities during the license period are not
expected to affect the intellectual property being licensed to the customer. In that case revenue is
recognized at the start of the license period, that is, when the right is transferred.

24. a – nearest amount for unearned service revenue but the suggested correct answer should be
P11,947 (refer to entry below):

Recognition of Franchise Rights Revenue Over Time

Depending on the economic substance of the rights, the franchisor may be providing access to the
right rather than transferring control of the franchise rights. In this case, the franchise revenue is
recognized over time, rather than at a point in time (August 1, 20x8), therefore, the P11,947 is
unearned service revenue (note: not as a unearned franchise revenue in contrast to PAS 18)

August 1, 20x5: Date of Signing:

Cash. ....................................................... . . . . . . . . . . . . . . . . 40,000
Notes receivable (P30,000 x 2)................................................ 60,000
Unearned Interest Income/Discount on Notes Receivable 6,502
Unearned franchise revenue............................................... 41,555
Unearned service revenue – training services..................... 11,947
Unearned sales revenue – equipment................................ 39,996

Cash/down-payment..............................................................P 40,000
PV of Installment payment for two (2) periods:
P30,000 x 1.78326 (PV of an annuity of P1 for 2 periods) 53,498
Total............................................................................................P 93,498

The PV of the elements of revenue of P93,498 should be allocated to:

Rights to trade name: P93,498 x (40,000/90,000)............P 41,555
Training services: P93,498 x (11,500/90,000).................... 11,947
Equipment: P93,498 x (38,500/90,000)............................ 39,996
Total..................................................................................... P 93,498
 Recognition of Franchise Rights Revenue Over Time
Depending on the economic substance of the rights, the franchisor may be providing access to the
right (over time) rather than transferring control of the franchise rights. In this case, the franchise
revenue is recognized over time, rather than at a point in time (August 1, 20x5), therefore, the
P11,9470 is unearned service revenue (note: not as a unearned franchise revenue in contrast to IAS
18)

25. c
Cash = P560,000 + P48,000 = P608,000
Franchise Fee Revenue = P560,000
Unearned Franchise Fees = P48,000 × 20% = P9,600
Revenue from Franchise Fees = P48,000 – P9,600 = P38,400.

26. b - Down payment P200,000

Add: Present Value 545,872
Total 745,872
Less: (120,000-96,000) 4,000___ deferred*
Revenue from Franchise 721,872

*Recognized as revenue (point in time) when the equipment is delivered.

27. a
Total Franchise Fee…………………………………………… P1,600,000
Less: Unearned Interest Income
Amount due (P1,600,000 – P320,000, downpayment) P1,280,000
Less: Present value of payments…………………. 1,014,000 ( 266,000)
Bargain Purchase Option (P60,000-P50,000) – note ( 10,000)
Advertising (P1,000 x 60 months)……………………. ( 60,000)
Revenue from Franchise Fee………………………………. P1,264,000

28. d
Incidentally, the entry would be as follows: (Gross Method)
Cash …………………………………………………………................... 320,000
Notes Receivable........................................................................ 1,280,000
Unearned Interest Income/Discount on Notes Receivable.. 266,000
Revenue from Franchise Fees............................................... 1,264,000
Unearned Franchise Fees (P10,000 + P60,000)..................... 70,000

Incidentally, the entry would be as follows: (Net Method)

Cash …………………………………………………………................... 320,000
Notes Receivable (P1,280,000 – P266,000)................................... 1,014,000
Revenue from Franchise Fees............................................... 1,264,000
Unearned Franchise Fees (P10,000 + P60,000)..................... 70,000

29. c
Because Carlos had completed training and was open for business on August 1, 20x6,
Ronella apparently has satisfied its performance obligation with respect to the initial
training, equipment and furnishings, so it would recognize P50,000 of revenue in 20x6.

In addition, since Carlos was a franchisee for the last six months of 20x6 (starting July 1),
Ronella should recognize 6 ÷ 12 = 50% of a yearly fee of P30,000, or P15,000.

In total, Ronella recognizes revenue from Carlos of P50,000 + P15,000 = P65,000 in 20x6.

30. a -
Total amount of franchise agreement P 600,000
Less: stand-alone selling price of training (15,000)
Less: stand-alone selling price of building and equip. __(450,000)
Stand-alone selling price of five-year right P 135,000

31. b - As of July 1, 20x6, Joey Monitor has not fulfilled any of its performance obligations, so the
entire P600,000 franchise fee is recorded as deferred revenue.
Cash 75,000
Notes receivable 525,000
Unearned/Deferred revenue 600,000
32. d - On September 1, 20x6, Joey Monitor has satisfied its performance obligations with
respect to training and certifying Perkins and delivering an equipped Joey Monitor building.
Therefore, Joey Monitor should recognize revenue of P15,000 + P450,000 = P465,000 on that
date. In addition, by December 31, 20x6, Joey Monitor has earned 4 months of revenue
(September – December) associated with the five-year right it granted to Althea, so Joey
Monitor should recognize revenue of P135,000 × (4 ÷ (5 × 12)) = P9,000 associated with that
right. Total revenue recognized for the year ended December 31, 20x6, is P465,000 + P9,000
= P474,000.

33. d
Revenue = P400,000
Interest income = P160,000 ×8% ×9/12 = P9,600
Cash = P128,000 – P9,600 = P118,400
Repossession revenue: P240,000 – P128,000 = P112,000.

34. b
The revenue from franchise would be:
Cash……………………………………………………………………………………………… P 25,000
PV of Note…………………………………………………………………………..P68,234
Less: Reasonable profit on sale of
Equipment P15,000 – P12,000)………………………………………….… 3,000 65,234
P 90,234
Incidentally, the entries would be:
Upon receipt of IFF:
Cash………………………………………………………………………… 25,000
Notes Receivable………………………………………………………… 90,000
Unearned Interest Income (P90,000 – P68,234)…………. 21,766
Franchise Revenue……………………………………………. 90,234
Unearned Franchise Revenue………………………………. 3,000

35. d
Total Franchise Fee…………………………………………… P 800,000
Less: Unearned Interest Income
Amount due (P800,000 – P160,000 down payment) P 640,000
Less: Present value of payments…………………. 507,200 ( 132,800)
Bargain Purchase Option (P60,000-P50,000)……… ( 10,000)
Advertising (P1,000 x 60 months)……………………. ( 60,000)
Revenue from Franchise Fee………………………………. P 597,200

36. c – refer to No. 37

37. d
Incidentally, the entry in relation to Nos. 35 and 36 would be as follows: (Net Method)
Cash …………………………………………………………................... 160,000
Notes Receivable (P640,000 – P132,800)................................... 507,200
Revenue from Franchise Fees............................................... 597,200
Unearned Franchise Fees (P10,000 + P60,000)..................... 70,000

Incidentally, the entry would be as follows: (Gross Method)

Cash …………………………………………………………................... 160,000
Notes Receivable........................................................................ 640,000
Unearned Interest Income/Discount on Notes Receivable.. 132,800
Revenue from Franchise Fees............................................... 597,200
Unearned Franchise Fees (P10,000 + P60,000)..................... 70,000