Franchise Accounting

TERUEL, MARIA NICOLE

True or False
FALSE 1. PFRS 15 does not address the accounting for revenue from franchise agreements
TRUE 2. Under the current PFRSs, a franchisor recognizes the initial franchise fee as revenue in full at the
commencement of the franchisee’s business operations
TRUE 3. If a promise to grant a license is not 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
TRUE 4. If the intellectual property to which the customer has rights does not change over the license period, the
nature of the entity’s promise to transfer the license is most likely a “right to access”
TRUE 5. According to PFRS 15, if, at the inception of contract, the entity determines that the collectability of the
consideration in a franchise agreement is significantly uncertain, the entity may recognize revenue from the
contract using either the installment sales method or the cost recovery method

Multiple Choice:

6. A promise to grant a license is most likely to be distinct if

a. The license is integral to the functionality of a tangible good
b. The customer can benefit from the license only in conjunction with a related service
c. The performance obligation is satisfied over time
d. The customer can benefit from the license on its own and the license is separately identifiable

7. If the promise to transfer a license is distinct

a. The entity shall treat all the promises in the contract as a single performance obligation
b. The entity shall determine whether the performance obligation is satisfied over time or at a point in
time using the general principle of PFRS 15
c. The entity shall determine the nature of the grant of license as either “right to access” or “right to
use”
d. B and C

8. An entity enters into a contract with a customer to license intellectual property related to the design and
production processes for a good. The contract also specifies that the customer will obtain any updates to that
intellectual property for new designs or production processes that may be developed by the entity. The
updates are essentials to the customer’s ability to use the license because the customer operates in an
industry in which technologies change rapidly. The entity does not sell the updates separately and the
customer does not have the option to purchase the license without the update. Which of the following
statement is incorrect?
a. The promise to grant the license and to provide the updates are two separate performance obligations
b. The license and the updates are accounted for together as a single performance obligation
c. The general principles are applied to determine how the performance obligation is satisfied
d. The single performance obligation is satisfied over time.

9. Which of the following would most likely not be considered a separate performance obligation in relation to
a franchise agreement
a. Grant of license to use the frachisor’s trade name
b. Transfer of equipment to be use in the franchisee business
c. Franchisor’s promise to undertake activities to support the franchise
d. All of these are separate performance obligation
 10. On November 1, 20x1 an entity enters into a franchise agreement to grant a franchisee the right to operate a
shop using the entity’s trademark for 3 years. As consideration, the franchisee pays an upfront fee plus sale
based royalty. The entity customarily undertakes activities that aim to further improve the trademark.
Although those activities do not result in the direct transfer of good or a service to the franchisee, it is expected
that the franchisee will benefit from those activities. All the necessary preparations were completed on
January 31, 20x2. How would the entity recognize from the initial franchise
a. In full on November 1, 20x1
b. In full on January 31, 20x2
c. Deferred and amortized from November 1, 20x1 to January 31, 20x2
d. Deferred and amortized over the license period starting January 31, 20x2.

Problem Solving:

On January 1, 20x1 N Company enters into a contract to grant a franchisee the right to use N Company’s trade name and
sell its product for 10 years. In addition, the company also promises to provide the equipment necessary to operate the
franchise store. The contract stated a fixed consideration of Php 450,000 and a 5% sale based royalty. The fixed
consideration includes Php 150,000 payment for the equipment. This reflects the stand alone selling price of the
equipment. The company as a franchisor, has developed a customary business practice to undertake activities such as
analyzing the customer’s changing preference and implementing product improvements, pricing strategies, marketing
campaigns and operational efficiencies to support the franchise name. The company delivers the equipment to the
customer on February 1, 20x1. The customer commence business operations on March 1, 20x1 at which date the 10-year
license period starts to run. The franchisee reports sale of Php 1,200,000 for the year.

Required: Determine the following:

11. The performance obligations in the contract and how these will be satisfied

N Co. has two performance obligations. First, they must provide the franchisee with the necessary equipment.
Second, they must grant the franchisee the right to use the business name “N Co.” for them to succeed. On top of
that, researching customer preferences, product improvements, pricing strategies, marketing campaigns, and
performance to support franchisees are all part of the process.

12. The transaction price

Fixed Consideration 450,000

Add: 5% sale-based royalty (1.2M*5%) 60,000
Transaction Price 510,000

13. How the transaction price is allocated

The transaction price allocated to franchise right and equipment, as equipment stand-alone price is 150,000:

Franchise right 300,000 plus 5% of sales-based royalty = 360,000

Equipment 150,000.

14. How revenue will be recognized from the contract

Fixed Consideration 450,000
Divided by: 10 10
Add: 5% sale-based royalty (1.2M*5%) 60,000
Transaction Price 105,000

15. Provide the journal entries

Sr No. Particulars Debit Credit

1 Current assets 105,000
To revenue 105,000

2 Debtor 105,000
To current sales 105,000

3 Bank 105,000
To debtor 105,000