Licenses &

Royalties,
Franchises,
Non-refundable
Upfront Fees
01 02
INTRODUCTION LICENSES
Licenses & Royalties, Point-in-time vs. Overtime
Franchises
Performance Obligation

03 04
ROYALTIES FRANCHISES
Variable Consideration Initial Franchise Fee and
Continuing Franchise Fee
Income Statement

05 06
OTHER FRANCHISE NON-REFUNDABLE
TOPICS UPFRONT FEES
Bargain Purchase,
Commingled Revenue,
Repossessed Franchise,
Purchase option
01
INTRODUCTION
 Licenses and Royalties
• Licenses allows a customer to use another entity’s intellectual
property (IP) in exchange for a fee.
• Examples of Licenses of IP are Software and Technology, Media
and Entertainment, Royalties, Franchises, Patents, Copyrights, and
Trademarks.
• The new standards for Licenses falls on PFRS 15, Revenue from
Contracts with Customer that includes Construction Contracts,
Royalties, Franchises, and Consignment.
 Franchise Accounting
• The franchisor grants to the franchisee all rights to sell the franchisor’s
products and use its name for a specified period of time
• Four types of franchising arrangement have evolved:
1.) Manufacturer-retailer;
2.) Manufacturer-wholesaler;
3.) Service Sponsor-retailer;
4.) Wholesaler-retailer.
• The franchisor also typically provides initial start-up services as well as
providing ongoing products and services
 Performance Obligations
• The franchisor must evaluate each part of the franchise agreement
to identify and determine if they qualify as separate performance
obligations and accounted for accordingly.
• If the promise to grant a license is distinct from other promised
goods or services, it is a separate performance obligation.
• Whether the separate performance obligation is satisfied at a point
in time or overtime depends on the right conferred.
 02
LICENSES
 Types of Licenses
1. Right to Access (OVERTIME/OT)
• Provision of access to Intellectual Property (IP) as it exists throughout the
license period.
• Revenue is recognized overtime.

2. Right to Use (POINT-IN-TIME/PT)

• If licensed IP does not have those characteristics in Right to Access, it
provides a Right to Use, by default (Transfer of a right to use IP as it exists
at the point in time in which the license is granted).
• Revenue is recognized at a certain point in time.
 Right to Access (OVERTIME/OT)
• Some licenses provide customer with access to the seller’s IP with the
understanding that the seller will undertake ongoing activities during the
license period that affect the benefit customer receives.
• Licenses are considered Right to Access when they meet all of the
following criteria:
1. Contract requires or customers expects that IP will change and
customer has right to changed IP.
2. Rights granted by license may have negative or positive effects on the
customer.
3. No further transfer of good or service (similar to US GAAP).
 Right to Use (POINT-IN-TIME/PT)
• Some licenses transfer a right to use the seller’s IP as it exists when
the license is granted.
• Subsequent activity by the seller does not affect the benefit that the
customer receives.
• Licenses are considered Right to Use when they did not meet Any
of the following criteria stated on Right to Access
(OVERTIME/OT)
• Revenue is recognized at the point in time when the right is
transferred.
 Renewals of IP Licenses
• When an entity and a customer enter into a contract to renew (or
extend the period of) an existing licenses, the entity needs to
evaluate whether the renewal or extension should be treated as a
new contract or as a modification of the existing contract.
03
Royalties
 Variable Consideration
• It is the portion of a transaction price that depends on the outcome
of future events.
• Royalty payments are not performance obligation but part of the
transaction price.
• Because they depends on the future sales amounts, they are
recognized overtime.
 04
FRANCHISES
 Franchise Revenue
PFRS 15 on franchise agreements identifies two sources of revenues:
1. Initial Franchise Fee (IFF) – Payment for establishing the
relationship and providing some initial services.

2. Continuing Franchise Fee (CFF) – received in return for continuing

rights granted by the agreement and for providing management
training, advertising, and promotion, legal assistance, and other
support.
 Initial Franchise Fee (IFF)
• Normally involves services such as assistance in site location,
evaluation of potential income, supervision of construction activities,
assistance in the acquisition of signs and equipment, provision of
bookkeeping and advisory services, provision of employee and
management training, provision of quality control, etc.
• Key element of the revenue recognition principle is that a company
recognizes revenue to depict the transfer of goods or services to
customers in an amount that reflects the consideration that it receives, or
expects to receive, in exchange for those goods or services.
 Initial Franchise Fee (IFF)
• Revenue should be recognized over time if one of the following
conditions are satisfied:
1. The customer consumes the benefit of the seller’s work as it is
performed, or
2. The customer controls the asset if it is created,
3. The seller is creating an asset that has no alternative use to the
seller, and the seller has the legal right to receive payment for
progress to date
• Revenue should be recognized point-in-time if none of the following
conditions stated above are satisfied.
Situation 1: IFF – Point in
Time
Date of signing is different from Date of opening
Example 1: Providing rights on initial training, machinery, equipment necessary
to be a distributor of its products and furnishings. It also helps locate the site,
negotiate the lease of purchase of the site, supervise construction activity and
provide employee training. Satisfies performance obligation at the point-in-time,
no further obligation with respect to these rights.
Situation 2: IFF – Point in
Time
No Date of opening or Date of signing is same from Date of opening
Example 2: Providing rights on initial training, machinery, equipment necessary
to be a distributor of its products and furnishings. It also helps locate the site,
negotiate the lease of purchase of the site, supervise construction activity and
provide employee training. Satisfies performance obligation at the point-in-time,
no further obligation with respect to these rights.
 Situation 3: IFF – Over
Time
Date of signing is different from Date of opening
Example 3: Right to open the store, sell products and services in the area for the
coming years. Under the contract, the company also provides the franchisee with a
number of services to support and enhance the franchise brand, including advising
and consulting on the operations of the store; communicating new products and
service techniques; providing business and training manuals; and advertising
programs and training. Ongoing training materials can satisfy the performance
obligation over time once the franchisee begins operating a franchise by providing
access to the rights and must continue to perform updates and services.
 Situation 3: IFF – Over
Time
Date of signing is different from Date of opening
Example 3:
 Situation 4: IFF – Over
Time
No Date of opening or Date of signing is same from Date of opening
Example 4: Same case with Situation 3 except that there was no date of opening.
 Continuing Franchise Fee (CFF)
• They are received in return for the continuing rights granted by the
franchise agreement and for providing such services as management
training, advertising and promotion, quality control, budgeting and
other accounting services, legal assistance, building maintenance and
other support.
• These revenues are generally recognized over time as the related
product and services are provided or transferred to the franchisee
during the franchise period.
 Situation 5: CFF – Over
Time
Date of Signing is the same as Date of opening
Example 5: Franchisor receives ongoing royalty based on the franchisee’s annual
sales (payable the following year). The franchise began operations in February 1,
20x4 and recognized sales revenue in 20x4. Franchisor satisfies the performance
obligation over time. That is, once the franchisee begins operating the franchise.
Franchisor is providing access to the rights and must continue to perform updates and
services.
 Situation 6: IFF – Point in Time and CFF –
Over Time
No Date of opening or Date of signing is same from Date of opening
Example 6: Franchisor receives ongoing royalty based on the franchisee’s annual
sales (payable the following year). The franchise began operations in February 1,
20x4 and recognized sales revenue in 20x4. Franchisor satisfies the performance
obligation over time. That is, once the franchisee begins operating the franchise at
the date of signing with the franchisor already provides an access to the rights on
that date must continue to perform updates and services continuously.
 Situation 6: IFF – Point in Time and CFF –
Over Time
No Date of opening or Date of signing is same from Date of opening
Example 6:
 Income Statement
Initial Franchise Fee XXX
Continuing Franchise Fee XXX
Total Franchise Revenue XXX
Less: Cost of goods sold XXX
Gross Profit XXX
Add: Other Income XXX
Less: Operating Expenses XXX
Net Income XXX
05
OTHER
FRANCHISES
 Sale of Equipment, other tangible
assets
• In most franchise agreements, the franchisor provides equipment
and other tangible assets to the franchisee for a separate fee
• The franchisor may also purchase goods centrally and supplies
directly to the franchisees
• A markup, purchasing or handling fees may be charged on tangible assets
transferred to the franchisees
 Commingled Revenue
• 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 this assets are recognized upon transfer of
ownership regardless when substantial performances of services
were made.
 Situation 7: Commingled Revenue
Sweet, Inc. charges P90,000 for a franchise, with P18,000 paid when the agreement is
signed and the balance in four annual payments. The present value of the annual
payments discounted at 9%, is P58,315. The franchisee has the right to purchase
P16,000 of equipment for P20,000. The performance of services by Sweet Inc. has
occurred, the entries to record the above transaction are as follows:

Ca sh/ Accounts receiva ble 18,000

Notes receiva ble (90,000 – 18,000) 72,000
Unea rned interest income (72,000 – 58,315) 13,685
Fra nchise revenue (18,000 + 58,315 – 14,000) 72,315
Unea rned fra nchise revenue – equipment sale 4,000
 Situation 7: Commingled Revenue
All criteria to recognize initial franchise fee as revenue are met, except that an amount
of P4,000 equivalent to indicated reasonable profit (P20,000, selling price less
P16,000 option price) will be deferred.

When the franchisee subsequently purchases the equipment, the entries will be:

Cash/ Accounts receivable 16,000

Unearned franchise revenue – equipment sale 4,000
Franchise revenue – equipment sale 20,000

Cost of franchise – equipment sales 16,000

Equipment inventory 16,000
 Bargain Purchases
• In addition to providing services as part of the continuing franchise
fee, a franchisor often sells supplies to the franchisee.
• This sales occur because the franchisor may be able to obtain quantity
discounts from manufacturers or wholesalers, or to ensure the quality of the
supplies.
• The franchisor records this sales and related expenses in the normal manner
• Also, franchisees frequently purchased some or all of their
equipment and supplies from the franchisor.
• Sometimes, however, the franchise agreement grants the franchisee
the right to make bargain purchases of equipment or supplies after
the initial franchise fee is paid.
 Bargain Purchases
• The amount to be deferred shall be either of the following:
• The reasonable profit if indicated bargain price or option price is lower than
the normal selling price of the same product
• or if it does not provide the franchisor a reasonable profit, then a portion or the
full amount of the initial franchise fee should be deferred.
 Situation 8: Bargain Purchases
Assume that during the year, Dreicy Company sells supplies costing P75,000 to the
franchisee at the normal price of P98,000, the entries would be

Ca sh/ Accounts receiva ble 98,000

Fra nchise revenue – supplies sa les 98,000

Cost of fra nchise – supplies sa les 75,000

Supplies inventory 75,000
 Repossessed Franchise
• Franchisor officially have the right to repossess franchises.
• When a franchisee decides not to open an outlet or there are violations of the
franchise contract, which warrant its cancellation, the franchisor may recover
franchise rights through repossession.
• In such cases, previously recognized revenue would have to be canceled
against the period of repossession’s franchise revenue if the franchise fee is
refunded.
• If no refund is made upon repossession, the franchisor would make adjustments
to any uncollectible receivables, eliminate deferred revenues, and recognize
any revenue on any retained, but not previously recognized consideration.
 Situation 9: Repossessed Franchise
On April 1, 20x4, Weston, Inc. entered into a franchise agreement with a local
business-man. The franchisee paid P240,000 and gave a P 160,000 8%, 3-year note
payable with interest due annually on March 31. Weston, Inc. recorded the P400,000
initial franchise fee as revenue on April 1, 20x4. On December 31, 20x4, the
franchisee decided not to open an outlet under Weston's name. Weston, Inc. canceled
the franchisee's note and refunded P128,000, less accrued interest on the note, of the
P240,000 paid on April 1. The entries during 20x4 are as follows:
20x4
4/ 1 Ca sh 16,000
Notes receiva ble 4,000
Fra nchise revenue 20,000

12/ 31 Fra nchise revenue – initial fra nchise fee 400,000

Interest income (160,000 * 8% * 9/ 12) 9,600
Ca sh (128,000 – 9,600) 118,400
Notes receiva ble 160,000
Ga in or revenue from repossessed fra nchise 112,000
 Option to purchase
• A franchise agreement may give the franchisor an option to
purchase the franchisee’s business.
• For example, as a matter of management policy, the franchisor may reserve the
right to purchase a profitable franchise outlet or to purchase one that is in
financial difficulty
• If it is probable at the time the option is given that the franchisor
will ultimately purchase the outlet, then the initial franchise fee
should not be recognized as revenue but should be recorded as
liability
• When the option is exercised, the liability would reduce the
franchisor’s investment in the outlet
 Situation 10: Option to Purchase
Joey’s Pancake Restaurants Inc. sells franchises for an initial fee of P360,000. The
initial fee covers site selection, training, computer and accounting software, and on-
site consulting and troubleshooting, as needed, over the first five years. On March 15,
20x4, Tom Cruise signed a franchise contract, paying the standard P60,000 down with
the balance due over 5 years with interest.
Assume at March 15, 20x4, the time of signing the contract, collectibility of the
receivable was reasonably assured and there were no significant continuing
obligations. The agreement provides that Joey have the option to purchase within five
years to acquire franchisee’s business and it seems certain that Joey's Pancake
Restaurant, Inc. will exercise the option. The journal entry on March 15, 20x4:

Ca sh 60,000
Notes receiva ble 300,000
Deferred fra nchise purchase option liability 360,000
 Situation 10: Option to Purchase
Despite no significant continuing obligations to be performed, the refund period
already expired and the collectibility of the note is reasonably assured, but there is an
option to purchase the outlet and it is certain to be exercised, any franchise fee is
recognized as liability. Few years after Joey's Pancake Restaurants Inc. rendered
services to the franchisee amounting to P240,000, the journal entry would be:

Deferred cost of fra nchise revenue/ Investment in Fra nchise 240,000

Ca sh, etc. 240,000
 Situation 10: Option to Purchase
Any costs related to the franchisee should also be deferred to match with the liability
being set up.
from the option is exercised after 5 years and acquires the franchise outlet by paying
P70,000, the journal entry would be:

Deferred fra nchise purcha se option lia bility 360,000

Deferred cost of fra nchise revenue/ Investment in Fra nchise 240,000
Ca sh, etc. 70,000
Ga in – option to exercise to purcha se the franchise outlet 50,000
 06
NON-
REFUNDABLE
 Upfront Payments
• Generally relate to the initiation, activation, or setup of a good or
service to be provided or performed in the future.
• Usually not refundable
• Should not be recorded as revenue at the time of payment but rather as a
deferred revenue and recognized as revenue when each performance
obligation is satisfied (e.g. fare fee, season tickets) or allocated over the
periods benefited (e.g. membership fee, activation fee)
 REVIEW THE LESSON 05
01 NON-REFUNDAB
INTRODUCTION UPFRONT FEES
05
02 OTHER FRANCHISE
LICENSES TOPICS
03 04
ROYALTIES FRANCHISES
THANKS
Does anyone have any questions?
• Advanced Financial Accounting Volume 1 by Antonio Dayag
• Accounting for Special Transactions 2018 by Zeus Vernon Millan
• Advanced Accounting: Principles and Procedural Applications 2017 by Pedro
Guerrero and Jose Peralta

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