FRANCHISE

ACCOUNTING
MS. ELLERY DE LEON
 Apply the five-step model under PFRS 15:
• Identify the contract
• Identify performance obligations
Franchise Fee • Determine the transaction price
Revenue • Allocate the transaction price to the
performance obligations in the contract
• Satisfaction of performance obligations
Recognition of Revenue
Promise to grant license is:
Not distinct Distinct

Treat all promises in the contract as a single Treat the promise to grant the license as a
performance obligation. separate performance obligation

Use general principles to determine whether the Use specific principles to determine if the
performance obligation is satisfied over time or promise provides the customer
at a point in a. time. a. Right to access - performance
obligation is satisfied over time.
Revenue is recognized over the
license period.
b. Right to use -performance
obligation is satisfied at a point in
time. Revenue is recognized at the
time when the license is provided.
Recognition of Revenue
Promise to grant license is distinct:
Right to Access Right to Use

1. The customer cannot direct the use of, and 1. The customer can direct the use of, and
obtain all the remaining benefits from, the obtain all the remaining benefits from, the
license at the time it was granted license at the time it was granted
2. Intellectual property (IP) changes throughout
the license period. 2. Intellectual property (IP) does not change
a. The entity continues to be involved with throughout the license period.
the IP; and
b. The entity undertakes activities that
significantly affect the IP.
3. May be evidenced by a sales based royalty
agreement between the entity and the
customer
 Identify Performance Obligations

Case 1: License is not distinct

An entity, a pharmaceutical company, licenses to a The promises are not separately identifiable because:
customer its patent rights to an approved drug a. the customer cannot benefit from on its own without
compound for 10 years and also promises to the manufacturing service
manufacture the drug for the customer. The drug
is a mature product; therefore the entity will not b. the promises are highly interrelated, and therefore, not
undertake any activities to support the drug, which separately identifiable
is consistent with its customary business practices.
Under the general principles, the single performance
No other entity can manufacture this drug because obligation is satisfied over time because the customer
of the highly specialized nature of the simultaneously receives and consumes the benefits of
manufacturing process. As a result, the license the entity's performance as it occurs, i.e., as the entity
cannot be purchased separately from the provides the manufacturing services.
manufacturing services.
 Franchise Fee Revenue

Case 2: License is distinct There are two separate performance obligations in the contract
The manufacturing process used to produce the namely: (1) License of patent rights and (2) Manufacturing
drug is not unique or specialized and several service.
other entities can also manufacture the drug
for the customer. Since the license is distinct, the entity applies the specific
principles to determine whether the customer has the right to
access or right to use the entity's intellectual property.

Application of the General principles: "The drug is a mature product; therefore the entity will not
undertake any activities to support the drug.
Promises to provide the license and the
manufacturing service are distinct because the From the statement above, it can be inferred that the
customer can benefit from the license without intellectual property does not change throughout the license
the manufacturing service and the promises are period.
separately identifiable from each other.
The performance obligation provide that the license is satisfied
at a point in time.
Transaction Price

Franchise fees come in the form of:

1. Initial franchise fee this is the one-off payment made by the franchisee to the
franchisor to obtain the franchise right. Initial franchise fees are normally paid at
the signing of the franchise agreement and are normally non-refundable.

2. Continuing franchise fees - these are the periodic payments made by the
franchisee to the franchisor for the ongoing franchisee support. Continuing
franchise fees are also referred to as royalty fees.

3. Sale of equipment and other tangible assets - in most franchise agreements, the
franchisor provides equipment and other tangible assets to the franchisee for a
separate fee.
Problem 1
Step 1: Identify the Contract

Step 2: Identify the performance obligations in the contract

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

The supporting activities (i.e., marketing research, etc.) are not performance obligations because these
do not directly transfer goods or services to the franchisee. Rather, these are part of ABC's promise to
grant the license and, in effect, change the intellectual property to which the franchisee has rights.

There are two separate obligations in the contract, namely:

(1) Franchise license; and
(2) Equipment.
Problem 1

The entity determines whether each performance obligation is satisfied over time or at a point in time:
1) Franchise license:
Since the license is distinct, ABC applies the specific principles to determine whether the
franchisee has the right to access or right to use ABC's intellectual property. The problem states
that ABC undertakes activities to support the franchise. Accordingly, the franchisee can validly
expect that its rights will change (for example, the right to sell additional products that ABC might
introduce in the future).

Conclusion: The customer has the right to access, and thus the performance obligation is satisfied
over time.

2) Equipment: Entity applies the general principles to determine whether the performance obligation
to transfer 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 satisfied at a point
in time.
Problem 1

Step 3: Determine the transaction price

The transaction price includes a fixed consideration of P1.2M. and a variable consideration for the
sales-based royalty.

Step 4: Allocate the transaction price to the obligations

The P1.2M upfront fee is allocated as follows:
a) P200K to the equipment (because this reflects the stand. alone selling price); and
b) P1M balance to the franchise license. The 10% sales-based royalty is allocated entirely to the
franchise license
Problem 1

Step 5: Recognize revenue when (or as) an obligation is satisfied

a. The P200K is recognized as revenue when the equipment is transferred to the franchisee.

b. For the P 1M, ABC applies the general principles to determine a measure of progress that best
depict its performance. Because the contract provides the franchisee with unlimited use of ABC's
intellectual property for a fixed term (i.e, 10 years), an appropriate measure of progress may be a
time-based method (i.e., straight-line method) , ABC starts to amortize the P 1M on April 1, 20x1
(the commencement of the franchisee's business) because it is on this date that the franchisee is
able to use and obtain the economic benefits from the license.

c. The sales-based royalty is recognized as the sales occur

Problem 1

Jan. 1, Cash 1,200,000

20x1 Contract liability 1,200,000

Feb 1 Contract Liability 200,000

20x1 Revenue 200,000

Dec 31 Contract Liability 75,000

20x1 Revenue 75,000
(1M / 10 yrs) x 9/12

Cash 900,000
Revenue 900,000
Problem 2

Step 1: Identify the Contract

Step 2: The only performance obligation in the contract is the promise to grant the franchise license.

The pre-opening/setup activities associated with the franchise license are not performance
obligations because these do not directly transfer a good or service to to the customer. Rather,
these are part of the entity's promise to grant the license.

The existence of a shared economic interest (i.e. the sales-based royalty) and regular advertising
campaigns indicate that ABC will continue to be involved with the intellectual property, and thus
the customer has the right to access ABC’s intellectual property. Accordingly, the performance
obligation is satisfied over time.
Problem 2

Step 3: The transaction price includes a fixed consideration of P120,000 (the initial franchise fee) and a
variable consideration 3% of customer sales (the continuing franchise fee).

Step 4: Both the fixed and variable considerations are allocated to the sole performance obligation of
granting the license.

Step 5: Revenue recognition:

a. The P120,000 is recognized over the 5-year license period using straight-line method

b. The sales-based royalty is recognized as the sales occur.

Problem 2

Dec. 1, 20x1 Cash 120,000

Contract Liability 120,000

Dec. 31, 20x1 Contract Liability 2,000

Revenue 2,000
(120,000/ 5 yrs.) x 1/12

Cash or Receivable 60,000

Revenue 60,000
Problem 3

Case 1: Right to use

Dec. Cash 1,000,000
20x1 Contract liability 1,000,000

Deferred contract costs 120,000

Expense (indirect costs) 30,000
Cash 150,000

Jan 2 Contract Liability 1,000,000

20x2 Revenue 1,000,000

Cost of License 120,000

Deferred Contract Cost 120,000
 Problem 3
Case 2: Right to access
Dec. Cash 1,000,000
20x1 Contract liability 1,000,000

Deferred contract costs 120,000

Expense (indirect costs) 30,000
Cash 150,000

Jan 2 NO ENTRY
20X2 No revenue is recognized on Jan. 2, 20x2 because the performance obligation is satisfied over time. ABC will
start recognizing revenue (and amortizing the related deferred costs) on Jan. 31, 20x2 onwards.

Jan. 31 Contract liability (1M/4 yrs.) x 1/12 20,833.33

20x2 Revenue 20,833.33

Cost of license (120K / 4 yrs.) x 1/12 2,500

Deferred contract costs 2,500