4. Franchise IFRS 15 2020 PDF

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FRANCHISE and Consignment Sales Accounting JLM FRANCHISE The core principle of IFRS 15 is that an entity will recognize 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 th...

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Special Revenue Recognition: FRANCHISE and Consignment Sales Accounting JLM FRANCHISE The core principle of IFRS 15 is that an entity will recognize 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. This core principle is delivered. in a five-step model framework: 1. Identify the contract with a customer 2. Identify all the individual performance obligations within the contract 3. Determine the transaction price 4. Allocate the price to the performance obligations 5. Recognize revenue as the performance obligations are fulfilled The specific provision of the standards that deals with the accounting for franchise can be found on the licensing topic of PFRS 15. A Franchise is a type of license that a party (franchisee) acquires to allow them to have access to a business (the franchisor) proprietary knowledge, processes and trademarks in order to allow the party to sell a product or provide a service under the business name. Two types of Franchise 1. A contract between two private entities or individuals. 2. A contract between private entity or an individual and the government. Under the licensing section of PFRS 15, the promise to grant the license must be determined first whether the license of Intellectual Property (IP) is distinct or not because PFRS 15 includes specific application guidance for distinct licenses of IP. For licenses that are not distinct, an entity will follow the general requirements in the standards to account for all promises as a single performance obligation (that contains a license and at least one other good or service). For distinct licenses of IP, the promise to grant a license is treated as a separate performance obligation from other promises in the contract. An entity must determine whether the license transfers to the customer at a point in time or over time by considering the nature of the promise to the customer. The standard states that entities provide their customers with either ➢

A right to access the entity's intellectual property as it exists throughout the license period, including any changes to that intellectual property, which is recognized as revenue over time. Therefore, the consideration received is recognized as revenue over the license period.

➢

A right to use the entity's intellectual property as it exists at the point in time when the license is granted, which is recognized as revenue at a point in time. Therefore, the consideration received is recognized as revenue at the time the license is provided.

Right to Access (Over Time) The customer has the right to access the entity's IP as it exists throughout the license period if 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 the license is granted. A license is a promise to provide a right to access if all of the following criteria are met: 1. The contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights. 2. The rights granted by the license directly expose the customer to any positive or negative effects of the entity's activities. 3. The entity's activities do not result in the transfer of a good or a service to the customer as those activities occurs (i.e., they do not represent a separate performance obligation). Although not determinative, the existence of a shared economic interest between the parties (e.g., sales or usage-based royalties) may be an indicator that the customer has a reasonable expectation that the entity will undertake such activities.

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Special Revenue Recognition: FRANCHISE and Consignment Sales Accounting JLM Right to Use (At a Point in Time) The customer has the right to access the entity's IP as it exists throughout the license period if 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 the license is granted. If the license does not meet all three criteria, the license agreement provides a right to use the license and the entity would recognize revenue at the point in time when the control of the license transfers to the customer. Sales Based or Usage Based Royalties The standard provides explicit application guidance for recognizing sales-based and usage-based royalties from licenses of IP. Specifically, the standard creates an exception to the requirement to estimate variable consideration for transactions that involve sales and usage-based royalties resulting from the licenses of IP. As a result, these amounts are only recognized at the later of when; 1. The sale or usage occurs or 2. The performance obligations (to which some or all of the sales or usage- based royalties have been allocated) have been satisfied (or partially satisfied). This exception may result in an accounting treatment that is similar to current practice. FRANCHISE REVENUES 1. Initial Franchise Fees - it is a once off lump sum, paid by the franchisee to the franchisor, upon signing the franchise agreement. It acts as a payment for: a. Assistance in site selection, leased negotiation, financing and supervision of construction activity. b. Initial training in all facets of operating a business c. Assistance with staff recruitment and training d. Access to preferential purchasing arrangements the franchisor has put in place. e. Provision of bookkeeping and advisory services f. Provision of quality control g. Advertising and promotion h. Assistance in the acquisition of signs, fixture and equipment 2. Continuing Franchise Fee (Royalty Fee) - it is a fee paid by the franchisee for the ongoing services (e.g. management trainings, advertising, promotion, accounting, legal assistance and other special services received from franchisor. Typically, it is computed based on a percentage of gross sale franchisee and it is paid on a regular basis. CASES (IAS 18) 1. reasonable expectation of refund and significant performance by franchisor required 2. low expectation of refund, minimal amount of future services to be provided by franchisor, and collection of the note reasonably assured 3. no refund, substantial performance by franchisor required, and collection reasonably assured 4. if down payment refundable, or substantial performance by franchisor required 5. no refund of initial down payment, no performance by franchisor required, and collection highly uncertain

Services (Performed)

Refund (Low/No)

Collectability (Assured/Not)

Earned/Unearned

x

x

-

Unearned

√

√

Assured

Earned

x

√

Assured

x

x

-

√

√

Highly Uncertain

DP - Earned N/R - Unearned DP - Unearned N/R not recognize DP - Earned N/R not recognize

3. Franchisor’s Cost – Overall objective is to match related costs and revenues – Direct costs are deferred for any specific franchise sale where revenue has not been recognized – Indirect costs, such as selling and administrative expenses, are expensed as incurred 4. Bargain Purchase – When the franchisee may purchase assets at a lower than market price from the franchisor – Portion of initial franchise fee is deferred if the bargain price is lower than normal selling price or if franchisor does not make a reasonable profit – Adjustment to selling price when assets are purchased by the franchisee Page 2 of 14

Special Revenue Recognition: FRANCHISE and Consignment Sales Accounting

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5. Options to Purchase – Where the franchisor has the right to purchase the franchisee’s business – Initial franchise fee recorded as a liability if it is probable that a purchase will occur – When option is exercised, the liability would reduce the franchisor’s investment -doneIAS 18 Problem 1 Conrad Franchising Corporation franchises its name to different people across the country. The franchise agreement requires the franchisee to make an initial payment of P1,440,000 and signs a P3,840,000 non-interest-bearing note on the agreement date. The note is to be paid in four (4) annual payments of P960,000 each year beginning December 31 from the agreement date. The initial payment is refundable until the date of opening. Interest rates are assumed to be 10% for this type of borrowing arrangement. (use four decimal points) The franchiser agrees to make market studies, find a location, train the employees, and perform a few relatively minor services. The following transactions in 20x4, describe he relationship with Rita, a franchisee: January 3: Entered into a franchise agreement. February 2: Completed a market study at a cost of P120,776 (direct costs). June 13: General expenses paid P 50,000 (indirect costs) August 8: Found suitable location, Service cost P 300,000 (direct costs) November 2: Completed training program for employees, cost, P 700,000 (direct costs). December 8: Franchise outlet opened, and business operations started. December 31: Received first annual payment. Required: 1. Prepare entries on the books of franchisor to record the following, assuming: A. the collectability of the note is reasonably assured, and B. the collectability of the note is not reasonably assured (use installment sales method. 2. Compute the revenue, gross profit and net income, assuming: A. the collectability of the note is reasonably assured, and B. the collectability of the note is not reasonably assured (use installment sales method). Problem 2 MacDonald. Inc. charges P108,000 for a franchise, with P21,600 paid when the agreement signed and the balance in four annual payments. The present value of the annual payments. discounted at 9%, is P69,978. The franchisee has the right to purchase P24,000 of equipment P19,200. If the collectability of the payments is reasonably assured, and substantial performance by Sweet. Inc. has occurred. Required: Prepare entries on the books of franchisor to record the above transaction Problem 3 AB Inc., franchisor, entered franchise agreement with AD Inc., franchisee on July 1, 2018. The initial franchise fee agreed upon is Php 850, 000, of which Php 150, 000 is payable upon signing and the balance to be covered by a noninterestbearing note payable in four equal annual instalments. It was agreed that the down payment is not refundable, notwithstanding lack of substantial performance of services by franchiser. Probability of collection is unlikely. The following expenses were incurred: Initial services: Direct Cost Php 235, 000 Indirect Cost 64, 000 Continuing Services: Direct Cost 23, 900 Indirect Cost 9, 000 The management of AD has estimated that they can borrow loan at the rate of 12%. The franchisee commenced its operation on July 31, 2018. A continuing franchise fee equal is to 5% of its monthly gross sales. AD reported gross sales of Php 950, 000 for the month. When AB prepares its financial statements on August 31, 2018, how much is the net income to be reported? (use two decimal point)

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Special Revenue Recognition: FRANCHISE and Consignment Sales Accounting JLM Problem 4 On August 1, 2018, I’m Yours Inc. entered into franchise agreement with You’re Mine franchisee. The initial franchise fees agreed upon is Php 246, 900, of which Php 46, 900 is payable upon signing and the balance to be covered by a noninterest-bearing note payable in four equal annual installments. The down payment is refundable within 100 days. Collection of the note is highly uncertain. Out-of-pocket cost of Php 125, 331 and Php 12, 345 were incurred for direct expenses and indirect expenses respectively. Prevailing market rate is 9%. PV factor is 3. 2397. On the fiscal year ended October 31, 2018, how much income will the franchisor recognize? A. Php 161, 985 B. Php -0C. Php 208, 885 D. Php 3, 645 Problem 5 MIAH Inc charges an initial franchise fee of P115,000, with P25,000 paid when the agreement was signed and the balance in five annual payments. The present value of the future payments, discounted at 10% is P68,234. The franchisee has the option to purchase P15,000 equipment for P12,000. MIAH has substantially provided all initial services required and collectability of the payments is reasonably assured. How much is the amount of revenue from franchise fees? A. 25,000 B. 90,234 C. 93,234 D. 115,000 PFRS 15 Revenue from Contracts with Customers Problem 1 Neil’s Foods enters into a franchise agreement on November 1, 20x7, giving Nathan Corp. the right to operate as a franchisee of Neil's Foods for 5 years. Neil's charges Nathan an initial franchise fee of P1,425,000 for the right to operate as a franchisee. Of this amount, P570,000 is payable when Nathan Corp. signs the agreement, and the balance is payable in five annual payments of P171,000 each on December 31. Nathan also promises to pay ongoing royalty payments of 1% of its annual sales (payable every January 31 of the following year) and is obliged to purchase products from Neil's at its current standalone selling prices at the time of purchase. The credit rating of Nathan indicates that money can be borrowed at 8%. Consider the following for allocation of the transaction price at December 31, 20x7 Rights to the trade name, market area, technical and proprietary know-how P 570,000.00 Services- training. etc 283,751.70 Machinery and equipment, etc. (costing P285,000) 399,000.00 Total transaction price P 1,252,751. 70 Training is completed in January 20x8, the equipment is installed in January 20x8. and Nathan holds a grand opening on February 2, 20x8. On February 2, 20x8. franchise opens. Neil satisfies the performance obligations related to the franchise rights, training, and equipment. Required: Prepare entries on the books of franchisor Neil Foods on December 31, 20x7 and February 2, 20x8. Problem 2 Nina, a new fast food chain, sells exclusive franchises for P25,000. For this fee, franchisees receive training, assistance on site selection, assistance during the construction phase, and promotional considerations for the grand opening including a visit by Nina. There is also a P500 per month continuation fee for institutional advertising and accounting services after the store is open for business. On March 20 of the current year, Nina sold a franchise to Fatimah for the standard fee. The franchisor received a 20% down payment and a 10%, four-year note for the balance. On June 15, Fatimah had her grand opening and Nina had met all requirements for substantial performance. On July 15, Nina received P500 or the continuing fee. Required: Prepare the appropriate journal entries for Nina at March 20, June 15, and July 15. Problem 3 On January 1, 20x1, Miah Co. enters into a contract with a customer to transfer a license for a fixed fee of P100,000 payable as follows: • 20% is payable upon signing of contract. • 80% is represented by a note receivable collectible in 4 equal annual installments starting December 31, 20x1. The appropriate discount rate is 12%. • The license transfers to the customer on January 3, 20x2. • During 20x1, Miah Co. incurs direct contract costs of P20,000. • Collectability of the note is reasonably assured. Page 4 of 14

Special Revenue Recognition: FRANCHISE and Consignment Sales Accounting JLM • The license provides the customer with the right to use Miah's intellectual property as it exists at the point in time at which the license is granted. Requirement: Compute for the profits in 20x1 and 20x2, respectively. Problem 4 On July 1, 20x1, JC Co. entered into three franchise agreements. Information on these agreements is summarized below: Franchisee A B C Totals

Probability of Collection Reasonable Assured Uncertain Significantly uncertain

Cash Down Payment 20,000 20,000 20,000 60,000

PV of Note 60,747 48,037 33,801 142,585

Direct Cost Incurred 32,000 25,000 21,520 78,520

Additional information: • The cash down payments are non-refundable and were received upon the signing of contracts. • The appropriate discount rate on all the contracts is 12%. • The first installment on each of the note receivable is due on July 1, 20x2. • It was assessed that the receivable from Franchisee B is doubtful of collection. This is because, at contract inception JC Co. determines that the region where the customer operates is undergoing economic difficulty. Therefore, JC Co. expects that the consideration will not be collected in full. However, JC Co. believes' that the region's economy will recover in the near term and that the license will help the customer increase its sales. Accordingly, JC Co. expects to provide the customer a price concession and concludes that it is probable that it will collect only half of the P48,000 note receivable. The adjusted present value of the note is P24,018. The adjusted discount rate is 12%. • All the three licenses provide the customers the right to use the entity’s intellectual property as it exists at the point in time at which the license is granted. • The licenses are transferred to the customers on July 1, 20x1. Requirements: Compute for the total profit from the three contracts in 20x1. MULTIPLE CHOICE PROBLEMS 1. Charot Inc. charges an initial franchise fee of P90,000 broken down as follows: Rights to trade name, market area, and proprietary know-how P 40,000 Training services 11,500 Equipment (cost of P10,800) 38,500 Total initial franchise fee P 90,000 Upon signing of the agreement, a payment of P40,000 is due. Thereafter, two annual payments of P30,000 are required. The credit rating of the franchisee is such that it would have to pay interest of 8% to borrow money. The franchise agreement is signed on August 1, 20x8, and the franchise commences operation on November 1, 20x8. Assuming that no future services are required by the franchisor once the franchise begins operations, what journal entry is included on November 1, 20x8? A. a credit to Unearned Franchise Revenue for P40,000. B. a debit to Service Revenue for P11,500. C. a debit to Sales Revenue for P38,500. D. a debit to Unearned Franchise Revenue for P40,000. 2. Assume that the total training fees includes training services for the period leading up to the franchise opening (P5,500 value and for 3 months following opening, what journal entry is included on August 1, 20x8? A. a credit to Unearned Service Revenue for P11,500. B. a credit to Unearned Service Revenue for P6,000. C. a debit to Sales Revenue for P38,500. D. a debit to Unearned Franchise Revenue for P40,000. 3. On January 1, 20x4 Dairy Treats. Inc. entered into a franchise agreement with a company allowing the company to do business under Dairy Treats’ name. Dairy Treats had performed substantially all required services by January 1, 20x4, and the franchisee paid the initial franchise fee of P560,000 in full on that date. The franchise agreement specifies that the franchisee must pay a continuing franchise fee of P48,000 annually, of which 20% must be spent on advertising by Dairy Treats. What entry should Dairy Treats make on January 1, 20x4 to record receipt of the initial franchise fee and the continuing franchise fee for 20x4? Page 5 of 14

Special Revenue Recognition: FRANCHISE and Consignment Sales Accounting A. Cash 608,000 Franchise Fee Revenue Unearned franchise revenue B. Cash 608,000 Unearned franchise revenue C. Cash 608,000 Franchise revenue Unearned franchise revenue Revenue from Continuing Franchise Fees D. Prepaid advertising 9,600 Notes receivable 608000 Franchise revenue Revenue from Continuing Franchise Fees Unearned Franchise Fees

JLM 560,000 48,000 608,000 560,000 9,600 38, 400

560,000 48,000 9,600

4. Wynne Inc. charges an initial franchise fee of P920.000, with P200.000 paid when the agreement is signed and the balance in five annual payments. The present value of the future payments., discounted at 10%. is P545,872. The franchisee has th...