Accounting for Franchise Operations – Operations – Franchisor Franchisor (PRFS 15 Revenue from Contract with Customers} The provisions of PFRS 15 that directly relate to the accounting for franchises can be found on the “licensing section” of PFRS 15 (PFRS 15.B52-B63). 15.B52-B63). An entity shall apply the specific principles in this section in conjunction with the general principles that are applicable to all types of contract with customers. PFRS 15 defines a license as one that “establishes a customer’s rights to the intellectual property on an entity.” Examples of licenses of intellectual property: a. Software and technology b. Motion pictures, music and other forms of media and entertainment c. Franchises; and Franchises; and d. Patents, trademarks and copyrights franchise is a contractual arrangement under which the franchisor grants the franchisee the right to sell A franchise certain products or services, to use certain trademarks or trade names or to perform certain functions, usually within a designated geographical area. Franchises are of two types: 1. Contractual arrangement between two private entities or individuals 2. Contractual arrangement between a private entity or an individual and the government (frequently referred to as license or permits) Application of the Principles of PFRS 15 I.
Identify the contract with the customer A contract with a customer is accounted for only when all when all of of the following criteria are met: a. The contracting parties have approved the contract (in writing, orally or implied in customary business practices) and are committed to perform their respective obligations b. The entity can identify each party’s rights regarding rights regarding the goods or services to be transferred c. The entity can identify the payment the payment terms for terms for the goods or services to be transferred d. The contract has commercial substance (i.e. the risk, timing or amount of the entity’s future cash flows is expected to change as a result of the contract and e. The consideration in the contract is probable of collection. collection . When assessing collectability, the entity shall consider only the customer’s ability and intention to pay the consideration on due date. No revenue is revenue is to be recognized on a contract that does not meet the criteria above. Any consideration liability and recognized only when either of the following received from such contract is recognized as liability and occurred: i. The entity has no remaining obligation to transfer goods or services to the customer and all, or substantially all, of the consideration has been received and is non-refundable; or ii. The contract has been terminated and the consideration received is non -refundable The entity need not assess the criteria above if they have been met on contract inception unless there is an indication of a significant change in facts and circumstances, for example, when the customer’s ability to pay subsequently deteriorates significantly.
II.
Identify the performance obligations in the contract General Principles: Each promise to transfer the following is a performance obligation to be accounted separately: a. A distinct good distinct good or service (or a distinct bundle of goods or services); or b. A series of series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer A promised good or service is distinct if: a. The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and b. The promise to transfer the good or service is separately identifiable identifiable from other promises in the contract
Page 1 of 3 Lyndon P. Regodon, CPA, MIA
Customer can benefit A customer can benefit from a good or service if the good or service could be used, consumed, sold for an amount that is greater than scrap value or otherwise held in a way that generates economic benefits. The fact that the entity regularly sells a good or service separately indicates that a customer can benefit from the good or service on its own or with other readily available resources. Separately identifiable A promise to transfer good or service is separately identifiable if the good or services: a. Is not an output to a combined output by the customer b. Does not significantly modify other goods or services promised in the contract c. Is not highly interrelated with other goods or services promised in the contract. For example, the customer’s decision of not purchasing good or service does not affect the other promised goods or services in the contract. Performance obligations include only activities that involves the transfer of a good or service to a customer. Performance obligations do not include administrative tasks to set up a contract. Satisfaction of performance obligations At contract inception, the entity shall determine whether the identified performance obligations will be satisfied either a. Over time or b. At a point in time A performance obligations is satisfied over time if one of the following criteria is met a. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs b. The entity’s performance creates or enhances an asset (e.g. work in progress) that the customer controls as the asset is created or enhanced. c. The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. If the entity cannot demonstrate that a performance obligation is satisfied over time, it is presumed that the performance obligation is satisfied at a point in time.
Specific Principles: (Licensing’ section)
Promise to grant franchise Not Distinct
Distinct
Treat all promises in the contract as a single performance obligation Use general principles to determine whether the performance obligation is satisfied over time or at a point in time
Treat the promise to grant the license as a separate performance obligation Use specific principles to determine if the promise provides the customer a: 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.
Promise to grant license is distinct Right to access
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.
Right to use
The customer can direct the use of, and obtain substantially all of the remaining benefits from, the license at the point in time which the license is granted.
Page 2 of 3 Lyndon P. Regodon, CPA, MIA
III.
Intellectual Property (IP) changes throughout the license period. a. The entity continues to be involved with the IP; and b. The entity undertakes activities that significantly affect the IP.
Intellectual property (IP) does not change throughout the license period.
May be evidenced by a sales-based royalty agreement between the entity and the customer
Determine the transaction price The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods and services to a customer, excluding amounts collected on behalf of third parties (e.g. some sales taxes). The transaction price is normally the contract price. However, the transaction price may not be equal to the contract price if the consideration in the contract is affected by any of the fol lowing: a. Variable consideration b. Constraining estimates of variable consideration c. The existence of a significant financing component in the contract d. Non-cash consideration e. Consideration payable to a customer The transaction price in a franchise contract is commonly referred to as franchise fees. Franchise fees refer to payments made by the franchisee to the franchisor in relation to the franchise right granted by the franchisor. These fees may cover the supply of know-how, initial and subsequent services, and equipment and other tangible assets.
IV.
1.
Initial franchise fee – this is the one-off payment made by the franchisee to the franchisor to obtain the franchise right. It is normally paid at the signing of the franchise agreement and are normally non-refundable. However, some franchise agreements allow initial franchise fees to be paid over an extended period of time and provide for the right of refund up to a certain amount. Initial franchise fees do not normally include cost of initial inventory or furniture and fixtures.
2.
Continuing franchise fees – these are the periodic payments made by the franchisee to the franchisor for the ongoing franchisee support. It is 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.
Allocate the transaction price to the performance obligations The transaction price is allocated to the performance obligations based on the relative stand-alone prices of the distinct goods and services. The stand-alone is the price at which a promised good or service can be sold separately to a customer.
V.
Recognize revenue when (or as) performance obligation is satisfied A performance obligation in the contract is satisfied when the control over a promised good or service is transferred to the customer. Revenue is measured at the amount of the transaction price allocated to the satisfied performance obligation.
Page 3 of 3 Lyndon P. Regodon, CPA, MIA
