Prepared by: Patricia Zima, CA Mohawk College of Applied Arts and TechnologyUpdated for IFRS by:Anupma Goel,CASeneca College of Arts and Technology

Chapter 6 Appendix 6A Franchises

*FranchisesFranchise revenue recognized from two sources:Initial Franchise Fee: sale of initial franchises and related assets or services Continuing Franchise Fees: based on franchise operationsNo explicit guidance given in IFRS other than in the illustrative examples (which are not technically part of the standard)

*Initial Franchise FeeRecorded as revenue only when and as the franchisor has established substantial performance:The services obligated to be performed have been so performedNo obligation to refund any portion of the fee received to dateSubstantial performance of required servicesCollection of the fee is reasonably assuredThe beginning of operations normally considered the earliest time substantial performance has occurred

*Initial Franchise Fee ExampleInitial franchise fee: $50,000Down payment: $10,000Balance: five equal annual instalmentsDiscount rate: 8%PV of $8,000 ordinary annuity = $31,942Difference (40,000 31,942) = $8,058 is interest revenue to franchisorEntries if reasonable expectation of refund and significant performance by franchisor required:Cash 10,000Notes Receivable 40,000 Discount on Note 8,058 Unearned Franchise Fees 41,942

*Initial Franchise Fee ExampleInitial franchise fee: $50,000Down payment: $10,000Balance: 5 equal annual instalmentsDiscount rate: 8%PV of $8,000 ordinary annuity = $31,942Difference (40,000 31,942) = $8,058 is interest revenue to franchisorEntries if low expectation of refund, minimal amount of future services to be provided by franchisor, and collection of the note reasonably assured:Cash 10,000Notes Receivable 40,000 Discount on Note 8,058 Revenue from Franchise Fees 41,942

*Initial Franchise Fee ExampleInitial franchise fee: $50,000Down payment: $10,000Balance: 5 equal annual instalmentsDiscount rate: 8%PV of $8,000 ordinary annuity = $31,942Difference (40,000 31,942) = $8,058 is interest revenue to franchisorEntries if no refund, substantial performance by franchisor required, and collection reasonably assured:Cash 10,000Notes Receivable 40,000 Discount on Note 8,058 Revenue from Franchise Fees 10,000Unearned Franchise Fees 31,942

*Initial Franchise Fee ExampleEntries if no refund of initial down payment, no performance by franchisor required, and collection highly uncertain:Cash 10,000Revenue from Franchise Fees 10,000Entries if down payment refundable, or substantial performance by franchisor required:Cash 10,000Unearned Franchise Fees 10,000

*Continuing Franchise FeesReceived in return for continuing rights under the franchise agreement and provision of services by franchisorReported as revenues when they are earned and receivable from the franchiseeIf an amount is included which is ear-marked for a specific purpose e.g. for local advertising, that amount is deferred

*Special IssuesBargain PurchaseWhen the franchisee may purchase assets at a lower than market price from the franchisorPortion of initial franchise fee is deferred if the bargain price is lower than normal selling price or if franchisor does not make a reasonable profitAdjustment to selling price when assets are purchased by the franchisee

*Special IssuesOptions to PurchaseWhere the franchisor has the right to purchase the franchisees businessInitial franchise fee recorded as a liability if it is probable that a purchase will occurWhen option is exercised, the liability would reduce the franchisors investment

*Special IssuesFranchisors CostOverall objective is to match related costs and revenuesDirect costs are deferred for any specific franchise sale where revenue has not been recognizedIndirect costs, such as selling and administrative expenses, are expensed as incurred

*Disclosures of FranchisorsFull disclosure of all significant commitments and obligations is requiredDescription of services yet to be performed is also requiredInitial franchise fees are reported as a separate revenue line item if significantRevenues and costs of franchisor-owned outlets should be disclosed separate from the revenues and costs of franchised outlets

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