CHAPTER 11 - Franchise Accounting

SOLUTIONS TO PROBLEMS

Problem 11 – 1
a. The collectibility of the note is reasonably assured.
Jan. 2: Cash............................................................................12,000,000
Notes receivable.........................................................8,000,000
Deferred Revenue from IFF.................................. 20,000,000
July 31: Deferred cost of Franchises......................................2,000,000
Cash....................................................................... 2,000,000
Nov. 30: Cash/AR..................................................................... 29,000
Revenue from continuing franchise fee (CFF)....... 29,000
Dec. 31: Cash / AR................................................................... 36,000
Revenue from CFF................................................. 36,000
Cash...........................................................................2,800,000
Notes receivable..................................................... 2,000,000
Interest income (P8,000,000 x 10%)...................... 800,000
Adjusting Entries:
(1) Cost of franchise revenue...............................................2,000,000
Deferred cost of franchises.................................. 2,000,000

(2) Deferred revenue from IFF............................................20,000,000

Revenue from IFF.................................................. 20,000,000
To recognize revenue from the initial franchise fee.
b. The collectibility of the note is not reasonably assured.
Jan. 2 to Dec. 31 = Refer to assumption a.
Adjusting entry: to recognized revenue from the initial franchise fee (installment method)
(1) To defer gross profit:
Deferred Revenue from IFF...........................................20,000,000
Cost of Franchise Revenue........................................ 2,000,000
Deferred gross profit – Franchises............................ 18,000,000
GPR = P18,000 / P20,000,000 = 90%
(2) To recognize gross profit:
Deferred gross profit – Franchises................................12,600,000
Realized gross profit.................................................. 12,600,000
(P14,000,000 X 90%)

Problem 11 – 2
a. Collection of the note is reasonably assured.
Jan. 5: Cash. .............................................................................. 600,000
Notes Receivable............................................................1,000,000
Unearned interest income.......................................... 401,880
Deferred revenue from F.F........................................ 1,198,120
Face value of NR............................................................ 1,000,000
Present value (P200,000 x P2,9906)............................. __598,120
Unearned interest........................................................... 401,880
Nov. 25: Deferred cost of Franchise........................................ 179,718
Cash....................................................................... 179,718
Dec. 31: Cash / AR................................................................... 4,000
Revenue from CFF................................................. 4,000
 (P80,000 X 5%)
Cash........................................................................... 200,000
Notes Receivable.................................................... 200,000
Adjusting Entries:
1) Unearned interest income................................................ 119,624
Interest income........................................................... 119,624
P598,120 x 20%
2) Cost of Franchise............................................................. 179,718
Deferred cost of Franchise........................................ 179,718
3) Deferred revenue from FF...............................................1,198,120
Revenue from FF........................................................ 1,198,120
b. Collection of the note is not reasonably assured.
Jan. 5 to Dec. 31 before adjusting entries – Refer to Assumption a.
Dec. 31: Adjusting Entries:
1) Unearned interest income.............................................. 119,624
Interest income.......................................................... 119,624
2) Cost of franchise............................................................ 179,718
Deferred cost of franchise.......................................... 179,718
3) Deferred revenue from FF.............................................1,198,120
Cost of Franchise....................................................... 179,718
Deferred gross profit – Franchise............................. 1,018,402
GPR = 1,018,402 / 1,198,120 = 85%)
4) Deferred gross profit – Franchise.................................578,319.60
Realized gross profit – Franchise.............................. 578,319.60
(P600,000 + P200,000- P119,624) x 85%

Problem 11 – 3
2010
July 1: Cash. .................................................................................... 120,000
Notes Receivable.................................................................. 320,000
Unearned interest income.............................................. 66,408
Deferred revenue from FF............................................. 373,592
Face value of NR..................................................................P320,000
Present value (P80,000 x 3.1699)........................................ _253,592
Unearned interest income....................................................P   66,408
Sept. 1 to
Nov. 15:Deferred cost of franchise.................................................... 80,000
Cash. .............................................................................. 80,000
(P50,000 + P30,000)
Dec. 31:Adjusting Entry:
Unearned interest income.................................................... 12,680
Interest income............................................................... 12,680
(P253,592 x 10% x 1/2)
2011
Jan. 10: Deferred cost of franchise.................................................... 50,000
Cash. .............................................................................. 50,000
July 1: Cash. .................................................................................... 80,000
Note receivable.............................................................. 80,000
Dec. 31:Adjusting Entries:
 (1) Cost of franchise.................................................................. 130,000
Deferred cost of franchise.............................................. 130,000
(2) Deferred revenue from FF................................................... 373,592
Revenue from FF............................................................ 373,592
(3) Unearned interest income.................................................... 25,360
Interest income............................................................... 25,360

Problem 11 – 4
2011
Jan. 10: Cash. ....................................................................................6,000,000
Deferred revenue from FF............................................. 6,000,000
Jan. 10 to
July 15: Franchise expense................................................................2,250,000
Cash. .............................................................................. 2,250,000
Deferred revenue from FF...................................................4,000,000
Revenue from FF............................................................ 4,000,000
Initial Franchise fee.............................................................P6,000,000
Deficiency
Market value of costs (P180,000  90%) x 10 yrs.......(  2,000,000)
Adjusted initial fee (revenue)...............................................P4,000,000
July 15: (a) Continuing expenses...................................................... 180,000
Cash / Accounts payable............................................ 180,000
(b) Deferred revenue from FF............................................. 200,000
Revenue from CFF..................................................... 200,000
(P180,000/ 90%)

Problem 11 – 5
a) Adjusted initial franchise fee:
Total initial F.F.................................................................... P4,500,000
Less: Face Market value of kitchen equipment................... _1,800,000
Adjusted initial FF............................................................... P2,700,000
Revenues:
Initial FF............................................................................... P2,700,000
Sale of kitchen equipment.................................................... 1,800,000
Continuing F.F. (P2,000,000 x 2%)..................................... ___40,000
Total. .................................................................................... 4,540,000
Expenses:
Initial expenses.....................................................................P  500,000
Cost of kitchen equipment...................................................1,500,000 _2,000,000
Net income................................................................................. P2,540,000
b) Journal Entries:
Jan. 2: Cash. ....................................................................................1,500,000
Notes receivable...................................................................3,000,000
Deferred revenue from FF (adjusted SV)...................... 2,700,000
Revenue from FF (Market value of equipment)............. 1,800,000
Cost of kitchen equipment....................................................1,500,000
Kitchen equipment......................................................... 1,500,000
Jan. 18: Franchise expense................................................................ 500,000
Cash........................................................................... 500,000
April 1: Cash ....................................................................................2,000,000
Notes receivable......................................................... 2,000,000
Dec. 31:Cash ....................................................................................1,000,000
Notes receivable......................................................... 1,000,000
Cash / Account receivable................................................... 40,000
Revenue from continuing FF..................................... 40,000
Deferred revenue from FF...................................................2,700,000
Revenue from FF........................................................ 2,700,000

Problem 11 – 6
Recognition of initial franchise fee (IFF) (6 mos. after opening)
Revenue from initial FF:
Total initial FF...........................................................................P2,500,000
Less: Deficiency in continuing FF (Sch. 1)............................... 160,000 2,340,000
Expense (costs of initial services)...................................................... __700,000
Net income. ........................................................................................ P1,640,000
Schedule 1 – Estimated deficiency in CFF
(1) (2)
Yr. of Estimated Market Value (Excess of 2 over 1)
Contract Continuing FF of Continuing Services Deficiency
1 P220,000 P250,000 P 30,000
2 220,000 250,000 30,000
3 220,000 250,000 30,000
4 220,000 125,000 –
5 220,000 125,000 –
6 150,000 125,000 –
7 150,000 125,000 –
8 150,000 125,000 –
9 90,000 125,000 35,000
10 90,000 125,000 __35,000
P160,000
Recognition of revenue from CFF and costs:
Years 1-3 Years 4-5 Years 6-8 Years 9-10
Revenue from CFF..................... P250,000 P220,000 P150,000 P125,000
Expenses .................................... _200,000 _100,000 _100,000 _100,000
Net income................................. P  50,000 P120,000 P  50,000 P  25,000

Problem 11 – 7
1/12/2011 6/1/2011 7/1/2011 6/30/2011
Revenue
Initial FF (Sch. 1) – – 287,200 –
Interest income – – –
45,490*
Continuing FF – – –
48,000
Others 62,500 80,000 – –
Expenses:
Initial expenses – – (  70,000) –
Continuing expense – – – ( 36,000)
 Others ( 50,000)(  68,000) – –
Net Income P 12,500 P  12,000 P217,200 P 57,490
* P454,900 x 10% = P45,490
Schedule 1: Computation of initial FF to the recognized:
Total initial fee....................................................................................... P750,000
Less: Interest unearned on the note..................................................... ( 145,100)
A
Market value of inventory.......................................................... (  80,000)
B
Market value of equipment........................................................ (  62,500
B
Deficiency in continuing costs................................................... ( 175,200)
C
Adjusted initial FF................................................................................. P287,200
A. Unearned Interest:
Face value of the note...................................................................... P600,000
Present value (120,000 x 3.7908).................................................... 454,900
rounded
Unearned interest............................................................................. P145,100
B. Market value of equipment and inventory:
Equipment (P50,000 / 80%)............................................................. P 62,500
Inventory .......................................................................................... 80,000
Income from Sales:
Equipment Inventory Total
Sales Price........................................ P62,500 P80,000 P142,500
Cost. ................................................. 50,000 68,000 118,000
Net income....................................... P12,500 P12,000 P 24,500
C. Analysis of Continuing costs:
Market value of costs is P4,000/Mo. or P48,000 / yr.
Continuing Fees:
Years 1-4 Years 5-16 Years 17-20
Gross revenues................................. P330,000/mo. P450,000/mo. P500,000/mo.
Gross fees per month....................... P  2,475/mo. P  3,375/mo. P  3,750/mo.
Gross fees per year........................... P     29,700 P     40,500 P     45,000
Market value of continuing costs..... (     48,000) (     48,000) (     48,000)
Deficiency per year.......................... (     18,300) (      7,500) (      3,000)
Number of years............................... x4 x 12 x4
Deficiency .................................... P(    73,200) P(    90,000) P(    12,000)
Total deficiency for 20 years is P175,200
Dates of Revenue Recognition:.............................................. Types of Revenue
January 12, 2011...................................................... Sale of equipment
June 1, 2011............................................................. Sale of inventory
July 1, 2011.............................................................. Initial FF (as adjusted0
June 30, 2012........................................................... Interest income and continuing
revenue.