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Chapter 6

Franchises
Franchises are rights to sell a specific brand of product or services in a certain geographic area.
There are two parties involve in franchising, namely the franchisor who grants the right to sell
his brand of product or services to another party called the franchisee. Each party contributes
resources.

The franchisor contributes his trade name, product, and companys reputation. He also imparts
his expertise and on continuing basis provides guidance and duties on the manner in which the
franchisee must operate his establishment. The franchisee on the other hand, provides
operating capital for the operation of the franchised business.

Problems on franchising are seldom given in the actual CPA board examination but with
increasing number of businesses requiring arrangement especially that of a service sponsor-
retailer arrangement, e.g. operation of restaurants, it is likely that franchise problems will be
included in the CPA examination more often. Candidates should therefore be familiar with the
accounting techniques and procedures applicable to this topic.

Franchise Fees

Franchise agreement usually requires the franchisee to make payments, called the franchise
fees to the franchisor in consideration for the reputation, skill, products and services
contributed by the franchisor. There are two types of franchise fees, the initial franchise and
the continuing franchise fee.

Revenue Recognition-Initial Franchise Fee

Before a franchise is granted, an initial franchise fee is paid by the franchisee to the franchisor.
Usually the initial franchise fee is paid by the franchisee via a down payment with the balance
evidenced by a note payable in installment.

In the actual CPA board examination problems involving franchise accounting may require the
computation of the revenue (earned) from initial franchise fee to be recognized by the
franchisor and the amount of the unearned franchise fee at the end of the year. The
determination of revenue earned on the initial franchise fees lies on the following factors: (1)
the point at which fee is to be considered earned; and (2) the assurance of collectability of the
unpaid portion of the fee, if the initial franchise fee is not paid in full.

Revenue from the initial franchise fee should be recognized on the consummation of the
transaction, which occurs when all material services or conditions of the agreement have been
substantially performed. There is substantial performance by the franchisor when the following
conditions are met:

a. The franchisor is not obliged in any way to refund cash already received or forgive
unpaid debt.
b. The initial services required of the franchisor have been substantially performed.
c. No other material conditions or obligations exist.

It is assumed that substantial performance occur when the franchisee actually commence
operations of the franchise business.

Cost of Services

Direct franchise costs of initial services rendered by the franchisor shall be deferred until
related revenue is recognized. These costs should not exceed anticipated related revenue.
Indirect costs that occur on a regular basis should be expensed when incurred. Costs yet to be
incurred should be accrued and charged against income not later that the period in which the
related revenue is recognized.

The earned and the unearned revenue from the initial franchise fee are computed using the
following approaches:

With Direct Franchise Costs

a. If collection of the note is assured:


Earned franchise fee = Cash collection plus the balance of the note (accrual
method)
Unearned franchise fee = None
b. If collection of the note is not assured:
Earned franchise fee = Cash collections applying to principal X Gross profit
rate (installment method)
Unearned franchise fee = Balance of the note

Without Direct Franchise Costs:

a. If collection of the note is assured:


Earned franchise fee = Cash collection plus the balance of the note
Unearned franchise fee = None
b. If collection of the note is not assured:
Earned franchise fee = Cash collections
Unearned franchise fee = Balance of the note

Revenue Recognition-Continuing Franchise Fee


Continuing franchise fee is usually collected from the franchisee at the end of each month in
payment of the continuing services rendered by the franchisor. This is usually based on a
certain percentage of the monthly sales of the franchisee. Continuing franchise fees are
recognized as revenue when actually received.

All direct and indirect costs related to continuing franchise fees are recognized as expense.

Option to Purchase

The franchise agreement may include a provision to the effect that the franchisor has an option
to purchase the franchise business. If the option is granted at the time the franchise agreement
is signed, the initial franchise fee is to be deferred. When the option is exercised and the
franchisor acquires the franchise business, the deferred revenue from the initial franchise fee is
treated as a reduction from the franchisors investment.
PROBLEMS
1. On December 31, 2013, Mocha Blends, Inc. authorized Jose Miguel to operate as a
franchise for an initial franchise fee of P1,500,000. Of this amount, P600,000 was
received upon signing the agreement and the balance, represented by a note, is due in
three annual payments of P300,000 each beginning December 31, 2014. The presented
value on December 31, 2013, of the three annual payments appropriately discounted is
P720,000. According to the agreement, the non-refundable down payment represents a
fair measure of the services already performed by Mocha Blends, Inc. Collectability of
the note is reasonable.

On December 31, 2013, Mocha Blends, Inc. should record the initial franchise fee with
the following entry:

a. Cash 600,000
Notes receivable 900,000
Unearned interest income 180,000
Franchise revenue 600,000
Deferred revenue from franchise fee 720,000

b. Cash 600,000
Note receivable 900,000
Unearned interest income 180,000
Deferred revenue from franchise fee 1,320,000

c. Cash 600,000
Note receivable 900,000
Deferred revenue from franchise fee 1,500,000

d. Cash 600,000
Note receivable 900,000
Unearned interest revenue 180,000
Franchise revenue 1,320,000

2. Each of the Coffee Beanery Companys 21 new franchisee contracted to pay an initial
franchise fee of P30,000. By December 31, 2013, each franchise had paid a non-
refundable P10,000 fee and signed a note to pay P10,000 principal plus the market rate
of interest on December 31, 2014, and December 31, 2015. Experience indicates that
one franchise will default on the additional payments. Services for the initial fee will be
performed in 2014.

What amount of net unearned franchise fees would Coffee Beanery report at December
31, 2013?
a. P400,000
b. P600,000
c. P610,000
d. P630,000

3. On January 2, 2013, Pedro Jose got the franchise of Marios Inc. a known steakhouse of
upscale patronage. The franchise agreement required a P500,000 franchise fee payable
P100,000 upon signing of the franchise and the balance in four annual instalments
starting December 31, 2013. At present value using 12% as discount rate, the four
instalments would approximate P199,650. The fees once paid are not refundable. The
franchise may be cancelled subject to the provisions of the agreement. Should there be
unpaid franchise fees attributed to the balance of main fee (P500,000), same would be
due and demandable upon cancellation. Further, the franchisor is entitled to a 5% fee
on gross sales payable monthly within the first ten days of the following month.

The note receivable for the balance of the franchise fee was guaranteed by the Metro
Bank.

The first year of operations yielded gross sales of 9 million. On December 3, 2013,
Marios, Inc. earned franchise fee is:

a. P550,000
b. P650,000
c. P749,650
d. P950,000

4. On December 31, 2013, Maxs Inc. signed an agreement authorizing Maria de Jesus to
operate as a franchisee for an initial franchise fee of P500,000. Of this amount,
P200,000 was received upon signing of the agreement and the balance is due in three
annual payments of P100,000 each beginning December 31, 2014. The agreement
provides that the down payment (representing a fair measure of the initial services
already performed by Max) is not refundable although future services are yet to be
performed. Marias credit rating is such that collection of the note is reasonably
assumed. The present value at December 31, 2013 of the three annual payments
discounted at 14% is P232,200.

On December 31, 2013, Maxs, Inc. should record unearned franchise fee of:

a. P232,200
b. P300,000
c. P422,200
d. P -0-
5. Dryers Inc. sell franchise for ice cream outlets in Metro Manila. One contract has been
signed on January 5, 2013. The agreement calls for an initial franchise fee of P6,000,000
to be paid by the franchisee at the signing of the contract. The franchisors initial cost of
services is P2,250,000 to be incurred uniformly over the six-month period prior to the
scheduled opening date of July 15, 2013. No future payments are to be made by the
franchisee, although there will be continuing costs of P180,000 per year for services
rendered during the ten year term of the contract. The normal return for the franchisor
on continuing operations involving franchise outlets is 10%.

How much net income would be recognized by Dryers, Inc. on July 15, 2013.

a. P3,750,000
b. P5,750,000
c. P6,000,000
d. P1,750,000

6. On August 31, 2013, KFC, Inc. entered into franchise agreements with two franchisees.
The agreements required an initial franchise fee payment of P700,000 plus four
P300,000 payments due every four months, the first payment is due on December 31,
2013. The market interest rate is 12%. The initial deposit is refundable until substantial
performance has been completed. The following data describes each agreement:
Franchise Probability of full Services performed Total costs incurred
collection by franchisor dec. to Dec.31,2013
31,2013
Juan Jose Likely Substantially P700,000
Pedro Pablo Doubtful 25% N/A
The present and future value tables at 4% for four (4) periods were as follows:
Present value of P1 0.8548
Present value of an annuity of P1 3.6299
Future value of P1 1.1699
Future value of an ordinary annuity of P1 4.2465
What amount of net income is to be reported by KFC in 2013, assuming P1,000,000 was
received from each franchisee during the year.
Juan Jose Pedro Pablo
a. P1,088,970 P-0-
b. P1,788,970 P-0-
c. P1,132,529 P-0-
d. P1,132,529 P43,559
7. KFC Fried Chicken Inc., granted a franchise to Manuel Villa. Manuel was to pay
P1,000,000 payable in five equal annual instalments starting with the payment upon
signing of the franchise agreement. The franchisee was to pay monthly 5% of gross sales
of the preceding month. Should the operating of the outlet prove to be unprofitable, the
franchise may be cancelled with whatever obligation owing KC, in connection with the
P1,000,000 franchise fee, waived.

The first year of operations generated a gross sales of P500,000. For the first year, KFC
Fried Chicken, Inc., should report revenue from the franchise fee of:
a. P200,000
b. P1,025,000
c. P1,000,000
d. P225,000
8. On June 30,2013 UCC, Inc. franchisor, entered into a franchise agreement with May
Tuazon, franchisee. The initial fee agreed upon is P1,100,000 of which P100,000 is
payable upon signing of the contract and the balance payables in four equal annual
instalments. It was agreed that the down payment is not refundable, not-withstanding
lack of substantial performance of services by franchisor. On July 1,2013 Miss Tuazon
was able to start the operation.

When UCC, Inc. prepares its financial statements on December 31,2013, the unearned
franchise fee to be reported is:
a. P1,000,000
b. P1,000,000
c. P-0-
d. P100,000
9. D Marks Pizza, awarded its franchise to Miguel de Jesus for an initial franchise fee of
P1,000,000. Of the said amount, 50% was payable upon signing of the agreement and
the balance in two equal annual payments. The contract provided that in the event the
first year would result in an operating loss, the franchising agreement may be cancelled
without the need for returning any portion of the franchise fee already paid nor the
payment of any balance still unpaid.

The entry to record the granting of the franchise to Miguel would be:
a. No entry
b. Cash 500,000
Notes receivable 500,000
Deferred revenue from franchise fee 1,000,000
c. Cash 500,000
Notes receivable 500,000
Revenue from franchise fee 1,000,000
d. Cash 500,000
Notes receivable 500,000
Deferred revenue from franchise fee 500,000
Revenue from franchise fee 500,000
10. On January 2,2013, David, Inc. signed an agreement authorizing Jose Pidal to operate as
a franchisee for an initial franchise fee of P5,000,000. Of this amount, P2,000,000 was
received upon signing of the agreement and the balance evidence by a 12% promissory
note which is due in three annual instalment payments of P1,000,000 each beginning
December 31,2013, Pidal started franchise operations on September 1,2013, after David
rendered the required initial services at a total cost of P500,000. Although the first
instalment was collected on due date, collection of the balance was not reasonably
assured.

What is the realized gross profit on franchise fee to be recognized by David at December
31,2013?
a. P2,700,000
b. P4,500 000
c. P3,000,000
d. P5,000,000
11. Ling Nam, Inc. granted a franchise to Robin Reyes to operate a restaurant. The
agreement signed on January 2,2013 called for a P300,000 downpayment plus two
P100,000 annual payment representing the value of initial services to be rendered by
Ling Nam. The present value of two annual payments appropriately discounted at its
implicit rate is P177,355. In addition, the agreement required the franchisee to pay 5%
of its gross sales to the franchisor, this was deemed sufficient to cover the cost and
provide a reasonable profit margin on continuing franchise services to be performed by
Ling Nam. The restaurant opened early in 2013, and its sales for the year amounted
P1,000,000.

How much revenue from the franchise would be recognized by Ling Name on December
31,2013?
a. P527,355
b. P977,355
c. P300,000
d. P-0-
12. On June 1,2013, Figaro Corporation, franchisor, receives P200,000 from Angel Sy
representing down payment on the franchise agreement signed that day. Angel Sy gave
Figaro a 12% interest bearing promissory note for the balance of P1,000,000 payable in
four semi-annual instalments. Franchise services was substantially competed by Figaro
on November 15 at a cost of P900,000. On December 1,2013, the first semi-annual
instalment became due and was accordingly paid by Angel Sy. Figaro appropriately uses
the accrual method of recording franchise revenues.

In its December 31,2013 financial statements, how much will Figaro report as realized
franchise income of the year?
a. P112,500
b. P300,000
c. P250,000
d. P187,500
13. On july 1,2013, Manuel Tenng entered into a franchise agreement with Polo, Inc., to sell
their products. The agreement provides for an initial franchise fee of P1,250,000,
payable as follows: P350,000 cash to be paid upon signing of the contract, and the
balance in five equal annual payments every December 31 starting December 31,2013.
Manuel Teng signs 15% interest bearing note for the balance. The agreement further
provides that the franchisee must pay continuing franchise fee equal to 5% of its
monthly gross sales. On October, the franchisor completed the initial services required
in the contract at a costs of P787,500 and incurred expenses of P42,900. The franchisee
commenced business operations on November2,2013. The gross sales reported to the
franchisor are:
November sales P121,000
December sales 147,500
Assuming the collection of the note receivable is not reasonably assured, in its
statement of comprehensive income for the year ended December 31,2013, how much
is the net income?
a. P234,125
b. P301,625
c. P220,700
d. P166,625
14. On December 31,2013, Arcee Ice Cream, Inc. authorized Jose Lee to operate as a
franchisee for an initial franchise fee of P3,000,00. Of this amount, P1,200,000 was
received upon signing of the contract, and the balance by a non-interest bearing note,
due in three annual payments of P600,000, beginning December 31,2014. The present
value on December 31,2013 of the three annual payments of appropriately discounted
is P1,263,900. The collectability of the note is not reasonably assured.

On December 31,2013, Arce should record the receipt of the initial franchise fee by the
following entry:
a. Cash 1,200,000
Note receivable 1,800,000
Unearned interest income 536,100
Deferred revenue from franchise fee 2,463,900
b. Cash 1,200,000
Note receivable 1,800,000
Deferred revenue from franchise fee 3,000,000
c. Cash 1,200,000
Note receivable 1,800,000
Revenue from franchise fee 3,000,000
d. Cash 1,200,000
Note receivable 1,800,000
Unearned interest income 536,100
Revenue from franchise fee 2,463,900
15. On January 2,2013, UCC, Inc. authorized Pedro de Jesus to operate as a franchisee for an
initial franchise fee of P750,000. Of this amount, P300,000 was received as
downpayment upon signing the agreement, and the balance represented by a 12% note
due in three annual payments, beginning december31,2013. UCC rendered the required
initial services at a cost of P150,000 and Pedro was able to operate the franchise on
April 27,2013.

Assuming the collection of the note is not reasonably assured, the realized revenue
form the initial franchise on December 31,2013 is:
a. P360,000
b. P650,000
c. P300,000
d. P450,000
16. Using the date in No. 5, but assuming the collection of the note is reasonably assured,
the net income to be presented in its statement of comprehensive income on December
31,2013 is:
a. P654,000
b. P900,000
c. P650,000
d. P750,000
17. Mr. Villa is about to purchase a franchise from Pizza, Inc. the standard contract provides
for a 10-year term and an initial franchise fee of P450,000 a payable as follows:
P150,000 at the date of signing. The expected date of signing is January 1,2013. A
continuing fee of 2% of gross sale is also to be paid to the franchisor. Monthly gross
sales are expected to be P200,000 for the first four years and P375,000 for the
remainders of the contract. An additional of P50,000 for initial services are incurred on
January 17,2013. There are no associated continuing costs.

What is the net income to be recognized by Pizza Inc. for the fiscal year ending
December 31,2013 assuming that the franchisor started operations on February 1,2013?
a. P444,000
b. P140,400
c. P240,400
d. P440,800
18. Macdo Burger, Inc. sells franchise to independent operators in Metro Manila. The
franchise contract includes the following provisions:
a. The initial franchise fee is P25,000,000. Of this amount, P5,000,000 is payable when
the agreement is signed and a P4,000,000 non-interest-bearing note is payable at
the end of each of the five subsequent years.
b. All of the initial franchise fee collected by Macdo, Inc. is to be refunded and the
remaining obligation cancelled if for any reason, the franchisee fails to open the
franchise.
c. In addition to the initial franchise fee, the franchisee is required to pay Macdo, Inc.
a monthly fee of 2% of sales.

Macdo, Inc. estimates that the value of the services rendered to the franchises after
the contract is signed amounts of P5,000,000. All franchises to date have opened
their locations at the scheduled time and none had defaulted on any of the notes
receivable. The credit rating of all franchises would entitle them to borrow at the
current rate of 10%. The present value of an ordinary annuity of five annual receipts
of P4,000,000 each, discounted at 10% is P5,163,000.

What is the amount of the deferred revenue from the initial franchise fee to be
recorded on the date the agreement is signed?
a. P25,000,000
b. P20,000,000
c. P20,163,000
d. P25,163,000
19. On January 1,2013, Jolybee Corporation sold a franchise to Mr. AMG for P10,000,000 for
the right to operate as a franchisee of Jolybee Corporation. Terms of the franchise
contract were:
1. The initial franchise fee of P1,000,000 is payable in cash, when the contract is signed
and the balance in five equal instalment every december 31, evidenced by a 12%
promissory note.
2. The franchisor will assist in locating the site, supervise construction activity and
training of management and employees.

On December 31,2013 direct cost of services rendered to the franchisee amounted


to P2,000,000.

Assuming that there is substantial performance of services required in the contract


and the collectability of the note receivable is not reasonably assured, using the
instalment method how much net income is to be recognized by Jolybee on
December 31,2013?
a. P1,000,000
b. P1,880,000
c. P3,320,000
d. P2,800,000
20. On January 1,2013, a Michael Company signed an agreement to operate as a franchisee
of Perfect Pizza, Inc. for an initial franchise fee of P1,600,000 for a period of 10 years. Of
this amount P600,000 (not refundable) was paid when the agreement was signed and
the balance payable in five annual payments of P200,000 beginning December 31,2013.
Michael signed a noninterest bearing note for the balance.

Michaels credit rating indicates that it can borrow money at 20% for a loan of this type.
Information on present and future value factors is an follows:

Present value of P1 at 20% for 5 periods .402


Present value of an annuity of P1 at 20% for 5 periods 2.9906
Future amount of P1 at 20% for 5 periods 2.488
In return for the initial franchise fee, the franchisor will help in locating the site,
negotiate the lease or purchase the site, supervise the construction activity and provide
training to employees.

On December 31,2013, the initial services required of the franchisor are substantially
performed.

Assuming that the collectability of the note is reasonably certain, the revenue from
franchise fee to be reported on December 31, 2013 is:
a. P1,198,120
b. P1,600,000
c. P600,000
d. P1,500,000
21. On January 2,2013, Jolly Services, Inc. awarded a franchise to Ms. Anson for an initial
franchise fee of P700,000. Ms. Anson gave Jolly Services a 15% note to cover the initial
franchise fee. The agreement provides that Jolly Services has the option (within
365days) to acquire the franchise business and it seems certain that Jolly will exercise
the option. Ms. Anson makes payment makes payment of P175,000 on this note on
September 30,2013.

Assuming that Jolly Services, Inc. prepares interim financial statements for the period
ended September 30,2013. How much would be the revenue to be recognized from this
transaction?
a. P78,750
b. P105,000
c. P700,000
d. P-0-
22. On January 1,2013, Ms. Joy Cruz signed an agreement to operate as a franchisee of
Queen Barbecue, Inc. for an initial franchise fee of P1,875,000 for 7 years. Of this
amount, P375,000 was paid when the agreement was signed and the balance payable in
three annual payments beginning on December 31,2013. Ms. Joy signed a non-interest
bearing note for the balance. Present value factor for this note is 2.17. Ms. Joys ceredit
rating indicated that the borrow money at 18% for the loan of this type.

Queen Barbecue rendered substantial services amounting to P584,000. Other indirect


costs of P51,000 was also incurred by Queen. The collection of the note is not
reasonable assured.

What is the entry of Queen Barbecue on January 1,2013 to be record the receipt of the
initial franchise fee from Ms. Joy Cruz?
a. Cash 375,000
Note receivable 1,500,00
Unearned interest 415,000
Deferred revenue from IFF 1,460,000
b. Cash 375,000
Note receivable 1,085,00
Deferred revenue from IFF 1,460,000
c. Cash 375,000
Note receivable 1,500,00
Deferred revenue from IFF 1,875,000
d. Cash 375,000
Note receivable 1,085,00
Unearned interest 415,000
Deferred revenue from IFF 1,045,000
23. Using the data in No. 22, what is the net income for the year ended December 31,2013?
a. P335,000
b. P552,120
c. P660,000
d. P474,000
24. On January 2, 2013, Ms. Jenny Lopez signed an agreement to operate as a franchisee of
Cebu Lechon, Inc., for an initial franchise fee of P3,125,000 for 10 years. Of this amount,
40% was paid when the agreement was signed and the balance payable in four semi-
annual payments beginning June 30, 2013. Ms. Jenny Lopez issued a non-interest note
for the balance. Credit rating of Ms. Jenny indicates that it can borrow money at 24% on
the loan of this type. Present value factor of the note is 0.34. Cebu Lechon rendered the
services required in the contract at a cost of P802,500. Ms. Jenny Lopez commenced
business operations on March 1, 2013.

The collection of the note of Ms. Jenny is not reasonable assured.

What is the entry of Cebu Lechon on January 2, 2013 to record the receipt of the initial
franchise fee from Ms. Jenny?

a. Cash 1,250,000
Note Receivable 1,875,000
Deferred revenue from IFF 3,125,000

b. Cash 1,250,000
Note Receivable 1,875,000
Unearned interest income 450,000
Deferred revenue from IFF 2,675,000

c. Cash 1,250,000
Note Receivable 1,425,000
Deferred revenue from IFF 2,675,000

d. Cash 1,250,000
Note Receivable 1,425,000
Unearned interest income 450,000
Deferred revenue from IFF 2,225,000

25. Using the data in No. 24, what is the realized gross profit on the initial franchise fee to
be recognized on December 31,2013?

a. P1,338,307
b. P1,316,861
c. P1,321,345.50
d. P1,069,031.50
Answers
1. a 6. c 11. a 16. a 21. a
2. c 7. d 12. b 17. a 22. a
3. c 8. a 13. a 18. c 23. b
4. d 9. b 14. a 19. c 24. b
5. d 10. a 15. a 20. a 25. b

SOLUTIONS AND EXPLANATIONS


1. Franchise fee revenue is recognized when all material services have been substantially
performed by the franchisor. Substantial performance means the franchisor has and has
no remaining obligation to refund any cash received. The P600,000 non-refundable
down payment applies to the initial services already performed by Rice. Therefore, the
P600,000 may be recognized as revenue in 2013. The three remaining P300,000
installments relate to substantial future services to be performed by Rice. The present
value of these payments (P720,000) is recorded as unearned franchise fee and
recognized as revenue once substantial performance of the future services has
occurred. The difference between the face value of the note (P900,000) and its present
value (P720,000) is recognized as unearned interest income. Therefore entry (A) is
correct.

2. Initial franchise fees are not recognized as revenue until the franchisor makes
substantial performance of the required services, and collection is reasonably assured.
Since Beanery Coffee has not yet performed the required services, the initial franchise
fee (21 x P30,000 = P630,000) is reported as unearned franchise fees at 12/31/2013. The
estimated uncollectible amount (P20,000) normally would be recorded as debit to bad
debt expense and a credit to allowance for uncollectible accounts. However, since no
revenue has yet been recognized, it is inappropriate to record bad debt expense.
Instead, unearned franchise fees is debited, because an unearned revenue should not
be recorded when, in effect, no related asset has been received. Therefore, the net
unearned franchises fees is P610,000 (P630,000 P20,000).

3.
Downpayment P100,000
Present value of the balance of the franchise fee 199,650
Earned initial franchise fee P299,650
5% fees on gross sales (9 million x .05) 450,000
Earned franchise fees P749,650

4. Since no substantial future services are required to be performed by the franchiser, the
P200,000 downpayment and the present value of the note receivable, P232,200 are
recognized as revenue in 2013, therefore the unearned franchise fee on December 31,
2013 is zero.

5.
Initial franchise fee P6,000,000
Less: value of continuing costs [(P180,000/90%)x 10] 2,000,000
Adjusted franchise fee 4,000,000
Less: initial expenses 2,250,000
Net income P1,750,000

6. From Juan Jose:


Franchise revenue (Full):
Downpayment P700,000
Present value of the note (P330,000 x 3.6299) 1,088,970
Total P1,788,970
Cost of franchise 700,000
Gross profit P1,088,970
Interest income (P1,088,970 x 4%) 43,559
Net income P1,132,529
From Pedro Pablo: None

7. Revenue:
Initial franchise fee (P1,000,000/ 5) P200,000
Continuing franchise fee (P500,000 x 5%) 25,000
Total revenue P225,000

8. Initial franchise fee P1,100,000


Less: down-payment 100,000
Balance (unearned) P1,000,000

9. At the time of the granting of the franchise, no substantial services have been rendered
by the franchisor thus no revenue is recognize. The total initial franchise fee of
P1,000,000 is deferred. Therefore entry (B) is correct.

10. Revenue from franchise fee P5,000,000


Cost of franchise fee 500,000
Gross profit P4,500,000
Gross profit rate (P4,500,000 / P5,000,000) 90%
Realized Gross Profit [(P2,000,000 + P1,000,000)x 90%] P2,700,000

11. Initial franchise fee (P300,000 + P177,355) P477,355


Continuing franchise fee (P1,000,000 x 5%) 50,000
Total revenue P527,355
12. Franchise revenue:
Downpayment P200,000
Note receivable P1,000,000
Total P1,200,000
Cost of franchise fee 900,000
Realized gross profit P300,000

13. Realized gross profit on initial franchise fee (schedule 1) P196,100


Continuing franchise fee (P268,500 x 5%) 13,425
Total revenue P209,525
Interest income (P900,000 x 15% x 6/12) 67,500
Total P277,025
Expenses 42,900
Net income P234,125

Sch. 1:
Collections
Downpayment P350,000
1st installment 180,000 P530,000
GPR (P462,500 P1,250,000) 37%
RGP P196,100

14. Face value of note receivable P1,800,000


Present value 1,263,900
Unearned interest P536,100
Initial franchise fee P3,000,000
Less: unearned interest 536,100
Deferred revenue from franchise fee P2,463,900
Therefore the entry is letter (a)

15. Initial franchise fee (deferred revenue) P750,000


Cost of franchise fee 150,000
Gross profit P600,000
Gross profit rate (P600,000 / P750,000) 80%

Realized gross profit:


Down-payment P300,000
Installment collected (P450,000 / 3) 150,000
Total collection P450,000
Gross profit rate 80%
Realized gross profit P360,000

16. Revenue from initial franchise fee P750,000


Cost of franchise fee 150,000
Gross profit P600,000
Interest income (P450,000 x 12%) 54,000
Net income P654,000

17. Initial franchise fee P450,000


Continuing fee (P200,000 x 2%)x 11 months 44,000
Total 494,000
Initial expenses 50,000
Net income P444,000

18. Initial franchise fee P25,000,000


Less: Unearned interest
FV of the note receivable P20,000,000
PV of the note receivable 15,163,000 4,837,000
Deferred revenue from IFF P20,163,000

19. Realized Gross Profit From Franchise Fee:


Downpayment P1,000,000
Collection of NR (P9,000,000 5) 1,800,000
Total 2,800,000
GPR (P8,000,000 P10,000,000) 80%
RGP 2,240,000
Interest income (P9,000,000 x 12%) 1,080,000
Net income P3,320,000

20. Since the services required of the franchisor are substantially performed and the
collectability of the note is reasonably certain, then the revenue (earned) from franchise
fee is equal to the downpayment of P600,000 plus the present value of the note of
P598,120 (P200,000 x 2.9906) or P1,198,120.

21. The initial franchise fee of P700,000 will not be recognized as revenue on September 30,
2013. It is to be deferred because of the condition on the contract that the franchisor
has the option to repurchase the franchise after one year. The only revenue to be
recognized on September 30, 2013 is the interest of P78,750 (P700,000 x 15% x 9/12).

22. Entry (a) is correct the amounts in the entry are computed as follows:

Initial franchise fee P1,875,000


Cash Downpanyment (Dr.) 375,000
Face value of note receivable (Dr.) 1,500,000
Present value (P1,500,000 3)x 2.17 1,085,000
Unearned interest income (Cr.) P415,000
Adjusted sales value of the IFF (P1,875,000 P415,000) P1,460,000
23. The net income is computed as follows:

Adjusted sales value of IFF P1,460,000


Cost of franchise (direct) 584,000
Gross profit P876,000
Gross profit rate (P876,000 P1,460,000) 60%

Computation of net income:


Down-payment P375,000
Installment collected (P1,500,000 3) 500,000
Interest income (P500,000 x 2.17) x 18% (195,300)
Collections applying to principal P679,700
Gross profit rate 60%
Realized gross profit P407,820
Interest income 195,300
Total revenue 603,120
Expenses (indirect costs) (51,000)
Net income P552,120

24. Entry (b) is correct. The computation of the amounts in the entry is as follows:

Initial franchise fee P3,125,000


Cash downpayment (Dr), 40% 1,250,000
Face of the note receivable (Dr) 1,875,000
Present of the note receivable (P1,875,000 4) x 3.04 1,425,000
Unearned interest income (Cr) P450,000
Deferred revenue from IFF (P3,125,000 P450,000) P2,675,000

25. Under the installment method, the realized gross profit on the initial franchise fee is
computed as follows:

Downpayment P1,250,000
Collection of the note applying to principal (Sch. 1) 631,230
Total collections P1,881,230
Gross profit rate (Sch. 2) 70%
Realized gross profit P1,316,861

Schedule 1:
Date Collections Interest Principal PV of Note
Jan. 2 P1,425,000
June 30 P468,750 P171,000 P297,750 1,127,250
Dec. 30 468,750 135,270 333,480 793,770
Total P631,230
Schedule 2:
Adjusted sales value of IFF (No. 24) P2,675,000
Direct cost of services 802,500
Gross profit P1,872,500
Gross profit rate (P1,872,500 P2,675,000) 70%