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Revenue Recognition - Franchise Fees

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Revenue Recognition - Franchise Fees

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Recognition of Franchise Fee Revenue by the Franchisor

When can franchise fees be recognized?

According to FASB 45, the franchisor can record revenue from the initial sale of the franchise only when all significant services and obligations applicable to the sale have been substantially performed. Substantial performance is indicated when:
o There is absence of intent to give cash refunds or relieve the accounts receivable due from the franchisee.
o Nothing material remains to be done by the franchisor.
o Initial services have been rendered.

The earliest date on which substantial performance can occur is the franchisees commencement of operations unless special circumstances can be shown to exist. In the case where it is probable that the franchisor will ultimately repurchase the franchise, the initial fee must be deferred and treated as a reduction of the repurchase price.

How are deferred franchise fee revenues reported? If revenue is deferred, the related expenses must be deferred for later matching in the year in which the revenue is recognized. The exception is that if the price charged for the continuing services or goods to the franchisee is below the price charged to third parties, it indicates that the initial franchise fee was in essence a partial pre-payment for the recurring franchise fee. In this situation, part of the initial fee has to be deferred and recognized as an adjustment of the revenue from the sale of goods and services at bargain prices.

What are the requirements for initial franchise fees?

In the case where the initial fee includes both initial services and property (real or personal), there should be an appropriate allocation based on fair market values. When part of the initial franchise fee applies to tangible property, revenue recognition is based on the fair value of the assets. Revenue recognition may take place prior to or after recognizing the portion of the fee related to initial services. EXAMPLE: Part of the fee for equipment may be recognized at time title passes with the balance of the fee being recorded as revenue when future services are performed.

How do I handle recurring franchise fees? Recurring franchise fees are recognized as earned and receivable. Related costs are expensed.

If the deferred amount should be adequate to meet future costs and generate an adequate profit on the recurring services. This situation may occur if the continuing fees are minimal relative to services provided or if the franchisee has the privilege of making bargain purchases for a particular time period.

Don't adjust previously recorded revenue for the repossession. When continuing franchise fees will not cover the cost of the continuing services and provide for a profit to the franchisor, the part of franchise fee should be deferred and amortized over life.

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Return to CPA Review.

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