Chapter 1: Environment and Theoretical Structure of Financial Accounting

REVENUE RECOGNITION FOR FRANCHISES

22. Franchise fees are properly recognized as revenue
a. when received in cash.
b. when a contractual agreement has been signed.
c. after the franchise business has begun operations.
d. after the franchiser has substantially performed its service.

c. record the portion of the initial franchise fee which is attributable to the bargain purchase
option as a reduction of the future amounts receivable from the franchisee.
d. None of these.
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S, S & S

Initial Franchise Fee

Allocation of initial franchise fee.
27. Some of the initial franchise fee may be allocated to
a. continuing franchise fees.
b. interest revenue on the future installments.
c. options to purchase the franchisee's business.
d. all of these may reduce the amount of the initial franchise fee that is recognized as
revenue.
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Future bargain purchase option.
29. Occasionally a franchise agreement grants the franchisee the right to make future bargain
purchases of equipment or supplies. When recording the initial franchise fee, the franchisor
should
a. increase revenue recognized from the initial franchise fee by the amount of the expected
future purchases.
b. record a portion of the initial franchise fee as unearned revenue which will increase the
selling price when the franchisee subsequently makes the bargain purchases.
c. defer recognition of any revenue from the initial franchise fee until the bargain purchases
are made.
d. None of these.
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Option to purchase franchisee's business agreement.
30. A franchise agreement grants the franchisor an option to purchase the franchisee's business.
It is probable that the option will be exercised. When recording the initial franchise fee, the
franchisor should
a. record the entire initial franchise fee as a deferred credit which will reduce the franchisor's
investment in the purchased outlet when the option is exercised.
b. record the entire initial franchise fee as unearned revenue which will reduce the amount of
cash paid when the option is exercised.

Spiceland/Sepe/Tomassini

Continuing Franchise Fees.

28. Continuing franchise fees should be recorded by the franchisor
a. as revenue when earned and receivable from the franchisee.
b. as revenue when received.
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c. in accordance with the accounting procedures specified in the franchise agreement.
d. as revenue only after the balance of the initial franchise fee has been collected.
JOURNAL ENTRIES
Accounting for initial and annual continuing franchise fees.
51. On January 1, 2001 Dairy Delight, Inc. entered into a franchise agreement with a company
allowing the company to do business under Dairy Delight's name. Dairy Delight had performed
substantially all required services by January 1, 2001, and the franchisee paid the initial
franchise fee of $105,000 in full on that date. The franchise agreement specifies that the
franchisee must pay a continuing franchise fee of $9,000 annually, of which 20% must be
spent on advertising by Dairy Delight. What entry should Dairy Delight make on January 1,
2001 to record receipt of the initial franchise fee and the continuing franchise fee for 2001?
a. Cash
114,000
Franchise Fee Revenue
105,000
Revenue from Continuing Franchise Fees
9,000
b. Cash
114,000
Unearned Franchise Fees
114,000
c. Cash
114,000
Franchise Fee Revenue
105,000
Revenue from Continuing Franchise Fees
7,200
Unearned Franchise Fees
1,800
d. Prepaid Advertising
1,800
Cash
114,000
Franchise Fee Revenue
105,000
Revenue from Continuing Franchise Fees
9,000
Unearned Franchise Fees
1,800
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Chapter 1: Environment and Theoretical Structure of Financial Accounting

Cancellation of franchise agreement.

50. On April 1, 2001 Reebles, Inc. entered into a franchise agreement with a local business-man.
The franchisee paid $75,000 and gave a $50,000, 8%, 3-year note payable with interest due
annually on March 31. Reebles recorded the $125,000 initial franchise fee as revenue on April
1, 2001. On December 30, 2001, the franchisee decided not to open an outlet under Reebles'
name. Reebles canceled the franchisee's note and refunded $40,000, less accrued interest on
the note, of the $75,000 paid on April 1. What entry should Reebles make on December 30,
2001?
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a. Loss on Repossessed Franchise
40,000
Cash
40,000
b. Loss on Repossessed Franchise
37,000
Cash
37,000
c. Loss on Repossessed Franchise
87,000
Cash
37,000
Note Receivable
50,000
d. Revenue from Franchise Fees
125,000
Interest Income
3,000
Cash
37,000
Note Receivable
50,000
Revenue from Repossessed Franchise
35,000
Use the following to answer questions 73-75:
S, S & T
Happy Jack's Pancake Restaurants Inc. sells franchises for an initial fee of $36,000 plus operating
fees of $500 per month. The initial fee covers site selection, training, computer and accounting
software, and on-site consulting and troubleshooting, as needed, over the first five years. On
March 15, 2003, Tim Cruise signed a franchise contract, paying the standard $6,000 down with the
balance due over 5 years with interest.
1

Assuming that the initial services to be performed by Happy Jack's subsequent to the signing
are substantial and that collection of the receivable is reasonably assured, the journal entry
required at signing would include a credit to:
A. Franchise fee revenue for $36,000.
B. Franchise fee revenue for $ 6,000.
C. Unearned franchise fee revenue for $36,000.
D. Unearned franchise fee revenue for $30,000.

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Spiceland/Sepe/Tomassini

Assume that at the time of signing the contract, collection of the receivable was assured and
that service obligations were substantial. However, by October 20, 2003, substantially all
continuing obligations had been met. The journal entry required at October 20, 2003 would
include a:
A. Credit to franchise fee receivable for $27,000.
B. Credit to franchise fee revenue for $9,000.
C. Debit to unearned franchise fee revenue for $36,000.
D. Debit to unearned franchise fee revenue for $27,000.

Assume at the time of signing the contract, collectibility of the receivable was reasonably
assured and there were no significant continuing obligations. The journal entry at signing
would include a:
A. Credit to franchise fee revenue for $36,000.
B. Credit to franchise fee revenue for $9,000.
C. Credit to unearned franchise fee revenue for $36,000.
D. Credit to unearned franchise fee revenue for $27,000.

.
Note receivable
Unearned franchise fee revenue

.
Note receivable
Franchise fee revenue

(C)
30,000

Cash

6,000
36,000

10/20/03:
Unearned franchise fee revenue
Franchise fee revenue
(A)
30,000

36,000
36,000
Cash

6,000
36,000