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Franchise Fee Revenue Calculations

Rich Services Inc. recorded $95,000 in revenue from franchise fees in 2021, which included an initial $70,000 fee and 5% of Yummy Company's $500,000 in gross sales. Ray Company earned $80,000 in franchise fees from Ruth in the first year, which included a $20,000 initial fee payment and 1% of $500,000 in gross sales. Figaro Inc. realized $1,316,861 in gross profit for 2021 from its franchise agreement with JJ Company, which included payments of $1,250,000 upfront and $631,230 in principal on notes receivable, less $802,500 in services costs.

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172 views3 pages

Franchise Fee Revenue Calculations

Rich Services Inc. recorded $95,000 in revenue from franchise fees in 2021, which included an initial $70,000 fee and 5% of Yummy Company's $500,000 in gross sales. Ray Company earned $80,000 in franchise fees from Ruth in the first year, which included a $20,000 initial fee payment and 1% of $500,000 in gross sales. Figaro Inc. realized $1,316,861 in gross profit for 2021 from its franchise agreement with JJ Company, which included payments of $1,250,000 upfront and $631,230 in principal on notes receivable, less $802,500 in services costs.

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  • Problem 3 Evaluation
  • Problem 2 Discussion
  • Problem 1 Analysis
  • Problem 4 Insight
  • Problem 5 Assessment

College of Business and Accountancy

Seatwork-Assignment in ACCSTRA

1. On January 2, 2021, Rich Services Inc. signed an agreement authorizing


Yummy Company to operate as a franchisee over a 20 year period for an
initial franchise fee of P 70,000 received when the agreement was signed.
Yummy commenced operations on July 1, 2021, at which date all of the initial
services required of Rich had been performed. The agreement also provides
that Yummy must pay annually to Rich a continuing franchise fee equal to 5%
of their gross sales. Yummy reported gross sales of P 500,000 for 2021.

For the year ended December 31, 2021, how much should Rich Services, Inc.
record as revenue from franchise fees with respect to the yummy franchise?
a. P 95,000 c. P 45,000
b. 70,000 d. 25,000

Solution:

Initial franchise fee 70,000


Continuing franchise fee (500,000 x 5%) 25,000
Total revenue from franchise fees 95,000

2. Ray Company granted a franchise to Ms. Ruth. Ruth was to pay P 100,000
initial franchise fee payable in five equal annual installments starting with the
payment upon signing of the agreement. The franchisee was to pay monthly
1% of gross sales of the preceding month. Should the operation of the outlet
prove to be unprofitable, the franchise may be cancelled with whatever
obligation owing Ray, in connection with the P 100,000 franchise fee, waived.

The first year of operations generated a gross sales of P 500,000. For the first
year, Ray Company earned franchise fee of:
a. 100,000 c. P 160,000
b. 80,000 d. 25,000

Solution:

Initial franchise fee (100,000/ 5 years) 20,000


Continuing franchise fee (500,000 x 12%) 60,000
Total earned from franchise fees 80,000

3. On January 2, 2021, JJ Company signed an agreement to operate as a


franchisee of Figaro, inc. for an initial franchise fee for P 3,125,000 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, 2021;
JJ Company signed a non-interest bearing note for the balance. JJ’s credit
rating indicates that it can borrow money at 24% on the loan of this type.
Substantial services costing P 802,500 has been rendered by Figaro Inc. the
present value of an annuity of P 1 at 12% for 4 periods is 3.04

If the collection of the note is not reasonable assured, the realized gross profit
for the year ended December 31, 2021 is:
a. P 1,338,307 c. P 1,321,345.50
b. 1,316,861 d. 1,069,031.50

Solution:

First payment (3,125,000 x 40%) 1,250,000


PV of notes receivable
((1,875,000/ 4 years) x (468,750 x 3.04) 1,425,000
Total 2,675,000
Direct cost of services 802,500
Gross profit 1,872,500

Gross profit rate (1,872,000/2,675,000) 70%

Date Collection Interest Principal Balance of NR


Jan. 1 1,425,000
Jun. 30 468,750 171,000 297,750 1,127,250
Dec. 30 468,750 135,270 333,480 793,770
Total principal 631,230
First payment 1,250,000
Total collection 1,881,230
Gross profit rate 70%
Realized gross profit, end 1,316,861

For Nos. 4 and 5


Ms. Jasmin Sy purchased franchise from Goldilock, Inc. the franchise agreement
provides an initial franchise fee of P 4,500,000, payable as follows: P 1,500,000 at
the date of signing, P 2,000,000 three months after signing, and the balance one
year after signing. The expected date of signing is January 2, 2021. A continuing fee
of 2% of the gross sales is also to be paid to the franchisor. Total sales for the year
reported by the franchisee amounts to P 2,000,000.

Costs associated with the initial franchise fee are as follows:


a. Title to kitchen equipment, with a cot of P 1,500,000, is to be transferred to
the transferred to the franchisee on the day the agreement is signed. The fair
market value of the equipment is P 1,800,000
b. An additional P 500,000 for initial services are incurred on January 18, 2021.

There are no associated continuing costs.

4. What is the entry of Goldilock to record the initial franchise fee on January 2,
2021?
a. Cash P 1,500,000
Note receivable 3,000,000
Deferred revenue from IFF 4,500,000

b. Cash 1,500,000
Note receivable 3,000,000
Revenue from IFF 4,500,000

c. Cash 1,500,000
Note receivable 3,000,000
Deferred revenue from IFF 2,700,000
Revenue from IFF 1,800,000

d. Cash 1,500,000
Note receivable 3,000,000
Revenue from IFF 1,800,000
Unearned interest revenue 2,700,000

5. How much is the net income to be recognized by Goldilocks on December


31, 2021?
a. P 740,000 c. P 2,540,000
b. 4,040,000 d. 2,500,000

Solution:

Initial franchise fee 4,500,000


Less: Initial services (500,000)
Gross profit 4,000,000
Continuing franchise fee (2,000,000 x 2%) 40,000
Net income recognized 4,040,000

6. Kopi Cafe sold a coffee shop franchise to Mr. J. the sale agreement signed in
March 2020 called for a P 350,000 down payment plus two P 175,000 annual
payment representing the value of initial franchise services rendered by Kopi
Cafe.

In addition, the agreement required the franchisee to pay 8% of its gross


sales to the franchisor.
The coffee shop opened in October 2020 and its sales for the quarter ended
amounted to P 2,625,000.

The PV of annuity of 1 at 12% for two periods is 1.6901.


Assuming a 12% interest rate is appropriate, what will the Kopi Cafe’s total
revenue for 2020?
a. P 295,767.50
b. P 891,261
c. P 855,767.50
d. P 933,261.

Solution:

Annual payment (175,000 x 1.6901) 295,767.50


Gross profit interest (2,626,000 x 8%) 210,000.00
First payment 350,000.00
Total revenue for 2020 855,767.50

Common questions

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Continuing franchise fees, often set as a percentage of gross sales, like Kopi Cafe's 8%, provide a recurring revenue stream that aligns franchisees' and franchisors' interests, incentivizing growth and operational efficiency. It creates a business model focused on sustainable growth, hinging on mutual success, and adaptive to market dynamics .

The realized gross profit is P 1,316,861. It is calculated based on the total collections of P 1,881,230 for 2021, consisting of the first payment of P 1,250,000 and principal payments totaling P 631,230. A 70% gross profit rate is applied, resulting in recognized profit given the credit profile of JJ Company and the structure of non-interest-bearing notes .

On January 2, 2021, Goldilock records the transaction with the following entry: Cash P 1,500,000; Note receivable P 3,000,000; Deferred revenue from initial franchise fee (IFF) P 4,500,000. This reflects the need to defer the revenue from the IFF until all services tied to the fees are performed .

Kopi Cafe's total revenue for 2020 is P 855,767.50. This includes the initial payment of P 350,000, the present value of two annual P 175,000 payments calculated at P 295,767.50 (using the PV of annuity factor 1.6901), and a continuing franchise fee of P 210,000 (8% of gross sales of P 2,625,000).

Rich Services, Inc. should record a total of P 95,000 as revenue from franchise fees for 2021. This amount consists of the initial franchise fee of P 70,000 and a continuing franchise fee of P 25,000 (5% of Yummy Company’s reported gross sales of P 500,000).

Goldilock should recognize a net income of P 4,040,000. This is derived from a total initial franchise fee of P 4,500,000, less initial service costs of P 500,000, and adding continuing franchise fees from sales (P 2,000,000 x 2%) amounting to P 40,000 .

Initial service costs, such as the P 500,000 incurred by Goldilock, reduce the gross profit from the initial franchise fee (P 4,500,000), impacting net income. Strategically, the company must view such costs in light of their potential to enhance franchisee operations, thus supporting long-term revenue from continuing fees .

The non-interest-bearing notes require JJ Company to discount future payment obligations to their present value using the appropriate rate (24%). This results in a lower present value of notes (P 1,425,000) affecting the timing and amount of revenue recognition, emphasizing the significance of interest rate assumptions in financial agreements .

A franchisee must consider the potential variability in financial outcomes, especially the possibility of waiving fee obligations if operations are unprofitable, impacting cash flow projections and business sustainability. Legal terms of fee adjustments, penalties, and the strategic fit within their broader business objectives must also be assessed to optimize the franchise’s financial health .

For the first year, Ray Company should recognize a total franchise fee revenue of P 80,000. This includes the initial franchise fee portion of P 20,000 (P 100,000 over 5 years) and the continuing franchise fee of P 60,000 (1% monthly of P 500,000 in gross sales). Since obligations can be waived if the franchise is unprofitable, it is crucial for Ray Company to assess the realizability of future payments .

College of Business and Accountancy Seatwork-Assignment in ACCSTRA 1. On January 2, 2021, Rich Services Inc. signed an agreem
b. 1,316,861 d. 1,069,031.50 Solution: First payment (3,125,000 x 40%) 1,250,
Note receivable 3,000,000 Deferred revenue from IFF

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