p2 - Guerrero Ch6

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 company’s 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 sponsorretailer 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 franchisor’s 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 Notes receivable Unearned interest income Franchise revenue Deferred revenue from franchise fee

600,000 900,000

b. Cash Note receivable Unearned interest income Deferred revenue from franchise fee

600,000 900,000

c. Cash Note receivable Deferred revenue from franchise fee

600,000 900,000

d. Cash Note receivable Unearned interest revenue Franchise revenue

600,000 900,000

180,000 600,000 720,000

180,000 1,320,000

1,500,000

180,000 1,320,000

2. Each of the Coffee Beanery Company’s 21 new franchisee contracted to pay an initial franchise fee of P30,000. By December 31, 2013, each franchise had paid a nonrefundable 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. b. c. d.

P400,000 P600,000 P610,000 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. b. c. d.

P550,000 P650,000 P749,650 P950,000

4. On December 31, 2013, Max’s 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. Maria’s 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, Max’s, Inc. should record unearned franchise fee of: a. b. c. d.

P232,200 P300,000 P422,200 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 franchisor’s 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. b. c. d.

P3,750,000 P5,750,000 P6,000,000 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-0b. P1,788,970 P-0c. P1,132,529 P-0d. 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-0d. 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-012. 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. Michael’s 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 Present value of an annuity of P1 at 20% for 5 periods Future amount of P1 at 20% for 5 periods

.402 2.9906 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-022. 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. Joy’s 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 semiannual 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 Note Receivable Deferred revenue from IFF

1,250,000 1,875,000

b. Cash Note Receivable Unearned interest income Deferred revenue from IFF

1,250,000 1,875,000

c. Cash Note Receivable Deferred revenue from IFF

1,250,000 1,425,000

d. Cash Note Receivable

1,250,000 1,425,000

3,125,000

450,000 2,675,000

2,675,000

Unearned interest income Deferred revenue from IFF

450,000 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. b. c. d.

P1,338,307 P1,316,861 P1,321,345.50 P1,069,031.50

Answers 1. 2. 3. 4. 5.

a c c d d

6. 7. 8. 9. 10.

c d a b a

11. 12. 13. 14. 15.

a b a a a

16. 17. 18. 19. 20.

a a c c a

21. 22. 23. 24. 25.

a a b b 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 Present value of the balance of the franchise fee Earned initial franchise fee 5% fees on gross sales (9 million x .05) Earned franchise fees

P100,000 199,650 P299,650 450,000 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 Less: value of continuing costs [(P180,000/90%)x 10] Adjusted franchise fee Less: initial expenses Net income

6. From Juan Jose: Franchise revenue (Full): Downpayment Present value of the note (P330,000 x 3.6299) Total Cost of franchise Gross profit Interest income (P1,088,970 x 4%) Net income From Pedro Pablo:

P6,000,000 2,000,000 4,000,000 2,250,000 P1,750,000

P700,000 1,088,970 P1,788,970 700,000 P1,088,970 43,559 P1,132,529 None

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

P200,000 25,000 P225,000

8. Initial franchise fee Less: down-payment Balance (unearned)

P1,100,000 100,000 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 Cost of franchise fee Gross profit Gross profit rate (P4,500,000 / P5,000,000) Realized Gross Profit [(P2,000,000 + P1,000,000)x 90%]

P5,000,000 500,000 P4,500,000 90% P2,700,000

11. Initial franchise fee (P300,000 + P177,355) Continuing franchise fee (P1,000,000 x 5%) Total revenue

P477,355 50,000 P527,355

12. Franchise revenue: Downpayment Note receivable Total Cost of franchise fee Realized gross profit

P200,000 P1,000,000 P1,200,000 900,000 P300,000

13. Realized gross profit on initial franchise fee (schedule 1) Continuing franchise fee (P268,500 x 5%) Total revenue Interest income (P900,000 x 15% x 6/12) Total Expenses Net income Sch. 1:

Collections Downpayment 1st installment GPR (P462,500 ÷ P1,250,000) RGP

P350,000 180,000

P196,100 13,425 P209,525 67,500 P277,025 42,900 P234,125

P530,000 37% P196,100

14. Face value of note receivable Present value Unearned interest Initial franchise fee Less: unearned interest Deferred revenue from franchise fee Therefore the entry is letter (a)

P1,800,000 1,263,900 P536,100 P3,000,000 536,100 P2,463,900

15. Initial franchise fee (deferred revenue) Cost of franchise fee Gross profit Gross profit rate (P600,000 / P750,000)

P750,000 150,000 P600,000 80%

Realized gross profit: Down-payment Installment collected (P450,000 / 3) Total collection Gross profit rate Realized gross profit

P300,000 150,000 P450,000 80% P360,000

16. Revenue from initial franchise fee Cost of franchise fee

P750,000 150,000

Gross profit Interest income (P450,000 x 12%) Net income

P600,000 54,000 P654,000

17. Initial franchise fee Continuing fee (P200,000 x 2%)x 11 months Total Initial expenses Net income 18. Initial franchise fee Less: Unearned interest FV of the note receivable PV of the note receivable Deferred revenue from IFF

P450,000 44,000 494,000 50,000 P444,000 P25,000,000 P20,000,000 15,163,000

19. Realized Gross Profit From Franchise Fee: Downpayment Collection of NR (P9,000,000 ÷ 5) Total GPR (P8,000,000 ÷ P10,000,000) RGP Interest income (P9,000,000 x 12%) Net income

4,837,000 P20,163,000 P1,000,000 1,800,000 2,800,000 80% 2,240,000 1,080,000 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 Cash Downpanyment (Dr.) Face value of note receivable (Dr.) Present value (P1,500,000 ÷ 3)x 2.17 Unearned interest income (Cr.) Adjusted sales value of the IFF (P1,875,000 – P415,000)

P1,875,000 375,000 1,500,000 1,085,000 P415,000 P1,460,000

23. The net income is computed as follows: Adjusted sales value of IFF Cost of franchise (direct) Gross profit Gross profit rate (P876,000 ÷ P1,460,000)

P1,460,000 584,000 P876,000 60%

Computation of net income: Down-payment Installment collected (P1,500,000 ÷ 3) Interest income (P500,000 x 2.17) x 18% Collections applying to principal Gross profit rate Realized gross profit Interest income Total revenue Expenses (indirect costs) Net income

P375,000 500,000 (195,300) P679,700 60% P407,820 195,300 603,120 (51,000) P552,120

24. Entry (b) is correct. The computation of the amounts in the entry is as follows: Initial franchise fee Cash downpayment (Dr), 40% Face of the note receivable (Dr) Present of the note receivable (P1,875,000 ÷ 4) x 3.04 Unearned interest income (Cr) Deferred revenue from IFF (P3,125,000 – P450,000)

P3,125,000 1,250,000 1,875,000 1,425,000 P450,000 P2,675,000

25. Under the installment method, the realized gross profit on the initial franchise fee is computed as follows: Downpayment Collection of the note applying to principal (Sch. 1) Total collections Gross profit rate (Sch. 2) Realized gross profit Schedule 1: Date Jan. 2 June 30 Dec. 30 Total

Collections P468,750 468,750

Interest P171,000 135,270

P1,250,000 631,230 P1,881,230 70% P1,316,861

Principal

PV of Note P1,425,000 P297,750 1,127,250 333,480 793,770 P631,230

Schedule 2: Adjusted sales value of IFF (No. 24) Direct cost of services Gross profit Gross profit rate (P1,872,500 ÷ P2,675,000)

P2,675,000 802,500 P1,872,500 70%