solution chapter 9

Chapter 9

Problem I

1. Jollibee has substantially performed all material services, the refund period has expired,

and the collectibility of the note is reasonably assured. Jollibee recognizes revenue as

follows:

Cash.. 240,000

Notes receivable. 600,000

Franchise revenue.. 840,000

2. The refund period has expired and the collectibility of the note is reasonably

assured, but Jollibee has not substantially performed all material services. Jollibee

does not recognize revenue, but instead recognizes a liability as follows:

Cash.. 240,000


Unearned franchise revenue.. 840,000

Franchisor will recognize the unearned franchise fees as revenue when it has performed

all material services, the adjusting entry to record the revenue then would be:

Unearned franchise revenue... 840,000


3. Jollibee has substantially performed all services and the collectibility of the note is

reasonably assured, but the refund period has not expired. Jollibee does not recognize

revenue, but instead recognizes a liability as follows:

Cash.. 240,000



The franchisor will recognize the unearned franchise fees as revenue when the refund

period expires, the adjusting entry to record the revenue then would be:


Franchise revenue... 840,000

4. Jollibee has substantially performed all services and the refund period has expired, but the

collectibility of the note is not reasonably assured. Jollibee recognizes revenue by the

installment or cost recovery method. If we assume that Jollibee uses the installment

method, it recognizes revenue of P240,000 as follows:

Cash.. 240,000



Unearned franchise revenue 600,000

The franchisor is using the installment method, it recognizes the unearned franchise fees as

revenue in the amount of P120,000 each year as it receives cash assuming there is no cost

of franchise, the entry would be as follows:

Unearned franchise revenue 120,000


This revenue recognition may be true only in the event there is no cost of franchise at all.

On the other hand, it may be somewhat misleading since under the installment sales

method; gross profit is earned or realized thru collections.

5. The refund period has expired, but Jollibee has not substantially performed all services

and there is no basis for estimating the collectibility of the note. Jollibee does not

recognize the note as an asset. Instead, it uses a form of the deposit method. For

example, suppose Jollibee has developed an entirely new product whose success is

uncertain and the franchisee will pay the note from the cash flows from the sale of the

product, if any. Jollibee records the initial transaction as follows:

Cash.. 240,000


The franchisor may recognize the unearned franchise fees as revenue under the

accrual method in the normal manner at the completion of the services to be

performed (if collectibility is reasonably assured), the adjusting entry to record the

revenue then would be:



Alternatively, it may recognize revenue under the installment method if it has no basis for

estimating the collectibility of the note.

6. Now assume that Jollibee has earned only P360,000 from providing initial services, with

the balance being a down payment for continuing services. If the refund period has

expired and the collectibility of the note is reasonably assured, Jollibee recognizes

revenue of P360,000 as follows:

Cash.. 240,000




The franchisor recognizes the unearned franchise revenue of P480,000 as revenue when it

performs the continuing services, the adjusting entry to record the revenue then would

be:



In all these cases except the fifth, the franchisor accounts for the collection of interest

and principal on the note receivable in the usual manner. In the fifth situation, it does not

recognize the note and revenue until a future event occurs. In addition, the franchisor

accounts for its costs in the same way as its revenue recognition. That is, if it defers

revenue, then it defers the related cost of goods sold. Then, when it recognizes revenue, it

matches the cost of goods sold against the revenues. The franchisee accounts for its

payments as an intangible asset.

Sometimes the franchisor collects the initial franchise fee far in advance of performing its

services. At other times collection of part of the initial franchise fee is deferred until the

franchise is operating successfully.

Problem II

1.

Cash ......................................... 75,000

Unearned Franchise Fee ..................... 75,000 2.

Cash ......................................... 75,000

Note Receivable .............................. 120,000

Unearned I.I. or Discount on Note Receivable 28,881

Revenue from Franchise Fee ................. 166,119

[P{75,000 + (P30,000 x 3.0373)] = P116,119

(Table IV n = 4, i = 12%)

3.

Cash ......................................... 75,000

Note Receivable .............................. 120,000

Unearned I.I. or Discount on Note Receivable 28,881

Revenue from Franchise Fee ................. 75,000

Unearned Franchise Fee ..................... 91,119

Problem III

1. If there is a reasonable expectation that the down payment may be refunded and

substantial future services remain to be performed by Pizza, Inc., the entry should be: Cash.. 120,000.00

Notes receivable. 480,000.00

Unearned interest income (or Discount on notes receivable) 80,583.20

Unearned franchise revenue.. 419,416,80

2. If the probability of refunding the initial franchise fee is extremely low, the amount of future

services to be provided to the franchisee is minimal, collectibility of the note is reasonably

assured, and substantial performance has occurred, the entry should be: Cash.. 120,000.00



Franchise revenue.. 503,300.16

3. If the initial down payment is not refundable, represents a fair measure of the services

already provided, with a significant amount of services still to be performed by the franchisor

in future periods, and collectibility of the note is reasonably assured, the entry should be: Cash.. 120,000.00




Unearned franchise revenue 383,300.16

4. If the initial down payment is not refundable and no future services are required by the

franchisor, but collection of the note is so uncertain that recognition of the note as an asset is

unwarranted, the entry should be:

Cash.. 120,000.00


Where the collection of the note is extremely uncertain, revenue thru gross profit is

recognized by means of cash collection using the cost recovery method.

5. If the initial down payment is refundable or substantial services are yet to be performed, but

collection of the note is so uncertain that recognition of the note as an asset is unwarranted,

the entry should be: Cash.. 120,000


Where the collection of the note is extremely uncertain, revenue thru gross profit is

recognized by means of cash collection using the cost recovery method.

Problem IV

1. If the down payment is refundable, and no services have been rendered at the time the

arrangement is made, and collection on the note is reasonably certain, the entry should be:

Cash.. 120,000.00



Unearned franchise revenue.. 262,645.50

2. Initial services are determined to be substantially performed, the refund period has expired

and the collection of the note is reasonably assured, the full accrual method would be used.

Assume that substantial performance of the initial services costs P52,529.1 the entry should be:

Cash.. 120,000.00




Cost of franchise revenue 52,529.10

Cash, etc 52,529.10

Few months after, the collectibility of the note becomes doubtful or no reasonable assurance,

the installment sales method could be used as a general rule. In addition to the entries

above, following entries would be required:

a. To set-up cost of franchise:

No entry required, already set-up previously.

b. To defer gross profit on franchise:

Franchise revenue 262,645.50

Cost of franchise revenue 52,529.10

Deferred gross profit on franchise 210,116.40

c. Adjustments to recognize gross profit on franchise:

Deferred gross profit on franchise 96,000.00

Realized gross profit on franchise 96,000.00


Less: Cost of franchise revenue 52,529.1

Gross profit.. 210,116.4

Gross profit rate (210,116.4/262,645.5) 80%

Collections as to principal. P120,000.00

Multiplied by: Gross profit rate. 80%

Realized gross profit on franchise.. P 96,000.00

Problem V

If we assume that ECHI, whose fiscal year ends on December 31, secures the lease and the

permits on February 1, 20x5, and operations commence at that time, the following journal

entries would be appropriate:

July 1, 20x3:

Cash.. 120,000



Deferral of revenue recognition is required when substantial performance" of franchisor services has not been completed. It would call for deferral of revenue recognition until

evidence of service performance was available. The best evidence, of course, would be the

commencement of operations of the franchise outlet and at this point in time, revenue is

recognized.

During 20x3:

Deferred cost of franchise revenue. 360,000

Cash.... 360,000

December 31, 20x3:

Interest receivable (P480,000 x 14% x 6/12).. 33,600

Cash.... 33,600

February 1, 20x4:



Cost of franchise revenue.. 360,000

Deferred cost of franchise revenue.. 360,000

Problem VI

Reasonably Assured

No reasonable

assurance

January 1, 20x4

Cash.. 1,500,000 1,500,000

Notes receivable. 4,500,000 4,500,000

Unearned franchise revenue. 6,000,000 6,000,000

Receipt of initial franchise fee.

Conditions to be met: Cash Notes Cash Notes

Services No No No No

Period of refund Yes Yes Yes Yes

Collectibility

Reasonably

assured

No

reasonable

assurance

1/1/20x4 Balance 1,500,000 4,500,000 1,500,000 4,500,000

Status Liability Liability Liability Liability

December 31, 20x4

Cash.. 1,575,000 1,575,000


Interest income (P3,750,000 x 10%) 450,000 450,000 Annual collection.

Deferred cost of franchise 1,800,000 1,800,000

Cash 1,800,000 1,800,000 To defer cost of franchise since substantial

services had not been performed.

Operating expenses 120,000 120,000

Cash 120,000 120,000 To record expenses.

Adjustments:

Cost of franchise 1,800,000

Deferred cost of franchise 1,800,000 To recognize cost of franchise.

Unearned franchise revenue. 6,000,000

Franchise revenue 6,000,000 To recognize franchise revenue based on the

following analysis:

Conditions to be met: Cash Notes

Services Yes Yes

Period of refund Yes Yes

Collectibility

Reasonably

assured

1/1/20x4 Balance.. 1,500,000 4,500,000

12/31/20x4: Collection as to principal 1,125,000 (1,125,000)

12/31/20x4 Balance 2,625,000 2,625,000

Status Revenue Revenue

Adjustments (Installment sales method)


No entry*

b. To set-up deferred gross profit

Unearned franchise revenue 6,000,000

Deferred cost of franchise revenue 1,800,000

Deferred gross profit 4,200,000 *There are different options on this matter, an entry may be made to set-up cost of franchise and eventually it will be

closed to set-up deferred gross profit. Regardless of the option, the objective is to set-up deferred gross profit. Refer to

Illustration 9-6 for alternative treatment to set-up cost of franchise.

Conditions to be met: Cash Notes

Services Yes Yes

Period of refund Yes Yes

Collectibility

No

reasonabe

assurance

1/1/20x4 Balance.. 1,500,000 4,500,000

12/31/20x4: Collection as to principal 1,125,000 (1,125,000)

12/31/20x4 Balance 2,625,000 2,625,000

Status

Revenue I/S Method

Liability

c. To recognize realized gross profit on

franchise:

Deferred gross profit 1,837,500

Realized gross profit on franchise 1,837,500 Collections principal x gross profit rate P2,625,000 x (6,000 1,800)/6,000 = P1,837,500

2.

Reasonably Assured

No reasonable

assurance

Income Statement, 12/31/20x4:

Franchise revenue (accrual method)* P6,000,000 P 0

Less: Cost of franchise (accrual method)* 1,800,000 0

Gross profit on regular franchise

(accrual)* P4,200,000 P 0

Add: Gross profit on franchise (installment

sales method) -0- *1,837,500

Gross profit on franchise P4,200,000 P1,837,500

Less: Operating expenses 120,000 120,000

P4,080,000 P1,717,500

Add: Interest income.. 450,000 450,000

Net income. P4,530,000 P2,167,500

Problem VII 1.

Reasonably Assured

No reasonable

assurance

January 1, 20x4

Cash.. 1,440,000 1,440,000


Unearned interest income* 796,896 796,896

Unearned franchise revenue. 4,483,104 4,483,104

Receipt of initial franchise fee.

Conditions to be met: Cash Notes (PV) Cash Notes (PV)

Services** No No No No

Period of refund until date of Opening No No No No

Collectibility

Reasonably

assured

No

reasonable

assurance

1/1/20x4 Balance 1,440,000 3,043,104*** 1,440,000 3,043,104***

Status Liability Liability Liability Liability *Unearned interest income or discount on notes receivable: P3,840,000 P3,043,104 = P796,896. * *Services had been substantially performed only on the date of opening which is December 8. Revenue is deferred and

subsequent direct cost of franchise should also be deferred.

***P960,000 x 3.1699 = P2,535,920

February 2, 20x4:

Deferred cost of franchise 144,931.20 144,931.20

Cash 144,931.20 144,931.20 To defer cost of franchise since substantial


June 13, 20x4:

General expenses 60,000 60,000

Cash 60,000 60,000 To record expenses.

August 8, 20x4:

Deferred cost of franchise 360,000 360,000

Cash 360,000 360,000 To defer cost of franchise since substantial


November 2, 20x4:

Deferred cost of franchise 840,000 840,000

Cash 840,000 840,000 To defer cost of franchise since substantial


November 2, 20x4:

Substantial completion of services.

December 31, 20x4:

Cash.. 960,000 960,000

Notes receivable 960,000 960,000 Annual collections.

Adjustments:

Unearned interest income 304,310.40 304,310.40

Interest income 304,310.40 304,310.40

To recognize interest income thru

amortization as follows:

10% x P3,043,104 = P304,310.4.

Cost of franchise 1,344,931.20

Deferred cost of franchise 1,344,931.20 To recognize cost of franchise.

Unearned franchise revenue. 4,438,1040

Franchise revenue 4,438,1040 To recognize franchise revenue based on the

following analysis:

Conditions to be met: Cash Notes (PV)

Services** Yes Yes

Period of refund outlet already opened. Yes Yes

Collectibility

Reasonably

assured

1/1/20x4 Balance 1,440,000 4,438,104

12/31/20x4:

Collection..... . P960,000 Less: Interest collection 304,310.40

Collection Principal.P655,689.60 655,689.60

( 655,689.60)

2,095,689.60 2,387,414.40


Adjustments (Installment sales method)


Cost of franchise revenue.. 1,344,931.20

Deferred cost of franchise revenue 1,344,931.20

b. To set-up deferred gross profit:

Unearned franchise revenue 3,483,104

Cost of franchise revenue 1,344,931.20

Deferred gross profit 2,138,172.80 *There are different options on this matter, an entry may be made to set-up cost of franchise and eventually it will be

closed to set-up deferred gross profit. Regardless of the option, the objective is to set-up deferred gross profit. Refer to

Illustration 9-5 for alternative treatment to set-up cost of franchise.

Conditions to be met: Cash Notes (PV)

Services** Yes Yes

Period of refund outlet already opened. Yes Yes

Collectibility

No

reasonable

assurance

1/1/20x4 Balance 1,440,000 304,104

12/31/20x4:

Collection..... . P960,000 Less: Interest collection 304,310.40 Collection Principal.P655,689.60 655,689.60

( 655,689.60)

2,095,689.60 2,387,414.4

Status

Revenue I/S Method

Liability

c. To recognize realized gross profit on

franchise:

Deferred gross profit 1,466,983.20

Realized gross profit on franchise 1,466,983.20

Collections principal x gross profit rate P2,095,689.60 x (4,483,104 1,344,931.20)/4,483,104 = P1,466,983.20

2.

Reasonably Assured

No reasonable

assurance

Income Statement, 12/31/20x4:

Franchise revenue (accrual method)* P 4,471,1040 P 0

Less: Cost of franchise (accrual method)* 1,344,931.20 0

Gross profit on regular franchise

(accrual)* P3,138,172.8 P 0

Add: Gross profit on franchise (installment

sales method) -0- *1,466,983.20

Gross profit on franchise P3,138,172.8 P1,466,983.20

Less: Operating expenses 60,000 60,000

P3,078,172.8 P1,406,983.20

Add: Interest income.. 304,310.40 304,310.40

Net income. P3,382,483.20 P1,771,293.60

*Note: This item represents regular franchise sales-type transaction. If the collectibility of the fee

(note receivable) is reasonably assured, the permissible method to be applied should be the

accrual method. It should be observed that in the event, there is cost of franchise and the

installment sales method is used, the concept of revenue recognition does literally apply to

franchise revenue but to the recognition of realized gross profit on franchise thru collections as to

principal multiplied by gross profit rate.

Alternatively, computation of interest and principal collections are as follows:

Date

Collection

Interest (10% of

Unpaid Balance)

Principal

Unpaid Balance

1/03/20x4 4,483,104

1/03/20x4 1,440,000 -0- 1,440,000 3,043,104

12/31/20x4 960,000 304,310.40 655,689.60 2,387,414.40

Total 2,400,000 304,310.40 2,095,689.60

Problem VIII

1. The fee is earned for providing continuing services: Cash or Accounts receivable 108,000

Franchise revenue continuing franchise fee 108,000

2. If P10,000 of the fee is for national advertising: Cash or Accounts receivable 108,000


Unearned franchise revenue continuing franchise fee 12,000

The franchisor recognizes the unearned franchise fees as revenue when it performs the

advertising services and also records the costs as expenses, the entries should be:

Advertising expenses xxx

Cash, etc.. xxx

Unearned franchise revenue continuing franchise fee 12,000


Problem IX

March 20: Cash 5,000

Notes receivable 20,000

Unearned franchise fee 25,000

June 15: Unearned franchise revenue 25,000

Franchise revenue 25,000

July 15: Cash 500

Service revenue 500

Problem X Cash or Accounts receivable 117,600

Franchise revenue supplies sales.. 117,600

Cost of franchise supplies sales 90,000

Supplies inventory. 90,000

Problem XI Cash. 21,600

Notes receivable (P108,000 P21,600) 86,400

Unearned interest income (P86,400 P69,978) 16,422

Franchise revenue (P21,600 + 69,978 P4,800*) 86,778

Unearned franchise revenue equipment sale* 4,800

All the criteria to recognize initial franchise fee as revenue was met, except that an amount of

P4,800 equivalent to indicated profit (P24,000, selling price less P19,200 option price) will be

deferred.

When the franchisee subsequently purchases the equipment, the entries are as follows: Cash or Accounts receivable 19,200

Unearned franchise revenue equipment sale 4,800

Franchise revenue equipment sale.. 24,000

Cost of franchise - equipment sale. 19,200

Equipment inventory. 19,200

Problem XII

April 1, 20x4:

Cash. 288,000


Franchise revenue (P21,600 + P86,400 P4,800*) 480,000

December 31, 20x4:

Franchise revenue initial franchise fee 480,000

Interest income (P192,000 x 8% x 9/12) 11,520

Cash (P153,600 P11,520). 142,080


Gain or revenue from repossessed franchise 134,400

Problem XIII Cash 72,000


Deferred franchise purchase option liability. 432,000

Deferred cost of franchise revenue 288,000

Cash, etc 288,000

Investment.. 120,000

Deferred franchise purchase option liability. 432,000

Deferred cost of franchise revenue 288,000

Cash, etc 264,000

Multiple Choice Problems

1. a following conditions should be observed to recognize revenue: Services none Period of Refund expired Collectibility of the note reasonably assured

There was failure on one condition; therefore, no revenue should be recognized.

2. d following conditions should be observed to recognize revenue: Services Performed yes Period of Refund not expired / still refundable Collectibility of the note reasonably assured

There was failure on one condition; therefore, no revenue should be recognized.

3. a - following conditions should be observed to recognize revenue:

Services Performed none Period of Refund expired Collectibility of the note very uncertain or extremely uncertain.

There was failure on one condition; therefore, no revenue should be recognized. Since, the

collectibility of the note is extremely uncertain recognition of the note as an asset in

unwarranted (or should not be recorded).

4. d the problem already indicated that P300,000 is earned, therefore the remaining balance of P400,000 (P700,000 P300,000 is considered as unearned revenue.

5. a Cash 6,000


Unearned franchise fee 36,000

6. b Unearned franchise fee 36,000

Franchise fee revenue 36,000

7. a Cash 6,000


Franchise fee revenue 36,000

8. b

9. b

10. d

11. d the franchise fee revenue should be zero, since no substantial performance of services had been performed (and the down payment is still refundable).

12. b

In this problem, since there is doubtful of collection, it is safely assumed to used installment

method. Therefore, the realized gross profit would be:

Collections in 20x4..P 200,000 x: Gross profit rate [100% - (P150,000/P500,000)]. 70% Realized gross profit in 20x4. P 140,000 Revenue Analysis:

Cash N/R

Services Yes Yes

Period of Refund Yes Yes

Collectibility No Reas.

Assured

200,000 300,000

Status Rev I/S Method Liability

13. d In this problem, full accrual method is used to recognized the initial franchise fee of

Initial Franchise Fee:

Cash Notes Receivable

Services Yes Yes


Collectibility Reasonably Assured

P20,000 P80,000


Substantial performance of services has been rendered because commencement of

operations by the franchisee shall be presumed to be the earliest point of which substantial

performance has occurred, unless it can be demonstrated that substantial performance of

all obligations, including services rendered voluntarily, has occurred before that time.

Period of refunding the initial franchise fee and collectibility of the notes is not anymore a

problem (they depend on the profitability of its first year of operations) because the result

of operations in the first year is profitable. Therefore, the initial franchise fee of P100,000

(P20,000 + P P80,000) is considered as revenue, and a continuing franchise fee of P5,000

(1% x P500,000) should be also be recognized as revenue continuing fanchise.

Therefore, the earned franchise fee amounted to P105,000 (P100,000 initial plus P5,000

continuing).

14. a

Initial franchisee revenue (since all services had been performed

and assumed that period of refunding already expired).. P100,000 Add: Continuing franchise revenue (5% x P800,000) 40,000 Total Revenue from franchise. P140,000

15. d

There is already substantial performance of services rendered since, the franchise outlet

started operations and it is assumed that period of refund has expired.

The continuing franchise fee is recognized also as revenue since it is earned at the time it

was received.

The net income would be:

Franchise Revenue:

Initial Franchise Fee:

Down payment P 30,000 PV of installment (P10,000 x 1.7355). 17,355 P47,355 Continuing Franchise Fee (5% x P500,000) 25,000

Total Franchise Revenue P72,355 Add: Interest Income (10% x P17,355) 1,735 Total Revenue/Net Income P74,090

16. a

All conditions that initial franchise fee be recognized as revenue had been met as follows: Revenue Analysis for IFF

Cash N/R

Services Yes Yes

Period of Refund

(note)

Yes Yes

Collectibility Reas. Assured

200,000 300,000


The Net Income then would be as follows:

Franchise Revenue..P 500,000 Less: Cost of Franchise 150,000 Net IncomeP 350,000

17. d

In this problem, full accrual method is used to recognized the initial franchise fee of

P100,000 analyze as follows:

Revenue Analysis for IFF

Cash N/R

Services Yes Yes

Period of Refund

(note)

Yes Yes

Collectibility Reas. Assured

20,000 80,000


Note: Period of refunding the initial franchise fee was presumed to have been expired

since the business operates profitably in its first year of operation.

Continuing Franchise Fee: Considered revenue the moment continuing services had been

rendered amounted to P5,000 (1% x P500,000).

Initial Franchise FeeP 100,000 Continuing franchise fee. 5,000 Total P 105,000 Less: Indirect cost of franchise 15,000 Net incomeP 90,000

18. d

Revenue = P400,000

Interest income = P P9,600

Cash = P128,000 P9,600 = P118,400 Repossession revenue: P240,000 P128,000 = P112,000.

19. c

Cash = P560,000 + P48,000 = P608,000

Franchise Fee Revenue = P560,000

Unearned Franchise Fees = P P9,600

Revenue from Continuing Franchise Fees = P48,000 P9,600 = P38,400.

20. b - P200,000 + P545,872 P24,000 = P721,872.

21. b Franchisee frequently purchases all of the equipment, products, and supplies from the franchisor.

The franchisor would account for these sales as if, it would be a product sales. Sometimes,

however, the franchise agreement grants the franchisee the right to make bargain purchases of

equipment or supplies after the initial franchise fee is paid. If the bargain price is lower that the

normal selling price of the same product or it does not provide the franchisor the reasonable profit,

then, a portion of the initial franchise fee should be deferred. The deferred portion would be

accounted for as adjustment of the selling price when the franchisee subsequently purchases the

equipment or supplies. Therefore, the amount of revenue would be P90,234 computed as follows:


Services Yes Yes



P25,000 P68,234

Status Revenue Revenue except

P3,000 reasonable

profit on sale of

equipment

The revenue from franchise would be:

Cash P 25,000 PV of Note..P68,234 Less: Reasonable profit on sale of

Equipment P15,000 P12,000). 3,000 65,234 P 90,234

Incidentally, the entries would be:

Upon receipt of IFF:

Cash 25,000 Notes Receivable 90,000 Unearned Interest Income (P90,000 P68,234). 21,766 Franchise Revenue. 90,234 Unearned Franchise Revenue. 3,000

If equipment was sold:

Cash or Accounts Receivable 12,000 Unearned Franchise Revenue 3,000 Franchise Revenue Equipment 15,000

Cost of Sales equipment 12,000 Equipment Inventory.. 12,000

22. b


Services No No

Period of Refund No No


P25,000 PV - P39,623

FV P50,000 UII/Disct. P10,377

Status Liability Liability

Theories

1. True 6. True 11. a

2. False 7. True 12. b

3. False 8. True 13. a

4. False 9. b 14. d

5. True 10, d 15,

solution chapter 9

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