For franchise transactions to be correctly recorded in the books, both franchisors and franchisees are required to adhere to a set of regulations and principles that must be followed.
The practice of granting one company (the franchisor) the right to provide another firm (the franchisee) the right to use its name, trademarks, and operational procedures in exchange for a fee is known as franchising. Franchising is a prevalent model for doing business.
This article will cover the foundations of franchise accounting, including how to keep track of important details like the initial purchase price of the franchise, any recurring royalties, and any leases that may be linked with the franchise.
Franchisors as well as franchisees need to have a solid understanding of how franchises are recorded and accounted for in the books. This will allow them to maintain accurate financial records and ensure that they comply with any applicable accounting standards.
This article will explore the perspectives of both the franchisor and the franchisee on franchise accounting to shed light on the nuanced nature of financial reporting in the ever-evolving franchising business. The goal of this essay is to expose the nuanced nature of financial reporting in the franchising industry.
How Is Franchise Recorded In Accounting?
For franchises to be properly accounted for, both the franchisor and franchisee must follow a set of guidelines. Let’s look at the books from both sides to see how franchises are accounted for, Here are More hints:
Initial Franchise Fee
- When a franchisor sells a franchise to a new franchisee, they typically receive an initial franchise fee.
- This fee is recognized as revenue when earned, typically when the franchise agreement is signed, and the franchisor has fulfilled its obligations.
- It is recorded as revenue on the income statement.
Ongoing Royalties and Fees
- Franchisors often charge ongoing royalties, advertising fees, or other periodic payments from franchisees.
- These revenues are recognized as they are earned, typically on a monthly or quarterly basis.
- Ongoing royalties and fees are recorded as revenue on the income statement.
- Franchisors may periodically assess the carrying value of their franchise rights for impairment.
- If the expected future cash flows from the franchise network are less than the carrying value, the franchise rights should be written down.
- Impairment charges are recorded as expenses on the income statement.
- If the franchisor owns or leases real estate for franchise locations, lease accounting standards (e.g., ASC 842) must be applied.
- Right-of-use assets and lease liabilities are recognized on the balance sheet, impacting both the balance sheet and income statement.
Initial Franchise Fee
- When a franchisee pays the initial franchise fee, it is considered a prepaid expense.
- This fee is amortized over the life of the franchise agreement, usually the shorter of the initial term or any renewals.
- Amortization is recorded as an expense on the income statement.
Royalties and Fees
- Ongoing royalties and fees paid to the franchisor are recognized as expenses when incurred, typically every month.
- These expenses are recorded on the income statement.
- If the franchisee leases property for its franchise location, lease accounting standards (e.g., ASC 842) must be followed.
- Lease liabilities and right-of-use assets are recognized on the balance sheet, affecting both the balance sheet and income statement.
- If a franchisee acquires an existing franchise business, they may need to assess any resulting goodwill.
- Goodwill is recognized and tested for impairment, following relevant accounting standards (e.g., ASC 350).
Franchise Agreement Disclosure:
Financial statements for franchisees often require disclosures related to the terms of the franchise agreement, including commitments and future payments.
The Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS), if applicable, are two of the most commonly utilised accounting standards.
Both franchisors and franchisees are required to adhere to these standards to produce financial statements that are accurate and in compliance with applicable regulations. A rigorous approach to franchise accounting makes it feasible to generate an accurate set of financial statements and to make decisions that are based on reliable information.
What Accounting Classification Is Franchise?
From the franchisor’s or franchisee’s point of view, the franchise may be categorised differently for accounting purposes. Franchises can be placed into one of the following primary accounting categories:
Intangible Asset (Franchisor Perspective):
- For franchisors, the franchise rights they grant to franchisees are typically classified as intangible assets.
- These intangible assets represent the value of the franchise brand, trademarks, and the right to use the franchisor’s business system.
- Initial franchise fees are initially recognized as revenue but may be subsequently reclassified as a deferred liability if certain criteria are met.
Prepaid Expense (Franchisee Perspective):
- From the franchisee’s perspective, the initial franchise fee is typically classified as a prepaid expense.
- This fee is considered an asset because it represents a payment in advance for future economic benefits (i.e., the right to operate the franchise business).
- The initial franchise fee is amortized over the life of the franchise agreement and recorded as an expense on the income statement over time.
Lease Liability and Right-of-Use Asset (Both Perspectives, if Real Estate Is Involved):
- If real estate is leased for franchise locations, lease accounting standards, such as ASC 842 in the United States, require the recognition of lease liabilities and right-of-use assets on the balance sheet.
- This classification impacts both the franchisor and franchisee’s financial statements, affecting the balance sheet and income statement.
Goodwill (Franchisee Perspective, in Business Acquisitions):
- When a franchisee acquires an existing franchise business, any excess payment over the fair value of identifiable assets and liabilities is considered goodwill.
- Goodwill is an intangible asset and is recorded on the balance sheet.
It is of the utmost importance to keep in mind that different countries’ accounting standards, such as GAAP in the United States or IFRS in many other countries, may affect the way that particular kinds of financial data are categorised and reported.
Franchisors and franchisees need to work with accountants and abide by the local accounting standards and procedures to ensure that their financial reporting is accurate and in compliance with applicable regulations.
How franchisees are accounted for differs depending on whether the situation is seen from the point of view of the franchisor or the franchisee. Franchises entail a one-of-a-kind collection of monetary transactions and responsibilities, and because of this, they are categorised differently in accounting for each person involved.
When it comes to franchisors, franchise rights are considered intangible assets, and revenue is recognised when it is collected. On the other hand, when it comes to franchisees, initial franchise costs are recorded as prepaid expenses and amortised throughout the life of the franchise agreement.
When real estate is involved, lease accounting standards may also apply, which has the potential to affect the balance sheets and income statements of both parties. When acquiring new businesses, franchisees often record goodwill as an intangible asset on their balance sheets.
Accounting categories are susceptible to distinct accounting standards and might change depending on the jurisdiction in question. Franchisors and franchisees alike must speak with accountants and adhere to the various accounting rules and regulations in their respective regions.
Doing so will help guarantee that financial reports are accurate and in compliance with applicable guidelines. For the sake of openness, sound decision-making, and accurate financial reporting, accurate accounting of franchises is necessary.