Franchise fees and revenue

A franchise revenue example

A franchisor signs a 10-year agreement with a new franchisee for an initial fee of 50,000, a royalty of 5% of sales and an advertising fund contribution of 2% of sales. Before opening, it helps choose the site and trains staff. The franchisee's first-year sales are 2,000,000.

The remaining 45,000 of the initial fee is a contract liability at the end of year 1. Recognising the whole fee when the store opened, as many franchisors did before IFRS 15, would put 50,000 into year 1.

Are pre-opening services a separate performance obligation?

Usually not. Site selection, training and help with opening generally only make sense in combination with the franchise licence, so they are not distinct and form part of it. Goods transferred separately, such as equipment or initial inventory sold to the franchisee, are distinct and recognised when control passes. US GAAP offers private company franchisors a practical expedient to treat certain pre-opening services as distinct, which IFRS does not.

Why are royalties recognised as sales occur?

IFRS 15 has a specific exception for sales-based royalties on licences of intellectual property: they are recognised only when the later of the underlying sale and the satisfaction of the performance obligation occurs. The franchisor does not estimate future royalties; it recognises them as franchisees report their sales.

How are advertising fund contributions treated?

If the franchisor controls the fund and the advertising, deciding how it is spent, it is usually the principal: contributions are revenue and the advertising spending is an expense. Some franchisors previously netted these, so IFRS 15 increased their reported revenue and costs without changing profit.

What about renewals and transfers?

Renewal fees relate to the renewal period, so they are recognised over it from when the renewal starts. Fees for transferring a franchise to a new owner are usually recognised over the remaining term, or when the transfer is completed if no further obligations arise.

What about area development and master franchise fees?

An area development agreement gives a developer the exclusive right to open a number of stores in a territory, for an upfront fee. The fee usually relates to the franchises to be granted, so it is recognised as each store opens and over each store's franchise term, rather than when the agreement is signed. Master franchise fees for a whole country follow similar reasoning.

How do company-owned and franchised stores differ in the accounts?

Sales in company-owned stores are the franchisor's revenue in full, with the store's costs; franchised stores contribute only fees and royalties. A chain that refranchises stores, selling them to franchisees, therefore reports lower revenue but often higher margins, and recognises a gain or loss on the stores sold.

What do franchisors disclose?

Revenue split between royalties, initial fees, advertising fund contributions and sales from company-owned stores, the contract liabilities for initial fees not yet recognised, and the judgements on whether pre-opening services are distinct.

How does the franchisee account?

The initial fee is usually an intangible asset, the franchise right, amortised over the term, and royalties are expenses as sales occur. See licences of intellectual property and retail accounting.

This guide is general information. It is not tax or legal advice for your situation.