Chapter 7 1

Long-Term Construction Contracts and Franchising

I. Introduction
A. Construction and Franchising Industries
1. Are among the fastest growing industries in the country
2. Construction Industries
a. Undeveloped property are converted either as:
1. Subdivisions; or
2. Condominium Buildings
b. Several roads and bridges are being built in various parts of the
country
3. Franchising Industries
a. Several successful entities grant other entities and individuals
to:
1. Operate using their trade names
2. Sell their products
b. Such an arrangement is called franchising
B. Transactions of a Construction of Company (or Contractor) and the
Franchisor
1. Examples
a. Acquisition of Plant Assets
b. Materials
c. Payment of Operating Expenses
2. Accounted for in the same manner as those of a manufacturing
firm or a merchandising firm
C. Activities of a Construction Company
1. Incurrence of Material, Labor, and Overhead Costs
2. Billings to Customers
3. Collections from Customers
4. Recognition of:
a. Revenue
b. Cost of Revenue
c. Gross Profit
D. Transactions that are Peculiar to the Franchisor
1. Receipt of Initial Franchise Fee
2. Rendering of Services to the Franchisee:
a. Initial
b. Continuing
II. Long-Term Construction Contracts
A. Nature and Types of Construction Contracts
1. Nature
a. Procedures in a Construction Project
1. Contractors are invited to bid for the project;
2. The specifications of the project are given to the bidders;
3. Bidders will prepare an estimate of the costs that will be
incurred on the project;
4. Bid Price = Cost Estimates + Desired Profit;
5. The contract is awarded to the lowest bidder; or the
contractor that bids the lowest contract price based on the
specification submitted by the contractee or client
b. Construction Contract as Provided in PAS 11
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Long-Term Construction Contracts and Franchising

1. Definition
a. Contract specifically negotiated for the construction of an
asset (building or a ship) or a combination of assets
that are closely interrelated or interdependent in terms of
their (1) design, (2) technology, (3) function, or their
ultimate (4) purpose or (5) use [complex pieces of
plant or equipment]
b. As stated in paragraph 5:
1. Contracts for rendering of services which are directly
related to asset construction, such as
a. Project Managerial Services
b. Architectural Services
2. Contracts for:
a. Asset Destruction
b. Asset Restoration
c. Environment Restoration Following Asset
Demolition
2. Treatment Guidelines (Single or Group)
a. When a contract covers a number of assets, the
construction of each asset should be treated as a
separate construction contract when:
1. Separate proposals have been made for each asset
2. Each asset has been subject to separate negotiation
and the contractor and the customer have been able
to accept or reject the part of the contract relating to
each asset
3. The costs and revenues of each asset can be identified
b. A group of contracts, whether with a single customer or
with several customers, should be treated as a single
construction contract when:
1. The group of contracts is negotiated as a single
package
2. The contracts are so closely interrelated that they are,
in effect, part of a single project with an overall profit
margin
3. The contracts are performed concurrently or in a
continuous sequence
c. A contract may provide for the construction of an
additional asset at the option of the customer or may be
amended to include the construction of an additional
asset. The construction of an additional asset when:
1. The asset differs significantly in design, technology or
function from the asset or assets covered by the
original contract
2. The price of the asset is negotiated without regard to
the original contract price
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Long-Term Construction Contracts and Franchising

2. Types
a. Fixed Price Contract
1. Contractor agrees to a fixed:
a. Contact Price; or
b. Rate Per Unit of Output
2. In some cases, the agreed upon price or unit rate is subject
to cost escalation clauses, which may provide for an increase
in the original contract price if (a) prices of construction
materials or (b) costs of labor increase by a certain
percentage subsequent to contract signing
b. Cost-Plus Contract
1. Contractor is reimbursed for:
a. Allowable or otherwise defined costs;
b. Plus:
1. A percentage of allowable or otherwise defined costs;
or
2. A fixed fee
2. Some contracts, however, contain characteristics of both
types, such as a cost plus contract with an agreed maximum
price
B. Contract Revenue and Contract Costs
1. Contract Revenue
a. PAS No. 11 defines contract revenue as the initial amount of
revenue agreed in the contract and variations in contract work,
claims, and incentive payments.
b. Composition:
1. Bid (Contract) Price
a. Initial amount of revenue agreed in the contract
b. Submitted by the contractor during the bidding process
2. Variations in Contract Work
a. Instruction by the customer for a change in the scope of
the work to be performed under the contract
b. It may:
1. Increase the original contract revenue
2. Decrease the original contract revenue
c. It includes changes in:
1. Asset Specifications
2. Asset Design
3. Contract Duration
d. Included in contract revenue when:
1. It is probable that the customer will approve (a) the
variation and (b) the amount of revenue arising from
the variation
2. The amount of revenue can be measured reliably
3. Claims
a. Amount that the contractor seeks to collect from (1) the
customer or (2) another party as reimbursement for costs
excluded in the contract price
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Long-Term Construction Contracts and Franchising

b. May arise from:

1. Customer Caused Delays
2. Disputed Variations in Contract Work
3. Errors in:
a. Specifications
b. Design
c. Included in contract revenue when:
1. Negotiations have reached an advanced stage such
that it is probable that the customer will accept the
claim
2. The amount of the probable claim can be measured
reliably
4. Incentive Payments
a. Additional amount paid to the contractor if
1. Specified Performance Standards are:
a. Met
b. Exceeded
2. The Contract is Completed Early
b. Included in contract revenue when:
1. The contract is sufficiently advanced that it is
probable that the specified performance standards
will be (a) met or (b) exceeded
2. The amount of incentive payment can be measured
reliably
2. Contract Costs
a. Costs that are incurred in the construction project
b. Contract Cost Groups:
1. Costs that relate directly to the specific contract
a. Site Labor Costs, including Site Supervision
b. Cost of Materials Used in Production
c. Depreciation of Plant and Equipment Used on the Contract
d. Costs of Moving Plant, Equipment and Materials To and
From the Contract Site
e. Costs of Hiring Plant and Equipment
f. Costs of Design and Technical Assistance that is Directly
Related to the Contract
g. Estimated Costs of Rectification and Guarantee Work,
including Expected Warranty Costs
h. Claims from Third Parties
2. Costs that are attributable to contract activity in
general and can be allocated to the contract
a. Insurance
b. Costs of Design and Technical Assistance that is
Indirectly Related to the Contract
c. Construction Overheads such as Cost of Preparing and
Constructing Personnel Payroll
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Long-Term Construction Contracts and Franchising

3. Such other costs as are specifically chargeable to the

customer (reimbursable) under the terms of the
contract
a. General Administration Costs
b. Development Costs
C. Construction Contract Terminologies
1. Contract Price
a. Price agreed upon by the contractor and the client for the
construction of a specific project
b. Represents Contract Revenue
2. Cost Incurred To Date actual cumulative construction costs
incurred by the contractor from the time the project started up to a
particular balance sheet date
3. Estimated Cost To Complete
a. Additional construction costs reasonably expected to be incurred
to complete the project
b. Made by engineers at every balance sheet date
4. Total Estimated Cost
a. Cost Incurred To Date + Estimated Cost to Complete
b. Total Estimated Cost upon completion of the project
5. Total Estimated Gross Profit
a. Contract Price Total Estimated Cost; where CP > TEC
b. Excess of contract price over total estimated cost
6. Total Estimated (Anticipated) Loss
a. Total Estimated Cost Contract Price; where TEC > CP
b. Excess of total estimated cost over contract price

D. Accounts Used By a Construction Company

Normal
Account Title Used Nature of Account Balance
Construction in Progress Asset (Inventory) Debit
Accounts Receivable Asset (Receivable) Debit
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Long-Term Construction Contracts and Franchising

Progress Billings on Construction Liability [Deferred (Unearned)

Contracts Revenue] Credit
Revenue from Long-Term
Construction Contracts Revenue Credit
Cost of Long-Term Construction
Contracts Expense Debit

E. Construction Activities

To record purchase of construction materials

Construction Materials xxx
Cash (or Accounts Payable) xxx
To record cost of materials incurred in construction
Construction in Progress xxx
Construction Materials xxx
To record cost of construction labor
Construction in Progress xxx
Payroll xxx
To record payment of construction overhead costs
Construction in Progress xxx
Cash xxx
To record other construction overhead costs
Construction in Progress xxx
Accrued Expenses/Various Accounts xxx
To record billings on customers
Accounts Receivable xxx
Progress Billings on Construction Contracts xxx
To record collections from customers
Cash xxx
Accounts Receivable xxx

F. Measurement of Contract Revenue

1. Measured at the fair value of the consideration:
a. Received
b. Receivable
2. Affected by some uncertainties that depend on the outcome of
future events
3. Estimates may need to be revised as:
a. Events occur
b. Uncertainties are resolved
4. Some items that affect measurement of revenue, as previously
discussed
a. Variations in Contract Work
b. Claims
c. Incentives
G. Recognition of Contract Revenue and Expenses
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Long-Term Construction Contracts and Franchising

1. PAS no. 11 Guidelines

a. When the outcome of a construction contract can be estimated
reliably:
1. Use the percentage-of-completion method
2. How to tell when construction contract outcomes are reliably
estimable
(NOTE: ALL CONDITIONS MUST BE SATISFIED)
a. Fixed Price Contract
1. Total (a) contract and (b) revenue can be measured
reliably
2. It is probable that the economic benefits associated
with the contract will flow to the enterprise (i.e., there
is reasonable assurance as to the collectability of the
contract price)
3. Both (a) the contract costs to complete the contract
and (b) the stage of completion at the statement of
financial position date can be measured reliably
4. The contract costs attributable to the contract can be
(a) clearly identified and (b) measured reliably so that
actual contract costs incurred can be compared with
prior estimates
b. Cost-Plus Contract
1. It is probable that the economic benefits associated
with the contract will flow to the enterprise (i.e., there
is reasonable assurance as to the collectability of the
contract price)
2. The contract costs attributable to the contract,
whether or not specifically reimbursable, can be
clearly identified and measured reliably
b. When the outcome of a construction contract cannot be
estimated reliably:
1. Use the cost recovery method
2. Revenue should be recognized only to the extent of contract
costs incurred that it is probable will be recoverable
3. Contract costs should be recognized as expense in the period
in which they are incurred
c. The completed contract method is not generally accepted under
PAS No 11
2. Percentage-of-Completion Method
a. Recognition Guidelines
1. Contract Revenue, Cost of Contract Revenue, and Gross Profit
a. Recognized by contractor as the work progresses
proportionate to the work completed
b. Recognized as revenue (expense) in the income
statement in the accounting period in which the work is
performed (related revenue is recognized)
2. Anticipated loss
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Long-Term Construction Contracts and Franchising

a. Should be recognized in full in the period it is determined

b. Occurs when Contract Price < Total Estimated Cost
3. Operating expenses recognized in the income statement in
the period they are incurred
b. Determining the Percentage of Completion of the Contract
1. Input Method
a. Also known as Cost-to-cost Method
b. The proportion that contract costs incurred for work
performed to date bear to the estimated total contract
costs
c. Most popular method whereby the basis of measurement
is the ratio of cost incurred to date to the total estimated
cost
d. Cost of revenue is equal to actual cost incurred
2. Output Method
a. Also known as Architects or Engineers Estimates
b. Based on:
1. Surveys of work performed
2. Completion of a physical proportion of the contract
work
c. Cost of revenue may not equal actual cost incurred
c. Procedures Followed in Applying the Percentage-of-Completion
Method (At the End of Each Accounting Period)
1. A schedule is prepared showing the total estimated costs,
total estimated gross profit (loss), and the percentage of
completion

Subsequent
First Year Year/s Final Year
P P P
a. Contract Price xxx xxx xxx
P P P
b. Cost Incurred To Date xxx xxx xxx
c. Estimated Cost To Complete xxx xxx xxx
P P P
d. Total Estimated Cost (b + c) xxx xxx xxx
e. Total Estimated Gross Profit P P P
(Loss) [a - d] xxx xxx xxx
Percentage of Completion
f. (b d) xxx% xxx% xxx%

2. A schedule is prepared showing the computation of revenue,

cost of revenue, and gross profit to be recognized

To Date Recognized in To Be
Prior Year/s Recognized in
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Long-Term Construction Contracts and Franchising

Current Year
First Year
P P
Recognized Revenue xxx - xxx
Cost of Revenue xxx - xxx
P P
Gross Profit (Loss) xxx - xxx

Subsequent Year/s
P P P
Recognized Revenue xxx xxx xxx
Cost of Revenue xxx xxx xxx
P P P
Gross Profit (Loss) xxx xxx xxx

Final Year
P P P
Recognized Revenue xxx xxx xxx
Cost of Revenue xxx xxx xxx
P P P
Gross Profit (Loss) xxx xxx xxx

(a
) Recognized Revenue = Contract Price x Percentage of Completion
(b
) Cost of Revenue = Total Estimated Cost x Percentage of Completion
(c Gross Profit (Loss) x Percentage of Completion, or
) Gross Profit (Loss) = (a) - (b)

3. A journal entry is prepared to record:

a. Revenue, Cost of Revenue, and Gross Profit (Loss)
recognized for that period
b. Upon completion of the project, to close the balances of:
1. Construction in Progress
2. Progress Billings on Construction Contracts

To record recognized revenue, cost of revenue, and gross profit

xx
Cost of Long-Term Construction Contracts (Cost of Revenue) x
xx
Construction in Progress (Realized Gross Profit) x
Revenue from Long-Term Construction Contracts (Recognized xx
Revenue) x
To record recognized revenue, cost of revenue and anticipated loss
xx
Cost of Long-Term Construction Contracts (Cost of Revenue) x
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Long-Term Construction Contracts and Franchising

xx
Construction in Progress (Full Anticipated Loss) x
Revenue from Long-Term Construction Contracts (Recognized xx
Revenue) x
To close the balances of construction in progress and progress billings on
construction contracts
xx
Progress Billings on Construction Contracts (Total Contract Price) x
Construction in Progress [Total Cost of Revenue + Gross Profit ( - xx
Anticipated Loss)] x

d. Key Theories
1. The Construction in Progress account
a. The gross profit (loss) recognized each year is debited
(credited) to the account, thereby increasing (decreasing)
its balance
b. Balance:
1. Is composed of:
a. Cost incurred to date
b. Gross profit (loss) to date
2. Also represents the revenue to date
2. The amount of revenue, cost of revenue, and gross profit
(loss) to be recognized in the current year are the respective
balances to date less the amount recognized in prior year/s.
In the case the anticipated losses, immediate recognition (or
recognition in full) is required
3. Upon completion of the project and full billings to the
customer, the balance of the Progress Billings on
Construction Contract will be equal to the total contract
revenue. On one hand, the balance of the Construction in
Progress account will also equal to the total contract revenue
since both contract costs and gross profit (loss) on the
contract are recorded in the account. The balances of these
two accounts relating to a particular project must be closed
upon completion of such project
e. Financial Statement Presentation and Disclosures
1. Financial Statement Presentation
a. Since the operating cycle of a construction company that
emphasizes long-term construction contracts is generally
more than one year, the statement of financial position
(balance sheet) accounts related to construction activities
are classified as current
b. Accounts Receivable is reported as a current asset
c. Balance of Construction in Progress and Progress Billings
on Construction Contracts
1. Are reported net, either as current asset or as current
liability
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Long-Term Construction Contracts and Franchising

2. When the balance of Construction in Progress is more

than (less than) the balance of the Progress Billings on
Construction Contracts account, they are reported
under the current assets (liabilities) section
3. The balances of the two accounts for individual
projects must be determined for proper financial
statement presentation
4. A net debit balance in one project must not be offset
against a net credit balance in another project
2. Disclosures (either parenthetically or in the notes, as required
by PAS No 11)
a. Amount of:
1. Contract revenue recognized as revenue in the period
2. Advances received for each contract in progress
3. Retentions [amount of progress billings which are not
paid until (a) the satisfaction of conditions specified in
the contract for payment of such amounts or until (b)
defects have been rectified] for each contract in
progress
b. Methods Used To Determine:
1. Contract revenue recognized in the period
2. Stage of completion of contracts in progress
c. Aggregate Amount of:
1. Costs Incurred To Date For Each Contract in Progress
2. Recognized Profit (Less Recognized Losses) To Date For
Each Contract in Progress
f. Anticipated Loss on Long-term Construction Contracts
1. When it is probable that total contract costs for a particular
project will exceed total revenue, the expected or anticipated
loss should be recognized as expense immediately, that is, in
the period it is determined
2. PAS No. 11, paragraph 37 provides that the amount of loss is
determined irrespective of:
a. Whether or not work has commenced on the contract
b. The stage of completion of contract activity
c. The amount of profits expected to arise on other contracts
g. Accounting For Contract Change Orders
1. Contract Change Orders
a. Instances when modifications in the original contract price
are made as intended by either (a) the contractor or (b)
the customer
b. Include Changes in:
1. Specifications
2. Designs
3. Method of Performance
4. Manner of Performance
5. Facilities
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Long-Term Construction Contracts and Franchising

6. Equipment
7. Materials
8. Etc.
2. Accounting Treatment
a. Affected elements:
1. Contract Price
2. Cost of Construction
b. Considered as changes in estimates that will affect:
1. Current Period
2. Current and Future Periods
3. Cost Recovery Method
a. Used when the outcome of a contract cannot be estimated
reliably
b. Revenue is recognized only to the extent of the contract costs
incurred that is probable of recovery (may be < actual cost
incurred to date)
1. If Actual Cost Incurred To Date > Probably Recoverable
Contract Costs, the difference would be recognized as a loss
2. If Actual Cost Incurred To Date < Probably Recoverable
Contract Costs, the difference would be ignored since
recognizing such would lead to a gross profit, which would
violate the cost recovery (zero-profit) method
c. Examples of circumstances in which the recoverability of
contract costs may not be probable, as enumerated by PAS No.
11
1. Contracts which are not fully enforceable, that is, their
validity is seriously in question
2. Contracts in which their completion is subject to the outcome
of pending litigation or legislation
3. Contracts relating to properties that are likely to be
condemned or expropriated
4. Contracts wherein customers are unable to meet their
obligations
5. Contracts where contractor is unable to complete the
contract or otherwise meet its obligations under the contract
d. When the uncertainties that prevented the reliable estimation of
the outcome of the contract no longer exist, revenue and
expenses associated with the construction contract should be
recognized using the percentage-of-completion method
e. Journal entries for the cost recovery method is the same as in
percentage-of-completion method, except for the amount of
revenue and profit to be recognized
III. Franchising
A. Has been one of the fastest growing retail business
B. Franchisor
1. Establishments which create faster growth by selling rights for the
use of their:
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Long-Term Construction Contracts and Franchising

a. Patents
b. Secret Processes
c. Trade Names
d. Products
2. Examples:
a. Jollibee
b. McDonalds
c. Shakeys
d. Mercury Drug
e. Goldilocks
f. Mini-Stop
g. Chowking
h. Pizza Hut
C. Franchisee
1. Buys the rights sold by the franchisor
2. Operate their own units as independent organizations
D. Initial Franchise Fee payment by the franchisee for:
1. Establishing the franchise relationship
2. Providing some initial services as operation goes on:
a. Conduct of Market Studies
b. Training of Employees
c. Finding a Suitable Location
d. Sale of Product
E. Major Accounting Issues Relating to Sale of Franchise Right
1. Initial franchise fee received by the franchisor
2. Cost incurred prior to opening of the franchise outlet
3. Payment of continuing franchise fee
4. Sale of goods by the franchisor to the franchisee
F. Accounting for Franchise Fee and Related Cost of Revenue (based on
FASB Statement No. 45 and IAS No. 18)
1. Substantial performance of services
a. Occur when the franchisor has:
1. No obligation to
a. Refund any cash received
b. Excuse any nonpayment of a note
2. Performed all the initial services required under the contract
b. As provided by FASB Statement No. 45, the earliest point at
which substantial performance has occurred is when the
operation of the franchisee has commenced unless it can be
demonstrated that substantial performance of all obligations,
including services rendered voluntarily, has occurred before that
time
2. Prior to substantial performance of services - Deposit Method
a. Franchise fee received by the franchisor is:
1. Paid in lump-sum
2. Treated as a deposit, which may be refunded (should the
franchise agreement be canceled for one reason or another)
in
a. Whole
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Long-Term Construction Contracts and Franchising

b. Part
3. Recorded as a deferred revenue
b. Costs incurred are recorded as deferred cost
c. Pro-forma journal entries:

To record signing of franchise agreement

Cash, etc. xxx
Unearned Franchise Fee (at fair value of consideration
received) xxx
To record initial cost incurred and/or additional cost of services
Deferred Franchise Cost xxx
Cash, etc. xxx
To record the franchise revenue and cost of franchise revenue (opening of
franchise outlet)
Unearned Franchise Fee xxx
Franchise Fee Revenue (balance of Unearned Franchise Fee) xxx

Cost of Franchise Fee Revenue (balance of Deferred Franchise

Cost) xxx
Deferred Franchise Cost xxx

3. Upon substantial performance of services

a. The initial franchise fee is:
1. Paid in installments
2. Considered earned
b. Deferred revenue must be transferred to earned revenue
account
c. Full Accrual Method
1. Used when collection of the unpaid fee is reasonably assured
2. Pro-forma journal entries:
d. Installment Sales Method
1. Used when collection of the unpaid fee is not reasonably
assured
2. Pro-forma journal entries:

To record signing of franchise agreement

Cash, etc. xxx
Notes Receivable (face value) xxx
Discount on Notes Receivable (face value - present
value) xxx
Unearned Franchise Fee (at fair value of
consideration received) xxx
To record installment payment/s and to amortize discount
Cash (periodic installment) xxx
Discount on Notes Receivable (cv of note x implicit rate
x time) xxx
Interest Revenue (discount amortization) xxx
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Long-Term Construction Contracts and Franchising

Notes Receivable (periodic installment - discount

amortization) xxx
To record initial cost incurred and/or additional cost of services
Deferred Franchise Cost xxx
Cash xxx
To record the franchise revenue and cost of franchise revenue (opening of
franchise outlet)
Unearned Franchise Fee xxx
Franchise Fee Revenue (balance of Unearned
Franchise Fee) xxx

Cost of Franchise Fee Revenue (balance of Deferred

Franchise Cost) xxx
Deferred Franchise Cost xxx
To record deferred gross profit
Franchise Fee Revenue (recognized amount) xxx
Deferred Gross Profit on Franchise (difference) xxx
Cost of Franchise Fee Revenue (recognized amount) xxx
To record realized gross profit
Deferred Gross Profit on Franchise (realized gross
profit) xxx
Realized Gross Profit on Franchise xxx

P
Down payment (if any) xxx
Installment Applied to Principal:
P
Periodic Installment xxx
( xx
Installment Applied to Interest/Discount Amortization x) xxx
P
Total Collections xxx
Multiply by Gross Profit Rate:
P
Gross Profit xxx
Divided by Franchise Fee Revenue/Cost of Franchise x xxx
Fee Revenue xxx %
P
Realized Gross Profit xxx

4. Special Rules
a. If (1) the probability of refunding the initial franchise fee is
extremely low, (2) the amount of future services to be provided
to the franchisee is minimal, (3) collectability of the note is
reasonably assured, and (4) substantial performance has
occurred, the total franchise fee (that is, the down payment and
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Long-Term Construction Contracts and Franchising

the present value of unpaid franchise fee) is recorded as

revenue immediately
b. If (1) the initial down payment is (a) not refundable and (b) it
represents a fair measure of the service already provided, with
(2) a significant amount of services still to be performed by the
franchisor in future periods, and (3) collectability of the note is
reasonably assured, the down payment is recorded as revenue
and the present value of the unpaid franchise fee is recorded as
deferred (unearned) revenue
c. If (1) the initial down payment is not refundable and (2) no
future services are required by the franchisor, but (3) collection
of the note is uncertain, the down payment is recorded as a
revenue and the note may not be recorded
d. If (1) the initial down payment is refundable or (2) substantial
services are yet to be performed and (3) the collection of the
note is uncertain, the down payment is recorded as unearned
revenue and the note may not be recorded
G. Accounting For Other Franchise Fees (as provided by PAS No. 18)
1. Supplies of Equipment and Other Tangible Assets the
amount, based on the fair value of the assets sold, is recognized as
revenue when the items are delivered or tile passes
2. Supplies of Initial and Subsequent Services
a. Fees for the provision of continuing services, whether (1) part of
the initial fee or (2) a separate fee are recognized as revenue
as services are rendered
b. When the separate fee does not cover the cost of continuing
services together with a reasonable profit, part of the initial fee,
sufficient to cover (1) the costs of continuing services and (2) to
provide reasonable profit on those services, is deferred and
recognized as revenue as the services are rendered
c. When the terms of the franchise agreement allows the
franchisee to obtain equipment, inventories or other tangible
assets at a bargain purchase price [that is, (1) at a price lower
than that charged to others or (2) a price that does not provide
a reasonable profit on those sales]
1. Part of the initial fee, sufficient to (a) cover estimated costs
in excess of that price and (b) to provide a reasonable profit
on those sales, is deferred and recognized over the period
the goods are likely to be sold to the franchisee
2. The balance of the initial fee is recognized as revenue when
performance of all the initial services and other obligations
required of the franchisor has been substantially completed
3. Continuing Franchise Fee fees charged for the use of
continuing rights granted by the agreement, or for other services
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Long-Term Construction Contracts and Franchising

provided during the period of the agreement, are recognized as

revenue as the services are provided or the rights are used
4. Agency Transactions
a. Transactions may take place between the franchisor and the
franchisee which, in substance, involve the franchisor acting as
agent for the franchisee, such as (1) the ordering of supplies
and (2) arranging for their delivery to the franchisee at no profit
b. Such transactions do not give rise to revenue
H. Repossession (Reacquisition) of Franchise
1. Franchise Fee Is Refunded
a. Accounting treatment is equivalent to a cancellation of original
sale
b. Revenue previously recognized is reported as a reduction in
revenue of the current period in which the franchise is
repossessed (reacquired)
2. Franchise Fee Is Not Refunded
a. No adjustment is required
b. If a balance is still owed by the franchisee:
1. The Allowance for Uncollectible Accounts related to the
transaction should be reviewed
2. Any deferred revenue on the original sale should now be
recognized in full