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Franchise - Mr Accounting - Solution
Accountancy and Business Management (ABM001)
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Franchise
Problem 1 On May 31, 2020, Mister entered into a franchise agreement with Accounting, Inc. to sell their products. The agreement provides for an initial franchise fee of 1,200,000 which is payable as follows: 400,000 cash to be paid upon signing of the contract and the balance in five equal annual installments every December 31, starting 2020.
Mister signs a non-interest bearing note for the balance. The credit rating of the franchisee indicates that the money can be borrowed at 10%. The present value factor of an ordinary annuity at 10% for 5 periods is 3.
The agreement further provides that the franchisee must pay a continuing franchise fee equal to 5% of its monthly gross sales. Accounting, Inc. incurred direct cost of 540,000 of which 170,000 is related to continuing services and indirect costs of 72,000 of which 18,000 is related to continuing services.
The franchisee started business operations on September 2, 2020 and was able to generate sales of 950,000 for 2020. The first installment payment was made in due date.
Compute for the net income under the following scenarios: I. Collectibility of the note is reasonably assured II. Collectibility of the note is not reasonably assured III. Collectibility of the note is uncertain
Solution I. Accrual Method II. Gross Profit Method (Installment Sales) III. Cost Recovery Method
Initial Franchise Fee: Down Payment 400, Non-Interest Bearing Note 800,000 (1,200,000 – 400,000) (800,000 / 5 years = 160,000 annual payment) (1st 160,000 is paid on December 31, 2020)
Present Value of Note (3 x 160,000 = 606,528) Annual Interest on Note (606,528 x 10% x 7/12 = 35, (7 months from May 30 to Dec. 31)
Direct cost of 540, Cost of Goods Sold 370, OPEX 170,
Indirect cost (Whole OPEX) 72, Total OPEX (170,000 + 72,000 = 242,000)
Continuing Franchise Fee (950,000 x 5% = 47,500)
Revenue (IFF) (400,000 + 606,528) 1,006, Cost (370,000) Gross Profit 636,528 GP Rate 63%
Collections x GP% (Down Payment + Principal Collection) x GP% Principal Collection = 160,000 - 35,381 = 124, (400,000 + 124,619 = 524,619 x 0 = GP Earned 331,769)
GP under Cost Recovery Method (Collections) 400,000 + 124,619 – 370,000 = 154,
I. Accrual Method II. Gross Profit Method III. Cost Recovery Method Down Payment 400, PV of Note 606, Cost (370,000) Gross Profit 636,528 331,769 154, Expenses (242,000) (242,000) (242,000) Continuing FF 47,500 47,500 47, Interest Income 35,381 35,381 35, Net Income 477,409 172,650 (4,500)
Problem 2 On January 2, 2020, Super signed an agreement to operate as a franchisee of Hero, Inc. for initial franchise fee of 10,000,000 for 10 years. Of this amount, 2,000,000 was paid when the agreement was signed and the balance payable in four annual payments beginning on December 30, 2020. Super signed a non-interest bearing note for the balance.
Super’s rating indicates that he can borrow money at 8% for the loan of this type. Present value of an annuity of 1 for 4 periods at 8% is 3.
A 2% continuing franchise fee is to be paid every end of the month. Assume that substantial services amounting to 1,293,000 had already been rendered by Hero, Inc. and that additional indirect franchise cost of 272,000 was also incurred. Super generated a total of 1,500,000 sales for the year 2020. Installment payment was made in due date.
I. If the collection of the note is reasonably assured, what is the earned franchise revenue for the year ended December 31, 2020? a. 8,620,000 c. 8,650, b. 10,000,000 d. 10,030,
II. If the collection of the note is not reasonably assured, what is the realized gross profit for the year ended, December 31, 2020? a. 2,949,840 c. 3,400, b. 2,915,136 d. 3,364,
Solution I. Accrual Method Initial Franchise Fee Down Payment 2,000, PV of Non-Interest Bearing Note (8,000,000/4 years = 2,000,000 x 3) 6,620, Initial Franchise Fee 8,620, Cost (1,293,000) Indirect Cost (272,000) Continuing FF (1,500,000 x 2%) 30, Interest Income (6,620,000 x 8%) 529, Net Income 7,614,
Suggested Solution (Revenue includes continuing franchise fee) 2,000,000 + 6,620,000 + 30,000 = 8,650,
II. Gross Profit Method (Installment Sales) IFF 8,620, Cost (1,293,000) Gross Profit 7,327,000 GP Rate (7,327,000 / 8,620,000 = 85%)
Collections: Down Payment 2,000, Principal (2,000,000 – 529,600) 1,470, Total 3,470, GP Earned (3,470,400 x 85% = 2,949,840)
Franchise - Mr Accounting - Solution
Course: Accountancy and Business Management (ABM001)
