FRANCHISOR ACCOUNTING

RELATED STANDARDS: PFRS 15 – REVENUE FROM CONTRACTS WITH CUSTOMERS

TOPIC OUTLINE

FRANCHISOR
ACCOUNTING

The Five-
Basic
Steps Accounting
Concepts
Process of for Franchise
and
Revenue Costs
Introduction
Recognition
LECTURE NOTES
BASIC CONCEPTS AND INTRODUCTION
A FRANCHISE is a contractual agreement under which the franchisor grants the franchisee the right to sell certain products or
services, to use a certain trademarks or trade names or to perform certain functions, usually within a designated geographical
geographica area.

ly the requirements of PFRS 15 in accounting its income from franchise contracts. PFRS 15 supersedes PAS
The franchisor should apply
18, Revenue.

Core Principle of PFRS 15

An entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount tha
thatt reflects the
consideration to which the entity expects to be entitled in exchange for those goods or services

THE FIVE STEPS PROCESS OF REVENUE RECOGNITION (PFRS 15)

STEP 1: Identify the contract with the customer
The contract is with a customer and the collectability of the consideration is PROBABLE
PROBABLE.

STEP 2:Identify the performance obligations in the contract

Each promise to deliver a DISTINCT good or service in the contract is treated as a separate performance ob
obligation.

A promised good or service is distinct if:

(a) The customer can benefit form the good or service either on its own or together with other resources that are readily available
availab
to the customer.
(b) The promise to transfer the good or service is separately identifiable from other promises in the contract

If the promise to grant the license is distinct from other promises in the contract, the entity should determine whether the license
provides the customer with either RIGHT TO ACCESS the entity's intellectual property or RIGHT TO USE the entity's intellectual
property.

RIGHT TO ACCESS - Performance obligation is satisfied OVER TIME since the customer cannot direct the use of and obtain
substantially all of the remaining benefits from the license at the point in time at which it is granted. Thus revenue recognition is OVER
THE LICENSE PERIOD.

RIGHT TO USE - Performance obligation is satisfied AT A POINT IN TIME since the customer can direct the use of and obtain
substantially all of the remaining benefits from the license at the point in time at which it is granted. Thus revenue recognition is AT A
POINT IN TIME after satisfaction of performance obligation."

STEP 3: Determine the transaction price

Transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods
or services to a customer, EXCLUDING amounts collected on behalf of third parties. (e.g. sales tax or VAT)

NOTE: If there is a significant financing component, then the consideration receivable needs to be discounted to present value using
the rate at which the customer would borrow.

Transaction price in a franchise contract is commonly referred to as the franchise fees

fees.

Franchise fees come in the form of:

(1) INITIAL FRANCHISE FEE – payment for establishing the relationship and providing some initial services.
CRITERIA TO RECOGNIZE REVENUE:
S – satisfaction of performance obligation (substantial performance)
P – period of refund has expired (non-refundable)
(non (
if silent)
C – collectability is reasonably assured (
if silent)

NOTE: (EXCEPTION TO THE RULE ABOVE) Cash received as down payment is recognized as revenue if non non-refundable
refundable and
represents a fair measure of the services already rendered by franchisor even though there is no substantial performance.
(2) CONTINUING FRANCHISE FEE (CONTINGENT FRANCHISE FEE) –are are fees received (a) in return for continuing rights granted by
the agreement; (b) for providing management training, advertising and promotion, legal assistance and other support.

Continuing franchise fees (royalty fee) should be reported as revenue when they are earned unless portion of them has been
designated for a particular purpose. (e.g. if it is conditional)

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 STEP 4: Allocate the transaction price to the performance obligations.
The transaction price is allocated to the performance obligations on the RELATIVE STAND-ALONE PRICES of the distinct goods and
services. (Using relative sales value approach or residual approach)

STEP 5: Recognize revenue when (or as) a performance obligation is satisfied.

• For performance obligations satisfied over time, revenue is recognized as the entity progresses towards the complete
satisfaction of the performance obligation.
• For performance obligations satisfied at a point in time, revenue is recognized when the entity completely satisfied the
performance obligation.
NOTE: Revenue is measured at the amount of transaction price allocated to the performance obligation satisfied.

ACCOUNTING FOR FRANCHISE COSTS

Franchise accounting also involves proper accounting for the franchisor’s cost. The objective is to match related costs and revenues by
reporting the as components of income in the same accounting period.

Franchisors should normally DEFER DIRECT COSTS (incremental costs) relating to specific franchise sales for which revenue has not
yet been recognized.

INDIRECT COSTS of a regular and recurring nature, such as selling and administrative expenses, should be EXPENSED AS INCURRED.

STRAIGHT PROBLEMS:
1. On January 1, 2020 HANZO CORP. entered into a franchise agreement with MOBA INC. to market their products. The
agreement provides for an initial fee of P12,500,000 payable as follows: P3,500,000 to be paid upon signing of the contract
and the balance in five annual payments every end of this year starting December 31, 2020. The agreement further provides
9m/5= that the franchisee must pay a continuing franchise fee equal to 3% of the monthly gross sales. On August 31, the franchiser
1.8m completed the initial services required in the contract at a cost of P4,290,120 and incurred indirect cost of P175,000. The
franchisee commenced business operations on November 30, 2020. The gross sales reported to the franchiser were P1,800,000
on December 31, 2020, The first installment payment was made in due date. (Round gross profit rate in 2 decimal places)

REQUIREMENTS: Under the following assumptions: (1) Compute for the total revenue for the year 2020; (2) How much is the
net income for the year ended, December 31, 2020?

(a) Assume that HANZO signed an interest bearing note for the remaining balance of initial franchise fee and the
collectability of the note is reasonably assured. (The interest rate is 15%)
Initial franchise fee P12,500,000
Continuing franchise fee (1,800,000 x 3%) 54,000
Interest revenue (9,000,000 x 15%) 1,350,000
Total revenue P13,904,000
Direct costs (4,290,120)
Indirect costs (175,000)
Net income P9,438,880

(b) Assume that HANZO signed non-interest bearing note for the remaining balance of initial franchise fee and the
collectability of the note is reasonably assured. (The effective interest rate is 15%)
Initial franchise fee [3,500,000 + (1,800,000 x 3.352) P9,533,600
Continuing franchise fee (1,800,000 x 3%) 54,000
Interest revenue (6,033,600 x 15%) 905,040
Total revenue 10,492,640
Direct costs (4,290,120)
Indirect costs (175,000)
Net income P6,027,520

(c) Assume that HANZO signed an interest bearing note for the remaining balance of initial franchise fee and did not
substantially transferred control over the asset with a license period is 10 years.
Initial franchise fee (12,500,000 ÷ 10) 1,250,000
Continuing franchise fee (1,800,000 x 3%) 54,000
Interest revenue (9,000,000 x 15%) 1,350,000
Total revenue P2,654,000
Direct costs (4,290,120 ÷ 10) (429,012)
Indirect costs (175,000)
Net income P2,049,988

2. LOLITA CORP. sold a fast food restaurant franchise to TANK CORP. The signed agreement on January 1, 2020 provides for the
following stipulations:
• A P100,000 down payment shall be paid representing the fair value of initial services provided by the franchisor.
• The balance is to paid by four annual payments of P50,000 evidence by a non-interest bearing note signed by the
franchisee. The credit rating of the franchisee indicates that it can borrow money at a 10% interest for a loan of this
type. (Round-off present value factors in 2 decimal places.)
• The agreement further provides that the franchisee is to pay ongoing payment for royalties at 5% of its gross revenues.
The restaurant opened early this year and its sales for the year amounted to P50,000. The franchisor incurred direct costs and
indirect costs amounting to P63,400 and P15,000, respectively.
REQUIREMENTS: Using the following assumptions: (1) How much is LOLITA’s 2020 total franchise revenue? (2) Compute for
the company’s net income for the year 2020.
(a) Assuming the collectability of the note is reasonably assured.
Initial franchise fee [100,000 + (50,000 x 3.17)] 258,500
Continuing franchise fee (50,000 x 5%) 2,500
Total franchise fees 261,000
Interest income (158,500 x 10%) 15,850
Total revenues 276,850
Direct costs (63,400)
Indirect costs (15,000)
Net income P198,450

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 (c) Assuming that the performance obligation has yet performed during the year and the collectability of the note is
reasonably assured.
Initial franchise fee 100,000
Continuing franchise fee (50,000 x 5%) 2,500
Total franchise fees 102,500
Interest income (158,500 x 10%) 15,850
Total revenues 118,350
Direct costs -
Indirect costs (15,000)
Net income P103,350

3. On April 1, 2020, FARAMIS INC. entered into a franchise agreement with KAJA CORP. The initial franchise fees agreed upon is
P246,900 of which, P46,900 is payable upon signing and the balance to be covered by a non-interest bearing note payable in
four equal annual installments. The down payment is refundable within 100 days. KAJA has a high credit rating, thus
collection of the note is reasonably assured. FARAMIS substantially performed all necessary requirements and incurred out-of-
pocket costs of P125,331 and P12,345 for direct expenses and indirect expenses respectively. Prevailing market rate is 9%. PV
factor is 3.2397.

REQUIREMENT: For the fiscal year ended June 30, 2020, how much contract liability from franchise fee will the franchisor
recognize?

[(50,000 x 3.2397) + 46,900] = 208,885 (From April 1 to June 30, it is just 91 days. Therefore, the whole initial franchise fee
shall be recognized as unearned income or contract liability under PFRS 15.)

4. On January 1, 2020, FANNY INC. granted a franchise to a certain franchisee. The franchisee agreement provided for the
following terms:
• The franchisee is required to pay a non-refundable upfront fee in the amount of P500,000 and an on-going royalties of
3% of the sales of the franchisee.
• In relation to the upfront fee, the franchise agreement required the entity to render the following performance
obligations:
(a) To construct the franchisee’s stall.
(b) To deliver 10,000 units of raw materials to the franchisee.
(c) To allow the franchisee to use the entity trade name for a period of 5 years starting January 1, 2020.
The franchisee paid the upfront fee on January 1, 2020. The stand-alone prices of each performance obligations are as follows:
Construction of franchise stall P 150,000
Delivery of raw materials (10,000 units) 150,000
Use of trade name 300,000

The construction of the stall was completed on June 30, 2020. As of December 31, 2020, FANNY was able to deliver 6,000 units
of raw materials to the franchisee and the franchisee reported sales amounting to P1,000,000. FANNY determined that each
performance obligations are separate and distinct from each other.

REQUIREMENT: What amount of revenue is to be recognized for each performance obligation for the year ended December 31,
2020?
Performance obligations Stand-alone prices Revenue allocated Revenue recognized
Construction of franchise stall P 150,000 P125,000 P125,000
Delivery of raw materials (10,000 units) 150,000 125,000 75,000
Use of trade name 300,000 250,000 50,000
Total 600,000 500,000 P250,000
Continuing franchise fee (1,000,000 x 3%) 30,000
Total franchise revenue (2020) P280,000

PROBLEMS

Problem 1:

On January, 1, 20x1, Franchisor Co. enters into a contract with Franchisee Co. The franchise contract gives Franchisee Co. the right to
use Franchisor’s trade name and the right to sell Franchisor’s products for a period of 4 years. The franchise requires payment of an
upfront fee of ₱1,000,000, payable at contract inception, and 5% of future sales of the products, payable at each month-end.

The franchise contract requires Franchisor Co. to undertake activities that would further improve its brand and its products, to which
Franchisee Co. has marketing and promotional activities. Although those activities do not result in the transfer of a good or a service
to Franchisee Co. as those activities occur, it is expected that Franchisee Co. will benefit from those activities.

All the necessary preparations were completed, and TIPPLE Co. started operations, on January 31, 20x1.

1. How should Franchisor Co. recognize revenue from the ₱1,000,000 initial franchise fee?
a. Recognize the ₱1,000,000 initial franchise fee as revenue in full on January 1, 20x1.
b. Recognize the ₱1,000,000 initial franchise fee as revenue in full on January 31, 20x1.
c. Recognize the ₱1,000,000 initial franchise fee as revenue throughout the license period.
d. Any of the above, as matter of accounting policy choice.

2. How should Franchisor Co. recognize revenue from the 5% of sales continuing franchise fee?
a. Franchisor Co. shall estimate the variable consideration and amortize it as revenue over the license period.
b. Franchisor Co. shall estimate the variable consideration, subject the estimate to the “Constraining estimates of
variable consideration” principle of PFRS 15 and amortize it as revenue over the license period.
c. Franchisor Co. shall discount the amount determined in Choice (b) above and amortize it as revenue over the license
period.
d. Franchisor Co. shall recognize revenue equal to 5% of Franchisee’s sales as and when those sales occur.

Problem 2:

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On January 1, 20x1, ABC Co. enters into a franchise contract with a customer to grant the right to open a store in a specified location.
The store will bear ABC Co.’s trade name and the franchisee will have the right to sell ABC’s product for 7 years, starting on the
commencement of operations of the new store. The contract requires the franchisee to pay a ₱1,400,000 non-refundable up-front fee
(initial franchise fee). The franchise contract requires ABC Co. to maintain the brand through product improvements, marketing
campaigns, research and development, and other activities that would strengthen the brand’s marketing position.

The franchisee’s new store started operations on July 1, 20x1.

Requirements: Apply “Steps 2 to 5” of PFRS 15 to identify the following:

a. The performance obligation(s) in the contract. State how the performance obligation(s) are satisfied.
b. The transaction price.
c. Allocation of the transaction price.
d. The recognition of revenue from the contract.
e. Provide all the necessary journal entries in 20x1.

Step 2: Identify the performance obligations in the contract

There is only one performance obligation in the contract, i.e., the promise to grant the license.

Since the promise to grant the license is distinct, the entity shall apply the specific principles to determine whether the license
provides the customer a right to access or a right to use the entity’s intellectual property.

Analysis:
a. The contract requires ABC Co. to undertake activities that significantly affect the intellectual property to which the customer has
rights (i.e., ABC Co. is continually involved in developing further the brand).
b. The customer is exposed to any positive or negative effects of those activities.
c. Those activities do not result in the transfer of a good or a service to the customer as those activities occur.

Conclusion:
The license provides the customer the right to access the entity’s intellectual property as it exists throughout the license period.
Therefore, the performance obligation is satisfied over time.

Step 3: Determine the transaction price

The transaction price is the fixed payment of ₱1,400,000.

Step 4: Allocate the transaction price to the performance obligations

The ₱1,400,000 transaction price is allocated to the single performance obligation of granting the license.

Step 5: Recognize revenue when (or as) a performance obligation is satisfied

Since the performance obligation is satisfied over time, the entity recognizes revenue over the license period by measuring its
progress towards the complete satisfaction of the performance obligation. The entity shall apply the general principles of PFRS 15 to
identify the method that best depicts its performance in the license.

Because the contract provides the customer with unlimited use of the licensed characters for a fixed term (i.e., 7 years), the
most appropriate measure of progress may be a time-based method (i.e., straight-line method).

Journal entries:
Jan. 1, 20x1 Cash on hand 1,400,000
Contract liability 1,400,000
to record the non-refundable initial franchise fee
July 1, 20x1 No entry
Dec. 31, 20x1 Contract liability (1.4M ÷ 7) x 6/12 100,000
Revenue 100,000
to recognize revenue from the franchise

REVIEW QUESTIONS

1. Under IFRS 15, how shall revenue from contracts with customers such as revenue from initial franchise fee be recognized by the
franchisor?
A. Upon receipt of the initial franchise fee by the franchisor.
B. Upon signing of the franchise agreement.
C. When the franchisor satisfies the performance obligation under the franchise agreement.
D. Applying the legality over the substance of the transaction.

2. Under IFRS 15, how many an entity satisfy a performance obligation under in a contract with customers?
A. Satisfaction of performance obligation over time.
B. Satisfaction of performance obligation at a point in time.
C. Either A or B.
D. Neither A nor B.

3. IFRS 15 provides the initial franchise fee shall be recognized as revenue over time (percentage of completion method) if any one
of the following criteria provided below is met. Which of the following indicator shows that the initial franchise fee shall be
recognized as revenue at a point int time instead over time?
A. When the franchisee simultaneously receives and consumes the benefits provided by the franchisor’s performance as the
franchisor performs.
B. When the franchisor’s performance creates or enhances an asset that the franchisee controls as the assets is created or
enhanced.
C. When the franchisor’s performance does not create an asset with alternative use to the franchisor and the franchisor has an
enforceable right to payment for performance completed to date.
D. When the franchisee has legal title to the franchise and has the significant risks and rewards of ownership of the franchise.

4. Under IFRS 15, when shall a franchisor recognize revenue from contingent franchise fee or revenue for a sales-based royalty?
A. When the sales of the franchisee occurs.

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 B. When the performance obligation to which some or all of the contingent franchise fees or sales-based royalty has been
satisfied or partially satisfied.
C. When both A and B events occur.
D. When either A or B event occurs.

5. What is the measurement of franchise revenue recognized from franchise agreement?

A. Fair value of the consideration received or receivable.
B. Book value of the consideration received or receivable.
C. Carrying amount of the consideration received or receivable.
D. Nominal amount of the consideration received or receivable.

PROBLEM: CLASSROOM ACTIVITY

On December 1, 20x1, CANOROUS Co. granted a 5-year franchise right to MELODIOUS, Inc. for an initial franchise fee of ₱400,000.
The non-refundable initial franchise fee was collected in full upon signing of the contract. As of December 31, 20x1, CANOROUS has
no remaining obligation or intent to refund any of the cash received, all of the services pertaining to pre-opening activities to set-up
the contract have been performed and there are no other material conditions or obligations required of CANOROUS under the
franchise agreement.

Case #1: Promise to grant license is not distinct

1. If the promise to grant the franchise right is not distinct, how should CANOROUS account for the transaction?
a. CANOROUS should use only the general principles of PFRS 15 to determine whether the performance obligation is
satisfied over tine or at a point of time.
b. CANOROUS should use the general principles of PFRS 15 first then the specific principles to determine whether the
grant of license provides the customer the right to access or the right to use the intellectual property granted.
c. CANOROUS should use only the specific principles of PFRS 15.
d. CANOROUS should use the old GAAP (FAS No. 45). i.e., “substantial performance.”

2. If the promise to grant the franchise right isnot distinct and that the performance obligation is satisfied at a point in time,
how much revenue shall CANOROUS recognize in December 20x1?
a. 400,000 c. 0
b. 80,000 d. None of these

Case #2: Promise to grant license is distinct

3. If the promise to grant the franchise right is distinct, how should CANOROUS account for the transaction?
a. CANOROUS should use only the general principles of PFRS 15 to determine whether the performance obligation is
satisfied over time or at a point in time.
b. CANOROUS should use the general principles of PFRS 15 first then the specific principles to determine whether the
grant of license provides the customer the right to access or the right to use the intellectual property granted.
c. CANOROUS should use only the specific principles of PFRS 15.
d. CANOROUS should use the old GAAP (FAS No. 45). i.e., “substantial performance.”

4. If the promise to grant the franchise right is distinct and that the grant of franchise provides the customer the right of use
the entity’s intellectual property, how much revenue shall CANOROUS recognize in December 20x1?
a. 400,000 c. 0
b. 80,000 d. 6,667.67

5. If the promise to grant the franchise right is distinct and that the grant of franchise provides the customer the right of
access the entity’s intellectual property, how much revenue shall CANOROUS recognize in December 20x1?
c. 400,000 c. 0
d. 80,000 d. 6,667.67

(400,000 ÷ 5) = 80,000 x 1/12 = 6,666.67

Use the following information for the next four (4) questions:

On January 1, 20x20, an entity granted a franchise to a franchisee. The franchise agreement required the franchisee to pay a
nonrefundable upfront fee in the amount of P400,000 and on-going payment of royalties equivalent to 5% of the sales of the
franchisee. The franchisee paid the nonrefundable upfront fee on January 1, 20x20.

In relation to the nonrefundable upfront fee, the franchise agreement required the entity to render the following performance
obligations:
• To construct the franchisee’s stall with stand-alone selling price of P200,000.
• To deliver 10,000 units of raw materials to the franchisee with stand-alone selling price of P250,000.
• To allow the franchisee to use the entity tradename for a period of 10 years starting January 1, 20x20 with stand-alone selling
price of P50,000.

On June 30, 20x20, the entity completed the construction of the franchisee’s stall. On December 31, 20x20, the entity was able to
deliver 3,000 units of raw materials to the franchisee. For the year ended December 31, 20x20, the franchisee reported sales revenue
amounting to P100,000.

The entity had determined that the performance obligation are separate and distinct from one another.

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1. What is the amount of nonrefundable upfront fee to be allocated to the construction of the franchisee’s stall?
A. P200,000 B. P160,000 C. P250,000 D. P120,000

Allocated revenue to construction of stall (400,000 x 200,000/500,000) 160,000

2. What is the amount of revenue to be recognized in relation to the use of delivery of raw materials for the year ended December
31, 20x20?
A. P100,000 B. P200,000 C. P60,000 D. P75,000

Revenue from delivery of raw materials

(400,000 x 250,000 / 500,000) x 3,000/10,000) 60,000

3. What is the amount of revenue to be recognized in relation to the use of entity’s tradename for the year ended December 31,
20x20?
A. P5,000 B. P4,000 C. P50,000 D. P10,000

Revenue from use of entity's trade name

(400,000 x 50,000 / 500,000) / 10 years 4,000

4. What is the total revenue to be recognized by the entity for the year ended December 31, 20x20?
A. P229,000 B. P220,000 C. P285,000 D. P224,000

Revenue from construction of stall 160,000

Revenue from delivery of raw materials 60,000
Revenue from the use of entity's trade name 4,000
Revenue from contingent franchise fee (100,000 x 5%) 5,000
Total Revenue 229,000

QUESTIONS AND ANSWERS

1. An entity, a creator of comic strips, licenses the use of the images and names of its comic strip characters in three of its
comic strips to a customer for a four-system term. There are main characters involved in each of the comic strips. However,
newly created characters appear regularly and the images of the characters evolve over time. The customer, an operator of
cruise ship, can use entity’s characters in various ways, such as in shows or parades, within reasonable guidelines. The
contract requires the customer to use the latest images of the characters. In exchange for granting the license, the entity
receives a fixed payment of CU1 million in each year of the four-year term. (IFRS 15: IE299-302)

Requirements: Apply “Steps 2 to 5” of PFRS 15 to identify the following:

a. What is (are) the performance obligation(s) in the contract?
b. Does the license provide the customer the right to access or the right to use the entity’s intellectual property?
c. Is (Are) the performance obligation(s) in the contract satisfied over time or at a point in time?
d. How shall the entity recognize revenue form the contract?

1. Solutions:

Requirement (a):
Step 2: Identify the performance obligations in the contract
There is only one performance obligation in the contract, i.e., the promise to grant the license.

The additional activities associated with the license (i.e., the creation of new characters and the changes to the images of the
characters) do not directly transfer a good or service to the customer because they are part of the entity’s promise to grant a license
and, in effect, change the intellectual property to which the customer has rights.

Since the promise to grant the license is distinct, the entity shall apply the specific principles to determine whether the license
provides the customer a right to access or a right to use the entity’s intellectual property.

Analyses:
The problem states the following:
a. “However, newly created characters appear regularly and the images of the characters evolve over time.”
b. “The contract requires the customer to use the latest images of the characters.”

From the above statements, we can infer that the intellectual property to which the customer has rights changes throughout the
license period. This is because new characters are continually created and that the images of the characters are continually changed.
Also, the contract requires the customer to use the latest images of the characters.

Requirements (b) and (c):

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Accordingly, the license provides the customer the right to access the entity’s intellectual property as it exists throughout the license
period. Therefore, the performance obligation is satisfied over time.

Moreover, the following criteria under PFRS 15 are met:

a. The customer reasonably expects (arising from the entity’s customary business practices) that the entity will undertake activities
that will affect the intellectual property to which the customer has rights (i.e., the characters). Those activities include
development of the characters and the publishing of a weekly comic strip that includes the characters.
b. The rights granted by the license directly expose the customer to any positive or negative effects of the entity’s activities because
the contract requires the customer to use the latest characters.
c. Even though the customer may benefit from those activities through the rights granted by the license, they do not transfer a good
or service to the customer as those activities occur.

Requirement (d):
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
Since the performance obligation is satisfied over time, the entity recognizes revenue over the license period by measuring its
progress towards the complete satisfaction of the performance obligation. The entity shall apply the general principles of PFRS 15 to
identify the method that best depicts its performance in the license.

Because the contract provides the customer with unlimited use of the licensed characters for a fixed term (i.e., 4 years), the
most appropriate measure of progress may be a time-based method.

2. An entity, a movie distribution company, licenses Movie XYZ to a customer. The customer, an operator of cinemas, has the
right to show the movie in its cinemas for six weeks. In exchange for providing the license, the entity will receive a portion of
the operator’s ticket sales for Movie XYZ. (IFRS 15: IE307-308)

Requirements:
a. (Step 2) Identity the performance obligation(s) in the contract.
b. (Step 3) Determine whether the transaction price is a fixed consideration or a variable consideration.
c. (Step 4) Determine how the transaction is allocated to the performance obligations in the contract.
d. (Step 5) State how the entity recognizes revenue from the contract.

2. Solutions:
Requirement (a):
The only performance obligation in the contract is the promise to grant the license.

Requirement (b):
The transaction price includes a variable consideration (i.e., sales-based royalty).

Requirement (c):
The transaction price allocated to the single performance obligation of granting the license.

Requirement (d):
Regardless of whether the license provides the customer the right to access or the right to use the entity’s intellectual property, the
entity recognizes revenue as and when the ticket sales occur.

This is because the consideration for the license is a sales-based royalty and the entity has already transferred the license to the
movie to which the sales-based royalty relates.

3. On January 1, 20x1, Pongcuter Co. enters into a contract with a customer to grant a software license for ₱1,000,000. The fee
is payable at contract inception. The license has a term of four years, to reckon from the date the customer can use the
software. The customer can determine how and when to use the right without further performance by Pongcuter Co. and
does not expect that Pongcuter Co. will undertake any activities that significantly affect the intellectual property to which the
customer has rights. The software is transferred to the customer on February 1, 20x1. However, the code, which is necessary
for the customer to use the software, is transferred only on April 1, 20x1.

Requirements: Apply “Steps 2 to 5” of PFRS 15 to identify the following:

a. The performance obligation(s) in the contract.
i. Does the license provide the customer the right to access or the right to use the entity’s intellectual property?
ii. Is (Are) the performance obligation(s) in the contract satisfied over time or at a point in time?
b. The transaction price.
c. Allocation of transaction price.
d. The recognition of revenue from the contract.
e. Provide the journal entries.

3. Solutions:
Requirement (a):
Step 2: Identify the performance obligations in the contract
There is only one performance obligation in the contract, i.e., the promise to grant the license.

Since the promise to grant the license is distinct, the entity shall apply the specific principles to determine whether the license
provides the customer a right to access or a right to use the entity’s intellectual property.

Analyses:
The problem states that “The customer can determine how and when to use the right without further performance by Pongcuter Co.
and does not expect that Pongcuter Co. will undertake any activities that significantly affect the intellectual property to which the
customer has rights.”

From the statement above, it can be inferred that the intellectual property to which the customer has rights will not change because
the entity does not undertake activities that significantly affect the intellectual property to which the customer has rights.

Requirement (a.i):

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Therefore, the nature of the entity’s promise in transferring the license is to provide a right to use the entity’s intellectual property in
the form and the functionality with which it exists at the point in time that it is granted to the customer.

Requirement (a.ii):
Consequently, the license is a performance obligation satisfied at a point in time.

Requirement (b):
Step 3: Determine the transaction price
The transaction price is the fixed fee of ₱1,000,000.

Requirement (c):
Step 4: Allocate the transaction price to the performance obligations
The ₱1,000,000 transaction price is allocated to the single performance obligation of granting the license.

Requirement (d):
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
Pongcuter Co. recognizes the ₱1,000,000 fee as revenue on April 1, 20x1 when the customer has the ability to use the software.

Requirement (e):
Jan. 1, 20x1 Cash on hand 1,000,000
Contract liability 1,000,000

Feb. 1, 20x1 No entry

Apr. 1, 20x1 Contract liability 1,000,000
Revenue 1,000,000

4. On January 1, 20x1, ABC Co. enters into a contract with a customer to transfer a license.
• The initial franchise fee is ₱100,000 payable as follows: 20% cash down payment upon signing of the contract and the
balances is payable in 4 equal annual installments starting December 31, 20x1. The appropriate discount rate is 12%.
• The contract also requires ABC Co. to transfer equipment to the customer. The equipment has a cost of ₱30,000 and a stand-
alone selling price of ₱40,000.
• The license has a stand-alone selling price of ₱38,000.
• ABC Co. regularly sells the license and the equipment separately.
• The license provides the customer the right to use the entity’s intellectual property as it exists at the point in time at which
the license is granted.
• The equipment is transferred to the customer on January 15, 20x1 while the license is transferred to the customer on
February 1, 20x1.

Requirements: Apply “Steps 2 to 5” of PFRS 15 to identify the following:

a. The performance obligation(s) in the contract. State how the performance obligation(s) are satisfied.
b. The transaction price.
c. Allocation of transaction price.
d. The recognition of revenue from the contract.
e. Provide the necessary journal entries in January and February 20x1

4. Solutions:

Step 2: Identify the performance obligations in the contract

The promise to grant the license and the promise to transfer the equipment are distinct because:
a. The customer can benefit from each promise on their own or together with other resources that are readily available. (That is, the
customer can benefit from the license together with the equipment that is delivered before the opening of the franchise and the
equipment can be used in the franchise or sold for an amount other than scrap value.)
b. The license and equipment are separately identifiable.

Moreover, the fact that ABC Co. regularly sells the license and the equipment separately indicates that a customer can benefit from
each of the license and the equipment on its own or with other readily available resources.

Conclusion:
There are two separate performance obligations in the contract:
1. License; and
2. Equipment.

 Since the license is distinct,the entity applies the specific principles to determine whether the license provides the customer the
right to access or the right to use the entity’s intellectual property.

The problems states that the license provides the customer the right to use the entity’s intellectual property as it exists at the point
in time at which the license is granted. Therefore, the performance obligation of transferring the license is satisfied at a point in
time.

 ABC Co. uses the general principles to identify whether the performance obligation of transferring the equipment is satisfied over
time or at a point in time.

Since control over the equipment transfers to the customer upon delivery, the performance obligation is also satisfied at a point in
time.

Summary of answers to Requirement (a):

The two separate performance obligations in the contract are as follows:
1. License (satisfied at a point in time)
2. Equipment (satisfied at a point in time)

Requirement (b):
Step 3: Determine the transaction price

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The transaction price is sum of the 20% cash down payment and the present value of the future cash flows from the note receivable.
This is computed as follows:

Cash down payment (100,000 x 20%) 20,000

PV of note receivable:
[(100K x 80%) ÷ 4] x PV of ordinary annuity @12%, n=4 60,747
Transaction price 80,747

Requirement (c):
Step 4: Allocate the transaction price to the performance obligations
The transaction price is allocated to the performance obligations in the contract on the basis of their stand-alone selling prices. The
allocation is done as follows:

Performance obligations Stand-alone selling prices Allocation Transaction price

License 38,000 (80,747 x 38K/78K) 39,338
Equipment 40,000 (80,747 x 40K/78K) 41,409
Totals 78,000 80,747

Requirement (d):
Step 5: Recognize revenue when (or as) a performance obligation is satisfied
The ₱41,409 allocated to the equipment will be recognized as revenue on January 15, 20x1 while the ₱39,338 allocated to the license
will be recognized as revenue on February 1, 20x1.

Requirement (e):

The entry on January 1, 20x1 is as follows:

Jan. 1, 20x1 Cash on hand 20,000
Note receivable 80,000
Contract liability 80,747
Unearned interest income 19,253

Jan. 15, 20x1 Contract liability 41,409

Revenue 41,409

Jan. 15, 20x1 Cost of sales 30,000

Inventory 30,000

Don’t forget the journal entry to record amortization:

Dr. Unearned interest income
Cr. Interest income (PV notes x %)

The entry on March 1, 20x1 is as follows:

Feb. 1, 20x1 Contract liability 39,338
Revenue 39,338

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