Question

Franchise Fee, Initial Down Payment) On January 1, 2017, Lesley Benjamin signed an agreement, covering 5 years, to operate as a franchisee of Campbell Inc. for an initial franchise fee of \(50,000. The amount of \)10,000 was paid when the agreement was signed, and the balance is payable in five annual payments of \(8,000 each, beginning January 1, 2018. The agreement provides that the down payment is nonrefundable and that no future services are required of the franchisor once the franchise commences operations on April 1, 2017. Lesley Benjamin’s credit rating indicates that she can borrow money at 11% for a loan of this type.

Instructions

(a) Prepare journal entries for Campbell for 2017-related revenue for this franchise arrangement.

(b) Prepare journal entries for Campbell for 2017-related revenue for this franchise arrangement, assuming that in addition to the franchise rights, Campbell also provides 1 year of operational consulting and training services, beginning on the signing date. These services have a value of \)3,600.

(c) Repeat the requirements for part (a), assuming that Campbell must provide services to Benjamin throughout the franchise period to maintain the franchise value.

Short answer

Franchise revenue = $39,567.

Step-by-step solution

Franchise Agreement

The franchisor authorizes the franchisee to operate a company, market, or distribute products or services that are similar to or linked to the franchisor's trademark. In exchange, the franchisee provides one-time or periodic payments to the franchisor in accordance with the franchise agreement's amount, terms, and conditions.

Journal entries for Campbell for 2017

Date	Particular	Debit ($)	Credit ($)
January 1, 2017	Cash a/c	10,000
	Note receivable a/c	40,000
	Discount on note receivable a/c		10,433
	Unearned franchise fee a/c		39,567
April 1, 2017	Unearned franchise revenue a/c	39,567
	Franchise revenue a/c		39,567
December 31, 2017	Discount on notes receivable	3,252
	Interest revenue a/c		3,252

Working Notes:

$\begin{array}{rcl}\mathrm{Notes}\mathrm{Receivables}& =& \mathrm{Annual}\mathrm{payment}\times 5\mathrm{Years}\\ & =& \$8,000\times 5\\ & =& \$40,000\end{array}$

Present value of installment at 11% for 4 years

$\begin{array}{rcl}\mathrm{Unearned}\mathrm{franchise}\mathrm{fees}& =& (\mathrm{Annual}\mathrm{payment}\times \mathrm{Present}\mathrm{value}\mathrm{of}\mathrm{installment}\mathrm{at}11\%\mathrm{for}4\mathrm{years})+\mathrm{Down}\mathrm{payment}\\ & =& (\$8,000\times 3.6959)+\$10,000\\ & =& \$29,567+\$10,000\\ & =& \$39,567\end{array}$

role="math" localid="1648628169331" $\begin{array}{rcl}\mathrm{Discount}\mathrm{on}\mathrm{notes}\mathrm{recevable}& =& \mathrm{Franchise}\mathrm{Fees}-\mathrm{Unearned}\mathrm{franchise}\mathrm{fees}\\ & =& \$50,000-\$39,567\\ & =& \$10,433\end{array}$

$\begin{array}{rcl}\mathrm{Interest}\mathrm{Revenue}& =& (5\mathrm{years}\mathrm{annual}\mathrm{payment}-\mathrm{Discount}\mathrm{on}\mathrm{notes}\mathrm{receivables})\times \mathrm{Interest}\mathrm{rate}\\ & =& (\$40,000-\$10,433)\times 11\%\\ & =& \$3,252\end{array}$