Question

Trans Fat Express, Inc. entered an agreement with a franchisee on July 1, 2019. The agreement specified that Trans Fat Express receive an initial franchise fee of $400,000 (30% due at signing; the balance to be paid in equal annual installments plus interest at 8% of the unpaid balance beginning July 1, 2020). The $400,000 franchise fee is comprised of (1) consideration for the right to operate the franchise, and (2) payment for services to be performed by Trans Fat Express that include site selection and building design, employee training, and management training. Performance of these services occurs evenly from July 1 to the date when the franchise opens for business on March 1, 2020. All required services are deemed to have occurred by then. Trans Fat Express allocates 60% of the fee to the right to operate the franchise and the remainder to the services performed. Ignore interest income in the following.

Required:

1. How much revenue does Trans Fat Express, Inc. recognize in 2019?
2. How much revenue does Trans Fat Express, Inc. recognize in 2020?

Answer 1

Fees for right to operate is 60% of total fees i.e. 4,00,000* 60% which is equal fo 2,40,000 and as per FASB, revenue for initial licence for franchise should be offered to tax in first year itself. The balance amounting to 1,60,000 relates to services fo be provided during 1 July 2019 to 1 March 2020 (during 244 days).

Revenue for 2019

licence fees - 2,40,000

fees for services during 1.7.2019 to 31.12.2019= 184 /244* 160000=120656

total revenue for 2019 is 360656

revenue for 2020 includes only services fees which is pro rata for 1.1.2020 to 1.3.2020 i.e 60/244 *160000=39344