Reference no: EM132963376

Question - Tom Pizza, Inc. charges an initial franchise fee of 50,000 for the right to operate as a franchisee of Tom's Pizza. Of this amount, 10,000 is payable when the agreement is signed and the balance is payable in five annual payments of 8,000. In return for the initial franchise fee the franchisor will help in locating the site, negotiate the lease or purchase of the site, supervise the construction activity, and provide the bookkeeping services. The credit rating of the franchisee indicates that money can be borrowed at 8%. The PV of an ordinary annuity of five annual receipts of 8,000 each discounted at 8% is 31,941.68.

Requirements -

I. Profit recognition entries at year-end on the initial franchise fees under each of the following;

Compute for the net income in 2020:

a. If there is reasonable expectation that the down payment may be refunded and if substantial future services remain to be performed by Tom Pizza Inc.

b. If the probability of refunding the initial franchise fee is extremely low, the amount of future services to be provided to the franchisee is minimal, collectibility of the note is reasonably assured, and substantial performance has occurred.

c. If the initial down payment is not refundable, represents a fair measure of the services already provided, with a significant amount of services still to be performed by the franchisor in future periods and collectibility of the note is reasonably assured.

d. Collectibility of the note for the initial fee is reasonably assured and substantial performance by the franchisor has occurred. If after the initial franchise fee is paid, the franchisee has the right to purchase up to 20,000 supplies at their cost of 15,000.

e. If the initial down payment is not refundable and no future services are required by the franchisor, but the collection of the note is so uncertain that recognition of the note as an asset is unwarranted.

f. Under the same conditions as those listed under (d) except that the down payment is refundable or substantial services are yet to be performed.

II. Profit recognition entries assuming that Tom Pizza, Inc. charges a continuing franchise fee of 4,200 monthly for services rendered during the year. Compute for the net income in 2020

a. If 20% of the continuing franchise fee is designated especially for building maintenance to be provided by the franchisor (with 25% mark-up)

b. If during the year, Tom Pizza, Inc. sells supplies costing 3,000 to the franchisee at the normal 4,000 price.