Franchise fees received

Franchise arrangements bundle several distinct promises (initial licence/access rights, training and set-up support, and ongoing use of the brand funded by royalties), and IFRS 15 requires the franchisor to identify each performance obligation and recognize revenue only as control transfers, not on the date the joining fee is invoiced or cash is collected. Recognizing the full upfront fee immediately overstates current-period revenue and understates future-period revenue tied to the franchisor's ongoing obligation to maintain the brand and system over the licence term. Sales-based royalties are subject to a specific recognition constraint (the sales-based royalty exception) that overrides the general variable consideration guidance, so they cannot be estimated and accrued in advance of the underlying franchisee sales occurring. Getting this wrong distorts KPIs used by investors and lenders to assess franchise network growth versus recurring royalty income, and is a common area of restatement risk in franchisor financial statements.

Does the upfront franchise fee relate to a distinct pre-opening service (site selection, training) that is satisfied separately, or mainly to access the brand and system over the franchise term? Are ongoing royalties based on the franchisee's sales, triggering the sales-based royalty exception (recognized as the underlying sales occur, not on receipt)? Is the standalone selling price used to allocate the upfront fee supportable?

1. Identify all distinct promises in the franchise agreement: the licence to use the brand/system over the contract term, initial training/site set-up services, and the ongoing royalty-generating right to access the brand.
2. Assess whether the initial franchise licence is a right to access (recognized over time) or a right to use (recognized at a point in time); in practice most franchise brand licences are rights to access because the franchisor continues to update the system/brand, so revenue is recognized over the licence term.
3. Separate any distinct pre-opening services (e.g., site-specific training, equipment set-up supervision) that are capable of being distinct and are distinct in the context of the contract; recognize revenue for these as the services are delivered.
4. Allocate the upfront fee to each identified performance obligation based on relative standalone selling price; do not default to recognizing the entire fee on signing or on store opening.
5. For sales-based (or usage-based) royalties tied to a licence of intellectual property, apply the sales-based royalty exception: recognize royalty revenue only when (or as) the underlying franchisee sales occur, even if the licence portion is otherwise recognized over time.
6. Reassess at contract modification (e.g., territory expansion, renewal, fee renegotiation) whether the modification is a separate contract or a change to the existing one.

Measure the transaction price as the upfront fixed fee plus estimated variable consideration only where not subject to the sales-based royalty exception. Allocate the fixed upfront fee to distinct obligations using relative standalone selling prices (estimated via adjusted market assessment, expected cost-plus-margin, or residual approach where appropriate, since franchise licences rarely have an observable standalone price). The portion allocated to the over-time licence is recognized on a systematic basis (typically straight-line) over the licence term unless another method better depicts the pattern of the franchisor's performance. Royalty revenue is measured at the percentage rate applied to actual reported franchisee sales for the period, not an estimate accrued in advance. Any contract asset/liability arising from timing differences between invoicing and recognition is subsequently measured at the unrecognized transaction price balance, with contract liabilities released as the licence service is performed.

Disaggregation of revenue between upfront/licence revenue and royalty revenue; contract liability balance for unearned franchise fees presented separately, with opening/closing reconciliation; amount of revenue recognized in the period that was included in the opening contract liability balance; significant judgments used to determine standalone selling prices and the allocation method; description of performance obligations (licence term, training, ongoing brand support) and typical timing of satisfaction; description of the sales-based royalty exception applied to variable consideration; remaining performance obligations disclosure (aggregate transaction price allocated to unsatisfied obligations and expected recognition timing), noting the royalty exemption from this disclosure where applicable

• Recognizing the entire upfront joining fee as revenue on the signing date or store opening date instead of allocating and deferring it
• treating training/set-up services as part of the licence instead of assessing them as a potentially distinct performance obligation
• accruing estimated royalty revenue in advance of franchisee sales actually occurring, in breach of the sales-based royalty exception
• using an arbitrary or unsupported standalone selling price allocation instead of a defensible estimation method
• failing to reassess the contract liability release pattern when franchise terms are renewed or renegotiated
• omitting remaining performance obligation and contract liability roll-forward disclosures