Franchise accounting can be complicated. Not only do you have to take into consideration the initial purchase price, but also the ongoing costs that come with working with a franchisor.
Think of all of the benefits you receive from working with a franchisor. While you are owning your own restaurant, you’re doing so at a much lower risk as the brand and business are already established – complete with marketing, pricing, and products.
And unfortunately, but fairly, as a franchisee you have to pay the franchisor for those low-risk benefits. Let’s explore the different franchise fees that come into play with franchise accounting.
The initial fees are occurred when the franchisee first acquires the franchise. These fees are what gives the franchisee the ability to use the franchisor’s name, brand, trademark, products, and operating systems. Even though it accounts for many smaller startup costs, the initial fees are incurred as one lump sum that the franchisee must pay before owning the restaurant.
Because of the high cost of the initial fees, there is a possibility for franchisees to amortize them. This means that the franchisee is now able to deduct the cost of the initial fee from their business tax return.
Amortization is similar to depreciation, but instead of dealing with a tangible asset, it works with intangible assets. In the case of a franchise, this would include trademarks and operating systems. The costs can be evenly divided over a period of 15 years. If your contract is for less than 15 years, then the fee will just last the length of the contract.
Today, the initial fee for a franchise can run anywhere from $20,000 to $100,000 dollars. Generally, it covers the training costs, recruiting, territory analysis, site identification, and other costs like specialist equipment.
Unlike initial fees which are a one-time cost, royalty fees are an ongoing cost. Typically, these fees are a percentage of your franchises’ gross revenue, but they can also be calculated as a fixed amount. Each franchise has its own requirement for how high the royalty fee percentage will be. As such, they can run anywhere from 5% to 50% of your revenue.
Monthly royalties are how your franchisors make their money. In the franchise restaurant business, it’s not uncommon for a franchise to exceed $1 million in revenue annually. At that level, 5% in royalties would then be $50,000.
Great franchise accounting is so important when it comes to royalty fees. These fees add up fast, and calculating them accurately is important.
When was the last time you saw a franchise restaurant commercial? Whether it’s Arby’s “We’ve got the meat” or McDonald’s “I’m Loving It,” each franchise’s marketing is as unique as the business.
And, now that you’re benefitting from that marketing, you have to pay for it. Many franchises require their franchisees to participate in a marketing program, and as long as it works, it is well worth it. Franchise’s spend fortunes on their marketing, oftentimes to great success. With franchise accounting, you can factor in your marketing fees into your daily budget to assure smooth cash flow.
Similar to royalties, marketing fees are an ongoing cost that franchisees pay for monthly. These fees are a percentage of your revenue, ranging from 1 to 4 percent. Occasionally it will be a fixed contribution.
Franchise accounting can help you figure out exactly what percentage of your revenue you can afford, and how to budget for it.
According to Investopedia, revenue recognition is “a generally accepted accounting principle (GAAP) that determines the specific conditions in which revenue is recognized or accounted for.”
As a franchisee, think of the implications recognized revenue can have on the other fees that you incur. If recognized incorrectly, your marketing and royalty fees could all go up, costing you thousands yearly. A good franchise accountant with a firm understanding of revenue recognition can help you avoid that.
Revenue recognition is a little more complicated than marketing, royalty, or initial fees. Before 2014, Generally Accepted Accounting Principles (GAAP) were broadly written, allowing franchise accountants to interpret them. But the Financial Accounting Standards Board (FASB) issued a new standard that wasn’t open to interpretation and converged GAAP and International Financial Reporting Standards (IFRS).
Today revenue recognition for franchise accounting looks very different. It consists of five steps to recognize when revenue is allocated.
These five steps include:
- Franchisor identifies contract with a customer (i.e. franchisee)
- Performance obligations are set within the contract
- Transaction price is determined, including franchise and any equipment fees.
- Allocate transaction price to each performance obligation
- Revenue is recognized as each performance obligation is fulfilled.
As revenue recognition continues to change over the years, make sure you pick franchise accounting services that are ready for the future and up-to-date on the latest changes with revenue recognition.
Know Where You Stand.
Franchise accounting can very quickly become complicated and have lasting effects on the other fees that you incur during your time as a franchise. If your revenue is recognized improperly or at the wrong time, you could be incurring expenses that you don’t have the money to pay for. It’s not uncommon to struggle with having funds in your account at the right time.
When you work with GSS, you don’t have to worry about franchise accounting mistakes that could put your company at risk. Outsource accounting services to make restaurant processes more efficient and affordable and get the expert-level insight your business needs to grow.
Don’t wait. Move your business forward.
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With GSS, we meet our franchisor requirements on time and with accuracy. The local CPA could not handle our volume. We are so happy to have made the change. GSS knows our business and our franchisor requirements.Multi-unit fast sandwich Owner