Under a franchise, an entity promises to grant a license to use its intellectual property to a customer.
In addition to a promise to grant a licence to a customer, an entity may also promise to transfer other goods or services to the customer
If the promise to grant a licence is not distinct from other promised goods or services in the contract in accordance, an entity shall account for the promise to grant a licence and those other promised goods or services together as a single performance obligation.
If the promise to grant the licence is distinct from the other promised goods or services in the contract and, therefore, the promise to grant the licence is a separate performance obligation, an entity shall determine whether the licence transfers to a customer either at a point in time or over time.
Determining the nature of the entity’s promise
To determine whether an entity’s promise to grant a licence provides a customer with either a right to access an entity’s intellectual property or a right to use an entity’s intellectual property, an entity shall consider whether a customer can direct the use of, and obtain substantially all of the remaining benefits from, a licence at the point in time at which the licence is granted.
The nature of an entity’s promise in granting a licence is a promise to provide a right to access the entity’s intellectual property if all of the following criteria are met:
(a) the contract requires, or the customer reasonably expects, that the entity will undertake activities that significantly affect the intellectual property to which the customer has rights;
(b) the rights granted by the licence directly expose the customer to any positive or negative effects of the entity’s activities; and
(c) those activities do not result in the transfer of a good or a service to the customer as those activities occur.
If the criteria are met, an entity shall account for the promise to grant a licence as a performance obligation satisfied over time because the customer will simultaneously receive and consume the benefit from the entity’s performance of providing access to its intellectual property as the performance occurs.
If the criteria are not met, an entity shall account for the promise to provide a right to use the entity’s intellectual property as a performance obligation satisfied at a point in time.
Sales-based or usage-based royalties
An entity shall recognise revenue for a sales-based or usage-based royalty promised in exchange for a licence of intellectual property only when (or as) the later of the following events occurs:
(a) the subsequent sale or usage occurs; and
(b) the performance obligation to which some or all of the sales-based or usage-based royalty has been allocated has been satisfied (or partially satisfied).
Example A
An entity enters into a contract with a customer and promises to grant a franchise licence that provides the customer with the right to use the entity’s trade name and sell the entity’s products for 10 years. In addition to the licence, the entity also promises to provide the equipment necessary to operate a franchise store. In exchange for granting the licence, the entity receives a sales-based royalty of five per cent of the customer’s monthly sales. The fixed consideration for the equipment is CU150,000 payable when the equipment is delivered.
The entity assesses the goods and services promised to the customer to determine which goods and services are distinct in accordance with paragraph 27 of FRS 115. The entity observes that the entity, as a franchisor, has developed a customary business practice to undertake activities such as analysing the customer’s changing preferences and implementing product improvements, pricing strategies, marketing campaigns and operational efficiencies to support the franchise name. However, the entity concludes that these activities do not directly transfer goods or services to the customer because they are part of the entity’s promise to grant a licence and, in effect, change the intellectual property to which the customer has rights.
The entity determines that it has two promises to transfer goods or services: a promise to grant a licence and a promise to transfer equipment. In addition, the entity concludes that the promise to grant the licence and the promise to transfer the equipment are distinct. This is because the customer can benefit from each promise (ie the promise of the licence and the promise of the equipment) on their own or together with other resources that are readily available (see paragraph 27(a) of FRS 115). (That is, the customer can benefit from the licence together with the equipment that is delivered before the opening of the franchise and the equipment can be used in the franchise or sold for an amount other than scrap value.) The entity also determines that the franchise licence and equipment are separately identifiable, in accordance with the criterion in paragraph 27(b) of FRS 115, because none of the factors in paragraph 29 of FRS 115 are present. Consequently, the entity has two performance obligations:
(a) the franchise licence; and
(b) the equipment.
Allocating the transaction price
The entity determines that the transaction price includes fixed consideration of CU150,000 and variable consideration (five per cent of customer sales).
The entity applies paragraph 85 of FRS 115 to determine whether the variable consideration should be allocated entirely to the performance obligation to transfer the franchise licence. The entity concludes that the variable consideration (ie the sales-based royalty) should be allocated entirely to the franchise licence because the variable consideration relates entirely to the entity’s promise to grant the franchise licence. In addition, the entity observes that allocating CU150,000 to the equipment and the sales-based royalty to the franchise licence would be consistent with an allocation based on the entity’s relative stand-alone selling prices in similar contracts. That is, the stand-alone selling price of the equipment is CU150,000 and the entity regularly licences franchises in exchange for five per cent of customer sales. Consequently, the entity concludes that the variable consideration (ie the sales-based royalty) should be allocated entirely to the performance obligation to grant the franchise licence.
Example B
An entity operates and franchises restaurants around the world. As part of its franchise agreement, the entity requires a franchisee to pay a non-refundable upfront franchise fee of CU95,000 upon opening a restaurant and ongoing payment of royalties, based on a percentage of sales. As part of the franchise agreement, the entity provides pre-opening services, including supply and installation of cooking equipment and cash registers, valued at CU30,000 (i.e., the stand-alone selling price of the pre-opening services). In addition, the franchise agreement includes a licence of IP (i.e., the entity’s trademark and trade name) to the franchisee. Assume that the entity has determined the licence provides a right to access the IP (over time). the entity has determined the stand-alone selling price of the licence is CU70,000. The franchise agreement has a term of 15 years. the entity evaluates the arrangement and determines it meets the criteria to be accounted for as a contract with a customer. the entity determines its pre-opening services and licence of IP are each distinct and, therefore, need to be accounted for as separate performance obligations. the entity recognises CU28,500 [(CU30,000 / CU100,000) × CU95,000] as revenue at the point in time when the performance obligation to supply and install cooking equipment and cash registers is satisfied. the entity will recognise revenue associated with the licensed IP, CU66,500 [(CU70,000 / CU100,000) × CU95,000], rateably over the 15-year licence term (i.e., the period of time the franchisee will have to the right to access the entity’s IP), as the entity determined the licence provided a right to access the IP over the licence term.