Franchising offers potential business owners an opportunity to start a business using a proven business model and reputable name. Franchisees purchase the business model and pay ongoing fees to the franchisor. The franchisor often offers training and additional resources to the franchisee.
Most franchise agreements require an upfront payment by the franchisee in order to enter the contract and open up for business. In return for this payment, the franchisee receives franchise rights, signage, consultation or business training. The franchisee cannot expense the initial franchise fee at one time and must capitalize this amount as Initial Franchise Fees. The franchisee needs to determine the useful life for which the initial fees apply and amortize the amount over this period. The accountant debits Initial Franchise Fees and credits Cash for the amount to capitalize. Every period, the franchisee amortizes a portion of the initial franchise fee by debiting Franchise Amortization Expense and crediting Initial Franchise Fees for the amount to be amortized.
Many franchises require regular payments or royalty payments for the use of the franchise name and resources. Resources provided by the franchisor include updated marketing information, ongoing training opportunities or national advertising. These amounts become expenses when incurred. The franchisee records these payments in the accounting records by debiting Franchise Fees and crediting Cash every time a payment is made.
The balance sheet lists all of the asset, liability and equity balances for the company. The total assets equal the total of the liability accounts plus the equity accounts. Initial Franchise Fees are recorded as a noncurrent asset and are listed on the balance sheet. Cash is an asset. The initial franchise fee and the continuing franchise fees reduce the company’s cash balance.
The income statement lists revenues, subtracts expenses and determines net income. Franchise Amortization Expense and Franchise Fees are both expenses. The income statement subtracts both of these expenses from the company’s revenues to determine the company’s net income.