Many entrepreneurs consider a variety of businesses before deciding on the best fit for themselves. They might consider developing a new business idea on their own, giving them the freedom to build the business independently. They may purchase an existing business with a current business operation. Or they might invest in a franchise using materials provided by the franchisor.
A franchise business refers to a business model designed by one company, the franchisor. The franchisor provides information regarding the business model, business training, advice or equipment to the entrepreneur, or franchisee. The franchisee uses the ready-made materials to open the business, create the product and sell to the public. Franchisees typically pay the franchisor to purchase the right to operate in a specific area, the right to use the franchise name and the materials provided. Franchisees may also pay royalties and franchise fees to the franchisor.
Franchisees use various accounts when accounting for the business. These include franchise fee expense, franchise royalties and goodwill. Franchise fee expense refers to the money invested to purchase the right to use the franchise name, materials and service provided by the franchisor. Franchise royalties refer to money paid to the franchisor each year in exchange for the continued use of the franchise name. Goodwill refers to the money paid to open the business in excess of the combined value of the assets.
The company calculates the value of goodwill after determining the value of each asset recorded in the financial records. The entrepreneur subtracts the total of all the assets from the total amount paid to start up the business. She records this difference as goodwill. Goodwill is an intangible asset which remains on the company’s financial records until the entrepreneur determines it no longer maintains the same value. This is called impairment, and the entrepreneur reduces the value of goodwill in the financial records at that time.
The accounts used to record franchise transactions appear on the income statement and balance sheet. Franchise Fee Expense and Franchise Royalties represent expenses to the company and appear on the income statement. These accounts reduce the company’s net income. As an intangible asset, Goodwill appears on the balance sheet and increases the total asset balance.