Question

Which of the following statements describe the accounting rules for a franchise agreement?

1) Amortize the cost of the franchise over its life.
2) Capitalize the cost of the franchise.
3) Expense the cost of the franchise in the year of acquisition.
4) Capitalize the periodic payments each year.
5) Expense periodic payments as incurred.

Answer 1

The cost of the franchise should be capitalized and amortized over the life of the franchise agreement, while periodic royalty payments should be expensed as incurred.

Step-by-step explanation:

When accounting for a franchise agreement, the general treatment is that you would capitalize the cost of the franchise and then amortize this cost over the life of the franchise agreement, which represents the useful economic life of the franchise to the business. This reflects the enduring benefit the franchisee receives from the franchise. Initially, this means that the franchise fee is recorded on the balance sheet as an intangible asset. The periodic payments made to the franchisor, often in the form of royalty fees, should typically be expensed as they are incurred during the fiscal period and considered operating expenses. This treatment aligns with the matching principle in accounting, whereby expenses are recognized in the period in which the related revenues are earned.