Final answer:
Costs that can be capitalized as an intangible asset for a franchise include the initial payment for the rights to operate the franchise, legal costs for drawing up the franchise agreement, and interest on a note payable until the franchise is ready to open for business. Correct answer is option 1.
Step-by-step explanation:
When a business acquires a franchise, certain costs are capitalized as intangible assets. The costs that are capitalized must provide economic benefits to the franchisee for more than one year. Generally, initial payments for a franchise can be capitalized because they are often large sums paid for the rights to operate the franchise for an extended period. This would include the franchise fee as well as any other upfront payments required to acquire the franchise rights.
Legal costs associated with drawing up the franchise agreement are also typically capitalized. These are one-time costs that are directly associated with the negotiation and securing of the franchise, and they provide a benefit over the life of the agreement.
Interest on a note payable to purchase the franchise is a bit more complex. Generally, interest is considered a borrowing cost and can be capitalized during the period required to bring the asset to the condition for its intended use. In the case of a franchise, this would mean that interest can be capitalized up until the point the franchise is ready to open for business.
However, periodic payments for services by the franchisor, such as ongoing royalty fees or marketing contributions, are not capitalized. These payments are considered operating expenses and should be expensed as incurred. They are not part of the initial franchise purchase and do not provide a benefit extending beyond the current period in which they are paid.