Chapter 5, Problem 5.19P

Franchise sales; installment sales method

Olive Branch Restaurant Corporation sells franchises throughout the western states. On January 30, 2018, the company entered into the following franchise agreement with Jim and Tammy Masters:

1. 1. The initial franchise fee is $1.2 million. $200,000 is payable immediately and the remainder is due in ten, $100,000 installments plus 10% interest on the unpaid balance each January 30, beginning January 30, 2019. The 10% interest rate is an appropriate market rate.
2. 2. In addition to allowing the franchisee to use the franchise name for the 10-year term of the agreement, in exchange for the initial fee Olive Branch agrees to assist the franchisee in selecting a location, obtaining financing, designing and constructing the restaurant building, and training employees.
3. 3. All of the initial down payment of $200,000 is to be refunded by Olive Branch and the remaining obligation canceled if, for any reason, the franchisee fails to open the franchise.
4. 4. In addition to the initial franchise fee, the franchisee is required to pay a monthly fee of 3% of franchise sales for advertising, promotion, menu planning, and other continuing services to be provided by Olive Branch over the life of the agreement. This fee is payable on the 10th of the following month. Substantial performance of the initial services provided by Olive Branch, which are significant, is deemed to have occurred when the franchise opened on September 1, 2018. Franchise sales for the month of September 2018 were $40,000.

Required:

1. 1. Assuming that collectibility of the installment receivable is reasonably certain, prepare the necessary journal entries for Olive Branch on the following dates (ignore interest charges on the installment receivable and the costs of providing franchise services):
   1. a. January 30, 2018
   2. b. September 1, 2018
   3. c. September 30, 2018
   4. d. January 30, 2019
2. 2. Assume that significant uncertainty exists as to the collection of the installment receivable and that Olive Branch elects to recognize initial franchise fee revenue using the installment sales method. Prepare the necessary journal entries for the dates listed in requirement 1 (ignore interest charges on the installment receivable and the costs of providing franchise services).
3. 3. Examine your answer to requirement 1a of this problem (the January 30, 2018, journal entry under the installment sales method). What is the effect of that journal entry on Olive Branch’s balance sheet? (Ignore cash.) Briefly explain your answer.