Question Tag: Franchise

Unity Link Ltd (ULL) has enjoyed a significant market share in the southern part of Ghana over the years. However, ULL has suffered liquidity challenges due to the effects of the pandemic lockdown and its subsequent restrictions. ULL’s main source of income, dealings in luxury goods, has reduced significantly because customers have shifted their demand to necessities of life.

The following transactions were undertaken by ULL:

a) ULL has entered into a contract to sell one of their gold refinery equipment on 31 January 2023 and immediately lease it back. The Finance Director, in consultation with the Finance Manager, has decided to classify this transaction as a non-current asset “held for sale” in its financial statements for the year ended 31 December 2022 as he rates this transaction as highly probable. The market value for the gold refinery equipment has not changed in many years and is unlikely to change in the foreseeable future. The contract states that the gold refinery equipment should be disposed of at its fair value of GH¢6 million and for ULL to lease it back over a period of 10 years. It is estimated that GH¢400,000 is needed to refurbish the gold refinery equipment and there is no legal requirement to do so. ULL has in error treated this amount as a reduction of the asset’s carrying amount at 31 December 2022, and the corresponding debit has been made to profit or loss. The gold refinery equipment is depreciated at 5% per annum using the reducing balance method, and at 31 December 2022, the carrying amount after depreciation and deduction of the proposed cost of refurbishment is GH¢3.6 million. (7 marks)

b) ULL has established a chain of business franchise. This franchise was obtained from a foreign company. In this arrangement, dealers in luxury items, especially refined gold, obtain a franchise under a brand name “Lockhert” from ULL to sell its own refined gold. The budgeted costs of obtaining a franchise from a foreign company are based on the estimated revenues from the franchise given out to local companies. These costs of obtaining a franchise are then capitalised as an intangible asset and called “Franchise cost.” The Finance Director is convinced that the franchise is consumed as Franchisees produce their own refined gold. ULL currently amortises the franchise based on estimated future revenues from the franchise. For example, the franchise is estimated to generate GH¢1.6 million of revenue in total, and GH¢800,000 of that revenue will be generated in year one. The intangible asset will be amortised by 50% in year one. However, industry practice is to amortise the capitalised cost less its recoverable amount over its remaining useful life. (6 marks)

c) ULL’s franchise registration fee, which is separate from the franchise fee, is treated as an intangible asset and is initially recognised at the fair value of the consideration paid for the registration. Subsequent franchise fees, which are paid yearly, are subject to negotiation. The franchise contract has embedded contingent performance conditions where a franchisee may be paid a bonus based on an increase in sales. This bonus is an additional contract cost. ULL has reasoned that the only way to determine the value-in-use of the cost of the franchise is when a new customer takes over from an existing one who is prepared to sell his franchise. This treatment is what prevails in the industry. (7 marks)

Required:

In accordance with International Financial Reporting Standards, discuss the appropriate accounting treatment of the above transactions in the financial statements of ULL.