Franchises have some special accounting needs. Both the franchisor and franchisee need to understand the basics of accounting, but also their unique circumstances.
One aspect of franchise accounting is routine audits and inspections. The franchisor needs to know that the franchisee is running a solid business and doing their best by their brand. The public often blame the franchisor for the franchisee’s errors.
Here are some special considerations:
The franchisee pays fees to the franchisor. These vary depending on the specific agreement, but include an initial fee and royalty fees. You have to “amortize” the initial fee, that is spread the tax deduction over the length of the contract or 15 years, whichever is shorter. This fee, however, includes the start-up costs, such as training provided by the franchisor, branded equipment, etc.
Royalties are typically a percentage of gross sales paid every month, quarter, or year, often with a minimum amount. There may also be contributions to a marketing fund. In return for the fees, the franchisee gets to use the franchisor’s brands, trademarks, and reputation. McDonald’s, for example, is a franchise-based system, but all McDonald’s still look and feel the same.
Royalty audits are typically conducted every year or two. These audits make sure the franchisee is paying the right amount in royalties, and thus are primarily in the interest of franchisors. Permission is included in the franchise agreement. The audit is paid for by the franchisor, but the agreement may shift costs to the franchisee if it’s found they wilfully understated revenues. Refusing to allow an audit is grounds for termination.
Franchisees must keep particularly good records for these audits, which include income, expenses, and sources of income. Some franchise agreements, for example, may specify a different royalty rate for branded merchandise. Problems often occur over off-site and internet sales and gift cards.
If you are buying a franchise or expanding your business as a franchisor, Complete Tax and Notary Services can help. Contact us to discuss your unique needs today.