Wraps Inc. is a franchisor of fast-food restaurants that specialize in providing a variety of wraps filled

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Wraps Inc. is a franchisor of fast-food restaurants that specialize in providing a variety of wraps filled with healthy food, the most popular of which is the sundried tomato wrap filled with fresh vegetables and a special California sauce. The restaurants all do business under the name of Wraps, but all are owned and operated by independent entrepreneurs; the original Wraps outlets are separately owned by the founding shareholders of Wraps Inc., and not by the franchisor corporation itself.

Wraps Inc. sells franchises for $400,000. Of the total amount, $50,000 is due when the franchise agreement is signed, another $60,000 is due when the outlet opens, and the remainder is due 18 months after the opening. All payments are non-refundable. Wraps Inc. also receives a royalty of 3% of the invoice cost of the special supplies that the outlets are required to use (such as the special California sauce and the paper goods and other supplies that are imprinted with the Wraps logo). Wraps Inc. does not produce any of these goods; special arrangements are made with suppliers in each region of the country, and the royalties are forwarded to Wraps directly by the suppliers rather than by the franchisees.

Before the franchise agreement is signed, there is a period of discussion and exploration that can last from one to six months. During this time, the general feasibility of establishing a new outlet is examined. Market surveys are conducted to determine whether the local market could support another fast-food outlet, and the financial strength and backing of the prospective franchisee are examined.

The costs incurred during the pre-signing stage are borne by Wraps Inc.

Once the franchise agreement is signed, Wraps Inc. actively assists the franchisee in selecting a site, planning the restaurant, gaining building permits, equipping the restaurant, and selecting and training the staff. All of the direct costs of establishing the outlet are paid by the franchisee, but Wraps Inc. contributes substantial assistance in the form of legal, architectural, planning, and management experts. The experts are retained by Wraps Inc. as regular staff consultants, and they are paid a fixed-fee retainer each month, regardless of the amount of service that they provide to Wraps or its franchisees in that month. A supporting staff is employed directly by the franchisee.

Some of the expert assistance is delivered on-site, with Wraps Inc. paying the travel and other incidental costs. Head office provides other assistance—such as drafting construction blueprints (based on master plans kept at Wraps Inc. head office) and preparing supporting documents for city council site-zoning bylaws—and Wraps Inc. absorbs those costs as well. The period of time between the signing of the franchise agreement and the opening of the outlet can vary from six months to two years. On average, though, it is approximately one year.

The direct involvement of Wraps Inc. largely ends when the outlet opens.

Some additional management and employee training assistance is sometimes offered, but any significant additional services must be paid for by the franchisee.


Required:

Assume that you are an accounting advisor to Wraps Inc. Recommend an accounting and reporting policy for revenue and expense recognition for Wraps Inc. under each of the three following separate cases. Be sure to evaluate all of the alternative policies in light of the objectives of financial reporting in each case.

Case A: Wraps Inc. is a well-established franchisor that has franchised hundreds of successful outlets throughout North America. The corporation is controlled by the original founders, who own 54% of the outstanding common shares. The setng t7h e otad 36 remaining shares are publicly traded on the Toronto Stock Exchange. The success rate is very high for the franchisees; only 3% of the licensed franchisees have failed to open during the history of Wraps Inc., and only 8% have failed before payment of the final installment of the franchise fee.

Case B: Wraps Inc. is privately owned by its three founders; each owns one-third of the common shares. There is no long-term debt, and few current liabilities.

The company is well established, and has a good record of successful openings, similar to the success rate described in Case A, above.

Case C: Wraps Inc. is a relatively new company, having been founded only three years previously. Only five franchised restaurants have been opened (in addition to the three owned by Wraps Inc.’s founders) and all have been successful. Eight more franchise agreements have been signed and good progress is being made towards opening all of the new outlets. Wraps Inc. is planning to offer shares to the public in the near future. In the meantime, the corporation has been borrowing substantial sums from the bank in order to meet the upfront costs of opening new franchises.

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