Factory Optical Distributors (FOD) is a publicly held manufacturer and distribu tor of high-quality eyeglass lenses located in Burnaby, British Columbia. For the past 10 years, the company has sold its lenses on a wholesale basis to optical shops across Canada. Beginning in Year 3, the company began to offer franchise oppor tunities to opticians wanting to sell only FOD lenses.
The franchise agreements contain the following stipulations:
• Each franchise must be a corporation. FOD (Burnaby) will purchase 35% of the corporation's outstanding common shares and the franchisee will hold the remaining 65%. No other equity instruments can be issued.
• Franchises can be established in new locations or in existing locations under the name Factory Optical Distributors. If a new building is required, FOD (Burnaby) will guarantee the mortgage to ensure that the best interest rates can be obtained. If an existing location is used, it must be renovated to meet com pany specifications, and again FOD (Burnaby) will guarantee any required financing.
• To qualify as a franchisee, an individual must be a licensed optician and must commit to 40 hours a week in the franchise location, managing the day-to-day activities.
• Franchisees are to be paid a salary that does not exceed 1.5 times the industry average for opticians with equivalent experience.
• The franchise agreement specifies that only FOD lenses can be sold in fran chise locations. FOD lenses can be purchased by franchisees at 20% below normal selling price for the first $500,000 of purchases and at 25% below nor mal selling price if purchases exceed $500,000 on an annual basis.
• The agreement also requires that frames sold by the franchisee be purchased from designated suppliers, to ensure the best quality and fit to FOD lenses.
• All franchise advertising must be approved by FOD (Burnaby). Franchisees must allocate 1% of revenue to advertising each month.
• The franchisee is required to participate in special promotions and seasonal sales as determined by FOD (Burnaby).
• A franchise fee of 2% of sales is payable monthly to FOD (Burnaby).
• Other products and services can be sold from the franchise location provided that they do not negatively impact the sale of FOD lenses.
During Year 5, eight franchise agreements were signed in locations across Canada. At December 31, Year 5, the company's year-end, five of these locations were open for business.
It is now January Year 6. You are the senior auditor on the FOD (Burnaby) account. The company's corporate controller has come to you with the franchise agreement to discuss how FOD must report its share ownership in the five operat ing franchises. She has heard that the definition of control in IFRS 10 encompasses some situations where 50% share ownership does not exist.
Required:
Examine the details of the franchise agreement. Do you think FOD controls the franchise operations? Would consolidation be required? Explain.