Magleby Inn sells franchises to independent operators throughout the western part of the United States. The contract with the franchisee includes the following provisions:
(a) The franchisee is charged an initial fee of $25,000. Of this amount, $5,000 is payable when the agreement is signed and a $4,000 non-interest-bearing note is payable at the end of each of the five subsequent years.
(b) All the initial franchise fee collected by Magleby Inn is to be refunded and the remaining obligation canceled if, for any reason, the franchisee fails to open the franchise.
(c) In return for the initial franchise fee, Magleby agrees to assist the franchisee in selecting the location for the business; negotiate the lease for the land; obtain financing and assist with the building design; supervise construction; establish accounting and tax records; and provide expert advice over a 5-year period relating to such matters as employee and management training, quality control, and promotion.
(d) In addition to the initial franchise fee, the franchisee is required to pay to Magleby Inna monthly fee of 2% of sales for recipe innovations and the privilege of purchasing ingredients from Magleby Inn at or below prevailing market prices. Management of Magleby Inn estimates that the value of the services rendered to the franchisee at the time the contract is signed amounts to at least $5,000. All franchisees to date have opened their locations at the scheduled time, and none has defaulted on any of the notes receivable. The credit ratings of all franchisees would entitle them to borrow at the current interest rate of 10%. Given the nature of Magleby’s agreement with its franchisees, when should revenue be recognized? Discuss the question of revenue recognition for both the initial franchise fee and the additional monthly fee of 2% of sales.