Performance obligations are the backbone of franchise agreements—they define what franchisors and franchisees are responsible for. Franchises follow a franchise model, where a franchisor licenses its brand, systems, and support to franchisees. A franchise business is where an entrepreneur (the franchisee) operates under the franchisor’s established brand and proven business model. Franchise businesses span many industries, from food service to retail.
This model enables rapid expansion by letting individuals run tried-and-tested systems with ongoing franchisor support. The success of a franchise agreement relies heavily on the strength and consistency of the business model.
These obligations clarify expectations and how value flows between parties. A key part is identifying the services promised to the franchisee, which determines how and when revenue is recognised.
Identifying Distinct Goods and Services
Franchise agreements include various performance obligations, generally split into pre-opening goods or services and ongoing support.
Pre-opening services cover site selection assistance, initial training, equipment setup, and grand opening support—distinct tasks focused on getting the new outlet operational. Each distinct good or service must be assessed as a separate performance obligation.
Ongoing support includes brand marketing, operational advice, and supply management. Each is evaluated individually to determine when and how revenue should be recognised. Sometimes, services provided over time may be grouped or separated depending on their nature.
Role of Trademarks and Intellectual Property
The licence to use trademarks and intellectual property (IP) is central in most franchise deals. It grants the right to use the franchisor’s brand and system. Franchisees often receive exclusive rights to operate under the brand within a specific territory.
Trademarks offer instant brand recognition and customer trust. By becoming a franchisee, you pay for the right to use this established IP. Being part of a franchise system ensures consistency across locations.
The IP package typically includes:
- Brand names and logos
- Proprietary business methods
- Operating manuals and procedures
- Recipes or product specifications
Under the franchise agreement, the franchisee buys the rights to use these assets.
This IP licence is usually treated as a distinct performance obligation, with clear terms on usage. Most agreements view it as a right-to-access arrangement lasting the franchise term.
Franchisor and Franchisee Responsibilities
Both sides have their own responsibilities. As a franchisee, you’re generally expected to:
- Maintain brand standards and quality
- Pay ongoing royalties and marketing fees
- Meet minimum performance targets
- Follow operational guidelines
- Report sales and other data regularly
Franchisors, meanwhile, provide:
- Initial and ongoing training
- Operational and business support
- Marketing and advertising assistance
- Maintenance services
- Quality control and system-wide development
They ensure franchisees maintain standards and the franchise system runs smoothly.
Master franchise agreements often include extra obligations, like opening a set number of outlets within a timeframe, supporting the franchisor’s growth plans.
Marketing fees collected can’t be kept by franchisors; they must be spent on activities benefiting the whole system.
Revenue Recognition and Financial Reporting Standards
Recent accounting standards require careful assessment of franchise agreements. Revenue is recognised as performance obligations are met, aligning income with the delivery of goods or services. Variable consideration, such as royalties based on sales, affects how revenue is measured and recognised. Practical expedients can simplify this by recognising revenue based on amounts invoiced. Measuring progress in transferring goods or services, often by percentage of completion, is vital for recognising revenue over time.
Application of ASC 606 and Topic 606
ASC 606 outlines a five-step revenue recognition process: identify the contract, determine performance obligations, set the transaction price, allocate it, and recognise revenue when obligations are fulfilled.
Pre-opening activities need close examination to decide if they’re separate performance obligations. If multiple pre-opening services are similar and transferred over time in the same pattern, they may be grouped as a single obligation. Consistent methods should be applied to measure progress and satisfaction of obligations, which determines revenue recognition timing.
A performance obligation is satisfied when control of the good or service passes to the customer—this may be on customer acceptance, milestone completion, or when the customer can benefit without significant rework. The period over which obligations are fulfilled—daily, monthly, or as per contract—also impacts revenue recognition timing.
Impact on Franchise Fees and Payments
Initial franchise fees are no longer recognised all at once. Instead, you need to determine if pre-opening activities are separate obligations. If they are, you can recognise part of the fee as those activities are completed; if not, you spread it over the agreement’s duration. The franchise fee, including the initial fee, is an upfront payment by the franchisee for the rights to operate under the franchisor’s brand and receive initial training and support.
This fee is central to the financial and contractual relationship between franchisor and franchisee. Through this contract, the franchisee gains access to the franchisor’s trademarks, business system, and ongoing support.
The transaction price must be allocated across all performance obligations—not just initial fees but also ongoing royalties and other payments. Royalties are often a percentage of the franchisee’s sales, so revenue recognition depends on sales performance.
IFRS 15, the international counterpart to ASC 606, requires detailed financial reporting on franchise revenue sources for clarity and comparability. In some cases, transaction processing—such as handling payments or providing a series of similar services—may be treated as a separate performance obligation.
Structuring and Drafting Franchise Agreement Performance Obligations
Clearly defining performance obligations is vital in a franchise agreement. They set expectations and protect both parties with precise language and measurable standards. It’s important to specify obligations to deliver goods and services, ensuring clarity on what the franchisor must provide.
Agreements may vary for new franchisees compared to established ones, reflecting their different needs and stages. They often reference other franchises within the network to clarify territory, support, and competition. When drafting, consider potential franchisees’ needs, startup costs, ongoing fees, and available support. The structure of the agreement can affect the appeal and success of the business model. For more details, see relevant sections in IFRS 15 and ASC 606.
Legal Considerations and Common Clauses
When drafting these obligations, be clear and specific—include minimum sales targets, quality standards, and operational benchmarks. Franchise agreements often grant exclusive rights to a franchisee within a particular territory, ensuring local exclusivity and preventing overlap.
The franchise network offers ongoing support, collective marketing, and shared resources to help each franchisee succeed. Franchising is a cost-effective way for businesses to expand rapidly and efficiently. It’s vital that every franchisee follows the proven business model to maintain consistency and quality. The franchisor provides resources, training, and upholds brand standards across the network, while the franchisee must operate according to the agreement and uphold these standards.
Include provisions for performance failures. Liquidated damages clauses can help but should be reasonable to avoid legal issues. A step-by-step approach is best: start with a warning, offer extra training if needed, and consider termination only as a last resort.
Reporting requirements are essential. Franchisors need regular sales reports, quality checks, and customer feedback to monitor performance. However, avoid excessive control, as courts may favour business independence in some jurisdictions.
Challenges and Best Practices for Managing Performance Obligations
Managing performance obligations requires strong systems and clear processes to keep relationships healthy and ensure compliance. Maintaining consistent quality across all franchise locations is crucial for a uniform customer experience. Operating under the same brand enforces standards and strengthens recognition. Many businesses use franchising to expand their reach while maintaining consistency across markets.
Monitoring and Assessing Compliance
Franchisors need robust systems to monitor franchisees. Regular financial audits help catch issues early. Using a mix of financial and operational metrics, such as a balanced scorecard, is effective. Measuring the entity’s progress ensures goods or services are transferred as agreed and helps maintain compliance. Evaluating assets for alternative use is also important, as repurposable assets may require different monitoring.
Digital dashboards provide real-time updates. Useful tools include:
- Mystery shoppers to assess customer experience
- Quarterly financial reviews
- Compliance checklists
- Benchmarking against top-performing locations
Training field reps to provide constructive feedback encourages franchisee buy-in. Clear expectations about monitoring timing and methods should be set from the start.
Resolving Disputes and Non-Compliance
If performance issues arise, address them promptly. Start with a conversation to understand the situation—often it’s just a misunderstanding.
Use a tiered approach:
- Advisory support – Provide extra training and resources. Franchisors may have a stand ready obligation to offer assistance whenever needed, not just at set times.
- Performance improvement plans – Set clear goals with deadlines.
- Formal notices – Record if there’s no improvement.
- Mediation – Involve a neutral party before considering legal action.
Keep a record of all interactions. The franchise agreement should specify the consequences of continued non-compliance, including possible termination.
Be firm but fair—balancing brand protection with understanding individual circumstances helps maintain good relationships and standards.
Contact Us
Have questions about performance obligations in your franchise agreement? Diamond Accounts can help clarify your contractual and financial reporting responsibilities.
We offer assistance with:
- Identifying performance obligations in franchise contracts
- Revenue recognition, including current accounting standards
- Structuring and reporting franchise fees
- Understanding minimum performance requirements
Let’s review your franchise agreement together—sometimes a little guidance is all you need.