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Burger's Home Inc: Accounting Policies and Financing Options for Franchising

Background and Overview

Burger’s Home Inc (BHI) is a private fast-food chain established ten years ago by two brothers – Frank and Malcolm.  Frank is in charge of accounting and finance while Malcolm focuses on operations. BHI’s specialty is selling high-quality, organic burgers at competitive prices. The beef is sourced locally at an organic cattle farm which supplies to all of BHI’s restaurants. BHI has grown steadily over the years to fifteen corporately owned locations in Ontario. Prior to the pandemic, the brothers were gearing up to expand the chain into a franchise. Negotiations with potential franchisees halted when the pandemic hit but in May 2021, several interested parties came back to the negotiation table. Extracts of the Franchisor Agreement are presented in Exhibit I and Exhibit II.

BHI’s long-term loan with their local bank is coming due shortly after the end of the year. The brothers would like to refinance this debt with the bank but they were also contacted by a private investor who is interested in providing either equity or debt financing to BHI. The investor requires an audited set of financial statements before he makes the decision. In the current loan agreement with the bank, there are two covenants: the debt-to-equity ratio must be no higher than 0.7 and the current ratio must be greater than 2. It is likely that the bank will offer similar terms if they choose to refinance with the bank. The brothers are not sure if they are in compliance or not with the covenants and they also would like to know how the accounting impact of the events this year may affect their financing plan. BHI’s year-end is November 30th and it follows ASPE. Draft balance sheet is presented in Exhibit III.

It is now November 3, 2021.  You, CPA, are the new controller at BHI and just joined the company in October. You have been asked to establish all the necessary accounting policies to complete this year’s financial statements because this is the first year the chain receives an audit.  In particular, the brothers would like you to establish solid accounting policies pertaining to franchising with regard to revenue recognition and financing for franchisees. You also need to address the queries raised by the brothers and discuss the accounting implications of this year’s events. The brothers expect the report by December 3rd, 2021.

In April 2021, Brad and Jenny Smith contacted Frank because they would like to join the franchise family of BHI. They are the first and only franchisee so far and BHI hopes to close a few more deals in early 2022. On top of paying for the initial franchise fees as stipulated in the agreement, they asked BHI to help with financing the construction and renovation of the new restaurant. The construction expenditure amounted to $850,000 and BHI agreed to provide $250,000 interest free over the term of the franchise. A loan of this nature normally carries an effective interest rate of 8%. The first annual payment is due March 31, 2022.

The new restaurant was up and running on July 1st, 2021. Brad and Jenny were on time with the initial franchise payments and advertising funds but missed the October payment for the continuing franchise fees.

In addition to being busy with getting everything done for the new franchise, the owners have been busy with another issue. About one week ago, the Vice President of Public Relations received an angry phone call from a customer who claimed to have purchased a big order of burgers for take-out for a party. Allegedly, half of the guests came down with food poisoning shortly after the party. The VP of Public Relations did not think much of the call until the customer’s lawyer contacted him just a day ago stating the customer is planning to file a claim in court. Having shared the news with management, the VP suggested to settle with the customer for $25,000 and to investigate the incident further to see if it has any merit. At the very least, the VP suggested to throw out all of the remaining burgers at that location since it is not a large restaurant anyway. While the VP is not convinced that the case has merit, he believes this would ‘look good’ if all the meat is disposed of in case this catches on with the public. The organic farm BHI deals with has recently switched to a new delivery service due to labour shortage in the province. Malcolm is going to test samples of meat in a lab to see if there is indeed any bacteria or other issues and have asked you not to book any journal entries pertaining to this complaint yet. Beef made up of about 50% of the chain’s inventory.

Answer the questions:

1. Should they settle with the customer for 25k?

2. Should they get rid of the 50% beef inventory

  1. Prepare the report with a maximum of 5 pages double-spaced and submit on eClass by the deadline.

  2. The title page should include only members who have contributed to the assignment. There will be a peer evaluation form for you to fill out on eClass.

  3. You should start with an overview of the major users of the financial statements and their needs, then followed by the identifying accounting issues and analyze them one by one. Remember to draw conclusions after analyzing each issue. There should be a concluding paragraph that summarizes your findings that will address the owners’ most pressing concerns.

  4. You will be evaluated based on:
    1. Number of issues addressed
    2. Depth of analysis on each issue. Depth is measured by citing appropriate accounting criteria, discussing alternative accounting treatments when appropriate, supporting with case facts and calculations, and drawing a reasonable conclusion
    3. Effectiveness in communication.

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