What are royalties and ad fund fees?
A royalty is the ongoing fee a franchisee pays to stay in the system, usually a percentage of gross sales, paid weekly or monthly. The ad fund, also called a brand or marketing fund, is a contribution that pays for system-wide advertising. Both are disclosed in the Franchise Disclosure Document and set in the franchise agreement.
The FTC notes that royalties are based on gross income, so they are owed even in a month the store loses money, and that ad fund money may go to national advertising rather than your market. Many systems add other recurring fees, such as technology or software fees, and a local advertising cooperative or minimum local marketing spend.
How should a franchisee record each franchise fee?
Ongoing fees are expenses of the period: royalties and ad fund in the month of the related sales, technology fees in the month of service. The initial franchise fee is different: it is recorded as an intangible asset and amortized over the franchise term. Keep each fee in its own account so it can be reconciled.
| Fee | How it is usually charged | Franchisee accounting |
|---|---|---|
| Initial franchise fee | One-time, at signing | Intangible asset, amortized over the franchise term |
| Royalty | Percentage of gross sales, weekly or monthly | Operating expense in the month of the sales; accrue the unpaid amount |
| Ad fund / brand fund | Percentage of gross sales, with the royalty | Advertising or marketing expense in the month of the sales; accrue the unpaid amount |
| Local co-op or local marketing | Set by the agreement or co-op | Advertising expense: expensed as incurred or the first time the advertising runs (ASC 720-35) |
| Technology or software fee | Flat or per-store, monthly | Operating expense in the month of service |
| Renewal fee | One-time, at renewal | Generally capitalized and amortized over the renewal term |
What is the journal entry for a monthly royalty and ad fund?
For a store with $100,000 of royalty-eligible sales, a 6% royalty and a 4% ad fund, debit royalty expense $6,000 and advertising fund expense $4,000, and credit a liability to the franchisor for $10,000. When the franchisor drafts the payment, debit the liability and credit cash.
| Account | Debit | Credit |
|---|---|---|
| Royalty expense (6%) | $6,000 | |
| Advertising fund expense (4%) | $4,000 | |
| Royalties and ad fund payable to franchisor | $10,000 |
If the franchisor drafts weekly, most of the month's fees are paid before month end and only the last partial week is accrued. Booking the full month's expense from sales, then clearing the liability as drafts post, keeps the P&L right regardless of payment timing.
What sales are royalties calculated on?
Royalties are calculated on the sales base your franchise agreement defines, usually gross sales with specific exclusions. Read the definition closely: it decides how sales tax, discounts, refunds, employee meals, gift card sales and redemptions, and third-party delivery orders are treated, and it is the number the franchisor can audit.
Build the calculation from the POS sales report for each store using the agreement's definition, not from the bank deposit. Deposits are net of card fees, delivery-app commissions and timing differences, so they will not match the royalty base.
How do you reconcile royalties to what the franchisor drafted?
Each period, recalculate every store's royalty and ad fund from its POS sales using the agreement's rates and sales base, then compare that to the amount the franchisor drafted from the store's bank account. Investigate any difference before close, and keep the calculation as support in case the franchisor audits your reported sales.
- Pull each store's sales for the period from the POS, by the categories the agreement uses.
- Apply the agreement's exclusions to get royalty-eligible sales.
- Calculate royalty, ad fund and any other sales-based fees per store.
- Match each calculation to the franchisor's draft or invoice for that store and period.
- Clear differences: late sales adjustments, a wrong rate, a missed exclusion, or a draft posted to the wrong entity.
- Record the month's expense and accrue anything not yet drafted.