Boston Chicken, Inc. - No Chicken About Aggressive Franchising

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statements appear below.

Revenue Recognition Revenue from company-operated stores is recognized in the period for which related food and beverage products are sold. Royalties are recognized in the same period related franchise store revenue is generated. Revenue derived from initial franchise fees and area development fees is recognized when the franchise store opens. Interest, real estate services, and software maintenance fees are recognized as earned. Lease income is recognized over the life of the lease on a straight-line basis. Software license income is recognized as the software is placed in service.

Accounts Receivable Accounts receivable includes amounts currently due from area developers and franchisees other than for loans (see discussion of Notes Receivable below). The amounts appearing in Exhibit 1 are net of an allowance for uncollectible accounts of $77,000 on December 27, Year 12, $323,000 on December 26, Year 13, $246,000 on December 25, Year 14, and $1,043,000 on December 31, Year 15. Bad debt expense was $321,000 for Year 13, $187,000 for Year 14, and $797,000 for Year 15.

Notes Receivable Notes receivable include amounts payable by area developers and franchisees under multi-year lending arrangements (see discussion of area developer financing above). The company maintains an allowance for loan losses at a level that in management’s judgment is adequate to provide for estimated possible loan losses. The company bases the amount of the allowance on management’s review of each area developer’s use of loan proceeds, adherence to its store development schedule, store performance trends, type and amount of collateral securing the loan, prevailing economic conditions, and other factors which management deems relevant at the time. Based upon this review and analysis, no allowance was required at the end of the Year 12, Year 13, Year 14, or Year 15 fiscal years.

National and Local Advertising Funds The company administers a National Advertising Fund to which company-operated stores and franchisees make contributions based on individual franchise agreements (2 percent of store revenues). Collected amounts are spent primarily on developing marketing and advertising materials for use system wide. The National Advertising Fund is accounted for separately and not included in the financial statements of the company. The company maintains Local Advertising Funds that provide comprehensive advertising and sales promotion support for the Boston Market stores in particular markets. Periodic contributions by company-owned stores and franchisees (generally 4 percent of store revenues) finance local advertising and promotion expenditures. The Local Advertising Fund is accounted for separately and not included in the financial statements of the company. Actual expenditures on national and local advertising as of December 31, Year 15 have exceeded the amounts collected from franchisees by $9.6 million. The company includes this excess amount in other current assets on its balance sheet.

Related Party Transactions The company and certain area developers have entered into secured loan and area development agreements with certain area developers in which certain directors and certain current and former officers of the company and members of their families have a direct or indirect equity interest. The company has received from these entities in Year 13, Year 14, and Year 15, approximately $6.6 million, $30.9 million, and $46.0 million, respectively, in development, franchise, royalty, software license, software maintenance, accounting and other miscellaneous fees, rent, and interest on their loans with the company. In addition, these entities have paid approximately $3.5 million, $11.3 million, and $20.0 million in national and local advertising contributions during the same periods. The company has also sold to certain of these entities Boston Market stores, inventory, equipment, and other miscellaneous assets, including reimbursement of the Company’s general and administrative costs and expenses of operating the stores, for which it received $5.0 million, $47.1 million, and $14.6 million in Year 13, Year 14, and Year 15 respectively. The company believes that the terms of these agreements are as favorable to the company as those with other area developers. The company has paid to one of these area developers $146,000 in Year 14 and $100,000 in Year 15 for various services. During Year 13, the Company’s chief executive officer received from the Company $107,066 as reimbursement for payments he made to Bowana Aviation, Inc. for the Company’s use of an aircraft owned by Bowana. During Year 14 and Year 15, the Company paid $527,744 and $661,960, respectively, to Bowana for the use of aircrafts. The company’s chief executive officer and a relative own Bowana. The company believes that the amounts charged are at rates comparable to those charged by third parties.

Relocation In September Year 14, the Company consolidated its four Chicago-based support center facilities into a single facility and relocated to Golden, Colorado. The cost of the relocation, including moving personnel and facilities, severance payments, and the write-off of vacated leasehold improvements, was $5.1 million.

Required:

a. Discuss the appropriateness of the timing of revenue recognition by Boston Chicken for each of the following:

(1) development franchise fee

(2) initial franchise fee

(3) royalties

(4) interest on loans to area developers

(5) real estate service and leasing fees

- software license and maintenance fee

(Hint: Analyze the changes in the allowance for uncollectible accounts for Year 13, Year 14, and Year 15 to assess the collectibility of outstanding accounts and notes receivable.)

b. Suggest possible reasons why Boston Chicken might choose to develop and operate its stores through non-owned area developers and franchisees instead of outright ownership.

c. Suggest possible reasons why Boston Chicken might choose to structure its marketing activities using the National Advertising Fund and the Local Advertising Fund.

d. Exhibit 4 presents selected operating data and financial statement ratios for Boston Chicken (in addition to the common size income statement in Exhibit 2). Analyze the changes in the profitability and risk of Boston Chicken between Year 13 and Year 15.

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