How should a franchisee keep documents aligned with franchisor reporting requirements?

Where are your reporting obligations written?

An International Franchise Association (IFA) article on royalty audits says that, for the most part, audit rights and obligations are controlled by the language of the franchise agreement. Gather these documents in the versions that apply to you:

• The agreement. Include every amendment, addendum and renewal document.
• Other agreements. Include any lease, option, purchase or other agreement you signed in connection with the franchise.
• The manual. Keep each version of the operations or accounting manual with the date you received it.
• Required systems. Keep the documentation of any point-of-sale, reporting or accounting system the agreement requires.
• The disclosure document, if you received one. It works as an index to the others.

The FTC's Franchise Rule (16 CFR 436.5) requires the disclosure document's Item 9 to list the franchisee's principal obligations in a table that cross-references each one to any applicable section of the franchise or other agreement; its rows include records and reports, inspections and audits, and post-termination obligations. Item 22 attaches the proposed agreements, so read each cross-referenced section in the agreements you signed.

Then turn the documents into a definite list: for each clause or manual section that tells you to report, keep, use or allow access to something, write one line giving what, how often, by when, in what form, and the clause reference. Work to that list, not to a field representative's requests: an obligation nobody has asked about is still in the agreement, and an audit can test it.

Which kinds of obligation should you tell apart?

Each kind asks something different of your books, so label every line on your list with its class:

• Account structure. The IFA article suggests franchisors collect quarterly and annual financial statements formatted according to the franchisor's standard chart of accounts.
• Periodic reports. The IFA article says franchisors should require periodic royalty reports and calculation worksheets at the intervals the agreement sets.
• Statements and returns. The IFA article also suggests franchisors collect copies of state and federal sales and income tax returns.
• Required systems and procedures. The Franchise Rule requires Item 11 to say whether you must buy or use electronic cash registers or computer systems, and the FTC's consumer guide says franchisors may demand that you use certain accounting or bookkeeping procedures.
• Inspection and audit rights. These decide which records you must be able to produce at any time.

Where alignment happens depends on what the franchisor prescribes:

How does one set of books serve both you and the franchisor?

Keep one ledger and a mapping from it to the franchisor's format. A second set of records drifts from the first with every entry made in one and not the other, and then neither can be shown to be right. The mapping must preserve four things:

• Completeness. Every account maps to exactly one report line or is marked as not reported, so nothing is counted twice or dropped.
• Traceability. Each reported line equals its mapped accounts for the period, adjusted only by the lines on your reconciliation schedule; each balance opens to its transactions, and each transaction to its source document.
• Units. With several units, tag every transaction with its unit (a location, class or tracking tag, whichever your software provides), or with an entity-level tag for items no single unit carries, following any allocation rule your manual sets. Build each unit's report from its own transactions, and check that the units' reports plus the entity-level items add up to the consolidated books.
• History. When your accounts or the franchisor's format change, update and date the mapping before the next report, keeping the old version for the periods it produced.

If the franchisor's system does not connect to your accounting software, check each period that the system's total, the books' total and the reported figure agree once the lines on your reconciliation schedule are applied, and trace any difference the schedule does not explain. Posting a day's sales, recording marketplace sales, designing a chart of accounts and aligning it to tax-return lines are covered in the related questions.

Why can the sales figure you report differ from your book revenue?

The IFA article says the definition of gross revenues in the agreement, or whatever term the agreement uses to calculate royalty payments, is sometimes the subject of disagreement, and that disputes over off-site sales, Internet sales and gift card sales or redemptions are common. The same article says careful review by legal counsel of the agreement's financial definitions and royalty calculation method can help prevent this. Where you cannot tell whether a category is in or out of the measure, have counsel review that definition before you rely on an exclusion, and file the outcome with your schedule. Your book revenue follows your accounting method and feeds your tax return, lender statements and ownership records, so do not change it to match the agreement's measure.

Carry the difference in a reconciliation schedule each period: book revenue from the mapped sales accounts, then each addition or exclusion the agreement defines, with its clause reference and amount, ending at the reported figure. If your books are on the cash basis and the agreement counts sales when made, that timing difference is one more line in the schedule.

Where the agreement allows exclusions or adjustments, capture each classification when the transaction happens, with a dedicated point-of-sale key or code for each excluded category and a document made at the time for anything outside the system, rather than rebuilding it later from summary reports.

What should you keep behind each reported figure?

The IRS's page on what records to keep says to keep supporting documents that show the amounts and sources of your gross receipts, listing cash register tapes, deposit information for cash and credit sales, receipt books, invoices and Forms 1099-MISC, and that all requirements for hard copy books and records also apply to electronic records. Behind each reported figure, keep:

• The point-of-sale period summary and the daily summaries behind it
• Bank deposit records and card processor statements for the period
• The reconciliation schedule and calculation worksheet
• The evidence for each exclusion or adjustment
• The report as submitted, with its confirmation

The IRS's page on how long to keep records says you generally must keep records that support an item of income, deduction or credit on your return until the period of limitations for that return runs out, and not discard records no longer needed for tax until you check whether you must keep them longer for other purposes. Your agreement's records clause is one such purpose, so keep each record until the later period ends. The periods themselves are covered in the related question on business records.

Which franchisor documents do you need to check, and how?

The Franchise Rule's Item 6 table of other fees gives examples including advertising cooperatives, purchasing cooperatives, audits, accounting, inventory, transfers and renewals. File by unit and period every royalty, fund and other fee bill, required-supplier invoice and statement, rebate statement, and initial, renewal or transfer fee document.

If supplier rebates are paid to you, tie each rebate statement to the purchase invoices behind it. For books kept under U.S. GAAP, PwC's financial statement presentation guide says consideration received from a vendor is generally a reduction of the purchase price of that vendor's goods or services, and consideration contingent on a cumulative level of purchases is recognized when probable and reasonably estimable. The guide sets out three exceptions: payment for a distinct good or service you transfer to the vendor, reimbursement of specific, incremental, identifiable costs you incur to sell the vendor's products, and reimbursement of the vendor's own sales incentives to end customers; have your accountant apply them. For cash- or tax-basis books, agree the rebate treatment with your accountant.

Reconcile each bill when it arrives:

1. Match the sales base on the bill to your submission for the same unit and period.
2. Check the rate, any minimum and the arithmetic against the agreement's fee clause.
3. Put the result on one of the paths below, and file the bill, submission and reconciliation together.

The agreement's terms keep running while you ask, so check straight away what it says about due dates and disputed amounts. Agree with your accountant, before the due date, how to record the bill while the difference is open. If checking shows your own report was wrong, submit a correction in the form the agreement requires and save it like any other submission.

What does one period look like from books to bill?

The figures are invented, and the agreement is hypothetical: it counts vending commissions in its sales measure and excludes employee meals.

The March royalty bill then lands on one of three paths:

How do you keep your own record of what you reported?

For every submission, save to storage you control:

• The report exactly as submitted: the exported file, or screenshots of each portal page before you submit
• The confirmation or receipt showing the date and time
• The worksheet and reconciliation behind it
• Who prepared, reviewed and submitted it
• Any later correction, saved the same way

Name files by unit and period. A portal the franchisor runs is its record, not yours, and if your access changes in a dispute or ends when you leave, that history goes with it.

What if a required system reports for you?

The Franchise Rule requires Item 11 to disclose whether the franchisor will have independent access to the information generated or stored in a required electronic cash register or computer system and, if so, to describe that information and any contractual limitations on that access. When the franchisor reads figures straight from a system, your books become the check rather than the source. Where your books' sales are posted from that same system, the bank and processor statements are the independent check. Each period, if the system can produce a report of what it sent for you, save it; either way, compare the system's sales with your books and with bank deposits and card processor statements from your own logins, reconcile the base on each bill to them as above, and raise any difference with the franchisor in writing.

What calendar and review routine keeps reporting repeatable?

Turn the list into a standing checklist, with your own dates for closing, preparing and reviewing ahead of each due date. This one uses the hypothetical agreement; yours supplies the real clauses and dates:

Where staffing allows, the reviewer is not the preparer. The reviewer traces the reported figure through the mapping and schedule to the books, ties sales to bank deposits and card processor statements pulled from the owner's own access rather than copies from the preparer, and checks the evidence for a sample of exclusions. If you do everything yourself, nobody else catches your errors: do the deposit tie-out on a different day from preparation, and have your outside accountant review a sample of periods each year.

What can an inspection reach, and how do you stay ready?

Your agreement's audit clause sets what applies to you. The IFA article, written by an attorney who counsels franchisors, advises franchisors that their agreements should let them and their representatives review a franchisee's financial, accounting, tax records and all underlying data, and that audit rights should extend to electronic and digital versions of all financial records.

Close each period only when its folder holds the supporting documents listed above, the bill reconciliations and any correspondence. Keep a yearly bridge from reported sales to the sales on your sales-tax and income tax returns and in any reports you give your landlord or lenders: the IFA article says a review of tax records, financial reports to landlords and lenders, customer counts and supplier purchase records can often reveal unreported sales. Preparing sales-tax returns is a separate topic. Keep folders in an exportable electronic form, and each quarter check that a randomly chosen past period's folder can be produced the same day.

Which records do you keep for yourself if you sell, renew, add a unit or leave?

In every case, your books, submission copies, reconciliations, agreements and fee documents stay in your own storage. Each event adds its own steps: