60 Franchise Brands plc Annual Report and Accounts 2018 2 Critical accounting estimates and judgements The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the amounts reported for assets and liabilities as at the balance sheet date and the amounts reported for revenues and expenses during the period. The nature of estimation means that actual outcomes could differ from those estimates. Each of the following items contain judgements and significant estimates and have the most significant effect on amounts recognised in the financial statements. Revenue recognition Deferred payments The Group offers deferred payment terms in relation to some of the franchisee fees payable. The Group assesses the level of doubt over the ultimate recovery of the deferred fees based on historic experience. If there is significant doubt over the recovery of the franchisee fee the balance is not recognised until the level of risk associated reduces to an acceptable level. The deferred payment terms do not include any financing impact due to their short-term nature. As at 31 December 2018 £147,000 (2017: £147,000) had been recognised as a debtor, and £132,000 (2017: £132,000) was not recognised. Metro Rod revenue recognition In line with our other networks Metro Rod charges its franchisees a management service fee at the rate of 22.5% of their underlying system sales. The franchise network has two types of system sales: National Accounts and Commercial. In the case of National Accounts Metro Rod bears the credit risk, whereas for Commercial the franchisee bears the risk. Therefore, for National Accounts, the Directors believe that we are acting as a principal and recognise the whole of the system sales as revenue, with a cost of 77.5% to leave a gross margin of 22.5%. In relation to Commercial sales the Directors believe that we are acting as an agent, and we only recognise our 22.5% management fee as revenue. Business combinations Determining a value for assets acquired Determining the fair value of acquired intangible assets and goodwill acquired in business combinations requires the use of estimates regarding the value of intangible assets. The values are determined using discounted cash flows and based upon latest approved budgets which include estimates concerning factors such as new franchise sales and timing of such sales. Performing impairment tests Subsequent impairment reviews also require the use of estimates to value the cash generating units to which goodwill and indefinite life intangibles have been allocated. The value in use calculations, which are run on an annual basis for goodwill and indefinite life intangibles, or when there is an indicator of impairment for tangible and finite life intangible fixed assets, determine whether there is any impairment to the carrying value of assets arising from business combinations. More details of these estimates can be found in Note 11. Indefinite life assessment Management has determined that the brands and trademarks acquired with Barking Mad Limited (“Barking Mad”) and Metro Rod are to be treated as an indefinite life asset. Management has determined that there is nothing to suggest the future economic benefits will have a finite life. Management further believes the sectors Barking Mad and Metro Rod operate in are sufficiently large and contain sufficient opportunity to support these assumptions. As with all tangible and intangible assets the brands and trademarks will be reviewed at the end of each reporting period to determine whether there is any indication that they have suffered an impairment loss. 3 Financial instruments – risk management Capital risk management The Group manages its capital to ensure that entities in the Group will be able to meet their financial obligations as they arise while maximising the return to stakeholders. The capital structure of the Group consists of cash and cash equivalents and equity attributable to equity holders of the Parent, comprising issued capital, reserves and retained earnings, and long- and medium-term debt facilities. Term loans are used to finance long-term investment such as acquisitions. Revolving credit facilities are used to manage short-term cash requirements and minimise interest costs. The Group’s financing facilities contain the usual financial covenants including maximum gearing, minimum interest cover and minimum operating cash flow. The Group met these requirements throughout the year. The Group’s dividend policy is to provide sustainable dividends to shareholders, consistent with the Group’s earnings growth, to attract long term investors and to enable shareholders to enjoy returns on their investment in tandem with the Group’s growth. The payment and amount of any dividends or distributions to shareholders is at the discretion of the Board, and subject to shareholder approval. NOTES FORMING PART OF THE FINANCIAL STATEMENTS continued For year ended 31 December 2018