Franchising a Hong Kong Business: Defining Turnover Reporting and Audit Rights

When you run company-owned outlets, you control the till records. Once you start franchising, however, head office must rely on independently operated franchisees to report their revenue. If management fees are calculated on turnover, a refund, a gift voucher or a deduction by a delivery platform can all become sources of disagreement. Building a franchise network based on mutual trust does not mean asking franchisees to hand over all their data. It means agreeing in advance on reporting and audit procedures that both sides can follow consistently.

1. Define the basis for charging fees — do not simply write ‘turnover’

The franchise agreement should contain a separate definition of the turnover used to calculate management fees, rather than relying directly on the revenue figure in the franchisee’s financial statements. Accounting rules for recognising revenue and the agreed basis for calculating fees are not necessarily the same.

At a minimum, address each of the following:

• Discounts and refunds: Are fees calculated on the pre-discount price or the amount actually received? In which reporting period should a refund relating to an earlier month be deducted? What evidence must be retained for cancelled orders?
• Platform orders: Is the calculation based on the order amount paid by the customer or the settlement amount after the platform deducts its commission? How are platform-funded subsidies distinguished from discounts funded by the outlet?
• Gift vouchers and advance payments: Are these included when sold, when payment is received or when redeemed? If one outlet collects payment and another provides the service, how will double charging be avoided?
• Other amounts: How are delivery charges, service charges, staff purchases and complimentary items treated? Are any sums collected on behalf of third parties excluded from the fee calculation?

The definition need not always favour head office, but it must allow franchisees to anticipate their costs. Ideally, include a few hypothetical transactions showing, step by step, the original price, discounts, refunds and final amount used to calculate the fee. These examples should be consistent with the contract, rather than left to separate verbal explanations from franchise recruitment staff.

2. Test reporting and reconciliation procedures in company-owned outlets

Before recruiting franchisees, have company-owned outlets complete a full settlement cycle under the proposed rules. The point is not to produce an attractive report, but to establish whether outlet managers can submit all the required information alongside their normal workload, and whether head office can identify the causes of discrepancies.

A basic reporting template could include total transaction values by sales channel, discounts, cancelled transactions, refunds, gift voucher redemptions and any adjustments specified in the agreement. Show the turnover used for fee calculation, the applicable rate and the amount payable separately, and retain records of who prepared and reviewed the report.

Head office should cross-check point-of-sale records, platform settlement statements and records of payments received, but should not assume that all three must match exactly on any given day. Delayed platform payments, credit card settlement times and unredeemed gift vouchers can all create legitimate differences. Ask for explanations of discrepancies rather than treating them automatically as under-reporting.

The trial should also cover exceptions: how to enter transactions retrospectively when the system goes offline, how to adjust for refunds across reporting periods, and how to correct errors discovered after the reporting deadline. Keep a record of the reason, date and approver for each correction, rather than simply overwriting the original data. If even company-owned outlets struggle to follow the rules, simplify the process before imposing it on franchisees.

3. Set out audit rights as a clearly bounded procedure

Hong Kong has no franchise-specific legislation, nor a general franchise registration or statutory pre-contract disclosure regime. The filing and disclosure requirements under mainland China’s Regulations on the Administration of Commercial Franchises should not be applied directly to arrangements confined to Hong Kong. If the business involves mainland China, a separate assessment is needed.

Franchise relationships in Hong Kong are governed mainly by common law principles of contract and applicable legislation, including the Misrepresentation Ordinance. Turnover reporting obligations and audit rights should therefore be expressly agreed in the contract. Head office should not assume that operating under the same brand automatically entitles it to inspect all of a franchisee’s accounts. Where customer or employee personal data is involved, the Personal Data (Privacy) Ordinance must also be observed.

Audit clauses submitted to a Hong Kong solicitor for review should cover:

• Scope: Limit access to records relevant to fee calculations and reporting accuracy. Specify the types of documents to be retained and the retention periods, taking applicable statutory retention requirements into account.
• Procedure: Set out the notice period, timing and frequency of routine audits, along with special arrangements where significant irregularities arise.
• Who conducts the audit: State whether audits will be carried out by designated head office staff or an independent accountant, and define confidentiality obligations and procedures for handling conflicts of interest.
• Costs: Specify who pays for routine audits and which reasonable costs may be charged to the franchisee if under-reporting meeting the agreed criteria is found.
• Challenges: Allow a defined period for the franchisee to explain findings, submit supporting evidence or request a review, and specify how undisputed amounts will be handled while a dispute remains unresolved.

Avoid simply stating that ‘all audit costs are payable by the franchisee’. Nor should every discrepancy automatically be treated as fraud. Data entry errors, differing interpretations of the rules and deliberate concealment call for different responses.

4. Collect only necessary data and establish correction and review procedures

Checking management fees does not usually require customers’ full names, telephone numbers or payment card details. Head office can prioritise transaction references, dates, outlets, amounts and refund status. Where access to personal data is genuinely necessary, first confirm the purpose, access permissions and safeguards. A franchise agreement alone does not remove privacy obligations.

System design should support these controls: allocate access rights by role, log downloads and changes, and establish appropriate data retention and deletion arrangements. If using an outsourced point-of-sale or cloud service, clarify how data exports, termination of access and service outages will be handled, so that audit evidence remains available when needed.

After each audit, send the franchisee a list of discrepancies that clearly distinguishes the facts, the contractual basis and the proposed adjustments. Give the franchisee an opportunity to respond before confirming any additional payment, refund or credit against the next period’s fees. Disputes over definitions used to calculate fees should be referred to the designated person or handled through the procedure specified in the contract. If the same errors recur, review training or system settings rather than merely increasing the frequency of audits.

Practical takeaway: Start with a one-page definition of turnover, a monthly reporting template and a procedure for resolving discrepancies, then test them in a company-owned outlet. Only when you can clearly explain how each charge arises are you ready to introduce the audit framework across your franchise network.