Natalie's high school friend, Sasha Petrolinski, has been operating a microbrewery for approximately 10 months, which he calls Blazing Skies Brew. Natalie and Sasha usually meet once a month to catch up and discuss problems they have encountered while operating their respective businesses. Sasha wishes to borrow from his bank so he can purchase a new state-of-the-art distillery unit. He recognizes that the bank will be evaluating his financial statements.
Sasha has recently negotiated a one-year contract with Libations Bar to provide 150 cases of craft beer every week. Libations Bar, upon receipt of a monthly invoice, will send Sasha a cheque by the 15th of the following month. Sasha has decided that, because he has signed this contract, he is able to record the total contract price that will be earned over the next 12 months as revenue in his financial statements. When Sasha negotiated the contract with Libations Bar, he purchased additional brewing supplies to meet the increased demand for his craft beer. He has decided that he will not record the purchase of these supplies until the invoice is due, which is in about 30 days. He argues that the amount to be paid for the purchase of brewing supplies is relatively small and the amount won't really make much of a difference to the bank when it decides whether to lend him the money. Sasha assures Natalie that this is the right way to account for this revenue and the purchase of additional supplies. He is sure that the bank will lend him the money that he needs to purchase the new distillery unit. Natalie is confused and comes to you with the following questions:
1. Is Sasha accounting for the contract revenue correctly? (Assume that Sasha uses the contract-based approach to revenue recognition.)
2. Is Sasha accounting for the purchase of the brewing supplies correctly?
3. What other information will the bank be considering when deciding whether or not to extend the loan to Sasha?
4. Do you think that Sasha's income statement will be representationally faithful and provide relevant information to the bank?
Instructions
(a) Answer Natalie's questions.
(b) How should Sasha be recording this revenue? Why?
(c) How should Sasha be recording the purchase of brewing supplies? Why?
(d) How could Sasha ensure that the bank is aware of the contractual arrangement with Libations Bar when it reads his financial statements?