okay it is time for a practical example
earlier we talked about the five criteria that determine whether we can
register revenue let’s describe a few regular business situations and see
whether these criteria are satisfied shall we yes let’s do that imagine you
own a juice bar and you sell orange fresh five dollars for five hundred
milliliters a client walks in and orders a 500 milliliter bottle of orange fresh
he hands you five dollars and you accept his payment and prepare the bottle of
fresh once it is ready you hand it to the client and he walks out of your
juice bar right let’s remember the five rules risks and rewards have been
transferred from the seller to the buyer the seller has no control over good salt
collection of payment is reasonably assured the amount of revenue can be
reasonably measured costs of earning the revenue can be reasonably measured so
let’s compare whether we’ve satisfied all five rules this looked like a
complete transaction but you never know risk and rewards have been transferred
from the seller to the buyer well the client received the bottle of juice and
it is in his possession so yes risks and rewards have been transferred from the
seller to the buyer the second rule is satisfied – we have no control over the
bottle of juice anymore the third rule is satisfied as well the client paid for
the juice and we can measure how much he paid us five dollars rule number four is
satisfied – what about the costs of earning the revenue what type of costs
did we sustain we had to buy oranges a machine that squeezes them and the cost
of your time must be factored into the calculation nevertheless these costs can
be reasonably measured therefore condition number five is satisfied –
fine let’s try with a different situation the same bar the same barista
and the same person walks in however this time instead of a sole orange juice
bottle the client says he would like a muffin –
the standalone price of a muffin is $3 however unfortunately you are out of
muffins so you offer the client to pay you the combined price of a bottle of
orange juice and a muffin which is eight dollars and
in exchange you would give the client a coupon for two muffins with which he can
get two muffins for free the client accepts and you give him the coupon for
two muffins and prepare the orange juice once the
juice is ready the client receives the bottle and walks away from your bar
please remember that the price of a coupon for two muffins is four dollars
okay perfect are you going to recognize revenue in
this case and if yes how much the situation is more complicated isn’t it
we’ll have to take a careful look at the five criteria for revenue recognition
the first criterion considers whether risks and rewards have been transferred
from the seller to the buyer well that happened only partially right
the client received a bottle of juice but he received no muffin the risks and
rewards related to the bottle of juice have been transferred given he received
it however the two muffins coupon given to the client isn’t an actual product
let’s look at the second rule the seller has no control over the goods sold this
one is only partially true as well right the muffins haven’t been delivered
therefore it is you the seller who has control over them on the other hand you
don’t have control over the bottle of juice collection of payment is
reasonably assured that’s true the client paid eight dollars and the amount
of revenue can be reasonably measured is satisfied as well we know how much the
client paid eight dollars it shouldn’t be very difficult to measure the costs
of earning the revenue given your bar sells these products frequently and have
a certain cost of the ingredients you use to produce them so we’ve got an
issue with criteria one and two right they were satisfied only partially the
entire job has been carried out only partially how much revenue if any should
we recognize the entire amount of $8 nothing or perhaps somewhere in between
well given that the first and second criteria were satisfied only partially
we’ll recognize revenue only partially a to muffin coupon costs $4 the client
paid $8 we still owe him the to muffins and we gave him a coupon therefore out
of the eight dollars he paid us four dollars can be recognized and the other
four dollars should be registered as a prepayment accounting-wise we can’t
recognize revenue as conditions one and two were not satisfied what a great
exercise this was right now you’ve seen how revenue recognition criteria work in
practice to excellent work