Apple Inc Financial Case Study Solution
Apple Inc Financial Case Study Solution
- Should the FASB have overturned the software revenue recognition portion within ASC 985-605? As part of your explanation, consider whether firms will now have too much flexibility to manipulate revenues.
The answer is NO.
The revenue recognition portion changed the accounting model for revenue arrangements that included both tangible products and software elements. Tangible products containing software components and non-software components that function together to deliver the tangible product’s essential functionality are no longer within the scope of the software revenue guidance in portion 985-605. The portion require that hardware components of a tangible products containing software components always be excluded from the software revenue guidance, it also provides additional guidance on how to determine which software, if any, relating to the tangible product also would be excluded from the scope of the software revenue guidance. If the software contained on the tangible product is essential to the tangible product’s functionality, the software is excluded from the scope of the software revenue guidance. This exclusion includes essential software that is sold with or embedded within the product and undelivered software elements that relate to that tangible product’s essential software. For example, if a vendor sells a computer that includes an operating system that is deemed essential to that computer’s functionality and also sells post-contract customer support services for that operating system, both the operating system and the support services in the arrangement are excluded from the scope of the software revenue guidance.
The 2009-13 update significantly improved the reporting of certain transactions to more closely reflect the underlying economics of the transactions. Previously, the absence of vendor-specific objective evidence of selling price of the undelivered item in an arrangement was a common reason entities were unable to separate deliverables in an arrangement involving tangible products that include software. In those situations, the timing of revenue recognition may be deferred until the delivery of the last deliverable or the entire fee may be recognized over the
period during which the last deliverable is delivered or performed. As a result, constituents maintained that the accounting often did not reflect the underlying economics of a transaction. The amendments in this Update revised the scope of the software revenue guidance such that software-enabled tangible products would not be within its scope. The most significant effect of was that a vendor no longer needed to have vendor-specific objective evidence of selling price of the undelivered elements sold with a software-enabled tangible product; this is expected to increase a vendor’s ability to separately account for the sale of those products from any undelivered elements in an arrangement including those products.
Those disclosures significantly improved financial reporting by providing users with greater transparency of how a vendor allocates revenue to deliverables in its arrangements, the significant judgments made and changes to those judgments in allocating that revenue, and how those judgments affect the timing and amount of revenue recognition. The firms did not have too much flexibility to manipulate revenues.
- Is Apple’s explanation for why it adopted the new rules retrospectively clear? Is it valid?
It was totally good and valid for Apple to begin to account for its iPhone sales under the new rules. In the past, iPhones were accounted for by a 24-month subscription system whereby revenues and earnings were dribbled out over a 730-day time frame. Sell an iPhone on the last day of the quarter and book only 1/730th of the sale, the new accounting method Apple and investors were forced into were not favorable.
Apple and a number of other companies successfully lobbied the FASB to alter this muddled approach. The new regulations allowed the vast portion of the revenue generated by iPhone sales to be logged at the time of sale. Soon Apple could sell an iPhone at Best Buy and actually declare the income that quarter. Calculating iPhone deferred revenue will largely become a thing of the past.
The FASB mandated the new approach to take place at the start of the fiscal year beginning June 15, 2010. For Apple, that meant by January 2011. At that time, Apple prospectively accounted for its iPhone sales and did not need to recast its old sales. Thus, all deferred revenue associated with the iPhone on the balance sheet were moved over its 24-month amortization.
Apple had the option of moving sooner to in making the changes. However, if it didn’t, it would have risked a complicated accounting.
The adoption of the new accounting principles increased the Company’s net sales by $6.4 billion, $5.0 billion and $572 million for 2009, 2008 and 2007, respectively. As of September 26, 2009, the revised total accumulated deferred revenue associated with iPhone and Apple TV sales to date was $483 million; revised accumulated deferred costs for such sales were zero.
- Is Apple’s explanation of how it implemented the new rules clear? Is the new revenue recognition/deferral method reasonable?
It was absolutely reasonable because it increased sales hence more profitability.
The Company believed retrospective adoption provided the most comparable and useful financial information for financial statement users, is more consistent with the information the Company’s management used to evaluate its business, and better reflected the underlying economic performance of the Company. Accordingly, the Company had revised its financial statements for 2009, 2008 and 2007 in this Form 10-K/A to reflect the retrospective adoption of the new accounting principles. There was no impact from the retrospective adoption of the new accounting principles for 2006 and 2005. Those years predated the Company’s introduction of iPhone and Apple TV
The adoption of the new accounting method was well thought and as a result no negative effect was noted. It also proved that the new deferral method was reasonable.
For both iPhone and Apple TV, the Company indicated it may from time-to-time provide future unspecified software upgrades and features free of charge to customers. The Company identified two deliverable generally contained in arrangements involving the sale of iPhone and Apple TV. The first deliverable was the hardware and software essential to the functionality of the hardware device delivered at the time of sale, and the second deliverable was the right included with the purchase of iPhone and Apple TV to receive on a when-and-if available basis future unspecified software upgrades and features relating to the product’s essential software.
- Explain the changes to Apple’s 2008 and 2009 balance sheets and its 2007, 2008, and 2009 income statements. Do the restated financial statements better reflect Apple’s financial condition?
Apple’s success continued undiminished in fiscal 2008 and 2009 partially fueled by growing unit
sales of the iPhone. Still, Apple management was dissatisfied with subscription accounting for the iPhone that translated unit sales into dollar sales. CEO Steve Jobs felt the accounting understated the importance of the iPhone and confused both investors and Apple managers. Because by its nature subscription accounting spreads the impact of iPhone’s contribution to Apple’s overall sales, gross margin, and net income over two years, it can make it more difficult for the average Apple manager to evaluate the company’s overall performance.
But this past quarter, iPhone business had grown to about $4.6 billion, or 39% of Apple’s total business, clearly too big for Apple management or investors to ignore. Hence our introduction today of non GAAP financial results alongside our reported GAAP results.
At the heart of the problem for Apple was its decision to offer iPhone owners free software updates from time to time a practice that required its accountants to spread the revenue from iPhone sales over the life of a cellphone contract, typically two years. Recognizing revenue for sales of products with multiple deliverables. Then existing revenue recognition rules for products with multiple elements or ‘deliverables’ relied on ‘vendor specific objective evidence’ (VSOE) of the fair value of each deliverable. If any deliverable in the bundle did not have VSOE, revenue had to be deferred for all elements of the bundle. The financial position for Apple proved stable.
- Why are there no revised statements of cash flows in Note 2 of the 2009 10-K/A?
The previous statements of cash flows in Note 2 of the 2009 10 K/A already reflected the new rules of accounting and therefore no revision was required.
Apple Inc. was filing this Amendment No. 1 to the Annual Report on Form 10-K to amend its Annual Report on Form 10-K for the year ended September 26, 2009, which was filed with the Securities and Exchange Commission on October 27, 2009. As amended by this Form 10-K/A, the Form 10-K reflects the Company’s retrospective adoption of the Financial Accounting Standards Board’s amended accounting standards related to revenue recognition for arrangements with multiple deliverables and arrangements that include software elements. The new accounting principles permit prospective or retrospective adoption, and the Company elected retrospective adoption.