Ahead of the Accounting Curve, Too

Technology giant Apple has benefited from its early adoption of new revenue-recognition rules. But for other companies, the rules could present some challenges.

With its iPad device ready to hit U.S. retail shelves next week, Apple continues to build on its reputation as a revolutionary technology company. But the computer giant is also ahead of the curve in accounting, as shown by its early adoption of new revenue-recognition rules.

In January Apple announced it had adopted the new rules in the first quarter of fiscal 2010, on a retrospective basis. The move enabled the company to accelerate the recognition of revenue for popular products such as the iPhone and Apple TV, giving revenues and profits a boost — indeed, the quarter was Apple’s best ever. The company also provided comparable financial results for its last three fiscal years as if the new rules had been in effect.

Apple is one of the few companies so far to adopt the new accounting rules, which were issued in September and come in two parts: EITF Issue 08-1 and EITF Issue 09-3. The rules change the way companies account for bundled products and services. Technology outfits that bundle elements such as hardware, software, software upgrades, and services into one product price are particularly affected, but the change applies to any company that generates revenue through a multifaceted arrangement. That may include, for example, a biotech firm or solar-energy company that has contracts detailing a raft of product and service milestones.

The EITF rules come ahead of a much more comprehensive overhaul of American and international revenue-recognition rules. An exposure draft on the larger project is due out before June, but technology companies had called for quick action on the bundled-products issue. Their call was answered by the Emerging Issues Task Force (EITF), a subset of the Financial Accounting Standards Board that issues rule revisions and guidance in response to changing market needs.

Although mandatory adoption of the EITF rules is slated for the first quarter of fiscal 2011 for calendar-year companies, Apple decided to take advantage of FASB’s offer of early adoption. By doing so, the company is permitted to recognize “substantially all of the revenue and product costs” for its iPhone and Apple TV when the products are sold to customers, as it noted in its January 10-Q.

That would have been impossible under the old rules, as historically Apple was required to follow software revenue-recognition rules and book revenue using subscription accounting. Subscription accounting is used when there are “future deliverables” associated with a product. In the case of Apple, the deliverable could have been free upgrades for the iPhone, the value of which is bundled into the selling price of the device. Under the old rules, a promise of free upgrades in the iPhone product road map (a schedule of promised product and service release dates) would have forced Apple to recognize the device’s revenue over the road-map time line. That’s no longer the case.

Now, if the software is considered “essential to the functionality of the product,” a company can abandon the software-recognition rules and instead estimate the selling price of the undelivered elements, defer just that chunk of revenue, and book the rest. That accounting process is known as the relative-value method of allocation.

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