Discussion Question Set #1 – iPhone at Apple (25 points) Lenny Allegretti 1. Which accounting method best reflects the economic reality? Put another way, which accounting numbers – the GAAP or non-GAAP numbers best reflects economic reality? [10 points] Economic reality can be defined as the overall outlook of the economy at a certain point in time. This outlook includes factors such as interest rates, politics, and speculation. In its Q4 financial results Apple reported both GAAP and non-GAAP revenue and net profit for the iPhone.
Their GAAP results showed 7. 9 billion in revenue and 1. 1 billion in net profit. The non-GAAP showed revenue of 11. 7 billion and net profit of 2. 4 billion. The GAAP results reflect the usage of subscription accounting for the iPhone. Subscription accounting recognizes product cost and revenue on a straight line basis over 24 months (the average user time period of a single mobile device). This causes the sale of an iPhone to be placed in deferred revenue to be evenly distributed for the next two years. It also accounts for the costs of goods sold.
The non-GAAP results followed the time of sale method. This accounts for the product revenue and cost in the period that revenue or product cost is incurred. Considering the facts I believe that the non-GAAP numbers best reflect economic reality. These are the true numbers of how the iPhone truly performed in that quarter. Apple is a company that spends a tremendous amount of money on R & D each year and they will continue to do that until they cease to exist. Therefore, purchasing an iPhone should not be recorded as a subscription, but it should be recorded time of sale.
The fact is that Apple will continue to upgrade its platforms and its devices. The idea of straight line basis accounting for the iPhone does not follow an economic reality. The reality is people want to know how sales and revenue for the iPhone faired in that quarter. The fact that past quarters sales have an effect on that does not economically show the reality of the influence the iPhone has on Apple. 2. Should Apple lobby for their non-GAAP numbers to be sanctioned by FASB? [7. 5 points] I believe that Apple should not lobby for their non-GAAP numbers to be sanctioned by FASB.
Apple decided to use the subscription method due to consumer backlash at an upgrade fee for the iPhone. Today Apple holds a large portion of the smart phone industry. If a small upgrade fee for the iPhone was enacted I personally believe it would not affect sales. For example, people pay on average $75-$100 for their cell phone bill a month; a small $5 one or two time fee would not stray people from purchasing an iPhone. Therefore, there would be no need to lobby for the non-GAAP numbers because the new numbers with fees charged for upgrades would be accepted under GAAP.
However, with the industry standard set at free upgrades for the consumer, it may be beneficial for Apple along with other smartphone companies to lobby for this. Realistically the smartphone market is a booming market. Time will tell if these companies will decide to lobby to the FASB. Even though I believe it is not necessary for Apple to do with their current stake in the market; I do believe that it may occur with the industry standard set. 3. Does it matter if the revenue recognition rule for smartphones changes? 7. 5 points] We have established that there are two methods to recognize smartphone revenue: time of sale and subscription methods. The company providing the phone has the option on which one to pick. If they choose to offer free upgrades by GAAP they are forced to pick the subscription method. If they choose to charge a fee for upgrades they are allowed to choose the time of sale method. Since consumers are drawn into the “free” upgrades I believe that revenue recognition for smartphones will remain to be subscription.
Even though the time of sale method can be positive for companies with concerns to their financials, the industry has almost set the standard of offering consumers free upgrades. Overall, I do believe it will matter if the revenue recognition is changed. It will allow financial analysts to gather a greater understanding of the financial position a smartphone company is in. This helps gauge future growth and company position on the public market.
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