Did we miss this somewhere along the way?

http://www.cnbc.com/id/32636006?__source=RSS*blog*&par=RSS

Few understand deferred revenue accounting so the story does not grab attention. It’s also speculation. I’d much prefer Apple’s method to be accepted by the GAAP folks (become the standard in this instance and instances) than for Apple to change its current method of accounting for iPhone sales.

I don’t see Apple giving up subscription accounting; I see it increasing as hardware prices fall, and Apple’s cloud services get more extensive and compelling, and as VOIP becomes the norm.

What FASB does its up to them, but it’s likely to move both sides (Apple and the non-subcription mainstream) towards a central point of comparable accounting.

sleepytoo - 03 September 2009 06:54 AM

I don’t see Apple giving up subscription accounting; I see it increasing as hardware prices fall, and Apple’s cloud services get more extensive and compelling, and as VOIP becomes the norm.

What FASB does its up to them, but it’s likely to move both sides (Apple and the non-subcription mainstream) towards a central point of comparable accounting.

Agreed. 

I suspect deferred revenue or subscription accounting is here to stay and more concrete and uniform guidelines established for its use.

I posted this earlier in the “China” thread, but it might be (slightly) relevant here…

“IF, IF, IF (can you tell I want to qualify this) China Unicom is the party legally/technically responsible for delivering iPhone software updates, then Apple might be able to immediately (not over 2-years) recognize the revenues from their iPhone presale to China Unicom. IF the quantity/price presale rumors are true, this would be a nice $1.46 billion add to revenue in the next quarter for Apple (AAPL).”

Down in the “Welcome to the “wild rumors” portion of the show” at

iPhonAsia

issue#1 - 03 September 2009 11:08 AM

I posted this earlier in the “China” thread, but it might be (slightly) relevant here…

“IF, IF, IF (can you tell I want to qualify this) China Unicom is the party legally/technically responsible for delivering iPhone software updates, then Apple might be able to immediately (not over 2-years) recognize the revenues from their iPhone presale to China Unicom. IF the quantity/price presale rumors are true, this would be a nice $1.46 billion add to revenue in the next quarter for Apple (AAPL).”

Down in the “Welcome to the “wild rumors” portion of the show” at

iPhonAsia

I don’t see that as a cause to change accounting methods. No matter which entity delivers the updates to the consumer, Apple is still obligated to provide the updates for distribution as part and parcel of the contract.

I find it ridiculous that anyone in a position to recommend stocks (Credit Suisse, et al) doesn’t understand subscription accounting.  Did these analysts come straight from Burger King?

I certainly hope subscription accounting, at least as applied in Apple’s case, is ended.

It has been an unmitigated diasater.

The purpose of financial reporting and associated rules is to foster transparency and understanding so that shareholders, investors, regulators and other interested parties can fairly evaluate the health of a company.  This has FAILED in the case of Apple.

There is LESS understanding about the true financial picture of the company. The confusion has gotten so perverse that even Apple itself must post two sets of numbers - keep two sets of books to try to get the message across.

For Christ’s sake, how on earth is one expected to hope that ordinary investors would fairly grasp the implications of Apple’s future recognition of earned profits if even the mainstream financial press, high profile analysts and even fairly sophisticated investors DON’T GET IT?

It has become a farce. The current form of subscription accounting has misinformed investors, obfuscated Apple’s true financial health and done a gross disservice to current shareholders.

It’s a shame that this is allowed to go on.

Mike in Helsinki - 06 September 2009 07:41 AM

It’s a shame that this is allowed to go on.

MiH:

I wouldn’t call it a farce. Palm is using the same accounting method for the Pre. It’s required by law since the implementation of Sarbanes-Oxley. I’d much prefer GAAP rules adopt this method so the reports are consistent and the method becomes the standard.

The variances between GAAP and non-GAAP will gradually narrow and this method may become more common as Apple increases the number of products and services sold under a contract with a determined beginning and end date rather than an outright sale to the consumer.

DawnTreader - 06 September 2009 10:25 AM

Mike in Helsinki - 06 September 2009 07:41 AM

It’s a shame that this is allowed to go on.

MiH:

I wouldn’t call it a farce. Palm is using the same accounting method for the Pre. It’s required by law since the implementation of Sarbanes-Oxley. I’d much prefer GAAP rules adopt this method so the reports are consistent and the method becomes the standard.

The variances between GAAP and non-GAAP will gradually narrow and this method may become more common as Apple increases the number of products and services sold under a contract with a determined beginning and end date rather than an outright sale to the consumer.

I also wouldn’t call it a farce but agree total with MiH.  The problem for the average analyst and investor is almost every other stock does not follow the same rules so when Apple is compared to the universe their growth rates are grossly misrepresented. If the Iphone would have been a failure this would not have mattered, but the fact that the Iphone is powering Apple ahead during a recession is lost on 90% of the investing public.  If you look at the GAAP numbers for 2009 vs 2008 their is small bit of growth when in reality Non-GAAP paints a totally different picture.  I agree that at some point analyst and investors will recognize the changes as the revenue appears on the GAAP side of accounting but we will have to wait to be rewarded for Apple the company’s stellar performance.

MIke, I think you’re wrong, for many reasons. But the simplest one is that the carriers act as distributors for iPhone; the “true” situation is that the real buyer is paying for iPhone over about 2 years. The carrier takes on debt and hands the borrowed money over to Apple. The carrier then expenses this debt amortized over the contract life. It’s more honest accounting IMO for Apple to make the matching reverse adjustment: cash has been lent to Apple by the carriers and is recognised as revenue as the real iPhone owner pays for it through contract servitude.

To put it another way, the bean counters who run the carriers lent money to the happy handset engineers, fooling them that they were getting a wonderful price for their product, and thereby stole control of handset specifications to drive still higher service revenues/margins. Apple wisely wanted none of this, and has protected itself with subscription accounting against the day this artificial business model breaks under market forces. At that point, “high margin” smartphone makers who are not subscription accounting will hit a horrible earnings wall, while Apple will go on unaffected. If that day never comes, Apple may become the first global MVNO; iPhone free with mobileMe plus voice. The huge negative cashflow impact of funding all those iPhones paid for out of the accumulated cash mountain; the reported revenue/earnings having not a hiccup.

Edit: I’m delighted about subscription accounting. It also helps to win the market war without bloodshed. The others wake up one day having already lost.

If you are a long term investor (5 years plus), you should be delighted that the market is underpricing Apple; you can buy more at a discount. If you are (also) trading, then your understanding of the market’s misunderstanding Apple gives you a trading edge, no?

sleepytoo - 06 September 2009 11:47 AM

Edit: I’m delighted about subscription accounting. It also helps to win the market war without bloodshed. The others wake up one day having already lost.

If you are a long term investor (5 years plus), you should be delighted that the market is underpricing Apple; you can buy more at a discount. If you are (also) trading, then your understanding of the market’s misunderstanding Apple gives you a trading edge, no?

These are important points. Subscription accounting (and the eventual realization of its impact) are among the reasons I see AAPL reaching $300 per share (based on today’s share equivalents) relatively quickly.

Other benefits of subscription accounting include:

A softening of the eventual seasonality of iPhone sales.

A deepening of the Apple/customer relationship from a transaction paradigm to one of an “ongoing conversation” with the customer over the two-year anticipated economic life of the product.

However, the variance between GAAP and non-GAAP results due to iPhone sales will gradually narrow especially as a percentage of iPhone revenue as the 3GS iPhone continues its global advance. The variance becomes the difference between the unit sales in the reported period and the historical handset sales in the prior seven quarters and only a small percentage of sales in the current period is recognized. Necessarily the variance in reporting will narrow and eventually materially extinguish itself.

As much as subscription accounting may be misunderstood, I don’t think the quality of reporting in today’s world would accurately reflect the seasonality of Apple product sales resulting in misleading reporting on current-period results if all iPhone sales were fully baked into the results.

In other words, this issue will gradually eliminate itself over time.

Mike in Helsinki - 06 September 2009 07:41 AM

I certainly hope subscription accounting, at least as applied in Apple’s case, is ended.

The purpose of financial reporting and associated rules is to foster transparency and understanding so that shareholders, investors, regulators and other interested parties can fairly evaluate the health of a company.  This has FAILED in the case of Apple.

There is LESS understanding about the true financial picture of the company. The confusion has gotten so perverse that even Apple itself must post two sets of numbers - keep two sets of books to try to get the message across.

For Christ’s sake, how on earth is one expected to hope that ordinary investors would fairly grasp the implications of Apple’s future recognition of earned profits if even the mainstream financial press, high profile analysts and even fairly sophisticated investors DON’T GET IT?

It has become a farce. The current form of subscription accounting has misinformed investors, obfuscated Apple’s true financial health and done a gross disservice to current shareholders.

It’s a shame that this is allowed to go on.

MiH I agree with you sentiment. Subscription accounting does obfuscate things. Not only for shareholders but for the consumer. One of the reasons I thing there is so much angst against telcos in general is their spurious manner of explaining contracts and rates. For instance why does my telco give me $640 of value per month for $60 subscription??? ..... they don’t… They give me less than $60 per month value so that they can make a profit.

sleepytoo - 06 September 2009 11:47 AM

MIke, I think you’re wrong, for many reasons. But the simplest one is that the carriers act as distributors for iPhone; the “true” situation is that the real buyer is paying for iPhone over about 2 years. .

The huge negative cashflow impact of funding all those iPhones paid for out of the accumulated cash mountain; the reported revenue/earnings having not a hiccup.

Edit: I’m delighted about subscription accounting. It also helps to win the market war without bloodshed. The others wake up one day having already lost.

If you are a long term investor (5 years plus), you should be delighted that the market is underpricing Apple; you can buy more at a discount. If you are (also) trading, then your understanding of the market’s misunderstanding Apple gives you a trading edge, no?

As a consumer I want the option to purchase my products outright. With a subscription model I get a general “I’m being fleeced” feeling (If that does not translate… I mean, getting ripped off). I do get that it can be a great way to generate revenue, as it is by drawing smaller portions of blood in regular amounts rather than having the ‘pound of flesh’ extracted in one go.

sleepytoo - 06 September 2009 11:47 AM

I don’t see Apple giving up subscription accounting; I see it increasing as hardware prices fall…..

But Apple does not fit into this model per se. Apple is a value proposition and not a baseline commodity. Apple could redefine the microwave oven and sell it for four times as much and it would sell like hotcakes. I certainly hope that Apple does not become entrenched in the subscription model, but rather uses it to supplement its revenue stream in establishing market share and mind share.

benoir - 07 September 2009 12:20 PM

But Apple does not fit into this model per se. Apple is a value proposition and not a baseline commodity. Apple could redefine the microwave oven and sell it for four times as much and it would sell like hotcakes. I certainly hope that Apple does not become entrenched in the subscription model, but rather uses it to supplement its revenue stream in establishing market share and mind share.

As I understand Apple’s position, subscription accounting is required under SOX in order to comply with the law. Palm is following the same model for the Pre. To eliminate subscription accounting under the law, Apple would need to charge iPhone customers for each OS upgrade (as the company does for the iPod touch). This is not the manner in which Apple desires to “converse” or deepen the relationship with the company’s iPhone customers. Knowing I will receive free OS upgrades in my view assists in justifying the two-year carrier contract and adds value to the device. My cell phone will not face accelerated obsolescence and I will not be charged an additional fee to keep my iPhone as technologically current as possible.

DawnTreader - 07 September 2009 12:48 PM

As I understand Apple’s position, subscription accounting is required under SOX in order to comply with the law. Palm is following the same model for the Pre. To eliminate subscription accounting under the law, Apple would need to charge iPhone customers for each OS upgrade (as the company does for the iPod touch). This is not the manner in which Apple desires to “converse” or deepen the relationship with the company’s iPhone customers. Knowing I will receive free OS upgrades in my view assists in justifying the two-year carrier contract and adds value to the device. My cell phone will not face accelerated obsolescence and I will not be charged an additional fee to keep my iPhone as technologically current as possible.

I guess this is the point in difference with Apple in that they are creating a value proposition with updates and so on. I suppose as long as I see a subscription as a value proposition and not as a means of ripping me off then I would be satisfied. I have no problem in paying for premium products and Apple falls into this category. So I agree with your point DT….

benoir - 07 September 2009 12:59 PM

I guess this is the point in difference with Apple in that they are creating a value proposition with updates and so on. I suppose as long as I see a subscription as a value proposition and not as a means of ripping me off then I would be satisfied. I have no problem in paying for premium products and Apple falls into this category. So I agree with your point DT….

In this case I see Apple using SOX to its advantage. Adopting subscription accounting not only complies with SOX, it also establishes a strong precedence for competitors who seek to follow Apple’s model of providing free updates to use the same accounting method. For handset makers who choose not to provide free OS upgrades over the anticipated economic life of their handsets Apple claims a value-added advantage.

Again, the variance between GAAP and non-GAAP results relative to iPhone sales will gradually diminish over time.

I understand your initial concerns and MiH’s points as well. But I’m not sure coverage of Apple would become anymore accurate if subscription accounting was not deployed.

I do find sleepy’s point appealing. For those of us who have taken the time to understand Apple’s approach to iPhone accounting, we do have a real advantage in seeing the company’s discounted share value and we stand to reap the benefits of the rising share price as this method of accounting is eventually understood.