Apple Case Financial Accounting

Apple case
Financial Accounting – MBA 2013 – Module Finance & Accounting

Date of submission: 02. May 2012

Tasks
Written discussion of the following questions:
1. What is the difference between ‘subscription accounting’ and the accounting approach reflected in Apple’s non-GAAP measures?
2. What are Apple management’s motives behind presenting the non-GAAP measures?
3. Whatis the discretion that Apple management has when calculating non-GAAP measures?
4. What are the pros and cons of non-GAAP measures from the perspective of investor?
5. As an investor, what would you consider ‘legitimate’ adjustments in non-GAAP measures?

Answers
1. What is the difference between ‘subscription accounting’ and the accounting approach reflected in Apple’s non-GAAPmeasures?
The term ‘subscription accounting’ describes an accounting method that is concerned with the recognition of revenues and costs arising from the sale of goods and services. Subscription accounting is used in instances in which a company has committed itself to deliver services to customers in the future whose value can be estimated with a certain degree of accuracy at the time of the sale.An example for such a commitment is the offering of free software updates by Apple Inc. following the initial sale of a package consisting of hard- and software such as the iPhone. Under the subscription accounting rules in U.S. GAAP, all cash flows associated with the sale of a product are collected and recognized at the time of sale. In contrast to cash flows, revenues and costs of goods soldare recognized over a specified period of time, which reflects the estimated useful life of the product sold. The subscription accounting method for revenue and cost recognition leads to the build-up of deferred revenues and deferred revenues on the asset and liabilities/equity side of the company’s balance sheet. Both balance sheet items, deferred revenues and deferred costs, are subsequentlyamortized over a predefined period of time with no future cash flow impact.
When comparing ‘subscription accounting’ under US GAAP with non-GAAP accounting such as IFRS, it has to be noted that under non-GAAP, no distinction is made between revenue recognition and the time of sale. Therefore, under non-GAAP accounting rules, all revenues and costs of a specific sale are recognized at the time ofsale, hence no deferred revenues and costs are recognized on a company’s balance sheet. Consequently, no amortization of such deferred revenues and expenses occurs under non-GAAP. When contrasting ‘subscription accounting’ under US GAAP with non-GAAP accounting, it has to be noted that no differences exist with respect to the cash flows.

The following three tables illustrate the effects ofsubscription accounting and immediate revenue recognition in an imaginary company. Assuming constant sales during the 7 quarters following Q1, the company’s GAAP results incorporate the subscription method while non-GAAP figures represent the immediate revenue and cost recognition method. As shown in the tables labeled “Constant Sales”, the company results in GAAP will converge to the non-GAAP figuresover time, resulting in equal revenues and margins. This demonstrates the effect that subscription accounting has on the results of the performance metrics of a company, which results in smoother revenue and earnings metrics over time, albeit from a lower base due to the amortization of revenues and cost over time. A similar picture arises when a quarter-over-quarter decline in sales is applied.While the non-GAAP financial results immediately reflect the changes in sales volumes, this effect is not immediately reflected in GAAP financials that are based on subscription accounting. In an example in which sales figures fluctuate, a similar effect on earnings occurs as revenue and cost curves in the GAAP model are smoothened out over time in contrast to the non-GAAP statements. It has to be...