Though not yet a done deal, a tentative change in accounting rules could have a dramatic effect on the earnings reports of tech companies, and in particular, Apple.
Apple stands to gain a lot from a new draft of rules that governs how companies recognize revenue from subscriptions, as Fortune noted. Though it still needs final approval from the Financial Accounting Standards Board, the change could mean that Apple will stop recognizing revenue for its highly successful iPhone over a two-year period, the length of a standard wireless contract, and instead recognize it as soon as a phone is sold.
As Apple showed for the first time in October last year, as successful as the company had been with sales of the iPhone, the current accounting practice was obscuring the true wealth the device is actually generating for the company. For the most recent quarter, adherence to GAAP (generally accepted accounting principles) meant that Apple reported US$8.34 billion in iPhone and Apple TV revenue (assume the iPhone is a large chunk of that number). In reality the company recorded US$9.74 billion in revenue.
Now, flash-forward to today, after a summer in which we saw the most successful iPhone launch of the three since 2007, and it's clear that if the revenue from each device were accounted for all at once, the company's overall earnings would be much higher. And, as Apple Vice President and Controller Betsy Rafael wrote while lobbying for the rule change, the company's stock price would likely see significant gains if investors were able to see how much money the company was actually bringing in every quarter.
In a letter to the FASB last month, Rafael wrote that the current practice "often results in accounting that does not reflect the underlying economics of transactions and can result in financial reporting that lacks the transparency necessary to fully inform users making investment decisions."
The reason Apple recognizes revenue from the iPhone over a two-year period stems from an uproar surrounding an upgrade to the MacBook Pro more than two years ago. Apple had secretly sold those laptops with an 802.11n chip but didn't activate it right away. Because the famously secretive Apple kept the existence of a new 802.11n chip under wraps, and because it recognized all of the revenue from the sale of those notebooks at the time they were sold, accounting experts said Apple had to charge a fee to satisfy accounting regulations that require companies to establish a value for product upgrades.
Apple only applies this practice to the iPhone and Apple TV, but not Macs or iPods, and it's the reason why iPod Touch owners have to pay a fee to upgrade to each new iPhone OS software update, whereas iPhone owners do not.
If the rule were to be approved by the FASB--the next meeting isn't until mid-November--it would mean a far less bewildering method of accounting for all tech companies that adhere to it, but especially Apple and investors who follow the company. And it also means we should be prepared for a bigger than usual jump in results whenever Apple does institute the practice.
This article was first published as a blog post on CNET News.
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