The Accounting Behind iPods

Posted on 09. Feb, 2008 by in Accounting, Business, News

Apple announced in a quarterly earnings call last year that they’d be doing something interesting (to me at least) with the revenue recognition of iPhones and the AppleTV. Instead of recognizing the revenue of a $500 iPhone on the date of sale or delivery, Apple would recognize the revenue over time – 24 months to be exact. Why the difference? Apparently Apple had decided that enough features would be rolled out subsequent to the device’s release that it wouldn’t be complete. Put another way, bundled in the price of the iPhone was 2 years worth of free upgrades. As far as GAAP (Generally Accepted Accounting Principles) go, this may or may not have been the correct treatment. In my mind, I could come up with arguments for and against this treatment. But in the end Apple, and its auditor KPMG, thought that the deferral of revenue into the future would be appropriate.

Now just a few weeks ago, at the Macworld Expo in San Francisco Apple announced software upgrades to the iPhone, the AppleTV, and the iPod Touch. As expected, the iPhone and AppleTV owners weren’t charged a dime because that type of upgraded was included in the original purchase price.

However, the software update to the iPod Touch was more significant that the others with the addition of five new mobile apps—Mail, Maps, Stocks, Weather, and Notes. So Apple decided that such a significant software upgrade would require $19.99 to activate. Now I have no problem with Apple charging for the new apps. In fact, I think it adds to the perceived value that the iPod Touch has and adds even more value to the software running the iPod Touch as well as the iPhone. What I do have a problem with is everyone and their dog explaining that Apple was forced to charge for the upgrade, citing GAAP accounting principles or even worse, Sarbanes-Oxley.

Doesn’t anybody remember the $1.99 charged for the 802.11n wireless adapter last year? Everyone blamed the extra fee on accounting rules then, just as they are now. But the more stories I read, the more that this argument appears asinine. Why would any company be forced to charge for a product? Hasn’t anyone heard of Google?

The simple fact is that Apple charged $19.99 because they thought the upgrade was worth it. Whether or not you agree is up to you, but it had nothing to do with accounting principles. In fact, I went back and dug up this quote from Lynn Turner, former chief accountant of the Securities and Exchange Commission, which I thought explained the situation perfectly:

“[generally accepted accounting principles] doesn’t require you to charge squat. You charge whatever you want. GAAP doesn’t even remotely address whether or not you charge for a significant functionality change. GAAP establishes what the proper accounting is, based on what you did or didn’t charge for it.”

In this light, the revenue recognition treatment of the iPhone and AppleTV appears reasonable because the accounting rules apply to how the company dealt with the $500 it had already charged customers. In fact, it is probably in Apple’s best interest to “smooth” the earnings of the iPhone over 24 months instead of recognizing it all up front and then explaining subsequent drops in earnings. In that case, the accounting treatment used is a privilege for Apple, not a requirement.

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