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Case 5.3 Apple, Inc.

and Retrospective Adoption of Revenue

Recognition Rules
Intermediate, pages 381-392
Revised revenue recognition rules for multiple-element sales
Financial restatements
Retrospective adoption
AICPA Statement of Position 97-2 from 1997 required that if a firm made a multiple element
sale that included software, the revenue must be pro-rated over the life of the contract using
the subscription model unless the firm had vendor specific evidence as to the value of each
element comprising the sale.
When Apple sells an iPhone, it offers free software updates for about two years. Because
Apple does not sell the software separately, it has no evidence as to the fair value of the
software. As a result, Apple recognized revenue from iPhone sales equally over a 24 month
period. If it sold an iPhone for $480, its initial journal entry would be a debit to cash for
$480, a credit to revenue for $20, and a credit to unearned revenue for $460.
Because the cost of software is trivial relative to the value of the hardware, nearly everyone
ignored Apples reported net income. Instead, they treated the sale as if all revenue should
have been recognized on the sale date. As iPhone sales grew, Apple had nearly $12 billion
of deferred revenue at year end September 26, 2009.
In October 2009, possibly in response to Apples deferred revenue, the FASB issued two
Accounting Software Updates that substantially changed reporting rules for sales with
multiple elements that include software. The primary change was that firms no longer
needed specific evidence for the fair value of each element in a sale that included software;
management judgment would be sufficient. This case covers Apples J anuary 25, 2010,
retrospective restatement of its 2009 financial statements because of changes to those rules.
The restatements increased Apples 2009 pre-tax net income by $4.1 billion and its 2008
pretax net income by $2.1 billion. The revised financial statements had no detectable effect
on Apples share price because investors essentially ignored Apples use of SOP 97-2.
Best uses:
Undergraduate intermediate accounting
First-year MBA/Executive MBA Financial accounting
Financial reporting
Financial statement analysis