Before 2009, for multi-element product, a company required to obtain the specific evidence of separate selling price of every element of the product. If it could not provide it as per the strict valuation requirements (EITF 0021), it has to sell the product as a single unit and estimate its revenue over extended period of the time i.e. life of the product.
In 2007, Apple released iPhone which had both hardware and software components. As per the contract, company was committed to customers to provide all the future updates of software free of cost.But it was very difficult to calculate the exact price of these future updates, because sometimes update had not been designed or its market price was unknown. Hence, company used to sell iPhone/ Apple TV as a single package of hardware, its required software and all the future upgrades and identify its revenue over a period of 2 years. As a result of this, most of the price of the product used to be a part of a deferred revenue. So, although with the sales of iPhone, company was growing exponentially, profit margin was considerably constant, which was directly affecting earning per share. This was clearly underestimating the company’s revenue and that’s why Apple presented Non – GAAP financial results along with GAAP results in Oct 2008.
In 2009, due to the constant demand by many tech companies, FASB approved two standards EITF 01-9 and 08-13. These standards permitted the company to break the product in multiple units and recognize its revenue at different time periods. Also it allowed company to ‘estimate’ the selling price of these units if actual value cannot be calculated. Apple, immediately used these standards. Thus, Apple’s earnings boosted and most of the selling price of the unit got accumulated in revenue part, leaving very little portion for the deferred revenue.
These changes got clearly reflected in the stock price.
In summary, although this revenue recognition method did not affect that on the cash activities, it certainly increased company’s retained earnings. As company adopted this standard just before the release of an iPad, it certainly offered a company a strong position in a market.
References:
http://blogs.wsj.com/marketbeat/2010/01/25/apple-earnings-the-iphone-accounting-issue/
http://www.apple.com/pr/library/2009/10/19Apple-Reports-Fourth-Quarter-Results.html
http://www.ft.com/intl/cms/s/2/2c9a239a-0a04-11df-8b23-00144feabdc0.html#axzz2gnQ5iF48