Last fall, the Financial Accounting Standards Board (FASB) approved changes to the way many high-tech companies will recognize revenue. We saw the first of what will be many earnings reports affected by this when Apple reported on Monday results of its fiscal first-quarter earnings.
Other companies likely to be affected include such heavy weights as Cisco Systems and Tivo.
Often such changes take months for companies to adopt. And in this case, companies have until 2011 to adopt them. But this one is different because it will give companies a significant bump in short-term revenue. So many are racing ahead. As such, investors need to watch carefully to see if a company adopted the new standard, and if they reconciled old numbers to take the new standard into account.
On Monday, Apple disclosed the accounting change up front for this year, and also adopted it retrospectively for the past two years and reconciled past earnings in an amended annual filing. Companies are not required to do adopt it for past years. So good for Apple. Many companies may only make the change going forward, making comparisons harder.
This change is not trivial. To see the impact on revenue, look at the revised numbers from years past. The change bumped revenue for Q1 2009 (last year) from $10.2 billion (0ld) to $11.9 billion (new). As far as I can tell, the company didn’t disclose what the current quarter revenue would have been under the old standard.
Still, that didn’t stop the company, in a press release, from crowing about the big numbers:
“If you annualize our quarterly revenue, it’s surprising that Apple is now a $50+ billion company,” said Steve Jobs, Apple’s CEO. “The new products we are planning to release this year are very strong, starting this week with a major new product that we’re really excited about.”
That’s true. But under the old standard, Apple’s annualized revenue wouldn’t be quite as high. It would probably be four or five billion less, though still over $50 billion.
So what’s going on? For the details, read on.
FASB adopted the new rules in September, dubbed Accounting Standards Updates 2009-13 and 2009-14.
Last fall, I had a chance to talk with Kelley Wall, a senior consultant at RoseRyan, a Newark-based accounting and finance consulting firm, who walked me through the upcoming changes.
“We are going to see a spike in revenue,” Wall said. “Revenue won’t be smoothed over time.”
As Wall explained, the change affects companies that sell a product that contains a bundle of things, such as hardware, software and services. If you just sell software, you recognize the revenue over an extended period of time, as a kind of subscription, because the accounting assumes that you’ll be offering periodic updates for free over that time.
Where things have been muddled in the past is when you sell a gadget that includes both hardware and software. Do you recognize the revenue all at once? Or spread it out? Companies like Apple have been spreading it out for products like the iPhone and Apple TV.
You may recall that last summer, when Palm started selling the Pre, it switched from recognizing all the revenue up front for its gadget, to recognizing them over two years. After that big change, Palm will now have to switch back.
This can be a good thing, as in the case of Palm, because the company said last summer that the change would allow it to offer free software updates without having to count them as additional costs or to charge for them. On the other hand, it can be extremely confusing for investors who didn’t know the changes were coming. Also, as Wall points out, different companies will adopt at different times, making comparisons with competitors dicey over the coming year.
Despite the big impact, the FASB discussions hadn’t been on the radar for many analysts who were scrambling after Apple’s earnings to re-calculate their projections based on the new accounting.
While this seems to be good news in the short term, the problems with the changes, if there are any, might be seen over time. When counting revenue over time, companies have a baseline that makes their income seem less volatile, or bumpy. But if you count the sale all at once, then there could be more swings from quarter to quarter which will be tied much more closely to sales that period.
In other words, the short-term sales numbers will be much more clear, and so will the need to keep them growing. You can’t rely on the lingering revenue from quarters passed to make things look healthy.
