BKAL 3063 INTEGRATED CASE STUDY

GROUP E (6)

(CASE REPORT ANALYSIS OF ACCOUNTING FOR THE IPHONE AT APPLE INC)

GROUP MEMBERS:

Norpadilah Binti Mohd Roslanudin 224031

Nur Fatihah Binti Zainal Lim 221536

Siti Filzah Binti Muhamad Nadzri 221357

Ummi Fadhilah Binti Mansor 221410

LECTURER’S NAME:PN ROHANA @ NORLIZA BT YUSSUF

SUBMISSION DATE:6 OCTOBER 2015

EXECUTIVE SUMMARY:

Apple Incorporation was establish as the phone manufacturer and produce products such as

smartphone, iPod touch user and also develop extraordinary application store which provide their

user with wide variety of mobile applications ranging from games to productivity tools. This

company has undergone the rapid development on their technical and design innovation about

the software updates. Apple announced the financial results for Quarterly of every year. The

highlighted issues in this case, this Apple Incorporation use GAAP and Non-GAAP reporting as

attempt to disclose about their quarterly results and share value. The solutions to overcome this

issues by suggest that Apple Inc should immediately cease giving GAAP-based

earnings guidance and instead offer guidance on adjusted earnings. Next,

Apple also can implement the uses of Non-GAAP recognition because by

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using this method, it could show how much a company is actually making in

a particular period.

1.0 INTRODUCTION

Financial reporting is important to provide financial information about the reporting

entity that is useful to existing and potential investors, lenders and other creditors in making

decisions about providing resources to the Apple Incorporation. To produce the reliable financial

reporting Apple Incorporation prepared financial report accordance to the GAAP which is

include of the common set of accounting principles, standards and procedures that companies

use to compile in their financial statements.

However there also have the uses of the Non-GAAP earnings in this company in

addition to the required GAAP earnings, stating that the alternate figure more accurately reflects

the company's performance. Some common examples of non-GAAP earnings measures are cash

earnings, operating earnings, and pro-forma income. A non-GAAP financial measure is a

numerical measure of a company’s historical or future financial performance, financial position

or cash flows that includes or excludes amounts from the most directly comparable GAAP

measure.

The Securities and Exchange Commission (SEC) in U.S permits companies to present

non GAAP financial measures in their public disclosures as well as registration statements filed

under the Securities Act of 1933 (Securities Act) and periodic reports filed under the Securities

Exchange Act of 1934 (Exchange Act), subject to compliance with Regulation G and Item 10(e)

of Regulation S-K (Item 10(e)). These regulations were adopted to ensure that investors are

provided with financial information that is fulsome and not misleading.

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2.0 ANALYSIS OF PROBLEM

2.1 Statement of problems

In 2008 Apple decided to include non-GAAP measures of earnings along with its

earnings under GAAP. The results had shown that there was a 48% increase different between

the two methods. Revenues and income under non-GAAP recording are exponentially larger

which seems like the obvious choice in recording revenues. However, the issue is, because of

Apple must recognize revenues under GAAP so that they are required to use the “subscription

method of accounting.” According to a CBS Marketwatch article, under the accounting method

used in the past, the company would recognize a full month’s revenue from a subscription

agreement, even if a deal was sealed in the middle of the month, for example, the effect of the

accounting change is to defer a portion of the revenue that had previously been recorded during

the month that the subscription started to the end of the contract. So what it comes down to is a

timing issue. In the example just now, a full month of revenue gets recognized even only if the

customer signed in the middle of the month.

Under GAAP Apple is required to record under software revenue recognition. This

requires that Apple have to recognize revenues and product costs on a straight line basis for the

life of its service coverage periods. Revenue has to be deferred and recognized over time. The

impact of this on the income statement is that reported revenues would only account for a small

portion of actual sales of the product. This make the company not making a high profit. On the

other hand, Non-GAAP recognition show how much a company is actually making in a

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particular period. Apple decided to provide its non-GAAP financial statements to show revenues

without the subscription accounting method. The non-GAAP method makes companies look

more profitable on their financial statements by boosting the revenue that would be recognize.

This method tends to benefit the company instead of shareholders and customers. Also, it does

not account for things that may happen between the time of purchase and the end of the

subscription period.

2.2 Cause of problems

Opportunistic reasons

Apple Corporation exploiting chances offered by immediate circumstances without reference to

a general plan whereby they use subscription accounting for the solution to adopt for them to

provide free software updates to iPhone users under GAAP accounting rules. While they used

Non-GAAP results "eliminate the impact of subscription accounting," which is a strange way to

describe deferred revenue, unless the objective is to convey stronger performance regardless of

accounting standards

The Power of Control in Top Management

Apple Incorporation use the power to make an agreement with the AT&T to get benefit from the

iPhone sales whereby they does not follow the mobile carriers that provide subsidies to lower the

purchase price of the new phone. They tend to make a revenue-sharing agreement that gave

Apple a share of the subscribers’ monthly service fees. Apple should realize the money when

they get it. So if AT & T pays Apple when a customer buys an iPhone for the entire length of the

contract then Apple should report the total amount. If AT & T gives Apple a check every month

then they should report what they got.

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3.0 ALTERNATIVE SOLUTIONS

The numbers in the Financial Statement in Apple Inc. were different

under the two methods. There is little to nothing Apple could do to fix the

current market perception regarding its fundamentals in the short term,

Apple can take certain defensive steps that could potentially alter the

market’s views in the long term. Therefore, there are two alternative

solutions that Apple can implement which is follow GAAP and non-GAAP

accounting method.

First, Apple should immediately cease giving GAAP-based earnings

guidance and instead offer guidance on adjusted earnings. If Jobs really

wants the market to shift its focus from Apple’s GAAP-based earnings to real

earnings, then he really needs to start offering guidance on an adjusted basis

which a practice that several other tech companies already employed. By

doing this, Apple would benefit in both the short and long term.

It would benefit in the short term because there are no adjusted-

earnings “guidance expectations” that Apple would have to meet because

there are no adjusted-earnings consensus estimates at the present moment.

Thus, near-term strong earnings results would not be hampered by Apple’s

excessive conservatism in guidance because Apple would not be guiding

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below any expectations. In other words, Apple would limit near-term

headline risk regarding its guidance because it would simply not be providing

any.

Yet, the major benefit Apple would gain from offering only adjusted-

based earnings guidance is that analysts will be forced to comment and give

estimates on Apple’s adjusted earnings which will eventually shift the market

focus in that direction as well.

Furthermore, Under GAAP companies recognize revenues when

persuasive evidence of an arrangement exists, delivery occurs, price is fixed,

and collection is probable. Thus, the GAAP method best reflects the

economic reality because it accounts for actual instances where sales cannot

be recognized, such as when deliveries are lost, subscriptions are cancelled,

or when payment isn’t collected.

The next solution that Apple can implement is use Non-GAAP

recognition. By using this method, it could show how much a company is

actually making in a particular period. This makes it easier for a company to

show its potential for future performance. Apple decided to provide its non-

GAAP financial statements to show revenues without the subscription

accounting method which recognized the revenue at the point of sale.

The non-GAAP numbers did not adjust the estimated costs associated

with its plan to provide new features and software upgrades to Iphone

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buyers free of charge and these figures were not prepare under a

comprehensive set of rules or principles.

Apple should really consider is doing away with subscription accounting

altogether. It could do so in tandem with its next iPhone refresh by stating

that third-iteration iPhone purchases will have to pay for future software

upgrades as they become available. All previous 3G and EDGE iPhone

revenue would be amortized under subscription accounting while next

generation iPhone revenue would be recognized at the point of sale in the

quarter in which the sale occurs.

4.0 RECOMMENDED SOLUTIONS

The best recommended among the alternative solution for Accounting for the iPhone at

Apple Inc. is by using non-GAAP recognition.

It is because when Apple Inc. using non-GAAP tends to benefit the company instead of

shareholder and customer. It is because revenue and income recording by using this method is

larger which seem like obvious choice in recording revenues and it shows how much a company

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actually making a sale of iPhone. When record the actual revenue and sale, the company look

more profitable on their financial statement be boosting the revenues that would be recognized.

When using the real revenue and sale, easy for company to predict the performance in

future and better information for future investor to invest in the company. Research also, suggest

for Apple to used non-GAAP supplementary disclosure to communicate adjusted accounting

number that better prediction future performance it also assuming that non-GAAP numbers

informative and credible. By using non-GAAP it does a not mean Apple make any fraud or

misconduct of financial statements. By doing this, Apple would benefit in both the short and

long term.

5.0 EXTERNAL SOURCING

https://www.sec.gov/rules/final/33-8176.htm

http://www.skadden.com/newsletters/Corporate_Finance_Alert_The_Use_of_Non-

GAAP_Financial_Measures_A_Disclosure_Guide.pdf

http://faculty.washington.edu/rbowen/cases/Apple%20Revenue%20Rec%20Strategy

%20(A)_10-10.pdf

http://www.beyondvc.com/2004/07/subscription_ac.html

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http://bullishcross.com/2009/01/how-the-iphone-and-poor-apple-management-have-

contributed-to-the-downfall-of-apple/

http://seekingalpha.com/article/132536-apples-non-gaap-earnings-are-the-real-story

http://bullishcross.com/2009/01/how-the-iphone-and-poor-apple-management-have-

contributed-to-the-downfall-of-apple/

http://bullishcross.com/2009/01/how-the-iphone-and-poor-apple-management-have-

contributed-to-the-downfall-of-apple/

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