Accounting rule change in Apple's favor
Image: FASB
A change in accounting rules for which Apple (AAPL) — among other high-tech companies — lobbied heavily won tentative approval last Thursday. The change could significantly affect both the company's reported earnings and its stock price.
The new rules are in draft form and must still win final approval from the FASB — the organization empowered by the SEC to set accounting standards in the United States.
But they have the force of law. And they could put an end to iPhone subscription accounting, a balance-sheet sleight of hand required by the old rules that has confused analysts and investors from the day the iPhone hit the market.
Subscription accounting meant that Apple has been under-reporting earnings on its bestselling smartphone for two years — one of the factors, Apple bulls believe, that kept its share price from fully reflecting the success of one most profitable products Apple has ever made.
It's not clear when the rule change will take effect; one option on the table is the start of Apple's next fiscal year, which begins in less than two weeks (although Apple wrote the FASB earlier this month asking for more flexibility in terms of timing).
But whenever it happens, the impact on Apple could be dramatic. In the company's third fiscal quarter, for example, it reported earnings of $1.35 per share using the current generally accepted accounting principles (GAAP). Its so-called non-GAAP earnings, by contrast, were $2.14 a share — 58.5% higher.
"It is our belief," Apple controller Betsy Rafael wrote the chairman of the FASB's Emerging Issues Task Force in August, "that investors, analysts and preparers would benefit significantly from the proposed changes … [The current rule] often results in accounting that does not reflect the underlying economics of transactions and can result in financial reporting that lacks the transparency necessary to fully inform users making investment decisions." (link to pdf)
At the heart of the problem for Apple is its decision to offer iPhone owners free software updates from time to time — a practice that required its accountants to spread the revenue from iPhone sales over the life of a cellphone contract, typically two years.
Apple is not the only company that finds itself in this situation. Software makers like Microsoft (MSFT) and Oracle (ORCL) that do a lot of enterprise business are in the same boat. And indeed, Apple was one of dozens of companies, from TiVo (TIVO) to Xerox (XRX), that wrote to the FASB in support of the rule change.
But it could be argued that no company's product has been more misunderstood by more investors because of the old rules than Apple's iPhone.
The FASB's Emerging Issues Task Force met on Sept. 9 and 10, and decided in favor of the rule change on Sept. 10, according to Credit Suisse's accounting and tax research team. A meeting originally scheduled for Oct. 15 has been canceled; the next meeting is penciled in for Nov. 18-19.
For more on iPhone subscription accounting, see:
I will give it to Steve Jobs and Apple. They make a great consumer product that people will pay a premium for…but Apple taking share from Microsoft (in any real sense of the word)….unlikely.
Posted By Ray, Dallas, TX: September 15, 2009 5:42 PM
Apple already takes enterprise market share without even trying… this is what scares IT pros supporting Windows and that's precisely the reason why Microsoft trolls like Ray posts on Apple blogs.
You guys crack me up. Apple is a high end consumer electronics company like a Sony or Panansonic. Name one Fortune 2000 company that runs entirely on Apple software.
What are the products that comprise the Apple enterprise software stack? Oh, that is right…they don't have one!
I will give it to Steve Jobs and Apple. They make a great consumer product that people will pay a premium for…but Apple taking share from Microsoft (in any real sense of the word)….unlikely.
@Dave:
Maybe I wasn't clear, I think Apple is going to completely take the ball from Softie. Not sure how long it's going to take, but Apple already has about 99% of the mindshare, the rest can't be that far off.
However, the question was about the rule and how quickly the stock could move based on this change. Wall Street isn't going to make a move on something like this. Let me be blindingly obvious… Wall Street isn't going to up any targets on Apple just because Apple's earnings per share is about to go through the roof. They will try to buy the very limited shares AFTER it happens, not before. The institutional investors are easily 99% in the dark about Apple, and pretty uninformed about the company in general.
RE: Brian: You got it. The 90% Windows users DON'T get it, like you, for example. No problem for me. Some of them will get it. Macs are moving into businesses, where WIndows generally runs the show. That is changing. 90% of Windows users don't see that. 10% do, and some of them switch. Those switching…upper management. That is forcing IT to support Macs when they had been saying no. Now IT says we only support a few Macs, but internally IT is talking about needing to ramp up Mac support and management of their Mac systems. hen that comes online, even you will see something is happening. Most likely you will still be in denial, but it is coming. When upper management buys what IT doesn't yet support, IT ends up supporting it. That is the way it works. That is the way it is working, which is why we support iPhones and Mac laptops now that are not in the graphics department. It is coming. You can't stop it.
Laugh all you want, geniuses. But selling to the 90% Windows users is a tough sell. Apple is the company so many love to hate, maybe for their secrecy, their liberal viewpoints, their shunning of business market, no dividend, etc… Or perhaps the 90% windows users just don't get it.
The fact that 'analysts' routinely fail to account for subscription accounting revenue is well known.
Also, don't assume change occurs immediately. No one wants to be the first to jump.
A minor point. It is the Emerging Issues Task Force. As an accountant, I can verify FASB rarely has to address emergencies…
ex ped: Thanks! Fixed.
@ iphonerulez – lol
ANOTHER possible side effect is that Apple will no longer be required to charge iPod Touch users for upgrades. I think they would be happy to eliminate this annoyance for the users.
Yeah, analysts can't factor it in. How strange? Advanced math is beyond them. Apparently only a few brilliant Apple fans understand this method since investors don't seem all that impressed about Apple suddenly becoming an investment powerhouse.
I still somehow think this talk of near doubling of share price is merely Apple fanboy exaggeration. No way could something so big remain hidden without some major investor starting to buy up huge amounts of shares. Whatever, I just hope the fanboys are right because Apple could certainly use a little more boost to keep the share price inching upward.
It could be easily argued because it is true. But it's been a great buying opportunity, as the math is easy to do (despite how the 'analysts' can't seem to factor it in).
@Ray
Enterprise stack? That's a buzzword. Their enterprise software is all about making life easy for the IT guys. Do you think anyone cares about that? All MSFT have ever done is rip off others, buy others, and build monopoly barriers (like Exchange and the proprietary .DOC and .XLS formats) to any competition. They can't handle any real competition, their products don't even recognize any tech but their own, and everyone agrees they are doing a very poor job of support. It's lame.
Vista 2.0, aka Windows '7' will be just as big a flop as Vista 1.0 was, and IT types will be running for cover, realizing they can't just ignore other OSes any longer.
Ask yourself this. How much longer can MSFT get a free pass? Would any other company with so many flops still be worth anything on the market? I think not.
Apple is nearly the size of softie now, and they only have 10% of the marketshare.
Is IT buying all low end computers? They must be, because Apple already has 91% of the market for high end (very loosely defined as >$1000 machines).
I love to watch you windoze fanboys squirm. It just gets better and better as the months go by.
Last year no one would even publicly admit that Apple was gaining share.