How New Accounting Rules Affect High Tech

(MoneyWatch) 

The changes in revenue recognition rules by the Financial Accounting Standards Board (FASB) were seen by most in light of what it might mean to Apple earnings, as it would no longer have to delay recognizing a good chunk of iPhone hardware revenue. However, for all the thought that Apple stock price would rise because so would earnings estimates, it's easy to forget that there are actually other tech companies that have to look at the issues. Some may gain an advantage over competitors, and even for Apple this isn't a change without a downside.

The whole to-do is over how a company recognizes revenue when it sells hardware and software that are packaged together. Previously under U.S. GAAP accounting rules, when companies started offering hardware, services, software, and support as a package, "their sales organizations [got] pretty creative on how these things are priced," says Steve Hobbs, a managing director with Protiviti. As the salespeople bundled things, or split them apart, and changed pricing, it became very difficult for the accounting departments to be able to point to a definitive price for products. So under GAAP, they often had to start amortizing hardware and software sales over the period of time they were used. "All of a sudden some companies were letting the accounting rules dictate what they were doing with pricing with respect to their customers," he says.

The new rules change that, allowing the hardware portion of the sale to be recognized immediately, putting U.S. rules closer to those used in the International Financial Reporting Standards used in most of the rest of the world. But the change can have some unpleasant effects, depending on how a high tech company has designed and sold its products. "If you had two competitors and one had a software only solution and the other had a bundled hardware and software solution, the competitor with the hardware software solution under these rules would get more favorable accounting," says Brian Minnihan, a partner in the technology practice of BDO Seidman.

Suddenly company A with the combined solution can recognize a bigger piece of revenue up front, while software-only company B is forced to continue amortizing the entire amount, so A looks better to investors. Also, the advantage only lasts so long because the lack of delayed recognition of revenue means that money which would have appeared in later quarters suddenly won't be there.

And so the sudden revenue increase for Apple will also level out. But there are other considerations for the company. Apple has been able to hide somewhat behind the revenue recognition rules, with much of the hardware sales relegated to deferred revenue and no one outside of the company sure about how it will be applied. That put Apple at an advantage over its competitors in the smartphone space. Now that obfuscation from regulation largely disappears.

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