For some time now, analysts have pointed out that Apple’s share price doesn’t appropriately reflect the true financial health of the company, with the reason being that Apple spreads out the revenue it earns from each iPhone sale over a period of 24 months. Because Apple periodically offers iPhone users significant software updates, current accounting rules dictate that Apple must recognize all iPhone income on a subscription basis (i.e over a period of time) as opposed to recognizing it all at once. That same accounting rule is also the reason why Apple requires iPod Touch owners to pay for software updates – otherwise they’d have to defer iPod revenue as well.
In the simplest of terms, only a fraction of money derived from an iPhone sold today is cooked into Apple’s current financial statement, and while many analysts do factor this revenue deferment into their calculations, many reports still don’t appreciate the significant impact that iPhone sales have had on Apple’s financial situation and Apple’s share prices becomes arguably diluted in the process.
To wit, Fortune points out that in the third fiscal quarter of 2009, Apple posted earnings of $1.35 under the current accounting rules. Had Apple been allowed to recognize all of its iPhone income in one fell swoop, it would have reported earnings of $2.14 a share. Obviously, Apple’s financial health remains the same no matter how Apple ends up reporting its earnings, but it certainly makes its income statement look a lot stronger.
All that said, Apple is seeking special permission which would allow it to ignore the above-mentioned accounting quirk and recognize all of its iPhone revenue at the point of sale.
Apple has even laid out its case to the FASB, writing in August:
It is our belief 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.
Tomorrow, the Financial Accounting Standards Board (FASB) will take a vote on the proposed rule change, and if ratified, Apple may very well start implementing changes in its accounting as early as the first fiscal quarter of 2010, according to Morgan Stanley analyst Kathryn Huberty.