FASB Approves Accounting Change To Quicken Tech Profits

The Financial Accounting Standards Board today approved an accounting change that would affect how tech companies recognize revenue related to hardware products that include software. The proposed change passed in a unanimous vote. Up to now, tech companies that sold products like cell phones would recognize the sale over a period of time. This change allows tech firms to record the hardware portion of those profits immediately.

The Wall Street Journal reported on this change this morning, prior to the vote. It provided some detail:

When devices combine hardware with software, the entire sale is generally treated as software under the current rules. Under the change, companies could recognize the hardware portion of the devices' revenue and the value of some software upfront; the rest of the software portion of the revenue would still be recognized gradually.

The example that WSJ uses is Apple's iPhone. Currently, Apple recognizes the sale of an iPhone over a two-year period, because that's how long it expects most customers use the device before buying another. Now, the hardware portion of the sale -- which likely accounts for the vast majority of revenue -- can be recognized immediately.

This will make a big difference in their reporting. WSJ explains:

As a result, Apple, in its quarter ended June 27, said its $8.34 billion in revenue would have been 17% higher and its $1.23 billion in earnings 58% higher if revenue was recognized all at once. Its iPhone business, which appears to comprise just 20% of its overall revenue under current accounting, is likely to be a much bigger portion after a rule change, analysts say. An Apple spokesman declined to comment on the rule change.

This change seems pretty sensible. When these hardware sales are paid for in full, the revenue really should be recognized immediately. The alternative doesn't make much sense, since these products are not really used up, have a definitive lifetime or require renewal. I think the rule provides clarity and will make it easier to see how a company's sales affect the bottom line from quarter to quarter.

However, the WSJ notes a downside:

Companies will be able to use their best estimates of the components' stand-alone sale prices in determining how the revenue gets allocated, but that could be tricky to determine because often the components aren't sold by themselves.

Accountants hate when firms have the discretion over reporting -- and for good reason: financial results should be as objective as possible. When companies can decide on numbers subjectively, results can be manipulated.

The Journal says that the rule is set to take effect in 2011, but some companies can adopt the rule sooner. So if you see sudden spikes in tech revenue from certain types of products in upcoming earnings announcements, this could be part of the reason why.

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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