WRITE-UP 2

1) What are the key features of the iPhone business model?

Apple launched the Personal Computer revolution, then it catalyzed the digital-
media industry (iPod and iTunes) and then entered in the mobile-phone market with
the iPhone: a smartphone with a touch-screen interface and the company’s now
mobile operating system, iOS.
The original iPhone was available with a partnership with AT&T (selling strategy).
Both Apple and AT&T gained for this agreement: revenue-sharing. To make iPhone
more attractive, Apple announced that the following software updates would have
been free oof charges (while Mac and iPod ones were for a fee). The competitive
advantage consists of this. Apple continued to differ from most other industry
participants when it offered existing iPhone users upgrades to its second-generation
operating system at no cost.
Furthermore, iPhone business model started focusing on customer, customer
experience and customer acceptance. People should speak well of Apple!

2) What is subscription accounting? What impact does it have on a firm’s cash flows?
Subscription accounting is a different way to calculate revenues and COGS. Apple
recognized these on a straight-line basis over 24-month (which is the economic life
of the iPhone). With this method you divide the revenues by 24 and shift them in
each of the following months. The revenues are deferred but the cash flows do not
look at accounting methods  no impact on Cash Flows.

3) Does Apple use subscription accounting for its iPhone? What about for its Mac
computers? Why or why not?
Yes Apple uses subscription accounting for its iPhone. For its Mac computers Apple
does not use the subscription accounting method, revenues are recognized at the
time of sale. In fact when the iPhone business grew, it was necessary to introduce
also the non-GAAP financial results io order to have either a distorted analysis and a
realistic one.
The reason of the non- subscription accounting for its Mac could be that their
software updates and new features are for a fee.

4) Discuss GAAP, non-GAAP numbers and their impact on financial statements.

Which method best reflects economic reality?
GAAP and non-GAAP numbers are too far from each other. If we focus out attention
on the Q4 of 2008 we see that total sales with the Non- GAAP method is much
higher than with the GAAP (where they are accounted with subscription accounting).
And it is mostly driven by the iPhone sales. The increase of total sales is by 48% and
of iPhone Sales is by 475% if we use the Non-GAAP method. This could not be the
same if we analyze another quarter (ex. when there is not the launch of the new
iPhone).
 In my opinion the GAAP method is the one which best reflects the economic reality. I
believe that Apple uses resources, puts effort, has costs, ecc… for 1 entire year and
then launches the new iPhone model. The revenues are, in this way, not linear and
they do not reflect the effort and the economic results that the company puts in
please for the whole period before the launch. The economic reality is that Apple
works hard for 1 year and the revenues should be aligned with this.
Another example is a company which builds cruise ships. They work or 5 years and
then they get the revenues at the end. It is not fair to recognize them only at the
end. They should be deferred or anticipated in order to reflect the reality.

5) How would a change in the revenue recognition rule for smartphones affect
Apple?
For sure Cash and Net Income would be more aligned if they changed the revenue
recognition according to the Non-GAAP method. There would be more seasonality
and more variability in sales. The income statement would definitely be affected by
this change but the Cash Flow Statement will not.

6) A finance student says, “Why pay any attention to accounting earnings numbers,
given that a ‘clean’ number like cash from operations is readily available?” Why do
you agree or not?
I do not agree with this statement. This finance student should retake the FSA
course because he is missing that Accounting results are wat too different from cash
results. He would make a big confusion if he analyzed the cash related data.
Looking at income statement is, instead, crucial.

7) A fund manager says, “I refuse to buy companies that make voluntary accounting
changes, since it’s certainly a case of managers trying to hide bad news.” Why do
you agree or not?
I do not agree with this fund manager. Hiding BAD news is not correlated with
voluntary accounting changes, especially if they are made in the light of day, without
hiding anything. Accounting changes could be made for a lot of reasons which could
be also good reasons.
Disclaimer: many times accounting changes are made to sneak something and this
would be the case I wouldn’t buy that company.