Question

Apple Inc. has led the market for so-called smart phones with its iPhone, while competitors crowd the market daily with products such as the Galaxy from Samsung, Nexus, co-developed by Google and LG Electronics, and Motorola's Droid. Manufacturers that sell these products are producing both hardware and software for their customers, not only selling the phone but also providing services to make the phone as functional as possible. Historically, the companies would record the revenue from the sale over the assumed life of the product, typically two years. Recently, however, the FASB approved changes that allow these companies to record more of the revenue in earlier periods of the phone's use. How do companies recognize revenue, and how are the financial statements affected? What might motivate management to recognize revenue early, and how might a company's stock price react to such behavior?

Answer 1

Ans. Previously, the companies looked at recognizing the revenue in a straight line method over the life of the product. However, FASB approved the changes and now a company can book more revenue in the first year itself.

If a company begins to recognize revenue in the first year itself, it'll lead to the company recording more profits in the first year as compared to the later years. Therefore, the financial statement of the company will show a distorted figure as to the amount of revenue being recognized.

The management may recognize revenue early due to the following reasons: (i) It leads to better results in the first year (ii) They'll end up getting more commission on profit (iii) In order to fulfill performance obligations

The stock of a company will fluctuate leaps and bounds. In one year, it'll rise due to increase in profit. However, in the subsequent years it'll fall sharply due to inadequate profits.