GAAP and SOX Compliance
After no small amount of speculation, with some reports throwing up numbers like $4.99, Apple is apparently going to charge $1.99 for the 802.11n firmware update to its Core 2 Duo machines. Depending on which source you go with, Apple is blaming either the Sarbanes-Oxley Act (SOX) or the Generally Accepted Accounting Principles (GAAP), and various other entities are starting to call bullshit. The accusation is that Apple is trying to squeeze more money out of its users or is trying to force users into buying the AirPort Extreme ($179) to get the patch. While certainly headline-grabbing, neither of these accusations really make much sense.
No one at Apple is going to sit around and say “You know what would be cool? What if we could secretly include some hardware, not tell anyone about it, wait six months, then charge everyone a couple of bucks each to unlock it.” First off, no more than about 2 million Macs[1] have shipped with this stealth feature, so Apple only stands to bring in about $4 million of revenue if they achieve total penetration. In reality, a fairly large number of users will buy the AirPort Extreme to get their N-fix, both in terms of the Base Station and in terms of the patch, and the $1.99 price isn’t enough to force any significant number of customers into Apple’s hardware instead of a third party. No one who is going to elect a $149[2] router over Apple’s $179 offering is going to change their mind because of a $1.99 patch unless they failed math something awful.
The next theory is that Apple wants to simply make a few bucks off people who purchase third party routers. First off, make no mistakes. 802.11N doesn’t really buy anything for the average user. If you’re lucky, your home broadband internet connection pulls down 6Mbps, a data rate that is practically equivalent to the typical rates encountered with the original 802.11b[3] and well within the bounds of 802.11g. N will only be of use to customers with home networks and a need to push around very large media files, currently a small subset of the population. From my experience with an insanely wide variety of customers at the Genius Bar over the years, I’d bet that fewer than a fourth of all eligible Macs will even upgrade to N. Assuming every single one of them gets the patch for $1.99, that’s a hair less than a million dollars in revenue. In reality, this will not be a heavily advertised “product” and, largely, it will only be widely known to the same bloggers that are whining about it now. The vast, overwhelming majority of customers will never know that $1.99 is even an option unless they go looking for such support – remember, Apple never told any of its customers that N support was included at any level. Most will remain in ignorance. It’s reasonably to expect that Apple will not see more than a few hundred thousand dollars in revenue from this patch, an amount that will likely be nearly negated by the design, implementation, support, and accounting costs for this program. Apple doesn’t stand to actually make any significant money off this program.
I have another angle I’d like to explore, though.
According to C|Net, a spokesman for the Financial Accounting Standards Board has specifically called bullshit on Apple. The FASB is the organization that publishes the GAAP standards, so you’d think that they’d know if anyone would.
To be certain, GAAP does not require companies to charge customers … Further, GAAP does not tell companies how to run their business. Gerard Carney, FASB spokesman, quoted by C|Net
But what of the fact that Apple blames not just the GAAP standards but calls out the specific standard therein? SOP 97-2 isn’t something that either applies to Apple or doesn’t. It applies to a situation. One product Apple provides, while apparently similar to customers, may be subject while another is not, based purely on how Apple reports the revenue on their books. While Carney is technically correct in saying that the GAAP “doesn’t tell companies how to run their business,” the GAAP does tell them “if you report this, you have to do this. Otherwise, you can do this.” It’s a tree. Carney is probably not at all familiar with how Apple booked the prior sales, so his opinion can’t be counted on when it is so broadly put.
There’s also apparently disagreement in the CPA community (see the above link) about whether this kind of update would trigger the provisions of SOP 97-2 or those of EITF 00-21. In a worse case, if Apple provides it free, one provision or the other (I think SOP 97-2? But I’m not an accountant) would require to defer sales revenue to the quarter it was realized, in a quantity equivalent to the new feature’s fair market value. Someone, somewhere, might argue that they’re providing the functionality of a new piece of hardware and Apple could be forced to defer the entire cost of a new wireless card for every Mac sold in the last six months. Apple sold about 3 million Macs, give or take a few hundred thousand, in the last 6 months, and an 802.11N card costs around $75. In that case, Apple may have to move nearly a quarter of a billion dollars from that period in to this quarter. Charging for the update adds a tremendous amount of certainty to the situation. First, they get to dictate the “fair market value” of this feature. Second, that fair market value is being realized when the product is delivered. There is no threat of restated earnings or deferred recognition.
My take, though, is that this is an attempt by Apple to both cover their own ass in any eventuality and to give themselves cause to potentially challenge the rules that make this whole shell game necessary. As you can see, they won’t really benefit financially from the sales themselves, and the entire exercise seems to be an attempt to get around the insanity that SOX has implanted in the daily lives of accountants.[3]
fn1. And let’s not forget that the low end Core 2 Duo iMac, most certainly one of the hot sellers, isn’t N-compatible…
fn2. Linksys’s WRT300N retails for $149, but Amazon is “currently selling it for $129″:http://www.amazon.com/Linksys-WRT300N-Wireless-N-Broadband-Router/dp/B000FDOWQK/sr=8-1/qid=1169311421/ref=pd_bbs_1/103-7845922-3293452?ie=UTF8&s=electronics. You can pick up other options at Amazon starting from about $130.
fn3. Ask any accountant you know about the SOX Act. It’s not a pretty picture. As an aside, I live with one. Through no fault of my own, and no real interest, I get to spend a lot of time discussing the evilness that is SOX and GAAP.
