A Comparative Study of Revenue Recognition in The Technology Sector

Abstract

This literature review investigates the International Financial Reporting Standard and the United States General Accepted Accounting Principles. The paper highlights the revenue recognition standards, IFRS 15 and ASC 606 of both accounting principles and provides examples of two companies, Nokia Corporation and Apple Inc., which are using the standards. Thus, the paper aims to answer the research question what the differences in revenue recognition in the technology sector are. As the bachelor paper is a literature review, mainly scientific previewed articles were used. Additionally, books on US-GAAP and IFRS are paraphrased in this paper. Furthermore, articles from the economist helped to demonstrate the current position of the two companies. The literature review concludes that there are only small differences between the recognition standards. IASB and FASB designed the revenue recognition standards together to eliminate differences and increase the comparability of accounting standards within industries. Nevertheless, the most important difference between the two revenue recognition standard is the definition of probable. The paper also detects that Nokia Corporation and Apple Inc. use various methods to investigate the standalone selling price and chose similar performance obligations.

Keywords: Revenue Recognition; IFRS vs. US-GAAP; IFRS 15 and ASC 606; Nokia Corporation; Apple Inc.

Introduction

Globalization and governments eliminate borders and boundaries worldwide to increase international affairs. This leads to the result that different accounting standards need to be comparable to each other und understandable around the globe. Thus, this paper aims to investigate the International Financial and Reporting Standard and the United States General Accepted Accounting Principle. Those standards were chosen because most of the world’s capital markets require IFRS except the US, which requires US-GAAP. (PwC 2014, 1-6) Moreover, this essay will highlight the differences between the two standards and detailly focuses on their revenue recognition standards. Revenue is the headline of the income statement and the ultimate measure of a business success. (Prather-Kinsey, Boyar, and Hood 2018, 1) Therefore, it is important to understand how IFRS 15, revenue from contracts with customers in IFRS, and ASC 606, revenue from contracts in US-GAAP, differentiate each other. In addition, this bachelor paper provides two examples of companies which are using the standards. Nokia Corporation (from here on referred to as “NOKIA”) is an example of a company using IFRS and its revenue recognition standard. NOKIA is one of the leading technology devices provider worldwide. Nevertheless, the company combated to remain in the mobile device industry. (Doz 2017) Apple Inc. (from here on referred to as “APPLE”) is the example of the US-GAAP principle and the ASC 606 standard. APPLE is a direct competitor of NOKIA and one of the reasons why Nokia Corporation was forced out of the industry in the early 2000s. (Doz 2017) Hence, this paper will answer the research question what the differences in revenue recognition in the technology sector. Additionally, questions like what the most significant differences between the concepts of IFRS and US-GAAP are, will be answered in this paper. This bachelor paper firstly explains IFRS and its revenue recognition standard IFRS 15. To give directly a practical example, it describes the company NOKIA as well as its history, its financial performance and its revenue recognition principle. Secondly, the paper highlights US-GAAP and its standard revenue from contracts with customers, ASC 606. Afterwards, the company APPLE, its history and its revenue recognition policies are analyzed. Lastly, this essay investigates the differences between IFRS and US-GAAP and its revenue recognition policy. To answer the research question, the paper focuses on the differences between NOKIA and APPLE’s revenue recognition standard. The current essay is a systematic literature review based on Briner and Denyer (2012) (Briner and Denyer 2012). Thus, mostly peer-reviewed, scientific articles were considered. Useful articles were found in the following databases: Science Direct, Springer Jisc Collections and SpringerLink. In order to find relevant literature for the literature review, a collection of different keywords and numerous combinations were exercised in the search process. Examples of those keywords are “IFRS”, “Revenue recognition” and “Differences in revenue recognition”. Moreover, the annual financial statement reports for the fiscal year from NOKIA and APPLE were used as a literature source. In addition, this paper paraphrases scientific books about IFRS and US-GAAP. Some articles from online platforms like The Economist were used to guarantee up-to-date information about the two companies. WorldCat-Discovery, the online literature search system provided by the University of Applied Science Wiener Neustadt, found 510 articles based on the keywords described above. After ensuring that only peer-reviewed articles will be shown, the list was reduced to 183. Additionally, academic articles from low ranked journals were eliminated, which lead to the result that only journals scoring of 4 or 4*, according to “Academic Journal Guide 2018”, provided the basis for this essay.

International Financial and Reporting Standard

The International Financial and Reporting Standard, short IFRS, is required on the most significant capital markets worldwide since it is not country specific. (PwC 2014, 1) The following chapter provides the principles of IFRS.

Authorities

IFRS was established in 2001 by the International Accounting Standards Boards (IASB) which has been managing IFRS since and has top-level authority over IFRS. The Board is overseen by the International Accounting Committee which consist of a group of trustees called the International Financial Reporting Interpretations Committee (IFRIC). In addition, the Monitoring Board, a group of capital market authorities, aims to protect IFRS from political influence as the standard is not country-specific based. (Hays 2015, 1)

The conceptual framework

The conceptual framework presents the nature, function, and boundaries within financial accounting. The framework highlights the general purposes of financial statements. It was published by the IASB. The main objective of financial reporting is to deliver financial information, about a reporting entity, which is useful to existing and potential investors, lenders, and other creditors. That information include data on the entity’s economic resources, claims and changes on those resources and claims. Generally, financial information, about a reporting entity, help users make investment decisions. Additionally, they display a company’s strengths and weaknesses. (Harrison Jr. et. al. 2014, 8-9)

The conceptual framework explains that qualitative characteristics will make financial information useful to its users. Financial information is useable when it is relevant and faithfully represented. Those are called fundamental qualitative characteristics. It is necessary to note that the degree of relevance is influenced by the materiality of the information. Materiality means the given information must be important enough, so in case it is left out it changes the user’s decision. Fundamental qualitative characteristics can be strengthened by enhancing qualitative characteristics. Enhancing qualitative characteristics are comparability, verifiability, time, and understandability. (Harrison Jr. et. al. 2014, 8-11)

Financial statements

Annual reports are the main source for shareholders, lenders and other stakeholders to gain information about a company. Annual reports usually include the company’s goals, its vision as well as its financial statements. (Harrison Jr. et. al. 2014, 220)

A firm, operating under IFRS, is required to present its results of operations and its financial position according to a set of rules. A company needs five financial statements. The first statement is the statement of financial position which includes a company’s assets, liabilities and equities at a point in time. The second statement is the statement of comprehensive income. This statement displays a company’s income and expenses during a fiscal year. The third statement is called statement of changes in equity. It reflects the changes in equity for the presented year. The fourth statement is the statement of cash flow, which represents all cash in- and outflows from operating, financing, and investing activities during a fiscal year. The last statement is the notes, which summarize accounting policies and additional information. The revenue recognition standard a company uses is detailly explained in the notes. (Murphy 2020, 153-154)

Chapter summary

The International Financial and Reporting Standard is managed and overseen by IASB. (Hays 2015, 1) The conceptual framework summarizes the most important rules on how to use IFRS. The framework especially highlights that information has to be relevant and faithfully represented so one can use it for financial statements. (Harrison Jr. et. al. 2014, 8-11) The five financial statements are the statement of financial position, the statement of comprehensive income, the statement of cash flow, the statement of changes in equity and the notes. The main objective of those statement is to give readers information about the current position of a company. Hence, financial statements can be described as an information source. (Murphy 2020, 153-154)

IFRS 15 – Revenue from contracts with customers

Revenue is the headline of the income statement and the ultimate measure of company’s success. (Prather-Kinsey, Boyar, and Hood 2018, 1) This section provides an overview of how IFRS describes revenue and which steps have to be followed in order to recognize revenue.

The objective of IFRS 15

IFRS 15 has been effective since January 1st, 2018. It replaced all existing revenue recognition standards from IFRS. In comparison to the old revenue recognition standard, IFRS 15 requires significantly more qualitative and quantitative disclosures. The main objective of IFRS 15, revenue from contracts with customers, is for a firm to report useful information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer in the financial statements. In order to meet this objective, an entity should report revenue when the control of the product or service transfers to the customer. (IFRS Foundation 2019, 5)

It is important to note that this standard is specified for an individual contract with a customer. However, entities are allowed to use this standard for a portfolio of contracts with similar characteristics. If a company decides to use this standard for a portfolio, it has to estimate and assume the size and composition of the portfolio. Also, IFRS 15 distinguishes between performance obligations satisfied over time and performance obligations at a point in time. (IFRS Foundation 2019, 5)

Five steps to recognizing revenue

IASB designed five steps, which need to be followed in order to recognize revenue correctly. Those steps are as followed, provided by IFRS Foundation 2019:

1. Identify the contract with the customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize revenue when (or as) a performance obligation is satisfied

(IFRS Foundation 2019)

The goal of the five-step model is to grant a comprehensive revenue recognition model in order to enhance comparability across and within industries and across capital markets. This aims to increase competition between various markets as well as decrease barriers between accounting principles. (PWC 2017, 13)

Identify contract with the customer

According to IFRS 15 contracts can either be agreed in a written form, an oral form or by the business practice. Moreover, the standard explains a contract is an arrangement between parties that results in obligations and rights. Furthermore, a contract has to meet the following principles in order to be identified:

1. Parties agreed on the contract and are legally responsible to fulfill their obligations
2. The corporation can analyze each party’s rights
3. The corporation can evaluate the payment
4. The contract has commercial substance
5. It is probable that the contract will be fulfilled

(IFRS Foundation 2019, 6-7)

A company can recognize the contract if it is probable that the contract will be fulfilled. In order to find out the probability, a firm may analyze the customer’s ability to pay the promised amount. Therefore, a firm shall investigate the past transactions with the customer and the customer’s account balances. In IFRS probable is defined as “more likely than not” which is known to be more than 50%. In other words, if the probability, that a customer satisfies its performance obligation, is more than 50%, the firm recognizes the contract. (IFRS Foundation 2019, 6-7)

Identify performance obligations in the contract

The standard defines two kind of performance

1. A good or service which is distinct
2. A series of distinct goods or services, which are generally the same and have the same transportation to the customer

(IFRS Foundation 2019, 10-12)

Generally, only the goods or services agreed to in the contract, will be delivered to the customer. Nevertheless, in some cases the performance obligations are not limited to the ones in the contract and arise from a company’s business practice. Nonetheless, this can verify in the B2B and B2C market. (IFRS Foundation, 10-12)

Determine the transaction price

After the performance obligations are satisfied, an entity has to recognize revenue at the amount of the transaction price, which is in accordance with the performance obligation. When an entity determines the transaction price, it has to examine the terms of the contract as well as its business practice. The consideration of the transaction price should include fix costs or variable costs or both. If the consideration includes a variable amount, a company has to estimate the consideration, since it may vary due to discounts, refunds, etc. Moreover, firms are not required to reveal their pricing method. Usually, the nature, timing and amount of consideration affect the transaction price. IFRS 15 states that an entity should not put into consideration that a contract will be renewed or canceled. (IFRS Foundation 2019, 17)

Allocation of the transaction price to the performance obligation

A corporation has to allocate a transaction price to each performance obligation at an amount it plans to receive for the promised goods or services to the customer. In order to meet this objective, a corporation should identify each obligation on a stand-alone selling price basis. The stand-alone selling price is the amount of a good or service for which a corporation would sell it separately to a customer. Sometimes a list price or a contractually stated price may be the stand-alone selling price of a good or service. If the stand-alone price is not directly recognizable, a company should estimate the stand-alone price. Hereby, the corporation has to consider all information available, including market position, economic factors, internal factors and information about the customers. Moreover, the entity has to use estimation methods to come up with a stand-alone price. Adjusted market assessment approach or residual approach is example for such methods. (IFRS Foundation 2019, 22-26)

In addition, a customer may receive a discount if the sum of the stand-alone prices in the contract exceeds the promised consideration in a contract. However, if a corporation has proof that the discount only relates to one or more but not all performance obligations, it can allocate the discount to the proportionate performance obligations. (IFRS Foundation 2019, 22-26)

The price stated in the contract can change for various reasons. Hence, only amounts which satisfy the performance obligations should be recognized as revenue or a reduction to revenue in the period the transaction price changes. It is only allowed to state changes entirely to one or more but not all performance obligations. Moreover, changes in a transaction price, which arise as a result of a contract modification, have to be explained in the financial statements. (IFRS Foundation 2019, 22-26)

Recognize revenue when (or as) a performance obligation is satisfied

After a party performed its contract obligations, the corporation needs to show the contract in the statement of financial position. It either shows the contract in the statement as a contract asset or a contract liability, depending on the relationship between the company’s performance and customer payment. In order to disclose revenue, a corporation has to ensure that users of the financial statements find information about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Moreover, a company has to disclose the following:

1. Opening and closing balance of receivables, contract assets and contract liabilities from contracts with customers
2. Revenue recognized in the reporting period
3. Revenue recognized in the reporting period from performance obligations satisfied in previous periods

(IFRS Foundation 2019, 29-31)

Furthermore, an entity has to describe in the notes when performance obligations are usually satisfied, the company’s payment terms, the nature of the goods or services, and the obligations of the company in case of returns or refunds.(IFRS Foundation 2019, 29-31)

Chapter Summary

IFRS 15 has been in practice since January 1st, 2018. It was implemented to give a guideline on how to recognize revenue in various industries. This aims to enhance comparability across various markets. Five steps have to be followed in order to correctly recognize revenue. The first step is the identification of the contract, followed by the identification of the performance obligations. Afterward, the transaction price has to be determined. The fourth step is to allocate the transaction price, and lastly to recognize revenue. (PWC 2017, 1-13)

Nokia Corporation

In order to provide a practical example of a company using IFRS, NOKIA was selected. NOKIA consists of seven different business groups in the technology sector and operates in about 120 countries.

History

NOKIA was founded in 1865 in Finland and began their telecommunications business in the 1990s. Due to their rapid success it became the best-selling mobile phone brand in 1998 and launched the first camera phone in 2003. However, the strong competition from iOS and Android led to the outcome that NOKIA entered into a strategic partnership with Microsoft. By 2014 Microsoft bought NOKIA’s mobile and devices division. Between 2013 and 2015 the Finnish company shifted its focus to grow into a network hardware and software provider. Therefore, the company started a joint-venture partnership with Siemens in 2013. In 2015 NOKIA purchased Franco-American telecommunications equipment provider Alcatel-Lucent, this enhanced NOKIA’s portfolio and customer base. Additionally, NOKIA was able to position itself as a global technology leader in the communications industry. The firm gained this position through acquisitions. In 2016 the company started again in the mobile handset market via a licensing agreement with HMD Global, a Finnish mobile phone manufacturer. Hence, they were able to offer phones under the Nokia brand again. (Nokia 2020)

Nokia’s downfall

NOKIA accounted for 4% of the Finish GDP at its peak in the 1990s and early 2000s, when it was the world’s leading mobile phone manufacturer. The whole Finish society was self-confident in the company. Between 1996 and 2000 the company was able to increase its revenue about 500%. However, the downside of this success was that NOKIA’s development centers were under pressure and did not have the resources to forecast that society will soon change to smartphones. Between 2001 and 2004 many strategic decisions were made to compensate NOKIA’s huge success and to reorganize the company. However, this directed to the departure of important leadership members. Also, the changing management struggled to adopt to the new economic environment, which was pioneered by APPLE. Hence, the dysfunctional organizational structure, the wrong management decisions and the missing investment in the research department forced NOKIA to lose its market position. (Doz 2017)

The graph underneath, from Yahoo!Finance, shows the massive increase of the company’s stock between 1998 and 2000. The graphic also indicates the loss of the market position between 2000 and 2002.

NOKIA since 2018

NOKIA’s main goal was to enhance its image and increase its market position in the industries it is operating in. The company has been benefiting from its technology licensing business and a solid cost reduction. In addition, NOKIA’s stock price rose by 20% from 2017 to 2018, which indicates that the firm is in a successful direction to become a leading mobile provider again. Since 2018 the firm believed that its primary growth drives from the adoption of 5G technology. Additionally, the firm has successfully expanded its licensing operations to new markets and considers this sector to have an annual compounded growth of 10%. It is important to mention that NOKIA has been working on a cost-saving initiative, which plans to cut costs at an annual rate of EUR 700 million by 2020. (Forbes 2018)

Financial performance in 2019

NOKIA operates in about 120 countries and had an average number of employees of 98.000 in 2019. The company has seven business groups. Those groups are: Mobile Networks, Global Services, Fixed Networks, IP/Optical Networks, Nokia Software, Nokia Enterprise, and Nokia Technologies. Nokia Corporation had net sales in 2019 of 23.315 billion EUR. Their highest growth area in 2019 was the Asia-Pacific region with 12%. The company was able to increase its net sales by 3.3%. In addition, Nokia was able to generate profit in 2019, which is a result of the company’s cost-saving initiative. (Nokia 2019, 6)

In 2019 NOKIA’s highest sales by geographic region was North America with an increase of 6%. The second highest region was Europe. However, the company had to report a decrease of 15% in sales in the Greater China region. It is interesting to see that the firm’s biggest business by net sales is the network business. Mobile access is the strongest part within this business and the IP routing part gained 15% in 2019. (Nokia 2019, 6)

Gross margin

A company’s gross margin is the earnings from its sales after the deduction the costs, which are directly associated with the sales. It measures how well a firm generates earnings. (Harrison Jr. et. al. 2014, 357) NOKIA’s gross margin in 2019 was 35.7% compared to 37.4% in 2018. In 2017 the gross margin was 39.5%. According to the company’s annual report this loss comes from lower gross profit in Networks, Group Common and Other and Nokia Technologies. The losses were partially offset by lower product-related costs and higher gross profit in Nokia Software. (Nokia 2019, 49-51)

Cost-saving program

In 2016 the firm started a cost-saving program, which aim was to reduce costs by 1.2 million EUR till 2018. The company was able to complete this program and achieved its goal. In 2018 NOKIA began another cost-saving initiative, which plans to reduce costs by 300 million till 2020. (Nokia 2019, 52)

Revenue recognition

According to NOKIA’s annual report 2019 the Group reports revenue based on the geographic area of the revenue. Furthermore, it describes that the primary customer base are companies that operate on a country-specific base. In detail, NOKIA accounts for contracts with customers when both parties approved the contract in a written form. This usually happens when both parties commit to perform their obligations and their right. Those rights include payment terms, identification of the transformation of goods and services, commercial substance, and the consideration to which extant NOKIA expects the contract to be probable. The stated indicators apply to the IFRS 15, step one according to the five-step model. (Nokia 2019, 129-130)

NOKIA explains it reports revenue from contracts with customers to show the transformation of the agreed good or service to the customer. The company includes variable consideration, like discounts or sales-based royalties, into the price only if it expects that it is highly probable that a revenue will not occur. (Nokia 2019, 129-130) This information aims the firm to complete step two and three of the IFRS 15 model.

The general payment terms of NOKIA are between 90 to 180 days. In addition, the firm allocates the price of each performance obligation on the basis of their stand-alone selling price. In case a stand-alone price cannot observed, it is estimated. Additionally, the Finnish company describes that a good or service has to be distinct. NOKIA states that it recognizes revenue when the performance obligation of the company is fulfilled. This usually happens when the good or service is transferred to the customer and the customer obtains control of the product. Hence, NOKIA uses the interpretation of IFRS 15 when a performance obligation is fulfilled. Moreover, the firm establishes a product to be distinct and calculates the product price on its stand-alone selling price. (Nokia 2019, 129-130) This is NOKIA’s approach to complete step three and four of the five step model.

A performance obligation can be satisfied over time or at a point in time. The company represents the contracts with customers either as a contract asset or a contract liability, depending on the situation. A contract asset presents that a product has been transferred to the customer before the customer paid its obligation. While on the other side, a contract liability represents that a customer paid its obligation, but NOKIA has not transferred the product to the customer yet. NOKIA distinguishes three different kind of sales. Those three different kinds are as follows:

1. Sale of products
2. Sale of services
3. Sale of intellectual property licenses

(Nokia 2019, 129-130)

The company is implementing the five-step revenue recognition process by matching the steps to the company’s operations. The firm realized the steps approach as precise as possible for its business, in order to be comparable to its direct competitors. Furthermore, using the approach continuously helps the company to investigate its progression over the years.

Sale of products

Revenues for products are reported when control of the product has transferred. Such products are networking equipment or network operations. Usually, the control transfers before delivery. However, sometimes, mainly within the submarine cable business, revenue is recognized over time using the output method. The output method concentrates on finding the total output of a nation by finding the total value of all goods and services a nation produces. In terms of NOKIA, it means that the company tries to assess the products transferred to the customer and right of the payment for the work which is completed to a specific date. The method varies from each contract depending on the situation. (Nokia 2019, 130)

Sale of services

Revenue from a service is recognized when the customer obtains the benefits of the performance. Such services are maintenance, customer’s network management or provisions of networking equipment. Service revenues are recognized over time as NOKIA performs those services during a fixed contract term and a client continuously receives the benefits. (Nokia 2019, 130)

Sale of intellectual property licenses

Revenue from a sale of a software license is recognized before delivery or acceptance of the software. This is due to the determination that each software release is distinct and the license for the software is granted when it exists at the point of transfer or control of customer. Moreover, the license fee revenue is recognized in accordance with the related agreement. Hence, revenue is recognized over time. (Nokia 2019, 130)

Chapter Summary

NOKIA had its peak in the late 1990s and 2000s when it was the leading mobile phone provider. However, wrong strategic decision-making of the management led to a huge crisis of the company with the outcome that the company could not maintain its mobile division alone. Additionally, NOKIA could not satisfy the changing customer needs, which were pioneered from Apple Inc. Nevertheless, the company rebuilt and reentered the mobile phone industry. (Doz 2017) The firm could generate a profit and has been working on cost-saving programs. NOKIA bundled its products into three categories for revenue recognition purposes. (Nokia 2019, 52-130)

United States General Accepted Accounting Principles

United States General Accepted Accounting Principles, short US-GAAP, is one of the most used accounting standards worldwide on capital markets. (PwC 2014, 1) The following section’s goal is to describe the objectives and scopes of US-GAAP.

Authorities

The US-GAAP Codification was established and is overseen by the Financial Accounting Standards Boards, short FASB. FASB reports to a group of trustees called the Financial Accounting Foundation. Moreover, the Securities and Exchange Commission (SEC) is the rule-making authority to the FASB. The United States General Accepted Accounting Principles have to be applied by public companies which are based in the USA. Since many big players have their base in the United States it is one of the most used accounting standards on capital markets. The US-GAAP is a country-specific accounting standard and shaped by corporate lobbying. Thus, it has specific standards which mainly benefit corporations in the United States. For example the standard for pension and postretirement benefits. (Hays 2015, 1)

Principles

US-GAAP uses the conceptual framework, which is designed to describe the nature, function, and limits of financial accounting and reporting. The FASB interprets that the conceptual framework benefits to solve difficult financial accounting problems by:

• Providing a set of premises as a basis,
• Providing detailed terminology,
• Helping to ask efficient questions,
• Limiting areas of judgment
• Deciding disciplines

(Flood 2016, 17-18)

The US General Accepted Accounting Principles applies the rule-based principle. Rule-based means that the standard requires detailed guidelines, scope expectations and a signification volume of application guidance. Hence, it makes this standard more precise and limits the opportunity to apply professional judgments or fraud. (Ghosh, Bairagi, and Mondal 2020, 2) Furthermore, the standard’s recognition principles describe the timing and measurement of items that become part of the accounting cycle and have an impact on the financial statements. In other words, quantitative standards indicate economic information to be reflected numerically. The disclosure principles determine factors which are not quantifiable. Disclosures are qualitative information which are important to a full set of financial statements. If that information was missing, it would have an impact on the reader’s decision-making. Disclosures enhance numerical data in a written form by explaining accounting policies, uncertainties, etc. (Flood 2016, 4)

Financial statements

Financial statements must be prepared on a going-concern basis. Going concern means that the accounts and auditors have to assume that the company will continue its operations in the upcoming fiscal year. According to US-GAAP, the financial statements consist of five different statements. The first one is called balance sheet or statement of financial position. It shows a firm’s assets, liabilities and equities. The second statement is the statement of shareholder’s equity, which reports the change of shareholder’s equity. In addition, an entity has to prepare an income statement, which highlights a firm’s incomes and expenses. The fourth statement is called cash flow statement. The main purpose of the statement is to give information about cash inflow and cash outflow. The statement is divided into three categories: operating, financial and investment. The last part of financial statements are notes. Notes usually explain accounting policies and disclosures. Their main objective is to make the other financial statements more understandable and to provide detailed information. The balance sheet points out the effect of an entity’s transactions at a point in time. The statements of income, retained earnings, comprehensive income and cash flow describe a company’s financial situation during a specific period of time. (Flood 2016, 33-89)

Chapter summary

United States General Accounting Principles are a country-based accounting standard, which is managed by the FASB. US-GAAP is one of the most used accounting standards on capital markets, as companies, with their headquarters in the United States, are required to use the standard. (Hays 2015, 1) The US-GAAP principle is called the rule-based approach, which requires detailed guidelines and provides many regulations for accountants using this standard. (Ghosh, Bairagi, and Mondal 2020, 2) Similar as IFRS, US-GAAP uses the conceptual framework. The framework should help answering complex accounting questions. The standard requires an entity, depending on its size, to provide five financial statements, which either show the firm’s financial position over a point in time or at a point in time. The five statements are called, balance sheet, income statement, shareholder’s equity statement, cash flow statement and notes. (Flood 2016, 1-89)

ASC 606 – Revenue from contracts with customers

Revenue results from a company’s general operations and is the most significant financial reporting metric. (Flood 2017, 2) This chapter describes the objectives of ASC 606, the revenue recognition standard under US-GAAP. Additionally, it grants an overview on the steps which need to be followed when recognizing revenue.

Objective

The result of a satisfied performance obligation is the creation of revenue. The performance obligation is completed when the control of the product is transferred to the customer. (Hepp 2018, 1)

ASC 606-10-10-1 describes the objective as:

“to establish the principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer.” (Flood 17, 12)

The main principle is that an entity is required to recognize revenue when the transfer of the good or service has occurred, at the amount an entity expects the good or service to become in exchange of the product. This principle should show the asset and liability approach that underlines this standard. The approach perceives that revenue is based on the exchange of assets and liabilities. It focuses on the timing of cash flows. An entity can fulfill this approach by applying five steps. (Flood 2017, 12)

Five steps

The following five steps need to be fulfilled in order to recognize revenue and satisfy the asset liability approach.

1. Identify the contract with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price
5. Recognize revenue when or as the entity satisfies a performance obligation

(Flood 17, 12)

Identification of the contract

ASC 606 explains that a contract exists if it meets five criteria. The first criterion is that the contract is approved and committed by both parties. In addition, the rights of both parties need to be identifiable, as well as the payment terms. The contract must have commercial substance. Commercial substance means, future cash flows of a business change due to the contract transaction. The last criteria is the collection of the payment needs to be probable. In US-GAAP probable can be defined as “likely to occur”, which, in numerical terms, is known to be around 75%-80%. (Flood 2017, 29-30)

Identification of performance obligations

A performance obligation is a promise to transfer a good or service to a customer. Therefore, the good or service has to be distinct. The main objective is to decide the unit of account to which the transaction price has to be allocated. Moreover, goods or services identified in a contract might not be limited to the goods and services, which are stated in the contract. Hence, services could be provided to the customer which result out of the company’s business practices. (Flood 2017, 46)

Determination of transaction price

The transaction price is only allowed to include amounts to which the entity has rights. It does, for example, not include sales taxes or shipping costs from third parties. (Flood 2017, 61)

Allocation of the transaction price

When allocating the transaction price, an entity firstly has to determine the stand-alone price of the product. If an entity cannot observe the stand-alone price, it has to estimate the price. Each company uses a different method to estimate the price. (Flood 2017, 86)

Revenue recognition

An entity is allowed to recognize revenue when the performance obligations are satisfied. This usually happens when the customer takes over control of the product or service. (Flood 2017, 102) In case the shipping and handling of activities is performed before the customer has control over the product, the shipping and handling activities are necessary to fulfill the company’s performance obligations. (Flood 17, 15-30)

Chapter Summary

ASC 606 objective is to provide useful information from revenue regarding its amount, timing, and uncertainty. In order to recognize revenue correctly and meet the objectives, a firm has to use a five-step approach. The approach is identical to the five-step model according to IFRS. (Flood 17, 12)

Apple Inc.

This chapter gives a practical example of a technology company which reports under the US-GAAP financial reporting standard. APPLE was chosen because it is a direct competitor of NOKIA and its modern, innovative technology were one of the reasons why NOKIA had to leave the mobile technology industry in the early 2000s.

APPLE designs manufactures and markets smartphones, personal computers, tablets, wearables and accessories. In addition, it grants a variety of related services. Tim Cook is the chief executive officer of APPLE. (Levy 1998)

History

APPLE was founded in 1976 by Steve Jobs and Steve Wozniak. Their mission at that time was to create computers, which are small enough, so people can have them at home or in offices. The two entrepreneurs achieved their mission by finding a lack, the small computers, in the technology industry and by building such computers. Therefore, the firm’s sales jumped from USD 7.8 million in 1978 to USD 117 million in 1980. Steve Wozniak left the company in 1983 due to the different interests of the two CEOs. Steve Jobs released the Macintosh, the most innovative product in 1984. The computer was a massive success. Due to the rapid advancements of the company, Jobs employed John Sculley, an experienced leader in the industry. However, Sculley forced Steve Jobs out of his own company in 1985. Nevertheless, Jobs established a new technology company which was highly successful. In 1997 APPLE bought Steve Jobs new firm since APPLE faced difficulties which could not have been solved without Jobs. Hence, Jobs became the CEO of APPLE again and brought the firm to an improved level of achievement. Steve Jobs died in October 2011 due to cancer. However, the firm is still running Jobs’ vision. Before Jobs death, he handed over the company to Timothy Donald Cook who has been leading the firm since August 2011. (Levy 1998)

APPLE’s success

APPLE became the first U.S. company to reach a USD 2 trillion market cap in August 2020. In other words, the company was worth USD 2 trillion on the open market in August 2020. The firm has been one of the most valuable companies in the world since 2010. The main reasons for its success are their popular, innovative products as well as their generous margins. Moreover, their success lies in their strategic vision to include desktop computing to mobile devices and wearables. APPLE was the first mover in this niche sector. This allowed APPLE to highly increase their sales, since no substitutes were available at that time. Additionally, APPLE’s products are good-looking and easily to use. Those characteristics ended up being the company’s primary USP on the new market. APPLE has been sustainable the market leader in their industry and could therefore grow its stock value. The firm has a high gross margin compared to its competitors. Moreover, the past years showed that APPLE’s customers hold a high brand loyalty. Also, Steve Jobs has a high impact on APPLE’s brand, as he is recognized as the world’s first auteur chief executive. Hence, the innovative, easy-to-use products and its high-profit margin, are the firm’s key driver of their success. (BBC 2018)

Financial highlights in 2019

APPLE fiscal year starts on October first and ends on September 30rd the following year. The company had total net sales of USD 260.174 million in 2019, which is a decrease of 2% compared to 2018. The net income of APPLE also decreased due to the loss in sales. However, APPLE paid out higher cash dividends. As stated above, APPLE is the first company which reached a market capitalization of USD 2 trillion. This indicates that investors still believe in the company and its future success. Another good indicator is that the firm did not increase its liabilities from 2018 to 2019. (Schwarz 2019, 20)

Net sales

APPLE’s total net sales decreased by 2% between 2019 and 2018. According to APPLE’s annual report, this is due to lower unit sales of the iPhone. In other words, the sales of iPhones decreased by 14% in 2019. Nevertheless, the sector “wearables, home and accessories” increased by 41%. The company’s annual report explained that sale for AirPods and the Apple Watch continuously increased. Since 2017 APPLE was able to double its net sales in this category. In addition, APPLE accounted for a decrease in the iPad sector in 2018. But managed to boost the sales in 2019 by 16%. The company stated that this achievement is due to the release of the iPad Pro. (Schwarz 2019, 22)

The company’s main sales come from the American region, which is also the region with the highest increase in 2019. The Greater China region accounted for the biggest loss with a 16% decrease. According to APPLE, the weakness of the USD as well as lower sales of the iPhone are the main reasons for the loss. In addition, the Europe region had a decrease of 3% in 2019, which is crucial since the firm was able to increase this region by 14% in 2018. The firm stated again that the weakness of the USD is one of the major reasons why the decrease happened.

Chapter Summary

This chapter provides a detailed overview of Apple Inc., a technology company that reports under the US-GAAP financial reporting standard. Founded in 1976 by Steve Jobs and Steve Wozniak, the company designs, manufactures, and markets a wide range of products including smartphones, personal computers, tablets, wearables, and accessories. Apple has been one of the most valuable companies in the world since 2010 and was the first U.S. company to reach a $2 trillion market cap in August 2020. The chapter explains the company's history, financial highlights in 2019, and its net sales, which decreased by 2% between 2019 and 2018 due to lower unit sales of the iPhone. However, the wearables, home, and accessories sector increased by 41%. The chapter also provides an overview of the company's success, driven by their popular, innovative products, strategic vision, high-profit margins, and brand loyalty.

Conclusion

After examining the revenue recognition standards of the International Financial Reporting Standard (IFRS) and the United States General Accepted Accounting Principles (US-GAAP), with a focus on IFRS 15 and ASC 606, and analyzing Nokia Corporation and Apple Inc. as practical examples, this review concludes that a deep understanding of these standards is necessary to ensure accurate and comparable financial reporting. The IFRS 15 aims to increase competition between various markets and enhance comparability across and within industries and capital markets, using a five-step process to recognize revenue correctly. Similarly, US-GAAP is an essential framework for financial reporting in the United States and has a significant impact on capital markets worldwide. Nokia Corporation's financial performance in 2019 showed that the company had learned from its past mistakes and was moving in a successful direction to become a leading mobile provider again, while Apple Inc.'s success demonstrated the importance of innovation and brand loyalty in the technology industry. Therefore, an understanding of these standards and practical examples is crucial for businesses to report useful information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a contract with a customer in the financial statements accurately.