A student of mine brought to my attention an article in the Wall Street Journal September 24, 2009, “Investors Should Focus on Apple’s Core.”  In that article, Martin Peers points out that existing guidance for firms who have products that combine hardware and software, like Apple’s iPhone, required firms to obtain specific evidence about the separate selling prices of the components in order to recognize revenue on separate deliverables.  If the firm couldn’t find objective evidence, they had to defer revenue recognition until all of the components were delivered.  This caused firms like Apple to defer a relatively large proportion of their revenues.  With this rule change (Accounting Standards Update 2009-13 to Topic 605), such specific evidence, while preferred, is no longer required.  Instead, if firms are unable to obtain specific evidence, they are permitted to estimate the stand-alone prices that would obtain for the separate components of the product/service.

As noted in the article, this will likely lead many firms who have such products to recognize a greater proportion of their revenues upfront, leading to a significant shift in the time series of their revenue (and likely profit).

This raises some potentially interesting empirical questions:  (1) to what extent did investors fully understand that revenues were previously somewhat conservatively recognized? (2) How will investors respond to the significantly higher earnings that result from the change in accounting?  (3) Apparently some firms (such as Apple) were previously disclosing hypothetical revenue numbers prior to this rule change.  Which numbers were more closely related to investors’ assessments of firm value?

Academic research into these questions, while likely small-sample studies, it seems to me could be potentially informative to the revenue recognition project of the FASB and IASB in that it would reveal how investors respond to relatively conservative versus less conservative revenue recognition.