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1.Should the FASB have overturned the software revenue recognition portion within ASC 985-605? As part of your explanation, consider whether firms will now have too much flexibility to manipulate revenues.

2. Is Apple's explanation for why it adopted the new rules retrospectively clear (Exhibit 1)? Is it valid?

3. Is Apple's explanation of how it implemented the new rules clear (Exhibit 2)? Is the new revenue recognition/ deferral method reasonable?

4. Explain the changes to Apple's 2008 and 2009 balance sheets and its 2007, 2008, and 2009 income statements (Exhibit 3). Do the restated financial statements better reflect Apple's financial condition?

Apple Inc. and Retrospective Adoption of Revenue Recognition Rules Many sales include arrangements with multiple deliverables; some goods or services are delivered immediately, whereas others are provided later, in a different accounting period. Examples include the following: sale of heavy equipment that includes maintenance and parts for three years; sale of a computer system that includes hardware, software, and software updates for three years; and sale of copiers (with imbedded software) that includes software updates for three years. The revenue recognition principles established by SEC Staff Accounting Bulletin 104 (SAB 104) apply to sales with multiple deliverables. These four principles are (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller's price to the buyer is fixed or determinable, and (4) collectability is reasonably assured. In the first example, revenue can usually be recognized for heavy equipment when the equipment is delivered. However, revenue for maintenance or parts must be recognized pro rata over the next three years because the service and parts will be delivered over that three-year period, not at contract inception. In the second example, revenue can usually be recognized for hardware and software at the beginning of the contract, when they are delivered, but not for software updates, which are provided later. Similarly, revenue can usually be recognized for the copying equipment when delivered, but software update revenue would be recognized over the three-year update period, unless it is immaterial. In each instance, firms must allocate the total sales price between the multiple elements in a reasonable way. The most reliable way might be to use the firm's own history of selling items separately. Suppose a firm sells heavy equipment and also offers three-year maintenance contracts on equipment it sells and on equipment sold by competitors. The maintenance contract price may be a percentage of the original cost of the equipment, adjusted for usage or age. If the firm has evidence that it routinely sells service contracts on equipment bought elsewhere and that it routinely sells equipment without maintenance contracts, then the firm has support for the selling price of both the equipment and the maintenance contract. If the firm sells equipment bundled with a maintenance contract at a discount, it can use historical selling prices for equipment and maintenance contracts to allocate the discounted revenue to the separate elements. The firm might also consider prices its competitors charge for the separate elements or use its best judgment to allocate revenue to each element in a multiple element sale. However, some firms that sell software bundled with updates or support seemingly allocate too much revenue to the initial software component and too little to the subsequent support or maintenance. That practice lets firms recognize too much revenue at the start of the contract period. Later, when the firm incurs high support or maintenance costs, it has minimal revenue to offset those expenses. ACS 985-605 (SOP 97-2) In response, the American Institute of Certified Public Accountants (AICPA) issued ASC 985-605, Statement of Position 97-2 (SOP 97-2), in 1997. Under ASC 985-605, if a multiple element sale includes software that is more than incidental to the sale, a vendor must have vendor-specific objective evidence (VSOE) of the selling price of each element in the sale (i.e., evidence it had sold each item separately and that the sales were more than occasional or incidental). Without VSOE, firms had two options. If the cost of the future service was highly uncertain, the firm was required to defer all revenue until the contract was complete. In most cases, however, firms provided services gradually; in those instances, firms were required to use the subscription method (i.e., recognize the entire selling price evenly over the contract period). Although it was difficult to completely satisfy ASC 985-605's VSOE requirements, many firms assumed they could avoid using the subscription method if their deviations from ASC 985-605 were immaterial. However, when the Public Company Accounting Oversight Board (PCAOB) began reviewing auditing firms in 2004, one of its main findings was that companies were not meeting ASC 985-605's VSOE requirement. The PCAOB noted that some companies had only occasional sales of items in a multiple-element sale or even sales that seemed contrived. The PCAOB further noted that selling prices of different items fluctuated too much relative to each other to be deemed reliable. As a result, some firms were required to restate their financial statements to show far lower revenues and profits than in the past. In many instances that change made financial statements highly misleading; in other instances, the change made it difficult for firms that were economically profitable to obtain funding. For example, a firm might sell software that included updates for a three-year period. The software might be far more valuable than the updates, but without VSOE the firm was required to use subscription accounting. To avoid subscription accounting, firms went to great lengths to establish VSOE. This trend was particularly true for companies that sold high-value products that contained software deemed more than incidental to the product. Some customers will agree to a total price for a multiple-element sale but want that price allocated to individual elements in some way for internal purposes. Because that could have caused the selling firm to violate ASC 985-605, many firms had revenue recognition specialists who were required to approve the contract terms before the selling company could accept the order. That procedure clearly interfered with a firm's business practices, but the FASB seemed unwilling to change VSOE rules. The iPhone In 2007, Apple began selling its iPhone, a product with highly sophisticated imbedded software. Apple decided to offer customers free software updates over an unspecified period. At the time, Apple probably had little idea of the cost or even the extent of these software updates, or the eventual popularity of the iPhone. Because it was offering the software at no cost, Apple had no VSOE for the price of the software updates. As a result, Apple adopted the subscription model and decided to spread iPhone revenue evenly over 24 months. If Apple sold an iPhone for $480 it recognized $20 of revenue the first month and recorded $460 as deferred (unearned) revenue. As iPhone sales grew, deferred revenues grew past $12 billion, and it was apparent that software update costs would be trivial relative to deferred revenues. Apple's 2009 10-K for the period ending September 30, 2009, included the following balance sheet and note disclosures about current and non-current deferred revenue:Apple Inc. and Retrospective Adoption of Revenue Recognition Rules Many sales include arrangements with multiple deliverables; some goods or services are delivered immediately, whereas others are provided later, in a different accounting period. Examples include the following: sale of heavy equipment that includes maintenance and parts for three years; sale of a computer system that includes hardware, software, and software updates for three years; and sale of copiers (with imbedded software) that includes software updates for three years. The revenue recognition principles established by SEC Staff Accounting Bulletin 104 (SAB 104) apply to sales with multiple deliverables. These four principles are (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller's price to the buyer is fixed or determinable, and (4) collectability is reasonably assured. In the first example, revenue can usually be recognized for heavy equipment when the equipment is delivered. However, revenue for maintenance or parts must be recognized pro rata over the next three years because the service and parts will be delivered over that three-year period, not at contract inception. In the second example, revenue can usually be recognized for hardware and software at the beginning of the contract, when they are delivered, but not for software updates, which are provided later. Similarly, revenue can usually be recognized for the copying equipment when delivered, but software update revenue would be recognized over the three-year update period, unless it is immaterial. In each instance, firms must allocate the total sales price between the multiple elements in a reasonable way. The most reliable way might be to use the firm's own history of selling items separately. Suppose a firm sells heavy equipment and also offers three-year maintenance contracts on equipment it sells and on equipment sold by competitors. The maintenance contract price may be a percentage of the original cost of the equipment, adjusted for usage or age. If the firm has evidence that it routinely sells service contracts on equipment bought elsewhere and that it routinely sells equipment without maintenance contracts, then the firm has support for the selling price of both the equipment and the maintenance contract. If the firm sells equipment bundled with a maintenance contract at a discount, it can use historical selling prices for equipment and maintenance contracts to allocate the discounted revenue to the separate elements. The firm might also consider prices its competitors charge for the separate elements or use its best judgment to allocate revenue to each element in a multiple element sale. However, some firms that sell software bundled with updates or support seemingly allocate too much revenue to the initial software component and too little to the subsequent support or maintenance. That practice lets firms recognize too much revenue at the start of the contract period. Later, when the firm incurs high support or maintenance costs, it has minimal revenue to offset those expenses. ACS 985-605 (SOP 97-2) In response, the American Institute of Certified Public Accountants (AICPA) issued ASC 985-605, Statement of Position 97-2 (SOP 97-2), in 1997. Under ASC 985-605, if a multiple element sale includes software that is more than incidental to the sale, a vendor must have vendor-specific objective evidence (VSOE) of the selling price of each element in the sale (i.e., evidence it had sold each item separately and that the sales were more than occasional or incidental). Without VSOE, firms had two options. If the cost of the future service was highly uncertain, the firm was required to defer all revenue until the contract was complete. In most cases, however, firms provided services gradually; in those instances, firms were required to use the subscription method (i.e., recognize the entire selling price evenly over the contract period). Although it was difficult to completely satisfy ASC 985-605's VSOE requirements, many firms assumed they could avoid using the subscription method if their deviations from ASC 985-605 were immaterial. However, when the Public Company Accounting Oversight Board (PCAOB) began reviewing auditing firms in 2004, one of its main findings was that companies were not meeting ASC 985-605's VSOE requirement. The PCAOB noted that some companies had only occasional sales of items in a multiple-element sale or even sales that seemed contrived. The PCAOB further noted that selling prices of different items fluctuated too much relative to each other to be deemed reliable. As a result, some firms were required to restate their financial statements to show far lower revenues and profits than in the past. In many instances that change made financial statements highly misleading; in other instances, the change made it difficult for firms that were economically profitable to obtain funding. For example, a firm might sell software that included updates for a three-year period. The software might be far more valuable than the updates, but without VSOE the firm was required to use subscription accounting. To avoid subscription accounting, firms went to great lengths to establish VSOE. This trend was particularly true for companies that sold high-value products that contained software deemed more than incidental to the product. Some customers will agree to a total price for a multiple-element sale but want that price allocated to individual elements in some way for internal purposes. Because that could have caused the selling firm to violate ASC 985-605, many firms had revenue recognition specialists who were required to approve the contract terms before the selling company could accept the order. That procedure clearly interfered with a firm's business practices, but the FASB seemed unwilling to change VSOE rules. The iPhone In 2007, Apple began selling its iPhone, a product with highly sophisticated imbedded software. Apple decided to offer customers free software updates over an unspecified period. At the time, Apple probably had little idea of the cost or even the extent of these software updates, or the eventual popularity of the iPhone. Because it was offering the software at no cost, Apple had no VSOE for the price of the software updates. As a result, Apple adopted the subscription model and decided to spread iPhone revenue evenly over 24 months. If Apple sold an iPhone for $480 it recognized $20 of revenue the first month and recorded $460 as deferred (unearned) revenue. As iPhone sales grew, deferred revenues grew past $12 billion, and it was apparent that software update costs would be trivial relative to deferred revenues. Apple's 2009 10-K for the period ending September 30, 2009, included the following balance sheet and note disclosures about current and non-current deferred revenue:

Note 4-Consolidated Financial Statement Details The following tables show the Company's consolidated financial statement disclosures as of September 26, 2009 and September 27, 2008 (in millions) about current and non-current deferred costs associated with the above deferred revenues: Other Current Assess

Possibly in response to Apple's financial reports, in October 2009 the FASB issued two Accounting Software Updates: ASC 605-25-ASU 2009-13, Revenue Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements and ASU 2009-14, Software (Topic 985) Certain Revenue Arrangements That Include Software Elements. These two ASCs incorporated the software recognition portion of ASC 985-605 with an acceptable hierarchy of revenue recognition rules for multiple-element sales that include software. The hierarchy is (1) vendor-specific objective evidence of fair value (VSOE), (2) third-party evidence of selling price (TPE), and (3) best estimate of the selling price (ESP). Although VSOE is still the preferred method, a company's own best estimate of the separate selling prices (ESP) is acceptable, so effectively, VSOE is now nearly irrelevant. Apple Retrospectively Adopts New Revenue Recognition Rules ASC 605-25 and ASC 985-605 are effective for new multiple-element sales entered into in fiscal years beginning on or after June 15, 2010. Most U.S. firms have a December 31 year end, so those firms are not required to use the new rules in their sales contracts until January 1, 2011. However, companies had the option to adopt the new rules immediately and apply them retrospectively, that is, restate prior periods as if the new rules had always been in effect. Apple issued its 10-K for the year ending September 30, 2009, on October 27, 2009. On January 25, 2010, Apple issued its 10-Q for the three months ended December 31, 2009, and also issued an amended (revised) 10-K (10-K/A) on that date that restated its prior financial results to reflect the new revenue recognition rules. Exhibit 1 is an explanatory note at the beginning of Apple's 2009 10-K/A (Amendment No. 1) that explains why it is restating its financial statements. Exhibit 2, an excerpt from Note 1 to that 10-K/A, explains Apple's new revenue recognition for arrangements with multiple deliverables. This note explains that Apple is deferring $25 of revenue for each iPhone sale for free software updates, and it explains the rationale. Exhibit 3 provides restated balance sheets as of September 26, 2009, and September 27, 2008, and provides restated income statements for the years ended September 26, 2009, September 27, 2008, and September 29, 2007. For each of the five statements, Apple shows an "As Reported" column, an "Adjustments" column, and an "As Amended" column EXHIBIT 1 EXPLANATORY NOTE, APPLE INC. 2009 10-K/A (AMENDMENT 1) Explanatory Note Apple Inc. (the "Company") is filing this Amendment No. 1 to the Annual Report on Form 10-K (the "Form 10-K/A") to amend its Annual Report on Form 10-K for the year ended September 26, 2009, which was filed with the Securities and Exchange Commission ("SEC") on October 27, 2009 (the "Original Filing" and together with the Form 10-K/A, the "Form 10-K"). As amended by this Form 10-K/A, the Form 10-K reflects the Company's retrospective adoption of the Financial Accounting Standards Board's ("FASB") amended accounting standards related to revenue recognition for arrangements with multiple deliverables and arrangements that include software elements ("new accounting principles"). The new accounting principles permit prospective or retrospective adoption, and the Company elected retrospective adoption. The Company adopted the new accounting principles during the first quarter of 2010, as reflected in the Company's financial statements included in its Quarterly Report on Form 10-Q for the quarter ended December 26, 2009, which was filed with the SEC on January 25, 2010. The new accounting principles significantly change how the Company accounts for certain revenue arrangements that include both hardware and software elements as described further below. Under the historical accounting principles, the Company was required to account for sales of both iPhone and Apple TV using subscription accounting because the Company indicated it might from time-to-time provide future unspecified software upgrades and features for those products free of charge. Under subscription accounting, revenue and associated product cost of sales for iPhone and Apple TV were deferred at the time of sale and recognized on a straight-line basis over each product's estimated economic life. This resulted in the deferral of significant amounts of revenue and cost of sales related to iPhone and Apple TV. Costs incurred by the Company for engineering, sales, marketing and warranty were expensed as incurred. As of September 26, 2009, based on the historical accounting principles, total accumulated deferred revenue and deferred costs associated with past iPhone and Apple TV sales were $12.1 billion and $5.2 billion, respectively. The new accounting principles generally require the Company to account for the sale of both iPhone and Apple TV as two deliverables. The first deliverable is the hardware and software delivered at the time of sale, and the second deliverable is the right included with the purchase of iPhone and Apple TV to receive on a when-and-if-available basis future unspecified software upgrades and features relating to the product's software. The new accounting principles result in the recognition of substantially all of the revenue and product costs from sales of iPhone and Apple TV at the time of sale. Additionally, the Company is required to estimate a standalone selling price for the unspecified software upgrade right included with the sale of iPhone and Apple TV and recognizes that amount ratably over the 24-month estimated life of the related hardware device. For all periods presented, the Company's estimated selling price for the software upgrade right included with each iPhone and Apple TV sold is $25 and $10, respectively. The adoption of the new accounting principles increased the Company's net sales by $6.4 billion, $5.0 billion and $572 million for 2009, 2008 and 2007, respectively. As of September 26, 2009, the revised total accumulated deferred revenue associated with iPhone and Apple TV sales to date was $483 million; revised accumulated deferred costs for such sales were zero. The Company had the option of adopting the new accounting principles on a prospective or retrospective basis. Prospective adoption would have required the Company to apply the new accounting principles to sales beginning in fiscal year 2010 without refl.ecting the impact of the new accounting principles on iPhone and Apple TV sales made prior to September 2009. Accordingly, the Company's financial results for the two years following adoption would have included the impact of amortizing the significant amounts of deferred revenue and cost of sales related to historical iPhone and Apple TV sales. The Company believes prospective adoption would have resulted in financial information that was not comparable between financial periods because of the significant amount of past iPhone sales; therefore, the Company elected retrospective adoption. Retrospective adoption required the Company to revise its previously issued financial statements as if the new accounting principles had always been applied. The Company believes retrospective adoption provides the most comparable and useful financial information for financial statement users, is more consistent with the information the Company's management uses to evaluate its business, and better reflects the underlying economic performance of the Company. Accordingly, the Company has revised its financial statements for 2009, 2008 and 2007 in this Form 10-K/A to reflect the retrospective adoption of the new accounting principles. There was no impact from the retrospective adoption of the new accounting principles for 2006 and 2005. Those years predated the Company's introduction of iPhone and Apple TV. EXHIBIT 2 NOTE 1, APPLE INC. 2009 10-K/A Note 1-Summary of Significant Accounting Policies Revenue Recognition Revenue Recognition for Arrangements with Multiple Deliverables For multi-element arrangements that include tangible products that contain software that is essential to the tangible product's functionality and undelivered software elements that relate to the tangible product's essential software, the Company allocates revenue to all deliverables based on their relative selling prices. In such circumstances, the new accounting principles establish a hierarchy to determine the selling price to be used for allocating revenue to deliverables as follows: (i) vendor-specific objective evidence of fair value ("VSOE"), (ii) third-party evidence of selling price ("TPE"), and (iii) best estimate of the selling price ("ESP"). VSOE generally exists only when the Company sells the deliverable separately and is the price actually charged by the Company for that deliverable. For both iPhone and Apple TV, the Company has indicated it may from time-to-time provide future unspecified software upgrades and features free of charge to customers. The Company has identified two deliverables generally contained in arrangements involving the sale of iPhone and Apple TV. The first deliverable is the hardware and software essential to the functionality of the hardware device delivered at the time of sale, and the second deliverable is the right included with the purchase of iPhone and Apple TV to receive on a when-and-if- available basis future unspecified software upgrades and features relating to the product's essential software. The Company has allocated revenue between these two deliverables using the relative selling price method. Because the Company has neither VSOE nor TPE for the two deliverables the allocation of revenue has been based on the Company's ESPs. Amounts allocated to the delivered hardware and the related essential software are recognized at the time of sale provided the other conditions for revenue recognition have been met. Amounts allocated to the unspecified software upgrade rights are deferred and recognized on a straight-line basis over the 24-month estimated life of the related hardware. All product cost of sales, including estimated warranty costs, are generally recognized at the time of sale. Costs for engineering and sales and marketing are expensed as incurred. For all periods presented, the Company's ESP for the software upgrade right included with each iPhone and Apple TV sold is $25 and $10, respectively. The Company's process for determining its ESP for deliverables without VSOE or TPE considers multiple factors that may vary depending upon the unique facts and circumstances related to each deliverable. The Company believes its customers, particularly consumers, would be reluctant to buy unspecified software upgrade rights related to iPhone and Apple TV. This view is primarily based on the fact that upgrade rights do not obligate the Company to provide upgrades at a particular time or at all, and do not specify to customers which upgrades or features will be delivered in the future. Therefore, the Company has concluded that if it were to sell upgrade rights on a standalone basis, such as those included with iPhone and Apple TV, the selling price would be relatively low. Key factors considered by the Company in developing the ESPs for iPhone and Apple TV upgrade rights include prices charged by the Company for similar offerings, the Company's historical pricing practices, the nature of the upgrade rights (e.g., unspecified and when-and-if-available), and the relative ESP of the upgrade rights as compared to the total selling price of the product. In addition, when developing ESPs for products other than iPhone and Apple TV, the Company may consider other factors as appropriate including the pricing of competitive alternatives if they exist, and product- specific business objectives. EXHIBIT 3 NOTE 2, APPLE INC. 2009 10-K/A Note 2-Retrospective Adoption of New Accounting Principles In September 2009, the FASB amended the accounting standards related to revenue recognition for arrangements with multiple deliverables and arrangements that include software elements. In the first quarter of 2010, the Company adopted the new accounting principles on a retrospective basis. The Company believes retrospective adoption provides the most comparable and useful financial information for financial statement users, is more consistent with the information the Company's management uses to evaluate its business, and better reflects the underlying economic performance of the Company. The financial statements and notes to the financial statements presented herein have been adjusted to reflect the retrospective adoption of the new accounting principles. Note 1, "Summary of Significant Accounting Policies" under the subheadings "Basis of Presentation and Preparation" and "Revenue Recognition" of this Form 10-K provides additional information on the Company's change in accounting resulting from the adoption of the new accounting principles and the Company's revenue recognition accounting policy. The following tables present the effects of the retrospective adoption of the new accounting principles to the Company's previously reported Consolidated Balance Sheets as of September 26, 2009 and September 27, 2008 (in millions, except share amounts):