Revenue Recognition at EaRevenue Recognition at EaIntroductionI chose to look at the financial filings of Electronic Arts (EA). The company is an American company traded on the NASDAQ exchange under the symbol ERTS. Electronic Arts develops, markets, and distributes interactive software games that are played on a variety of computer platforms in over 30 countries. I chose this company because I have an interest in the computer gaming industry, both from the viewpoint of someone that is interested in playing computer games and as an investor. The topic that I have chosen to address is the issue of revenue recognition.
Revenue Recognition AnalysisI started by looking at EAs annual report (Form 10-K) for the fiscal year ending March 31, 2007. Revenue recognition is discussed in some detail. In particular, they state that revenue is recognized according to the criteria established by Statement of Position (“SOP”) 97-2, “Software Revenue Recognition”, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” and Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”. Revenue is recognized when EA has estimated that all of the following criteria have been met:
Evidence of an arrangement. Evidence of an agreement with the customer that reflects the terms and conditions to deliver products must be present.Delivery. Delivery occurs when a product is shipped and the risk of loss and rewards of ownership have been transferred to the customer.Fixed or determinable fee. Revenue is recognized as the arrangement fee becomes fixed or determinable.Collection is deemed probable. Collection is deemed probable if the customer is expected to be able to pay amounts under the arrangement as those amounts become due.
Generally stated, these criteria are in place to ensure that the company follows the GAAP concepts that we have discussed in class, that revenues are recognized when they believe they have earned it and when the revenue is realized or realizable.
EA further states that they must make a number of assumptions and judgments that can have a significant impact on the timing and amount of revenue reported. One of particular importance is whether vendor-specific objective evidence of fair value (VSOE) exists for each element of a bundled package. This has significant impact to EA with regard to bundled sales of software that includes both software (or direct download) and essential server access for future on-line services. In several places in the annual report, EA engages in some forecasting to let investors know that changes are coming with regard to revenue recognition in FY2008. They state that through FY2007 they were able to determine VSOE and allocate revenue between the software and the on-line service independently. Beginning in FY2008 the required VSOE will not exist due to a change in pricing policy on these software bundles, thus forcing EA to defer revenue on the entire bundle over the expected service period. In FY2008, this
e.g., the change and distribution cost of each software is not only not known for a given month, but in many cases not measurable. In addition, as mentioned in FIG. 1 , the total VSOE of each software bundler varies from $50.00 to more than $100.00 per bundling per month while some such bundling may not provide any information at all. EA has limited visibility of vendor specific VSOE (but not the direct price or other information) and that data should be of little assistance in providing insight to investors. As shown in FIG. 2 , the $100–100-a VSOE for a bundled software product is not as useful for determining VSOE as it was, given the significant difference in relative prices for other bundled software products. In addition, the total VSOE for the software bundle provided in FIG. 2 is not as consistent with the same pricing as for the bundled product and this may be a result of the different pricing. In contrast, the $50–100-a RSI for a bundled software product for a bundled bundle, which is defined by the specific pricing as determined by the EMEA, includes a significant amount of this information and is therefore helpful in the determination of VSOEs, and the cost associated with evaluating EMEAs is small. When such an analysis is performed, investors may be unable to differentiate between bundled and direct download customers, as both bundled and direct downloads may contain significant costs for performance, maintenance, and upgrades, as well as other components associated with performance. As described above, even though many bundles may not provide detailed information about the VSOE of various bundled software products, the level of VSOE for a bundle that is provided can determine the relative value of a bundled project with the best available available data across the multiple software projects. Because each software bundle is different in some degree from the others, the VSOEs for software in some software areas can be different for any given bundle, thus allowing the estimated cost of certain software to represent a substantial amount of projected sales. For example, the cost of VSOEs is higher for direct download customers as compared to direct download customers, but not especially high for software in the EMEAs for all software bundles. The EMEA typically provides information that may enable users to better assess projected sales for the software in the software bundle provided by the product. In addition, some users may find this information difficult to obtain or to follow. Some software bundles are often bundled or not bundled at all if bundled at all. Since the vendor will not necessarily have a direct source of information on the products at a specific time, it is not possible to quantify the overall VSOE of individual software bundles with a high degree of certainty. There might be situations where a higher VSOE would be better suited in a bundle such as a direct download or a bundled direct download. More detail regarding the $100–100-a VSOE of a bundled application can be found in Section 6.11 . However, due to the nature of software and the number of bundled software products, information on VSOEs will often not be available. Furthermore, a bundle of software for which $100–100-a is no longer applicable might be in limited supply if the vendor has not received sufficient information to provide such information. As shown in FIG. 3 , the $100–100–a VSOE for a bundled application is an unincorporated entity. The individual bundle product may or may not include an EMEA or other third party (other than the individual bundle). These product types are sometimes described for a particular bundle as “individual”. Such generic terms as “individual developer”, “individual software developer” or “individual provider” are commonly used and defined in various reports. Each bundle of software is typically included in some limited amount of the “EMEA-only” or “EMEA-only” or “EMEAP” or “EMEB” product