Apple 2010 Annual Report Download - page 32

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Table of Contents
essential to the functionality of the hardware, and third-
party digital content sold on the iTunes Store in accordance with general revenue
recognition accounting guidance. The Company recognizes revenue in accordance with industry specific software accounting guidance for the
following types of sales transactions: (i) standalone sales of software products, (ii) sales of software upgrades and (iii) sales of software bundled
with hardware not essential to the functionality of the hardware.
For multi-element arrangements that include tangible products containing software essential to the tangible product’
s functionality and
undelivered software elements relating to the tangible product’
s essential software, the Company allocates revenue to all deliverables based on
their relative selling prices. In such circumstances, the Company uses a hierarchy to determine the selling price to be used for allocating revenue
to deliverables: (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. ESPs reflect the Company’
s best estimates of what the selling prices of elements would be if they
were sold regularly on a stand-alone basis.
For all past and current sales of iPhone, iPad, Apple TV and for sales of iPod touch beginning in June 2010, the Company indicated it might
from time-to-
time provide future unspecified software upgrades and features free of charge to customers. The Company has identified two
deliverables in arrangements involving the sale of these devices. The first deliverable is the hardware and software essential to the functionality
of the hardware device delivered at the time of sale. The second deliverable is the embedded right included with the purchase of iPhone, iPad,
iPod touch 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 embedded unspecified software upgrade right are deferred and recognized on a straight-
line
basis over the 24-
month estimated life of each of these devices. All product cost of sales, including estimated warranty costs, are recognized at
the time of sale. Costs for engineering and sales and marketing are expensed as incurred. If the estimated life of the hardware product should
change, the future rate of amortization of the revenue allocated to the software upgrade right will also change.
The Company’s process for determining its ESP for deliverables without VSOE or TPE involves management’s judgment. The Company’
s
process 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, iPad, iPod touch
and Apple TV. This view is primarily based on the fact that unspecified 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. Therefore, the Company has concluded if
it were to sell upgrade rights on a standalone basis, including those rights associated with iPhone, iPad, iPod touch and Apple TV, the selling
price would be relatively low. Key factors considered by the Company in developing the ESPs for these 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. The Company may also consider,
when appropriate, the impact of other products and services, including advertising services, on selling price assumptions when developing and
reviewing its ESPs for software upgrade rights and related deliverables. The Company may also consider additional factors as appropriate,
including the pricing of competitive alternatives if they exist, and product-
specific business objectives. If the facts and circumstances underlying
the factors considered change or should future facts and circumstances lead the Company to consider additional factors, the Company’
s ESP for
software upgrades related to future sales for these devices could change.
29