Apple 2015 Annual Report Download - page 35

In September 2015, the Company introduced the iPhone Upgrade Program, which is available to customers who purchase an iPhone 6s
and 6s Plus in one of its U.S. physical retail stores and activate the purchased iPhone with one of the four national carriers. The iPhone
Upgrade Program provides customers the right to trade in that iPhone for a new iPhone, provided certain conditions are met. One of the
conditions of this program requires the customer to finance the initial purchase price of the iPhone with a third-party lender. Upon exercise
of the trade-in right and purchase of a new iPhone, the Company satisfies the customer’s outstanding balance due to the third-party
lender on the original device. The Company accounts for the trade-in right as a guarantee liability and recognizes arrangement revenue net
of the fair value of such right with subsequent changes to the guarantee liability recognized within revenue.
The Company has entered into indemnification agreements with its directors and executive officers. Under these agreements, the
Company has agreed to indemnify such individuals to the fullest extent permitted by law against liabilities that arise by reason of their
status as directors or officers and to advance expenses incurred by such individuals in connection with related legal proceedings. It is not
possible to determine the maximum potential amount of payments the Company could be required to make under these agreements due
to the limited history of prior indemnification claims and the unique facts and circumstances involved in each claim. However, the
Company maintains directors and officers liability insurance coverage to reduce its exposure to such obligations.
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles (“GAAP”)
and the Company’s discussion and analysis of its financial condition and operating results require the Company’s management to make
judgments, assumptions and estimates that affect the amounts reported in its consolidated financial statements and accompanying
notes. Note 1, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this
Form 10-K describes the significant accounting policies and methods used in the preparation of the Company’s consolidated financial
statements. Management bases its estimates on historical experience and on various other assumptions it believes to be reasonable
under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
Actual results may differ from these estimates, and such differences may be material.
Management believes the Company’s critical accounting policies and estimates are those related to revenue recognition, valuation and
impairment of marketable securities, inventory valuation and valuation of manufacturing-related assets and estimated purchase
commitment cancellation fees, warranty costs, income taxes, and legal and other contingencies. Management considers these policies
critical because they are both important to the portrayal of the Company’s financial condition and operating results, and they require
management to make judgments and estimates about inherently uncertain matters. The Company’s senior management has reviewed
these critical accounting policies and related disclosures with the Audit and Finance Committee of the Company’s Board of Directors.
Revenue Recognition
Net sales consist primarily of revenue from the sale of hardware, software, digital content and applications, accessories, and service and
support contracts. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the
sales price is fixed or determinable and collection is probable. Product is considered delivered to the customer once it has been shipped
and title, risk of loss and rewards of ownership have been transferred. For most of the Company’s product sales, these criteria are met at
the time the product is shipped. For online sales to individuals, for some sales to education customers in the U.S., and for certain other
sales, the Company defers revenue until the customer receives the product because the Company retains a portion of the risk of loss on
these sales during transit. For payment terms in excess of the Company’s standard payment terms, revenue is recognized as payments
become due unless the Company has positive evidence that the sales price is fixed or determinable, such as a successful history of
collection, without concession, on comparable arrangements. The Company recognizes revenue from the sale of hardware products,
software bundled with hardware that is 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 hardware products containing software essential to the hardware product’s functionality,
undelivered software elements that relate to the hardware product’s essential software and/or undelivered non-software services, 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 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.
Apple Inc. | 2015 Form 10-K | 33