Updated with details on Apple's accounting changes.By Chris Bulkey, principal analyst at Technology Research Group Apple's ( AAPL - Get Report) quarterly report to regulators (10-Q) yielded some surprises. Several areas of Apple's financial reporting that had a positive impact on the company's income statement for all of 2009 and for the fiscal first quarter of 2010 were managed more conservatively in the fiscal second quarter of 2010. First, Apple's capitalized expenses completely disappeared. In the year-ago quarter, the company capitalized $23 million of research and development expenses. Keeping this constant would have added nearly 2 cents a share to the company's bottom line. Second, Apple made no meaningful use of deferred assets to lower its taxes payable. Elsewhere, Product warranty accounting did a 180-degree turn as accruals for product warranty costs moved to a net addition of $4 million vs. a drawdown of $56 million a year before. And the allowance for doubtful accounts was increased as a percentage of receivables balance. Such a sudden shift to being more conservative is almost unheard of. In fact, we can't recall an example that comes close. Nevertheless, Apple's numbers are what they are, and the company deserves credit for its results. The Financial Accounting Standards Board's decision to allow Apple to change the way it accounts for subscription revenue materially impacted the income statement and balance sheet. It gave a nice boost to the top line and reduced the balance of deferred revenue. Adoption of new policies is the reason deferred revenue was restated from $14.8 billion to $2.9 billion for the fiscal fourth quarter of 2009. It also explains why the line item dropped from $10.5 billion to $3.48 billion year over year in the fiscal second quarter of 2010. This makes the sequential change in this latest quarter the second normalized comparison. Apple has historically increased this "hidden revenue stream" in a seasonally down fiscal second quarter. Drawdown was small at roughly $29 million and had minimal effect on fiscal second-quarter 2010 results. Choosing not to lift the balance amid sales momentum, however, raises an eyebrow. Moreover, the line item was increased by more than $600 million quarter over quarter in the fiscal first quarter of 2010, making this latest progression the first time it was reduced post accounting change.
Despite Apple's increased conservatism with accounting, we're not moving to a more favorable rating on Apple's stock, and we are maintaining our sell rating. That's because of the sequential decline in the revenue deferrals. In isolation, this development was far from flagrant. In other words, it was small in absolute terms and was not a glaring irregularity amid lower sales. It was, however, a reversal of past tendencies. In each of the past two years, Apple built a fairly substantial backlog in the second quarter. It's unlikely this will precede a reduction to Apple's guidance, but it could make it more difficult to sustain momentum.