Apple now sitting on $10B in deferred revenue, more than Samsung or Google earned last quarter

Apple reported net earnings of $7.5 billion for the quarter ending in September, but it also amassed more than $10 billion in deferred revenues that it hasn't yet declared as income.

Apple's deferred revenues began rapidly building when the company initiated "subscription accounting" in 2007 with the release of the original iPhone, a practice that set aside a portion of new income that the company did not officially, immediately recognize it in its earnings reports, even though the company had collected the money.

Instead, Apple incrementally recognized a fraction of that deferred revenue each quarter over a two year period. The practice was designed to ensure that revenue wasn't counted ahead of delivering a full product, because in Apple's accounting, the iPhone wasn't finished until two years of software updates had been provided to the end user. Incredibly, none of Apple's critics in the tech media, or even in mainstream financial reporting circles, seems to realize this pool of billions even exists

Apple maintained the same delayed accounting for Apple TV, and later added similar accounting for iPad and Mac sales, explaining that with such subscription accounting in place, it could legally distribute updates and new features over the two or four year lifespan of new products without needing to charge even a nominal fee for the updates.

Apple's deferred revenues also include high margin sales of support contracts such as AppleCare, which are sold upfront and recognized as income over time as they expire, as well as gift cards for iTunes and the App Store that hold credits that have not yet been spent. Apple splits its deferred revenues into current (amounts it will recognize over the next 365 days) and non-current (deferred for longer than one year).

Apple has now amassed a rapidly growing pile of deferred revenue that is unlike any of its peers, and far greater than the recently released quarterly earnings of Microsoft, Samsung, or Google. Incredibly, none of Apple's critics in the tech media, or even in mainstream financial reporting circles, seems to realize this pool of billions even exists.

Windows 8.1 is not an upgrade

Microsoft, for example, has temporarily reported deferred revenues related to pre-sales of Windows, simply because it offers some PC buyers the right to download new software in the future once it becomes available. In the last quarter this only involved $113 million related to Windows 8.1. A year ago, Microsoft reported global pre-sales for both Windows 8 and a new version of Office, and the combined total was $1.3 billion.

As Microsoft explains in its quarterly report, "Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered [...] If updates are determined to not meet the definition of an upgrade, revenue is generally recognized as products are shipped or made available.""We evaluated Windows 8.1 and determined that it did not meet the definition of an upgrade" - Microsoft

Additionally, rather than holding that deferred revenue over years of incremental recognition, as Apple does with its iOS and OS X products, Microsoft simply delayed its revenue until it actually delivered the software to its users. "Windows 8.1 will enable new hardware, further the integration with other Microsoft services and address customer issues with Windows 8, and will be provided to Windows 8 customers when available at no additional charge," the company stated.

"We evaluated Windows 8.1 and determined that it did not meet the definition of an upgrade and thus have not deferred revenue related to this update. Windows 8.1 revenue was deferred for pre-sales of Windows 8.1 to original equipment manufacturers and retailers before general availability."

Android does not get updates

In the mobile world, nobody seems to be deferring revenue like Apple, in part apparently because nobody updates end users' software the way Apple does. Google's combined statements including Motorola only point to $907 million in deferred revenue, a figure up just $17 million over the past year. Google doesn't detail in its 10-Q what this deferred revenue includes.

In contrast, Apple's deferred revenue increased by $1.48 billion over the year ago quarter, and next quarter Apple said it will not only continue to grow, but grow at a faster rate: an estimated $900 million in additional deferred revenue, due to its increasing the amount it will defer for iOS, OS X and new iLife and iWork apps now being offered for free.

That indicates that by the end of calendar 2013, Apple will be sitting on around $11.3 billion in deferred revenue. That's essentially pure profit, because it's scraped off the top of reported revenue before reporting the earnings that are already leading the PC and mobile industries. Apple is earning more than everyone else by a huge margin, and it's not even needing to count all of its revenue at the time of sale in order to do so.

Investors looking at Apple's performance are therefore comparing earnings numbers that are misleadingly low, by billions of dollars. It's no secret that Apple is more profitable that all of its peers by a huge margin. But Apple actually makes even more than is publicly considered by pundits and analysts who only look at surface numbers.

Bloomberg does not get Apple

Illustrating the media's confusion, Adam Satariano, writing for Bloomberg, issued a report under the completely false headline, "Apple Forecasting Slower Holiday Sales Amid Samsung Gains."

Apple did not forecast slower holiday sales.

Instead, it outlined slower year over year growth, but guided for "faster" quarterly sales than in previous years (as Satariano acknowledged in his story), on top of the fact that it will be deferring recognition of over $1 billion of its income in the quarter, around $900 million more than usual.

In a Bloomberg video (below) titled "Margins Mystery Revealed," John Erlichman doesn't reveal any actual mystery, instead telling the story of "other players that are trying to gear up for strong holiday sales" against the iPad.

Samsung and other firms have been "trying to gear up" against the iPad since it appeared in 2010, but Samsung's tablet and PC business continues to make roughly a tenth of Apple's non-phone earnings, even with the deferred revenues delaying a portion of Apple's take from being reported each quarter.

Pressed to address Apple's margins, Erlichman said the takeaway from Apple's conference call was, "had they not done some of these accounting things, those margins would have been higher overall," further noting in passing, "this is a company that is still generating huge piles of cash."

In his thirteenth paragraph, after detailing Strategy Analytics' data on Apple's perilously small share of the global markets for smartphones and tablets, Satariano also added that Apple's "Chief Financial Officer Peter Oppenheimer said margins would have been better, if not for a new accounting method Apple is using for software."

The story makes no mention of the fact that Apple's "accounting things" now involves more money than Samsung's entire smartphone, PC, netbook and tablet operations reported in the past quarter.