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Running head: MANAGERIAL ACCOUNTING IN APPLE INC.

Managerial Accounting in Apple Inc.: The Rationale behind its Success Vrushali Soni Northwest University

MANAGERIAL ACCOUNTING IN APPLE INC. Apple Inc.

Established on January 3, 1977, Apple Inc. (Apple) is currently one of the leading innovator and mobile device provider. Headquartered in Cupertino California, it develops around 57 products, services, peripherals, networking solutions, third party digital content and application among which major products and services include iMac (personal computer), MacBook (laptop), Xserve (server), iPad (tablet PC), iPod (MP3 player), and iTunes (music downloading software). Starting at a niche market share, Apple currently operates more than 320 stores spread out in many countries worldwide and is planning to expand in more than 100 countries by the end of 2012. Its major clients are in education, business, government, IT sector, and consumer market. Apple is spread out in a number of divisions or departments including marketing, finance, and legal, retail, corporate, applications, facilities, supply chain, R&D and many others (Apple, n.d.). In 2011, Apples revenues accounted to be $108.25 billion with a growth of 65.96% in one year, and net income of $25.95 billion with a growth of 84.99% in one year. Its market capitalization is $625.35 billion. Apple has 63,400 hard-working and dedicated employees. The third quarter (ended June 30, 2012) result of 2012 fiscal year reports quarterly revenue of $35.0 billion, $6.4 billion more than that generated in the year-ago quarter. The Q3 2012 earned profit of $8.8 billion, $1.5 billion more than Q3, 2011. Gross margin was 42.8 % compared to year-ago quarters 41.7 % profit. Apples fiscal year ends on September 29, 2012. The expected revenue for fourth quarter is $34 billion due to releases of iPhone 5 and iOS 6 (Apple, n.d.). Apple launched iPhone 5 on September 21, 2012 and sold over 5 million iPhones in just three days. It surpassed its competitors by receiving 2 million iPhone 5 preorders in just 24 hours. In 22 other countries its launch is awaited, they will have its availability by September 28 and more than 100 countries all over the world will receive iPhone by the end of this year. The international sales accounted for 62% of the quarters revenues. The sales in this quarter include 26 million iPhones, 17 million iPads, 4 million Macs, 6.8 million iPods. All of its products record for growth except for iPod as it experienced 10% decline than the year-ago quarter (Apple, n.d.). Until June 2012, the reported revenues of Apple are $120. 54 billion and net income is $33.5 billion. iPhone and related products accounts for 43% of the revenue generation whereas iPad and related products account for 19% of the total revenues (Apple, 2012). The ROA (Return on Assets) of Apple is 29.77%, which indicates the profit generated by its assets. ROE (Return on Equity)/ RONW (Return on Net Worth) of the same is 44.32%; this indicates the efficiency of Apple to turn investments of shareholders into profit (Apple, n.d.). In both ROA and ROE, it surpasses its competitors including HP and Google (Apple, 2012). This paper focuses on primary managerial accounting principles followed by Apple Inc. for its profitability. This paper covers cost management, transfer pricing and responsibility accounting. Many articles, news and Apple Inc.s financial data underpins the information provided in this paper.

MANAGERIAL ACCOUNTING IN APPLE INC.

As compared to other leading tech companies, Apple is known for its efficient cost management. Despite of constant increase in human resource, R&D budget, 40 new retail stores, and other overhead costs, Apple has managed to decrease persistently the operating cost percentage of total sales. Apple calculates its overhead costs from two cost centers- SG&A (Sales, General and Administrative cost) and R&D (Research and development). In 2011, its SG&A cost accounts for 7% ($7.599 billion) of the total sales ($108.25 billion) as compared to 8% SG&A of total sales in 2010. Similarly, the R&D expense is 2% ($2.429 billion) in 2011 whereas 3% in 2010 of the total sales (Apple, n.d.). It is intuitive to think that increase in sales decreases the percentage of expense but when compared to other business rivals, Apple is excelling in cost management agenda. Most of the tech companies are reported to have either increasing or steady operating expense irrespective of increase or decrease in revenues (What Apple, 2011). Persistently releasing premium innovative products, Apple forced people to believe that its major expense is incurred in R&D cost center. On the contrary, it ranks 18th in the list of highest R&D expense reporting tech companies; however, it continues to be a pioneer in innovation. It ranks behind other technology giants and its closest competitors like Microsoft ($9.4 billion), Intel ($8.4 billion), IBM ($6.3 billion), Google ($5.2 billion), and HP ($3.2 billion) (Krantz, 2012). Cost containment and control proved to be an efficient way for Apple to evaluate the success of cost centers. R&D is not the only department contributing to cost control but accounting department also performs its role optimally. Apples effective tax rate in 2011 was 24.2%; in 2010, it was 24.4% whereas in 2009 it was 31.8%. The rationale behind the gradual decrease in tax rate and its variance from federal income tax rate of 35% is because of foreign earnings. U.S. does not issue tax bills on foreign earnings, as they are mandatory reinvestment outside U.S. (Apple, n.d.). Apple has retained millions of dollars in 2011 by cutting off federal tax bills. It took advantage of federal tax laws and skillfully managed the expenses. Apple has its R&D department in U.S where research and innovations are conducted but its manufacturing line is in China where these extrapolations of R&D are converted into a product. It has product design, marketing, software development, product management and many other high wage functions in U.S but only 30% of the total revenues are generated in U.S. In 2011, Apple paid $8.3 billion as total tax. This offshoring decision acts as tax shields for revenue generating cash flows. Assuming 50% of the profit making departments of Apple operates in U.S, the tax charged will be $2.4 billion more than the current expense. If these profit making departments account for 70% from U.S then Apple will have to pay $4.8 billion more as federal tax bill. It declared to have made 24 cents in pre-tax profits in U.S whereas 36 cents from abroad on every dollar of revenues (Klinger, 2012). At Apple, the resources are very limited and when asked for more resources one should literally mean what he is asking for. All of the resources at Apple provide great results even though they are stretched and limited. For instance, only two engineers were appointed to write the code for converting Safari web browser for iPad because Jobs believe Apples do morewith-less mentality (Lashinsky, 2011). Therefore, cost management proves to be a profit center for Apple. Apple is known to be a tuff place to work and the decisions are strict and imposed upon, still the employee turnover is very low. One of the reasons is that the employees of Apple believe in its mission and wish to be a contributor in fulfilling this mission (Lashinsky, 2011). The

MANAGERIAL ACCOUNTING IN APPLE INC.

former employees of Apple say that they still have that lasting impact of Apple on their lives and memories. Another reason is that they can get new products to use on daily basis. Apples incentive program includes employee gifts from iPod shuffle to iPad depending on their performance evaluation. Employee discounts for buying products range from 15 to 25% (William, 2011). The third major contributor towards the profit making of Apple Inc. is responsibility accounting. Apple has responsibility accounting in its DNA. Every function performed in Apple has a designated person responsible for that specific function. Accountability is strictly enforced, decisions are swift and communication is clear between top and bottom level of employees. The CEO, Timothy Cook (formerly Steven Jobs), makes every critical decision. Steve Jobs used to repeat in front of all new VPs that, When you're the janitor, reasons matter. Somewhere between the janitor and the CEO, reasons stop mattering. This culture of accountability is imbibed in all employees by various events, like weekly meetings between CEO and executive management team. On every Monday, a meeting is conducted to discuss results and strategies of every ongoing project. On every Wednesday, marketing and communication group meetings are held for the same purpose. In both meetings, 80% of the content remains same as previously discussed but 20% vary according to some change drivers. In some of the key departments like hardware design department, the entry-level employees used to get feedback on their work by top level executives. The employees either get positive feedback or are told to stop doing stupid shit (Lashinsky, 2011). DRI is a very famous term in Apple and its function is to prevent any confusion related to accountability. DRI- Directly Responsible Individual is a tag assigned to the person responsible for the concerned ongoing small to big process or function. Therefore, there is no incentive to shirk or free-rider problems in Apple. In addition, DRI helps the performance evaluation system to be more transparent and well deserved. Matrix organization is banned in Apple. Fig. 1 shows the organizational structure of Apple. Every person excels in the function he performs and contradictory to other companies in corporate world, he is not held accountable directly or indirectly for any other process except for the one where he is DRI. For instance, a sole person responsible for profits and loss is the CFO and his team. Only Tim Cook is responsible for inventory across the company. One of the core causes of Apple being successful in responsibility accounting is that it focuses on very few products or services at one time. (Lashinsky, 2011). Steve Jobs was known for his responsibility accounting and he wanted to leave behind few key lessons for the next generation executives so that Apple remains profitable even in his absence. For this purpose, he made a panel of a college dean and few professors who currently work on a project called Apple University. This project is based on drafting case studies on the thought processes and decision-making criteria considered by Steve Jobs and other higher authorities while carrying out any critical function or decision. The rationale behind this project is to give an overview of Apples working ethics to the new generation executives. Current top executives like Tim Cook and Ron Johnson will personally tech these case studies to Applites (Lashinsky, 2011). Discussion The above-mentioned measures taken by Apple to increase its profitability include cost management, transfer pricing and responsibility accounting. However, there are many other criteria responsible for the success of Apple. Discussing about these three measures, the small

MANAGERIAL ACCOUNTING IN APPLE INC.

size of Apple is highly responsible for its success. R&D expense is low as compared to its competitors because unlike Microsoft, HP, etc., Apple only focuses on very few products at one time and therefore can control its R&D expense. The employee volume is also less compared to other tech giants therefore can control SG&A expense. Its profit margins are far higher as it charges premium prices for its products. The offshoring decision of Apple is yielding high benefits by providing tax shields over its cash flows however, its supplier relations with Foxconn, one of the major manufacturing suppliers are worsening gradually. Bringing back the manufacturing line in-house, and exporting the products from U.S. to foreign countries might serve Apple with high operating expense and low profit margins. The RDI concept is great for the projects including small group of people, but as the company expands, it will have common corporate problems like goal incongruence, free rider problem, moral hazard, horizon problem, incentives to shirk and so on. Apple will have to take precautionary step before making high volume expansion, which it is planning to do soon. Conclusion The future is always a prediction but currently Apple is doing far better than its competitors are. Despite of charging premium prices in this price competitive world, it manages to lure more and more customers and revenues year after year. It recently released iOS 6, which had a major glitch in its map application, however; this did not affect its sales of iPhone 5. Therefore, it has surely captured a major market share worldwide. In addition to this, it is predicted that Apple will soon earn in trillions by 2013 and its stock price will sky rocket to $1000/share. However, currently it is busy managing two disasters, one being its supplier relations with Foxconn and the other one is its patent law suits against Samsung and vice versa. Currently Apples management is focusing on controlling the company. The decision-making is centralized, performance evaluation is transparent, employees believe in Apples Mission, Vision and Values. The accounting team is constantly working on the anticipated consequences of bringing some manufacturing work back to U.S. Apple is planning to invest more in next years R&D budget to release a new product before the iPad and iPhone market gets saturated with Apple products. Steve Jobs establishment of Apples management is very sound such that Apple still continues to follow his work ethics even in his absence.

MANAGERIAL ACCOUNTING IN APPLE INC.

Fig. 1 Organizational Structure in Apple Source: http://www.theofficialboard.com/org-chart/apple

MANAGERIAL ACCOUNTING IN APPLE INC.

References: Apple Three-Year Financial History. (n.d.). Retrieved form http://files.shareholder.com/downloads/AAPL/2090826035x0x444195/E7A8FE5F-883546AB-ACC2-6FA28DFB546D/Three_Yr_Financial_History.pdf Apple. (2012). Retrieved from http://www.theofficialboard.com/org-chart/apple Klinger, S. (2012). Retrieved from http://articles.baltimoresun.com/2012-04-09/news/bs-edapple-taxes-20120409_1_tax-avoidance-apple-tax-bill Krantz, M. (2012). Retrieved from http://usatoday30.usatoday.com/money/perfi/columnist/krantz/story/2012-03-20/applemarketing--research-and-development-spending/53673126/1 Lashinsky, A. (2011). Retrieved from http://tech.fortune.cnn.com/2011/08/25/how-apple-worksinside-the-worlds-biggest-startup/ What Apple Does Well: Cost Management. (2011). Retrieved from http://seekingalpha.com/article/284455-what-apple-does-well-cost-management