Introduction:
The Harvard Business School case “Accounting for Revenues at Electronic Arts (EA)” by Paul M. Healy and Marshal Herrmann discusses the revenue recognition practices of Electronic Arts (EA) and the challenges it faced in implementing the new revenue recognition standard. The case highlights the importance of accurately recognizing revenue and the impact of accounting practices on financial reporting.
Case Issue:
The main issue in the case is how to properly recognize revenue for video game publishers such as EA. Under the new revenue recognition standard, companies must recognize revenue when they satisfy a performance obligation by transferring a promised good or service to a customer. This means that companies must estimate the amount of revenue they expect to earn from each game sold over its entire life cycle.
Case Analysis:
Electronic Arts (EA) is a leading video game publisher that is subject to a complex set of revenue recognition standards. In 2010, EA introduced a new game called Battlefield 3, which was expected to generate significant revenue over its life cycle. However, EA faced several challenges in estimating the amount of revenue it would earn from the game.
First, EA had to estimate the number of units it would sell over the game’s life cycle. This was difficult because sales of video games tend to be concentrated in the first few weeks after release, followed by a long tail of lower sales over time. EA used a statistical model to estimate the number of units it would sell over the game’s life cycle, but this model was based on historical sales data that may not have been relevant to Battlefield 3.
Second, EA had to estimate the amount of revenue it would earn from each unit sold. This was difficult because the game included downloadable content that was sold separately from the base game. EA had to estimate the amount of revenue it would earn from this downloadable content and allocate it between the base game and the downloadable content.
Third, EA had to determine the appropriate accounting treatment for revenue earned from Battlefield 3. EA used the “sell-in” method to recognize revenue, which recognized revenue when the game was sold to retailers rather than when it was sold to end customers. This allowed EA to recognize revenue earlier than it would have under the “sell-through” method, which recognized revenue when the game was sold to end customers. However, this method could lead to overstated revenue if retailers returned unsold copies of the game.
Conclusion:
The case highlights the challenges that companies face in recognizing revenue under the new revenue recognition standard. It also highlights the importance of accurate revenue recognition for financial reporting and the potential consequences of misreporting revenue. Electronic Arts (EA) faced several challenges in estimating the amount of revenue it would earn from Battlefield 3, and its revenue recognition practices may have overstated revenue. This underscores the need for companies to carefully consider the appropriate revenue recognition method and to use accurate estimates when recognizing revenue.
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Recommendations:
To avoid potential misreporting of revenue, companies should carefully consider the appropriate revenue recognition method and use accurate estimates when recognizing revenue. They should also ensure that their revenue recognition practices comply with the new revenue recognition standard. Companies should consider the potential consequences of misreporting revenue and take steps to prevent misreporting. Finally, companies should consider the potential impact of revenue recognition practices on their financial reporting and the importance of accurate financial reporting for investors and other stakeholders.
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