Electronic Arts Inc - Accounting for Virtual Goods at Zynga

Electronic Arts, Inc. is one of the main competitors of Zynga and is traded on the NASDAQ: EA. So, Electronic Arts, Inc. also known as EA Games, is an American developer, marketer, publisher and distributor of video games headquartered in Redwood City, CA.

And Electronic Arts classifies its revenue as either product revenue or service and other revenue. Its product revenue includes revenue associated with the sale of software games or related content. And its service revenue includes revenue recognized from time-based subscriptions and games. There are several models Electronic Arts use to recognize their revenue, which are 1) traditional sales, 2) time-based subscription, and 3) free-to-download games. And the recognition models based on the four criteria: 1) evidence of arrangement, 2) fixed or determinable fees, 3) collection is deemed probable, and 4) deliver.

First of all, traditional sales are those associated with the sale of software games or related content.  Like many game industry, it’s a simple and effective way to recognize basic revenue from the proceeds of sales. Electronic Arts recognize revenues when the game is available to download and play.

Second, for the time-based subscription, the game players use the Electronic Arts’ servers to have access to the game like Battlefield 4 for $5 per month. FASB requires Electronic Arts to defer the revenue, and then recognize the revenue as the service is provided. For instance, when the customer signs up and pays their first month of service, Electronic Arts needs to account for that money by placing the balance in a deferred revenue account instead of directly into revenue. When the subscription circle is closed, the revenue will be distributed ratably over the subscription period.

Last but not least, for free-to-download games, customers can download and play games free of charge. Based on these “free” games, additional content and enhanced online services can be purchased directly through Origin online platform. Also, customers can buy some virtual goods to improve their game experience. Such virtual goods include two types: 1) durable, and 2) consumable. Electronic Arts first will record these proceeds they received as deferred revenue. For the proceeds from consumable virtual goods, the deferred revenue will be recognized as revenue when the goods are consumed by customer. For the proceeds from durable virtual goods, the deferred revenue will be recognized pro rata through the estimated offering period.  

The strengths of revenue recognition model used by Electronic Arts are as follows. 1) It smooths out earnings based on estimated offering period. 2) It distinguishes obligation exists.

There are also several weaknesses. 1) It’s hard to calculate the true offering period. 2) It’s hard to forecast the revenues and profitability because these models are inherently uncertain and volatile. I can tell from 10-K that the actual revenue and profit are significantly greater or less than their forecasts. 3) The models could fail for one or more of Electronic Arts’ titles, resulting in the loss of investment in the development and infrastructure needed to support these models, as well as the opportunity cost.