We Inspire the World to Play

The purpose of this document is to clarify accounting topics specific to Electronic Arts and the videogame industry. It also highlights how our accounting treatment may vary from our peers in effort to help the investment community when reviewing the industry as a whole.

This is intended to increase general understanding of EA’s business and financial results. As such, we have summarized select accounting policies in the answers below. This is not intended to be a definitive list of all investor questions or all material accounting policies. Please refer to our SEC filings for information regarding the topics discussed below for a full discussion of our accounting policies.

General Accounting Considerations

Why do you report net revenue, specifically?

Similar to many companies, we report a majority of our revenue as “net revenue” as opposed to “gross revenue”. Gross revenue is the revenue from an initial sale to a digital marketplace or retailer before factoring in any common deductions, such as allowances, platform provider fees, or discounting. Net revenue is the amount recognized after taking into consideration the above factors. We believe reporting net revenue is a more meaningful disclosure because it reflects the amount we ultimately receive.

Note: following the adoption of ASC 606, we now report the cost of some platform provider fees within cost of revenue and not within net revenue (see the section on ASC 606 below).

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Why do you defer revenue from full game sales and extra content?

GAAP reporting requires us to defer and subsequently recognize a portion our revenue from game sales over a period of time. This is driven by the online nature of our games. For example, a customer may buy a copy of Madden with the expectation that they will play online against their friends. We therefore have a responsibility to provide that service – the ability to play online – for a period of time. Similarly, we may update our games with new content for no additional fee and our customer would also have rights to that update. Consequently, GAAP requires us to recognize revenue over the period we anticipate providing the services and updates.

A general rule of thumb is that, for digital goods, (for example, purchasing and downloading Madden from the Microsoft Xbox Store), we recognize revenue over six months. For physical goods (selling Madden to a brick-and-mortar retailer), we assume the game will spend time in the retail channel and thus we recognize revenue over nine months.

Exactly how much revenue is deferred changed for FY19 (see the section on ASC 606 below). But the underlying principal remains consistent - we continue to defer a portion of our revenue under GAAP for games and extra content that have update rights or can be played online. As a result, the quarter in which we sell the most games and extra content may be different from the quarter in which we recognize the most revenue. Further, because we recognize the costs associated with selling the games as they are incurred, but a significant portion of the revenue is recognized over a period of time, the seasonality in our GAAP profits may appear counterintuitive. For example, historically our December quarter delivers the highest operating cash flow of our fiscal year but does not always correspond to the highest revenue or net income reported.

Our deferred net revenue balance is increased by the revenue being deferred for current sales and is reduced by the recognition of revenue from prior sales (this is referred to as the “net change” in the deferred revenue balance). Given the seasonal nature of our business, the net change in the deferred balance is often material. For example, our sales have historically been highest in the December quarter (due to our release slate and the holidays), and so the deferred net revenue balance generally increases in that quarter. Similarly, because sales have historically been lowest in the June quarter, the deferred net revenue balance generally decreases in that quarter.

Under GAAP, all video game companies may be required to defer a portion of revenue for games with content updates and/or online gameplay, although the deferral amount and recognition period may be different amongst companies.

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How do you recognize revenue from subscription services?

We recognize revenue from our subscription services ratably over the subscription contract. For example, if we sold an annual subscription to Origin Access Premier for $99.99 the revenue would be recognized ratably over twelve months.

There is no difference between our GAAP revenue treatment and net bookings treatment of subscription services revenue.

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What is net bookings?

Net bookings is the net amount of products and services sold digitally or sold-in physically in the period. It can be calculated by adding total net revenue to the change in deferred net revenue for online-enabled games and, for periods after the fourth quarter of fiscal 2018, mobile platform fees. We provide the calculation of net bookings for the periods presented in our earnings release under the heading “Operating Metric” and in the “Management Discussion and Analysis” of our annual and periodic reports under the heading “Net Bookings”.

Note that we have expressed the mobile platform fees as a negative number, reflecting the fact that this is the share taken by the mobile platform provider.

We believe net bookings tracks cash flow more closely than net revenue, and consequently, is an operational metric our management team uses internally to analyze the performance of our business. Many financial analysts use this metric to make comparisons with prior periods and with our peers.

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Do you capitalize game development costs?

No. We generally expense research and development costs associated with our games and services as incurred.

This treatment varies from some of our peers who capitalize and amortize these costs.

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Impact of ASC 606

What is ASC 606?

ASC 606 is a revenue standard under GAAP accounting that we adopted at the beginning of our fiscal 2019 year, which began April 1, 2018.

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How does the new standard impact Electronic Arts revenue?

Under ASC 606, GAAP revenue aligns closer to net bookings. This is because we are generally able to recognize more revenue at the time of the initial sale for games that can be played offline.

Under ASC 605, we were generally required to ratably recognize all of the revenue from a sale of a game that can be played either offline and online or online only over six or nine months. Under ASC 606, the value of a game that can be played either offline and online is comprised of three parts: the value of the software, the value of the future update rights, and the value of the online hosting (to play your friends online). The value of the software is recognized as revenue upfront, with the remaining amount (value of the updates and online hosting) recognized ratably over six months for digital goods or nine months for physical goods. As a result, we typically defer less revenue than we did under the previous revenue standard for games that can be played offline and online. For online only games, under ASC 606 there is no change from previous revenue standard as all the revenue is recognized ratably over time.

Other video game companies may use a different revenue split between upfront and a different time frame to recognize the deferred revenue.

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Does ASC 606 change how you report mobile revenue?

Yes, for GAAP reporting, and as a result of ASC 606, we started reporting most mobile revenue on a gross basis at the beginning of FY19. Previously, mobile platform fees retained by third-parties, such as Apple and Google, were reported on a net basis. In FY19, we started reporting most mobile platform fees within cost of revenue. As a result, both mobile revenue and cost of revenue increase by the amount of these mobile platform fees. We disclose mobile platform fees in our reported results and guidance to allow you to calculate revenue and net bookings in a way that is comparable to prior periods.

We made this reporting change because ASC 606 changes the criteria used to determine whether a third-party partner (such as Apple through its App Store) is an “agent” or a “principal”. For EA, this changes how the fee retained by the third-party partner is presented in EA’s financial statements (it is now a cost of sale rather than a reduction of revenue).

This change only affects revenue through Apple and Google, and not from other sources such as mobile advertising.

This is a GAAP reporting change that does not impact our net bookings metrics.

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Does ASC 606 change the way you classify net bookings?

It did not change our net bookings categories but caused us to make some minor adjustments to the classifications.

Under ASC 606, we are now able to allocate a sale to different net bookings categories. The primary example is a game that includes extra content – we call this a “bundle”. Under the previous standard, we did not, under certain circumstances, allocate value to the components of the bundled sale, hence the entire amount was classified as full game, even though it technically included extra content. Under ASC 606, we are able to allocate a value between full game net bookings and extra content net bookings. The update will not change the total net bookings amount recognized but will change the mix between the categories (we anticipate more extra content and less full game).

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Will ASC 606 impact gross margin?

There was a slightly dilutive impact to GAAP gross margin due to the change in the way we recognize mobile revenue and related mobile platform fees (from net to gross, as discussed above). However, there is no material impact to management reporting.

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Will there be a material effect on your cash flow?

Upon adoption of ASC 606, in the first quarter of fiscal 2019 we accelerated the revenue recognition on prior period game sales into retained earnings, which resulted in additional cash taxes.

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How will Electronic Arts incorporate ASC 606 into its financial statements?

We chose to adopt ASC 606 using the modified retrospective approach, which means we have not restated our historical financial statements. For comparability through FY19, we also report pro-forma financial results under ASC 605 in our periodic reports filed with the SEC. This provides the ability to compare FY19 financial results to FY18 financial results.

In addition, because we elected to not restate historical numbers for prior year periods, some metrics, such as our trailing twelve months disclosures, contain revenue recognized under both ASC 606 and ASC 605. For example, the trailing twelve months as of December 31, 2018 includes three quarters of revenue recognized under ASC 606 and one quarter under ASC 605. As a reminder, all revenue before April 1, 2018 is recognized under ASC 605 and all revenue after April 1, 2018 is recognized under ASC 606.

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Where can I find additional information about Electronic Arts’ adoption of ASC 606?

Our Form 10-Q filed with the SEC on February 6 2019, contains additional information regarding the adoption of ASC 606 under the heading “Recently Adopted Accounting Standards”. Updates, if any, will be included in our next Form 10-K, which we anticipate filing in May 2019.

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