GWU Revenue Recognition Case Study

Zynga: Revenue RecognitionReview the excerpts from the 2011 Zynga annual report and the Morgan Stanley exhibit and
briefly answer the following questions. This assignment should not exceed 1 page.
Zynga Inc. (ZNGA) is the world’s leading provider of social game services with 240 million
monthly users in over 175 countries. Zynga’s leading games include CityVille, Zynga Poker,
FarmVille, CastleVille, FrontierVille, Mafia Wars, Words with Friends and Draw Something.
Facebook is the primary distributor, marketer and payment platform for the company’s games,
although the games are available on other social networks and through mobile applications.
Zynga went public in December 2011 and is headquartered in San Francisco, CA.
1)
Does Zynga charge its customers to play the company’s games? How does Zynga earn
revenue?
2)
In your own words, explain how Zynga records revenue from the sale of virtual goods?
3a) Do you think Zynga’s method for accounting for virtual goods is appropriate? Why or why
not?
3b) What other information would you like Zynga to provide in order to better assess whether
the accounting treatment for virtual goods is appropriate
4a) Zynga notes that a change in the estimated average playing period resulted in an increase in
revenue of $53.9 million in 2011 and an offsetting reduction in revenue in 2012. What must
have happened to the average playing period (i.e., did it increase or decrease)? What does
that imply about the nature of Zynga’s business?
4b) What net income would Zynga have reported in 2011 had the company not made this
change?
Zynga Inc.
Consolidated Statements of Operations
(in thousands)
Year Ended December 31,
2011
2010
2009
Revenue
$
Costs and expenses:
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total costs and expenses
Income (loss) from operations
Interest income
Other income (expense), net
(Provision for) / benefit from income taxes
Net income (loss)
$
1,140,100
$ 597,459
$ 121,467
330,043
727,018
234,199
254,456
1,545,716
176,052
149,519
114,165
32,251
471,987
56,707
51,029
42,266
24,243
174,245
(405,616)
125,472
(52,778)
1,680
(2,206)
1,826
1,222
365
(36,464
177
(209)
(12)
(404,316)
$ 90,595
$ (52,822)
Zynga Inc.
Notes to Consolidated Financial Statements
Revenue Recognition
We derive revenue from the sale of virtual goods associated with our online games and the
sale of advertising within our games.
Online Game
We operate our games as live services that allow players to play for free. Within these
games, players can purchase virtual currency to obtain virtual goods to enhance their gameplaying experience.
We recognize revenue when the service has been provided to the player and the collection
of our fees is reasonably assured. For purposes of determining when the service has been
provided to the player, we have determined that an implied obligation exists to the paying player
to continue displaying the purchased virtual goods within the online game over their estimated
life or until they are consumed. The proceeds from the sale of virtual goods are initially recorded
in deferred revenue. We categorize our virtual goods as either consumable or durable:
Consumable virtual goods, such as energy in CityVille, represent goods that can be
consumed by a specific player action. Common characteristics of consumable goods include
virtual goods that are no longer displayed on the player’s game board after a short period of
time, do not provide the player any continuing benefit following consumption, or enable a
player to perform in-game action immediately. For the sale of consumable virtual goods, we
recognize revenue as the goods are consumed, which approximates one month.
Durable virtual goods, such as tractors in Farmville, represent virtual goods that are
accessible to the player over an extended period of time. We recognize revenue from the
sale of durable virtual goods ratably over the estimated average playing period of paying
players for the applicable game, which represents our best estimate of the estimated average
life of durable virtual goods.
Future usage patterns may differ from historical usage patterns and therefore the estimated
average playing periods may change in the future. We assess the estimated average playing
period for paying players and the estimated average life of our virtual goods quarterly.
Cumulative changes in estimated average playing period for paying players in 2011 resulted in
an increase in revenue of $53.9 million and will result in an offsetting reduction of 2012 revenue
in the same amount.
Advertising
We have contractual relationships with agencies, advertising brokers and certain advertisers
for advertisements within our games. We recognize advertising revenue for branded virtual
goods and sponsorships, engagement advertisements and offers, mobile advertisements and other
advertisements as advertisements are delivered to customers.
Zynga Inc.
Notes to Consolidated Financial Statements
We report our advertising revenue net of amounts due to advertising agencies and brokers
because we are not the primary obligor in our arrangements, we do not set the pricing, and we do
not establish or maintain the relationship with the advertiser.
Revenue by type
The following table presents the components of revenue (in thousands):
Online game
Advertising
Total revenue
$
$
Year Ended December 31,
2011
2010
2009
1,065,648
$ 574,632
$ 85,748
74,452
22,827
35,719
1,140,100
$
597,459
$ 121,467
MORGAN
STANLEY
RESEARCH
January 25, 2012
Zynga Inc.
MORGAN STANLEY RESEARCH
Zynga Inc.
January 25, 2012
Zynga: Company Overview – Virtual Goods
Consumable Goods – One-time use items, revenue recognized within current period
(Energy in Empires & Allies)
(Resources in CastleVille)
(Power-ups in Indiana Jones Adv. World)
Durable Goods – Revenue recognized over expected life of game
(Tractors in FarmVille)
Source: Company filing, Company website
Source: Investext. Reprinted for educational purposes.
(Fountain of Youth in CityVille)
(Weapons in Mafia Wars 2)