2. Summary of Significant Accounting Policies

Basis of Consolidation

The condensed consolidated financial statements include the accounts of Tesla and its wholly-owned subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, and reported amounts of expenses during the reporting period, including revenue recognition, residual value of operating lease vehicles, inventory valuation, warranties, fair value of financial instruments and stock-based compensation. Actual results could differ from those estimates.

Unaudited Interim Financial Statements

The accompanying condensed consolidated balance sheet as of June 30, 2015, the condensed consolidated statements of operations and condensed consolidated statements of comprehensive loss for the three and six months ended June 30, 2015 and 2014 and the condensed consolidated statements of cash flows for the three and six months ended June 30, 2015 and 2014, and other information disclosed in the related notes are unaudited. The condensed consolidated balance sheet as of December 31, 2014 was derived from our audited consolidated financial statements at that date. The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in our Form 10-K for the year ended December 31, 2014 filed with the Securities and Exchange Commission.

The accompanying interim condensed consolidated financial statements and related disclosures have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair statement of the results of operations for the periods presented. The condensed consolidated results of operations for any interim period are not necessarily indicative of the results to be expected for the full year or for any other future year or interim period.

Beginning in the three months ended March 31, 2015, we changed the composition of the revenue and cost of revenue lines in our consolidated statement of operations. Automotive includes revenues related to deliveries of new Model S vehicles, including customer selected options, data connectivity, Supercharger access, sales of regulatory credits to other automotive manufacturers, amortization of revenue for cars sold with resale value guarantees, and Model S leasing revenue. Services and other consists of sales of electric vehicle powertrain components and systems to other manufacturers, maintenance and development services, Tesla Energy products, and pre-owned Tesla vehicle sales. Prior period amounts have been reclassified to conform to the current period presentation.

Beginning January 1, 2015, the functional currency of each of our foreign subsidiaries changed to their local country’s currency. This change was based on the culmination of facts and circumstances that have developed as we expanded our foreign operations over the past year. The adjustment of $10.0 million attributable to the current rate translation of non-monetary assets as of the date of the change is included in accumulated other comprehensive loss on our condensed consolidated balance sheet.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued an accounting update which amends the existing accounting standards for revenue recognition. The new guidance provides a unified model to determine when and how revenue is recognized. Under the new model, revenue is recognized as goods or services are delivered in an amount that reflects the consideration we expect to collect. The guidance is effective for fiscal years beginning after December 15, 2017; early adoption is permitted for periods beginning after December 15, 2016. The new standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. We have not yet selected a transition method and are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

Revenue Recognition

We recognize revenues from sales of Model S, including vehicle options and accessories, vehicle service and sales of regulatory credits, such as zero emission vehicle and greenhouse gas emission credits, as well as sales of electric vehicle powertrain components and systems, such as battery packs and drive units. We recognize revenue when: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred and there are no uncertainties regarding customer acceptance; (iii) fees are fixed or determinable; and (iv) collection is reasonably assured.

Car sales include certain standard features and customer selected options and configurations that meet the definition of a deliverable under multiple-element accounting guidance, including internet connectivity, Supercharging access, and specified software updates for cars equipped with Autopilot hardware. These deliverables are valued on a stand-alone basis and we recognize their related revenue over our performance period which is generally the eight-year life of the car or, for software upgrades, as they are delivered. If we sell a deliverable separately, we use that pricing to determine its fair value; otherwise, we use our best estimated selling price by considering third party pricing of similar options, costs used to develop and deliver the service, and other information which may be available.

As of June 30, 2015, we had deferred $47.8 million, $34.6 million, $21.0 million, and $4.9 million related to the purchase of vehicle maintenance and service plans, access to our Supercharger network, Model S connectivity, and Autopilot software upgrades. As of December 31, 2014, we had deferred $39.7 million, $25.6 million, $14.4 million, and $1.5 million related to these same performance obligations.

Resale Value Guarantees and Other Financing Programs

We offer resale value guarantees or similar buy-back terms to all customers who purchase a Model S in the US, Canada and selected European and Asian markets and who finance their vehicle through one of our specified commercial banking partners. Under these program, Model S customers have the option of selling their vehicle back to us during the guarantee period of 36 to 39 months after delivery for a pre-determined resale value. Although we receive full payment for the vehicle sales price at the time of delivery, we account for transactions under the resale value guarantee program as operating leases and recognize revenue attributable to the lease on a straight-line basis over the guarantee period to automotive revenue. The amount of proceeds related to the residual value guarantee is deferred until the option expires or is exercised. We capitalize the cost of the leased vehicle and depreciate its value, less expected salvage value, to cost of automotive revenue over the same period.

At the end of the resale value guarantee period, which is the earlier of 39 months or the pay-off date of the initial loan, the resale value guarantee and any remaining deferred revenue balances are settled to automotive revenue and the net book value of the leased vehicle is expensed to costs of automotive revenue if our customer retains ownership of the car. In cases where a customer returns the vehicle back to us between months 36 and 39, we purchase the car in the amount of the resale value guarantee and settle any remaining deferred revenue balance to automotive revenue. As of June 30, 2015, $67.7 million of the resale value guarantee liability relates to guarantees that are exercisable by customers within the next twelve months.

In the fourth quarter of 2014, we also began offering residual value guarantees in connection with automobile sales to certain bank leasing partners. As we have guaranteed the value of these vehicles and as the vehicles are leased to end-customers, we account for them as collateralized borrowings. As of June 30, 2015 and December 31, 2014, we had $179.3 million and $19.6 million of such borrowings recorded in resale value guarantee and $40.7 million and $0 million recorded in deferred revenue liability, of which a portion will be accreted to revenue and a portion may be distributed to the bank leasing partner should we repurchase the vehicles at the end of the term or should the bank sell the car to a third party and receive proceeds less than the value we have guaranteed. The maximum cash payment to re-purchase these vehicles under these arrangements at June 30, 2015, is $131.6 million. Cash received upon the sale of such cars, net of revenue recognized during the period, is classified as collateralized lease borrowing within cash flows from financing activities in our consolidated statement of cash flows.

Account activity related to our resale value guarantee program consisted of the following for the periods presented (in thousands):

	Three Months Ended			Six Months Ended
	June 30, 2015			June 30, 2015
Operating Lease Vehicles
Operating lease vehicles under the resale value guarantee program—beginning of period	$	792,711		$	684,590
Net increase in operating lease vehicles under the resale value guarantee program		208,399			348,192
Depreciation expense recorded in cost of automotive revenues		(26,951	)		(48,993	)
Additional depreciation expense recorded in cost of automotive revenues as a result of early cancellation of resale value guarantee		(5,058	)		(9,455	)
Reclassifications to inventory resulting from return of vehicle under trade-in program		(6,364	)		(11,597	)
Operating lease vehicles under the resale value guarantee program—end of period	$	962,737		$	962,737

Deferred Revenue
Deferred revenue related to the resale value guarantee program—beginning of period	$	424,104		$	381,096
Net increase in deferred revenue including Model S deliveries with resale value guarantee and reclassification of collateralized borrowing from long-term to short-term		118,648			210,388
Amortization of deferred revenue and short-term collateralized borrowing recorded in automotive revenue		(54,175	)		(98,924	)
Additional revenue recorded in automotive revenue as a result of early cancellation of resale value guarantee		(3,310	)		(4,496	)
Release of deferred revenue resulting from return of vehicle under trade-in program		(2,695	)		(5,492	)
Deferred revenue related to the resale value guarantee program—end of period	$	482,572		$	482,572

Resale Value Guarantee
Resale value guarantee liability—beginning of period	$	606,221		$	487,879
Net increase in resale value guarantee		198,290			322,402
Reclassification from long-term to short-term collateralized borrowing		(3,743	)		(4,387	)
Additional revenue recorded in automotive revenue as a result of early cancellation of resale value guarantee		(2,966	)		(4,036	)
Release of resale value guarantee resulting from return of vehicle under trade-in program		(4,625	)		(8,681	)
Resale value guarantee liability—end of period	$	793,177		$	793,177

Model S Leasing Program

We offer a leasing program in the United States and Canada for Model S. Qualifying customers are permitted to lease a Model S directly from Tesla for 36 months. At the end of the lease term, customers have the option of either returning the vehicle to us or purchasing it for a pre-determined residual value. We account for these leasing transactions as operating leases and recognize leasing revenues over the contractual term and record the depreciation of these vehicles to cost of automotive revenues. As of June 30, 2015 and December 31, 2014, we had deferred $19.6 million and $9.4 million of lease-related upfront payments which will be recognized on a straight-line basis over the contractual term of the individual leases. Lease revenues are recorded in automotive revenue and for the three and six months ended June 30, 2015, we recognized $9.3 million and $15.9 million. Lease revenue for the three and six months ended June 30, 2014 was $0.2 million.

Warranties

We provide a manufacturer’s warranty on all vehicles, production powertrain components and systems sales, and we accrue warranty reserves upon delivery to the customer. Warranty reserves include management’s best estimate of the projected costs to repair or to replace items under warranty. These estimates are based on actual claims incurred to-date and an estimate of the nature, frequency and costs of future claims. These estimates are inherently uncertain and changes to our historical or projected experience may cause material changes to our warranty reserves in the future. The portion of the warranty provision expected to be incurred within 12 months is classified as current within accrued liabilities, while the remaining amount is classified as long-term within other long-term liabilities.

Accrued warranty activity consisted of the following for the periods presented (in thousands):

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014
Accrued warranty—beginning of period	$	155,301		$	71,932		$	129,043		$	53,183
Warranty costs incurred		(17,287	)		(9,271	)		(29,073	)		(18,571	)
Net changes in liability for pre-existing warranties, including expirations		567			1,541			11,329			9,661
Provision for warranty		26,014			20,169			53,296			40,098
Accrued warranty—end of period	$	164,595		$	84,371		$	164,595		$	84,371

Our warranty reserves do not include projected warranty costs associated with our operating lease vehicles and vehicles sold with resale value guarantee or similar buy-back terms as such actual warranty costs are expensed as incurred. For the three and six months ended June 30, 2015, warranty costs incurred for our operating lease vehicles were $2.4 million and $4.2 million and for the three and six months ended June 30, 2014 were $1.8 million and $3.0 million. Warranty expense is recorded as a component of cost of automotive revenue.

Cost of automotive revenue during the six months ended June 30, 2015 included a $11.3 million increase to our warranty reserve to reflect the additional preventative repairs we plan to perform on customer drive units and high-voltage battery packs when brought in for warranty related service.

Inventory Valuation

We value our inventories at the lower of cost or market. Inventories are recorded at cost on a first-in, first-out basis. We record inventory write-downs when we have amounts of inventory that are in excess of our planned production or where inventory has become obsolete to our production requirements.

We also review inventory to determine whether its carrying value exceeds the net amount realizable upon the ultimate sale of the inventory. This requires us to determine the estimated selling price of our vehicles less the estimated cost to convert inventory on hand into a finished product. Should our estimates of future selling prices or production costs change, material changes to these reserves may be required. A change in our estimates may result in a material charge to our reported financial results.

Concentration of Risk

Credit Risk

Financial instruments that potentially subject us to a concentration of credit risk consist of cash, cash equivalents, restricted cash and accounts receivable. Our cash equivalents are primarily invested in money market funds with high credit quality financial institutions in the United States. At times, these deposits and securities may be in excess of insured limits. We invest cash not required for use in operations in high credit quality securities based on our investment policy. Our investment policy provides guidelines and limits regarding credit quality, investment concentration, investment type, and maturity that we believe will provide liquidity while reducing risk of loss of capital. Our investments are currently of a short-term nature and include U.S. treasury bills.

As of June 30, 2015 and December 31, 2014, our accounts receivable were derived primarily from amounts to be received from financial institutions and leasing companies offering various financing products to our customers, sales of regulatory credits, as well as the development and sales of powertrain components and systems to automotive original equipment manufacturers (OEMs). As of June 30, 2015, we have two customers who individually account for 11% and 10% of our accounts receivable.

Supply Risk

Although there may be multiple suppliers available, many of the components used in our vehicles are purchased by us from a single source. If these single source suppliers fail to satisfy our requirements on a timely basis at competitive prices, we could suffer manufacturing delays, a possible loss of revenues, or incur higher cost of sales, any of which could adversely affect our operating results.

Stock-Based Compensation

We use the fair value method of accounting for our stock options and restricted stock units (RSUs) granted to employees and our Employee Stock Purchase Plan (ESPP) to measure the cost of employee services received in exchange for the stock-based awards. The fair value of stock options and ESPP are estimated on the grant date and offering date using the Black-Scholes option-pricing model. The fair value of RSUs is measured on the grant date based on the closing fair market value of our common stock. The resulting cost is recognized over the service period which is generally four years for stock options and RSUs and six months for the ESPP. Stock-based compensation expense is recognized on a straight-line basis, net of estimated forfeitures.

Net Loss per Share of Common Stock

Our basic and diluted net loss per share of common stock is calculated by dividing net loss by the weighted-average shares of common stock outstanding for the period. Potentially dilutive shares, which are based on the number of shares underlying outstanding stock options and warrants as well as our convertible senior notes, are not included when their effect is antidilutive.

The following table presents the potential weighted common shares outstanding that were excluded from the computation of diluted net loss per share of common stock for the periods presented. Anti-dilutive share counts for the twelve months ended December 31, 2014 have been updated.

	Three Months Ended June 30,				Six Months Ended June 30,				Twelve Months Ended December 31,
	2015		2014		2015		2014		2014
Employee share based awards		14,339,572		13,883,882		14,396,259		14,124,057		14,729,749
Convertible senior notes		2,517,573		2,145,517		2,301,823		2,082,759		2,344,998
Warrants issued May 2013		1,177,659		626,447		858,019		533,469		921,985

Since we expect to settle the principal amount of our outstanding convertible senior notes in cash, we use the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread will have a dilutive impact on diluted net income per share of common stock when the average market price of our common stock for a given period exceeds the conversion price of $124.52, $359.87 and $359.87 per share for the convertible senior notes due 2018 (2018 Notes), convertible senior notes due 2019 (2019 Notes), and convertible senior notes due 2021 (2021 Notes).

Uncertain Tax Positions

As of June 30, 2015 and December 31, 2014, the aggregate balances of our gross unrecognized tax benefits were $57.1 million and $41.4 million. $54.1 million and $39.1 million of these aggregate balances would not give rise to changes in our effective tax rate since these tax benefits would increase a deferred tax asset which is currently offset by a full valuation allowance.