Recently Issued Accounting Pronouncements

Recently adopted accounting pronouncements

Revenue recognition

As noted in Note 2 above, we adopted the new revenue accounting standard effective January 1, 2018. We utilized the modified retrospective method upon adoption and as a result, the comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. Additionally, we elected to apply the new revenue accounting standard only to contracts not completed as of the adoption date. For contracts that were modified before the period of adoption, we elected to reflect the aggregate effect of all modifications when (1) identifying the satisfied and unsatisfied performance obligations, (2) determining the transaction price, and (3) allocating the transaction price to the satisfied and unsatisfied performance obligations. We recognized the cumulative effect of initially applying the new revenue accounting standard as an adjustment to the opening balance of retained earnings. The cumulative effect adjustment recorded to our retained earnings was $88 million (see our consolidated statements of changes in shareholders’ equity) and included the impact from the following adjustments to our consolidated balance sheet at January 1, 2018 (amounts in millions):



Consolidated Balance Sheet:	Balance at December 31, 2017		Adjustments due to adoption of new revenue accounting standard			Balance at January 1, 2018
Assets
Accounts receivable, net	$	918	$	3		$	921
Software development	367		(20		)	347
Other current assets	476		(35		)	441
Deferred income taxes, net	459		(32		)	427
Other assets	440		4			444

Liabilities and Shareholders’ Equity
Deferred revenues	$	1,929	$	(194	)	$	1,735
Other liabilities	1,132		23			1,155
Shareholders’ equity	9,462		91			9,553

The most significant impacts of the new revenue accounting standard for us are:

•

The accounting for our sales of our games with significant online functionality for which we do not have vendor-specific objective evidence (“VSOE”) for unspecified future updates and ongoing online services provided. Under the prior accounting standards, VSOE for undelivered elements was required. This requirement was eliminated under the new revenue accounting standard. Accordingly, we are required to recognize as revenue a portion of the sales price upon delivery of this software, as compared to recognizing the entire sales price ratably over an estimated service period as previously required. This difference in accounting primarily impacts revenues from many of the titles within our Call of Duty franchise, where approximately 20% of the sales price is now recognized as revenue upon delivery of the games to our customers. The amount of revenue recognized upon delivery of games to our customers is analyzed on a title-by-title basis and may change in the future. For example, the entire sales price from our Call of Duty: Black Ops 4 release is being recognized ratably over an estimated service period, as the gameplay has an increased focus towards the online competitive and cooperative game modes with no single-player campaign mode. Many of our other franchises, such as Overwatch, World of Warcraft, and Candy Crush, are online hosted arrangements, and the accounting for our sales of these games under the new standard is relatively unchanged; and


•	The accounting for certain of our software licensing arrangements. While the impact of the new revenue accounting standard may differ on a contract-by-contract basis (as the actual revenue recognition treatment required under the standard will depend on contract-specific terms), the new revenue accounting standard generally results in earlier revenue recognition for these arrangements.

Adoption of the new revenue accounting standard impacted our consolidated statement of operations for the year ended December 31, 2018, and our consolidated balance sheet as of December 31, 2018, as follows (in millions, except per share data):



	For the Year Ended December 31, 2018
Consolidated Statement of Operations:	Under new revenue accounting standard		Under old revenue accounting standards		Increase (decrease) due to adoption of new revenue accounting standard
Net revenues
Product sales	$	2,255	$	2,398	$	(143	)
Subscription, licensing, and other revenues	5,245		5,166		79
Total net revenues	7,500		7,564		(64		)

Costs and expenses
Cost of revenues—product sales:
Product costs	719		737		(18		)
Software royalties, amortization, and intellectual property licenses	371		389		(18		)
Cost of revenues—subscription, licensing, and other revenues:
Game operations and distribution costs	1,028		1,028		—
Software royalties, amortization, and intellectual property licenses	399		403		(4		)
Product development	1,101		1,101		—
Sales and marketing	1,062		1,063		(1		)
General and administrative	832		832		—
Total costs and expenses	5,512		5,553		(41		)

Operating income	1,988		2,011		(23		)
Interest and other expense (income), net	71		71		—
Loss on extinguishment of debt	40		40		—
Income before income tax expense	1,877		1,900		(23		)
Income tax expense	64		65		(1		)
Net income	$	1,813	$	1,835	$	(22	)

Earnings per common share
Basic	$	2.38	$	2.41	$	(0.03	)
Diluted	$	2.35	$	2.38	$	(0.03	)



	At December 31, 2018
Consolidated Balance Sheet:	Under new revenue accounting standard		Under old revenue accounting standards		Increase (decrease) due to adoption of new revenue accounting standard
Assets
Accounts receivable, net	$	1,035	$	1,037	$	(2	)
Software development	264		266		(2		)
Other current assets	539		559		(20		)
Deferred income taxes, net	403		453		(50		)
Other assets	482		493		(11		)

Liabilities and Shareholders’ Equity
Deferred revenues	$	1,493	$	1,674	$	(181	)
Accrued expenses and other liabilities	896		914		(18		)
Other liabilities	1,147		1,102		45
Shareholders’ equity	11,357		11,288		69

Adoption of the new revenue accounting standard had no impact to net cash from or used in operating, investing, or financing activities in our consolidated statement of cash flows.

Financial Instruments

In January 2016, the FASB issued new guidance related to the recognition and measurement of financial assets and financial liabilities. The new standard, among other things, generally requires companies to measure investments in other entities, except those accounted for under the equity method, at fair value and to recognize any changes in fair value in net income. For investments in entities without a readily determinable fair value, the new standard provides for a measurement alternative that can be elected to account for the investments at cost, less impairment, and adjusted for changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. The new standard also simplifies the impairment assessment of equity investments without readily determinable fair values. The new standard is effective for fiscal years beginning after December 15, 2017, and the guidance should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The guidance related to equity investments without readily determinable fair values (including disclosure requirements) is applied prospectively to equity investments that exist as of the date of adoption. We adopted the new standard during the first quarter of 2018, and elected to apply the measurement alternative for our investments without a readily determinable fair value. The adoption of this standard did not have a material impact on our consolidated financial statements.

Statement of Cash Flows-Restricted Cash

In November 2016, the FASB issued new guidance related to the classification of restricted cash in the statement of cash flows. The new standard requires that a statement of cash flows explain any change during the period in total cash, cash equivalents, and restricted cash. Therefore, restricted cash will be included with “Cash and cash equivalents” when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard is effective for fiscal years beginning after December 15, 2017, and should be applied retrospectively.

We adopted the new standard during the first quarter of 2018 and applied the standard retrospectively for all periods presented. The application of this new standard did not have a material impact on our consolidated statements of cash flows for the years ended December 31, 2018 and 2017. For the year ended December 31, 2016, there is a significant impact to the consolidated statements of cash flows, as this period included, as an investing activity, the $3.6 billion movement in restricted cash resulting from the release of cash in escrow to complete the King Acquisition. Under this new standard, the restricted cash balance is included in the beginning and ending cash, cash equivalents, and restricted cash balances and, hence, is not included as an investing activity in the statement of cash flows. See a summary of impacts on our consolidated statement of cash flows for the year ended December 31, 2016 as follows (in millions):



	For the Year Ended December 31, 2016
	Under new standard after adoption			Under old standard before adoption			Increase (decrease) due to adoption of new standard
Acquisition of business, net of cash acquired	$	(4,586	)	$	(4,588	)	$	2
Release of cash in escrow	—			3,561			(3,561		)
Other investing activities	(7		)	(14		)	7
Net cash used in investing activities	(4,729		)	(1,177		)	(3,552		)

Net increase (decrease) in cash and cash equivalents and restricted cash	(2,130		)	1,422			(3,552		)
Cash and cash equivalents and restricted cash at beginning of period	5,392			1,823			3,569
Cash and cash equivalents and restricted cash at end of period	3,262			3,245			17

Derivatives and Hedging

In August 2017, the FASB issued new guidance related to the accounting for derivatives and hedging. The new guidance expands and refines hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments and hedged items in the financial statements, and includes certain targeted improvements to ease the application of current guidance related to the assessment of a hedge’s effectiveness. The new standard is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. We adopted the standard during the first quarter of 2018. The adoption of the standard did not have a material impact to our consolidated financial statements.

Recent Accounting Pronouncements Not Yet Adopted

Leases

In February 2016, the FASB issued new guidance related to the accounting for leases. The new standard will replace all current U.S. GAAP guidance on this topic. The new standard, among other things, requires a lessee to classify a lease as either an operating or financing lease, and to recognize a lease liability and a right-of-use asset for its leases. Classification will be based on criteria that are largely similar to those applied in current lease accounting. The lease liability will be equal to the present value of lease payments. The asset will be based on the lease liability, subject to adjustment for initial direct costs, lease incentives received, and any prepaid lease payments. Operating leases will result in a straight-line expense pattern, while finance leases will result in a front-loaded expense pattern. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Adoption guidance provides for an optional adoption method that allows companies to use the effective date of the new lease standard as the initial date of application on transition, and therefore does not require prior periods to be restated.

This standard is effective for us beginning with the first quarter of 2019, and we will report our adoption in our Form 10-Q for the first quarter of 2019. Upon adoption, we will elect to apply the available transition practical expedients, including the optional adoption method discussed above. We estimate the impact of adoption to result in the establishment of lease liabilities of approximately $275 million to $325 million, with a similar corresponding impact to total assets. Additionally, we expect that the new disclosure requirements will require us to design and implement additional internal controls over financial reporting, and we are in process of adjusting our processes and internal controls in preparation for adopting the new standard.

Goodwill

In January 2017, the FASB issued new guidance that eliminates Step 2 from the goodwill impairment test. Instead, if an entity forgoes a Step 0 test, an entity will be required to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit, as determined in Step 1 from the goodwill impairment test, with its carrying amount and recognize an impairment charge, if any, for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new standard is effective for fiscal years beginning after December 15, 2019, and should be applied prospectively. Early adoption is permitted. The effect of adoption should be reflected as of the beginning of the fiscal year of adoption. We are evaluating the impact, if any, of adopting this new accounting guidance on our consolidated financial statements.

Cloud Computing Arrangements

In August 2018, the FASB issued new guidance related to a customer’s accounting for implementation costs incurred in a cloud computing arrangement (i.e. hosting arrangement) that is a service contract. The new guidance requires customers to capitalize implementation costs for these arrangements by applying the same criteria that is utilized for existing internal-use software guidance. The capitalized costs are required to be amortized over the associated term of the arrangement, generally on a straight-line basis, with amortization of these costs presented in the same financial statement line item as other costs associated with the arrangement. The new standard is effective for fiscal years beginning after December 15, 2019, and can be applied retrospectively or prospectively. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.