Accounting Proof: Leave Elon Musk Alone!
Accounting Proof: Leave Elon Musk Alone!
Debunking Tesla's Q1 Deferred Revenue Conspiracy Theory
"I’m not sure how this Deferred Revenue conspiracy even started — because Tesla transparently discloses actual Q1 revenue recognized from deferred revenues."
CHAPTERS: 1. How Deferred Revenues Work 2. Why Tesla Couldn't Have “Pulled Forward” Deferred Revenues 3. Accounting Proof: Elon Did Nothing Wrong! 4. AI Analyzes: Tesla's Deferred Revenues (the answer will shock you!) 5. AI Article Summary (250 words) (scroll to bottom of report)
In last week’s article, I wrote about the case for Tesla possibly being in a similar industry downcycle as Netflix was in during May 2022 — when Bill Ackman sold his entire stake in it. Netflix has since climbed by +250%.
Since TSLA’s Q1 results were released mid-last week, I’ve been hearing a lot of noise on social media over their deferred revenues. So I decided to check it out.
It doesn’t seem like they even did anything — much less anything wrong.
The prevailing narrative is that Musk is somehow juicing Tesla’s Q1 revenues and profits by unfairly shifting revenue recognition which is supposed to belong to other quarters to Q1, in order to save Tesla from its current sorry state.
Since FSD upgrades pretty much have a 100% net margin, adding a gilded layer of FSD sales to cost-intensive auto sales could potentially have boosted Q1 profits by a mile. This could have been made worse if the recognition of those FSD revenues in Q1 was somehow abused (e.g. pulled-forward to make Q1 look shinier).
The long & short of it is that Tesla bears on social media are disparaging Musk for somehow pulling wool over their investor’s eyes, and misleading them with the appearance of higher Q1 profits.
However, the proof is always in the financial statements due diligence (F/S DD). And honestly, I can’t find any proof of such wrongdoing. In fact, I’d love to be proved egregiously wrong on this, because I’d learn something new about revenue recognition.
How Deferred Revenues Work
If you’re already familiar with the accounting treatment of deferred revenues, feel free to skip to the next section. Otherwise, this section is necessary to understand the actual analysis below.
When Starbucks sells a coffee, it collects cash upfront from the customer. Hence, the double entry is Dr Cash, Cr Revenue.
However, when Starbucks sells a gift voucher, the sale of that gift voucher is recognized as a deferred liability (it’s not always deferred revenues, but let’s just keep things simple here).
This is due to the GAAP revenue recognition principle that states that revenue should not be recognized until goods or services have been provided. When a company sells a gift card, cash has been received but goods or services have yet to be rendered.
Hence, the double entry involved when a gift card is sold would be Dr Cash, Cr Deferred Revenue. Only when that gift card is redeemed by the customer for a coffee can Starbucks recognize revenue from the sale of that gift voucher, i.e. Dr Deferred Revenue, Cr Revenue.
You’ll notice that this final double entry is the same as the one above, i.e. Dr Cash, Cr Revenue — just with one extra step in between.
For subscription-based software sales like FSD upgrades, this accounting logic is taken to the next level. Since the software industry has normalized annual subscriptions, many customers tend to pay upfront for a full year of subscriptions.
However, only the Revenue belonging to a particular period (e.g. subscriptions for Q1) can be recognized in that period; the remainder of the sale (e.g. subscriptions for Q2-Q4) should sit waiting in Deferred Revenue until the quarter it belongs to arrives.
The issue that many Tesla bears have been clutching their pearls over is that Tesla might potentially have incorrectly recognized Deferred Revenue from FSD sales belonging to other quarters in Q1 (i.e. “pull forward”) — which would have juiced Q1 revenues. And since FSD sales pretty much drop straight to the bottom-line, it could have exponentially juiced Q1 profits as well.
Now let’s debunk this conspiracy theory with hard facts.
Disclaimer: The contents of this document are NOT meant to serve as investment advice. Read our full disclaimers below:Why Tesla Couldn't Have “Pulled Forward” Deferred Revenues
Much of the social media angst around Tesla’s Deferred Revenues comes from the recent bombshell article published by Reuters on Apr 5. It revealed that Musk had internally directed that Tesla would be delaying production of the much-awaited low-cost Model 2, in favor of ramping up FSD subscription sales.
The logic of doing so is quite simple — FSD sales are software in nature, and have close to a 100% net margin. Hence, Musk might have had an incentive to abuse the recognition of Q1 revenues by pulling forward Deferred Revenues related to FSD sales to Q1.
Firstly, it needs to be highlighted that the Reuters article only came out on Apr 5 — five days after Tesla’s Q1 reporting period had ended. Hence, for these allegations to be relevant, the offending FSD sales would have to have occurred sometime during Q1. Also, the entire social media firestorm revolves around the potential misrepresentation of Q1 revenues resulting from incremental sales of FSD subscriptions, so that’s what I’ll be addressing.
The accounting logic as described in the previous section makes it impossible for Tesla to boost Q1 revenues by selling incremental FSD subscriptions in Q1 (part of which would be recognized as Deferred Revenue), and then incorrectly “pulling forward” FSD-related deferred revenues that are supposed to be recognized in future quarters (e.g. Q2-Q3) to Q1.
Think about the logic of Deferred Revenue recognition as explained earlier. If an FSD subscription is sold in January of this year, the related double entry in Q1 would be:
Dr Cash: 100% of the FSD sale
Cr Revenue: 33% of the FSD sale (attributable to Q1)
Cr Deferred Revenue: 66% of the FSD sales (attributable to Q2-Q3)
If so, Tesla would recognize more in Q1 cash receipts than it would recognize in Q1 revenue. Even if that 66% remainder in Deferred Revenue were abusively pulled forward to Q1, it still would not exceed the amount of Q1 cash sales1.
The worst-case fraud scenario here would be Q1 revenues being equal to Q1 cash sales. And since cash is king in business, the impact of such a “fraud” would merely be limited to accounting shenanigans without actually hurting cash sales — the true barometer of business health.
The real way that Tesla could have carried out a potential fraud involving Q1 Deferred Revenues would not have involved pulling forward the recognition of FSD sales from the future. Rather, it’d involve incorrectly “pushing forward” FSD sales that had already been recognized in the past.
For instance, if an FSD annual subscription was sold in October of last year (3Q23), there would still be two quarters of unrecognized Deferred Revenue remaining on the balance sheet in 1Q24. A belligerent Tesla CFO could have potentially recognized those remaining two quarters worth of FSD subscriptions under Q1 revenues, giving it a boost.
However, for this possibility to even matter, the offending FSD sales would have had to be made prior to Q1. Even if this were true, it’d still have nothing to do with the concerns as described in the Reuters article above — that Musk had cancelled Model 2 production in favor of incremental sales of FSD subscriptions during Q1, and somehow juiced up Q1 revenue recognition via deferred revenues.
Thus, this in itself already puts to rest popular concerns resulting from the Reuters article — namely the Model 2 being delayed in favor of an internal focus on pushing FSD subscriptions out the door in an unsustainable manner.
However, since we’ve already gotten this far, let’s see if Tesla might have had abused the recognition of Deferred Revenues previously recognized in the past.
Accounting Proof: Elon Did Nothing Wrong!
As we can see from page 9 of their Q1 results above, TSLA’s deferred revenue balances2 amounted to $3.50B in 1Q24 and and $3.54B in 4Q23.
I’m really not sure how this whole Deferred Revenue conspiracy theory even started, because Tesla transparently discloses the actual Q1 revenue amounts recognized from deferred revenues — $281M under Automotive and $417M under Energy:
Adding them up amounts to an incremental $700M being recognized in Q1 from past deferred revenues balances3 — with most of them actually coming from the Energy segment. That total represents just 4.4% of Q1 Automotive sales of $16.46B, putting fears of such FSD controversies to rest.
As for Q1 profit attributable to deferred revenues, it’s also clearly disclosed in their CFS — an incredibly measly $195M (1.2% of auto sales, 28% net margin4):
Also, if we look at their FY23 10-K, we can see that the total Deferred Revenue balances during FY23 and FY22 were roughly $6B and $4.5B respectively.
That means the above Q1 revenue of $700M recognized from past Deferred Revenue balances was merely 10% of their FY23 deferred revenue balance. If they were trying to pull a fast one (pun intended) on investors, aren’t they leaving a lot of fraud potential on the table?
The point here is that even if any of the allegations were true, none of the related figures are material enough to offset the purported catastrophically declining auto revenue in Q1 — and therefore justify the accusation that Musk is somehow pulling wool over investor’s eyes via the incorrect recognition of Deferred Revenue in Q1.
Musk may be a lot of things, but he’s not an abuser of Q1 revenue recognition from deferred revenue balances.
AI Analyzes: Tesla's Deferred Revenues
I uploaded my TSLA 3-statement model (paid subscribers can download it in tomorrow’s report) to AI, and asked it the following question:
“Is there any possible indication of deferred revenues being egregiously pulled forward to recognize incremental 1Q24 revenues?”
It produced the answer below. I was genuinely gobsmacked by it:
Based on the information provided in the financial statements, there does not appear to be any clear indication that Tesla is egregiously pulling forward deferred revenues to recognize incremental revenues in Q1 2024. A few key points:
1. Deferred revenues (both current and non-current portions) have been steadily increasing over time, from $1,747 million at the end of 2022 to $2,864 million at the end of 2023 and $3,024 million in Q1 2024. This gradual increase does not suggest any abnormal acceleration of revenue recognition.
2. Quarter-over-quarter changes in deferred revenues do not show any outsized increases in Q1 2024 compared to prior periods that would indicate pulling forward of revenues. The Q1 2024 increase of $160 million is in line with quarterly changes seen in 2023.
3. Automotive sales, the largest revenue segment, actually declined in Q1 2024 compared to Q4 2023, from $20,630 million to $16,460 million. A pullforward of revenues would more likely result in a substantial increase.
4. No discussion is provided in the excerpts regarding any changes in revenue recognition policies or unusual transactions that accelerated revenue in Q1 2024.
In summary, while a comprehensive analysis would require additional information, the financial data presented does not in itself substantiate claims of Tesla egregiously pulling forward deferred revenues to boost Q1 2024 revenue. The deferred revenue balances and automotive sales do not show abnormal patterns to support that assertion.AI Article Summary (250 words)
1. Reuter’s article on Apr 5 revealed Musk's internal announcement to delay production of low-cost Model 2 in favor of ramping up FSD subscription sales.
2. Concerns raised about potential abuse of Q1 revenue recognition by pulling forward FSD-related deferred revenues. For allegations to be relevant, offending FSD sales would have to have occurred during Q1.
3. GAAP accounting treatment of deferred revenues makes it impossible for Tesla to boost Q1 revenues by selling incremental FSD subscriptions in Q1 and incorrectly pulling forward future deferred revenues.
4. Worst-case fraud scenario would be Q1 revenues equaling Q1 cash sales, which wouldn't hurt cash sales — the true barometer of business health.
5. Real potential fraud involving deferred revenues would potentially involve incorrectly “pushing forward” FSD sales recognized in the past, not “pulling forward” future recognition. This possibility is unrelated to concerns from Reuters article about delaying Model 2 production in favor of incremental Q1 FSD sales.
6. Tesla's Q1 deferred revenues amounted to $3.50B, with the vast majority attributable to FSD subscription sales.
7. Of that amount, Tesla disclosed $700M recognized in Q1 from past deferred revenues, representing just 4.4% of Q1 automotive sales.
8. Non-cash Q1 profit attributable to deferred revenues was $195M, only 1.2% of auto sales.
9. Total deferred revenue balances in FY23 and FY22 were roughly $6B and $4.5B, with Q1 revenue recognized from past balances representing merely 10% of FY23 balance.
10. Figures are not large enough to materially justify accusations of incorrect deferred revenue recognition in Q1.
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While not explicitly disclosed, it is widely understood that the vast majority of these deferred revenues are attributable to FSD subscription sales rather than the other stuff also recognized under Deferred Revenues (supercharger, internet connectivity, over-the-air software updates).
I might have missed other smaller instances of revenue recognition in Q1 from past deferred revenue balances, but I can’t see how they would be material as compared to deferred revenue recognition related to auto sales and solar panels.
not the aforementioned 100% NM as expected, although this could’ve been diluted by deferred revenue from other segments
Thanks for the interesting article!
Just one question: "As for non-cash Q1 profit attributable to deferred revenues, it’s also clearly disclosed in their CFS — an incredibly measly $195M"
It might be a matter of wording/syntax that confuses me, but non-cash items do not show up in the cash flow statement when they are positive - so here it's really the actual cash they got from the deferred revenues.
What does F/S DD mean?