Microsoft Financial Reporting Strategy

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Microsoft’s Financial Reporting Strategy

Q1. What are the factors that likely explain the
equity and its reported book value of equity?

Question
1
2
3
4
5
6

1999
Market Capitalisation: USD 460 Billion
Book Value: USD 28 Billion

MVE more than 16 times of BVE!

Factor 1
Question
1
2
3
4
5
6

Intangible Assets
• BVE does not reflect certain intangible assets’ value
such as brand, customer loyalty, and human capital
– Likely to provide tremendous earnings growth in
the future
– Investors factor these into consideration during
valuation

Factor 2
Question
1
2
3
4
5
6

High Expected Growth (1985 to 1999)
• Revenue: USD 140 Million to USD 20 Billion
• Net income: USD 24 Million to USD 8 Billion
• Beat analysts’ expectations for 52 out of 53 quarters

Factor 3
Question
1
2
3
4
5
6

Conservative Accounting Policies
• Software Development Costs – Q2
• Revenue Recognition – Q3
• Depressing the company’s book value of equity

Q2.
capitalization policy have on its financial
statements? Ignore any potential tax effects.

Q2a.
expenses were incurred after technological feasibility was
established, that the average product life was two years, and that the company begins amortizing software costs on
and balance sheets.

Software Development Costs
Question
1
2
3
4
5
6

• GAAP Requirements:
1. Charged to expense until “technological
feasibility” has been established for the product
2. Thereafter, software production costs shall be
capitalized and subsequently reported at lower
of unamortized cost/NRV
• Straight-line amortization over remaining economic
life of the product

Software Development Costs
Question
1
2
3
4
5
6

• Microsoft’s software capitalization policy:
– R&D costs expensed as incurred
– Range from anywhere between 11% to 17% of
revenue

Software Development Costs
Question
Year 1

1
2a
3
4
5
6

40%
Expensed

Year 2

60%
Capitalised

Software Development Costs
Question
1
2a
3
4
5
6

Income Statement
1995
Current R&D Expense recorded

1996

1997

1998

1999

860

1326

1863

2601

2970

(516)

(796)

(1118)

(1561)

(1782)

344

531

745

1040

1188

Adjustment:
Capitalized Expenses (*60%)
Adjusted R&D Expenses

Amortization
1995

1996

1997

1998

1998

R&D Incurred

860

1,326

1,863

2,601

2,970

Capitalized R&D
Expenses (60%)

516

796

1,118

1,561

1,782

Amortization
Expense for the
Previous Year

-

516 x ½ =
258

½ x 796 =
398

½ x 1,118 =
559

½ x 1,561
=781

Total Amortization
Expense

258 + 398 =
656

398 + 559 =
957

559 + 781 =
1,340

Restated R&D balance
(Intangible Asset)

1,118 + 398
= 1,516

1,561 + 559
= 2,120

1,782 + 781
= 2,563

Software Development Costs
Income Statement

Question
1
2a
3
4
5
6

1997

1998

1999

3454

4490

7785

+ R&D Expenses

1,863

2,601

2,970

- Amortization Expenses

(656)

(957)

(1,340)

- 40% R&D Expenses

(746)

(1,040)

(1,188)

Adjusted Net Income

3915

5094

8227

Percentage Change

13%

13%

6%

Net Income
Adjustment:

Software Development Costs
Question
1
2a
3
4
5
6

Balance Sheet
1997
Intangible Assets

0

1998
0

1999
0

Adjustment:
Capitalized R&D Expenses

1,516
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