Microsoft Harvard Case Answers

Q1. Microsoft chose not to capitalize any software development cost and thus expensed them all as R&D. Assume that 60% of the reported R&D could have been capitalized and spread out over the following two years. For example. The amount of R&D capitalized into 1995 would be evenly spread out among 1996 and 1997. If this were the case how much would net income have been in 1997 and 1998? What would be the percentage increase in net income from 1997 t0 1998? Compare that to the actual reporting change in net income from 1997 to 1998

Year
1995
1996
1997
1998
Revenue
6075
9050
11936
15262
Reported R&D
860
1326
1863
2601
Adjusted R&D
860*40%=344
1326*40%=530.4
1863*40%=745.2
2601*40%=1040.4
R&D Capitalized
860-344=516
1326-530.4=795.6
1863-745.2=1117.8
2601-1040.4=1560.6
Reported NI
1453
2195
3454
4490
Adjusted NI

2195+1326-258-530.4=2732.6
3454+1863-258-397.8-745.2=3916
4490+2601-397.8-558.9-1040.4=5093.9
Percentage Increase(1997-1998)

40.7%
40.7%
Original Net income

3454
4490
Actual Percentage Increase(1997-1998)

29.99%
29.99%

Q2. Briefly explain earnings management, income smoothing and “cookie jar reserves”. Is this type of accounting common outside the US?
Earnings Management is an accounting techniques to produce financial reports that may paint a positive picture of a company's business activities and financial position. It is believed that earnings management from legitimate accounting choices to fraud that violates generally accepted accounting principles is very common. A company's number one goal is to make money. Not only do the company owners want to have a profit at the end of every accounting period, but they also want the company financial statements to look as good as they can.
Income smoothing is an accounting techniques to level out net income fluctuations from one period to the next, allowing it to appear like the company has a smooth growth pattern. Companies indulge in this practice because potential investors are generally willing