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Msft Financial Reporting Strategy
EM6602 Accounting for Decision-Making and Control
Microsoft’s Financial Reporting Strategy (HBR 9-100-027)

Team Members Toh Wei Hong, Prashant Trivedi, Preethy Varadarajan

Question 1
The difference between Microsoft’s market value and book value is primarily due to unrecorded intangible assets such as brand value, customer loyalty, human capital, and commercial advantages such as long-term contracts and market dominance. These intangible assets confer Microsoft a tremendous edge over its competitors in future earnings growth.

The market value is often representative of the net present value of expected future earnings. Granted Microsoft’s strong commercial position, its long term earnings growth is likely to hold up, and that is reflected in the market value. As Microsoft’s market value takes into account its potential future earnings, it will inevitably differ from the book value.

Question 2
Microsoft’s software capitalization policy has the effect of depressing net income.

Financial Year | FY97 | FY98 | FY99 | Reported Net Income | 3,454 | 4,490 | 7,785 | Adjusted Net income | 4,174 | 5,094 | 8,228 | Delta (millions) | 720 | 604 | 443 | Difference (%) | 6.0% | 4.0% | 2.2% |

Had Microsoft capitalized its R&D expense after technological feasibility has been established and amortized it over subsequent periods, its net income would have been higher by 6.0% in FY97, 4.0% in FY98 and 2.2% in FY99.

For details of Microsoft’s software capitalization policy on its financial statements, please refer to spreadsheets in appendices.

Question 2b
Microsoft may have chosen to expense all software costs as incurred rather than capitalizing part of these costs because:

1. Doing so improves YOY Growth of Net Income (and Earnings Before Tax)

Based on Microsoft’s reported numbers, net income grew an astounding 57.4% YOY in FY97. Although the YOY %-growth is lower in FY98, it is still an impressive 30.0%. In FY99, the

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