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MICROSOFT’S FINANCIAL

REPORTING STRATEGY
CASE STUDY
Individual Assignment

OCTOBER 3, 2018
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Contents
Contents ................................................................................................................................................ 0
Question 1 ............................................................................................................................................. 2
Question 2 ............................................................................................................................................. 3

2a ....................................................................................................................................................... 3

2b ....................................................................................................................................................... 3

Question 3 ............................................................................................................................................. 4
3a ....................................................................................................................................................... 4

3b ....................................................................................................................................................... 4

Question 4 ............................................................................................................................................. 4
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MICROSOFT’S FINANCIAL
REPORTING STRATEGY
CASE STUDY
Question 1
Book value is the difference between total assets and total liabilities, Preferred stock and
intangible assets. Market value is the total currency value of the equity which is determined
by multiplying the total outstanding shares with the market share price per share. This is very
important for judging when investing in a company. The formula is same for stock holder’s
equity. In simple terms it is the amount which will be left after the company paid of its debts
and liabilities and sell of its assets. The much higher ration of market value to book value
means that the investors are very sure about the earning power of the company’s assets.
There are multiple factors which can effect this. As the market value is due to the stick market
we have to judge all the factors taken into account by shareholders and also the accounting
policies followed by the company which determines the market value. In case of companies
like Microsoft which have a huge amount of intangible assets market value can vary widely.
In 1996 Microsoft Corp. changed its revenue recognition principle. They started to recognize
80% at point of sale and 20% over the lifecycle unlike before when they used to recognize
the whole revenue as soon as the software was sold. Their argument was that they needed
to provide updates and other services for the product for at least 2 years. Microsoft used to
project a negative image to the analysts so that they would understate their projection. This
actually helped them to meet analyst projections and exceed them which allowed for a
steady rise in the market price. Microsoft Corp expensed their development costs as at that
time the guidelines were vague. The action of expensing them instead of capitalizing them
reduced their profit after tax.
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Question 2
2a
Research and development expense as reported is given below for 1995 to 1999. We need
to remove 40% to obtain the correct figures.

Year 1995 1996 1997 1998 1999


Expense reported 860 1326 1863 2601 1970

We amortize the asset for 2 years.

Year 1995 1996 1997 1998 1999


Expense 244 788.4 1401 1997.1 1527.2

Change in Net income

Financial Year 1997 1998 1999


Reported net income 3454 4490 7785

After capitalization

Financial Year 1997 1998 1999


Reported net income After capitalization 3916 5094 8228

Change in intangible asset after capitalization.

Year 1995 1996 1997 1998 1999


Expense 516 795.6 1117.8 1560.6 1782

2b
There is a huge difference between capital expenditure and operating expenditure CAPEX
and OPEX respectively. These have a huge implication for the company’s financial
statements. The time when the case is based the software were made in phased-gated
waterfall methodology. The Software development progressed through a specific chain and
the stages were very clearly demarcated unlike now where most companies use the agile
methodology where the development is done in short iteration or sprints combining all stages
in each.

However expensing allowed for huge tax savings as the PAT was considerable lower. If the
cost would be capitalized the accumulated depreciation would appear as a contra asset in
the balance sheet. The profit and loss for the current year can be managed better if the costs
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are expensed allowing better prioritization of resources. Added on to that the vagueness of
the point that when software development costs can be capitalized can add to the admin
cost overheads. Also operation efficiency ratio will be much higher. It is also seen that
expensing the costs will be better for profitability in short term. Though in the long term effect
it should be evened out.

Question 3
3a
In the financial year 1996 Microsoft started bundling its products along came with it multiple
issues of support that the corporation

Annual revenue if policy was not applied in 1996.

Financial year 1996 1997 1998 1999


Annual Revenue 9050 11936 15262 19747

The actual data for annual revenue

Financial year 1996 1997 1998 1999


Annual Revenue 9610 12794 16732 21098

3b
Along with Windows 95 Microsoft offered bundled products for which they had to give
support. They wanted to assign the cost of the product over the life time of the bundles
products which were liable for bug fixes and other patches including but not limited to
security. To assign the value of these costs they used the 80% recognition at sale the point
which differed from customer type to customer type.

Question 4
Microsoft followed a conservative approach to accounting. In the words of the great Bill
Gates “Even if we do not have any sales for one year we should be able to pay year worth
salary to our workers.” This led to having the approach they were taking and they constantly
predicted dire growth and propagated enough negetism among the analysts so that they
would predict lower growth than the books and the history of numbers would indicate.

Initially they would recognize the revenue as soon as they would sell the product in case of
different customers they had different policies of what sale indicates. For corporate customers
who would purchase license in bulk they would recognize the revenue when the li9scene
would be activated. The research and development cost for all softwares would be
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expensed which would allow a reporting of lower PAT and thereby lower tax. There would be
no capitalization of the expense of the major components and there costs. SEC was
concerned with the growing cooperation between the analysts and the companies. More
and more people were participating in the event where the predictions would consistently
undermatch the real performance. SEC also was concerned about the reserves that
Microsoft would have and which they would use to smoothen their earnings. They would
overestimate the sales returns, warranty costs loan losses among others to stash returns in
accruals and in case of not matching performance they would use the hidden reserves to
match the predictions. One of the major wealth held by the stakeholders are shares and their
wealth is proportional to the market price of the shares. To maintain the wealth and thus the
market price they made sure they matched the predictions or overmatched the predictions
and held the image of steady and stable growth stabler that that without the extra leverage
of the accruals. They were also concerned about the liabilities being over stated based on
false asumptions.

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