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Microsoft's Financial Reporting Strategy Case Solution
Microsoft has adopted very conservative accounting and disclosure policies. Conservative policies usually result in reporting lower assets, higher liabilities and less income levels for one accounting period. Moreover, conservative accounting policies potentially misrepresent the economies of a company’s business. This implies that Microsoft could have adopted conservative accounting policies for hiding profits, signalling, competitive weapon and accounting complacency.
Following questions are answered in this case study solution:
What accounting methods does Microsoft select?
What is Microsoft's financial reporting strategy regarding the accounting issues of
A. Software capitalization and
B. Revenue recognition?
Discuss reasons for Microsoft's accounting and disclosure choices?
What issues can arise from Microsoft’s financial reporting regarding managing?
Case Study Questions Answers
1. What accounting methods does Microsoft select?
Microsoft usually follows Generally Accepted Accounting Principles as a method for reporting its financial statements and associated notes. Instead of following the Generally Accepted Accounting Principles in general, Microsoft has adopted the Generally Accepted Accounting Principles which are specifically practiced in United States of America. The financial statements published by Microsoft include the results for Microsoft Corporation and all other subsidiaries associated with the parent company. Furthermore, Microsoft follows cash-basis accounting and accrual accounting methods, as well. The cash basis accounting method states that companies should record expenses and costs in financial statements and related accounts only when the cash has been actually paid out. Similarly, Microsoft registers revenue and other cash profits only when the transaction has been completed, and the cash is received. Cash basis accounting is helpful for Microsoft as it assists in trailing down the transactions which are not sensibly matched on a timely basis. Moreover, cash basis accounting helps to develop the prudence concept within the company. The prudence concept prepares the company to foresee future and cautions the company regarding any future possible losses. The prudence concept in accounting emphasizes that the company should not recognize expenses until the money has been actually incurred, even if the expenses took place in a prior month. Similarly, the prudence concept also warns the company regarding the reporting of revenues. In case of revenue generation, the concept states that any revenue earned in an earlier period should not be reported as the revenue until the cash has been received in actual terms.
Besides cash basis accounting, Microsoft also uses accrual accounting method for financial reporting. The accrual accounting is used by a company to record the generated revenue only when the actual transaction has been completed in every sense. Unlike, cash basis accounting, receiving of cash does not signify the completion of transaction. This means that Microsoft records the revenue the moment it has been earned and, not when the revenue is received in the form of cash. Under accrual accounting method, similar treatment is regarded for expenses. Microsoft records the expenses the moment those expenses have been incurred and not when Microsoft has paid for those expenses. Accrual accounting method is used by the companies to properly match the expenses and revenues in a timely manner. This means that by following this method, Microsoft would be in a better position to keep a balance on its operational spending each month. This also helps in recognizing the profit levels earned every month.
Microsoft and all its subsidiaries are to use accrual and cash basis accounting methods if they are using Generally Accepted Accounting Principles.
2. What is Microsoft's financial reporting strategy regarding the accounting issues of
(A) software capitalization and
(B) revenue recognition?
The Financial Accounting Standard Board has outlined the procedures on the treatment of costs related to software development, in clear words. Microsoft follows the accounting standards set by FASB in this regard. FASB requires the company’s software capitalization only when the technological feasibility has been set out. Microsoft believed that such standard did not significantly affect the company’s financial progress on two grounds. Firstly, the time at which Microsoft established the technological feasibility of their services and products may have been sufficiently delayed for further process development. This means that the software costs related to product development, which are eligible for capitalization, are too negligible to have any significant material impact on Microsoft’s financial statements. Secondly, Microsoft has used the strategy which helps in estimating useful product life. Since, the products offered by Microsoft are very short lived due to rapid technological advances; the company makes the incurring expensing costs, more or less, equal to the overall capitalization of the software. Following these principles by Microsoft, it can be observed that from the year 1986 to 1999, annual expenditure for research and development has varied from 11 per cent to 17 per cent of the overall revenue generated during that year.
Microsoft’s financial reporting strategy regarding revenue recognition can be identified as a persuasive evidence of existing arrangements. Revenue at Microsoft is realized when the delivery of the final product has been shipped; the revenue is constant or determinable such as fees and the revenue has not been provisioned against any bad debt. Similarly, revenue generated from technological products is realized under guarantee programs, which offer free upgradable new versions of software products. The allocation of revenue is dependent upon vendor-specific goals evidence against the fair value of the associated products. Other products with multi-year licensing arrangements consist of a continuous license for specific products combined with rights to receive future versions of software products on the basis of availability. Revenue related to such products is generated through membership subscriptions.
In addition to that, other revenues generated through Xbox 360 and associated entertainment technology is realized on the transfer of ownership from manufacturer to end consumers. Revenue is earned on the related games when they are manufactured by the gaming publishers.
Lastly, Microsoft realized the revenue earned through advertising only when the specific advertisement in displayed in search engine results or when the essential actions to earn the revenue has been finalized. Other modes of revenue generation practiced by Microsoft include consulting services, delivery and purchase of software’s and other services.
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