What was the overall impact of both the software capitalization policy and the revenue recognition policy on Microsoft's fiscal 1997, 1998, and 1999 financial statements?

by blackwell7333 (student)

1: What was the overall impact of both the software capitalization policy and the revenue recognition policy on Microsoft's fiscal 1997, 1998, and 1999 financial statements?

The software capitalization policy of Microsoft during 1997, 1998, and 1999 was to expense 100% of the costs. The results of this policy was that so called research and development costs, which was mainly software development costs totaling $1,8 billion, $2.6 billion, and $3.0 billion was expensed. In other words the research and development costs reduced the income before taxes by these amounts. If we read the GAAP carefully, these costs should have been capitalized. By expensing these, the retained profits for year were reduced. On the other hand, had these costs been capitalized, they would have appeared on the assets side of the balance sheet and amortized over a period of time. The retained profits would have increased in the balance sheet and the net income would have increased in the Income Statement.

The revenue recognition policy of Microsoft also has a serious problem during 1997, 1998 and 1999. Unearned revenue reported in the balance sheet was $1.4 billion, $2.9 billion, and $4.2 billion. This value apparently represented the amounts that had been received by services related to these payments had not been delivered. The effect of unearned revenue recognition in the balance sheet was an increase in liabilities and a decrease in retained earnings.

2: In your opinion, during the same timeframe, did Microsoft provide its analysts' with information that was intentionally overly pessimistic? Are there any benefits to the company to ...

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2: In your opinion, during the same timeframe, did Microsoft provide its analysts' with information that was intentionally overly pessimistic? Are there any benefits to the company to being outwardly pessimistic about its future prospects?
As far as the software development costs are concerned the company contends that since the technology developed has reached technological feasibility, the software development costs should be expensed. Based on this policy the company expensed the software development cost. During the years 1997, 1998, and 1999, the software development cost expenses was 28%, 29% and 23% of the operating income before R&D expense.

The company's revenue recognition policy was explained that unearned revenue was not yet recognized in earnings. The company explained that a part of Microsoft's revenue was earned ratably over the product life, and in case of subscriptions over the license agreement period. The company stressed that the customers receive a part of the company's products over the specified period. The company gave examples of technical support and browser technology, where the customer would receive a part of the product.

There is a strong feeling that the company was outwardly pessimistic about its present performance. One of the main reasons was that Microsoft had a market share of more than 85% of the operating systems share in the PC market. The company had attracted anti-trust litigation and was arguing in a federal court that it had no monopoly power. Low profits at this time could swing the argument in favor of Microsoft.

There are several other benefits to Microsoft for being outwardly pessimistic. First, if the company shows moderate earnings and net income performance, it avoids complacency in the organization because of excessive profits, and the competitive spirit of its associates is maintained. The benefit is motivation. Second, Microsoft was able to set industry standards in revenue recognition and expensing of software development costs. Microsoft could maintain its leadership position because these standards would be hard to emulate. Third, Microsoft could show its financial strength by showing that it could take deductions from its earnings and still show good financial performance. Finally, Microsoft gets the benefits of conservatism from its polices.