Research Case 21-4 Locate and extract relevant information for a financial repor
ID: 2488736 • Letter: R
Question
Research Case 21-4 Locate and extract relevant information for a financial reporting issue; integrative; Microsoft Corporation
A meeting of your accounting department is scheduled for early tomorrow morning. One topic of discussion is certain to be the appropriate adjustments to net income in your company's statement of cash flows using the indirect method of reporting operating activities. Hallway discussions have suggested some degree of uncertainty, particularly regarding unearned revenues, which are substantial for the company. Because your firm went public only seven months ago, this reporting issue is a new one for you and most other members of the department. In preparation for the meeting, you sought out the financial statements of Microsoft Corporation, knowing that it too had substantial unearned revenues. The operating activities section of the comparative statements of cash flows for Microsoft is presented below.
Cash Flows Statements (in millions) Year Ended June 30, 2009 2008 2007
Operations
Net income $14,569 $17,681 $14,065
Adjustments to reconcile net income to net cash from operations:
Depreciation, amortization, and other noncash items 2,562 2,056 1,440
Stock-based compensation 1,708 1,479 1,550
Net recognized losses (gains) on investments and derivatives 683 (572) (292)
Excess tax benefits from stock-based compensation (52) (120) (77)
Deferred income taxes 762 935 421
Deferral of unearned revenue 24,409 24,532 21,032
Recognition of unearned revenue (25,426) (21,944) (19,382)
Changes in operating assets and liabilities:
Accounts receivable 2,215 (1,569) (1,764)
Other current assets (422) 153 232
Other long-term assets (273) (98) (435)
Other current liabilities (3,371) (748) (552)
Other long-term liabilities 1,673 173) 1,558
Net cash from operations 19,037 21,612 17,796
Required: 1. Locate the financial statements of Microsoft Corporation on the Internet. Search the disclosure notes for information about how Microsoft accounts for its unearned revenues. How is the undelivered portion of Microsoft's sales of Windows XP Professional recorded initially?
2. Why does the statement of cash flows include “unearned revenue” as an addition to net income in the operations section? Why is “recognition of unearned revenue” included as a deduction from net income? Why do you think Microsoft reported these two items separately rather than just adjusting net income for the change in the unearned revenue account balance?
3. Why is stock-based compensation added to net income?
Explanation / Answer
ANSWER A:-
UNEARNED REVENUE : As per Microsoft's Annual Report, it is said to comprise of three elements:-
1) Volume Licensing Programs- Which represents customer billings for multi-year licensing arrangements, paid either upfront or annually at the beginning of each billing coverage period, which are accounted for as subscriptions with revenue recognized ratably over the billing coverage period.
2) Undelivered elements- Represents the right to receive unspecified upgrades/enhancements of Microsoft Internet Explorer on a when-and-if-available basis and free post-delivery telephone support. This revenue deferral is applicable for Windows XP and prior versions shipped as retail packaged products, products licensed to OEMs, and perpetual licenses for current products under our Open and Select volume licensing programs. The amount recorded as unearned is based on the sales price of those elements when sold separately and is recognized ratably on a straight-line basis over the related product’s life cycle. Product life cycles are currently estimated at three and one-half years for Windows operating systems.
ANSWER B:-
Detemination of unearned revenue is crucial for operating activities, since the cash is already in bank, which affects the cash flow, but is not yet earned.Unearned revenue is cash received for goods or services to be provided. It is recorded as a liability on the business’s balance sheet until the contract is completed. Unearned Revenue is usually treated as a current liability, since it is usually for payments recievable within the year by performing the activity under the contract.
As unearned revenue is a current liability, the increase or decrease of unearned revenue will affect the value of operating activities as it will appear in the financial statements.
Deduction:- On collection or performance of contract this unerned revenue becomes part of Revenue of the company. This change in recognition does not affect the cash flows of the company, so a deduction of the amount serves to convert net income to cash basis
Microsoft reported these two items separately rather than just adjusting net income for the change in the unearned revenue account balance because even though adjustment for net income would yield same net result the cash amounts are sufficiently large to deem separate reporting of the figures.
ANSWER 3:-
stock-based compensation is recorded as an appopriate portion of fair value of such compensation on the date of grant. There is no cash flow assosciated with such compensation, so the expense is added back to net income to remove this noncash item from determination of cash for operating activities
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