Read Research Case 21-4 on locating and extracting relevant information for a fi

Question

Read Research Case 21-4 on locating and extracting relevant information for a financial reporting issue of Microsoft Corporation. (To access file, click on Discussion 6.1 link, then select Research Case 21-4 to download file) 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? 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 the 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? Why is stock-based compensation added to net income?

Explanation / Answer

In this case, a portion pertaining to the revenue associated with Windows XP is recorded as unearned because of certain undelivered elements viz. rights to receive unspecified enhancements or upgrades pertaining to the internet browser of Microsoft and free post delivery telephone support. Hence, it is ascertained that the part of the price set for sales of windows XP is being recorded as revenue (unearned) initially.

The cash flow statement involves the unearned revenue as an addition because the amount is being collected in cash and the same has not been recorded underlying the income statement. Since, at the time of collection the amount is being recorded as unearned revenue and it will be included in the revenue on its realization, therefore the unearned revenue will be included as deduction underlying the net income when it is being recognized. Since, the cash amount remains unaffected due to recognition of the unearned revenue, therefore subtracting the amount of unearned revenue results in conversion of net income into cash basis. Since, even after undertaking the adjustment underlying the net change resulted in similar net result, therefore, these two items are reported separately by the Microsoft rather than merely making adjustment underlying the income for the change in the account balance of the unearned revenue.

The compensation based on stock will be recorded as a an adequate portion pertaining to fair value associated with the compensation viz. stock options, restricted stock and SARs on the date when it is actually granted. The expenses will be added back to the net income as there is no cash flow which is related with such compensation. The expenses are being added back so as to remove this item (non cash) from the computation of the net flow of cash from the activities (operating) underlying the cash flow statement.

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