Microsoft 2006 Annual Report Download - page 46

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PAGE 45
NOTES TO FINANCIAL STATEMENTS
NOTE 1 ACCOUNTING POLICIES
ACCOUNTING PRINCIPLES
The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in
the United States of America.
PRINCIPLES OF CONSOLIDATION
The financial statements include the accounts of Microsoft Corporation and its subsidiaries. Intercompany transactions and
balances have been eliminated. Equity investments in which we exercise significant influence but do not control and are not the
primary beneficiary are accounted for using the equity method. Investments in which we are not able to exercise significant
influence over the investee and which do not have readily determinable fair values are accounted for under the cost method.
ESTIMATES AND ASSUMPTIONS
Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of
assets, liabilities, revenue, and expenses. Examples include estimates of loss contingencies, product life cycles, and stock-
based compensation forfeiture rates; assumptions such as the elements comprising a software arrangement, including the
distinction between upgrades/enhancements and new products; when technological feasibility is achieved for our products; the
potential outcome of future tax consequences of events that have been recognized in our financial statements or tax returns;
estimating the fair value and/or goodwill impairment for our reporting units; and determining when investment impairments are
other-than-temporary. Actual results and outcomes may differ from management’s estimates and assumptions.
We revised our expense classification policies during fiscal year 2006 which resulted in reclassifications of certain operating
expenses. We have reclassified the prior period amounts to conform to the current year presentation. These reclassifications
had no impact on total operating expenses, operating income and our net income.
FOREIGN CURRENCIES
Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date. Revenue and
expenses are translated at average rates of exchange prevailing during the year. Translation adjustments resulting from this
process are charged or credited to Other Comprehensive Income (“OCI”).
REVENUE RECOGNITION
Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or
determinable, and collectibility is probable. We enter into certain arrangements where we are obligated to deliver multiple
products and/or services (multiple elements). In these arrangements, we generally allocate the total revenue among the
elements based on the sales price of each element when sold separately (vendor-specific objective evidence).
Revenue for retail packaged products, products licensed to original equipment manufacturers (“OEM”), and perpetual
licenses for current products under our Open and Select volume licensing programs generally is recognized as products are
shipped, with a portion of the revenue recorded as unearned due to undelivered elements including, in some cases, free post-
delivery telephone support and the right to receive unspecified upgrades/enhancements of Microsoft Internet Explorer on a
when-and-if-available basis. The amount of revenue allocated to undelivered elements is based on the vendor-specific objective
evidence of fair value for those elements using the residual method. Under the residual method, the total fair value of the
undelivered elements, as indicated by vendor-specific objective evidence, is recorded as unearned, and the difference between
the total arrangement fee and the amount recorded as unearned for the undelivered elements is recognized as revenue related
to delivered elements. Unearned revenue due to undelivered elements is recognized ratably on a straight-line basis over the
related product’s life cycle.
Revenue from multi-year licensing arrangements are accounted for as subscriptions, with billings recorded as unearned
revenue and recognized as revenue ratably over the billing coverage period. Certain multi-year licensing arrangements include
rights to receive future versions of software product on a when-and-if-available basis under Open and Select volume licensing
programs (Software Assurance). In addition, other multi-year licensing arrangements include a perpetual license for current
products combined with rights to receive future versions of software products on a when-and-if-available basis under Open,
Select, and Enterprise Agreement volume licensing programs. Premier support services agreements, MSN Internet Access
subscriptions, Xbox Live, and Microsoft Developer Network subscriptions are also accounted for as subscriptions.