Microsoft 2011 Annual Report Download - page 36

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Impairment of Investment Securities
Investments are reviewed quarterly for indicators of other-than-temporary impairment. This determination requires
significant judgment. In making this judgment, we employ a systematic methodology quarterly that considers
available quantitative and qualitative evidence in evaluating potential impairment of our investments. If the cost of
an investment exceeds its fair value, we evaluate, among other factors, general market conditions, credit quality
of debt instrument issuers, the duration and extent to which the fair value is less than cost, and for equity
securities, our intent and ability to hold, or plans to sell, the investment. For fixed-income securities, we also
evaluate whether we have plans to sell the security or it is more likely than not that we will be required to sell the
security before recovery. We also consider specific adverse conditions related to the financial health of and
business outlook for the investee, including industry and sector performance, changes in technology, and
operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary,
an impairment charge is recorded to other income (expense) and a new cost basis in the investment is
established. If market, industry, and/or investee conditions deteriorate, we may incur future impairments.
Goodwill
We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business
combination. We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a
relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level (operating
segment or one level below an operating segment) on an annual basis (May 1 for us) and between annual tests if
an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit
below its carrying value. These events or circumstances could include a significant change in the business
climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion
of a reporting unit.
Application of the goodwill impairment test requires judgment, including the identification of reporting units,
assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination
of the fair value of each reporting unit. The fair value of each reporting unit is estimated using a discounted cash
flow methodology. This analysis requires significant judgments, including estimation of future cash flows, which is
dependent on internal forecasts, estimation of the long-term rate of growth for our business, estimation of the
useful life over which cash flows will occur, and determination of our weighted average cost of capital. Among our
reporting units, the fair value of OSD has been the closest to its carrying value. The carrying value of OSD’s
goodwill was $6.4 billion as of June 30, 2011.
The estimates used to calculate the fair value of a reporting unit change from year to year based on operating
results and market conditions. Changes in these estimates and assumptions could materially affect the
determination of fair value and goodwill impairment for each reporting unit.
Research and Development Costs
Costs incurred internally in researching and developing a computer software product are charged to expense until
technological feasibility has been established for the product. Once technological feasibility is established, all
software costs are capitalized until the product is available for general release to customers. Judgment is required
in determining when technological feasibility of a product is established. We have determined that technological
feasibility for our software products is reached after all high-risk development issues have been resolved through
coding and testing. Generally, this occurs shortly before the products are released to manufacturing. The
amortization of these costs is included in cost of revenue over the estimated life of the products.
Legal and Other Contingencies
The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. An
estimated loss from a loss contingency such as a legal proceeding or claim is accrued by a charge to income if it
is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be
reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a
loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the
degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of
loss. Changes in these factors could materially impact our financial statements.