Microsoft 2011 Annual Report Download - page 46

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Display advertising revenue is recognized as advertisements are displayed. Search advertising revenue is
recognized when the ad appears in the search results or when the action necessary to earn the revenue has been
completed. Consulting services revenue is recognized as services are rendered, generally based on the
negotiated hourly rate in the consulting arrangement and the number of hours worked during the period.
Consulting revenue for fixed-price services arrangements is recognized as services are provided. Revenue from
prepaid points redeemable for the purchase of software or services is recognized upon redemption of the points
and delivery of the software or services.
Cost of Revenue
Cost of revenue includes; manufacturing and distribution costs for products sold and programs licensed; operating
costs related to product support service centers and product distribution centers; costs incurred to include
software on PCs sold by OEMs, to drive traffic to our Web sites, and to acquire online advertising space (“traffic
acquisition costs”); costs incurred to support and maintain Internet-based products and services, including
royalties; warranty costs; inventory valuation adjustments; costs associated with the delivery of consulting
services; and the amortization of capitalized research and development costs. Capitalized research and
development costs are amortized over the estimated lives of the products.
Product Warranty
We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time
the related revenue is recognized. For hardware warranties, we estimate the costs based on historical and
projected product failure rates, historical and projected repair costs, and knowledge of specific product failures (if
any). The specific hardware warranty terms and conditions vary depending upon the product sold and the country
in which we do business, but generally include parts and labor over a period generally ranging from 90 days to
three years. For software warranties, we estimate the costs to provide bug fixes, such as security patches, over
the estimated life of the software. We regularly reevaluate our estimates to assess the adequacy of the recorded
warranty liabilities and adjust the amounts as necessary.
Research and Development
Research and development expenses include payroll, employee benefits, stock-based compensation expense,
and other headcount-related expenses associated with product development. Research and development
expenses also include third-party development and programming costs, localization costs incurred to translate
software for international markets, and the amortization of purchased software code and services content. Such
costs related to software development are included in research and development expense until the point that
technological feasibility is reached, which for our software products, is generally shortly before the products are
released to manufacturing. Once technological feasibility is reached, such costs are capitalized and amortized to
cost of revenue over the estimated lives of the products.
Sales and Marketing
Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other
headcount-related expenses associated with sales and marketing personnel, and the costs of advertising,
promotions, trade shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising
expense was $1.9 billion, $1.6 billion, and $1.4 billion in fiscal years 2011, 2010, and 2009, respectively.
Employee Severance
We record employee severance when a specific plan has been approved by management, the plan has been
communicated to employees, and it is unlikely that significant changes will be made to the plan. In January 2009,
we announced and implemented a resource management program to reduce discretionary operating expenses,
employee headcount, and capital expenditures. Severance expenses associated with this program were $59
million and $330 million in fiscal years 2010 and 2009, respectively, and are included in general and
administrative expenses.