Microsoft 2015 Annual Report Download - page 38

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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. 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 consolidated financial statements.
Income Taxes
The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the
current year and deferred tax liabilities and assets for the future tax consequences of events that have been
recognized in an entity’s financial statements or tax returns. We recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities,
based on the technical merits of the position. The tax benefits recognized in the financial statements from such a
position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon
ultimate settlement. Accounting literature also provides guidance on derecognition of income tax assets and
liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties
associated with tax positions, and income tax disclosures. Judgment is required in assessing the future tax
consequences of events that have been recognized in our consolidated financial statements or tax returns. Variations
in the actual outcome of these future tax consequences could materially impact our consolidated financial
statements.
Inventories
Inventories are stated at average cost, subject to the lower of cost or market. Cost includes materials, labor, and
manufacturing overhead related to the purchase and production of inventories. We regularly review inventory
quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory. These
reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales
levels, pricing strategy, and component cost trends. If our review indicates a reduction in utility below carrying value,
we reduce our inventory to a new cost basis through a charge to cost of revenue. The determination of market value
and the estimated volume of demand used in the lower of cost or market analysis require significant judgment.