Financial Reporting Strategy
Microsoft’s Financial Reporting Strategy
1. What are the factors that likely explain the difference between Microsoft’s market value of equity and its reported book value of equity?
One of the factors that explain the difference between Microsoft’s market value of equity and its reported book value of equity is the lack of effectiveness to record certain intangible assets such as stock of knowledge (i.e., human capital) customer loyalty, and brand value. These former intangible assets mentioned, provides a formidable amount of earning growth in the future, which determines the company’s market value. We also note that the company’s choice of cautious (conventional) accounting policies has the effect of discouraging the company’s book value of equity.
2. What effect did Microsoft’s software capitalization policy have on its financial statements? Ignore any potential tax effects.
a. Assume that 60% of Microsoft’s research and development expenses were incurred after technological feasibility was established, that the average product life was two years, and that the company begins amortizing software costs at the beginning of the following year. Estimate the effect of capitalizing software costs on Microsoft’s fiscal 1997, 1998, and 1999 income statements and balance sheets.
The decision involving whether R&D related costs should be expensed or capitalized has a major influence on both the Income Statement and the Balance Sheet of Microsoft as it will have a direct impact on the most basic accounting procedures and calculations of Microsoft’s value and profitability.
As listed on the table below, when Microsoft capitalized less of its R&D the company’s Balance Sheet would show less assets, which would decrease the value of Microsoft. At the same time, when more of the costs would be treated as expenses Microsoft’s profits on the Income Statement would be lower.
1995
1996
1997
1998
1999
Research and development on Income Statement
860
1326
1863
2061
2970
1. What are the factors that likely explain the difference between Microsoft’s market value of equity and its reported book value of equity?
One of the factors that explain the difference between Microsoft’s market value of equity and its reported book value of equity is the lack of effectiveness to record certain intangible assets such as stock of knowledge (i.e., human capital) customer loyalty, and brand value. These former intangible assets mentioned, provides a formidable amount of earning growth in the future, which determines the company’s market value. We also note that the company’s choice of cautious (conventional) accounting policies has the effect of discouraging the company’s book value of equity.
2. What effect did Microsoft’s software capitalization policy have on its financial statements? Ignore any potential tax effects.
a. Assume that 60% of Microsoft’s research and development expenses were incurred after technological feasibility was established, that the average product life was two years, and that the company begins amortizing software costs at the beginning of the following year. Estimate the effect of capitalizing software costs on Microsoft’s fiscal 1997, 1998, and 1999 income statements and balance sheets.
The decision involving whether R&D related costs should be expensed or capitalized has a major influence on both the Income Statement and the Balance Sheet of Microsoft as it will have a direct impact on the most basic accounting procedures and calculations of Microsoft’s value and profitability.
As listed on the table below, when Microsoft capitalized less of its R&D the company’s Balance Sheet would show less assets, which would decrease the value of Microsoft. At the same time, when more of the costs would be treated as expenses Microsoft’s profits on the Income Statement would be lower.
1995
1996
1997
1998
1999
Research and development on Income Statement
860
1326
1863
2061
2970