Microsoft 2004 Annual Report Download - page 40

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Revenue related to our Xbox game console is recognized upon shipment of the product to retailers. Revenue related to
games published by us is recognized when those games have been delivered to retailers net of allowances for returns
and price concessions. Revenue related to games published by third parties for use on the Xbox platform is recognized
when manufactured for the game publishers. Online 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.
Costs related to insignificant obligations, which include telephone support for developer tools software, PC games,
computer hardware, and Xbox, are accrued when the related revenue is recognized. Provisions are recorded for
estimated returns, concessions, and bad debts.
RESEARCH AND DEVELOPMENT
Research and development expenses include payroll, employee benefits, equity compensation, and other headcount-
related costs associated with product development. We have determined that technological feasibility for our software
products is reached shortly before the products are released to manufacturing. Costs incurred after technological
feasibility is established are not material, and accordingly, we expense all research and development costs when incurred.
SALES AND MARKETING
Sales and marketing expenses include payroll, employee benefits, equity compensation, and other headcount-related
costs as well as expenses related to advertising, promotions, tradeshows, seminars, and other programs. Advertising
costs are expensed as incurred. Advertising expense was $1.13 billion in fiscal 2002, $1.06 billion in fiscal 2003, and $904
million in fiscal 2004.
INCOME TAXES
Income tax expense includes U.S. and international income taxes, plus the provision for U.S. taxes on undistributed
earnings of international subsidiaries not deemed to be permanently invested. Certain items of income and expense are
not reported in tax returns and financial statements in the same year. The tax effect of such temporary differences is
reported as deferred income taxes.
DERIVATIVE AND FINANCIAL INSTRUMENTS
We consider all highly liquid interest-earning investments with a maturity of three months or less at the date of purchase to
be cash equivalents. Investments with maturities beyond one year may be classified as short-term based on their highly
liquid nature and because such marketable securities represent the investment of cash that is available for current
operations. All cash and short-term investments are classified as available for sale and are recorded at market value
using the specific identification method; unrealized gains and losses (excluding other-than-temporary impairments) are
reflected in OCI.
Equity and other investments include both debt and equity instruments. Debt securities and publicly traded equity
securities are classified as available for sale and are recorded at market using the specific identification method.
Unrealized gains and losses (excluding other-than-temporary impairments) are reflected in OCI. All other investments,
excluding those accounted for using the equity method, are recorded at cost.
We lend certain fixed income and equity securities to enhance investment income. Collateral and/or security interest is
determined based upon the underlying security and the creditworthiness of the borrower. The fair value of collateral that
we are permitted to sell or repledge was $499 million at both June 30, 2003 and 2004.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. We
employ a systematic methodology that considers available evidence in evaluating potential impairment of our investments
on a quarterly basis. If the cost of an investment exceeds its fair value, we evaluate, among other factors, general market
conditions, the duration and extent to which the fair value is less than cost, as well as our intent and ability to hold the
investment. 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, operational and financing cash flow factors,
and rating agency actions. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is
recorded and a new cost basis in the investment is established.
We use derivative instruments to manage exposures to foreign currency, equities price, interest rate, and credit risks.
Our objectives for holding derivatives include reducing, eliminating, and efficiently managing the economic impact of these
exposures as effectively as possible. Derivative instruments are recognized as either assets or liabilities and are