Microsoft 2007 Annual Report Download - page 26

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We use derivative instruments to manage exposures to interest rates, equity prices, and foreign currency
markets and to facilitate portfolio diversification. Derivative losses during fiscal 2007 were primarily driven by net
losses in time value on foreign currency contracts used to hedge anticipated foreign currency revenues. During
fiscal year 2006, we experienced lower net losses on derivatives as compared to fiscal year 2005 primarily due to
net gains on non-designated equity derivatives in fiscal 2006 as compared to net losses in fiscal 2005 and higher
net gains on commodity positions in fiscal 2006 driven by increases in the related commodity indices. These gains
were partially offset by higher net losses in time value on foreign exchange contracts used to hedge anticipated
foreign currency revenues and higher net losses on interest rate derivative contracts in fiscal 2006. Net derivative
losses in fiscal year 2005 were primarily related to losses on equity derivatives, interest rate derivatives, and
foreign currency contracts, partly offset by gains related to commodity positions used to provide portfolio
diversification. Gains and losses arising from derivatives not designated as accounting hedges are in large part
economically offset by unrealized losses and gains, respectively, in the underlying securities which are recorded
as a component of other comprehensive income. Commodity derivatives are held for the purpose of portfolio
diversification.
Other, net in fiscal year 2006 includes $195 million of gains that resulted from the restructuring of joint venture
relationships between Microsoft and NBC related to MSNBC Cable L.L.C. and MSNBC Interactive News, L.L.C.
Income Taxes
Our effective tax rate for fiscal years 2007, 2006, and 2005 was 30%, 31%, and 26%, respectively. The fiscal year
2007 rate reflects a recurring effective tax rate of 31% offset by a $195 million reduction resulting from various
changes in tax positions taken in prior periods, related primarily to favorable developments in an IRS position and
multiple foreign audit assessments. During fiscal year 2006, we recorded a tax benefit of $108 million from the
resolution of state audits and recorded a charge of €281 million ($351 million) from the European Commission fine
which was not tax deductible. The 2005 tax rate was lower from the reversal of previously accrued taxes and from
an IRS settlement.
Financial Condition
Cash and equivalents and short-term investments totaled $23.41 billion and $34.16 billion as of June 30, 2007
and 2006, respectively. Equity and other investments were $10.12 billion and $9.23 billion as of June 30, 2007
and 2006, respectively. Our investments consist primarily of fixed-income securities, diversified among industries
and individual issuers. Our investments are generally liquid and investment grade. The portfolio is invested
predominantly in U.S.-dollar-denominated securities, but also includes foreign-denominated securities in order to
diversify financial risk. As a result of the special dividend paid in the second quarter of fiscal year 2005 and shares
repurchased, our retained deficit, including accumulated other comprehensive income, was $29.46 billion at
June 30, 2007. Our retained deficit is not expected to impact our future ability to operate or pay dividends given
our continuing profitability and strong cash and financial position.
Unearned Revenue
Unearned revenue from volume licensing programs represents customer billings, paid either upfront or annually at
the beginning of each billing coverage period, that are accounted for as subscriptions with revenue recognized
ratably over the billing coverage period. For certain other licensing arrangements, revenue attributable to
undelivered elements, including free post-delivery telephone support and the right to receive unspecified
upgrades/enhancements of Microsoft Internet Explorer on a when-and-if-available basis for Windows XP and
previous PC operating systems, is based on the sales price of those elements when sold separately and is
recognized ratably on a straight-line basis over the life cycle of the related product. Other unearned revenue
includes services, Microsoft Dynamics business solution products, Xbox Live subscriptions, advertising, and TV
platform for which we have been paid upfront and earn the revenue when we provide the service or software, or
otherwise meet the revenue recognition criteria.