Microsoft 2007 Annual Report Download - page 30

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No. 06-2 requires companies to accrue the costs of compensated absences under a sabbatical or similar benefit
arrangement over the requisite service period. EITF Issue No. 06-2 is effective for us beginning July 1, 2007. The
cumulative effect of the application of this consensus on prior period results should be recognized through a
cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. Elective
retrospective application is also permitted. We do not expect the application of this consensus to have a material
impact on our financial statements.
In fiscal year 2007, we adopted Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year
Misstatements when Quantifying Current Year Misstatements. SAB No. 108 requires companies to quantify
misstatements using both a balance sheet (iron curtain) and an income statement (rollover) approach to evaluate
whether either approach results in an error that is material in light of relevant quantitative and qualitative factors,
and provides for a one-time cumulative effect transition adjustment. The adoption of SAB No. 108 did not have an
impact on our financial statements.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value,
establishes a framework for measuring fair value in generally accepted accounting principles, and expands
disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements,
but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source
of the information. This statement is effective for us beginning July 1, 2008. We currently are assessing the
potential impact that adoption of SFAS No. 157 would have on our financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial
Liabilities. SFAS No. 159 gives us the irrevocable option to carry many financial assets and liabilities at fair
values, with changes in fair value recognized in earnings. SFAS No. 159 is effective for us beginning July 1, 2008,
although early adoption is permitted. We are currently assessing the potential impact that adoption of SFAS
No. 159 will have on our financial statements.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Our financial statements and accompanying notes are prepared in accordance with U.S. GAAP. Preparing
financial statements requires management to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management’s
application of accounting policies. Critical accounting policies for us include revenue recognition, impairment of
investment securities, impairment of goodwill, accounting for research and development costs, accounting for
legal contingencies, accounting for income taxes, and accounting for stock-based compensation.
We account for the licensing of software in accordance with American Institute of Certified Public Accountants
Statement of Position (“SOP”) 97-2, Software Revenue Recognition. The application of SOP 97-2 requires
judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-
specific objective evidence (“VSOE”) of fair value exists for those elements. For some of our products, customers
receive certain elements of our products over a period of time. These elements include free post-delivery
telephone support and the right to receive unspecified upgrades/enhancements of Microsoft Internet Explorer on
a when-and-if-available basis. The fair value of these elements is recognized over the estimated life cycle for the
Windows XP and previous PC operating systems. For Windows Vista, there are no significant undelivered
elements and accordingly, no license revenue is deferred for Windows Vista sales. Changes to the elements in a
software arrangement, the ability to identify VSOE for those elements, the fair value of the respective elements,
and changes to a product’s estimated life cycle could materially impact the amount of earned and unearned
revenue. Judgment is also required to assess whether future releases of certain software represent new products
or upgrades and enhancements to existing products.
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and SAB Topic 5M,
Accounting for Noncurrent Marketable Equity Securities, provide guidance on determining when an investment is
other-than-temporarily impaired. Investments are reviewed quarterly for indicators of other-than-temporary
impairment. This determination requires significant judgment. In making this judgment, we employ a systematic
methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential
impairment of our investments. 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, and 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