Microsoft 2008 Annual Report Download - page 42

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STOCK-BASED COMPENSATION
We account for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment. Under
the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant
date based on the fair value of the award and is recognized as expense over the applicable vesting period of the
stock award (generally three to five years) using the straight-line method.
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.
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. The fair value of these investments approximates their carrying value. In
general, investments with original maturities of greater than three months and remaining maturities of less than
one year are classified as short-term investments. 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 equivalents and short-term investments are
classified as available for sale and are recorded at market value using the specific identification method. Changes
in market value are reflected in OCI (excluding other-than-temporary impairments).
Equity and other investments classified as long-term 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. Changes in market value are reflected in OCI (excluding other-than-temporary
impairments). 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. The loaned securities
continue to be carried as investments on our balance sheet. Collateral and/or security interest received is
determined based upon the underlying security lent and the creditworthiness of the borrower. Cash collateral is
recorded as an asset with a corresponding liability.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary.
We employ a systematic methodology on a quarterly basis 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 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, equity price, interest rate and credit
risks, to enhance returns, and to facilitate portfolio diversification. 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 measured at fair value. The
accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the
resulting designation. For a derivative instrument designated as a fair-value hedge, the gain or loss is recognized
in earnings in the period of change together with the offsetting loss or gain on the hedged item attributed to the
risk being hedged. For a derivative instrument designated as a cash-flow hedge, the effective portion of the
derivative’s gain or loss is initially reported as a component of OCI and is subsequently recognized in earnings
when the hedged exposure affects earnings. The ineffective portion of the gain or loss is recognized in earnings.
For options designated either as fair-value or cash-flow hedges, changes in the time value are excluded from the
assessment of hedge effectiveness and are recognized in earnings. Gains and losses from changes in fair values
of derivatives that are not designated as hedges for accounting purposes are recognized in earnings.