Microsoft 2009 Annual Report Download - page 29

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Fiscal year 2008 compared with fiscal year 2007
Dividends and interest income decreased reflecting lower interest rates on our fixed-income investments and a
reduction in the average balance of interest-bearing investments owned. Net recognized gains on investments,
which include other-than-temporary impairments of $312 million during fiscal year 2008 and $25 million during fiscal
year 2007, decreased primarily due to declines in equity values as a result of the recent stock market decline. Net
gains on derivatives increased primarily due to higher net gains on equity, commodity, and interest rate derivatives.
Income Taxes
Fiscal year 2009 compared with fiscal year 2008
Our effective tax rates in fiscal years 2009 and 2008 were 27% and 26%, respectively. While the fiscal year 2009
rate reflects a higher mix of foreign earnings taxed at lower rates, the rate increased from the prior year because the
fiscal year 2008 rate reflects the resolution of tax positions relating to our agreement with the Internal Revenue
Service (“IRS”) settling the 2000-2003 examination, partially offset by the European Commission fine which was not
tax deductible. As a result of the settlement and the impact on subsequent years, we paid the IRS approximately
$4.1 billion during fiscal year 2009.
Fiscal year 2008 compared with fiscal year 2007
Our effective tax rates in fiscal year 2008 and 2007 were 26% and 30%, respectively. The fiscal year 2008 rate was
lower due to the items noted above.
FINANCIAL CONDITION
Cash, cash equivalents, and short-term investments totaled $31.4 billion as of June 30, 2009, compared with $23.7
billion as of June 30, 2008. Equity and other investments were $4.9 billion as of June 30, 2009, compared with $6.6
billion as of June 30, 2008. 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 risk. We invest primarily in short-term securities to facilitate liquidity and for capital preservation. 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 $22.8 billion at June 30, 2009. Our retained deficit is not
expected to affect our future ability to operate, pay dividends, or repay our debt given our continuing profitability and
strong cash and financial position.
In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to
determine fair value. This pricing methodology applies to our Level 1 investments, such as exchange-traded mutual
funds, domestic and international equities, U.S. treasuries, and agency securities. If quoted prices in active markets
for identical assets or liabilities are not available to determine fair value, then we use quoted prices for similar assets
and liabilities or inputs other than the quoted prices that are observable either directly or indirectly. This pricing
methodology applies to our Level 2 investments such as corporate notes and bonds, foreign government bonds,
mortgage-backed securities, and certain agency securities. Level 3 investments are valued using internally
developed models with unobservable inputs. Assets and liabilities measured using unobservable inputs are an
immaterial portion of our portfolio.
A majority of our investments are priced by pricing vendors and are generally Level 1 or Level 2 investments as
these vendors either provide a quoted market price in an active market or use observable inputs for their pricing
without applying significant adjustments. Broker pricing is used mainly when a quoted price is not available, the
investment is not priced by our pricing vendors, or when a broker price is more reflective of fair values in the market
in which the investment trades. Our broker-priced investments are generally labeled as Level 2 investments because
the broker prices these investments based on similar assets without applying significant adjustments. In addition, all
of our broker-priced investments have a sufficient level of trading volume to demonstrate that the fair values used
are appropriate for these investments. Our fair value processes include controls that are designed to ensure
appropriate fair values are recorded. Such controls include model validation, review of key model inputs, analysis of
period-over-period fluctuations, and independent recalculation of prices where appropriate.