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PAGE 35
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 contingencies,
accounting for income taxes, accounting for stock-based compensation, and accounting for product warranties.
Revenue Recognition
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.
A portion of the revenue related to Windows XP is recorded as unearned due to undelivered elements including,
in some cases, 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 amount of revenue allocated to undelivered
elements is based on the VSOE of fair value for those elements using the residual method or relative fair value
method. Unearned revenue due to undelivered elements is recognized ratably on a straight-line basis over the
related products’ life cycles. Revenue related to Windows Vista is not subject to a similar deferral because there are
no significant undelivered elements. However, Windows Vista revenue is subject to deferral as a result of the
Windows 7 Upgrade Option program which started June 26, 2009. The program allows customers who purchase
PCs from participating computer makers or retailers with certain versions of Windows Vista to receive an upgrade to
the corresponding version of Windows 7 at minimal or no cost. In addition, purchasers of retail packaged Windows
Vista may also qualify for a free or discounted upgrade to the equivalent Windows 7 product with participating
retailers in participating markets when the product becomes generally available. Accordingly, estimated revenue
related to the undelivered Windows 7 product is deferred until the product is delivered.
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.
Impairment of Investment Securities
SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, Staff Accounting Bulletin No. 111,
and FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, 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, credit quality of debt instrument issuers, the duration and
extent to which the fair value is less than cost, and for equity securities, our intent and ability to hold, or plans to sell,
the investment. For fixed income securities, we also evaluate whether we have plans to sell the security or it is more
likely than not that we will be required to sell the security before recovery. 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, and operational and financing cash flow factors. Once a decline in fair value is
determined to be other than temporary, an impairment charge is recorded to other income (expense) and a new cost
basis in the investment is established. If market, industry, and/or investee conditions deteriorate, we may incur future
impairments.