Microsoft 2009 Annual Report Download - page 36

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
Goodwill
SFAS No. 142, Goodwill and Other Intangible Assets, requires that goodwill be tested for impairment at the reporting
unit level (operating segment or one level below an operating segment) on an annual basis and between annual
tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting
unit below its carrying value. These events or circumstances could include a significant change in the business
climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of
a reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting
units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and
determination of the fair value of each reporting unit. The fair value of each reporting unit is estimated using a
discounted cash flow methodology. This analysis requires significant judgments, including estimation of future cash
flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business,
estimation of the useful life over which cash flows will occur, and determination of our weighted average cost of
capital. Changes in these estimates and assumptions could materially affect the determination of fair value and
goodwill impairment for each reporting unit. We allocate goodwill to reporting units based on the reporting unit
expected to benefit from the combination. We evaluate our reporting units on an annual basis and, if necessary,
reassign goodwill using a relative fair value allocation approach.
During the second quarter of fiscal year 2009, we changed the date of our annual impairment test from July 1 to
May 1. The change was made to more closely align the impairment testing date with our long-range planning and
forecasting process. We believe the change in accounting principle related to changing our annual impairment
testing date did not delay, accelerate, or avoid an impairment charge. We have determined that this change in
accounting principle is preferable under the circumstances and does not result in adjustments to our financial
statements when applied retrospectively. During fiscal year 2009, the annual impairment test was performed as of
July 1, 2008 and was performed again as of May 1, 2009.
Research and Development Costs
We account for research and development costs in accordance with applicable accounting pronouncements,
including SFAS No. 2, Accounting for Research and Development Costs, and SFAS No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. SFAS No. 86 specifies that costs incurred
internally in researching and developing a computer software product should be charged to expense until
technological feasibility has been established for the product. Once technological feasibility is established, all
software costs should be capitalized until the product is available for general release to customers. Judgment is
required in determining when technological feasibility of a product is established. We have determined that
technological feasibility for our software products is reached after all high-risk development issues have been
resolved through coding and testing. Generally, this occurs shortly before the products are released to
manufacturing. The amortization of these costs is included in cost of revenue over the estimated life of the products.
Legal and Other Contingencies
The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. SFAS No. 5,
Accounting for Contingencies, requires that an estimated loss from a loss contingency such as a legal proceeding or
claim should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has
been incurred and the amount of the loss can be reasonably estimated. Disclosure of a contingency is required if
there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be
accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to
make a reasonable estimate of the amount of loss. Changes in these factors could materially impact our results of
operations, financial position, or our cash flows.