Microsoft 2010 Annual Report Download - page 41

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published by third parties for use on the Xbox 360 platform is recognized when games are manufactured by the
game publishers. Display advertising revenue is recognized as advertisements are displayed. Search advertising
revenue is recognized when the ad appears in the search results or when the action necessary to earn the revenue
has been completed. Consulting services revenue is recognized as services are rendered, generally based on the
negotiated hourly rate in the consulting arrangement and the number of hours worked during the period. Consulting
revenue for fixed-price services arrangements is recognized as services are provided.
Revenue generally is recognized net of any taxes collected from customers and subsequently remitted to
governmental authorities.
Cost of Revenue
Cost of revenue includes; manufacturing and distribution costs for products sold and programs licensed; operating
costs related to product support service centers and product distribution centers; costs incurred to include software
on PCs sold by OEMs, to drive traffic to our Web sites and to acquire online advertising space (“traffic acquisition
costs”); costs incurred to support and maintain Internet-based products and services; warranty costs; inventory
valuation adjustments; costs associated with the delivery of consulting services; and the amortization of capitalized
research and development costs. Capitalized research and development costs are amortized over the estimated
lives of the products.
Product Warranty
We provide for the estimated costs of fulfilling our obligations under hardware and software warranties at the time the
related revenue is recognized. For hardware warranties, we estimate the costs based on historical and projected
product failure rates, historical and projected repair costs, and knowledge of specific product failures (if any). The
specific hardware warranty terms and conditions vary depending upon the product sold and the country in which we
do business, but generally include parts and labor over a period generally ranging from 90 days to three years. For
software warranties, we estimate the costs to provide bug fixes, such as security patches, over the estimated life of
the software. We regularly reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and
adjust the amounts as necessary.
Research and Development
Research and development expenses include payroll, employee benefits, stock-based compensation expense, and
other headcount-related expenses associated with product development. Research and development expenses also
include third-party development and programming costs, localization costs incurred to translate software for
international markets, and the amortization of purchased software code and services content. Such costs related to
software development are included in research and development expense until the point that technological feasibility
is reached, which for our software products, is generally shortly before the products are released to manufacturing.
Once technological feasibility is reached, such costs are capitalized and amortized to cost of revenue over the
estimated lives of the products.
Sales and Marketing
Sales and marketing expenses include payroll, employee benefits, stock-based compensation, and other headcount-
related expenses associated with sales and marketing personnel, and the costs of advertising, promotions, trade
shows, seminars, and other programs. Advertising costs are expensed as incurred. Advertising expense was $1.6
billion, $1.4 billion, and $1.2 billion in fiscal years 2010, 2009, and 2008, respectively.
Employee Severance
We record employee severance when a specific plan has been approved by management, the plan has been
communicated to employees, and it is unlikely that significant changes will be made to the plan.
Stock-Based Compensation
We measure stock-based compensation cost at the grant date based on the fair value of the award and recognize it
as expense over the applicable vesting period of the stock award (generally four to five years) using the straight-line
method.