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Search advertising, including Bing and Bing Ads, is designed to deliver relevant online advertising to a global audience.
We have several partnerships with other companies, including Yahoo! Growth depends on our ability to attract new users, understand intent, and match intent with relevant content and advertiser offerings.
The Windows operating system faces competition from various software products and from alternative platforms and devices, mainly from Apple and Google.
We believe Windows competes effectively by giving customers choice, value, flexibility, security, an easy-to-use interface, and compatibility with a broad range of hardware and software applications, including those that enable productivity.
Our devices face competition from various computer, tablet, hardware, and phone manufacturers, and offer a unique combination of high-quality industrial design and innovative technologies across various price points, many of which are also current or potential partners and customers.
Our gaming platform competes with console platforms from Sony and Nintendo, both of which have a large, established base of customers. The lifecycle for gaming and entertainment consoles averages five to ten years.
Nintendo released their latest generation console in November Sony released their latest generation console in November In addition to Sony and Nintendo, we compete with other providers of entertainment services through online marketplaces.
We believe our gaming platform is effectively positioned against competitive products and services based on significant innovation in hardware architecture, user interface, developer tools, online gaming and entertainment services, and continued strong exclusive content from our own game franchises as well as other digital content offerings.
Our video games competitors include Electronic Arts and Activision Blizzard. Xbox Live faces competition from various online marketplaces, including those operated by Amazon, Apple, and Google.
Our search advertising business competes with Google and a wide array of websites, social platforms like Facebook, and portals that provide content and online offerings to end users.
We have operations centers that support all operations in their regions, including customer contract and order processing, credit and collections, information processing, and vendor management and logistics.
In addition to the operations centers, we also operate datacenters throughout the Americas, Australia, Europe, and Asia. To serve the needs of customers around the world and to improve the quality and usability of products in international markets, we localize many of our products to reflect local languages and conventions.
Localizing a product may require modifying the user interface, altering dialog boxes, and translating text.
We operate manufacturing facilities for the production and customization of phones, predominantly in Vietnam.
We announced the sale of our entry-level feature phone business in May , which includes the sale of our phone manufacturing facility in Vietnam.
Our devices, other than phones, are primarily manufactured by third-party contract manufacturers. We generally have the ability to use other manufacturers if a current vendor becomes unavailable or unable to meet our requirements.
We plan to continue to make significant investments in a broad range of research and development efforts. Internal development allows us to maintain competitive advantages that come from product differentiation and closer technical control over our products and services.
It also gives us the freedom to decide which modifications and enhancements are most important and when they should be implemented.
We strive to obtain information as early as possible about changing usage patterns and hardware advances that may affect software design. Before releasing new software platforms, we provide application vendors with a range of resources and guidelines for development, training, and testing.
Generally, we also create product documentation internally. We protect our intellectual property investments in a variety of ways.
We work actively in the U. We are a leader among technology companies in pursuing patents and currently have a portfolio of over 61, U.
From time to time, we enter into broader cross-license agreements with other technology companies covering entire groups of patents. We also purchase or license technology that we incorporate into our products or services.
At times, we make select intellectual property broadly available at no or low cost to achieve a strategic objective, such as promoting industry standards, advancing interoperability, or attracting and enabling our external development community.
While it may be necessary in the future to seek or renew licenses relating to various aspects of our products and business methods, we believe, based upon past experience and industry practice, such licenses generally could be obtained on commercially reasonable terms.
We believe our continuing research and product development are not materially dependent on any single license or other agreement with a third party relating to the development of our products.
We invest in a range of emerging technology trends and breakthroughs that we believe offer significant opportunities to deliver value to our customers and growth for the company.
Based on our assessment of key technology trends, we maintain our long-term commitment to research and development across a wide spectrum of technologies, tools, and platforms spanning digital work and life experiences, cloud computing, and devices operating systems and hardware.
While our main research and development facilities are located in Redmond, Washington, we also operate research and development facilities in other parts of the U.
This global approach helps us remain competitive in local markets and enables us to continue to attract top talent from across the world.
We generally fund research at the corporate level to ensure that we are looking beyond immediate product considerations to opportunities further in the future.
We also fund research and development activities at the business segment level. Much of our business segment level research and development is coordinated with other segments and leveraged across the company.
In addition to our main research and development operations, we also operate Microsoft Research. We market and distribute our products and services through the following channels: OEMs, distributors and resellers, online, and Microsoft retail stores.
Our sales force performs a variety of functions, including working directly with enterprises and public sector organizations worldwide to identify and meet their software requirements; managing OEM relationships; and supporting solution integrators, independent software vendors, and other partners who engage directly with our customers to perform sales, consulting, and fulfillment functions for our products.
We distribute software through OEMs that pre-install our software on new devices and servers they sell. The largest component of the OEM business is the Windows operating system pre-installed on computing devices.
OEMs also sell hardware pre-installed with other Microsoft products, including server and embedded operating systems and applications such as our Microsoft Office suite.
In addition to these products, we also market our services through OEMs and service bundles such as Windows with Bing or Windows with Office subscription.
There are two broad categories of OEMs. Although each type of reselling partner reaches organizations of all sizes, LSPs are primarily engaged with large organizations, distributors resell primarily to VARs, and VARs typically reach small- and medium-sized organizations.
Our Dynamics software offerings are also licensed to enterprises through a global network of channel partners providing vertical solutions and specialized services.
We distribute our retail packaged products primarily through independent non-exclusive distributors, authorized replicators, resellers, and retail outlets.
Individual consumers obtain these products primarily through retail outlets, including Microsoft retail stores. We distribute our devices through third-party retailers and Microsoft retail stores.
Our phones are also distributed through global wireless communications carriers. We have a network of field sales representatives and field support personnel that solicit orders from distributors and resellers, and provide product training and sales support.
Although on-premises software continues to be an important part of our business, increasingly we are delivering additional value to customers through cloud-based services.
Other services delivered online include our online advertising platform with offerings for advertisers and publishers, as well as Microsoft Developer Network subscription content and updates, periodic product updates, and online technical and practice readiness resources to support our partners in developing and selling our products and solutions.
As we increasingly deliver online services, we sell many of these cloud-based services through our enterprise agreements and have also enabled new sales programs to reach small and medium-sized businesses.
These programs include direct sales, direct sales supported by a large network of partner advisors, and resale of services through operator channels, such as telephone, cell, and cable providers.
We license software to organizations under agreements that allow the customer to acquire multiple licenses of products and services.
Our agreements for organizations to acquire multiple licenses of products and services are designed to provide them with a means of doing so without having to acquire separate licenses through retail channels.
In delivering organizational licensing agreements to the market, we use different programs designed to provide flexibility for organizations of various sizes.
While these programs may differ in various parts of the world, generally they include those discussed below. Designed primarily for medium- and large-sized organizations that want to obtain the best value by standardizing on a common IT platform across their organization.
Software Assurance also provides support, tools, and training to help customers deploy and use software efficiently. Enterprises can elect to acquire perpetual licenses or, under the Enterprise Subscription option, can acquire non-perpetual, subscription licenses for a specified period generally three years.
Online services are also available, and subscriptions are generally structured with three-year terms. Software Assurance and online services subscriptions are generally available for a term of up to three years.
We plan on expanding the offers under the MPSA in fiscal year to better enable organizations to obtain the best value by standardizing on a common IT platform across their organization.
Similar to Open programs, the Select Plus program allows customers to acquire licenses only, acquire licenses with Software Assurance, or renew Software Assurance upon the expiration of existing volume licensing agreements.
A subset of online services is also available for purchase through the Select Plus program, and subscriptions are generally structured with terms between one and three years.
In July , we announced the retirement over a two-year period of Select Plus agreements for commercial customers, in favor of modern licensing options.
Beginning July , no new Select Plus agreements were signed with commercial organizations, and customers who want to purchase licenses were encouraged to transition to the MPSA.
Starting in July , we will no longer be accepting orders from commercial organizations for Select Plus after their next agreement anniversary.
Under the Open Value and Open Value Subscription programs, customers can acquire perpetual or subscription licenses, respectively, over a three-year period.
Online services are available in each of the Open programs. Microsoft Online Subscription Agreement is designed to enable small and medium-sized businesses to easily purchase Microsoft Online Services.
The program allows customers to acquire monthly or annual subscriptions for cloud-based services. The Microsoft Cloud Solution Provider program enables partners to directly manage their entire Microsoft cloud customer lifecycle.
Partners in this program use dedicated tools to directly provision, manage, and support their customer subscriptions.
Partners can easily package their own tools, products, and services, and combine them into one monthly or annual customer bill.
The Microsoft Services Provider License Agreement is a program targeted at service providers and independent software vendors allowing these partners to provide software services and hosted applications to their end customers.
Agreements are generally structured with a three-year term, and partners are billed monthly based upon consumption.
The Independent Software Vendor Royalty program enables partners to use Microsoft software in their own software programs. Our customers include individual consumers, small- and medium-sized organizations, large global enterprises, public sector institutions, Internet service providers, application developers, and OEMs.
Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant. As of June 30, , we employed approximately , people on a full-time basis, 63, in the U.
Of the total employed people, 38, were in operations, including manufacturing, distribution, product support, and consulting services; 37, in product research and development; 29, in sales and marketing; and 10, in general and administration.
Certain employees are subject to collective bargaining agreements. In June , management approved a restructuring plan that eliminated approximately 7, positions in fiscal year , primarily in our phone hardware business.
In the fourth quarter of , management approved restructuring plans that would result in job eliminations, primarily across our smartphone hardware business and global sales.
In addition to the elimination of 1, positions that were announced in May , approximately 2, roles globally will be reduced during the year as an extension of the earlier plan, and these actions are expected to be completed by the end of fiscal year Our Internet address is www.
At our Investor Relations website, www. Our goal is to maintain the Investor Relations website as a portal through which investors can easily find or navigate to pertinent information about us, including:.
The information found on our website is not part of this or any other report we file with, or furnish to, the SEC.
In addition to these channels, we use social media to communicate to the public. It is possible that the information we post on social media could be deemed to be material to investors.
We encourage investors, the media, and others interested in Microsoft to review the information we post on the social media channels listed on our Investor Relations website.
We generate revenue by licensing and supporting an array of software products, by offering a wide range of services, including cloud-based services to consumers and businesses, by designing, manufacturing, and selling devices that integrate with our cloud-based services, and by delivering relevant online advertising to a global audience.
Our most significant expenses are related to compensating employees; designing, manufacturing, marketing, and selling our products and services; datacenter costs in support of our cloud-based services; and income taxes.
Much of our focus in fiscal year was toward transforming our organization to support our strategy of building best-in-class platforms and productivity services for a mobile-first, cloud-first world.
We achieved product development milestones, implemented organizational changes, and made strategic and tactical moves to support the three central ambitions that support our strategy: We will finance the transaction primarily through the issuance of new indebtedness.
The acquisition is anticipated to accelerate the growth of LinkedIn, as well as Office and Dynamics. Part of this strategy involves focusing our phone devices on a narrower range of customer categories and differentiating through the combination of hardware and software we are uniquely positioned to offer.
As anticipated, our change in phone strategy resulted in a reduction in units sold and associated expenses in fiscal year , and this trend is expected to continue in fiscal year Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models.
Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business.
At Microsoft, we push the boundaries of what is possible through a broad range of research and development activities that seek to identify and address the changing demands of customers and users, industry trends, and competitive forces.
The market for software, devices, and cloud-based services is dynamic and highly competitive. Our competitors are developing new software and devices, while also deploying competing cloud-based services for consumers and businesses.
We must continue to evolve and adapt over an extended time in pace with this changing environment. The investments we are making in devices and infrastructure will continue to increase our operating costs and may decrease our operating margins.
Our success is highly dependent on our ability to attract and retain qualified employees. We hire a mix of university and industry talent worldwide.
Aggregate demand for our software, services, and devices is correlated to global macroeconomic and geopolitical factors, which remain dynamic.
Our international operations provide a significant portion of our total revenue and expenses. Many of these revenue and expenses are denominated in currencies other than the U.
As a result, changes in foreign exchange rates may significantly affect revenue and expenses. The strengthening of the U. See a discussion of these factors and other risks under Risk Factors in our fiscal year Form K.
Our revenue historically has fluctuated quarterly and has generally been highest in the second quarter of our fiscal year due to corporate calendar year-end spending trends in our major markets and holiday season spending by consumers.
If our customers choose to license cloud-based versions of our products and services rather than licensing transaction-based products and services, the associated revenue will shift from being recognized at the time of the transaction to being recognized over the subscription period or upon consumption, as applicable.
As a result, we have separately disclosed product revenue and service and other revenue on our consolidated income statements. Product revenue includes sales from operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games; hardware such as PCs, tablets, gaming and entertainment consoles, phones, other intelligent devices, and related accessories; and training and certification of computer system integrators and developers.
Service and other revenue includes sales from cloud-based solutions that provide customers with software, services, platforms, and content such as Office , Azure, Dynamics CRM Online, and Xbox Live; solution support; and consulting services.
Service and other revenue also includes sales from online advertising. Segment information appearing in Note 21 — Segment Information and Geographic Data of the Notes to Financial Statements is also presented on this basis.
As a result, beginning in fiscal year , we report our financial performance based on our new segments, Productivity and Business Processes, Intelligent Cloud, and More Personal Computing, and analyze operating income as the measure of segment profitability.
We have recast certain previously reported amounts to conform to the way we internally manage and monitor segment performance.
We expect to report the financial performance of LinkedIn as part of our Productivity and Business Processes segment. Additional information on our reportable segments is contained in Note 21 — Segment Information and Geographic Data of the Notes to Financial Statements.
Windows 10 revenue is primarily recognized at the time of billing in the More Personal Computing segment, and the deferral and subsequent recognition of revenue is reflected in Corporate and Other.
More Personal Computing revenue decreased, mainly due to lower revenue from Devices and Windows, offset in part by higher revenue from search advertising and Gaming.
Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services and Enterprise Services.
Productivity and Business Processes revenue increased slightly, driven by an increase in Office and Dynamics revenue.
Productivity and Business Processes and More Personal Computing gross margin decreased, offset in part by higher gross margin from Intelligent Cloud.
More Personal Computing revenue increased, primarily due to higher revenue from Devices, search advertising and Gaming, offset in part by a decline in Windows revenue.
Intelligent Cloud revenue increased, primarily due to higher revenue from server products and cloud services.
Key changes in expenses were:. Productivity and Business Processes revenue increased slightly, primarily due to an increase in Office and Dynamics revenue.
Corporate and Other revenue primarily comprises certain revenue deferrals, including those related to Windows 10, Bundled Offerings, and video games.
Corporate and Other operating income loss primarily comprises revenue deferrals and corporate-level activity not specifically allocated to a segment, including impairment, integration, and restructuring expenses.
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.
Sales and marketing expenses include payroll, employee benefits, stock-based compensation expense, and other headcount-related expenses associated with sales and marketing personnel and the costs of advertising, promotions, trade shows, seminars, and other programs.
General and administrative expenses include payroll, employee benefits, stock-based compensation expense, severance expense, and other headcount-related expenses associated with finance, legal, facilities, certain human resources and other administrative personnel, certain taxes, and legal and other administrative fees.
Impairment, integration, and restructuring expenses include costs associated with the impairment of goodwill and intangible assets related to our phone business, employee severance expenses and costs associated with the consolidation of facilities and manufacturing operations related to restructuring activities, and systems consolidation and other business integration expenses associated with our acquisition of NDS.
Our annual goodwill impairment test as of May 1, indicated that the carrying value of our previous Phone Hardware reporting unit goodwill exceeded its estimated fair value.
All remaining goodwill and intangible assets are included in our Devices reporting unit, within More Personal Computing under our current segment structure.
We use derivative instruments to: Gains and losses from changes in fair values of derivatives that are not designated as hedges are primarily recognized in other income expense , net.
Other than those derivatives entered into for investment purposes, such as commodity contracts, the gains losses are generally economically offset by unrealized gains losses in the underlying available-for-sale securities and gains losses on certain balance sheet amounts from foreign exchange rate changes.
Dividends and interest income increased due to higher portfolio balances and slightly higher yields on fixed-income securities.
Interest expense increased due to higher outstanding long-term debt. Net recognized gains on investments decreased primarily due to higher other-than-temporary impairments and lower gains on sales of fixed-income securities, offset in part by higher gains on sales of equity securities.
Net losses on derivatives increased due to higher losses on currency and equity contracts and lower gains on interest rate contracts in the current period as compared to the prior period, offset in part by lower losses on commodity contracts.
For fiscal year , other reflects recognized losses from divestitures and certain joint ventures. Dividends and interest income decreased due to lower yields on fixed-income securities, offset in part by higher portfolio balances.
Net recognized gains on investments increased primarily due to higher gains on sales of equity securities, offset in part by higher other-than-temporary impairments.
Net losses on derivatives increased due to losses on commodity contracts in fiscal year as compared to gains in fiscal year , offset in part by lower losses on currency and equity contracts.
For fiscal year , other reflects recognized losses from certain joint ventures and divestitures. Our effective tax rate was lower than the U.
The decrease in our effective tax rate for fiscal year compared to fiscal year was primarily due to changes in the mix of our income before income taxes between the U.
The fiscal year effective tax rate included the tax impact of losses in foreign jurisdictions for which we may not realize a tax benefit, primarily as a result of impairment and restructuring charges.
The mix of income before income taxes between the U. We supply our Windows PC operating system to customers through our U. In fiscal year , our U.
Net revenue deferrals related to sales of Windows 10 negatively impacted our fiscal year U. Impairment, integration, and restructuring expense relating to our phone business decreased our fiscal year U.
On July 27, , the U. Tax Court issued an opinion in Altera Corp. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement.
This decrease relates primarily to tax credits available for carryover and a partial settlement of the IRS audit for tax years to , offset by increases relating to intercompany transfer pricing.
While we settled a portion of the IRS audit for tax years to during the third quarter of fiscal year , and settled a portion of the IRS audit for tax years to during the first quarter of fiscal year , we remain under audit for those years.
In February , the IRS withdrew its Revenue Agents Report for tax years to and reopened the audit phase of the examination. As of June 30, , the primary unresolved issue relates to transfer pricing, which could have a significant impact on our consolidated financial statements if not resolved favorably.
We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months.
Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.
We also continue to be subject to examination by the IRS for tax years to We are subject to income tax in many jurisdictions outside the U.
Our operations in certain jurisdictions remain subject to examination for tax years to , some of which are currently under audit by local tax authorities.
The resolutions of these audits are not expected to be material to our consolidated financial statements.
In fiscal year , this reduction was mostly offset by losses in foreign jurisdictions for which we may not realize a tax benefit, primarily as a result of impairment and restructuring charges.
Changes in the mix of income before income taxes between the U. In fiscal years and , our U. Our short-term investments are primarily intended to facilitate liquidity and for capital preservation.
They consist predominantly of highly liquid investment-grade fixed-income securities, diversified among industries and individual issuers.
The investments are predominantly U. Our fixed-income investments are exposed to interest rate risk and credit risk. The credit risk and average maturity of our fixed-income portfolio are managed to achieve economic returns that correlate to certain fixed-income indices.
The settlement risk related to these investments is insignificant given that the short-term investments held are primarily highly liquid investment-grade fixed-income securities.
The remaining cash equivalents and short-term investments held by our foreign subsidiaries were invested in foreign securities.
We lend certain fixed-income and equity securities to increase investment returns. The loaned securities continue to be carried as investments on our consolidated balance sheets.
Collateral received is recorded as an asset with a corresponding liability. Intra-year variances in the amount of securities loaned are mainly due to fluctuations in the demand for the securities.
In general, and where applicable, we use quoted prices in active markets for identical assets or liabilities to determine the fair value of our financial instruments.
This pricing methodology applies to our Level 1 investments, such as exchange-traded mutual funds, domestic and international equities, and U.
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, common and preferred stock, foreign government bonds, mortgage- and asset-backed securities, U.
Level 3 investments are valued using internally developed models with unobservable inputs. Assets and liabilities measured at fair value on a recurring basis 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 classified 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.
These controls include model validation, review of key model inputs, analysis of period-over-period fluctuations, and independent recalculation of prices where appropriate.
We issued debt to take advantage of favorable pricing and liquidity in the debt markets, reflecting our credit rating and the low interest rate environment.
The proceeds of these issuances were or will be used for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt.
Unearned revenue as of June 30, was comprised mainly of unearned revenue from volume licensing programs.
Unearned revenue from volume licensing programs represents customer billings for multi-year licensing arrangements paid for either at inception of the agreement or annually at the beginning of each coverage period and accounted for as subscriptions with revenue recognized ratably over the coverage period.
Unearned revenue as of June 30, also included payments for: Windows 10 licenses; post-delivery support and consulting services to be performed in the future; Office subscriptions; Xbox Live subscriptions; Microsoft Dynamics business solutions products; Skype prepaid credits and subscriptions; Bundled Offerings; and other offerings for which we have been paid in advance and earn the revenue when we provide the service or software, or otherwise meet the revenue recognition criteria.
The following table outlines the expected future recognition of unearned revenue as of June 30, While the program has no expiration date, we intend to complete it by December 31, We provide indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products and certain other matters.
Additionally, we have agreed to cover damages resulting from breaches of certain security and privacy commitments in our cloud business. In evaluating estimated losses on these indemnifications, we consider factors such as the degree of probability of an unfavorable outcome and our ability to make a reasonable estimate of the amount of loss.
These obligations did not have a material impact on our consolidated financial statements during the periods presented. The following table summarizes the payments due by fiscal year for our outstanding contractual obligations as of June 30, We expect the acquisition will close in calendar year , and we will finance the transaction primarily through the issuance of new debt.
We will continue to invest in sales, marketing, product support infrastructure, and existing and advanced areas of technology, as well as continue making acquisitions that align with our business strategy.
Additions to property and equipment will continue, including new facilities, datacenters, and computer systems for research and development, sales and marketing, support, and administrative staff.
We expect capital expenditures to increase in coming years in support of our productivity and platform strategy.
We have operating leases for most U. We have not engaged in any related party transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity or the availability of capital resources.
We earn a significant amount of our operating income outside the U. As a result, as discussed above under Cash, Cash Equivalents, and Investments, the majority of our cash, cash equivalents, and short-term investments are held by foreign subsidiaries.
We currently do not intend nor foresee a need to repatriate these funds. We expect existing domestic cash, cash equivalents, short-term investments, cash flows from operations, and access to capital markets to continue to be sufficient to fund our domestic operating activities and cash commitments for investing and financing activities, such as regular quarterly dividends, debt maturities, and material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.
In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months and thereafter for the foreseeable future.
Should we require more capital in the U. These alternatives could result in higher effective tax rates, increased interest expense, or dilution of our earnings.
We have borrowed funds domestically and continue to believe we have the ability to do so at reasonable interest rates. Our consolidated financial statements and accompanying notes are prepared in accordance with U.
Preparing consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses.
Critical accounting policies for us include revenue recognition, impairment of investment securities, goodwill, research and development costs, contingencies, income taxes, and inventories.
Revenue recognition for multiple-element arrangements requires judgment to determine if multiple elements exist, whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements.
Judgment is also required to assess whether future releases of certain software represent new products or upgrades and enhancements to existing products.
Certain volume licensing arrangements include a perpetual license for current products combined with rights to receive unspecified future versions of software products and are accounted for as subscriptions, with billings recorded as unearned revenue and recognized as revenue ratably over the coverage period.
Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered.
If updates are determined to not meet the definition of an upgrade, revenue is generally recognized as products are shipped or made available.
Microsoft enters into arrangements that can include various combinations of software, services, and hardware. Where elements are delivered over different periods of time, and when allowed under U.
GAAP, revenue is allocated to the respective elements based on their relative selling prices at the inception of the arrangement, and revenue is recognized as each element is delivered.
We use a hierarchy to determine the fair value to be used for allocating revenue to elements: For software elements, we follow the industry-specific software guidance which only allows for the use of VSOE in establishing fair value.
Generally, VSOE is the price charged when the deliverable is sold separately or the price established by management for a product that is not yet sold if it is probable that the price will not change before introduction into the marketplace.
ESPs are established as best estimates of what the selling prices would be if the deliverables were sold regularly on a stand-alone basis.
Our process for determining ESPs requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each deliverable.
In January , we announced Windows 10 would be free to all qualified existing users of Windows 7 and Windows 8. This offer differs from historical offers preceding the launch of new versions of Windows as it is being made available for free to existing users in addition to new customers after the offer announcement.
We evaluated the nature and accounting treatment of the Windows 10 offer and determined that it represents a marketing and promotional activity, in part because the offer is being made available for free to existing users.
As this is a marketing and promotional activity, revenue recognition of new sales of Windows 8 will continue to be recognized as delivered.
Customers purchasing a Windows 10 license will receive unspecified updates and upgrades over the life of their Windows 10 device at no additional cost.
As these updates and upgrades will not be sold on a stand-alone basis, we are unable to establish VSOE. Accordingly, revenue from licenses of Windows 10 is recognized ratably over the estimated life of the related device, which ranges between two to four years.
We currently are evaluating the impact of the new standard related to revenue recognition, which we anticipate will have a material impact on our consolidated financial statements.
We review investments 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 , net and a new cost basis in the investment is established.
We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination.
We evaluate our reporting units on an annual basis and, if necessary, reassign goodwill using a relative fair value allocation approach. Goodwill is tested for impairment at the reporting unit level operating segment or one level below an operating segment on an annual basis May 1 for us 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 primarily through the use of 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.
The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions, and other factors.
Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for each reporting unit.
Costs incurred internally in researching and developing a computer software product are charged to expense until technological feasibility has been established for the product.
Once technological feasibility is established, all software costs are 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.
The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty.
An estimated loss from a loss contingency such as a legal proceeding or claim is 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.
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 consolidated financial statements. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.
Accounting literature also provides guidance on derecognition of income tax assets and liabilities, classification of deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and income tax disclosures.
Judgment is required in assessing the future tax consequences of events that have been recognized on our consolidated financial statements or tax returns.
Variations in the actual outcome of these future tax consequences could materially impact our consolidated financial statements.
Inventories are stated at average cost, subject to the lower of cost or market. Cost includes materials, labor, and manufacturing overhead related to the purchase and production of inventories.
We regularly review inventory quantities on hand, future purchase commitments with our suppliers, and the estimated utility of our inventory.
These reviews include analysis of demand forecasts, product life cycle status, product development plans, current sales levels, pricing strategy, and component cost trends.
If our review indicates a reduction in utility below carrying value, we reduce our inventory to a new cost basis through a charge to cost of revenue.
Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report.
The Company designs and maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing consolidated financial statements and maintaining accountability for assets.
These systems are augmented by written policies, an organizational structure providing division of responsibilities, careful selection and training of qualified personnel, and a program of internal audits.
The Board of Directors, through its Audit Committee, consisting solely of independent directors of the Company, meets periodically with management, internal auditors, and our independent registered public accounting firm to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting.
We are exposed to economic risk from foreign exchange rates, interest rates, credit risk, equity prices, and commodity prices.
A portion of these risks is hedged, but they may impact our consolidated financial statements. Certain forecasted transactions, assets, and liabilities are exposed to foreign currency risk.
We monitor our foreign currency exposures daily and use hedges where practicable to offset the risks and maximize the economic effectiveness of our foreign currency positions.
Principal currencies hedged include the euro, Japanese yen, British pound, Canadian dollar, and Australian dollar. Our fixed-income portfolio is diversified across credit sectors and maturities, consisting primarily of investment-grade securities.
The credit risk and average maturity of the fixed-income portfolio is managed to achieve economic returns that correlate to certain global and domestic fixed-income indices.
Our equity portfolio consists of global, developed, and emerging market securities that are subject to market price risk. We manage the securities relative to certain global and domestic indices and expect their economic risk and return to correlate with these indices.
We use broad-based commodity exposures to enhance portfolio returns and facilitate portfolio diversification. Our investment portfolio has exposure to a variety of commodities, including precious metals, energy, and grain.
We manage these exposures relative to global commodity indices and expect their economic risk and return to correlate with these indices.
VaR is the expected loss, for a given confidence level, in the fair value of our portfolio due to adverse market movements over a defined time horizon.
The VaR model is not intended to represent actual losses in fair value, including determinations of other-than-temporary losses in fair value in accordance with U.
GAAP, but is used as a risk estimation and management tool. The distribution of the potential changes in total market value of all holdings is computed based on the historical volatilities and correlations among foreign exchange rates, interest rates, equity prices, and commodity prices, assuming normal market conditions.
The VaR is calculated as the total loss that will not be exceeded at the Several risk factors are not captured in the model, including liquidity risk, operational risk, and legal risk.
The following table sets forth the one-day VaR for substantially all of our positions as of June 30, and and for the year ended June 30, We have recast certain prior period amounts to conform to the current period presentation, with no impact on consolidated net income or cash flows.
The consolidated financial statements include the accounts of Microsoft Corporation and its subsidiaries.
Intercompany transactions and balances have been eliminated. Investments through which we are not able to exercise significant influence over the investee and which do not have readily determinable fair values are accounted for under the cost method.
As a result, beginning in fiscal year , we report our financial performance based on our new segments described in Note 21 — Segment Information and Geographic Data.
We have recast certain prior period amounts to conform to the way we internally manage and monitor segment performance during fiscal year This change primarily impacted Note 10 — Goodwill, Note 15 — Unearned Revenue, and Note 21 — Segment Information and Geographic Data, with no impact on consolidated net income or cash flows.
Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses.
Examples of estimates include: Examples of assumptions include: Assets and liabilities recorded in foreign currencies are translated at the exchange rate on the balance sheet date.
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