Microsoft Revenue Recognition

Microsoft Revenue Recognition Case

1. What effect did Microsoft’s revenue recognition policy have on its financial statements? Ignore any potential tax effects.

a. Estimate the amount of revenue that Microsoft would have been reported in each quarter from 1996 through 1999 if Microsoft had not adopted its new revenue recognition policy in 1996.

b. Speculate as to why Microsoft decided to defer a portion of its revenues in fiscal 1996.

Microsoft has typically followed a very conservative accounting principle, and when it started to expand its portfolio of products from a simple one time sale to a more managed solution (e.g.: Windows or Office with updates) it decided to book only part of the revenue (80%) immediately, and set aside 20% as unearned revenue. This 20% of unearned revenue would be realized over a period of time averaging 24 or 18 months for most complex products that typically get upgrades or have support.

Besides the above publicly stated reason, we suspect that there was also some other underlying economic concern. Microsoft’s decision to defer revenues may be partially due to its change in strategy to smooth revenue growth curve, especially during 1995-1996, the time of significant growth. We observe this very sharp increase in revenue by the end of 1995 from the revenue trend plot in Exhibit 1. This dramatic revenue climbing-up might have provided Microsoft an incentive to dampen their performance.

2. What was the overall impact of this policy on Microsoft’s fiscal 1997, 1998, 1999 financial statements?

We can see the impact of this new policy by graphing reported vs. actual revenue (see chart below). Reported revenue always lags actual revenue primarily because 20% of revenue is unearned and realized over 18 or 24 months.

3. In your opinion, did Microsoft provide its analysts’ with information that was intentionally overly pessimistic? Are there any benefits to the company to being outwardly pessimistic about...