*Microsoft’s Financial Reporting Strategy

1. What are the factors that likely explain the difference between Microsoft’s market value of equity and its reported book value of equity?

The most obvious reason for the difference between the market value of equity and the book value of equity is the inability to record certain intangible assets such as brand value, customer loyalty, and perhaps most importantly, human capital. These intangible assets are likely to provide tremendous earnings growth in the future which determines the company’s market value. Notice also that the company’s choice of conservative accounting policies has the effect of depressing the company’s book value of equity.

2. What effect did Microsoft’s software capitalization policy have on its financial statements? Ignore any potential tax effects. a. Assume that 60% of Microsoft’s research and development expenses were incurred after technological feasibility was established, that the average product life was two years, and that the company begins amortizing software costs at the beginning of the following year. Estimate the effect of capitalizing software costs on Microsoft’s fiscal 1997, 1998, and 1999 income statements and balance sheets.

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b. Why do you think Microsoft chose to expense all software costs as incurred rather than capitalizing a portion of these costs?

Remember that the FASB provides explicit guidelines for the treatment of software development costs that required capitalization once technological feasibility was established. Microsoft’s determination that the standard did not “materially affect the Company” likely rested on one of two lines of reasoning. First, the point at which the company determined the technological feasibility of their products may have been sufficiently late in the development process as to make