Microsoft and the U.S. Securities and Exchange Commission (SEC) have reached terms to end the government's three-year investigation of Microsoft's accounting practices. The company has not admitted any wrongdoing, and will not face any penalties or restate earnings, but it has agreed not to use certain accounting procedures that may have enabled it to smooth its reported quarterly earnings.

According to the charges, which Microsoft neither admitted nor denied, the company deliberately understated earnings in strong quarters during its fiscal years 1995 through 1998 and maintained seven undisclosed and unsupported cash reserve funds, totaling between US$200 million and US$900 million, to help it boost earnings in weak quarters during the same time. (For more background on the investigation, see "SEC Probes Microsoft Accounting Practices" on page 22 of the Aug. 1999 Update.) Without being specific, the company admitted that "certain aspects" of its "accounting and documentation for reserves, allowances, and accruals" did not follow generally accepted accounting practices, and it has agreed to avoid these practices in the future. The SEC did not charge Microsoft with fraud because it determined that the company did not intentionally mislead investors, according to SEC Associate Director of Enforcement Thomas C. Newkirk, who oversaw the investigation.

Unearned Revenue Not Affected

The investigation and settlement do not affect Microsoft's practice of booking between 10% and 25% of its revenue from desktop operating systems (OSs) and applications in each quarter as unearned revenue, then counting this revenue in later quarters. Because certain aspects of these products, such as support, service packs, and browser technologies, are delivered over time, Microsoft prorates revenue from them over their estimated lifecycle (18 months for desktop applications, three years for OSs), or, in the case of software purchased through multiyear volume licensing agreements, over the duration of the agreement (generally two or three years). This practice is not only acceptable, but is considered to be fiscally conservative.

In its most recent quarter ending Mar. 31, 2002, Microsoft booked about 30% of its total revenue, or US$2.17 billion, as unearned revenue from previous quarters, and carried forward US$6.91 billion in unearned revenue to future quarters.

Complete Microsoft financial statements are available at www.microsoft.com/msft.