Are You IFRS Ready?

Frank BrodCorporate Vice President, Finance & AdministrationChief Accounting OfficerMicrosoft Corporation

Agenda

IFRS Overview

FASB and IASB Convergence Activity—Memorandum of Understanding (MOU)

Regulatory Update

IFRS Conversion Strategy

Next Steps in Preparing for IFRS

IFRS – OverviewWhat is IFRS and who is responsible

IFRS is a single set of high quality, understandable and international

financial reporting standards (IFRS) for general purpose financial

statements

IFRS is set by the International Accounting Standards Board (IASB), the

independent standard-setting body of the International Accounting

Standards Committee Foundation (IASC Foundation)

IFRS is developed following an international consultation process,

involving interested individuals and organizations from around the

world and with the support of an external advisory council, the

Standards Advisory Committee (SAC)

The International Financial Reporting Interpretations Committee (IFRIC)

develops guidance to promote consistent practice

IFRS – Overview

What is the FASB doing to address IFRS

In October 2002 the Financial Accounting Standards Board(FASB) and IASB announced the issuance of amemorandum of understanding ("Norwalk Agreement― orMOU), marking a significant step toward formalizing theircommitment to the convergence of U.S. and internationalaccounting standards

In February 2006 the FASB and IASB reaffirmed thecommitment to enhance consistency, comparability andefficiency in global capital markets

IFRS – OverviewWhat is the FASB doing to address IFRS (continued)

The FASB has undertaken six key initiatives to further the goal of convergence of U.S. GAAP with IFRS

Joint projects being conducted with the IASB

Short-term convergence projects

Liaison IASB member on site at the FASB offices

Monitoring of IASB projects

Convergence research project

Explicit consideration of convergence potential in all Board agenda decisions

IFRS – Key Points

Inventory

Research and Development Expenses

Accounting for Share-based Compensation

Provisions and Estimates

Revenue Recognition

Property Plant & Equipment

Financial Statements (Disclosures)

IFRS – Inventory

IFRS inventory should be stated at the lower of cost or NRV

A reversal of a previously recorded inventory impairment is required where thecircumstances that previously caused inventories to be written down belowcost either no longer exist or where there is clear evidence of an increase inNRV or forecasted demand due to changed economic circumstances

The new carrying amount of the inventory would be the lower of cost orrevised NRV

The amount of the reserve of reserve that may be reversed is limited to theamount of the original write-down and is reflected against cost of revenuewhere the original impairment was recorded

Does not specify the P&L classification of the write-down

Requires use of FIFO or weighted average method for inventory costing

Same costing method is required for all inventories having a similar nature anduse to the entity

IFRS – Research and Development

IFRS makes a distinction between the research and development phases.

IFRS makes no distinction between treatment of development costs for internal purposes or to be sold.

Expenditures in the development phase must be capitalized if the following six criteria are met regardless of the nature of the development activity (i.e. software, hardware, etc.):

Technical feasibility

Intention to complete and use or sell

Ability to use or sell

Probable future economic benefits

Available resources

Ability to measure

IFRS – Research and Development

Costs to be capitalized in the development phase include:

Costs of materials and services used

Employment costs of direct employees

Legal fees

Registration fees

Absorption of overheads

Borrowing costs that meet the capitalization criteria

IFRS – Share-based Compensation

Based on a fair value approach

For non-employees the fair value of the award is based on the value of the goods and services received; fair value of the equity instruments used only if the fair value of the goods and services cannot be reliably determined

For non-employees the measurement date of the award is the date the entity obtains the goods and services; no performance commitment concept

Compensation cost must be recognized on an accelerated basis

IFRS – Provisions and Estimates

Defines a provision as a liability of uncertain timing or amount

Requires that an outflow of resources be probable and defines probable as a situation in which the outcome is more likely than not to occur, i.e., greater than 50% likelihood

In order to recognize a provision, an entity must have a present obligation (either legal or constructive) resulting from a past event

Unless fair value of obligation is observable in a market, provision is measured at the ―best estimate‖

Provision discounted only if time value of money is material

Restructuring costs are accrued when management has demonstrated commitment to a detailed exit plan

IFRS – Revenue RecognitionDefines revenues as follows:

―Revenue is the gross inflow of economic benefits during the period arising in

the course of the ordinary activities of an entity when those inflows result in

an increase in equity, other than increases relating to contributions from

equity participants‖

When to recognize revenue

Sale of goods

Transfer of risks and rewards of ownership of the goods

No continuing managerial involvement

Revenue can be measured reliably

Probable that economic benefits will flow to the entity

Costs can be measured reliably

Sale of services

Revenue can be measured reliably

Probable that economic benefits will flow to the entity

Stage of completion can be measured reliably

Costs incurred and costs to complete can be measured reliably

IFRS – Revenue Recognition

Limited guidance on the allocation of consideration(multiple elements) although it does emphasize the use ofthe most appropriate method that best reflects theeconomics of the underlying transaction; acceptablemethods include:

Relative fair value

Costs plus a reasonable margin

Residual method

Reverse residual method (extremely rare)

Fair value is the ―amount for which an asset could beexchanged, or a liability settled, between knowledgeable,willing parties in an arm‘s length transaction‖

Companies using IFRS cannot default to VSOE fair valuethreshold to avoid or delay revenue recognition

IFRS – Revenue Recognition

Approach to determining consideration to individual elements

Identify deliverables

Determine substance of arrangement

Examine the overall arrangement economics

Evaluate whether deliverables are ―inconsequential or perfunctory‖

Service revenue is required to be recognized by reference to the stage of completion (percentage of completion, surveys of work performed, etc)

IFRS has no rules specifically dedicated to software revenue recognition

IFRS – Property, Plant and Equipment

An entity may elect by class of asset either the Cost Model or theRevaluation Model for subsequent measurement of PP&E or intangibleassets

Use of the Revaluation Model for intangible assets requires an ―activemarket‖

Requires significant components of an item of PP&E be recorded anddepreciated separately

If a component is replaced, the cost of the replacement is recorded atcost and any remaining value of the old component is de-recognized

Any gain or loss arising from de-recognition of an item of property,plant and equipment included in profit or loss when the item isderecognized; gains are not be classified as revenue

IFRS – Property, Plant and Equipment

Substance rather than legal form is applied in determining lease classification and there are no ‗bright-line‘ percentage indicators

IFRS uses the term finance lease as opposed to capital lease under US GAAP

Requires a review at each financial year end, at a minimum, of useful lives for PP&E and intangibles

IFRS – Financial Statements (Disclosures)

Critical accounting estimates and assumptions

Significant areas of estimation and uncertainty underlying the quantification of key assets and liabilities

Variables and assumptions underlying management‘s most difficult, subjective or complex judgments

Nature of the assumption, a sensitivity analysis and expected resolution, where possible

Significant judgments

Significant judgments that management has made in its application and interpretation of accounting policies and literature

IFRS – Financial Statements (Disclosures)

Financial statement risk

Discussion of risk through the ―eyes of management‖

Extensive qualitative and quantitative disclosures on the nature and extent of risks arising from financial instruments to which the entity is exposed and how the entity manages them

Quantitative data for each type of risk (i.e., credit, liquidity and market risk) based on information collated and monitored by the Company for risk management purposes

Quantitative disclosures on market risk should include sensitivity analysis for each type of market risk (currency, interest and other price risk)

IFRS – Financial Statements (Disclosures)

Executive compensation

Key management compensation in total for each of the followingcategories:

Short-term employee benefits

Post-employment benefits

Other long-term benefits

Termination benefits

Share-based payments

Roll-forwards

Detailed roll-forwards for classes of components of certain financialstatement line items such as property, plant and equipmentdeveloped technology for intangible assets, land for investmentproperty and legal contingencies for provisions

IFRS – Financial Statements (Disclosures)

Impairment of non-financial assets

Impairment of non-financial assets, including significantassumptions made and sensitivity analysis

Investment property

Assets that meet investment property definition should beseparately presented in the balance sheet; management will haveto determine, formally document and disclose the fair value ofinvestment property at each reporting period (including interimreporting periods)

Implications of Proposed SEC Roadmap

Implications of Proposed SEC RoadmapMicrosoft is not likely included in the SEC‘s initial list of 110 eligible ―pilot‖ adoptioncompanies, but could petition to be included

Potentially, Microsoft will have the option of adopting IFRS in 2011 (MS FY 2012)

Denotes two-year dual reporting and reconciliation

2008

2009

2010 2012

2011 2013

2014

2015

Calendar Year

Ending

OPTION 1 :

“Pilot” adoption

point for Microsoft

Qualified

companies can

adopt IFRS

Potential mandatory

adoption of IFRS for

large accelerated filers

OPTION 2:

“Early” adoption

point for Microsoft

OPTION 3:

“Mandatory” adoption

point for Microsoft

SEC will evaluate the progress

and success of early adopters

against pre-defined milestones

General Themes of Comments Letter on Roadmap

84% of respondents supported moving to a single set ofglobal accounting standards

IFRS is only viable option, but needs improvement

Views varied on the path to IFRS, but many asked for moretime

Independence and accountability of the IASB is important

The change to IFRS proposed by the Roadmap will have amuch wider impact than expected

Microsoft 's Comment Letter on Roadmap

The milestones are appropriate

SEC should undertake a study on the implications for investors and other market participants of the implementation of IFRS

Proposed date is challenging leading to condensed implementation time and increased costs and decreased quality and efficiency; alternative is two years of financials

Concerned with volume of activity in the MOU; quiet period is necessary

Cost estimate of .125% of revenue appears reasonable but there could be great variability

Canadian Roadmap

IFRS will be mandatory beginning 2011 for ―publicly accountable enterprises‖ (PAE) Debt or equity securities in a public market

Assets in a fiduciary capacity for a broad group of outsiders

IFRS will be optional for organizations that are not a PAE

Canadian Securities Administrators (CSA) adopting IFRS as promulgated by the IASB as part of Canadian GAAP but has the authority to modify

2008 2009 2010 2011

2010 IFRS data needed for

2011 IFRS reporting

Canadian GAAP Reporting

Calendar Year

Ending

IFRS Reporting

MD&A disclosure about

IFRS transition and

possible impact

IFRS Conversion …It‘s More Than Accounting

Determine where you want to be from anoperational readiness perspective*

Establish detailed IFRS accounting policies andcomplete analysis of tax impacts

Prioritize components by complexity, resourcesand required time of completion

Assess subsidiaries to determine current IFRSactivities, system requirements and processchanges

Drive conversion on a corporate level and drivechange through to foreign subsidiaries

Manage communication and training programsfor impacted external and internal stakeholders

* Operational readiness from the manual vs. automated process perspective

What Has Microsoft Done to Address IFRS?

Conducted a feasibility study (Phase 1) focusing on thefinancial and operational impacts of 11 accountingcomponents

Targeted training to finance personnel on existingstandards

Prepared high-level IFRS proforma financial statements forfiscal year 2008

Partnered with other companies and trade organizations toshare best practices and leverage findings

Responded to SEC Roadmap

Microsoft IFRS Phase 1 Executive Summary

Irrespective of adoption decision between FY 2012 and 2015,there are activities that need to be started immediately

Certain strategic foreign subsidiaries will already be permitted orrequired to report under IFRS before the SEC proposedmandatory adoption in 2015

Revenue recognition provides the greatest accounting, systemsand process challenges to Microsoft‘s conversion

Microsoft will need to develop a centralized IFRS accountingpolicy decision and conversion protocol process

The tax implications of conversion to IFRS may have cash flowimpacts

Evaluating Microsoft's Conversion Options

Major systems implementation completed

Foreign subsidiary conversion in conjunction with corporate

High degree of complexity and burden on resources

Microsoft would shape the application of IFRS in tech sector

Confirmation of SEC positions on IFRS and stable platform of IFRS

Level of 404 compliance risk due to manual vs. automated controls

low high

Degree of Benefit

―Pilot‖

FY 2010

―Early‖

FY 2012

―Mandatory‖

FY 2015

Microsoft IFRS Pilot Study

The “pilot“ study assessed the accounting and operational impacts in the following components:

High Research & Development

Revenue

Business Combinations

HighLow

Accounting Impact

OperationalImpact

Financial Statements

Share Based Compensation

PPE

Inventory

Tax

Financial Instruments

Impairment

Provisions & Contingency

Key Operational Impacts

Level of Future Work Description of Future Activities

Research & Development

• Establish policy on technical feasibility to determine period of development cost capitalization

• Develop systems and processes to support tracking and capitalization of incremental costs and cost types for software and hardware development

Revenue

• Evaluate the structure of existing contractual arrangements to achieve desired subscription accounting

• Assess data and system requirements to support separation of bundled arrangements for Volume Licensing programs

Share Based Comp

• Update Options Manager System to process graded vesting, social costs and deferred taxes

• Revise employee award and withholding tax settlement process• Develop integrated processes between accounting, HR, tax and treasury

Low High

Key Operational Impacts

Level of Future Work Description of Key Activities

PP&E

• Develop processes and systems for implementing componentization (embedded base and ongoing)

• Affirm estimates of depreciable lives on an annual basis• Obtain third-party valuation for investment properties

Financial Statements

• Develop processes and controls to capture liquidity, credit and market risk• Incorporate uncertainty analysis and key management judgments• Assess data gaps and ability to meet requirements for non-financial assets and

provisions

Financial Instruments

• Create processes and controls for the creation and review of valuation models for non publicly traded equities and derivatives

• Develop new impairment processes• Create IFRS specific hedge accounting policies and programs

Low High

Key Operational Impacts

Low High

Level of Future Work Description of Key Activities

Low High

• Assess compliance costs and risks as book/tax differences change • Adjust methodologies for compiling cost sharing pool for R&D, IPR&D and

share based compensation• Adapt systems and process to ensure data integrity and accurate tax reporting

Tax

• Assess impact of lower recognition threshold and discounting• Develop process to calculate interest expense amortization• Restructure systems to monitor changes in provisions and contingencies

Provisions & Contingency

Key Operational Impacts

• Incorporate IFRS 3R knowledge transfer and training as a component of implementation of FAS 141R

• Assess ability of systems to handle increased volume of IPR&D projects• Identify specialists and processes for assessment of contingent liabilities

Business Combination

Inventory• Assess platform approach for inventory measurement• Evaluate if impairment analysis should be automated or manually calculated• Develop communications structure between Finance and BU controllers

Level of Future Work Description of Key Activities

Low High

Impairments• Increase resources and technical expertise to perform impairment testing• Update processes to facilitate value in use model• Develop process to evaluate impairment of capitalized R&D and IPR&D

Key Next Steps

Monitor the regulatory and standard setting environment

Formalize IFRS at corporate level for overall conversion strategyand accounting policies for critical components

Assess foreign subsidiaries knowledge, activities and readiness withrespect to IFRS

Use selected IFRS accounting component policies to map datagaps, system requirements and process changes

Conduct detailed analysis on the required process and systemchanges for both corporate and foreign subsidiaries

Develop a detailed estimated cost of conversion budget andimplementation plan

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conditions, it should not be interpreted to be a commitment on the part of Microsoft, and Microsoft cannot guarantee the accuracy of any information provided after the date of this presentation. MICROSOFT MAKES NO WARRANTIES, EXPRESS, IMPLIED OR STATUTORY, AS TO THE INFORMATION IN THIS PRESENTATION.