Unearned Revenue

A portion of Microsoft’s revenue is earned ratably over the product life cycle or, in the case of subscriptions, over the period of the license agreement.

End users receive certain elements of the Company’s products over a period of time. These elements include items such as browser technologies and technical support. Consequently, Microsoft’s earned revenue reflects the recognition of the fair value of these elements over the product’s life cycle. Upon adoption of American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 98-9, Modification of SOP 97-2, With Respect to Certain Transactions, during the fourth quarter of fiscal 1999, the Company was required to change the methodology of attributing the fair value to undelivered elements. The percentages of undelivered elements in relation to the total arrangement decreased, reducing the amount of Windows and Office revenue treated as unearned, and increasing the amount of revenue recognized upon shipment. The percentage of revenue recognized ratably decreased from a range of 20% to 35% to a range of approximately 15% to 25% of Windows desktop operating systems. For desktop applications, the percentage decreased from approximately 20% to a range of approximately 10% to 20%. The ranges depend on the terms and conditions of the license and prices of the elements. In addition, in the fourth quarter of fiscal 1999, the Company extended the life cycle of Windows from two to three years based upon management’s review of product shipment cycles. Product life cycles are currently estimated at 18 months for desktop applications. The Company also sells subscriptions to certain products via maintenance and certain organizational license agreements.

At June 30, 2000 and 2001, Desktop Applications unearned revenue was $1.84 billion and $2.19 billion. Desktop Platforms unearned revenue was $2.34 billion and $2.59 billion. Enterprise Software and Services unearned revenue was $433 million and $413 million. Unearned revenue associated with Consumer Software, Services, and Devices, and Other was $200 million and $427 million at June 30, 2000 and 2001.