CEOs often write letters to the shareholders each year. In Bill Gatess letter accompanying the 1998 annual

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Question:

CEOs often write letters to the shareholders each year. In Bill Gates’s letter accompanying the 1998 annual report, he noted: Our product goals require breakthrough innovation. During fiscal 1999 Microsoft will invest more than $3 billion in research and development, broadly defined.

1. Referring back to what you have learned about “capitalized software”, assume that one-third of the above $3 billion were expenditures made after reaching “technological feasibility.” In this case, what would the journal entries relating to these expenditures (all $3 billion) look like for 1999?

2. Assume that the capitalized software from the prior question begins to be sold in 2000. Microsoft expects to sell the software over the next three years, with expected revenues as follows:

2000: 1 billion

2001: 750 million

2002: 250 million

What journal entry (if any) would Microsoft make in 2000 related to the capitalized software (if sales were 1 billion as planned).

3. Now consider what might happen if the top management strongly felt the R&D from 1999 did not meet the threshold of “technological feasibility.” How would your journal entries from #1 and #2 change?

4. If $1 billion of the expenditures in 1999 are treated as capitalized software (versus immediately expensed), how would this choice impact the following:(lower/same/higher)

1999 Assets 1999 Revenue 1999 Net Income 1999 Retained Earnings

2000 Assets 2000 Revenue 2000 Net Income 2000 Retained Earnings

2001 Assets 2001 Revenue 2001 Net Income 2001 Retained Earnings

2002 Assets 2002 Revenue 2002 Net Income 2002 Retained Earnings

5. Assume Microsoft also sells Computers that come with a one-year warranty. Assume that Microsoft sold 100 computers that cost $500 each to produce for $2,000 each (in cash). Historically 5% of computers come back under the warranty (assume broken machines are swapped out for new computers).

A. What is your best estimate of the journal entry at the time of sale?

B. It is now 9 months later, and one computer comes back under the

If capitalized (as compared to expensed)

C. Would Microsoft have the incentive to overstate or understate the expected warranties on any computers sold in 1999? Would this be considered “conservative” or “aggressive”?