In 2015 Microsoft Corporation
In 2015 Microsoft Corporation reported a $5.1 billion charge forthe impairment of goodwill and a $2.2 billion charge for theimpairment of intangible assets in one of its reporting units(segments) in its 10-K annual report. Referring to Microsoft’s 2015financial statements and any other information from the media,address the following:
1. Microsoft’s segments serve as its reporting units forassessing goodwill for potential impairments. Which segmentsuffered a 2015 impairment? Describe the revenue model for thissegment.
2. What were the underlying business reasons that requiredMicrosoft to record a goodwill impairment in 2015?
3. How did Microsoft reflect the 2015 goodwill impairment in itsincome statement and cash flow?
4. Describe in your own words the goodwill impairment testingsteps performed by Microsoft in 2015 and the consequent lossmeasurement.
Answer:
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| Microsoft Corporation |
| Hi I havetaken the relevant data from Sec.gov website. |
| 1. Microsoft’s segments serve as its reporting units forassessing goodwill for potential impairments. Which segmentsuffered a 2015 impairment? Describe the revenue model for thissegment. |
| Phone Hardware segment suffered a 2015impairment. |
| GoodwillImpairment |
| Wetest goodwill for impairment annually on May 1 at the reportingunit level, primarily using a discounted cash flow methodology witha peer-based, risk-adjusted weighted average cost of capital. Webelieve use of a discounted cash flow approach is the most reliableindicator of the fair values of the businesses. |
| Uponcompletion of the annual testing as of May 1, 2015, Phone Hardwaregoodwill was determined to be impaired. In the second half offiscal year 2015, Phone Hardware did not meet its sales volume andrevenue goals, and the mix of units sold had lower margins thanplanned. These results, along with changes in the competitivemarketplace and an evaluation of business priorities, led to ashift in strategic direction and reduced future revenue andprofitability expectations for the business. As a result of thesechanges in strategy and expectations, we have forecasted reductionsin unit volume growth rates and lower future cash flows used toestimate the fair value of the Phone Hardware reporting unit, whichresulted in the determination that an impairment adjustment wasrequired. |
| Because our annual test indicated that Phone Hardware’s carryingvalue exceeded its estimated fair value, a second phase of thegoodwill impairment test (“Step 2”) was performed specific to PhoneHardware. Under Step 2, the fair value of all Phone Hardware assetsand liabilities were estimated, including tangible assets, existingtechnology, patent agreements, and contractual arrangements, forthe purpose of deriving an estimate of the implied fair value ofgoodwill. The implied fair value of the goodwill was then comparedto the recorded goodwill to determine the amount of the impairment.Assumptions used in measuring the value of these assets andliabilities included the discount rates and royalty rates used invaluing the intangible assets, and consideration of the marketenvironment in valuing the tangible assets |
| The revenue model for Phone Hardware |
| Revenue increased $6.7 billion or 8%, reflecting a full year ofPhone Hardware sales and growth in revenue from our CommercialCloud, Surface, server products, search advertising, and Xbox Livetransactions. These increases were offset in part by a decline inrevenue from Office Commercial, Windows OEM, licensing of WindowsPhone operating system, and Office Consumer. Revenue included anunfavorable foreign currency impact of approximately 2%. |
| Grossmargin increased $787 million or 1%, primarily due to higherrevenue, offset in part by a $6.0 billion or 22% increase in costof revenue. Cost of revenue increased, mainly due to PhoneHardware, as well as increasing costs in support of our CommercialCloud, including $396 million of higher datacenter expenses. Grossmargin, as a percentage of revenue, improved year over year in eachof our reportable segments. |
| 2. What were the underlying business reasons that requiredMicrosoft to record a goodwill impairment in 2015? |
| PhoneHardware did not meet its sales volume and revenue goals, and themix of units sold had lower margins than planned. These results,along with changes in the competitive marketplace and an evaluationof business priorities, led to a shift in strategic direction andreduced future revenue and profitability expectations for thebusiness. As a result of these changes in strategy andexpectations, we have forecasted reductions in unit volume growthrates and lower future cash flows used to estimate the fair valueof the Phone Hardware reporting unit, which resulted in thedetermination that an impairment adjustment was required. |
| 3. How did Microsoft reflect the 2015 goodwill impairmentin its income statement and cash flow? |
| Animpairment charge is recorded to other income (expense), net and anew cost basis in the investment is established. |
| Impairment charge is deducted from Gross Margin in the incomestatement. |
| Impairment charge is a non cash expense so it is added back to netincome for calculating Net cash from operations. |
| 4. Describe in your own words the goodwill impairmenttesting steps performed by Microsoft in 2015 and the consequentloss measurement. |
| Application of the goodwill impairment test requires judgment,including the identification of reporting units, assignment ofassets and liabilities to reporting units, assignment of goodwillto reporting units, and determination of the fair value of eachreporting unit. The fair value of each reporting unit is estimatedprimarily through the use of a discounted cash flow methodology.This analysis requires significant judgments, including estimationof future cash flows, which is dependent on internal forecasts,estimation of the long-term rate of growth for our business,estimation of the useful life over which cash flows will occur, anddetermination of our weighted average cost of capital. |
| Theestimates used to calculate the fair value of a reporting unitchange from year to year based on operating results, marketconditions, and other factors. Changes in these estimates andassumptions could materially affect the determination of fair valueand goodwill impairment for each reporting unit. |
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