Microsoft develops, manufactures, licenses, sells, and supports a wide range of software products, including operating systems for personal computers (PCs) and servers; server applications for client/server environments; business and consumer productivity applications; software development tools; and Internet and intranet software and technologies. The company has expanded its interactive content efforts, including MSN (the Microsoft Network online service), am. various Internet-based services, and entertainment and information software programs.

Microsoft also sells PC books and input devices, and it researches and develops advanced technologies for future software products.
The following excerpt is from an article that appeared in The Wall Street Journal.

MICROSOFT’S EARNINGS GROWTH SLOWED INTHE LATEST QUARTER Microsoft Corp:s growth juggernaut slowed in its fiscal fourth quarter, but the numbers masked a surprisingly potent performance by the software giant.
The Redmond, Wash., company’s earnings barely topped Wall Street's consensus, breaking a pattern of dramatic upside surprises for the company. But the company’s profit would have been considerably higher had it not salted away revenue in a special reserve account for use in future quarters. That account, dubbed “unearned revenues,’ continued to swell and underscore the returns Microsoft is reaping as a near-monopoly supplier of personal computer operating-software and key application programs.

The account represents revenues Microsoft has collected but hadn't yet reported. It was established because the company faces future costs to deliver up-grades and customer support for products that already have been paid for. The policy helps smooth out sharp swings in the company’s quarterly results.
Microsoft reported net income of \($1.06\) billion, or 80 cents a share, for the quarter ended June 30, an increase of 89% from \($559\) million, or 43 cents a share, a year earlier. Analysts had expected per-share earnings of about 79 cents, according to First Call Corp. Quarterly revenue was \($3.18\) billion, up 41%
from \($2.26\) billion a year earlier.

Other Information:
1. Appearing in the accompanying tables are the comparative income statements for the fourth quarters of fiscal 1996 and 1997 and for the fiscal years 1996 and 1997. Also shown are comparative balance sheets for fiscal 1996 and 1997.
2. The balance in the unearned revenues account on March 31, 1997 (the end of the third fiscal quarter of 1997) was \($1,285\) million.

3. The following description of Microsoft's unearned revenues account is taken from the company’s SEC filings:
The portion of the Company’s revenues that are earned later than billed is reflected in the unearned revenues account. Of the March 31, 1997 balance of \($1,285\) million, approximately \($765\) million represented the unearned portion of Windows desktop operating systems revenues and \($150\) million represented the unearned portion of Office 97 revenues. Unearned revenues associated with upgrade rights for Microsoft Office 97 were \($190\) million, and the balance of unearned revenues was primarily attributable to maintenance and other subscription contracts.

Required:
1. Calculate Microsoft's net profit margin for the fourth quarter of 1996 and 1997 and for the fiscal years 1996 and 1997. Comment on the results.
2. Calculate Microsoft’s working capital and current ratio. Comment on the results.
3. Did Microsoft fall short of, meet, or exceed analysts’ expectations for fourth-quarter [907 -EPS4. If no reductions were made from the Unearned revenues account during the fourth quarter of fiscal 1997, how much did Microsoft add to the account during that quarter?
5. Continuing requirement 4, how much higher or lower would Microsoft's fourth-quarter income before tax have been (on a per share basis) if this accrual adjustment had not been made?
6. Assume that Microsoft reduced its Unearned revenues account by \($188.0\) million during the first three quarters of fiscal 1997. How much did Microsoft add to the account during the fiscal year?
7. Continuing requirement 6, how much higher or lower would Microsoft’s annual income before tax have been (on a per share basis) if this accrual adjustment had not been made?
8. How much income before tax (on a per share basis) does Microsoft have “stored” in the Unearned revenues account at the end of 1997?
9. How can the Unearned revenues account be used to manage EPS?
10. How can analysts monitor the extent to which the Unearned revenues account is being used to manage EPS?
11. Does the existence of the Unearned revenues account necessarily mean that Microsoft intends to manage its reported earnings? Explain.

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Microsoft Corporation Income Statements ($ in millions, except Three Months Ended Years Ended June 30 June 30 earnings per share) 1996 1997 1996 1997 Net revenues $2,255 $3,175 $8,671 $11,358 Cost of revenues 241 242 1,188 1,085 Research and development 453 516 1,432 1,925 Sales and marketing 661 744 2,657 2,856 General and administrative 90 94 316 362 Total operating expenses 1,445 1,596 5,593 6,228 Operating income 810 1,579 3,078 5,130 Interest income 92 127 320 443 Other expenses (42) (80) (19) (259) Income before income taxes 860 1,626 3,379 5,314 Provision for income taxes 301 569 1,184 1,860 Net income $ 559 $1,057 Preferred stock dividends -0- Net income available for common shareholders $ 559 $1,050 Earnings per share $ 0.43 $ 0.80 Average shares outstanding 1,290 1,327 $2,195 -0- $2,195 $ 1.71 1,281 $ 3,454 $ 3,439 $ 2.63 15 1,312