Locate the financial statements of Microsoft Corporation on the Internet. Search the disclosure notes for information about how Microsoft accounts for its unearned revenues. How is the undelivered portion of Microsoft's sales of Windows XP Professional recorded initially? Unearned revenue is comprised of the following items: a. Volume Licensing Programs - Represents customer billings for multi-year licensing arrangements, which are accounted for as subscriptions with revenue recognized ratably over the billing coverage period, b. Undelivered Elements - receive unspecified upgrades/enhancements of Microsoft Internet Explorer on a when-and-if-available basis and free post-delivery telephone support. This revenue deferral is applicable for Windows XP and prior versions shipped as retail packaged products, products licensed to OEMs, and perpetual licenses for current products under our Open and Select volume licensing programs, c. Other - Represents payments for post-delivery support and consulting services to be performed in the future, online advertising for which the advertisement has yet to be displayed. 2. Why does the statement of cash flows include unearned revenue as an addition to net income in the operations section? Why is recognition of unearned revenue included as a deduction from net income? Why do you think Microsoft reported these two items separately rather than just adjusting net income for the change in the unearned revenue account balance? a. The statement of cash flows include "unearned revenue" as an addition to net income in the operations section because unearned revenue is considered a liability, and depending on the unearned revenue from the prior year it will affect the value of operating activities as it will appear on their financial statement, b. The unearned revenue include as a deduction from net income because this amount will be recognized as revenue. The revenue recognition does not increase cash, but by subtracting the amount will change the net income to cash, c. The two items that Microsoft reports separately instead of adjusting their net income is change in the unearned revenue, so by tweaking the net change will produce the same net result. 3. Why is stock-based compensation added to net income? Stock-based compensation is added to net income because if they reduce the net income, it will not reduce cash. Instead, it needs to be added back into the net income. Reference: https://www.microsoft.com/investor/reports/ar09/10k_fr_not_13.html http://www.wikinvest.com/stock/Microsoft_(MSFT)/Unearned_Revenue https://www.microsoft.com/investor/reports/ar09/10k_fr_not.html My question is: You stated, " The revenue recognition does not increase cash." You are correct in stating that when revenue is recognized on previously recorded unearned revenue cash is not involved. My question is though what about when unearned revenue is initially recorded. What happens at that point, is cash affected and how should this be handled on the statement of cash flows?