Financial Accounting News

Microsoft Financials Offer First Glimpse of Expanded Audit Report

Aug. 5, 2019, 8:50 PM

Microsoft was among the first batch of public companies to include a newly required extended audit report in its annual financial statement.

But if the extended report from its auditors at Deloitte LLP is a hint of things to come, investors may find limited new insights to dissect.

Microsoft’s annual financial statement filed Aug. 1 highlighted two critical audit matters, or CAMs—revenue recognition and income taxes.

The auditors for Open Text Corp. detailed similar CAMs in its Aug. 1 annual report.

That didn’t surprise Heidi Bartholomew, a professor at the Katz Graduate School of Business at the University of Pittsburgh.

Investors should expect revenue recognition to be a CAM for any tech or software company. Likewise, income taxes will likely result in a CAM for multinational companies because of the risk and because of how much money could be at stake. Both are subsets of critical accounting policies and they are likely to be the most commonly cited CAMs, Bartholomew said.

Despite the unlikelihood of major surprises, the disclosures gives investors a glimpse into the nature of the conversation between auditors and audit committees, she said.

They also give investors an idea of which areas of the financial statement are less certain and the steps the auditors take to feel comfortable with management’s figures and decisions, said Don Whalen, director of research at Audit Analytics.

“I found it interesting how much effort is placed on trying to time when revenue should be recognized,” Whalen said. “It shows you the complexity of the business.”

Auditor Judgment

Microsoft increasingly provides its software through a cloud-based subscription, often bundled with a service component. Each is considered a separate obligation with different timing for the revenue and related expenses under new accounting rules that took effect in 2018.

Deloitte auditors highlighted four aspects of the software company’s revenue recognition that required significant judgment. “The related audit effort in evaluating management’s judgments in determining revenue recognition for these customer agreements was extensive,” their report said

Calculating income taxes also involves uncertainty and judgment and is also a common reason for corporate restatements, Bartholomew said.

The 2017 tax law added fresh complexity to income taxes as companies began to reevaluate how they calculate their tax position and began to bring income back to the U.S. to take advantage of a lower corporate tax rate, she said.

The Microsoft report also highlights unresolved tax disputes with the IRS. The largest U.S. companies commonly have open audits with the IRS or foreign tax jurisdictions, which can drag on for years.

Microsoft’s unresolved IRS audits add to the uncertainties described in the company’s critical accounting policies. But it’s unclear whether the IRS audit was the tipping point for Deloitte to include income taxes as a CAM, Whalen said.

He’ll be watching to see if U.S. audit firms develop their own distinct style and approach to CAMs as more companies release their annual reports.

Annual financial statements released on or after June 30 for large accelerated filers will include the more detailed audit report. The Public Company Accounting Oversight Board required the new auditor communication to provide investors with more information about the financial health of a company. It builds on the existing pass-fail model.

To contact the reporter on this story: Amanda Iacone in Washington at aiacone@bloombergtax.com

To contact the editors responsible for this story: Jeff Harrington at jharrington@bloombergtax.com; Steven Marcy at smarcy@bloombergtax.com

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