How do Apple and Microsoft make money

During fiscal years 2020, 2019, and 2018, depreciation expense was $10.7 billion, $9.7 billion, and $7.7 billion, respectively. We have committed $5.0 billion for the construction of new buildings, building improvements, and leasehold improvements as of June 30, 2020.

During fiscal year 2020, we recorded an impairment charge of $186 million to Property and Equipment, primarily to leasehold improvements, due to the closing of our Microsoft Store physical locations.

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NOTE 8 — BUSINESS COMBINATIONS

GitHub, Inc.

On October 25, 2018, we acquired GitHub, Inc. (“GitHub”), a software development platform, in a $7.5 billion stock transaction (inclusive of total cash payments of $1.3 billion in respect of vested GitHub equity awards and an indemnity escrow). The acquisition is expected to empower developers to achieve more at every stage of the development lifecycle, accelerate enterprise use of GitHub, and bring Microsoft’s developer tools and services to new audiences. The financial results of GitHub have been included in our consolidated financial statements since the date of the acquisition. GitHub is reported as part of our Intelligent Cloud segment.

The allocation of the purchase price to goodwill was completed as of June 30, 2019. The major classes of assets and liabilities to which we allocated the purchase price were as follows:

(In millions) 
 
Cash, cash equivalents, and short-term investments$ 234
Goodwill5,497
Intangible assets1,267
Other assets143
Other liabilities(217 )
 
Total$   6,924
  

The goodwill recognized in connection with the acquisition is primarily attributable to anticipated synergies from future growth and is not expected to be deductible for tax purposes. We assigned the goodwill to our Intelligent Cloud segment.

Following are the details of the purchase price allocated to the intangible assets acquired:

(In millions)AmountWeightedAverage Life
  
Customer-related$ 648  8 years
Technology-based4475 years
Marketing-related17010 years
Contract-based22 years
 
Total$   1,2677 years
   

Transactions recognized separately from the purchase price allocation were approximately $600 million, primarily related to equity awards recognized as expense over the related service period.

Other

During fiscal year 2020, we completed 15 acquisitions for $2.4 billion, substantially all of which were paid in cash. These entities have been included in our consolidated results of operations since their respective acquisition dates. The effects of these business combinations, individually and in aggregate, were not material to our consolidated results of operations.

NOTE 9 — GOODWILL

Changes in the carrying amount of goodwill were as follows:

(In millions)June 30,2018AcquisitionsOtherJune 30,2019AcquisitionsOtherJune 30,
2020
 
Productivity and Business Processes$ 23,823  $ 514$ (60 )$ 24,277$ 7$ (94 )$ 24,190
Intelligent Cloud5,7035,605  (a)43  (a)11,3511,351(5 )12,697
More Personal Computing6,157289(48 )6,39896(30 )6,464
       
Total$   35,683$   6,408$   (65 )$   42,026$   1,454$   (129 )$   43,351
        

(a) Includes goodwill of $5.5 billion related to GitHub. See Note 8 – Business Combinations for further information.

The measurement periods for the valuation of assets acquired and liabilities assumed end as soon as information on the facts and circumstances that existed as of the acquisition dates becomes available, but do not exceed 12 months. Adjustments in purchase price allocations may require a change in the amounts allocated to goodwill during the periods in which the adjustments are determined.

Any change in the goodwill amounts resulting from foreign currency translations and purchase accounting adjustments are presented as “Other” in the table above. Also included in “Other” are business dispositions and transfers between segments due to reorganizations, as applicable.

Goodwill Impairment

We test goodwill for impairment annually on May 1 at the reporting unit level, primarily using a discounted cash flow methodology with a peer-based, risk-adjusted weighted average cost of capital. We believe use of a discounted cash flow approach is the most reliable indicator of the fair values of the businesses.

No instances of impairment were identified in our May 1, 2020, May 1, 2019, or May 1, 2018 tests. As of June 30, 2020 and 2019, accumulated goodwill impairment was $11.3 billion.

NOTE 10 — INTANGIBLE ASSETS

The components of intangible assets, all of which are finite-lived, were as follows:

(In millions)Gross
Carrying
Amount
Accumulated
Amortization
Net Carrying
Amount
Gross
Carrying
Amount
Accumulated
Amortization
Net Carrying
Amount
 
       
June 30,  2020  2019
       
Technology-based$ 8,160$ (6,381 )$ 1,779$ 7,691$ (5,771 )$ 1,920
Customer-related4,967(2,320 )2,6474,709(1,785 )2,924
Marketing-related4,158(1,588 )2,5704,165(1,327 )2,838
Contract-based474(432 )42574(506 )68
      
Total$    17,759$    (10,721 )$   7,038$  17,139  (a) $    (9,389 )$   7,750
       

(a) Includes intangible assets of $1.3 billion related to GitHub. See Note 8 – Business Combinations for further information.

No material impairments of intangible assets were identified during fiscal years 2020, 2019, or 2018. We estimate that we have no significant residual value related to our intangible assets.

The components of intangible assets acquired during the periods presented were as follows:

(In millions)AmountWeightedAverage LifeAmountWeightedAverage Life
 
Year Ended June 30,20202019
 
Technology-based$ 5316 years$ 8145 years
Customer-related3035 years7108 years
Marketing-related22 years17710 years
Contract-based00 years3 years
Total$   8365 years$   1,7087 years
 

Intangible assets amortization expense was $1.6 billion, $1.9 billion, and $2.2 billion for fiscal years 2020, 2019, and 2018, respectively.

The following table outlines the estimated future amortization expense related to intangible assets held as of June 30, 2020:

(In millions) 
 
  
Year Ending June 30, 
  
2021$ 1,483
20221,399
20231,219
2024851
2025447
Thereafter1,639
Total$   7,038
 

NOTE 11 — DEBT

The components of debt were as follows:

(In millions, issuance by calendar year)Maturities(calendar year)Stated InterestRateEffective InterestRateJune 30,2020June 30,2019
2009 issuance of $3.8 billion (a)20395.20%5.24%$ 559$ 750
2010 issuance of $4.8 billion (a)2020–20403.00%–4.50%3.14%–4.57%1,5712,000
2011 issuance of $2.3 billion (a)2021–20414.00%–5.30%4.08%–5.36%1,2701,500
2012 issuance of $2.3 billion2022–20422.13%–3.50%2.24%–3.57%1,6501,650
2013 issuance of $5.2 billion (a)2023–20432.38%–4.88%2.47%–4.92%2,9193,500
2013 issuance of €4.1 billion2021–20332.13%–3.13%2.23%–3.22%4,5494,613
2014 issuance018
2015 issuance of $23.8 billion (a)2020–20552.00%–4.75%2.09%–4.78%15,54922,000
2016 issuance of $19.8 billion (a)2021–20561.55%–3.95%1.64%–4.03%16,95519,750
2017 issuance of $17.0 billion (a)2022–20572.40%–4.50%2.52%–4.53%12,38517,000
2020 issuance of $10.0 billion (a)2050–20602.53%–2.68%2.53%–2.68%10,0000
  
Total face value 67,40772,781
Unamortized discount and issuance costs   (554 )(603 )
Hedge fair value adjustments (b)   930
Premium on debt exchange (a)   (3,619 )0
  
Total debt 63,32772,178
Current portion of long-term debt   (3,749 )(5,516 )
  
Long-term debt $   59,578$ 66,662
      

(a) In June 2020, we exchanged a portion of our existing debt at premium for cash and new debt with longer maturities. The premium will be amortized over the term of the new debt.

(b) Refer to Note 5 – Derivatives for further information on the interest rate swaps related to fixed-rate debt.

As of June 30, 2020 and 2019, the estimated fair value of long-term debt, including the current portion, was $77.1 billion and $78.9 billion, respectively. The estimated fair values are based on Level 2 inputs.

Debt in the table above is comprised of senior unsecured obligations and ranks equally with our other outstanding obligations. Interest is paid semi-annually, except for the Euro-denominated debt, which is paid annually.

The following table outlines maturities of our long-term debt, including the current portion, as of June 30, 2020:

(In millions) 
 
  
Year Ending June 30, 
  
2021$ 3,750
20227,966
20232,750
20245,250
20252,250
Thereafter45,441
Total$   67,407
 

NOTE 12 — INCOME TAXES

Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (“TCJA”) was enacted into law, which significantly changed existing U.S. tax law and included numerous provisions that affect our business. We recorded a provisional net charge of $13.7 billion related to the enactment of the TCJA in fiscal year 2018, and adjusted the provisional net charge by recording additional tax expense of $157 million in fiscal year 2019 pursuant to Securities and Exchange Commission Staff Accounting Bulletin No. 118.

In fiscal year 2019, in response to the TCJA and recently issued regulations, we transferred certain intangible properties held by our foreign subsidiaries to the U.S. and Ireland. The transfers of intangible properties resulted in a $2.6 billion net income tax benefit recorded in the fourth quarter of fiscal year 2019, as the value of future tax deductions exceeded the current tax liability from foreign jurisdictions and U.S. global intangible low-taxed income (“GILTI”) tax.

Provision for Income Taxes

The components of the provision for income taxes were as follows:

(In millions)
 
    
Year Ended June 30,202020192018
    
Current Taxes   
    
U.S. federal$ 3,537$ 4,718$ 19,764
U.S. state and local763662934
Foreign4,4445,5314,348
   
Current taxes$   8,744$   10,911$     25,046
    
Deferred Taxes   
    
U.S. federal$ 58$ (5,647 )$ (4,292 )
U.S. state and local(6 )(1,010 )(458 )
Foreign(41 )194(393 )
   
Deferred taxes$ 11$ (6,463 )$ (5,143 )
   
Provision for income taxes$  8,755$ 4,448$ 19,903
    

U.S. and foreign components of income before income taxes were as follows:

(In millions)
 
    
Year Ended June 30,202020192018
    
U.S.$ 24,116$ 15,799$ 11,527
Foreign28,92027,88924,947
   
Income before income taxes$  53,036$   43,688$  36,474
    

Effective Tax Rate

The items accounting for the difference between income taxes computed at the U.S. federal statutory rate and our effective rate were as follows:

    
Year Ended June 30,202020192018
 
Federal statutory rate21.0%21.0%28.1%
Effect of:
Foreign earnings taxed at lower rates(3.7)%(4.1)%(7.8)%
Impact of the enactment of the TCJA0%0.4%37.7%
Impact of intangible property transfers0%(5.9)%0%
Foreign-derived intangible income deduction(1.1)%(1.4)%0%
State income taxes, net of federal benefit1.3%0.7%1.3%
Research and development credit(1.1)%(1.1)%(1.3)%
Excess tax benefits relating to stock-based compensation(2.2)%(2.2)%(2.5)%
Interest, net1.0%1.0%1.2%
Other reconciling items, net1.3%1.8%(2.1)%
Effective rate16.5%10.2%54.6%
 

The decrease from the federal statutory rate in fiscal year 2020 is primarily due to earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland and Puerto Rico, and tax benefits relating to stock-based compensation. The decrease from the federal statutory rate in fiscal year 2019 is primarily due to a $2.6 billion net income tax benefit related to intangible property transfers, and earnings taxed at lower rates in foreign jurisdictions resulting from producing and distributing our products and services through our foreign regional operations centers in Ireland, Singapore, and Puerto Rico. The increase from the federal statutory rate in fiscal year 2018 is primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, offset in part by earnings taxed at lower rates in foreign jurisdictions. In fiscal year 2020, our foreign regional operating centers in Ireland and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 86% of our foreign income before tax. In fiscal years 2019 and 2018, our foreign regional operating centers in Ireland, Singapore, and Puerto Rico, which are taxed at rates lower than the U.S. rate, generated 82% and 87% of our foreign income before tax, respectively. Other reconciling items, net consists primarily of tax credits and GILTI tax. In fiscal years 2020, 2019, and 2018, there were no individually significant other reconciling items.

The increase in our effective tax rate for fiscal year 2020 compared to fiscal year 2019 was primarily due to a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers. The decrease in our effective tax rate for fiscal year 2019 compared to fiscal year 2018 was primarily due to the net charge related to the enactment of the TCJA in the second quarter of fiscal year 2018, and a $2.6 billion net income tax benefit in the fourth quarter of fiscal year 2019 related to intangible property transfers.

The components of the deferred income tax assets and liabilities were as follows:

(In millions)  
 
   
June 30,20202019
   
Deferred Income Tax Assets  
   
Stock-based compensation expense$ 461$ 406
Accruals, reserves, and other expenses2,7212,287
Loss and credit carryforwards8653,518
Depreciation and amortization6,3617,046
Leasing liabilities3,0251,594
Unearned revenue1,553475
Other354367
  
Deferred income tax assets15,34015,693
Less valuation allowance(755 )(3,214 )
  
Deferred income tax assets, net of valuation allowance$   14,585$   12,479
  
   
Deferred Income Tax Liabilities  
   
Book/tax basis differences in investments and debt$ (2,642 )$ (738 )
Unearned revenue0(30 )
Leasing assets(2,817 )(1,510 )
Deferred GILTI tax liabilities(2,581 )(2,607 )
Other(344 )(291 )
  
Deferred income tax liabilities$ (8,384 )$ (5,176 )
  
Net deferred income tax assets$ 6,201$ 7,303
   
   
Reported As  
   
Other long-term assets$ 6,405$ 7,536
Long-term deferred income tax liabilities(204 )(233 )
  
Net deferred income tax assets$ 6,201$ 7,303
   

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when the taxes are paid or recovered.

As of June 30, 2020, we had federal, state, and foreign net operating loss carryforwards of $547 million, $975 million, and $2.0 billion, respectively. The federal and state net operating loss carryforwards will expire in various years from fiscal 2021 through 2040, if not utilized. The majority of our foreign net operating loss carryforwards do not expire. Certain acquired net operating loss carryforwards are subject to an annual limitation, but are expected to be realized with the exception of those which have a valuation allowance.

The valuation allowance disclosed in the table above relates to the foreign net operating loss carryforwards and other net deferred tax assets that may not be realized. In fiscal year 2020, we removed $2.0 billion of foreign net operating losses and corresponding valuation allowances as a result of the liquidation of a foreign subsidiary. There was no impact to our consolidated financial statements.

Income taxes paid, net of refunds, were $12.5 billion, $8.4 billion, and $5.5 billion in fiscal years 2020, 2019, and 2018, respectively.

Uncertain Tax Positions

Gross unrecognized tax benefits related to uncertain tax positions as of June 30, 2020, 2019, and 2018, were $13.8 billion, $13.1 billion, and $12.0 billion, respectively, which were primarily included in long-term income taxes in

our consolidated balance sheets. If recognized, the resulting tax benefit would affect our effective tax rates for fiscal years 2020, 2019, and 2018 by $12.1 billion, $12.0 billion, and $11.3 billion, respectively.

As of June 30, 2020, 2019, and 2018, we had accrued interest expense related to uncertain tax positions of $4.0 billion, $3.4 billion, and $3.0 billion, respectively, net of income tax benefits. The provision for income taxes for fiscal years 2020, 2019, and 2018 included interest expense related to uncertain tax positions of $579 million, $515 million, and $688 million, respectively, net of income tax benefits.

The aggregate changes in the gross unrecognized tax benefits related to uncertain tax positions were as follows:

(In millions)   
 
    
Year Ended June 30,202020192018
    
Beginning unrecognized tax benefits$ 13,146$ 11,961$ 11,737
Decreases related to settlements(31 )(316 )(193 )
Increases for tax positions related to the current year6472,1061,445
Increases for tax positions related to prior years366508151
Decreases for tax positions related to prior years(331 )(1,113 )(1,176 )
Decreases due to lapsed statutes of limitations(5 )0(3 )
   
Ending unrecognized tax benefits$   13,792$   13,146$   11,961
    

We settled a portion of the Internal Revenue Service (“IRS”) audit for tax years 2004 to 2006 in fiscal year 2011. In February 2012, the IRS withdrew its 2011 Revenue Agents Report related to unresolved issues for tax years 2004 to 2006 and reopened the audit phase of the examination. We also settled a portion of the IRS audit for tax years 2007 to 2009 in fiscal year 2016, and a portion of the IRS audit for tax years 2010 to 2013 in fiscal year 2018. We remain under audit for tax years 2004 to 2013. In April 2020, the IRS commenced the audit for tax years 2014 to 2017.

As of June 30, 2020, the primary unresolved issues for the IRS audits relate to transfer pricing, which could have a material impact in our consolidated financial statements when the matters are resolved. We believe our allowances for income tax contingencies are adequate. We have not received a proposed assessment for the unresolved issues and do not expect a final resolution of these issues in the next 12 months. Based on the information currently available, we do not anticipate a significant increase or decrease to our tax contingencies for these issues within the next 12 months.

We are subject to income tax in many jurisdictions outside the U.S. Our operations in certain jurisdictions remain subject to examination for tax years 1996 to 2019, some of which are currently under audit by local tax authorities. The resolution of each of these audits is not expected to be material to our consolidated financial statements.

NOTE 13 — UNEARNED REVENUE

Unearned revenue by segment was as follows:

(In millions)  
 
   
June 30,20202019
   
Productivity and Business Processes$ 18,643$ 16,831
Intelligent Cloud16,62016,988
More Personal Computing3,9173,387
  
Total$   39,180$  37,206
   

Changes in unearned revenue were as follows:

(In millions) 
 
  
Year Ended June 30, 2020 
  
Balance, beginning of period$ 37,206
Deferral of revenue78,922
Recognition of unearned revenue(76,948 )
 
Balance, end of period$   39,180
  

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