How do Apple and Microsoft make money

Revenue allocated to remaining performance obligations, which includes unearned revenue and amounts that will be invoiced and recognized as revenue in future periods, was $111 billion as of June 30, 2020, of which $107 billion is related to the commercial portion of revenue. We expect to recognize approximately 50% of this revenue over the next 12 months and the remainder thereafter.

NOTE 14 — LEASES

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We have operating and finance leases for datacenters, corporate offices, research and development facilities, retail stores, and certain equipment. Our leases have remaining lease terms of 1 year to 20 years, some of which include options to extend the leases for up to 5 years, and some of which include options to terminate the leases within 1 year.

The components of lease expense were as follows:

(In millions) 
 
    
Year Ended June 30,202020192018
    
Operating lease cost$   2,043$   1,707$   1,585
    
Finance lease cost:   
Amortization of right-of-use assets$ 611$ 370$ 243
Interest on lease liabilities336247175
   
Total finance lease cost$ 947$ 617$ 418
    

Supplemental cash flow information related to leases was as follows:

(In millions) 
 
    
Year Ended June 30,202020192018
    
Cash paid for amounts included in the measurement of lease liabilities:   
Operating cash flows from operating leases$  1,829$   1,670$   1,522
Operating cash flows from finance leases336247175
Financing cash flows from finance leases409221144
    
Right-of-use assets obtained in exchange for lease obligations:   
Operating leases3,6772,3031,571
Finance leases3,4672,5321,933
 

Supplemental balance sheet information related to leases was as follows:

(In millions, except lease term and discount rate)  
 
   
June 30,20202019
   
Operating Leases  
   
Operating lease right-of-use assets$    8,753$    7,379
   
Other current liabilities$ 1,616$ 1,515
Operating lease liabilities7,6716,188
  
Total operating lease liabilities$ 9,287$ 7,703
   
   
Finance Leases  
   
Property and equipment, at cost$ 10,371$ 7,041
Accumulated depreciation(1,385 )(774 )
  
Property and equipment, net$ 8,986$ 6,267
   
Other current liabilities$ 540$ 317
Other long-term liabilities8,9566,257
  
Total finance lease liabilities$ 9,496$ 6,574
   
   
Weighted Average Remaining Lease Term  
   
Operating leases8 years7 years
Finance leases13 years13 years
   
Weighted Average Discount Rate  
   
Operating leases2.7%3.0%
Finance leases3.9%4.6%
 

Maturities of lease liabilities were as follows:

(In millions)  
 
   
Year Ending June 30,Operating
Leases
Finance
Leases
   
2021$ 1,807$ 880
20221,652894
20231,474903
20241,262916
20251,0001,236
Thereafter3,1227,194
  
Total lease payments10,31712,023
Less imputed interest(1,030 )(2,527 )
  
Total$    9,287$    9,496
   

As of June 30, 2020, we have additional operating and finance leases, primarily for datacenters, that have not yet commenced of $3.4 billion and $3.5 billion, respectively. These operating and finance leases will commence between fiscal year 2021 and fiscal year 2023 with lease terms of 1 year to 16 years.

During fiscal year 2020, we recorded an impairment charge of $161 million to operating lease right-of-use assets due to the closing of our Microsoft Store physical locations.

NOTE 15 — CONTINGENCIES

Patent and Intellectual Property Claims

There were 64 patent infringement cases pending against Microsoft as of June 30, 2020, none of which are material individually or in aggregate.

Antitrust, Unfair Competition, and Overcharge Class Actions

Antitrust and unfair competition class action lawsuits were filed against us in British Columbia, Ontario, and Quebec, Canada. All three have been certified on behalf of Canadian indirect purchasers who acquired licenses for Microsoft operating system software and/or productivity application software between 1998 and 2010.

The trial of the British Columbia action commenced in May 2016. Following a mediation, the parties agreed to a global settlement of all three Canadian actions, and submitted the proposed settlement agreement to the courts in all three jurisdictions for approval. The final settlement has been approved by the courts in British Columbia, Ontario, and Quebec, and the claims administration process will commence once each court approves the form of notice to the class.

Other Antitrust Litigation and Claims

China State Administration for Industry and Commerce Investigation

In 2014, Microsoft was informed that China’s State Agency for Market Regulation (“SAMR”) (formerly State Administration for Industry and Commerce) had begun a formal investigation relating to China’s Anti-Monopoly Law, and the SAMR conducted onsite inspections of Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. The SAMR has presented its preliminary views as to certain possible violations of China’s Anti-Monopoly Law, and discussions are expected to continue.

Product-Related Litigation

U.S. Cell Phone Litigation

Microsoft Mobile Oy, a subsidiary of Microsoft, along with other handset manufacturers and network operators, is a defendant in 40 lawsuits filed in the Superior Court for the District of Columbia by individual plaintiffs who allege that radio emissions from cellular handsets caused their brain tumors and other adverse health effects. We assumed responsibility for these claims in our agreement to acquire Nokia’s Devices and Services business and have been substituted for the Nokia defendants. Nine of these cases were filed in 2002 and are consolidated for certain pre-trial proceedings; the remaining cases are stayed. In a separate 2009 decision, the Court of Appeals for the District of Columbia held that adverse health effect claims arising from the use of cellular handsets that operate within the U.S. Federal Communications Commission radio frequency emission guidelines (“FCC Guidelines”) are pre-empted by federal law. The plaintiffs allege that their handsets either operated outside the FCC Guidelines or were manufactured before the FCC Guidelines went into effect. The lawsuits also allege an industry-wide conspiracy to manipulate the science and testing around emission guidelines.

In 2013, the defendants in the consolidated cases moved to exclude the plaintiffs’ expert evidence of general causation on the basis of flawed scientific methodologies. In 2014, the trial court granted in part and denied in part the defendants’ motion to exclude the plaintiffs’ general causation experts. The defendants filed an interlocutory appeal to the District of Columbia Court of Appeals challenging the standard for evaluating expert scientific evidence. In October 2016, the Court of Appeals issued its decision adopting the standard advocated by the defendants and remanding the cases to the trial court for further proceedings under that standard. The plaintiffs have filed supplemental expert evidence, portions of which the defendants have moved to strike. In August 2018, the trial court issued an order striking portions of the plaintiffs’ expert reports. A hearing is expected to occur in the second quarter of fiscal year 2021.

Other Contingencies

We also are subject to a variety of other claims and suits that arise from time to time in the ordinary course of our business. Although management currently believes that resolving claims against us, individually or in aggregate, will not have a material adverse impact in our consolidated financial statements, these matters are subject to inherent uncertainties and management’s view of these matters may change in the future.

As of June 30, 2020, we accrued aggregate legal liabilities of $306 million. While we intend to defend these matters vigorously, adverse outcomes that we estimate could reach approximately $500 million in aggregate beyond recorded amounts are reasonably possible. Were unfavorable final outcomes to occur, there exists the possibility of a material adverse impact in our consolidated financial statements for the period in which the effects become reasonably estimable.

NOTE 16 — STOCKHOLDERS’ EQUITY

Shares Outstanding

Shares of common stock outstanding were as follows:

(In millions)   
 
    
Year Ended June 30,202020192018
    
Balance, beginning of year7,6437,6777,708
Issued5411668
Repurchased(126 )(150 )(99 )
   
Balance, end of year7,5717,6437,677
    

Share Repurchases

On September 20, 2016, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in December 2016 and was completed in February 2020.

On September 18, 2019, our Board of Directors approved a share repurchase program authorizing up to $40.0 billion in share repurchases. This share repurchase program commenced in February 2020, following completion of the program approved on September 20, 2016, has no expiration date, and may be terminated at any time. As of June 30, 2020, $31.7 billion remained of this $40.0 billion share repurchase program.

We repurchased the following shares of common stock under the share repurchase programs:

(In millions)SharesAmountSharesAmountSharesAmount
 
    
Year Ended June 30,202020192018
       
First Quarter29$ 4,00024$ 2,60022$ 1,600
Second Quarter324,600576,100221,800
Third Quarter376,000363,899343,100
Fourth Quarter285,088334,200212,100
      
Total126$   19,688150$   16,79999$   8,600
       

Shares repurchased during the fourth quarter of fiscal year 2020 were under the share repurchase program approved on September 18, 2019. Shares repurchased during the third quarter of fiscal year 2020 were under the share repurchase programs approved on both September 20, 2016 and September 18, 2019. All other shares repurchased were under the share repurchase program approved on September 20, 2016. The above table excludes shares repurchased to settle employee tax withholding related to the vesting of stock awards of $3.3 billion, $2.7 billion, and $2.1 billion for fiscal years 2020, 2019, and 2018, respectively. All share repurchases were made using cash resources.

Dividends

Our Board of Directors declared the following dividends:

Declaration Date Record DatePayment DateDividendPer ShareAmount
 
      
Fiscal Year 2020    (In millions)
      
September 18, 2019 November 21, 2019December 12, 2019$ 0.51$ 3,886
December 4, 2019 February 20, 2020March 12, 20200.513,876
March 9, 2020 May 21, 2020June 11, 20200.513,865
June 17, 2020 August 20, 2020September 10, 20200.513,861
  
Total   $   2.04$   15,488
      
      
Fiscal Year 2019     
      
September 18, 2018 November 15, 2018December 13, 2018$ 0.46$ 3,544
November 28, 2018 February 21, 2019March 14, 20190.463,526
March 11, 2019 May 16, 2019June 13, 20190.463,521
June 12, 2019 August 15, 2019September 12, 20190.463,510
 
Total   $ 1.84$ 14,101
      

The dividend declared on June 17, 2020 was included in other current liabilities as of June 30, 2020.

NOTE 17 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

The following table summarizes the changes in accumulated other comprehensive income (loss) by component:

(In millions) 
 
    
Year Ended June 30,202020192018
    
Derivatives   
    
Balance, beginning of period$ 0$ 173$ 134
Unrealized gains (losses), net of tax of $(10), $2, and $11(38 )160218
Reclassification adjustments for gains included in revenue0(341 )(185 )
Tax expense included in provision for income taxes086
   
Amounts reclassified from accumulated other comprehensive income (loss)0(333 )(179 )
   
Net change related to derivatives, net of tax of $(10), $(6), and $5(38 )(173 )39
   
Balance, end of period$ (38 )$ 0$ 173
   
    
Investments   
    
Balance, beginning of period$ 1,488$ (850 )$ 1,825
Unrealized gains (losses), net of tax of $1,057, $616, and $(427)3,9872,331(1,146 )
Reclassification adjustments for (gains) losses included in other income (expense), net493(2,309 )
Tax expense (benefit) included in provision for income taxes(1 )(19 )738
   
Amounts reclassified from accumulated other comprehensive income (loss)374(1,571 )
   
Net change related to investments, net of tax of $1,058, $635, and $(1,165)3,9902,405(2,717 )
Cumulative effect of accounting changes0(67 )42
   
Balance, end of period$ 5,478$ 1,488$ (850 )
   
    
Translation Adjustments and Other   
    
Balance, beginning of period$ (1,828 )$ (1,510 )$ (1,332 )
Translation adjustments and other, net of tax effects of $1, $(1), and $0(426 )(318 )(178 )
   
Balance, end of period$   (2,254 )$   (1,828 )$ (1,510 )
   
Accumulated other comprehensive income (loss), end of period$ 3,186$ (340 )$ (2,187 )
    

NOTE 18 — EMPLOYEE STOCK AND SAVINGS PLANS

We grant stock-based compensation to employees and directors. As of June 30, 2020, an aggregate of 283 million shares were authorized for future grant under our stock plans. Awards that expire or are canceled without delivery of shares generally become available for issuance under the plans. We issue new shares of Microsoft common stock to satisfy vesting of awards granted under our stock plans. We also have an ESPP for all eligible employees.

Stock-based compensation expense and related income tax benefits were as follows:

(In millions)   
 
    
Year Ended June 30,202020192018
    
Stock-based compensation expense$ 5,289$   4,652$   3,940
Income tax benefits related to stock-based compensation938816823
 

Stock Plans

Stock awards entitle the holder to receive shares of Microsoft common stock as the award vests. Stock awards generally vest over a service period of four years or five years.

Executive Incentive Plan

Under the Executive Incentive Plan, the Compensation Committee approves stock awards to executive officers and certain senior executives. RSUs generally vest ratably over a service period of four years. PSUs generally vest over a performance period of three years. The number of shares the PSU holder receives is based on the extent to which the corresponding performance goals have been achieved.

Activity for All Stock Plans

The fair value of stock awards was estimated on the date of grant using the following assumptions:

    
Year ended June 30,202020192018
    
Dividends per share (quarterly amounts)$   0.46 – 0.51$   0.42 – 0.46$   0.39 – 0.42
Interest rates0.1% – 2.2%1.8% – 3.1%1.7% – 2.9%
 

During fiscal year 2020, the following activity occurred under our stock plans:

SharesWeightedAverageGrant-DateFair Value
 
(In millions) 
 
Stock Awards
   
Nonvested balance, beginning of year147$ 78.49  
Granted (a)53  140.49
Vested(65 )75.35
Forfeited(9 )90.30
  
Nonvested balance, end of year126$ 105.23
   

(a) Includes 2 million, 2 million, and 3 million of PSUs granted at target and performance adjustments above target levels for fiscal years 2020, 2019, and 2018, respectively.

As of June 30, 2020, there was approximately $10.2 billion of total unrecognized compensation costs related to stock awards. These costs are expected to be recognized over a weighted average period of three years. The weighted average grant-date fair value of stock awards granted was $140.49, $107.02, and $75.88 for fiscal years 2020, 2019, and 2018, respectively. The fair value of stock awards vested was $10.1 billion, $8.7 billion, and $6.6 billion, for fiscal years 2020, 2019, and 2018, respectively.

Employee Stock Purchase Plan

We have an ESPP for all eligible employees. Shares of our common stock may be purchased by employees at three-month intervals at 90% of the fair market value on the last trading day of each three-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period. Employees purchased the following shares during the periods presented:

(Shares in millions)   
 
    
Year Ended June 30,202020192018
    
Shares purchased91113
Average price per share$   142.22$   104.85$   76.40
 

As of June 30, 2020, 96 million shares of our common stock were reserved for future issuance through the ESPP.

Savings Plan

We have savings plans in the U.S. that qualify under Section 401(k) of the Internal Revenue Code, and a number of savings plans in international locations. Eligible U.S. employees may contribute a portion of their salary into the savings plans, subject to certain limitations. We contribute fifty cents for each dollar a participant contributes into the plans, with a maximum employer contribution of 50% of the IRS contribution limit for the calendar year. Employer-funded retirement benefits for all plans were $1.0 billion, $877 million, and $807 million in fiscal years 2020, 2019, and 2018, respectively, and were expensed as contributed.

NOTE 19 — SEGMENT INFORMATION AND GEOGRAPHIC DATA

In its operation of the business, management, including our chief operating decision maker, who is also our Chief Executive Officer, reviews certain financial information, including segmented internal profit and loss statements prepared on a basis not consistent with GAAP. During the periods presented, we reported our financial performance based on the following segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.

Our reportable segments are described below.

Productivity and Business Processes

Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

• Office Commercial, including Office 365 subscriptions, the Office portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (“CALs”).

• Office Consumer, including Microsoft 365 Consumer (formerly Office 365 Consumer) subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive.

• LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions.

• Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.

Intelligent Cloud

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises:

• Server products and cloud services, including Azure; SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub.

• Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

More Personal Computing

Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises:

• Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things; and MSN advertising.

• Devices, including Surface and PC accessories.

• Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, subscriptions, cloud services, and advertising), video games, and third-party video game royalties.

• Search.

Revenue and costs are generally directly attributed to our segments. However, due to the integrated structure of our business, certain revenue recognized and costs incurred by one segment may benefit other segments. Revenue from certain contracts is allocated among the segments based on the relative value of the underlying products and services, which can include allocation based on actual prices charged, prices when sold separately, or estimated costs plus a profit margin. Cost of revenue is allocated in certain cases based on a relative revenue methodology. Operating expenses that are allocated primarily include those relating to marketing of products and services from which multiple segments benefit and are generally allocated based on relative gross margin.

In addition, certain costs incurred at a corporate level that are identifiable and that benefit our segments are allocated to them. These allocated costs include costs of: legal, including settlements and fines; information technology; human resources; finance; excise taxes; field selling; shared facilities services; and customer service and support. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. Certain corporate-level activity is not allocated to our segments.

Segment revenue and operating income were as follows during the periods presented:

(In millions)   
 
    
Year Ended June 30,202020192018
    
Revenue   
    
Productivity and Business Processes$ 46,398$ 41,160$ 35,865
Intelligent Cloud48,36638,98532,219
More Personal Computing48,25145,69842,276
   
Total$   143,015$     125,843$     110,360
    
    
Operating Income   
    
Productivity and Business Processes$ 18,724$ 16,219$ 12,924
Intelligent Cloud18,32413,92011,524
More Personal Computing15,91112,82010,610
   
Total$ 52,959$ 42,959$ 35,058
    

No sales to an individual customer or country other than the United States accounted for more than 10% of revenue for fiscal years 2020, 2019, or 2018. Revenue, classified by the major geographic areas in which our customers were located, was as follows:

(In millions)   
 
    
Year Ended June 30,202020192018
    
United States (a)$ 73,160$ 64,199$ 55,926
Other countries69,85561,64454,434
   
Total$   143,015$     125,843$     110,360
    

(a) Includes billings to OEMs and certain multinational organizations because of the nature of these businesses and the impracticability of determining the geographic source of the revenue.

Revenue from external customers, classified by significant product and service offerings, was as follows:

(In millions)   
 
    
Year Ended June 30,202020192018
    
Server products and cloud services$ 41,379$ 32,622$ 26,129
Office products and cloud services35,31631,76928,316
Windows22,29420,39519,518
Gaming11,57511,38610,353
LinkedIn8,0776,7545,259
Search advertising7,7407,6287,012
Devices6,4576,0955,134
Enterprise Services6,4096,1245,846
Other3,7683,0702,793
   
Total$   143,015$   125,843$     110,360
    

Our commercial cloud revenue, which includes Office 365 Commercial, Azure, the commercial portion of LinkedIn, Dynamics 365, and other commercial cloud properties, was $51.7 billion, $38.1 billion and $26.6 billion in fiscal years 2020, 2019, and 2018, respectively. These amounts are primarily included in Office products and cloud services, Server products and cloud services, and LinkedIn in the table above.

Assets are not allocated to segments for internal reporting presentations. A portion of amortization and depreciation is included with various other costs in an overhead allocation to each segment. It is impracticable for us to separately identify the amount of amortization and depreciation by segment that is included in the measure of segment profit or loss.

Long-lived assets, excluding financial instruments and tax assets, classified by the location of the controlling statutory company and with countries over 10% of the total shown separately, were as follows:

(In millions)   
 
    
June 30,202020192018
    
United States$ 60,789$ 55,252$ 44,501
Ireland12,73412,95812,843
Other countries29,77025,42222,538
   
Total$   103,293$   93,632$   79,882
    

NOTE 20 — QUARTERLY INFORMATION (UNAUDITED)

(In millions, except per share amounts) 
 
      
Quarter EndedSeptember 30December 31March 31June 30Total
      
Fiscal Year 2020     
      
Revenue$   33,055$   36,906$   35,021$   38,033$   143,015
Gross margin22,64924,54824,04625,69496,937
Operating income12,68613,89112,97513,40752,959
Net income10,67811,64910,75211,20244,281
Basic earnings per share1.401.531.411.485.82
Diluted earnings per share1.381.511.401.465.76
 
      
Fiscal Year 2019     
      
Revenue29,08432,47130,57133,717125,843
Gross margin19,17920,04820,40123,30582,933
Operating income9,95510,25810,34112,40542,959
Net income (a)8,8248,4208,80913,18739,240
Basic earnings per share1.151.091.151.725.11
Diluted earnings per share (b)1.141.081.141.715.06
 

(a) Reflects the $157 million net charge related to the enactment of the TCJA for the second quarter and the $2.6 billion net income tax benefit related to the intangible property transfers for the fourth quarter, which together increased net income by $2.4 billion for fiscal year 2019. See Note 12 – Income Taxes for further information.

(b) Reflects the net charge related to the enactment of the TCJA and the net income tax benefit related to the intangible property transfers, which decreased (increased) diluted EPS $0.02 for the second quarter, $(0.34) for the fourth quarter, and $(0.31) for fiscal year 2019.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Microsoft Corporation and subsidiaries (the “Company”) as of June 30, 2020 and 2019, the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity, for each of the three years in the period ended June 30, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 30, 2020, expressed an unqualified opinion on the Company’s internal control over financial reporting.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Revenue Recognition — Refer to Note 1 to the financial statements

Critical Audit Matter Description

The Company recognizes revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company offers customers the ability to acquire multiple licenses of software products and services, including cloud-based services, in its customer agreements through its volume licensing programs.

Significant judgment is exercised by the Company in determining revenue recognition for these customer agreements, and includes the following:

• Determination of whether products and services are considered distinct performance obligations that should be accounted for separately versus together, such as software licenses and related services that are sold with cloud-based services.

• The pattern of delivery (i.e., timing of when revenue is recognized) for each distinct performance obligation.

• Identification and treatment of contract terms that may impact the timing and amount of revenue recognized (e.g., variable consideration, optional purchases, and free services).

• Determination of stand-alone selling prices for each distinct performance obligation and for products and services that are not sold separately.

Given these factors and due to the volume of transactions, the related audit effort in evaluating management’s judgments in determining revenue recognition for these customer agreements was extensive and required a high degree of auditor judgment.

How the Critical Audit Matter Was Addressed in the Audit

Our principal audit procedures related to the Company’s revenue recognition for these customer agreements included the following:

• We tested the effectiveness of controls related to the identification of distinct performance obligations, the determination of the timing of revenue recognition, and the estimation of variable consideration.

• We evaluated management’s significant accounting policies related to these customer agreements for reasonableness.

• We selected a sample of customer agreements and performed the following procedures:

– Obtained and read contract source documents for each selection, including master agreements, and other documents that were part of the agreement.

– Tested management’s identification and treatment of contract terms.

– Assessed the terms in the customer agreement and evaluated the appropriateness of management’s application of their accounting policies, along with their use of estimates, in the determination of revenue recognition conclusions.

• We evaluated the reasonableness of management’s estimate of stand-alone selling prices for products and services that are not sold separately.

• We tested the mathematical accuracy of management’s calculations of revenue and the associated timing of revenue recognized in the financial statements.

Income Taxes — Uncertain Tax Positions — Refer to Note 12 to the financial statements

Critical Audit Matter Description

The Company’s long-term income taxes liability includes uncertain tax positions related to transfer pricing issues that remain unresolved with the Internal Revenue Service (“IRS”). The Company remains under IRS audit, or subject to IRS audit, for tax years subsequent to 2003. While the Company has settled a portion of the IRS audits, resolution of the remaining matters could have a material impact on the Company’s financial statements.

Conclusions on recognizing and measuring uncertain tax positions involve significant estimates and management judgment and include complex considerations of the Internal Revenue Code, related regulations, tax case laws, and prior-year audit settlements. Given the complexity and the subjective nature of the transfer pricing issues that remain unresolved with the IRS, evaluating management’s estimates relating to their determination of uncertain tax positions required extensive audit effort and a high degree of auditor judgment, including involvement of our tax specialists.

How the Critical Audit Matter Was Addressed in the Audit

Our principal audit procedures to evaluate management’s estimates of uncertain tax positions related to unresolved transfer pricing issues included the following:

• We evaluated the appropriateness and consistency of management’s methods and assumptions used in the identification, recognition, measurement, and disclosure of uncertain tax positions, which included testing the effectiveness of the related internal controls.

• We read and evaluated management’s documentation, including relevant accounting policies and information obtained by management from outside tax specialists, that detailed the basis of the uncertain tax positions.

• We tested the reasonableness of management’s judgments regarding the future resolution of the uncertain tax positions, including an evaluation of the technical merits of the uncertain tax positions.

• For those uncertain tax positions that had not been effectively settled, we evaluated whether management had appropriately considered new information that could significantly change the recognition, measurement or disclosure of the uncertain tax positions.

• We evaluated the reasonableness of management’s estimates by considering how tax law, including statutes, regulations and case law, impacted management’s judgments.

/s/    DELOITTE & TOUCHE LLP

Seattle, Washington

July 30, 2020

We have served as the Company’s auditor since 1983.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND

FINANCIAL DISCLOSURE

Not applicable.

CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective.

REPORT OF MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our consolidated financial statements; providing reasonable assurance that receipts and expenditures of company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use, or disposition of company assets that could have a material effect on our consolidated financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our consolidated financial statements would be prevented or detected.

Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of June 30, 2020. There were no changes in our internal control over financial reporting during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Deloitte & Touche LLP has audited our internal control over financial reporting as of June 30, 2020; their report follows.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors of Microsoft Corporation

Opinion on Internal Control over Financial Reporting

We have audited the internal control over financial reporting of Microsoft Corporation and subsidiaries (the “Company”) as of June 30, 2020, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2020, based on the criteria established in Internal Control – Integrated Framework (2013) issued by COSO.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and the related notes (collectively referred to as the “financial statements”) as of and for the year ended June 30, 2020, of the Company and our report dated July 30, 2020, expressed an unqualified opinion on those financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/    DELOITTE & TOUCHE LLP

Seattle, Washington

July 30, 2020

DIRECTORS AND EXECUTIVE OFFICERS OF MICROSOFT CORPORATION

DIRECTORS

John W. Thompson 3,4Independent Board Chair,Microsoft CorporationSatya NadellaChief Executive Officer,Microsoft CorporationArne M. Sorenson 1President and Chief ExecutiveOfficer, Marriott International, Inc.
   
Reid G. HoffmanPartner, Greylock PartnersSandra E. Peterson 2,3Operating Partner,Clayton, Dubilier & RiceJohn W. Stanton 1,4Founder and Chairman, Trilogy Partnerships
   
Hugh F. Johnston 1Vice Chairman, Executive Vice President, and Chief FinancialOfficer, PepsiCoPenny S. Pritzker 4Founder and Chairman, PSPPartnersEmma N. Walmsley 2,4Chief Executive Officer,GlaxoSmithKline
   
Teri L. List-Stoll 1,3Former Executive Vice President andChief Financial Officer, The Gap, Inc.Charles W. Scharf 2,3President and Chief Executive Officer, Wells Fargo & CompanyPadmasree Warrior 2Founder, Chief ExecutiveOfficer and President,Fable Group Inc.

Board Committees

1. Audit Committee

2. Compensation Committee

3. Governance and Nominating Committee

4. Regulatory and Public Policy Committee

EXECUTIVE OFFICERS

Satya NadellaChief Executive OfficerKathleen T. HoganExecutive Vice President,Human Resources
  
Christopher C. CaposselaExecutive Vice President, Marketing and ConsumerBusiness, and Chief Marketing OfficerAmy E. HoodExecutive Vice President, ChiefFinancial Officer
  
Jean-Philippe CourtoisExecutive Vice President and President, MicrosoftGlobal Sales, Marketingand OperationsBradford L. SmithPresident and Chief Legal Officer

INVESTOR RELATIONS

Investor Relations

You can contact Microsoft Investor Relations at any time to order financial documents such as annual reports and Form 10-Ks free of charge.

Call us toll-free at (800) 285-7772 or outside the United States, call (425) 706-4400. We can be contacted between the hours of 9:00 a.m. to 5:00 p.m. Pacific Time to answer investment oriented questions about Microsoft.

For access to additional financial information, visit the Investor Relations website online at:

www.microsoft.com/investor

Our e-mail is msft@microsoft.com

Our mailing address is:

Investor Relations

Microsoft Corporation

One Microsoft Way

Redmond, Washington 98052-6399

Attending the Annual Meeting

The 2020 Annual Shareholders Meeting will be held as a virtual-only meeting. Any shareholder can join the Annual Meeting, while shareholders of record as of October 8, 2020 will be able to vote and submit questions during the meeting.

Date: Wednesday, December 2, 2020

Time: 8:00 a.m. Pacific Time

Virtual Shareholder Meeting:

www.virtualshareholdermeeting.com/MSFT20

Submit Your Question

We invite you to submit any questions via the proxy voting site at www.proxyvote.com. We will include as many of your questions as possible during the Q&A session of the meeting and will provide answers to questions on the Microsoft Investor Relations website under the Annual Meeting page.

Registered Shareholder Services

Computershare, our transfer agent, can help you with a variety of shareholder related services including:

• Change of address

• Lost stock certificates

• Transfer of stock to another person

• Additional administrative services

Computershare also administers a direct stock purchase plan and a dividend reinvestment program for the company.

Contact Computershare directly to find out more about these services and programs at 800-285-7772, option 1, or visit online at:

https://www.computershare.com/Microsoft

You can e-mail the transfer agent at:

web.queries@computershare.com

You can also send mail to the transfer agent at:

Computershare

P.O. Box 505000

Louisville, KY 40233-5000

Shareholders can sign up for electronic alerts to access the annual report and proxy statement online. The service gets you the information you need faster and also gives you the power and convenience of online proxy voting. To sign up for this free service, visit the Annual Report site on the Investor Relations website at:

http://www.microsoft.com/investor/AnnualReports/default.
aspx

Environmental, Social, Governance (“ESG”)/Corporate Social Responsibility (“CSR”)

Many of our shareholders are increasingly focused on the importance of the effective engagement and action on ESG topics. To meet the expectations of our stakeholders and to and maintain their trust, we are committed to conducting our business in ways that are principled, transparent, and accountable and we have made a broad range of environmental and social commitments. From our CEO and Senior Leadership Team and throughout our organization, people at Microsoft are working to conduct our business in principled ways that make a significant positive impact on important global issues. Microsoft’s Board of Directors provides insight, feedback, and oversight across a broad range of environmental and social matters. In particular, among the responsibilities of the Board’s Regulatory and Public Policy Committee is to review and provide guidance to the Board and management about the Company’s policies and programs that relate to CSR.

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