Financial Statement Analysis Comparison of Apple and Microsoft

By

Acc 101
Professor Durtschi
February 21, 2011

I. Summary of Findings

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 Apple and Microsoft both provide top of the line electronics and software.
They have both been around the industry for a lot of years and have a very good
reputation all over the world and that is why customers continue to buy their
products.

In order to determine which firm is a better financial investment, I had to

take into consideration multiple factors. Such, the company’s growth, liquidity,
profitability, their ability to pay off long-term debt, their sales, working capital,
return on equity, return on assets, and its profit margin.

I came to a conclusion, that Apple is the best financial investment. It was a

really close decision, it looks like Apple has more growth potential, they are better
off paying their long-term debts, better return in equity (which is really important
factor for an investor) and better return on assets.

Although I chose that Apple is the best investment, Microsoft really good
investment too. Maybe not as much as Apple but their stocks still have a lot of
potential. Apple is a good investment for someone who has a lot of money to
invest since its stock is at $350.56. For someone that only has a few hundreds to
invest Microsoft would a better choice since its stock is at 27.06. Only by looking
Apple’s stock history of 2 years someone can tell that the company’s growth is
increasing really fast. February of 2009 it was selling for only $93 that is a big
leap that Apple did in only 2 years.

Also by reading through the Management Discussions, made it harder for

me to choose which company has more potential of being the best investment,
since the differences were very little. Both firms have new products coming out in
the year of 2011 and both are going to be in high demand.

In conclusion, Apple is the best investment, because of the company’s

potential growth, liquidity, returns on assets and it doesn’t seem like the economic
crisis has affected their business, while looking back at Microsoft for the past few
years it looks like they have been affected. Apple is a great firm to invest in
because of the equity returns and its security.

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II. Financial Ratios

Ratio Apple Microsoft

Debt/Assets 0.36 0.46

Debt/Equity 0.57 0.64
Return on Equity 0.35 0.22

Profit Margin 0.21 0.30

Return on Assets 0.228 0.225
Working Capital 20,956 29,529
Current Ratio 2.01 2.13

*Red Indicates the better ratio

1) Debt to Assets

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The Debt to Asset financial ratio measures a company's solvency. Taking the
company’s total liabilities and dividing by the company’s total assets derive it.
Which means the lower the number the more Assets a company has. Apple in
this ratio is better off.

2) Debt to Equity
Debt to Equity is a financial ratio indicating the relative proportion of
shareholders' equity and debt used to finance a company's assets. Both companies
Apple and Microsoft are under 1.00, which is really good. Apple is better off
than Microsoft with 0.57 and Microsoft with 0.64

3) Return on Equity
Return on Equity (ROE) measures the rate of return on the ownership interest of
the common stock owners. It measures a firm's efficiency at generating profits
from every unit of shareholders' equity. In this case Apple is better off with a
return of 35% while Microsoft has a return of 22%

4) Profit Margin
Profit Margin is the ratio of net income to net sales of a company. In this the
better the percentage the better the company is doing. Clearly Microsoft is doing
much better than Apple with a percentage of 30% while Apple has only 21%.
This means that Microsoft has more sales than Apple.

5) Return on Assets
Return on Assets (ROA) is the percentage that shows how profitable a company’s
assets are in generating revenue. In this case Apple has more return on Assets
than Microsoft, although it is a really small difference between their numbers.
Apple has 22.8% return, while Microsoft has 22.5% return.

6) Working Capital
Working Capital is a financial metric, which represents operating liquidity
available to business. Apple is at 20,956 while Microsoft is doing better with
29,529 meaning that Microsoft has more liquidity than Apple. Liquidity plays a
really important role when choosing the company to invest at.

7) Current Ratio
Current Ratio is a financial ratio that measures whether or not a firm has enough
resources to pay its debts over the next 12 months. Apple is at 2.01 while
Microsoft is at 2.13, which means, Microsoft has more chances of paying off all
its current debt.

III. Management Discussion and Analysis

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 In the management discussions of both Apple and Microsoft, there were
a lot of similar topics. Both companies sell top of the line electronics.
They provide the market with high-end software and hardware. Apple
has really focused on advertising their newest products: IPod, Iphone,
and IPad, while Microsoft has focused more on updating their software.

Apple’s net sales consist primarily of revenue from the sale of

hardware, software, digital content and applications, peripherals, and
service and support contracts. Apple has met their Revenue goal for the
year, from in store sales, and online sales as well.

Microsoft managed to increase their revenue as well. Mainly due to

strong sales of Windows 7, which was released during fiscal year 2010,
and PC market improvement. Operating income increased reflecting the
change in revenue, offset in part by higher operating expense.

Apple and Microsoft had a good year in net sales, considering the fact
that we are in a economic crisis, but they still hope to increase their
revenue for the year 2011 by providing the market with new, more
advanced technology.

IV. Common Sized Income Statement

Account Apple Microsoft

Sales 65,225 1 62,484 1
COGS 39,541 0.60622 12,395 0.19836
Gross Margin 25,684 0.39377 50,089 0.80161

Other Income 18,540 0.28424 24,098 0.38566

Selling, General and Admin expenses 7,299 0.11190 38,386 0.61432

Other Expenses (including Dep) 0 0 915 0.01464

Income before interest and Taxes 18,540 0.28424 25,013 0.40031

Interest 0 0 0 0
Income before taxes 18,540 0.28424 25,013 0.40031

Taxes 4,527 0.06940 6,253 0.10007

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Other Adjustments 0 0 0 0
Net Income 14,013 0.21484 18,760 0.30038

V. Common Sized Balance Sheet

Balance Sheet Apple Microsoft

Assets
Cash and Cash equivalents 11,261 0.14978 5,505 0.06393
Short-term investments 14,359 0.19098 31,283 0.36328
Receivables 5,510 0.07328 13,014 0.15113
Inventories 1,051 0.01397 740 0.00859
Other Current assets 3,447 0.04584 5,134 0.05962
Total current assets 41,678 0.55435 55,676 0.64655

Long-term Assets
Land 0 0 0 0
Buildings and Improvements 0 0 0 0
Fixtures and Equipment 4,768 0.06341 7,630 0.08860
Other long-term assets 23,128 0.30762 22,807 0.26485
Construction in Progress 0 0 0 0
Less: Accum. Dep./Amortization 0 0 0 0
Total Long-Term Assets 31,242 0.41554 30,437 0.35345

Other Assets and Deferred Charges 2,263 0.03009 0 0

Total Assets 75,183 1 86,113 1

Liabilities and Shareholder’s

Investment
Current Liabilities
Short Term Borrowings 0 0 0 0
Accounts Payable 12,015 0.15981 4,025 0.04674
Accrued and other Current Liabilities 5,723 0.07612 3,283 0.03812
Long-term Debt-current Portion 0 0 1,000 0.01161
Unsecured Debt and other 0 0 0 0
Borrowings
Deferred Membership Fees 0 0 0 0
Other Current Liabilities 2,984 0.03969 17,839 0.20715
Total Current Liabilities 20,722 0.27562 26,147 0.30364

Long-term Liabilities

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Unsecured Debt and other 0 0 0 0
Borrowings
Nonrecourse Debt Collateralized by 0 0 0 0
Credit Card Receivables

Long-term Debt 0 0 4,939 0.05735

Deferred Income Taxes 1,139 0.01515 229 0.00266

Other Noncurrent Liabilities 5,531 0.07357 8,623 0.10014
Total Long-term Liabilities 6,670 0.08872 13,791 0.16015
Total Liabilities 27,392 0.36434 39,938 0.46379

Shareholder’s Equity
Common Stock 10,668 0.14189 62,856 0.72992
Additional Paid in Capital 0 0 0 0
Retained earnings 37,169 0 (16,681) (0.19371)
Accumulated other comprehensive (46) (0.00001) 0 0
Income/loss
Total Shareholders’ Investment 47,791 0.63566 46,175 0.53621
Noncontrolling Interest 0 0 0 0
Total Liabilities and Shareholders’ 75,183 1 86,113 1
investment

V. Apple’s Financial Statements

CONSOLIDATED STATEMENTS OF 12 Months Ended

OPERATIONS (USD $)
In Millions, except Share data in Sep. 25, Sep. 26,
Sep. 27, 2008
Thousands, unless otherwise specified 2010 2009
Net sales $ 65,225 $ 42,905 $ 37,491
Cost of sales 39,541 25,683 24,294
Gross margin 25,684 17,222 13,197
Operating expenses:

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Research and development 1,782 1,333 1,109
Selling, general and administrative 5,517 4,149 3,761
Total operating expenses 7,299 5,482 4,870
Operating income 18,385 11,740 8,327
Other income and expense 155 326 620
Income before provision for income taxes
18,540 12,066 8,947

Provision for income taxes 4,527 3,831 2,828

Net income $ 14,013 $ 8,235 $ 6,119
Earnings per common share:
Basic $ 15.41 $ 9.22 $ 6.94
Diluted $ 15.15 $ 9.08 $ 6.78
Shares used in computing earnings per
share:

Basic 909,461 893,016 881,592

Diluted 924,712 907,005 902,139

CONSOLIDATED BALANCE SHEETS (USD $) 12 Months Ended

In Millions Sep. 25, 2010 Sep. 26, 2009
Current assets:
Cash and cash equivalents $ 11,261 $ 5,263
Short-term marketable securities 14,359 18,201
Accounts receivable, less allowances of $55 and
$52, respectively 5,510 3,361
Inventories 1,051 455
Deferred tax assets 1,636 1,135
Vendor non-trade receivables 4,414 1,696
Other current assets 3,447 1,444
Total current assets 41,678 31,555

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Long-term marketable securities 25,391 10,528
Property, plant and equipment, net 4,768 2,954
Goodwill 741 206
Acquired intangible assets, net 342 247
Other assets 2,263 2,011
Total assets 75,183 47,501
Current liabilities:
Accounts payable 12,015 5,601
Accrued expenses 5,723 3,852
Deferred revenue 2,984 2,053
Total current liabilities 20,722 11,506
Deferred revenue - non-current 1,139 853
Other non-current liabilities 5,531 3,502
Total liabilities 27,392 15,861
Commitments and contingencies
Shareholders' equity:
Common stock, no par value; 1,800,000,000 shares
authorized; 915,970,050 and 899,805,500 shares
issued and outstanding, respectively 10,668 8,210

Retained earnings 37,169 23,353

Accumulated other comprehensive (loss)/income
(46) 77
Total shareholders' equity 47,791 31,640
Total liabilities and shareholders' equity
$ 75,183 $ 47,501
CONSOLIDATE
D
STATEMENTS
Accumulated
OF
Other
SHAREHOLDE Common Retained
Comprehensi Total
RS' EQUITY Stock Earnings
ve
(USD $)
Income/(Loss)
In Millions,
except Share
data
Beginning
Balance (in
872,329,000
shares) at Sep.
29, 2007
Beginning
Balance at Sep. $ 5,368 $ 9,100 $ 63 $ 14,531
29, 2007
Cumulative
effect of change 45 11 0 56
in accounting

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principle
Components of
comprehensive
income:
Net income 0 6,119 0 6,119
Change in
foreign currency 0 0 (28) (28)
translation
Change in
unrealized gain
(loss) on
0 0 (63) (63)
available-for-
sale securities,
net of tax
Change in
unrealized gain
on derivative 0 0 19 19
instruments, net
of tax
Total
comprehensive 6,047
income
Stock-based
513 0 0 513
compensation
Common stock
issued under
stock plans, net
of shares 15,888,000
withheld for
employee taxes
(in shares)
Common stock
issued under
stock plans, net
460 (101) 0 359
of shares
withheld for
employee taxes
Issuance of
common stock
in connection
109,000
with an asset
acquisition (in
shares)
Issuance of
common stock
in connection 21 0 0 21
with an asset
acquisition
Tax benefit from
employee stock 770 0 0 770
plan awards

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Ending Balance
(in shares) at 888,326,000
Sep. 27, 2008
Ending Balance
7,177 15,129 (9) 22,297
at Sep. 27, 2008
Components of
comprehensive
income:
Net income 0 8,235 0 8,235
Change in
foreign currency 0 0 (14) (14)
translation
Change in
unrealized gain
(loss) on
0 0 118 118
available-for-
sale securities,
net of tax
Change in
unrealized gain
on derivative 0 0 (18) (18)
instruments, net
of tax
Total
comprehensive 8,321
income
Stock-based
707 0 0 707
compensation
Common stock
issued under
stock plans, net
of shares 11,480,000
withheld for
employee taxes
(in shares)
Common stock
issued under
stock plans, net
404 (11) 0 393
of shares
withheld for
employee taxes
Tax benefit from
employee stock (78) 0 0 (78)
plan awards
Ending Balance
(in shares) at 899,805,500 899,805,500
Sep. 26, 2009
Ending Balance
8,210 23,353 77 31,640
at Sep. 26, 2009
Components of
comprehensive

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income:
Net income 0 14,013 0 14,013
Change in
foreign currency 0 0 7 7
translation
Change in
unrealized gain
(loss) on
0 0 123 123
available-for-
sale securities,
net of tax
Change in
unrealized gain
on derivative 0 0 (253) (253)
instruments, net
of tax
Total
comprehensive 13,890
income
Stock-based
876 0 0 876
compensation
Common stock
issued under
stock plans, net
of shares 16,164,000
withheld for
employee taxes
(in shares)
Common stock
issued under
stock plans, net
703 (197) 0 506
of shares
withheld for
employee taxes
Tax benefit from
employee stock 879 0 0 879
plan awards
Ending Balance
(in shares) at 915,970,050 915,970,050
Sep. 25, 2010
Ending Balance
$ 10,668 $ 37,169 $ (46) $ 47,791
at Sep. 25, 2010

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 CONSOLIDATED STATEMENTS OF 12 Months Ended
CASH FLOWS (USD $) Sep. 25, Sep. 26, Sep. 27,
In Millions 2010 2009 2008
Cash and cash equivalents, beginning
$ 5,263 $ 11,875 $ 9,352
of the year
Operating activities:
Net income 14,013 8,235 6,119
Adjustments to reconcile net
income to cash generated by
operating activities:
Depreciation, amortization and
1,027 734 496
accretion
Stock-based compensation expense 879 710 516
Deferred income tax expense 1,440 1,040 398
Loss on disposition of property, plant
24 26 22
and equipment
Changes in operating assets and
liabilities:
Accounts receivable, net (2,142) (939) (785)
Inventories (596) 54 (163)
Vendor non-trade receivables (2,718) 586 110
Other current assets (1,514) 163 (384)
Other assets (120) (902) 289
Accounts payable 6,307 92 596
Deferred revenue 1,217 521 718
Other liabilities 778 (161) 1,664
Cash generated by operating activities 18,595 10,159 9,596
Investing activities:
Purchases of marketable securities (57,793) (46,724) (22,965)

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Proceeds from maturities of
24,930 19,790 11,804
marketable securities
Proceeds from sales of marketable
21,788 10,888 4,439
securities
Purchases of other long-term
(18) (101) (38)
investments
Payments made in connection with
business acquisitions, net of cash (638) 0 (220)
acquired
Payments for acquisition of property,
(2,005) (1,144) (1,091)
plant and equipment
Payments for acquisition of intangible
(116) (69) (108)
assets
Other (2) (74) (10)
Cash used in investing activities (13,854) (17,434) (8,189)
Financing activities:
Proceeds from issuance of common
912 475 483
stock
Excess tax benefits from stock-based
751 270 757
compensation
Taxes paid related to net share
(406) (82) (124)
settlement of equity awards
Cash generated by financing activities 1,257 663 1,116
Increase/(decrease) in cash and cash
5,998 (6,612) 2,523
equivalents
Cash and cash equivalents, end of the
11,261 5,263 11,875
year
Supplemental cash flow disclosure:
Cash paid for income taxes, net $ 2,697 $ 2,997 $ 1,267

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Apple Inc.

We have audited the accompanying consolidated balance sheets of Apple Inc. as of

September 25, 2010 and September 26, 2009, and the related consolidated statements of
operations, shareholders’ equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles

14
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects,
the consolidated financial position of Apple Inc. at September 25, 2010 and September 26, 2009,
and the consolidated results of its operations and its cash flows for the years then ended, in
conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Apple Inc.’s internal control over financial reporting as of
September 25, 2010, based on criteria established in Internal Control – Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated October 27, 2010 expressed an unqualified opinion thereon.

San Jose, California /s/ Ernst & Young LLP

October 27, 2010

Management’s Discussion and Analysis of Financial Condition and Results of

Operations

Executive Overview
The Company designs, manufactures, and markets a range of personal computers,
mobile communication and media devices, and portable digital music players, and
sells a variety of related software, services, peripherals, networking solutions, and
third-party digital content and applications. The Company’s products and services
include Mac computers, iPhone, iPad, iPod, Apple TV, Xserve, a portfolio of
consumer and professional software applications, the Mac OS X and iOS
operating systems, third-party digital content and applications through the iTunes
Store, and a variety of accessory, service and support offerings. The Company
sells its products worldwide through its retail stores, online stores, and direct sales
force, and third-party cellular network carriers, wholesalers, retailers, and value-
added resellers. In addition, the Company sells a variety of third-party Mac,
iPhone, iPad and iPod compatible products, including application software,
printers, storage devices, speakers, headphones, and various other accessories and
peripherals through its online and retail stores. The Company sells to SMB,
education, enterprise, government, and creative markets.

The Company is committed to bringing the best user experience to its customers
through its innovative hardware, software, peripherals, services, and Internet
offerings. The Company’s business strategy leverages its unique ability to design
and develop its own operating systems, hardware, application software, and
services to provide its customers new products and solutions with superior ease-
of-use, seamless integration, and innovative industrial design. The Company
believes continual investment in research and development is critical to the

15
development and enhancement of innovative products and technologies. In
conjunction with its strategy, the Company continues to build and host a robust
platform for the discovery and delivery of third-party digital content and
applications through the iTunes Store. Within the iTunes Store, the Company has
expanded its offerings through the App Store and iBookstore, which allow
customers to browse, search for, and purchase third-party applications and books
through either a Mac or Windows-based computer or by wirelessly downloading
directly to an iPhone, iPad or iPod touch. The Company also works to support a
community for the development of third-party software and hardware products and
digital content that complement the Company’s offerings. Additionally, the
Company’s strategy includes expanding its distribution network to effectively
reach more customers and provide them with a high-quality sales and post-sales
support experience. The Company is therefore uniquely positioned to offer
superior and well-integrated digital lifestyle and productivity solutions.

VII. Microsoft’s Financial Statements

12 Months Ended
INCOME STATEMENTS (USD $)
In Millions, except Per Share data Jun. 30, Jun. 30,
Jun. 30, 2008
2010 2009
Revenue $ 62,484 $ 58,437 $ 60,420
Operating expenses:
Cost of revenue 12,395 12,155 11,598
Research and development 8,714 9,010 8,164
Sales and marketing 13,214 12,879 13,260
General and administrative 4,004 3,700 5,127
Employee severance 59 330 0
Total operating expenses 38,386 38,074 38,149
Operating income 24,098 20,363 22,271
Other income (expense) 915 (542) 1,543
Income before income taxes 25,013 19,821 23,814
Provision for income taxes 6,253 5,252 6,133
Net income $ 18,760 $ 14,569 $ 17,681
Earnings per share:
Basic $ 2.13 $ 1.63 $ 1.90
Diluted $ 2.10 $ 1.62 $ 1.87
Weighted average shares outstanding:

Basic 8,813 8,945 9,328

Diluted 8,927 8,996 9,470
Cash dividends declared per common share
$ 0.52 $ 0.52 $ 0.44

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 BALANCE SHEETS (USD $) 12 Months Ended
In Millions Jun. 30, 2010 Jun. 30, 2009
Current assets:
Cash and Cash Equivalents $ 5,505 $ 6,076
Short-term investments (including securities loaned of
31,283 25,371
$62 and $1,540)
Total cash, cash equivalents, and short-term
36,788 31,447
investments
Accounts receivable, net of allowance for doubtful
13,014 11,192
accounts of $375 and $451
Inventories 740 717
Deferred income taxes 2,184 2,213
Other 2,950 3,711
Total current assets 55,676 49,280
Property and equipment, net of accumulated
depreciation of $8,629 and $7,547 7,630 7,535

Equity and Other Investments 7,754 4,933

Goodwill 12,394 12,503
Intangible assets, net 1,158 1,759
Deferred income taxes 0 279
Other long-term assets 1,501 1,599
Total assets 86,113 77,888
Current liabilities:
Accounts payable 4,025 3,324
Short-term debt 1,000 2,000
Accrued compensation 3,283 3,156
Income taxes 1,074 725
Short-term unearned revenue 13,652 13,003
Securities lending payable 182 1,684
Other 2,931 3,142
Total current liabilities 26,147 27,034
Long-term debt 4,939 3,746
Long-term unearned revenue 1,178 1,281
Deferred income taxes 229 0
Other long-term liabilities 7,445 6,269
Commitments and contingencies
Stockholders' equity:
Common stock and paid-in capital - shares authorized
24,000; outstanding 8,668 and 8,908 62,856 62,382

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Retained deficit, including accumulated other
comprehensive income of $1,055 and $969 (16,681) (22,824)

Total stockholders' equity 46,175 39,558

Total liabilities and stockholders' equity
$ 86,113 $ 77,888

CASH FLOWS STATEMENTS (USD 12 Months Ended

$) Jun. 30, Jun. 30, Jun. 30,
In Millions 2010 2009 2008
Operations
Net income $ 18,760 $ 14,569 $ 17,681
Adjustments to reconcile net
income to net cash from
operations:
Depreciation, amortization, and other
2,673 2,562 2,056
noncash items
Stock-based compensation 1,891 1,708 1,479
Net recognized losses (gains) on
(208) 683 (572)
investments and derivatives
Excess tax benefits from stock-based
(45) (52) (120)
compensation
Deferred income taxes (220) 762 935
Deferral of unearned revenue 29,374 24,409 24,532
Recognition of unearned revenue (28,813) (25,426) (21,944)
Changes in operating assets and
liabilities:
Accounts receivable (2,238) 2,215 (1,569)
Other current assets 420 (422) 153
Other long-term assets (223) (273) (98)
Other current liabilities 1,295 (3,371) (748)
Other long-term liabilities 1,407 1,673 (173)
Net cash from operations 24,073 19,037 21,612
Financing
Short-term borrowings (repayments),
(991) 1,178 0
maturities of 90 days or less, net
Proceeds from issuance of debt,
4,167 4,796 0
maturities longer than 90 days
Repayments of debt, maturities longer
(2,986) (228) 0
than 90 days
Common stock issued 2,311 579 3,494
Common stock repurchased (11,269) (9,353) (12,533)
Common stock cash dividends paid (4,578) (4,468) (4,015)
Excess tax benefits from stock-based 45 52 120

18
compensation
Other 10 (19) 0
Net cash used in financing (13,291) (7,463) (12,934)
Investing
Additions to property and equipment (1,977) (3,119) (3,182)
Acquisition of companies, net of cash
(245) (868) (8,053)
acquired
Purchases of investments (30,168) (36,850) (20,954)
Maturities of investments 7,453 6,191 2,597
Sales of investments 15,125 19,806 25,132
Securities lending payable (1,502) (930) (127)
Net cash used in investing (11,314) (15,770) (4,587)
Effect of exchange rates on cash and
(39) (67) 137
cash equivalents
Net change in cash and cash
(571) (4,263) 4,228
equivalents
Cash and cash equivalents, beginning
6,076 10,339 6,111
of period
Cash and cash equivalents, end of
$ 5,505 $ 6,076 $ 10,339
period

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Microsoft Corporation:

We have audited the internal control over financial reporting of Microsoft Corporation
and subsidiaries (the “Company”) as of June 30, 2010, based on criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. 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 conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). 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.

A company’s internal control over financial reporting is a process designed by, or under
the supervision of, the company’s principal executive and principal financial officers, or
persons performing similar functions, and effected by the company’s board of directors,
management, and other personnel to provide reasonable assurance regarding the

19
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 the inherent limitations of internal control over financial reporting, including
the possibility of collusion or improper management override of controls, material
misstatements due to error or fraud may not be prevented or detected on a timely
basis. Also, projections of any evaluation of the effectiveness of the internal control over
financial reporting to future periods are subject to the risk that the controls may become
inadequate because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of June 30, 2010, based on the criteria established in
Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial statements as of
and for the year ended June 30, 2010, of the Company and our report dated July 30,
2010, expressed an unqualified opinion on those financial statements.

/s/ DELOITTE & TOUCHE LLP

Seattle, Washington
July 30, 2010

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

OVERVIEW AND OUTLOOK

The following Management’s Discussion and Analysis (“MD&A”) is intended to help the
reader understand the results of operations and financial condition of Microsoft
Corporation. MD&A is provided as a supplement to, and should be read in conjunction
with, our financial statements and the accompanying notes to the financial statements
(“Notes”). We generate revenue by developing, manufacturing, licensing, and supporting

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a wide range of software products and services for many different types of computing
devices. Our software products and services include operating systems for personal
computers, servers, and intelligent devices; server applications for distributed computing
environments; information worker productivity applications; business solutions
applications; high-performance computing applications; software development tools; and
video games. We provide consulting and product and solution support services, and we
train and certify computer system integrators and developers. We also design and sell
hardware, including the Xbox 360 gaming and entertainment console and accessories,
the Zune digital music and entertainment device and accessories, and Microsoft PC
hardware products. Online offerings and information are delivered to consumers through
Bing, Windows Live, Microsoft Office Web Apps, our MSN portals and channels, and to
businesses through Microsoft Online Services offerings, such as Microsoft Dynamics
CRM Online, Exchange Online, Windows Azure, SQL Azure and SharePoint Online. We
enable the delivery of online advertising across our broad range of digital media
properties and on Bing through our proprietary adCenter platform.

Our revenue historically has fluctuated quarterly and has generally been the highest in
the second quarter of our fiscal year due to corporate calendar year-end spending trends
in our major markets and holiday season spending by consumers. Our Entertainment
and Devices Division is particularly seasonal as its products are aimed at the consumer
market and are in highest demand during the holiday shopping season. Typically, the
Entertainment and Devices Division has generated approximately 40% of its annual
segment revenues in our second fiscal quarter. In addition, quarterly revenues may be
impacted by the deferral of revenue. See the discussions below regarding the deferral of
revenue related to eligible sales of the 2007 Microsoft Office system with a guarantee to
be upgraded to the 2010 Microsoft Office system at minimal or no cost (the “Office 2010
Deferral”) and sales of Windows Vista with a guarantee to be upgraded to Windows 7 at
minimal or no cost and of Windows 7 to original equipment manufacturers and retailers
before general availability (the “Windows 7 Deferral”).

Global macroeconomic factors have a strong correlation to demand for our software,
services, hardware, and online offerings. The unfavorable global economic environment
adversely affected our business in fiscal year 2009 as consumers and businesses cut
back on spending, which reduced PC shipments and IT investments. During fiscal year
2010, the environment began to improve. However, the current macroeconomic factors
remain dynamic and uncertain and are likely to remain so into 2011. Irrespective of
global economic conditions, we are positive about our relative market position, our
current product portfolio and future product pipeline. Because we offer a wide range of
products and services that enable companies to improve productivity and reduce costs,
including cloud-based services, we believe that Microsoft is well-positioned to create
new opportunities to increase revenue as the global economy improves. We remain
focused on executing in the areas we can control by continuing to provide high value
products at the lowest total cost of ownership while managing our expenses.

Technological innovation is the foundation of our long-term growth and we intend to

maintain our commitment to investment in research and development, engineering
excellence, and delivering high-quality products and services to customers and partners.
We continue to develop innovative software applications and solutions that we believe
will enhance information worker productivity, improve communication and collaboration
in work groups, aid business intelligence, and streamline processes for small and mid-

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sized businesses. To sustain growth in the face of competition from other vendors of
proprietary and open source software, our goal is to deliver products that provide the
best platform for network computing – software that is easiest to deploy and manage,
and that is most secure – with the lowest total cost of ownership.

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