A lot of media have been leading with the headline that Microsoft reported its first ever quarterly loss. This is completely true, and yet, Microsoft didn’t actually lose any money during the quarter. So, what really happened.
If the world of accounting had been better known to Mark Twain, he might have altered his famous quote to suggest that there are, “Lies, damn lies, and accounting.”
Accounting is one of those things that seems like it should be straightforward enough. The popular notion is that companies and their lawyers and accountants deliberately obfuscate the truth about their company’s finances. That isn’t entirely untrue, but it is also true that accounting for a large corporation is not simple.
Writing Down Goodwill
One of the most subjective, and yet, completely legit, parts of corporate accounting is something known as goodwill. Essentially, the idea is that when you purchase a company, you are buying not just the tangible assets and liabilities of the company, but also the “good will” that exists toward that company. The acquiring company gets to count this so-called goodwill as an asset on its balance sheet.
Although goodwill is a completely recognized, after all, a company is worth more than just the value of its buildings and machinery, it has no hard and fast value. The company gets to decide how much the goodwill is worth, within certain limits. Essentially, goodwill is used to justify an acquisition price higher than the sum of an acquisition’s true assets. Otherwise, every purchase would result in drop in the acquirer’s net value.
In this case, Microsoft bought a company called aQuantive in 2007 for $6.3 billion. However, the acquisition never really worked out. Microsoft therefore, no longer has any goodwill relating to that acquisition. The company can, therefore, no longer count that goodwill as an asset. In accounting terms, the company must “write down” the the “impaired goodwill” from the acquisition.
What Caused Microsoft’s Loss
Since Microsoft no longer has the “asset” of the Goodwill from the acquisition, it needs to take it off of its books. Doing so means subtracting it away as an asset. However, you can’t just destroy assets in accounting. Instead, you take a charge against your earnings, which is essentially creating an expense to eliminates the asset. In this case, Microsoft wrote down $6.19 billion dollars for the impaired goodwill.
That $6.19 billion charge affects the company’s quarterly earnings like there was a $6.19 billion expense. That is, of course, not what happened at all. Rather, over time, the value of that asset was diminished. In reality, that goodwill was likely lost years ago, and over several quarters, but that isn’t how accounting works.
Instead, the theory is that Microsoft realized (suddenly, I guess) that the value of that asset was no longer accurate and took a charge against it. That $6.19 billion expense, obviously, took a huge hit on the quarter resulting in a loss.
Microsoft’s “Real” Quarterly Results
Corporate accounting is designed to ensure that everyone plays by the same rules, not to mimic the day-to-day reality of a company’s financial situation. Under this paradigm, Microsoft had a loss and its accounting is completely legitimate. However, a quick look behind the numbers shows that Microsoft didn’t really lose money this quarter at all, except on paper.
Microsoft’s quarterly earnings without the enormous write off (and another accounting charge of $540 million) were $6.93 billion, or $0.73 per share. In other words, the company made plenty of money for the quarter, it just chose now to take its lumps for a bad acquisition.