This case covers Microsoft’s consent decree with the SEC over unsupported accounting accruals. It is an excellent governance case and also covers numerous accrual issues. Microsoft had very well designed systems at the operating level to prepare and monitor accruals. However, very senior management then made large unsupported accrual journal entries to a general account, allegedly to reach earnings targets. When SEC officials aligned the unsupported adjustments with relevant accounts, they discovered that for one quarter Microsoft actually had negative inventory.
Those activities occurred before Sarbanes-Oxley made such practices subject to civil and criminal penalties. As a result, Microsoft signed a consent decree whereby it neither denied nor admitted guilt, but promised to not engage in those practices in the future. There were no fines and no criminal charges against Microsoft.
The case can be used to discuss several accrual accounting issues. It can also be used to consider what can be done to prevent senior management from overriding internal controls. Finally, the case can be used to consider the motives of senior management. At the time, Microsoft was incredibly profitable, growing rapidly, and had a near monopoly on personal computer software. The adjustments were almost certainly immaterial, probably had little effect on Microsoft’s market value, and the firm’s key shareholders (Bill Gates and senior Microsoft executives) were neither buying nor selling shares.
Microsoft and many other firms routinely reported earnings per share in excess of analysts’ consensus forecasts. The entire process seemed designed to beat the consensus forecasts for revenues and earnings. Given Microsoft’s market dominance and its fluctuating revenues as it released new versions of Office and Windows, it seems unlikely that Microsoft’s market value would have declined much if revenues or earnings were slightly lower than consensus estimates, since Microsoft still had 95% of the Office and Windows markets.