The software giant included restated ad expenses in the annual report it filed this month with the Securities and Exchange Commission but didn't explain the restatement. In response to a query from Advertising Age, Microsoft said the changes were made after it earlier had "mistakenly" reported some MSN expenses as advertising costs.
The expense restatement, covering fiscal years 2001 and 2002, did not change Microsoft's revenue, net income or sales-and-marketing expenses. But it dramatically reduced what Microsoft reported for advertising costs, which are part of sales-and-marketing expenses.
A Microsoft spokeswoman said, "Microsoft determined that certain customer-acquisition costs were non-advertising costs and were therefore appropriately reclassified from advertising costs." Microsoft declined to make executives available to discuss the expense restatement.
The change slashed Microsoft's worldwide ad cost to $1.02 billion for the fiscal year ended June 30, 2001, down $340 million or 25% from what the company had disclosed last year in its annual report to the SEC. Microsoft reduced its reported fiscal 2002 ad expense to $1.13 billion, down $140 million or 11%.
"The amount [of the change] was immaterial and did not affect total net income," the spokeswoman said. "It isn't uncommon for companies to make classification adjustments from time to time."
Microsoft invested heavily during the two fiscal years to attract subscribers to MSN, its Internet service. The company would not discuss the specifics of the customer-acquisition costs it has reclassified.
The spokeswoman said Microsoft's ad spending financial disclosures are based on the American Institute of Certified Public Accountants' 1993 Statement of Position for Reporting on Advertising Costs. That statement, the standard for financial reporting of ad expenses, offers guidance on what types of customer-acquisition activities constitute advertising. Media spending counts as advertising; activities such as discounts or rebates are not considered advertising.
Microsoft is not the first company to face issues in accounting for Internet-service advertising. In 2000, America Online-without admitting or denying charges-paid $3.5 million to settle SEC charges that it had violated financial reporting rules. The SEC said AOL had improperly classified $385 million-money spent on acquiring customers-as an asset on the balance sheet rather than as advertising expenses on the income statement. That accounting allowed AOL to report profits in six quarters in 1995-96 rather than the losses it would have recorded had it reported the money as expenses. AOL took a writedown on the $385 million in fiscal 1997, contributing to a net loss for that year.
Microsoft's accounting issue is far different. The SEC said AOL understated ad expenses and so overstated profits. Microsoft, in contrast, acknowledges overstating ad costs by $480 million, but that had no effect on reported profits.