As required by GAAP [FASB ASC 320, previously SFAS No. 115], Microsoft Corporati
ID: 2458512 • Letter: A
Question
As required by GAAP [FASB ASC 320, previously SFAS No. 115], Microsoft Corporation reports its investments available-for-sale at the fair value of the investment securities. The net unrealized holding gain is not reported in the income statement. Instead, it's reported as part of Other comprehensive income and added to Accumulated other comprehensive income in shareholders' equity.
Comprehensive income is a broader view of the change in shareholders' equity than traditional net income, encompassing all changes in equity from non-owner transactions. Microsoft chose to report its Other comprehensive income as a separate statement in a disclosure note in its annual report: MSFT Annual Report 2011
What does Microsoft mean by the term “Reclassification adjustment for gains (losses) included in net income”? Can you think of an instance where reclassification adjustment could be used unethically?
Explanation / Answer
Answer: The term, “Reclassification adjustment for gains (losses) included in net income" refers to the use of a journal entry to remove any amounts associated with sold investments (Spiceland, et al., 2012, p. 633) . This item which is found in the comprehensive income note refers to a second double-counting situation. When Microsoft sells these investments that have unrealized gains or losses in the past and simply recording the total realized gain without adjustment would end up in double-counting the gain or loss. The reclassification adjustment ends up being the way Microsoft could clear the prior unrealized changes in fair value before the sale so that the double-counting is avoided. For Microsoft, the $(574) million adjustment to derivatives in 2009 most likely refers to the gains made on the derivatives sales, which should appear on the income statement. If that did happen it would be transferred to retained earnings, as a portion of shareholder’s equity. The derivatives sold must have already been included as $574 million in unrealized gains therefore, when the gains were realized upon sale, the reclassification adjustment was required to avoid double-counting the gain and overstating equity.
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