The Redmond, Wash. company revealed the timeline in a slide deck (download here) it posted on its investors website June 26. The presentation offered up additional information about Microsoft’s planned revenue deferrals for Windows 10, which the company first talked about in May.
“Revenue allocated is deferred and recognized on a straight-line basis over the estimated period the software upgrades are expected to be provided by estimated device life,” the most pertinent slide stated. “[The estimated device life] can range from two to four years.”
Microsoft will determine the device lifetime — and thus the support stretch — by “customer type.”
Microsoft has repeatedly said that the free updates and upgrades for Windows 10 would be tied to what it has called the “supported lifetime of the device.” It debuted that phrase in January, when it announced Windows 10’s name and a free upgrade for consumers and some businesses from Windows 7 or Windows 8.1 for one year following the new OS’s official release.
The free post-launch updates and upgrades, which will include new features and changes to the user interface (UI), are key to Microsoft’s strategy to transform the operating system into a service.
“With the launch of Windows 10, Microsoft will provide new features and functionality over time,” another slide in the short PowerPoint presentation said. “We will continue to keep it current for the supported lifetime of the device. We think of Windows as a Service — continuous updates over time.”
For accounting purposes, free upgrades require a company to set aside some revenue from the sale of the affected software — in this case, Windows 10 — then recognize that revenue over time. All the revenue from the software sale is eventually recorded, but at staggered intervals.
“We will have a new revenue recognition model because Windows 10 will include software updates provided over time, rather than at specifically-priced software upgrade events, which will result in the deferral of revenue,” Microsoft said.
In the slide deck, Microsoft said that the support lifetime would be calculated “primarily … by customer type,” different language than it used in May, when it said support would be determined by “form factor,” a way of saying the kind of device.
Customer type, on the other hand, hints at separating consumer and business device owners. Microsoft may use the edition of Windows 10 running on the device to make that determination. If that’s the case, free upgrades for Windows 10 Home, say, could be different — delivered for a shorter stretch, perhaps — than for Windows 10 Pro, the more expensive SKU (stock-keeping unit) aimed at power users, small businesses and corporations.
It’s unclear exactly how the upgrade lifetimes and associated deferrals will affect customers: Microsoft has said nothing about what happens after the lifetime expires, including whether upgrades will be discontinued entirely, be available for a fee, or effectively be moot because a new edition will have superseded Windows 10.
On the accounting front, Microsoft will do some financial acrobatics to deal with the deferrals, recording revenue as it has in the past but then debiting the “Corporate and Other” reporting segment by pro-rated amounts over the lifespan of the license. For $300 of revenue over a three-year span of Windows 10 Pro, for instance, Microsoft will recognize $100 in Year 1, deferring the remaining for the second and third years, then booking $100 in each. At the end of the three years, the full $300 would have been recognized.
Microsoft’s chief financial officer, Amy Hood has promised Wall Street that she would provide more information about the deferrals in a conference call at some point this year. “We’ll … share the exact details on lifecycles, how long the time will be, and the exact impact we expect,” Hood said in May. She also pledged that the company would provide what she called a “comparability bridge” in its earnings statements, meaning that those statements would show last year’s revenue as if Windows revenue had been deferred so that analysts will have an apples-to-apples comparison.
That additional information will probably be revealed in September or October, near the end of or after the close of the year’s third quarter financials.
The related upgrade lifecycles, however, will likely be disclosed before or at the launch of Windows 10, scheduled for July 29, as customers — notably businesses planning on adopting Windows 10 Pro — will need to know what they’re getting out of the upgrade offer.
Financially, the deferral will reduce Windows revenue on Microsoft’s balance sheet, at least for a time, as the income once recognized during the quarter of sale will instead be split amongst numerous quarters.
In the first nine months of Microsoft’s fiscal year 2015, it recorded about $9 billion for the affected Windows licenses, a pace of approximately $12 billion for 12 months. If the average deferral period is, say, three years, and Windows 10’s revenue equals 2015’s, Microsoft would thus record just a third, or $4 billion, in Year 1, or fiscal 2016. The remaining $8 billion would drop onto the books in Year 2 and Year 3, or in 2017 and 2018.