A meeting of your accounting department is scheduled for early tomorrow morning. One topic of discussion is certain to be the appropriate adjustments to net income in your company's statement of cash flows using the indirect method of reporting operating activities. Hallway discussions have suggested some degree of uncertainty, particularly regarding unearned revenues, which are substantial for the company. Because your firm went public only seven months ago, this reporting issue is a new one for you and most other members of the department. In preparation for the meeting, you sought out the financial statements of Microsoft Corporation, knowing that it too had substantial unearned revenues. The operating activities section of the comparative statements of cash flows for Microsoft is presented below.

Required:

1. Locate the financial statements of Microsoft Corporation on the Internet. Search the disclosure notes for information about how Microsoft accounts for its unearned revenues. How is the undelivered portion of Microsoft's sales of Windows XP Professional recorded initially?

2. Why does the statement of cash flows include "unearned revenue" as an addition to net income in the operations section? Why is "recognition of unearned revenue" included as a deduction from net income? Why do you think Microsoft reported these two items separately rather than just adjusting net income for the change in the unearned revenue account balance?

3. Why is stock-based compensation added to net income?