Capitalise, then depreciate

Buying a machine is not a cost in the year it is bought. It is an asset, charged to profit across the years it is expected to work.

Two numbers decide how much lands in each year, and neither of them is a fact. How long the asset will serve, and which pattern spreads the cost across that time.

The disclosure, in the company's own words

Microsoft's fiscal 2023 10-K, filed on 27 July 2023, says in its accounting policies note that in July 2022 it completed an assessment of the useful lives of its server and network equipment, and determined it should increase the estimated useful lives of both from four years to six.

The filing then quantifies it. The effect of the change for fiscal 2023 was an increase in operating income of $3.7 billion (Microsoft Corporation FY2023 10-K, accession 0000950170-23-035122) and net income of $3.0 billion (Microsoft Corporation FY2023 10-K, accession 0000950170-23-035122), or $0.40 per basic and diluted share.

Reported operating income for that year was $88,523 million (Microsoft Corporation FY2023 10-K, accession 0000950170-23-035122) and net income $72,361 million (Microsoft Corporation FY2023 10-K, accession 0000950170-23-035122). So the estimate change accounts for 4.2 percent of operating income and 4.1 percent of net income for the year.

Why the change is not applied backwards

A change in an accounting estimate is applied from the date of the change forward. Prior periods are not restated, because the earlier estimate was the best available at the time and was not an error.

That rule is why the effect shows up as a jump in one year's margin rather than a smooth restatement of history. A reader comparing fiscal 2022 with fiscal 2023 is comparing two different depreciation assumptions, and the only warning is the sentence in the note.

An error is different. A mistake in a prior period is corrected by restating that period, which is the subject of the non-reliance filings covered in the disclosure course.

The method, which is a second choice

This is not hypothetical. Caterpillar's fiscal 2025 10-K states that it computes depreciation of plant and equipment principally using accelerated methods, while most US industrial companies use straight line. Two identical fleets, two different early-year margins.

What to check, and where

Three places, all of them short.

The accounting policies note gives the lives and the method. Any change of estimate is disclosed there with its effect quantified, as Microsoft's was. And the property note gives gross cost against accumulated depreciation, whose ratio says roughly how far through its life the asset base is.

A company whose accumulated depreciation is approaching its gross cost has an old asset base and a capital spending decision ahead of it, whatever its margins currently look like.

Check yourself