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Accounting policy changes boost tech earnings
The big tech names have all updated accounting estimates recently, boosting earnings across the board.
Microsoft, Amazon and Oracle increased the estimated useful lives of their servers, decreasing reported expenses and increasing net income this quarter.
For Microsoft and Amazon, this is the second time they’ve updated estimates in recent history.
The change in estimated useful lives of servers is likely warranted and may better represent “reality”, in the esoteric accounting sense of reality. The other side of the coin, however, is that these changes gave a boost to current period earnings (or in Alphabet’s case prior period). If it hadn’t been for these changes, tech company results would have been even more disappointing.
Why should you care?
Accounting policy changes don’t generally represent an ongoing improvement in the company’s operations. This year’s “boost” is one-time only unless these companies keep changing estimates.
What is “estimated useful life”?
When a company buys a long-lived asset, such as a building or equipment, the cash goes out the door today, but the benefit is reaped over time. In order to match the cost of the asset with the future benefits, the cash is not recorded as an expense immediately but rather recorded over the expected life of the asset. This expense is called depreciation. Depreciation expense is often calculated as follows:
Depreciation expense = (Total cost of the asset) / (Estimated useful life of the asset)
In other words, the estimated useful life is the number of years that the asset will continue to efficiently generate revenue for the company before it needs to be sold, retired or disposed of.
Servers obviously don’t have indefinite useful lives. Like all hardware, servers become obsolete as technology improves and as they suffer from wear and tear.
A few years ago, most tech companies were estimating the useful life of their servers to be three years or so. Now server life estimates are up to 4 to 6 years, depending on the company. According to Amazon, the reason for the change is improvements in their “hardware, software, and data center designs”. We suspect that the primary reason for the change is that the pace of development in hardware has slowed and there is therefore less pressure to regularly upgrade this type of equipment.
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Who changed what and how it impacted earnings
What changed: Increase in useful life estimates for servers and network equipment. The new useful life estimates were changed from 4 years to 6 years.
Effective date: June 30, 2022 (FY 2023)
Impact on the most recent quarter: This change increased operating income by $1.1B. If not for this change, EPS would have been $2.23 (below expectations) instead of $2.35.
Previous changes: This isn’t the first time Microsoft has changed their depreciation-related accounting estimates. Microsoft had already increased the useful lives of their servers and network equipment in June 2020.
What changed: The estimated useful lives for their servers increased from 4 to 5 years and for networking equipment from 5 to 6 years.
Effective date: January 1, 2022 (FY 2022)
Impact on the most recent quarter: This change improved operating loss by $2.2B. If not for this change, EPS would have been -$0.50 instead of -$0.29 (wow).
Previous changes: Amazon increased the useful life of their servers from 3 years to 4 years in January 2020.
What changed:The estimate of the useful lives for their servers increased from 4 to 5 years.
Effective date: May 31, 2022 (FY 2023)
Impact on the most recent quarter: This change increased operating income by $131M (~5% of net income). If not for this change, EPS would have been $0.53 instead of $0.58.
The impact on Oracle’s EPS was not clearly disclosed but we calculated it for you. The above calculation did not take into account servers, if any, that were purchased during the current quarter and therefore may understate impact relative to the impact assessment provided by Alphabet and Amazon which did include current period purchases.
Previous changes: No other changes in recent years.
What changed: Useful life of their servers increased from 3 years to 4 years and for “certain network equipment” it increased from 3 years to 5 years
Effective date: January 1, 2021 (FY 2021)
Impact on the most recent quarter: Alphabet updated estimates in prior period. There was no new change in estimates in the current period.
Prior period impact: In 2021, the change in useful life reduced depreciation expense by $2.6 billion, impacting cost of revenues and R&D line items.
You’ll note that Alphabet led the wave here but now has the most conservative useful life estimates of the four companies. Microsoft’s estimate of server useful life is now 6 years, a full 2 years longer. Can we expect to see an update to Alphabet’s estimates next quarter?
Not all disclosure is equal. There was disparity in the level of transparency regarding these changes and also in how the impact of these changes was ultimately calculated. Amazon and Alphabet included newly purchased servers in their impact calculation, while Oracle and Microsoft did not. Oracle also failed to disclose the impact of the changes on EPS.
As heavy users of cloud infrastructure, it would be nice if these companies decided to pass on some of their new found cost savings to us.