MSFT Microsoft Corporation

NOTES TO FINANCIAL STATEMENTS

NOTE 1 — DESCRIPTION OF THE PLAN AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Plan Description

The One Microsoft Puerto Rico Retirement Plan (the “Plan”), a defined contribution retirement plan, is sponsored by Microsoft Operations Puerto Rico, LLC, Microsoft Caribbean, Inc., and Microsoft Retail Store-Puerto Rico, LLC (collectively, the “Sponsors”). The Plan is administered by the Administrative Committee (the “Plan Administrator”) and subject to the provisions of ERISA and Puerto Rico income tax laws. The Plan’s trustee and recordkeeper is Banco Popular de Puerto Rico—Trust Division. The information below summarizes certain aspects of the Plan as in effect during 2016 and 2015, and is intended to be a summary only. Plan participants should refer to the Summary Plan Description (“Plan Document”) for more complete information.

Accounting Principles

The financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Eligibility

Regular and retail services employees of participating employers who are on the Sponsor’s payroll, have reached age 18, and are residents of Puerto Rico may enroll in the Plan at any time. Eligible employees may become a participant in the Plan immediately on their hire date since there is no service requirement to become a Plan participant.

Eligible Compensation

Eligible compensation represents total compensation paid to participants that is included in income for income tax purposes. Eligible compensation excludes car allowance, Christmas bonus, severance package, relocation package, signing bonus, rewards, and recognitions.

Contributions

Participant Contributions

Participants may contribute to the Plan on a pre-tax basis using eligible compensation each pay period. Participants reaching age 50 or older by the end of the Plan year may also elect to make additional catch-up contributions to the Plan on a pre-tax basis. Such contributions are excluded from the participant’s taxable income for income tax purposes until received as a withdrawal or distribution from the Plan. Additionally, participants may make contributions on an after-tax basis which may not exceed 10 percent of the aggregate compensation paid to the employee during all the years he or she has been a Plan participant. Participants may also make rollover contributions representing distributions from other Puerto Rico qualified plans. All contributions are subject to certain Puerto Rico Internal Revenue Code (“PRIRC”) limitations and the limitations set forth in the Plan Document.

Effective July 2016, the investment of new contributions or transfer of existing account holdings into Microsoft Common Stock within the Plan was discontinued. Participant accounts with existing Microsoft Common Stock can retain those holdings, and dividends on Microsoft Common Stock can continue to be reinvested.

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Employer Contributions

The Sponsors make an employer matching contribution to each participant’s account equal to 50 percent of the amount of the participant’s contribution. The maximum participant contribution amount eligible to be matched is 6 percent of eligible compensation as defined by the Plan.

Participant Accounts  

Each participant’s account is credited with (a) participant contributions and employer contributions and (b) the allocation of Plan earnings and expenses, based on participant earnings or account balances, as defined. The benefit to which a participant is entitled is the benefit that can be provided from the participant’s vested account. All amounts in participant accounts are participant-directed. Participants may invest in various financial instruments including common stock and mutual funds.

Vesting

Participants are fully vested in Plan accounts at all times.

Distributions

Active participants may take a withdrawal from the Plan in the event of a financial hardship. A hardship withdrawal is limited to pre-tax contribution accounts and catch-up contribution accounts. A hardship withdrawal will result in a twelve-month suspension of pre-tax and after-tax contributions to the Plan. Active participants may also take a withdrawal from their rollover and after-tax account types within the Plan without meeting one of the hardship criteria.

After reaching age 59  ¹ ⁄ ₂ , active participants may withdraw all, or any portion, of the balance in their accounts. Distributions, in full or any portion, may also occur if the participant terminates employment, retires, becomes permanently disabled, or dies. Distributions of investments are in the form of cash and are normally made in a lump-sum, unless periodic payments are elected (monthly, quarterly, semiannual, or annual installments of substantially equal amounts over a period not to exceed 10 years). There were no participants who elected to withdraw from the Plan that had not yet been paid as of December 31, 2016 or 2015.

Administrative Expenses

The Plan’s administrative expenses are paid by the Sponsors as provided in the Plan Document. All investment management and transaction fees directly related to the Plan investments are paid by the Plan. Participants are responsible for fees associated with certain transactions such as loan originations and maintenance. Management fees and operating expenses charged to the Plan for investments are deducted from income earned on a daily basis and are not separately reflected. Consequently, management fees and operating expenses are reflected as a reduction of investment return for such investments.

Plan Amendment and Termination

The Sponsors have the right to amend or terminate the Plan. If the Plan is terminated, all account balances will be distributed in the form and manner determined by the Plan Administrator.

Risks and Uncertainties

The Plan utilizes various investment instruments, including common stock and mutual funds. Investment securities, in general, are exposed to various risks, such as interest rate risk, credit risk, and overall market volatility. Due to the level of risk associated with certain investment securities, it is reasonably possible that changes in the values of investment securities will occur in the near term and that such changes could materially affect the amounts reported in the financial statements.

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Use of Estimates  

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and changes therein. Actual results could differ from these estimates and assumptions. The Plan has no contingent assets or liabilities for any periods presented in these financial statements.

Valuation of Investments

Investments are recorded at fair value. Security transactions are accounted for as of the trade date. Dividend income is recorded on the ex-dividend date, and interest income is recorded as earned.

Participant Loans

Participant loans are measured at their unpaid principal balance plus any accrued but unpaid interest, and participant loans deemed distributed due to default are included in benefits paid to participants on the statements of changes in net assets available for benefits.

NOTE 2 — PARTICIPANT LOANS

Participants may borrow from their accounts up to a maximum equal to the lesser of (a) 50 percent of the vested account balance; or (b) $50,000, reduced by: (1) the current outstanding balance of all other loans from the Plan, and (2) the excess (if any) of all Plan loans during the previous 12 months over the current outstanding balance of Plan loans. The minimum amount that a participant can borrow is $500.

Loan terms range from one to five years for General Loans or up to 15 years for Primary Residence Loans. Participants may not have more than two loans outstanding at any point in time. The loans are secured by the balance in the participant’s account and bear interest at one percent over the prime rate, determined on a monthly basis. Principal and interest are paid ratably through payroll deductions, made each pay period for the scheduled amount. If a participant terminates employment with the Sponsors, the loan balance is settled at the time of the distribution of the participant’s vested interest in his or her account; however, the participant may pay off the outstanding loan balance prior to the distribution. As of December 31, 2016, outstanding participant loans have maturities with various dates through 2038, bearing interest ranging from 4.25 percent to 4.50 percent.

NOTE 3 — TAX STATUS

The Puerto Rico Treasury Department has determined and informed the Plan’s management by a letter dated June 2, 2014, that the Plan is qualified as a tax-exempt plan under the appropriate sections of the PRIRC. The determination letter covered Plan amendments adopted through April 1, 2013. The Plan Administrator believes that the Plan is currently designed and operated in compliance with the applicable requirements of the PRIRC. Therefore, the Plan is tax-exempt as of the financial statement date and no provision for income taxes has been recorded in the financial statements.

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NOTE 4 — PARTY-IN-INTEREST TRANSACTIONS

Exempt Party-In-Interest Transactions

Microsoft Corporation is the parent company of the Sponsors. Accordingly, transactions in Microsoft Common Stock qualify as exempt party-in-interest transactions. As of December 31, 2016 and 2015, the Plan held 36,401 shares of Microsoft Common Stock valued at $2,261,958 and 40,524 shares valued at $2,300,731, respectively. During the years ended December 31, 2016 and 2015, the Plan recorded Microsoft Common Stock dividend income of $57,848 and $53,264, respectively.

Nonexempt Party-In-Interest Transactions

The Plan remitted various participant contributions to the trustee later than required by the Department of Labor Regulation 2510.3-102. This regulation requires remittances to be made within three business days; however, in certain instances the remittances took four days or longer. To remediate these late remittances, the impacted participant accounts were credited by an amount representing investment income that would have been earned had the participant contributions been remitted on a timely basis. For 2013 through 2015, late contributions of $1,007,344 were made, of which $864,530 were remediated in 2016 and $142,814 were remediated in 2017, resulting in credits to participant accounts of $1,346 in 2016 and $40 in 2017. During the first half of 2016 there were late contributions totaling $481,364, of which $478,050 were remediated in 2016 and $3,314 were remediated in 2017, resulting in credits to participant accounts of $321 in 2016 and $1 in 2017.

NOTE 5 — FINANCIAL INSTRUMENTS

The Plan accounts for certain assets at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. The Plan categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

The Plan holds cash equivalents that are valued using the Net Asset Value (“NAV”) provided by the trustee in order to estimate fair value. Cash equivalents are held primarily in a short-term money market funds that are registered with the Securities and Exchange Commission. These funds primarily invest in short-term U.S. Treasury obligations. The Plan’s money market funds are valued using the NAV provided by the trustee in order to estimate fair value. The money market fund prices its units at NAV on a daily basis and the NAV is maintained at $1 a unit. The interests in the money market fund are currently redeemable at NAV on a daily basis.

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NOTE 6 — RELATED PARTY TRANSACTIONS

Certain general and administrative expenses are paid by the Sponsors on behalf of the Plan. During the years ended December 31, 2016 and 2015, these expenses amounted to $54,775 and $52,028, respectively.

NOTE 7 — SUBSEQUENT EVENTS

Subsequent events were evaluated through June 22, 2017, the date the financial statements were issued.

Late contributions of $146,128 from 2015 and 2016 were corrected in 2017, which resulted in earnings of $41 that were credited to participant accounts in 2017. See Note 4 — Party-In-Interest Transactions for additional details.

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