When is a Windows update not an update? When it's an upgrade

Microsoft labels Windows 8.1 an 'update,' not an 'upgrade,' to avoid deferring revenue

For Microsoft, there's a difference, a big difference, between a Windows upgrade and an update, even though both can be handed out free of charge to customers.

A free upgrade requires the company to set aside revenue at the time of sale, then recognize that revenue only when the upgrade is released. An update, on the other hand, lets the firm book all sales immediately.

The distinction may seem arcane or even meaningless to customers, but it has an impact: If Microsoft had called Windows 8.1, the overhaul slated to ship later this year, an upgrade, it would have had to either charge customers for the software or retroactively adjust Windows revenue to account for the deferrals, depressing that division's earnings over the last several quarters even further.

Microsoft spelled out the difference between upgrade and update in a regulatory filing this week with the U.S. Securities & Exchange Commission (SEC).

"Software updates are evaluated on a case-by-case basis to determine whether they meet the definition of an upgrade, which may require revenue to be deferred and recognized when the upgrade is delivered," Microsoft said in the Form 10-K.

"Windows 8.1 will enable new hardware, further the integration with other Microsoft services and address customer issues with Windows 8, and will be provided to Windows 8 customers when available at no additional charge," the company continued. "We evaluated Windows 8.1 and determined that it did not meet the definition of an upgrade and thus have not deferred revenue related to this planned release."

Microsoft can say Windows 8.1 is an update, not an upgrade, even though the list of new features, enhancements, improvements and changes has filled pages on the company's website and prompted much trumpeting by executives.

And those executives have been careful about what they call Windows 8.1, perhaps because of its accounting status, regularly labeling Windows 8.1 as an update and avoiding upgrade.

"It's a free update," said Tami Reller, then the CFO of the Windows group, at last month's Worldwide Partner's Conference (emphasis added). "I think it's safe to say that's a lot of functionality coming free in an update."

The casting of Windows 8.1 as an update reinforces the view by some analysts that Microsoft's oft-touted faster Windows development and release schedule is really its older practice of issuing irregular "service packs" with a new name.

Microsoft also gave away those service packs. It has discontinued them for Windows, but still issues them for other parts of its portfolio: A second service pack for Office 2010 shipped last week.

Windows 8.1 as an update also raises questions of how Microsoft will justify the eventual next upgrade of Windows.

The new faster tempo, most experts believe, will be composed of one or more interim updates -- Windows 8.1 is the first, Windows 8.2 next, and so on -- between each upgrade, the next of which could be called Windows 9. But if Windows 8.1 is packed with new features, software and hardware support, how much more will Microsoft have to deliver to, first of all, reasonably call Windows 9 an upgrade, and second, convince customers that the price tag is justified?

More importantly, how much more can Microsoft's engineers do for an every-few-years upgrade while they're also cranking out impressive interim updates?

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