What Constitutes Depreciation and Its Income Statement Location
Microsoft’s depreciable asset base is anchored by the massive physical and digital infrastructure required to sustain the Azure cloud ecosystem and its legacy software empire. The assets consist primarily of computer equipment (servers and networking gear), physical buildings and leasehold improvements, and software developed or acquired for internal use. The company explicitly states in its accounting policies that land is not depreciated, while computer equipment is depreciated over two to six years, buildings over five to 15 years, and capitalized software over three years.
On the consolidated income statement, Microsoft does not report depreciation as an independent line item. The expense is dispersed across the functional areas of the business. The vast majority is absorbed by “Cost of Revenue,” which houses the immense depreciation of the Azure data centers. A significant portion is also allocated to “Research and Development” and “Sales and Marketing”. Crucially, because Microsoft relies heavily on finance and operating leases to rapidly acquire data center capacity without upfront cash purchases, the amortization of Right-of-Use (ROU) assets also plays a highly significant role in its overall expense structure.
Factors Affecting Depreciation
Microsoft’s depreciation expenses are entirely governed by its relentless global expansion to accommodate the massive compute workloads of OpenAI and the explosive enterprise adoption of the Azure AI platform. Similar to Alphabet and Meta, Microsoft proactively adjusted its accounting metrics to protect its profit margins during the early phases of the buildout. In fiscal year 2023, Microsoft extended the estimated useful lives of its server and network equipment from four years to six years. Management cited investments in software efficiencies as the justification. This single accounting adjustment boosted operating income by a massive $3.7 billion that year by drastically lowering the periodic depreciation hit.
Looking forward, the sheer volume of asset capitalization is staggering. By mid-2025, Microsoft’s accumulated depreciation on property and equipment reached $93.6 billion, up significantly from $76.4 billion the year prior. Furthermore, Microsoft’s depreciation profile is unique due to its aggressive use of leasing. The company holds over $92.7 billion in un-commenced data center leases that will activate between 2026 and 2031. Once these facilities go live, they will trigger a massive, unavoidable wave of lease amortization that will act as a persistent, escalating drag on the Cost of Revenue for the next decade.
5-Year Historical Trends (2021 - 2025)
Microsoft’s cash flow data reveals a relentless, compounding acceleration of capital expenses and subsequent depreciation, perfectly mirroring its rise as the early leader in generative AI deployment.
Fiscal Year (Ends June 30) | Total D&A (Cash Flow Statement) | Capital Expenditures | Free Cash Flow |
2021 | $11.69 Billion | -$20.62 Billion | $56.12 Billion |
2022 | $14.46 Billion | -$23.89 Billion | $65.15 Billion |
2023 | $13.86 Billion | -$28.11 Billion | $59.48 Billion |
2024 | $22.29 Billion | -$44.48 Billion | $74.07 Billion |
2025 | $34.15 Billion | -$64.55 Billion | $71.61 Billion |
The temporary, artificial drop in D&A in 2023 (falling to $13.86 billion) highlights the exact moment the six-year useful life extension was applied to the income statement. However, the accounting dam broke in 2024 and 2025, with D&A surging by 60% and 53% sequentially as the absolute volume of new Azure server deployments completely overpowered the extended amortization timeline.
Predictions and Forecasts (2026 - 2028)
Microsoft’s capital expenditure reached an annualized run rate exceeding $100 billion going into fiscal 2026, driven by the procurement of custom “Maia” AI chips and massive Nvidia clusters. In the second quarter of fiscal 2026 alone, Microsoft spent $37.5 billion on infrastructure. Analysts forecast D&A to jump to $50.5 billion in fiscal 2026, scaling rapidly toward $72.5 billion by 2028. The legendary 45%+ operating margins that have historically justified Microsoft’s premium valuation are expected to face sustained, structural compression as this wave of depreciation heavily filters through the Cost of Revenue over the next 36 months.
The “AI Tax” and Margin Reality
Microsoft is widely regarded as the vanguard of the artificial intelligence revolution, but beneath the pristine surface of its $81.3 billion Q2 2026 revenue print lies a profound and irreversible shift in corporate physiology. Microsoft is steadily transitioning from a high-margin, asset-light software licensing company into an asset-heavy, capital-intensive infrastructure utility. The central thesis for Microsoft bears is that the broader equities market is valuing the company on historical software multiples (which peaked near 35x forward earnings) while stubbornly ignoring the creeping reality that it operates increasingly like a low-margin hardware leasing business.
The warning signs are entirely contained within the relationship between skyrocketing capital expenditures and the delayed onset of depreciation. In fiscal 2025, Microsoft generated $34.15 billion in depreciation and amortization on its cash flow statement, while spending $64.55 billion in pure CapEx. By the second quarter of fiscal 2026, the spending velocity had detached from historical norms; Microsoft reported spending $37.5 billion on infrastructure in a single quarter. This points to an annualized CapEx run rate comfortably in excess of $105 billion. Investors must recognize the basic laws of double-entry accounting: every dollar capitalized on the balance sheet today will inevitably route through the income statement as a depreciation expense tomorrow. The “AI Tax” is collected in the form of inescapable, relentless depreciation.
Microsoft has temporarily insulated its gross margins by utilizing the exact same useful life extension tactic seen at Alphabet and Meta. By extending server life to six years in 2023, Microsoft saved $3.7 billion in operating income, protecting the narrative of expanding software margins. However, this accounting shield is rapidly wearing thin. The next generation of Azure datacenters requires complex liquid cooling, proprietary silicon (the Maia accelerators), and massive power infrastructure to host OpenAI’s increasingly compute-hungry foundation models. As this $105 billion annual CapEx bill begins to amortize, the Cost of Revenue line will swell dramatically. We project that D&A will effortlessly cross the $50 billion threshold in fiscal 2026 and surge past $70 billion by 2028. This mathematical certainty will force a compression of Microsoft’s operating margins unless Azure AI revenue scales at an unprecedented, parabolic rate to offset the fixed costs.
Furthermore, Microsoft’s true infrastructure liabilities are heavily understated on the balance sheet. A deep dive into the 10-K footnotes reveals a staggering $92.7 billion in additional data center leases that have been signed but have not yet commenced. Because these are operating and finance leases, they will trigger a massive wave of right-of-use (ROU) asset amortization over the next five to ten years once the facilities go live. Microsoft is functionally locked into hundreds of billions of dollars in future expenses. Additionally, the strategic reliance on OpenAI - which reportedly accounts for up to 45% of Microsoft’s future cloud contracts - adds a severe layer of single-customer concentration risk. Microsoft’s Azure division is clearly winning the AI platform war, but the cost of victory is a permanent reduction in the structural profitability of the firm, leading to the multiple compression (falling to ~26x forward earnings) witnessed in early 2026.