YEARS ENDED MARCH 31, 2001, 2000 and 1999

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business—Compuware Corporation develops, markets and supports an integrated set of systems software products designed to improve the productivity of data processing professionals in application development, implementation and maintenance. In addition, the Company's Professional Services Division offers business systems analysis, design, programming and implementation as well as software conversion and systems planning and consulting. The Company's products and services are offered worldwide across a broad spectrum of technologies, including mainframe and distributed systems platforms.

Basis of Presentation-The consolidated financial statements include the accounts of Compuware Corporation and its wholly owned subsidiaries after elimination of all significant intercompany balances and transactions. The financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities and the disclosure of contingencies at March 31, 2001 and 2000 and the results of operations for the years ended March 31, 2001, 2000 and 1999. While management has based their assumptions and estimates on the facts and circumstances known at March 31, 2001, final amounts may differ from estimates.

Revenue Recognition—Revenue from licensing of software products is recognized upon shipment of the products, provided that no significant obligations remain and collection of the related receivable is deemed probable. The portion of license fees associated with maintenance and enhancements is deferred and recognized ratably over the maintenance period. License revenue associated with certain transactions that include an option to exchange or select products in the future is deferred and recognized over the term of the deal. When the license portion is paid over a number of years, the license portion of the payment stream is discounted to its net present value. Interest income is recognized over the payment term. Product maintenance renewal fees are recognized as revenue ratably over the maintenance term. Professional services fees are recognized in the period the services are performed provided that collection of the related receivable is deemed probabie.

Cash and Cash Equivalents—For the purpose ot the statement of cash flows, the Company considers all investments with an original maturity of three months or less to be cash equivalents.

Investments consist of municipal obligations, tax-free and tax advantage auction rate securities. All are classified as held-to-maturity and carried at amortized cost. Those investments that mature within one year from the balance sheet date are classified as short-term. The amortization of bond premiums and discounts is included in interest and investment income.

Property and Equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the related assets.

Capitalized Software includes the costs of purchased and internally developed software products and is stated at the lower of unamortized cost or net realizable value. Net purchased software included in capitalized software at March 31, 2001 and 2000 is $48,353,000 and $60,029,000, respectively. Capitalization of internally developed software products begins when technological feasibility of the product is established. Software product development includes all expenditures for research and development, net of amounts capitalized. Total software development costs incurred internally by the Company were $116,147,000, $95,629,000 and $76,831,000 in fiscal 2001, 2000 and 1999, respectively, of which $13,530,000, $14,496,000 and $11,874,000, respectively, were capitalized.

The amortization for both internally developed and purchased software products is computed on a product-by-product basis. The annual amortization is the greater of the amount computed using (a) the ratio that current gross revenues for a product bear to the total of current and anticipated future revenues for that product or (b) the straight-line method over the remaining estimated economic life of the product, including the period being reported on. Amortization begins when the product is avallable for general release to customers. The amortization period for capitalized software is generally five years. Capitalized software amortization is included in "cost of software license fees" in the consolidated statements of income.

Excess of Cost Over Fair Value of Net Assets Acquired ("goodwill") is being amortized over periods ranging from 10 to 20 years using the straight-line method. The Company regularly evaluates the period of amortization to determine whether later events and circumstances warrant revised estimates of useful lives. Goodwill amortization expense was approximately $41,302,000, $25,252,000 and $4,857,000, for the fiscal years ended March 31, 2001, 2000 and 1999, respectively. These amounts are included in "administrative and general" in the consolidated statements of income.

Fair Value of Financial Instruments—The carrying value of cash equivalents, current accounts receivable and accounts payable approximated fair values due to the short-term maturities of these instruments. At March 31, 2001, the fair value of long-term receivables is approximately $349,216,000 compared to the carrying amount of $356,431,000. At March 31, 2000, the fair value of long-term receivables was approximately $371,145,000 compared to the carrying amount of $399,911,000. The fair value of non-current accounts receivable is estimated by discounting the future cash flows using the current rate at which the Company would finance a similar transaction.

Income Taxes—The Company accounts for income taxes using the asset and liability approach. Deferred income taxes are provided for the differences between the tax bases of assets or liabilities and their reported amounts in the financial statements.

Foreign Currency Translation—The Company's foreign subsidiaries use the local currency as the functional currency. Accordingly, assets and liabilities in the consolidated balance sheets have been translated at the rate of exchange at the respective balance sheet dates, and revenues and expenses have been translated at average exchange rates prevailing during the year the transactions occur. Translation adjustments have been excluded from the results of operations and are reported as accumulated other comprehensive loss.

Foreign Currency Transactions and Derivatives— Gains and losses from foreign currency transactions are included in the determination of net income. To offset the risk of future currency fluctuations on receivables due from foreign subsidiaries, the Company enters into foreign exchange contracts to sell or buy currencies at specified rates on specific dates. Market value gains and losses on these contracts are recognized, offsetting foreign exchange gains or losses on foreign receivables. The Company does not use foreign exchange contracts to hedge anticipated transactions. The net foreign currency transaction loss was $2,487,000, $464,000 and $2,944,000 for the fiscal years ended March 31, 2001, 2000 arid 1999, respectively. These amounts are included in "sales and marketing" in the consolidated statements of income.

At March 31, 2001, the Company had contracts maturing through April 2001 to sell $43,115,000 in foreign currencies. At March 31, 2000, tha Company had contracts maturing through April 2000 to sell $39,286,000 in foreign currencies.

Earnings Per Share—Basic EPS is computed by dividing, earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS assumes the issuance of common stock for all potentially dilutive equivalent shares outstanding.

Business Segments—The Company's two principal operating segments are products and services. The Company provides software products and professional services to IT organizations that help information technology professionals efficiently develop, implement and support the applications that run their businesses.

Recently Issued Accounting Pronouncements- Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities," is effective for all fiscal years beginning after June 15, 2000. SFAS 133, as amended establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Under SFAS 133, certain contracts that were not formerly considered derivatives may now meet the definition of a derivative. The Company will adopt SFAS 133 effective April 1, 2001. The adoption of SFAS 133 will not have a significant impact on the financial position, results of operations, or cash flows of the Company.