The company announced a $6.2bn (£3.95bn) charge to write down the value of aQuantive, an online advertising agency it bought five years ago.
The announcement came as a surprise, but did not shock investors.
But the world's largest software company admitted: "The acquisition did not accelerate growth to the degree anticipated, contributing to the write-down."
Microsoft bought aQuantive for $6.3bn (£4.01bn) in an attempt to catch Google in the race for revenues from search-related display advertising.
It was Microsoft's biggest acquisition at the time, exceeded only by its purchase of Skype for $8.5bn (£5.4bn) last year.
But it never proved a success and aQuantive's top executives soon left Microsoft.
As a result of its annual assessment of goodwill - the amount paid for a company above its net assets - Microsoft said it would take a non-cash charge of $6.2bn, indicating the aQuantive acquisition is now worthless.
The charge is likely to wipe out any profit for the company's fourth financial quarter.
Wall Street was expecting Microsoft to report fiscal fourth-quarter net profit of about $5.25bn (£3.34bnbn), or 62 cents a share, on July 19.
In addition to the write-down, Microsoft said its expectations for future growth and profitability at its online services unit are "lower than previous estimates".
The unit includes the Bing search engine and MSN internet portal.
The company did not say what those previous estimates were, as it does not publish financial forecasts, but its online services division has proved the biggest drag on its earnings.
It is currently losing about $500m (£318.6m) a quarter as the company invests heavily in Bing in an attempt to catch up with market leader Google.
Even though its market share has been rising, Bing has not reached enough consumers to make the product profitable.
In the three years since then, Bing has almost doubled its market share to 15%, but that has been mostly at the expense of Yahoo.