The proposed device in is line with Microsoft's move toward becoming a hardware and software company in same vein as Apple, analysts said.
Microsoft has been open about its plans to produce more hardware in the future like its recently released Surface tablet computer.
Microsoft announced a partnership with smartphone company Nokia in February 2011 but has struggled to get many consumers interested in its Windows Phone operating system on phones made by partners including Samsung, LG and HTC, The Washington Post said.
The Wall Street Journal said unnamed "people familiar with the situation" in Taipei, Taiwan, told it the phone being tested in Asia has a screen size of 4- to 5 inches, which would position the phone between Apple's iPhone and Samsung's Galaxy S III.
Notable deaths of 2014 [PHOTOS]