American Home Shield 2006 Annual Report Download - page 35

connection with the acquisition of that entity. At any time, the former owners may convert this equity security into eight million
ServiceMaster common shares. The ServiceMaster shares are included in the shares used for the calculation of diluted earnings per
share whenever their inclusion has a dilutive impact. Subsequent to December 31, 2005, ServiceMaster has the ability to require
conversion of the security into ServiceMaster common shares, provided the closing share price of ServiceMaster's common stock
averages at least $15 per share for 40 consecutive trading days.
Total shareholders' equity was $1.1 billion and $992 million at December 31, 2005 and 2004, respectively. The increase primarily
reflects operating profits in the business offset in part by cash dividend payments and share repurchases.
Under federal tax rules, dividends are considered taxable only when paid out of current or accumulated earnings and profits as
defined under federal tax laws. As a result of its December 1997 reincorporation, the Company only began generating corporate
earnings and profits for tax purposes in 1998. Since 1998, earnings and profits for tax purposes have been reduced by dividend
payments, amortization of intangible assets for tax reporting, deductions relating to business closures and the timing of certain other
tax-related items. The Company currently expects that approximately 60 percent of its 2006 dividends on common stock will be
taxable as dividend income for federal income tax purposes. This is lower than the previously disclosed taxability percentage for
2005 dividends of 87 percent, primarily due to one-time effects of the pending dispositions. The 2006 estimate is subject to change,
based on the outcome of future events. Any portion of the dividend that is not taxable would be treated as a return of capital and
would generally be applied to reduce the cost basis of the shares. The Company expects that the taxable portion of its dividend will
rebound sharply in 2007, and grow to be fully taxable over the succeeding few years.
Financial Position – Businesses Held Pending Sale and Discontinued Operations
The assets and liabilities related to businesses held pending sale and discontinued businesses have been classified in a separate
caption on the Consolidated Statements of Financial Position. Assets from the businesses held pending sale and discontinued
operations have increased, reflecting growth in receivables at the American Residential Services (ARS) and American Mechanical
Services (AMS) businesses. The increase in liabilities from businesses held pending sale and discontinued operations represents
increases in payables and other current liabilities at the ARS and AMS businesses, partially offset by reductions associated with the
favorable conclusion of certain obligations related to the previously sold international pest control operations. The remaining
liabilities primarily represent payables and other current liabilities at the businesses held pending sale and obligations related to
long-term self-insurance claims.
Critical Accounting Policies and Estimates
The preparation of the financial statements requires management to make certain estimates and assumptions required under
generally accepted accounting principles which may differ from actual results. The more significant areas requiring the use of
management estimates relate to the allowance for receivables, accruals for self-insured retention limits related to medical, workers'
compensation, auto and general liability insurance claims, accruals for home warranty claims, the possible outcomes of outstanding
litigation, accruals for income tax liabilities as well as deferred tax accounts, the deferral and amortization of customer acquisition
costs, useful lives for depreciation and amortization expense and the valuation of tangible and intangible assets.
The allowance for receivables is developed based on several factors including overall customer credit quality, historical write-off
experience and specific account analyses that project the ultimate collectibility of the outstanding balance. As such, these factors
may change over time causing the reserve level to vary.
The Company carries insurance policies on insurable risks at levels which it believes to be appropriate, including workers'
compensation, auto and general liability risks. The Company has self-insured retention limits and insured layers of excess insurance
coverage above those limits. Accruals for self-insurance losses and warranty claims in the American Home Shield business are
made based on the Company's claims experience and actuarial projections. Current activity could differ causing a change in
estimates. The Company has certain liabilities with respect to existing or potential claims, lawsuits, and other proceedings. The
Company accrues for these liabilities when it is probable that future costs will be incurred and such costs can be reasonably
estimated. Any resulting adjustments, which could be material, are recorded in the period identified.
The Company records deferred income tax balances based on the net tax effects of temporary differences between the carrying
value of assets and liabilities for financial reporting purposes and income tax purposes. There are significant amortizable intangible
assets for tax reporting purposes (not for financial reporting purposes) which arose as a result of the Company's reincorporation
from partnership to corporate form in 1997. The Company records its deferred tax items based on the estimated value of the tax
basis. The Company adjusts tax estimates when required to reflect changes based on factors such as changes in tax laws, results of
tax authority reviews and statutory limitations.
Fixed assets, and intangible assets with finite lives, are depreciated and amortized on a straight-line basis over their estimated useful
lives. These lives are based on the Company's previous experience for similar assets, potential market obsolescence, and other
industry and business data. The Company also periodically reviews the assets for impairment and a loss would be recorded if and
when the Company determined that the book value of the asset exceeded its fair value. Changes in the estimated useful lives or in
asset values would cause the Company to adjust its book value or future expense accordingly.
The Company reviews its goodwill and trade names at least once a year for impairment. An impairment loss would be recorded if
and when the Company determines that the expected present value of the future cash flows deemed to be derived from the asset is
less than its corresponding book value. As permitted under SFAS 142, the Company carries forward a reporting unit's valuation
from the most recent valuation under the following conditions: the assets and
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