Chesapeake Energy 2010 Annual Report Download - page 105

Under accounting guidance for income taxes, an enterprise must use judgment in considering the relative
impact of negative and positive evidence. The weight given to the potential effect of negative and positive
evidence should be commensurate with the extent to which it can be objectively verified. The more negative
evidence that exists (i) the more positive evidence is necessary and (ii) the more difficult it is to support a
conclusion that a valuation allowance is not needed for some portion or all of the deferred tax asset. Among the
more significant types of evidence that we consider are:
• taxable income projections in future years;
• whether the carryforward period is so brief that it would limit realization of the tax benefit;
• future sales and operating cost projections that will produce more than enough taxable income to
realize the deferred tax asset based on existing sales prices and cost structures; and
• our earnings history exclusive of the loss that created the future deductible amount coupled with
evidence indicating that the loss is an aberration rather than a continuing condition.
If (i) natural gas and oil prices were to decrease significantly below present levels (and if such decreases
were considered other than temporary), (ii) exploration, drilling and operating costs were to increase
significantly beyond current levels, or (iii) we were confronted with any other significantly negative evidence
pertaining to our ability to realize our NOL carryforwards prior to their expiration, we may be required to provide
a valuation allowance against our deferred tax assets. As of December 31, 2010, we had deferred tax assets of
$1.9 billion.
Accounting guidance for recognizing and measuring uncertain tax positions prescribes a threshold
condition that a tax position must meet for any of the benefit of the uncertain tax position to be recognized in
the financial statements. Guidance is also provided regarding de-recognition, classification and disclosure of
these uncertain tax positions. Based on this guidance, we regularly analyze tax positions taken or expected to
be taken in a tax return based on the threshold condition prescribed. Tax positions that do not meet or exceed
this threshold condition are considered uncertain tax positions. We accrue interest related to these uncertain
tax positions which is recognized in interest expense. Penalties, if any, related to uncertain tax positions would
be recorded in other expenses. Additional information about uncertain tax positions appears in Note 5 of the
notes to our consolidated financial statements.
Disclosures About Effects of Transactions with Related Parties
Chief Executive Officer
As of December 31, 2010, we had accrued accounts receivable from our Chief Executive Officer, Aubrey
K. McClendon, of $30 million representing joint interest billings from December 2010 which were invoiced and
timely paid in January 2011. Since Chesapeake was founded in 1989, Mr. McClendon has acquired working
interests in virtually all of our natural gas and oil properties by participating in our drilling activities under the
terms of the Founder Well Participation Program (FWPP) and predecessor participation arrangements provided
for in Mr. McClendon’s employment agreements. Under the FWPP, approved by our shareholders in June
2005, Mr. McClendon may elect to participate in all or none of the wells drilled by or on behalf of Chesapeake
during a calendar year, but he is not allowed to participate only in selected wells. A participation election is
required to be received by the Compensation Committee of Chesapeake’s Board of Directors not less than 30
days prior to the start of each calendar year. His participation is permitted only under the terms outlined in the
FWPP, which, among other things, limits his individual participation to a maximum working interest of 2.5% in a
well and prohibits participation in situations where Chesapeake’s working interest would be reduced below
12.5% as a result of his participation. In addition, the company is reimbursed for costs associated with
leasehold acquired by Mr. McClendon as a result of his well participation.
On December 31, 2008, we entered into a new five-year employment agreement with Mr. McClendon that
contained a one-time well cost incentive award to him. The total cost of the award to Chesapeake was $75
million plus employment taxes in the amount of approximately $1 million. We are recognizing the incentive
award as general and administrative expense over the five-year vesting period for the clawback described
below, resulting in an expense of approximately $15 million per year beginning in 2009. In addition to state and
federal income tax withholding, similar employment taxes were imposed on Mr. McClendon and withheld from
the award. The net incentive award of approximately $44 million was fully applied against costs attributable to
interests in company wells acquired by Mr. McClendon or his affiliates under the FWPP. The incentive award is
subject to a clawback equal to any unvested portion of the award if during the initial five-year term of the
employment agreement, Mr. McClendon resigns from the company or is terminated for cause by the company.
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