Health Net 2005 Annual Report Download - page 104

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HEALTH NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
examination, and amounts are released from the reserve upon closure of such examinations or upon closure of the
statute of limitations for assessment. The estimates of contingent tax costs comprising the reserve balance have
been developed after careful analysis of the applicable statutory authority and court case precedent. As such, we
believe that the reserve reflects the probable outcome of contingent tax challenges and that the probability of
material assessments above the reserve balance is remote. The reserve is included in accounts payable and other
liabilities in our consolidated balance sheets.
Recently Issued Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123
(revised 2004), “Share-Based Payment,” (SFAS No. 123 (R)) which is a revision of FASB Statement No. 123,
“Accounting for Stock-Based Compensation” (SFAS No. 123). SFAS No. 123(R) supersedes Accounting
Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB Opinion 25) and
amends FASB Statement No. 95, “Statement of Cash Flows” (SFAS No. 95). Generally, the approach in SFAS
No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-
based payments to employees, including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS No. 123(R) also
requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing
cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce
net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot
estimate what those amounts will be in the future (because they depend on, among other things, when employees
exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax
deductions were $21.3 million, $2.5 million, and $15.7 million in 2005, 2004 and 2003, respectively.
SFAS No. 123(R) originally required adoption no later than July 1, 2005. In April 2005, the Securities and
Exchange Commission (SEC) issued a release that amends the compliance dates for SFAS No. 123(R). Under the
SEC’s new rule, we will be required to apply SFAS No. 123(R) as of January 1, 2006.
SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods:
• A “modified prospective” method in which compensation cost is recognized beginning with the
effective date (a) based on the requirements of SFAS No. 123(R) for all share-based payments granted
after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to
employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date.
• A “modified retrospective” method which includes the requirements of the modified prospective method
described above, but also permits entities to restate, based on the amounts previously recognized under
SFAS No. 123 for purposes of pro forma disclosures, either (a) all prior periods presented or (b) prior
interim periods of the year of adoption.
We plan to adopt SFAS No. 123 (R) using the modified-prospective method.
We expect the impact of SFAS No. 123(R) on our net income and net income per share to approximate that
shown in our current pro forma disclosure relating to share based compensation expense.
In June 2005, the Emerging Issues Task Force (EITF) reached consensus on the Issue No. 05-6,
“Determining the Amortization Period for Leasehold Improvements.” This Issue provides guidance on
determination of the amortization period for leasehold improvements that are purchased subsequent to the
inception of the lease. Such leasehold improvements should be amortized over the lesser of the useful life of the
asset or the lease term that includes reasonably assured lease renewals. This Issue is effective for the leasehold
F-16