Mercury Insurance 2008 Annual Report Download - page 70

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60
Depreciation and Amortization
Buildings are stated at the lower of cost or fair value and depreciated on a straight line basis over 30 years. Furniture and
equipment and purchased software are stated at cost and depreciated on a combination of straight-line and accelerated methods
over 3 to 10 years. Automobiles are depreciated over 5 years, using an accelerated method. Internally developed computer
software is capitalized in accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use,” and amortized on a straight-line method over the estimated useful life of the software,
not exceeding five years. Leasehold improvements are stated at cost and amortized over the life of the associated lease.
Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with SFAS No. 133, as amended by SFAS No.
138, “Accounting for Certain Derivative Instruments and Hedging Activities,” and SFAS No. 149, “Amendment of Statement 133
on Derivative Instruments and Hedging Activities.” SFAS No. 133 establishes accounting and reporting standards requiring that
all derivative instruments, other than those that meet the normal purchases and sales exception, be recorded on the balance sheet
as either an asset or liability measured at fair value which is generally based on information obtained from independent
parties. SFAS No. 133 also requires that changes in fair value be recognized currently in earnings unless specific hedge
accounting criteria are met. The Company’ s derivative instruments include interest rate swap agreements and are used to hedge
the exposure to:
• Changes in fair value of an asset or liability (fair value hedge);
• Variable cash flows of a forecasted transaction (cash flow hedge).
At December 31, 2008, the Company held one fair value hedge and one cash flow hedge, compared to one fair value
hedge at December 31, 2007.
Derivatives designated as hedges are evaluated based on established criteria to determine the effectiveness of their
correlation to, and ability to reduce the designated risk of specific securities or transactions. Effectiveness is reassessed on a
quarterly basis. Hedges that are deemed to be effective are accounted for as follows:
• Fair value hedge: changes in fair value of the hedging instrument, as well as the hedged item, are recognized in
income in the period of change.
• Cash flow hedge: changes in fair value of the hedging instrument are reported as a component of accumulated other
comprehensive income and subsequently amortized into earnings over the life of the hedged transactions.
If a hedge is deemed to become ineffective, it is accounted for as follows:
• Fair value hedge: changes in fair value of the hedging instrument, as well as the hedged item, are recognized in
earnings for the current period.
• Cash flow hedge: changes in fair value of the hedging instrument are reported in earnings for the current period. If it
is determined that a hedging instrument no longer meets the Company’ s risk reduction and correlation criteria, or if
the hedging instrument expires, any accumulated balance in other comprehensive income is recognized in earnings in
the period of determination.
Earnings Per Share
Earnings per share is presented in accordance with the provisions of SFAS No. 128, “Earnings per Share,” which
requires presentation of basic and diluted earnings per share for all publicly traded companies. Basic earnings per share is
computed based on the weighted average number of common shares outstanding. Diluted earnings per share is computed based
on the weighted average number of common and dilutive potential common shares outstanding. At December 31, 2008, potential
dilutive common shares consist of outstanding stock options. Note 13 of Notes to Consolidated Financial Statements contains the
required disclosures relating to the calculation of basic and diluted earnings per share.