Paychex 2010 Annual Report Download - page 43

as of the date of grant. We estimate the fair value of stock option grants using a Black-Scholes option pricing model.
This model requires various assumptions as inputs including expected volatility of the Paychex stock price and
expected option life. We estimate volatility based on a combination of historical volatility using weekly stock prices
over a period equal to the expected option life and implied market volatility. Expected option life is estimated based
on historical exercise behavior.
We are required to estimate forfeitures and only record compensation costs for those awards that are expected
to vest. Our assumptions for forfeitures were determined based on type of award and historical experience.
Forfeiture assumptions are adjusted at the point in time a significant change is identified with any adjustment
recorded in the period of change, and the final adjustment at the end of the requisite service period to equal actual
forfeitures.
The assumptions of volatility, expected option life, and forfeitures all require significant judgment and are
subject to change in the future due to factors such as employee exercise behavior, stock price trends, and changes to
type or provisions of stock-based awards. Any change in one or more of these assumptions could have a material
impact on the estimated fair value of an award and on stock-based compensation costs recognized in our results of
operations.
We have determined that the Black-Scholes option pricing model, as well as the underlying assumptions used
in its application, is appropriate in estimating the fair value of stock option grants. We periodically reassess our
assumptions as well as our choice of valuation model, and will reconsider use of this model if additional information
becomes available in the future indicating that another model would provide a more accurate estimate of fair value,
or if characteristics of future grants would warrant such a change.
Income taxes: We account for deferred taxes by recognition of deferred tax assets and liabilities for the
expected future tax consequences of events that have been included in the Consolidated Financial Statements or tax
returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the
financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. We record a deferred tax asset related to the stock-based compensation costs
recognized for certain stock-based awards. At the time of exercise of non-qualified stock options or vesting of stock
awards, we account for the resulting tax deduction by reducing our accrued income tax liability with an offset to the
deferred tax asset and any excess tax benefit increasing additional paid-in capital. We currently have a sufficient
pool of excess tax benefits in additional paid-in capital to absorb any deficient tax benefits related to stock-based
awards.
We maintain a reserve for uncertain tax positions. We evaluate tax positions taken or expected to be taken in a
tax return for recognition in our Consolidated Financial Statements. Prior to recording the related tax benefit in our
Consolidated Financial Statements, we must conclude that tax positions must be “more likely than not” to be
sustained, assuming those positions will be examined by taxing authorities with full knowledge of all relevant
information. The benefit recognized in our Consolidated Financial Statements is the amount we expect to realize
after examination by taxing authorities. If a tax position drops below the “more likely than not” standard, the benefit
can no longer be recognized. Assumptions, judgment, and the use of estimates are required in determining if the
“more likely than not” standard has been met when developing the provision for income taxes and in determining
the expected benefit. A change in the assessment of the “more likely than not” standard could materially impact our
results of operations or financial position. Our reserve for uncertain tax positions was $27.5 million as of May 31,
2010 and $25.7 million as of May 31, 2009. Refer to Note H of the Notes to Consolidated Financial Statements for
further discussion of our reserve for uncertain tax positions.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk Factors
Changes in interest rates and interest rate risk: Funds held for clients are primarily comprised of short-term
funds and available-for-sale securities. Corporate investments are primarily comprised of available-for-sale
securities. As a result of our operating and investing activities, we are exposed to changes in interest rates that
may materially affect our results of operations and financial position. Changes in interest rates will impact the
27