Paychex 2011 Annual Report Download - page 58

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conducted under their respective logos. Commissions earned by the Associates are based on the processing activity
for the related clients. Revenue generated from customers as a result of these relationships and commissions paid to
Associates are included in the Consolidated Statements of Income as service revenue and selling, general and
administrative expenses, respectively.
PEO workers’ compensation insurance: Workers’ compensation insurance reserves are established to
provide for the estimated costs of paying claims underwritten by the Company. These reserves include estimates for
reported losses, plus amounts for those claims incurred but not reported and estimates of certain expenses associated
with processing and settling the claims. In establishing the workers’ compensation insurance reserves, the Company
uses an independent actuarial estimate of undiscounted future cash payments that would be made to settle the
claims.
Estimating the ultimate cost of future claims is an uncertain and complex process based upon historical loss
experience and actuarial loss projections, and is subject to change due to multiple factors, including economic
trends, changes in legal liability law, and damage awards, all of which could materially impact the reserves as
reported in the consolidated financial statements. Accordingly, final claim settlements may vary from the present
estimates, particularly when those payments may not occur until well into the future.
The Company regularly reviews the adequacy of its estimated workers’ compensation insurance reserves.
Adjustments to previously established reserves are reflected in the results of operations for the period in which the
adjustment is identified. Such adjustments could possibly be significant, reflecting any variety of new and adverse
or favorable trends.
The Company’s maximum individual claims liability was $1.0 million under both its fiscal 2011 and fiscal
2010 policies. As of May 31, 2011 and May 31, 2010, the Company had recorded current liabilities of $7.3 million
and $5.8 million, respectively, and long-term liabilities of $20.6 million and $20.1 million, respectively, on its
Consolidated Balance Sheets for workers’ compensation claims.
Stock-based compensation costs: All stock-based awards to employees, including grants of stock options,
are recognized as compensation costs in the consolidated financial statements based on their fair values measured as
of the date of grant. The Company estimates 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. Volatility is estimated 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.
The Company is required to estimate forfeitures and only record compensation costs for those awards that are
expected to vest. The 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 the Company’s
results of operations.
The Company has 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. The Company
periodically reassesses its assumptions as well as its 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.
42
PAYCHEX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)