Pepsi 2006 Annual Report Download - page 67

For additional unaudited information
on our income tax policies, including
our reserves for income taxes, see “Our
Critical Accounting Policies” in
Management’s Discussion and Analysis.
Carryforwards, Credits and
Allowances
Operating loss carryforwards totaling
$6.1 billion at year-end 2006 are being
carried forward in a number of foreign
and state jurisdictions where we are
permitted to use tax operating losses
from prior periods to reduce future tax-
able income. These operating losses will
expire as follows: $0.2 billion in 2007,
$5.0 billion between 2008 and 2026 and
$0.9 billion may be carried forward
indefinitely. In addition, certain tax
credits generated in prior periods of
approximately $33.9 million are avail-
able to reduce certain foreign tax
liabilities through 2011. We establish
valuation allowances for our deferred
tax assets when the amount of
expected future taxable income is not
likely to support the use of the deduc-
tion or credit.
Undistributed International Earnings
The AJCA created a one-time incentive
for U.S. corporations to repatriate
undistributed international earnings by
providing an 85% dividends received
deduction. In 2005, we repatriated
approximately $7.5 billion in earnings
previously considered indefinitely rein-
vested outside the U.S. and recorded
income tax expense of $460 million
related to this repatriation. Other than
the earnings repatriated, we intend to
continue to reinvest earnings outside
the U.S. for the foreseeable future and,
therefore, have not recognized any U.S.
tax expense on these earnings. At
December 30, 2006, we had approxi-
mately $10.8 billion of undistributed
international earnings.
Reserves
A number of years may elapse before a
particular matter, for which we have
established a reserve, is audited and
finally resolved. The number of years
with open tax audits varies depending
on the tax jurisdiction. In 2006, we rec-
ognized non-cash tax benefits of
$602 million, substantially all of which
related to the IRS’s examination of our
consolidated income tax returns for the
years 1998 through 2002. The IRS issued
a Revenue Agent’s Report (RAR), and
we are in agreement with their conclu-
sion, except for one matter which we
continue to dispute. The agreed adjust-
ments relate to transfer pricing and
various other transactions, including
certain acquisitions, the public offering
of PBG, as well as the restructuring of
our international snack foods
operations during that audit period.
During 2004, we recognized $266 mil-
lion of tax benefits related to the
favorable resolution of certain previ-
ously open tax issues. In addition, in
2004, we recognized a tax benefit of
$38 million upon agreement with the
IRS on a previously open issue related to
our discontinued restaurant operations.
The IRS has initiated their audits of
our tax returns for the years 2003
through 2005. While it is often difficult
to predict the final outcome or the tim-
ing of resolution of any particular tax
matter, we believe that our reserves
reflect the probable outcome of known
tax contingencies. We adjust these
reserves, as well as the related interest,
in light of changing facts and circum-
stances. Settlement of any particular
issue would usually require the use of
cash. Favorable resolution would be rec-
ognized as a reduction to our annual
tax rate in the year of resolution. Our
tax reserves, covering all federal, state
and foreign jurisdictions, are presented
on our balance sheet within other liabil-
ities (see Note 14), except for any
amounts relating to items we expect to
pay in the coming year which are
included in current income taxes
payable. For further unaudited infor-
mation on the impact of the resolution
of open tax issues, see “Other
Consolidated Results.”
As further discussed in Note 2, we
will adopt FIN 48 as of the beginning of
our 2007 fiscal year.
Our stock-based compensation program
is a broad-based program designed to
attract and retain employees while also
aligning employees’ interests with the
interests of our shareholders. A majority
of our employees participate in our
stock-based compensation programs. In
addition, members of our Board of
Directors participate in our stock-based
compensation program in connection
with their service on our Board. Stock
options and RSUs are granted to
employees under the shareholder-
approved 2003 Long-Term Incentive
Plan (LTIP), our only active stock-based
plan. Stock-based compensation
expense was $270 million in 2006,
$311 million in 2005 and $368 million in
2004. Related income tax benefits rec-
ognized in earnings were $80 million in
2006, $87 million in 2005 and $103 mil-
lion in 2004. Stock-based compensation
cost capitalized in connection with our
BPT initiative was $3 million in 2006,
$4 million in 2005 and none in 2004. At
year-end 2006, 36 million shares were
available for future stock-based com-
pensation grants. For additional
unaudited information on our stock-
based compensation program, see “Our
Critical Accounting Policies” in
Management’s Discussion and Analysis.
Method of Accounting and
Our Assumptions
We account for our employee stock
options, which include grants under our
executive program and broad-based
SharePower program, under the fair
value method of accounting using a
Black-Scholes valuation model to mea-
sure stock option expense at the date of
grant. All stock option grants have an
exercise price equal to the fair market
value of our common stock on the date
of grant and generally have a 10-year
term. The fair value of stock option
grants is amortized to expense over the
vesting period, generally three years.
Note 6 — Stock–Based Compensation
65
267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 65