Prudential 2005 Annual Report Download - page 22

Reserves for Contingencies
A contingency is an existing condition that involves a degree of uncertainty that will ultimately be resolved upon the occurrence of
future events. Under GAAP, reserves for contingencies are required to be established when the future event is probable and its impact can
be reasonably estimated. An example is the establishment of a reserve for losses in connection with an unresolved legal matter. The initial
reserve reflects management’s best estimate of the probable cost of ultimate resolution of the matter and is revised accordingly as facts and
circumstances change and, ultimately, when the matter is brought to closure.
Accounting Policies Adopted
Accounting for Stock Options
Employee stock options issued during 2001 and 2002 are accounted for using the intrinsic value method prescribed by Accounting
Principles Board, or APB, No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, an allowable alternative
method under Statement of Financial Accounting Standards, or SFAS, No.123, “Accounting for Stock-Based Compensation.” Under APB
No. 25, we did not recognize any stock-based compensation expense for employee stock options as all employee stock options had an
exercise price equal to the market value of our Common Stock at the date of grant. Effective January 1, 2003, we changed our accounting
for employee stock options to adopt the fair value recognition provisions of SFAS No. 123, as amended, prospectively for all new awards
granted to employees on or after January 1, 2003. Under these provisions, the fair value of all employee stock options awarded on or after
January 1, 2003, is included in the determination of net income, but not for options awarded prior thereto. Accordingly, the amount we
include in the determination of net income is less than that which would have been recognized if the fair value method had been applied to
all awards since inception of the employee stock option plan. The fair value of employee stock options issued prior to January 1, 2003 was
estimated using a Black-Scholes option-pricing model. For options issued on or after January 1, 2003, the fair value of each option was
estimated using a binomial option-pricing model. Both option-pricing models consider the following assumptions in estimating fair value:
dividend yield, expected volatility, risk-free interest rate, and expected life of the option. If we had recognized stock option expense for all
employee stock options under the fair value based accounting method, net income of the Financial Services Businesses for the year ended
December 31, 2005, would have been reduced by $10 million or, $0.02 per share of Common Stock on both a basic and diluted basis. The
net income of the Closed Block Business for the year ended December 31, 2005, would not have changed. For the year ended
December 31, 2004, net income of the Financial Services Businesses would have been reduced by $26 million or, $0.05 per share of
Common Stock on both a basic and diluted basis. The net income of the Closed Block Business for the year ended December 31, 2004,
would have been reduced by $1 million with no change in earnings per share of the Class B Stock. For the year ended December 31, 2003,
net income of the Financial Services Businesses would have been reduced by $35 million or $0.06 and $0.07 per share of Common Stock
on a basic and diluted basis, respectively. The net income of the Closed Block Business for the year ended December 31, 2003, would have
been reduced by $1 million with no change in earnings per share of the Class B Stock.
Accounting for Certain Nontraditional Long-Duration Contracts and for Separate Accounts
See Note 2 to the Consolidated Financial Statements for a discussion of the cumulative effect of accounting change from the adoption
of Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts
and for Separate Accounts” or, SOP 03-1, which became effective on January 1, 2004.
Recent Accounting Pronouncements
Share-Based Compensation
See Note 2 to the Consolidated Financial Statements for a discussion of the final standard on accounting for share-based payments,
FASB Statement No. 123(R) (revised 2004), “Share-Based Payment,” which was implemented effective January 1, 2006.
Share-Based Compensation Awards with Non-Substantive Vesting Conditions
The Company issues employee share-based compensation awards, under a plan authorized by the Board of Directors, that are subject
to specific vesting conditions; generally the awards vest ratably over a three year period, “the nominal vesting period,” or at the date the
employee retires (as defined by the plan), if earlier. For awards that specify an employee vests in the award upon retirement, we account for
the awards using the nominal vesting period approach. Under this approach, we record compensation expense over the nominal vesting
period. If the employee retires before the end of the nominal vesting period, any remaining unrecognized compensation expense is recorded
at the date of retirement.
With the Company’s adoption of SFAS No. 123(R), we will revise our approach to apply the non-substantive vesting period approach
to all new share-based compensation awards. Under this approach, compensation cost will be recognized immediately for awards granted to
retirement-eligible employees, or over the period from the grant date to the date retirement eligibility is achieved, if that is expected to
occur during the nominal vesting period. We will continue to apply the nominal vesting period approach for any new awards granted prior
to our adoption of SFAS No. 123(R), and for the remaining portion of then unvested outstanding awards.
If the Company had accounted for all share-based compensation awards granted after January 1, 2003 under the non-substantive
vesting period approach, net income of the Financial Services Businesses for the years ended December 31, 2005, 2004 and 2003 would
have been reduced by $10 million, $4 million and $9 million, respectively, or $0.02, $0.01 and $0.02 per share of Common Stock,
respectively, on both a basic and diluted basis.
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