Prudential 2006 Annual Report Download - page 23

The amount of income taxes we pay is subject to ongoing audits in various jurisdictions. We reserve for our best estimate of potential
payments/settlements to be made to the Internal Revenue Service, or Service, and other taxing jurisdictions for audits ongoing or not yet
commenced. In 2006, the Service completed all fieldwork with regards to its examination of our consolidated federal income tax returns for
the tax years 2002 and 2003. We anticipate the final report to be submitted to the Joint Committee on Taxation for their review during the
first quarter of 2007. The statute of limitations for the 2002-2003 tax years expires in 2008. In addition, in January 2007 the Service began
an examination of the tax years 2004 through 2006.
Our liability for income taxes includes management’s best estimate of potential payments and settlements for audit periods still subject
to review by the Internal Revenue Service or other taxing jurisdictions. Audit periods remain open for review until the statute of limitations
has passed. The completion of review or the expiration of the statute of limitations for a given audit period could result in an adjustment to
our liability for income taxes. Any such adjustment could be material to our results of operations for any given quarterly or annual period
based, in part, upon the results of operations for the given period.
On January 26, 2006, the Service officially closed the audit of our consolidated federal income tax returns for the 1997 to 2001
periods. As a result of certain favorable resolutions, our consolidated statement of operations for the year ended December 31, 2005
includes an income tax benefit of $720 million, reflecting a reduction in our liability for income taxes.
For the tax year 2007, we have chosen to participate in the Service’s new Compliance Assurance Program, or CAP. Under CAP, the
Service assigns an examination team to review completed transactions contemporaneously during the 2007 tax year in order to reach
agreement with us on how they should be reported in the tax return. If disagreements arise, accelerated resolutions programs are available
to resolve the disagreements in a timely manner before the tax return is filed. It is management’s expectation this new program will
significantly shorten the time period between when we file our federal income tax return and when the Service completes its examination
of the return.
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 U.S. 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 and Recently Issued Accounting Pronouncements
See Note 2 to our Consolidated Financial Statements for information regarding accounting policies adopted including the effect of
adopting Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans” and Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” and recently issued
accounting pronouncements including FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” and AICPA Statement
of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of
Insurance Contracts.”
The following provides additional discussion of certain accounting policies adopted.
Share-Based Payments
Effect of Adoption
We issued employee stock options during 2001 and 2002 that were previously 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,” prior to its revision. 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. Accordingly, the amount we
included in the determination of net income for periods prior to January 1, 2006, 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. We adopted SFAS No. 123(R) on
January 1, 2006, using the modified prospective application transition method. There were no unvested stock options issued prior to
January 1, 2003, and, therefore, the adoption of SFAS No. 123(R) had no impact to the Company’s consolidated financial condition or
results of operations with respect to the unvested employee options.
For the changes required prospectively in accounting for options and awards with non-substantive vesting conditions, see Note 2 to
our Consolidated Financial Statements.
PRUDENTIAL FINANCIAL, INC. 2006 ANNUAL REPORT
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