Prudential 2007 Annual Report Download - page 24

Accounting Pronouncements Adopted and Recently Issued Accounting Pronouncements
See Note 2 to our Consolidated Financial Statements for a discussion of recently adopted accounting pronouncements, including the
effect of adopting FSP SFAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes
Generated by a Leveraged Lease Transaction,” an amendment of FASB Statement No. 13 and FIN No. 48, “Accounting for Uncertainty in
Income Taxes,” an Interpretation of FASB Statement No. 109 and SOP 05-1, “Accounting by Insurance Enterprises for Deferred
Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts.” See Note 2 to our Consolidated Financial
Statements for a discussion of recently issued accounting pronouncements.
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 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 our 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.
Valuation of Stock Options Issued to Employees
As described above, we did not record any compensation cost for employee stock options issued prior to January 1, 2003. However,
we are required to disclose the net income and basic and diluted earnings per share that we would have reported if we had been recognizing
compensation cost associated with those options. See Note 2 to our Consolidated Financial Statements for this proforma disclosure. For
purposes of this disclosure the fair value of these options was determined using a Black-Scholes option-pricing model. This model
considers dividend yield, expected volatility, risk-free interest rate, and expected life of the option and uses an equation to produce a fair
value. For options issued on or after January 1, 2003, the fair value of each option was estimated using a binomial option-pricing model.
This model also considers dividend yield, expected volatility, risk-free interest rate, and expected life of the option but, unlike the Black-
Scholes options pricing model, it produces an estimated fair value based on the assumed changes in price of a financial instrument over
successive periods of time. We selected the binomial option pricing model because, absent observable market prices, we believe it produces
a fair value that best reflects the substantive characteristics of the employee stock options we issue. See Note 15 to our Consolidated
Financial Statements for the assumptions used in valuing employee stock options issued in 2007, 2006, and 2005.
Excess Tax Benefits
An excess tax benefit is generated whenever the tax deduction associated with share-based payment arrangements exceeds the related
cumulative compensation cost recognized for financial reporting purposes. Excess tax benefits are included in additional paid-in capital in
the period that the related tax deduction reduces our taxes payable. If the tax deduction associated with share-based payment arrangements
is less than the cumulative compensation cost recognized for financial reporting purposes, the unused portion of the deferred tax asset is
first offset against additional paid-in capital generated from past excess tax benefits then charged to tax expense. As of the date of adoption
of SFAS No. 123(R), we were required to determine the portion of our additional paid-in capital that was generated from the realization of
excess tax benefits prior to the date of adoption and is therefore available to offset deferred tax assets that may need to be written off in
future periods had we adopted the fair value recognition provisions of SFAS No. 123 beginning in 2001. We chose to calculate this “pool”
of additional paid-in capital using the alternative transition, or short cut, method provided for in FASB Staff Position FAS 123(R)-3,
“Transition Election to Accounting for the Tax Effects of Share-Based Payment Awards.” Under the short cut method, this “pool” of
additional paid-in capital was calculated as the sum of all net increases of additional paid-in capital recognized in our financial statements
related to tax benefits from share-based payment transactions subsequent to the adoption of SFAS No. 123 but prior to the adoption of
SFAS No. 123(R) less the cumulative incremental pre-tax compensation costs that would have been recognized if SFAS No. 123 had been
used to account for share-based payment transactions, tax effected at our statutory tax rate as of the adoption of SFAS No. 123(R).
Effect on Calculation of Diluted Earnings Per Share of Common Stock
In calculating the dilutive effect of share-based payment arrangements such as stock options issued to employees, we apply the
treasury stock method prescribed by SFAS No. 128, “Earnings Per Share.” In applying the treasury stock method to such arrangements we
22 Prudential Financial 2007 Annual Report