UPS 2005 Annual Report Download - page 70

UNITED PARCEL SERVICE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
2005 2004 2003
Discounted stock purchase plan:
Expected dividend yield .............................................. 1.62% 1.42% 1.12%
Risk-free interest rate ................................................ 2.84% 1.18% 1.06%
Expected life in years ................................................ 0.25 0.25 0.25
Expected volatility .................................................. 15.46% 16.83% 19.79%
Weighted average fair value of purchase rights* ........................... $ 9.46 $ 9.56 $ 8.53
* Includes the 10% discount from the market price (see Note 11).
Expected volatilities are based on the historical returns on our stock and, due to our limited history of being
a publicly-traded company, an index of peer companies. The expected dividend yield is based on the recent
historical dividend yields for our stock, taking into account changes in dividend policy. The risk-free interest rate
is based on the term structure of interest rates at the time of the option grant. The expected life represents an
estimate of the period of time options are expected to remain outstanding.
Derivative Instruments
Derivative instruments are accounted for in accordance with FASB Statement No. 133, “Accounting for
Derivative Instruments and Hedging Activities” (“FAS 133”), as amended, which requires all financial derivative
instruments to be recorded on our balance sheet at fair value. Derivatives not designated as hedges must be
adjusted to fair value through income. If a derivative is designated as a hedge, depending on the nature of the
hedge, changes in its fair value that are considered to be effective, as defined, either offset the change in fair
value of the hedged assets, liabilities, or firm commitments through income, or are recorded in OCI until the
hedged item is recorded in income. Any portion of a change in a derivative’s fair value that is considered to be
ineffective, or is excluded from the measurement of effectiveness, is recorded immediately in income.
New Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (“FAS
123(R)”), which replaces FAS 123 and supercedes APB 25. FAS 123(R) requires all share-based awards to
employees, including grants of employee stock options, to be measured based on their fair values and expensed
over the period during which an employee is required to provide service in exchange for the award (the vesting
period). We had previously adopted the fair value recognition provisions of the original FAS 123, prospectively
for all new stock compensation awards granted to employees subsequent to January 1, 2003. FAS 123(R) was
effective beginning with the first interim or annual period after June 15, 2005; the SEC deferred the effective
date, and as a result, we adopted FAS 123(R) on January 1, 2006. On that date, there were no unvested stock
options or other forms of employee stock compensation issued prior to January 1, 2003.
We issue employee share-based awards, under our Incentive Compensation Plan, that are subject to specific
vesting conditions; generally, the awards cliff vest or vest ratably over a five 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.
Upon our adoption of FAS 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
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