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Foreign Currency Translation
The assets and liabilities of our foreign
operations are translated into U.S. dollars at current exchange
rates, and revenues and expenses are translated at average exchange
rates.
Cumulative Effects of Accounting Changes
Accounting
for Goodwill
Effective January 1, 2002, we adopted
SFAS No. 142. See Note 23 for the cumulative effect of this adoption.
Accounting
for Derivative Instruments
and Hedging Activities
Effective January 1, 2001, we adopted
SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities,” as amended by SFAS Nos. 137 and 138 (collectively,
SFAS No. 133). We use derivative instruments (primarily swaps, options
and futures) to manage interest rate exposure and the commodity
price risk inherent in some of our fossil fuel and electricity purchases
and sales. Under SFAS No. 133, all derivative instruments, including
our energy trading contracts, are recorded on our consolidated balance
sheets as either an asset or liability measured at fair value. Changes
in a derivative’s fair value must be recognized currently in earnings
unless specific hedge accounting criteria are met, in which case
changes are reflected in other comprehensive income. Cash flows
from derivative instruments are presented in net cash flows from
operating activities.
Derivative instruments used to manage
commodity price risk inherent in fossil fuel and electricity purchases
and sales are classified as energy trading contracts on our consolidated
balance sheets. Energy trading contracts representing unrealized
gain positions are reported as assets; energy trading contracts
representing unrealized loss positions are reported as liabilities.
Prior to January 1, 2001, gains and losses
on our derivatives used for managing commodity price risk were deferred
until settlement. These derivatives were not designated as hedges
under SFAS No. 133. Accordingly, on January 1, 2001, we recognized
an unrealized gain of $18.7 million, net of $12.3 million of tax.
This gain is presented on our consolidated statement of income for
2001 as a cumulative effect of a change in accounting principle.
After January 1, 2001, changes in fair
value of all derivative instruments used for managing commodity
price risk that are not designated as hedges are recognized in revenue
as discussed above under “— Revenue Recognition — Energy Sales.”
Accounting for derivatives under SFAS No. 133 will increase volatility
of our future earnings.
Revenue
Recognition
In the fourth quarter of 2000, we adopted
Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition,”
which had a retroactive effective date of January 1, 2000. The impact
of this accounting change generally required deferral of certain
monitored security services sales for installation revenues and
direct sales-related expenses. Deferral of these revenues and costs
is generally necessary when installation revenues have been received
and a monitoring contract to provide future service is obtained.
The cumulative effect of this change in
accounting principle was a charge to income in 2000 of approximately
$3.8 million, net of $1.1 million tax benefit, and is related to
changes in revenue recognition at Protection One Europe. Prior to
the adoption of SAB No. 101, Protection One Europe recognized installation
revenues and related expenses upon completion of the installation.
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Accounting Changes
Stock Based
Compensation
In December 2002, Financial Accounting
Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based
Compensation — Transition and Disclosure,” which amends SFAS No.
123, “Accounting for Stock-Based Compensation.” SFAS No. 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee compensation.
In addition, it amends the disclosure requirements of SFAS No. 123
to require prominent disclosures in both annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results.
This statement requires that companies follow the prescribed format
and provide the additional disclosures in their annual reports for
fiscal years ending after December 15, 2002. We apply the recognition
and measurement principles of APB Opinion No. 25, “Accounting for
Stock Issued to Employees,” as allowed by SFAS Nos. 123 and 148,
and related interpretations in accounting for our stock-based compensation
plans, as described in Note 15. We have adopted the disclosure requirements
of SFAS No. 148.
For purposes of the pro forma disclosures
required by SFAS No. 148, the estimated fair value of the options
is amortized to expense over the options’ vesting period. Under
SFAS No. 123, compensation expense would have been $0.8 million
in 2002 and $1.1 million in 2000. We would have recorded income
of $0.5 million in 2001 under SFAS No. 123. Information related
to the pro forma impact on our earnings and earnings per share follows.
Accounting
for Energy Trading Contracts
In October 2002, the FASB, through the
Emerging Issues Task Force (EITF), issued Issue No. 02-03, which
rescinded Issue No. 98-10, “Accounting for Contracts Involved in
Energy Trading and Risk Management Activities.” As a result, all
new contracts that would otherwise have been accounted for under
Issue No. 98-10 and that do not fall within the scope of SFAS No.
133 can no longer be marked-to-market and recorded in earnings as
of October 25, 2002. We are not affected by this change in accounting
principle and are not required to reclassify any of our contracts.
EITF Issue No. 02-03 also requires that energy trading contracts
and derivatives, whether settled financially or physically, be reported
in the income statement on a net basis effective January 1, 2003.
We began to classify our energy trading contracts on a net basis
during the third quarter of 2002.
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