## Notes to Consolidated Financial Statements 

(in thousands, except share and per share data) 

fluctuations. Additional risks associated with international operations include difficulties in enforcing intellectual property rights, the bur- dens of complying with a wide variety of foreign laws, potential geo- political and other risks associated with terrorist activities and local or cross border conflicts, potentially adverse tax consequences, tariffs, quotas and other barriers. 

Concentration of Credit Risk. Financial instruments that potentially subject the Company to significant concentrations of credit risk con- sist primarily of cash and cash equivalents, investments in short-term bank deposits and trade accounts receivable. The Company main- tains its cash investments with high credit quality financial institutions in investment-grade, short-term debt securities and limits the amount of credit exposure to any one commercial issuer. 

Income Taxes. The Company provides for income taxes utilizing the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recorded to reflect the tax conse- quences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each balance sheet date, based on enacted tax laws and statutory tax rates applica- ble to the periods in which the differences are expected to affect tax- able income. If it is determined that it is more likely than not that future tax benefits associated with a deferred tax asset will not be realized, a valuation allowance is provided. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enactment date. Tax benefits earned on exercise of employee stock options in excess of compen- sation charged to income are credited to additional paid in capital. 

Prior to 2002, it was management’s intent to repatriate all accumulat- ed earnings from India to the United States; accordingly, the Company has provided deferred income taxes on all such undistrib- uted earnings through December 31, 2001. During the first quarter of 2002, the Company made a strategic decision to pursue an interna- tional strategy that includes expanded infrastructure investments in India and geographic expansion in Europe and Asia. As a component of this strategy, beginning in 2002, the Company intends to use Indian earnings to expand operations outside of the United States instead of repatriating these earnings to the United States. Accordingly, effective January 1, 2002, pursuant to APB No. 23, “Accounting for Income Taxes-Special Areas”, the Company has not accrued incremental U.S. taxes on Indian earnings recognized in 2002 and subsequent periods as these earnings are considered to be indef- initely reinvested outside of the United States. Deferred U.S. income taxes on unremitted earnings from other foreign entities have not been provided for as such earnings are deemed to be permanently reinvested. 

Earnings Per Share (“EPS”). Basic EPS excludes dilution and is com- puted by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS includes all potential dilutive common stock in the weighted average shares outstanding. 

Reclassifications. Certain prior-year amounts have been reclassified to conform to the 2004 presentation. 

New Accounting Standard - Issued but Not Yet Effective. On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123(R)), which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB No. 25 and amends SFAS No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options and issuances under employee stock purchase plans, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative under the new standard. 

In accordance with the SEC’s amendment on April 14, 2005 of the compliance dates of SFAS No. 123(R), Cognizant must adopt SFAS No. 123(R) no later than January 1, 2006. Early adoption is permitted in periods in which financial statements have not yet been issued. Cognizant expects to adopt SFAS No. 123(R) on January 1, 2006. SFAS No. 123(R) allows for two transition methods. The basic differ- ence between the two methods is that the modified-prospective tran- sition method does not require restatement of prior periods, whereas the modified-retrospective transition method will require restatement. 

As permitted by SFAS No. 123, the Company currently accounts for share-based payments to employees using APB No. 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options or stock issuances under the employ- ee stock purchase plan. Although the full impact of Cognizant’s adoption of SFAS No. 123(R)’s fair value method has not yet been determined, the Company expects that it will have a significant impact on its results of operations. The disclosure of pro forma net income and earnings per share as if the Company had recognized compensation cost for share-based payments under SFAS No. 123 for the three years ended December 31, 2004 is not necessarily indica- tive of the potential impact of recognizing compensation cost for share based payments under SFAS No. 123(R) in future periods. The potential impact of adopting SFAS No. 123(R) is dependent on levels of share-based payments granted, the specific option pricing model utilized to determine fair value and the transition methodology selected. 

