Note 1 – Summary of Significant Accounting Policies
Nature of the Business. Watson Wyatt & Company Holdings (collectively referred to as “we,” “Watson Wyatt” or the “Company”), together with our subsidiaries, is an international company engaged in the business of providing professional consultative services on a fee basis, primarily in the human resource areas of employee benefits and compensation, but also in other areas of specialization such as human capital consulting and human resource related technology consulting.

Use of Estimates. Preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Estimates are used when accounting for revenue, allowances for uncollectible receivables, investments in affiliates, depreciation and amortization, profits on long-term contracts, asset write-downs, employee benefit plans, taxes, accruals for premiums for professional liability insurance, accruals for estimated losses related to reported and unreported professional liability claims and for discontinued operations.

Principles of Consolidation. Our consolidated financial statements include the accounts of the Company and our majority-owned and controlled subsidiaries after elimination of intercompany accounts and transactions. Investments
in affiliated companies over which we have the ability to exercise significant influence are accounted for using the equity method.

Restatement. The Company maintains professional liability insurance coverage. This insurance covers claims made during the insured period, but does not cover claims made after expiration of our current insurance contracts. Generally accepted accounting principles require that we record a liability for Incurred But Not Reported (IBNR) professional liability claims if they are estimable and probable, and for which we have not yet contracted for insurance coverage. The Company restated its consolidated balance sheets as of June 30, 2001 and 2000, to record an estimated liability for such IBNR claims. The amount of the estimated noncurrent liability was actuarially determined to be $11.4 million as of June 30, 2001. Corresponding estimated amounts, determined on an actuarial basis, were not significantly different at June 30, 2000 or 1999. Accordingly, the Company recorded $11.4 million as a noncurrent liability as of June 30, 1999, with an increase in deferred taxes of $4.6 million and a reduction of retained earnings of $6.8 million. The restatement had no impact on earnings or cash flow for the fiscal years ended June 30, 2001 and 2000.

Reclassifications. Certain amounts previously presented have been reclassified to conform to the current presentation.

Cash and Cash Equivalents. We consider short-term, highly liquid investments with original maturities of 90 days or less to be cash equivalents. Such investments were $74,400,000 at June 30, 2002, and $53,600,000 at June 30, 2001.

Receivables from Clients. Billed receivables from clients are presented at their billed amount less an allowance for doubtful accounts. Unbilled receivables are stated at full billing rates less an allowance for unbillable amounts.

Revenue Recognition. For consulting services, revenue is recorded as services are performed and is presented net of write-offs and estimated unbillable amounts. Services rendered are generally billed on a monthly basis using fee arrangements defined at the inception of the project. Revenue includes reimbursable expenses billed to clients. Anticipated losses on long-term contracts are recognized as they become known.

Other Non-Operating Income. Non-operating income for the year ended June 30, 2002, included a $1.0 million gain from the sale of our U.S.-based public plan retirement business and a $1.2 million gain from the receipt and sale of common stock received in the demutualization of a health and general insurance provider.

Foreign Currency Translation. Gains and losses on foreign currency transactions, including settlement of intercompany receivables and payables, are recognized currently in the Consolidated Statements of Operations. Assets and liabilities of our subsidiaries outside the United States are translated into the reporting currency, the U.S. dollar, based on exchange rates at the balance sheet date. Revenue and expenses of our subsidiaries outside the United States are translated into U.S. dollars at the average exchange rates during the year. Gains and losses on translation of our equity interests in our subsidiaries outside the United States and on intercompany notes that are not expected to be liquidated are not included in the Consolidated Statements of Operations, but are reported separately and accumulated as the cumulative translation gain or loss within stockholders’ equity in the Consolidated Balance Sheets. Prior to July 1, 2000, translation gains and losses on intercompany receivables and payables were included with the cumulative translation gain or loss since, prior to that time, the Company did not settle these accounts.

Fair Value of Financial Instruments. The carrying amount of our cash and cash equivalents, short-term investments, receivables from clients and notes and accounts payable approximates fair value because of the short maturity and liquidity of those instruments. We had no borrowings outstanding under our revolving credit agreement at June 30, 2002, or June 30, 2001. We know of no event of default that would require us to satisfy the guarantees described in Note 9. We do not use derivative instruments as a hedging strategy or for any other purpose.

Concentration of Credit Risk. Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of certain cash and cash equivalents, short-term investments and receivables from clients. We invest our excess cash with high quality financial institutions. Concentrations of credit risk with respect to receivables from clients are limited due to our large number of clients and their dispersion across many industries and geographic regions.

Incurred but Not Reported Claims. The Company accrues for IBNR professional liability claims that are estimable and probable, and for which we have not yet contracted for insurance coverage.

Stock-Based Compensation. We have elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), for stock options issued under the 2000 Long-Term Incentive Plan, and the 2001 Employee Stock Purchase Plan. Compensation expense for the 2000 Long-Term Incentive Plan, if any, would be recorded and measured as the difference between the fair market value of the stock at the date of the grant and the option price. The compensation expense would be recognized over the five-year vesting period identified in the plan. For any cash based, non-stock awards, such as stock appreciation rights, compensation expense will be recognized over the vesting period to the extent that the market price of the stock increases. We have elected the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (FAS 123). The Company does not currently intend to issue further stock options under the 2000 Long-Term Incentive Plan. Deferred Stock Units are now granted to senior employees of the Company in lieu of a portion of their annual fiscal year-end bonus. Each stock unit represents the Company’s obligation to issue one share of common stock to the recipient. Compensation expense is determined by the value of the stock at the date of the grant and will be recognized over the stock unit’s vesting period.

Earnings per Share. The computation of basic earnings per share is based upon the weighted average number of common shares outstanding. Diluted earnings per share is calculated on the basis of the weighted average number of common shares outstanding plus the effect of outstanding stock options using the “treasury stock” method. See Note 16 for identification of the components of basic and diluted earnings per share.

Goodwill and Intangible Assets. Watson Wyatt has historically applied the purchase method of accounting to its acquisitions and will continue to do so in the future. The Company adopted the provisions of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (FAS 142), effective July 2001. FAS 142 addresses the accounting for goodwill and intangible assets at and subsequent to their acquisition. FAS 142 provides that goodwill and indefinite-lived intangible assets will no longer be amortized and that these assets must be tested at least annually for impairment beginning in the year of adoption. The Company completed its transitional impairment testing of goodwill in July 2001, and its first annual impairment testing as of March 31, 2002, for all of its reporting units and concluded that no impairment of goodwill exists. FAS 142 also provides that other intangible assets that have finite useful lives will continue to be amortized over their useful lives. See Note 11 for the impact of this pronouncement on our financial results.

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