Item 8. Financial Statements and Supplementary Data

TABLE OF CONTENTS

Report on Management’s Assessment of Internal Control Over Financial Reporting	28
Reports of Independent Registered Public Accounting Firm	29
Consolidated Statements of Income and Comprehensive Income for the Years Ended May 31, 2013, 2012, and 2011	31
Consolidated Balance Sheets as of May 31, 2013 and 2012	32
Consolidated Statements of Stockholders’ Equity for the Years Ended May 31, 2013, 2012, and 2011	33
Consolidated Statements of Cash Flows for the Years Ended May 31, 2013, 2012, and 2011	34
Notes to Consolidated Financial Statements	35
Schedule II — Valuation and Qualifying Accounts for the Years Ended May 31, 2013, 2012, and 2011	54

REPORT ON MANAGEMENT’S ASSESSMENT OF

INTERNAL CONTROL OVER FINANCIAL REPORTING

Management of Paychex, Inc. (the “Company”) is responsible for establishing and maintaining an adequate system of internal control over financial reporting as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Consolidated Financial Statements. Our internal control over financial reporting is supported by a program of internal audits and appropriate reviews by management, written policies and guidelines, and careful selection and training of qualified personnel.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Audit Committee of our Company’s Board of Directors meets with the independent registered public accounting firm, management, and internal auditors periodically to discuss internal control over financial reporting and auditing and financial reporting matters. The Audit Committee reviews with the independent registered public accounting firm the scope and results of the audit effort. The Audit Committee also meets periodically with the independent registered public accounting firm and the chief internal auditor without management present to ensure that the independent registered public accounting firm and the chief internal auditor has free access to the Audit Committee. The Audit Committee’s Report can be found in the Definitive Proxy Statement to be issued in connection with the Company’s 2013 Annual Meeting of Stockholders.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of May 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in the Internal Control — Integrated Framework. Based on our assessment, management believes that the Company maintained effective internal control over financial reporting as of May 31, 2013.

The Company’s independent registered public accounting firm, Ernst & Young LLP, is appointed by the Company’s Audit Committee. Ernst & Young LLP has audited the Consolidated Financial Statements included in this Annual Report on Form 10-K, and as a part of their audit, has issued their report, included herein, on the effectiveness of the Company’s internal control over financial reporting.

/s/ Martin Mucci Martin Mucci President and Chief Executive Officer		/s/ Efrain Rivera Efrain Rivera Senior Vice President, Chief Financial Officer, and Treasurer

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors

and Stockholders of Paychex, Inc.

We have audited Paychex, Inc.’s internal control over financial reporting as of May 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Paychex, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report on Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Paychex, Inc. maintained, in all material respects, effective internal control over financial reporting as of May 31, 2013, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Paychex, Inc. as of May 31, 2013 and 2012, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended May 31, 2013 of Paychex, Inc., and our report dated July 22, 2013, expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Rochester, New York

July 22, 2013

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors

and Stockholders of Paychex, Inc.

We have audited the accompanying consolidated balance sheets of Paychex, Inc. as of May 31, 2013 and 2012, and the related consolidated statements of income and comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended May 31, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Paychex, Inc. at May 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the three years in the period ended May 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Paychex, Inc.’s internal control over financial reporting as of May 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 22, 2013 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Rochester, New York

July 22, 2013

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

In millions, except per share amounts

Year ended May 31,		2013				2012				2011
Revenue:
Service revenue		$	2,285.2			$	2,186.2			$	2,036.2
Interest on funds held for clients		41.0				43.6				48.1
Total revenue		$	2,326.2			$	2,229.8			$	2,084.3
Expenses:
Operating expenses		671.3				670.1				651.5
Selling, general and administrative expenses		750.1				705.8				646.4
Total expenses		1,421.4				1,375.9				1,297.9
Operating income		904.8				853.9				786.4
Investment income, net		6.6				6.4				5.8
Income before income taxes		911.4				860.3				792.2
Income taxes		342.4				312.3				276.9
Net income		$	569.0			$	548.0			$	515.3
Other comprehensive (loss)/income, net of tax:
Unrealized (losses)/gains on securities, net of tax		(15.7		)		0.2				(4.9		)
Total other comprehensive (loss)/income, net of tax		(15.7		)		0.2				(4.9		)
Comprehensive income		$	553.3			$	548.2			$	510.4
Basic earnings per share		$	1.56			$	1.51			$	1.42
Diluted earnings per share		$	1.56			$	1.51			$	1.42
Weighted-average common shares outstanding		363.8				362.4				361.8
Weighted-average common shares outstanding, assuming dilution		364.7				363.0				362.4
Cash dividends per common share		$	1.31			$	1.27			$	1.24

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

CONSOLIDATED BALANCE SHEETS

In millions, except per share amount

As of May 31,		2013				2012
Assets
Cash and cash equivalents		$	107.3			$	108.8
Corporate investments		398.2				207.5
Interest receivable		32.4				30.6
Accounts receivable, net of allowance for doubtful accounts		133.4				142.4
Deferred income taxes		2.3				1.6
Prepaid income taxes		49.9				5.6
Prepaid expenses and other current assets		36.6				35.2
Current assets before funds held for clients		760.1				531.7
Funds held for clients		4,072.5				4,544.2
Total current assets		4,832.6				5,075.9
Long-term corporate investments		369.1				473.7
Property and equipment, net of accumulated depreciation		346.0				324.3
Intangible assets, net of accumulated amortization		45.2				55.8
Goodwill		533.9				517.4
Deferred income taxes		34.1				29.2
Other long-term assets		2.8				3.3
Total assets		$	6,163.7			$	6,479.6
Liabilities
Accounts payable		$	42.7			$	69.7
Accrued compensation and related items		138.2				130.9
Deferred revenue		5.2				3.0
Deferred income taxes		8.1				13.9
Other current liabilities		34.3				33.8
Current liabilities before client fund obligations		228.5				251.3
Client fund obligations		4,039.7				4,494.4
Total current liabilities		4,268.2				4,745.7
Accrued income taxes		19.7				35.9
Deferred income taxes		53.3				40.6
Other long-term liabilities		48.8				52.9
Total liabilities		4,390.0				4,875.1
Commitments and contingencies — Note M
Stockholders’ equity
Common stock, $0.01 par value; Authorized: 600.0 shares; Issued and outstanding: 365.4 shares as of May 31, 2013, and 362.6 shares as of May 31, 2012, respectively		3.7				3.6
Additional paid-in capital		659.5				561.1
Retained earnings		1,088.5				1,002.1
Accumulated other comprehensive income		22.0				37.7
Total stockholders’ equity		1,773.7				1,604.5
Total liabilities and stockholders’ equity		$	6,163.7			$	6,479.6

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

In millions

		Common stock							Additional paid-in capital				Retained earnings				Accumulated other comprehensive income
		Shares			Amount				Total
Balance as of May 31, 2010		361.5			$	3.6			$	499.7			$	856.3			$	42.4			$	1,402.0
Net income													515.3								515.3
Unrealized losses on securities, net of tax																	(4.9		)		(4.9		)
Cash dividends declared													(448.8		)						(448.8		)
Stock-based compensation									25.0												25.0
Stock-based award transactions		0.6							10.9				(3.3		)						7.6
Balance as of May 31, 2011		362.1			3.6				535.6				919.5				37.5				1,496.2
Net income													548.0								548.0
Unrealized gains on securities, net of tax																	0.2				0.2
Cash dividends declared													(460.5		)						(460.5		)
Stock-based compensation									23.1												23.1
Stock-based award transactions		0.5							2.4				(4.9		)						(2.5		)
Balance as of May 31, 2012		362.6			3.6				561.1				1,002.1				37.7				1,604.5
Net income													569.0								569.0
Unrealized losses on securities, net of tax																	(15.7		)		(15.7		)
Cash dividends declared													(476.7		)						(476.7		)
Stock-based compensation									22.9												22.9
Stock-based award transactions		2.8			0.1				75.5				(5.9		)						69.7
Balance as of May 31, 2013		365.4			$	3.7			$	659.5			$	1,088.5			$	22.0			$	1,773.7

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

In millions

Year ended May 31,		2013				2012				2011
Operating activities
Net income		$	569.0			$	548.0			$	515.3
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization on property and equipment and intangible assets		98.2				97.8				88.7
Amortization of premiums and discounts on available-for-sale securities		56.2				42.5				38.9
Stock-based compensation costs		22.8				22.9				24.8
Provision for deferred income taxes		5.3				11.7				13.6
Provision for allowance for doubtful accounts		1.7				1.2				1.8
Net realized gains on sales of available-for-sale securities		(0.9		)		(1.0		)		(1.3		)
Changes in operating assets and liabilities:
Interest receivable		(1.8		)		(1.2		)		(0.7		)
Accounts receivable		8.3				17.6				23.7
Prepaid expenses and other current assets		(45.6		)		(9.4		)		1.8
Accounts payable and other current liabilities		(16.6		)		(26.9		)		2.2
Net change in other assets and liabilities		(21.3		)		3.4				6.5
Net cash provided by operating activities		675.3				706.6				715.3
Investing activities
Purchases of available-for-sale securities		(28,332.8		)		(10,180.5		)		(6,229.1		)
Proceeds from sales and maturities of available-for-sale securities		27,620.2				9,817.4				5,598.9
Net change in funds held for clients’ money market securities and other cash equivalents		1,019.4				(784.3		)		450.4
Purchases of property and equipment		(98.7		)		(89.6		)		(100.5		)
Acquisition of businesses, net of cash acquired		(21.3		)		(6.0		)		(126.4		)
Purchases of other assets		(5.1		)		(1.3		)		(2.8		)
Net cash provided by/(used in) investing activities		181.7				(1,244.3		)		(409.5		)
Financing activities
Net change in client fund obligations		(454.6		)		980.5				(34.9		)
Dividends paid		(476.7		)		(460.5		)		(448.8		)
Equity activity related to stock-based awards		72.8				7.5				12.6
Net cash (used in)/provided by financing activities		(858.5		)		527.5				(471.1		)
Decrease in cash and cash equivalents		(1.5		)		(10.2		)		(165.3		)
Cash and cash equivalents, beginning of fiscal year		108.8				119.0				284.3
Cash and cash equivalents, end of fiscal year		$	107.3			$	108.8			$	119.0

See Notes to Consolidated Financial Statements.

PAYCHEX, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note A — Description of Business, Basis of Presentation, and Significant Accounting Policies

Description of business: Paychex, Inc. and its wholly owned subsidiaries (the “Company” or “Paychex”) is a leading provider of payroll, human resource, and benefits outsourcing solutions for small- to medium-sized businesses in the United States (“U.S.”). The Company also has a subsidiary in Germany.

Paychex, a Delaware corporation formed in 1979, reports as one segment. Substantially all of the Company’s revenue is generated within the U.S. The Company also generates revenue within Germany, which was less than one percent of its total revenue for each of the years ended May 31, 2013 (“fiscal 2013”), 2012 (“fiscal 2012”), and 2011 (“fiscal 2011”). Long-lived assets in Germany are insignificant in relation to total long-lived assets of the Company as of May 31, 2013 and May 31, 2012.

Total revenue is comprised of service revenue and interest on funds held for clients. Service revenue is comprised of the Payroll and Human Resource Services portfolios of services and products. Payroll service revenue is earned primarily from payroll processing, payroll tax administration services, employee payment services, and other ancillary services. Payroll processing services include the calculation, preparation, and delivery of employee payroll checks; production of internal accounting records and management reports; preparation of federal, state, and local payroll tax returns; and collection and remittance of clients’ payroll obligations.

In connection with the automated payroll tax administration services, the Company electronically collects payroll taxes from clients’ bank accounts, typically on payday, prepares and files the applicable tax returns, and remits taxes to the applicable tax or regulatory agencies on the respective due dates. These taxes are typically paid between one and 30 days after receipt of collections from clients, with some items extending to 90 days. The Company handles regulatory correspondence, amendments, and penalty and interest disputes, and is subject to cash penalties imposed by tax or regulatory agencies for late filings and late or under payment of taxes. With employee payment services, employers are offered the option of paying their employees by direct deposit, payroll debit card, a check drawn on a Paychex account (Readychex®), or a check drawn on the employer’s account and electronically signed by Paychex. For the first three methods, Paychex electronically collects net payroll from the clients’ bank accounts, typically one business day before payday, and provides payment to the employees on payday.

In addition to service fees paid by clients, the Company earns interest on funds held for clients that are collected before due dates and invested until remittance to the applicable tax or regulatory agencies or client employees. The funds held for clients and related client fund obligations are included in the Consolidated Balance Sheets as current assets and current liabilities, respectively. The amount of funds held for clients and related client fund obligations varies significantly during the year.

The Human Resource Services portfolio of services and products provides small- to medium-sized businesses with retirement services administration, insurance services, eServices, and other human resource services and products. Paychex HR Solutions is available through an administrative services organization (“ASO”) and a professional employer organization (“PEO”). Both options offer businesses a combined package of services that includes payroll, employer compliance, human resource and employee benefits administration, risk management outsourcing, and the on-site availability of a professionally trained human resource services representative, among other services. These comprehensive bundles of services are designed to make it easier for businesses to manage their payroll and related benefits costs while providing a benefits package equal to that of larger companies. The PEO differs from the ASO in that Paychex serves as a co-employer of the clients’ employees, assumes the risks and rewards of workers’ compensation insurance, and offers health care coverage to PEO client employees. PEO services are sold through the Company’s registered and licensed subsidiary, Paychex Business Solutions, Inc. Paychex HR Essentials is an ASO product that provides support to the Company’s clients over the phone or online to help manage employee-related topics.

Basis of presentation: The consolidated financial statements include the accounts of Paychex, Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The Company has evaluated subsequent events for potential recognition and/or disclosure through the date of issuance of these financial statements.

Cash and cash equivalents: Cash and cash equivalents consist of available cash, money market securities, and other investments with a maturity of three months or less at acquisition.

Accounts receivable, net of allowance for doubtful accounts: Accounts receivable balances are shown on the Consolidated Balance Sheets net of the allowance for doubtful accounts of $1.0 million as of May 31, 2013 and $1.2 million as of May 31,

2012. Accounts receivable are written off and charged against the allowance for doubtful accounts when the Company has exhausted all collection efforts without success. No single client had a material impact on total accounts receivable, service revenue, or results of operations.

Funds held for clients and corporate investments: Marketable securities included in funds held for clients and corporate investments consist primarily of securities classified as available-for-sale and are recorded at fair value obtained from an independent pricing service. The funds held for clients portfolio also includes cash, money market securities, and short-term investments. Unrealized gains and losses, net of applicable income taxes, are reported as other comprehensive income in the Consolidated Statements of Income and Comprehensive Income. Realized gains and losses on the sale of available-for-sale securities are determined by specific identification of the cost basis of each security. On the Consolidated Statements of Income and Comprehensive Income, realized gains and losses from their respective portfolios are included in interest on funds held for clients and investment income, net.

Concentrations: Substantially all of the Company’s deposited cash is maintained at two large well-capitalized (as defined by their regulators) financial institutions. These deposits may exceed the amount of any insurance provided. All of the Company’s deliverable securities are held in custody with one of the two aforementioned financial institutions, for which that institution bears the risk of custodial loss. Non-deliverable securities, primarily time deposits and money market funds, are restricted to well-capitalized financial institutions.

Property and equipment, net of accumulated depreciation: Property and equipment is stated at cost, less accumulated depreciation and amortization. Depreciation is based on the estimated useful lives of property and equipment using the straight-line method. The estimated useful lives of depreciable assets are generally:

Category		Depreciable life
Buildings and improvements		Ten to 35 years or the remaining life, whichever is shorter
Data processing equipment		Two to seven years
Furniture, fixtures, and equipment		Seven years
Leasehold improvements		Ten years or the life of the lease, whichever is shorter

Normal and recurring repairs and maintenance costs are charged to expense as incurred. The Company reviews the carrying value of property and equipment for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Software development and enhancements: Expenditures for software purchases and software developed for internal use are capitalized and depreciated on a straight-line basis over the estimated useful lives, which are generally three to fifteen years. For software developed for internal use, certain costs are capitalized, including external direct costs of materials and services associated with developing or obtaining the software, and payroll and payroll-related costs for employees who are directly associated with internal-use software projects. Capitalization of these costs ceases no later than the point at which the project is substantially complete and ready for its intended use. Costs associated with preliminary project stage activities, training, maintenance, and other post-implementation stage activities are expensed as incurred. The carrying value of software and development costs is reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Goodwill and other intangible assets, net of accumulated amortization: The Company has recorded goodwill in connection with the acquisitions of businesses. Goodwill is not amortized, but instead is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change in a way to indicate that there has been a potential decline in the fair value of a reporting unit. Impairment is determined by comparing the estimated fair value of a reporting unit to its carrying amount, including goodwill. During fiscal 2012, the Company adopted guidance that allows it the option to perform a qualitative assessment to determine if it is more-likely-than-not that the fair value of the reporting unit has declined below carrying value. This assessment considers various financial, macroeconomic, industry, and reporting unit specific qualitative factors. The Company’s business is largely homogeneous and, as a result, goodwill is associated with one reporting unit. The Company performs its annual impairment testing in its fiscal fourth quarter. Based on the results of the Company’s reviews, no impairment loss was recognized in the results of operations for fiscal years 2013, 2012, or 2011. Subsequent to the latest review, there have been no events or circumstances that indicate any potential impairment of the Company’s goodwill balance.

Intangible assets are comprised primarily of client list acquisitions and are reported net of accumulated amortization on the Consolidated Balance Sheets. Intangible assets are amortized over periods generally ranging from five to twelve years. Client lists use the accelerated method, while other intangible assets use the straight-line method of amortization. The Company tests

intangible assets for potential impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Revenue recognition: Service revenue is recognized in the period services are rendered and earned under service arrangements with clients where service fees are fixed or determinable and collectibility is reasonably assured. Certain processing services are provided under annual service arrangements with revenue recognized ratably over the service period. The Company’s service revenue is largely attributable to payroll-related processing services where the fee is based on a fixed amount per processing period or a fixed amount per processing period plus a fee per employee or transaction processed. The revenue earned from delivery service for the distribution of certain client payroll checks and reports is included in service revenue, and the costs for the delivery are included in operating expenses on the Consolidated Statements of Income and Comprehensive Income.

PEO revenue is included in service revenue and is reported net of direct costs billed and incurred, which include wages, taxes, benefit premiums, and claims of PEO worksite employees. Direct costs billed and incurred were $3.0 billion for fiscal 2013, $3.3 billion for fiscal 2012, and $3.9 billion for fiscal 2011.

Interest on funds held for clients is earned primarily on funds that are collected from clients before due dates for payroll tax administration services and for employee payment services, and invested until remittance to the applicable tax or regulatory agencies or client employees. The interest earned on these funds is included in total revenue on the Consolidated Statements of Income and Comprehensive Income because the collecting, holding, and remitting of these funds are components of providing these services. Interest on funds held for clients also includes net realized gains and losses from the sales of available-for-sale securities.

PEO workers’ compensation insurance: Workers’ compensation insurance for PEO worksite employees is provided under a deductible workers’ compensation policy with a national insurance company. Workers’ compensation insurance reserves are established to provide for the estimated costs of paying claims underwritten by the Company. These reserves include estimates for reported losses, plus amounts for those claims incurred but not reported, and estimates of certain expenses associated with processing and settling the claims. In establishing the workers’ compensation insurance reserves, the Company uses an independent actuarial estimate of undiscounted future cash payments that would be made to settle the claims.

Estimating the ultimate cost of future claims is an uncertain and complex process based upon historical loss experience and actuarial loss projections, and is subject to change due to multiple factors, including economic trends, changes in legal liability law, and damage awards, all of which could materially impact the reserves as reported in the consolidated financial statements. Accordingly, final claim settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.

The Company regularly reviews the adequacy of its estimated workers’ compensation insurance reserves. Adjustments to previously established reserves are reflected in the results of operations for the period in which the adjustment is identified. Such adjustments could possibly be significant, reflecting any variety of new and adverse or favorable trends.

The Company’s maximum individual claims liability was $1.0 million under both its fiscal 2013 and fiscal 2012 policies. As of May 31, 2013 and May 31, 2012, the Company had recorded current liabilities of $6.8 million and $6.2 million, respectively, and long-term liabilities of $13.7 million and $19.0 million, respectively, on its Consolidated Balance Sheets for workers’ compensation costs.

Stock-based compensation costs: All stock-based awards to employees are recognized as compensation costs in the consolidated financial statements based on their fair values measured as of the date of grant. The Company estimates the fair value of stock option grants using a Black-Scholes option pricing model. This model requires various assumptions as inputs including expected volatility of the Paychex stock price and expected option life. Volatility is estimated based on a combination of historical volatility, using weekly stock prices over a period equal to the expected option life, and implied market volatility. Expected option life is estimated based on historical exercise behavior.

The fair value of stock awards is determined based on the stock price at the date of grant. For grants that do not accrue dividends or dividend equivalents, the fair value is the stock price reduced by the present value of estimated dividends over the vesting period or performance period.

The Company is required to estimate forfeitures and only record compensation costs for those awards that are expected to vest. The assumptions for forfeitures were determined based on type of award and historical experience. Forfeiture assumptions are adjusted at the point in time a significant change is identified, with any adjustment recorded in the period of change, and the final adjustment at the end of the requisite service period to equal actual forfeitures.

The assumptions of volatility, expected option life, and forfeitures all require significant judgment and are subject to change in the future due to factors such as employee exercise behavior, stock price trends, and changes to type or provisions of stock-based awards. Any change in one or more of these assumptions could have a material impact on the estimated fair value of a future award.

The Company has determined that the Black-Scholes option pricing model, as well as the underlying assumptions used in its application, are appropriate in estimating the fair value of stock option grants. The Company periodically reassesses its assumptions as well as its choice of valuation model, and will reconsider use of this model if additional information becomes available in the future indicating that another model would provide a more accurate estimate of fair value, or if characteristics of future grants would warrant such a change.

Refer to Note D for further discussion of the Company’s stock-based compensation plans.

Income taxes: The Company accounts for deferred taxes by recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. The Company records a deferred tax asset related to the stock-based compensation costs recognized for certain stock-based awards. At the time of the exercise of non-qualified stock options or vesting of stock awards, the Company accounts for the resulting tax deduction by reducing its accrued income tax liability with an offset to the deferred tax asset and any excess tax benefit increasing additional paid-in capital. The Company currently has a sufficient pool of excess tax benefits in additional paid-in capital to absorb any deficient tax benefits related to stock-based awards.

The Company also maintains a reserve for uncertain tax positions. The Company evaluates tax positions taken or expected to be taken in a tax return for recognition in its consolidated financial statements. Prior to recording the related tax benefit in the consolidated financial statements, the Company must conclude that tax positions must be more-likely-than-not to be sustained, assuming those positions will be examined by taxing authorities with full knowledge of all relevant information. The benefit recognized in the consolidated financial statements is the amount the Company expects to realize after examination by taxing authorities. If a tax position drops below the more-likely-than-not standard, the benefit can no longer be recognized. Assumptions, judgment, and the use of estimates are required in determining if the more-likely-than-not standard has been met when developing the provision for income taxes and in determining the expected benefit. A change in the assessment of the more-likely-than-not standard could materially impact the Company’s results of operations or financial position. The Company’s reserve for uncertain tax positions was $19.8 million as of May 31, 2013 and $36.8 million as of May 31, 2012. Refer to Note I for further discussion of the Company’s reserve for uncertain tax positions.

Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates, judgments, and assumptions that affect reported amounts of assets, liabilities, revenue, and expenses during the reporting period. Actual amounts and results could differ from these estimates.

Reclassifications: Certain prior period amounts have been reclassified to conform to the current period presentation and had no effect on reported consolidated earnings.

Recently adopted accounting pronouncements: Effective June 1, 2012, the Company adopted the Financial Accounting Standards Board (“FASB”) authoritative guidance on the presentation of comprehensive income. This guidance requires the Company to present components of net income and comprehensive income in one continuous statement or in two separate, but consecutive statements. There are no changes to the components that are recognized in net income or other comprehensive income. The Company elected to present net income and comprehensive income in one continuous statement, as presented in its consolidated financial statements.

Recently issued accounting pronouncements: In February 2013, the FASB issued additional guidance on reporting and disclosures surrounding comprehensive income. This guidance requires the reporting of the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income. It is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2012, and the Company will adopt this guidance effective June 1, 2013. The Company does not anticipate the adoption of this guidance will have a material effect on its consolidated financial statements.

In July 2012, the FASB issued updated guidance on the periodic testing of indefinite-lived intangible assets, other than goodwill, for impairment. This updated guidance will allow companies the option to first assess qualitative factors to determine if it is more-likely-than-not that an indefinite-lived intangible asset might be impaired and whether it is necessary to perform the quantitative impairment test required under current accounting standards. This guidance is applicable for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company currently does not have any indefinite-lived intangible assets other than goodwill and does not expect the adoption of this guidance will have a material effect on its consolidated financial statements.

Other recent authoritative guidance issued by the FASB (including technical corrections to the FASB Accounting Standards Codification), the American Institute of Certified Public Accountants, and the Securities and Exchange Commission (“SEC”) did not, or are not expected to have a material effect on the Company’s consolidated financial statements.

Note B — Basic and Diluted Earnings Per Share

Basic and diluted earnings per share were calculated as follows:

		Year ended May 31,
In millions, except per share amounts		2013				2012				2011
Basic earnings per share:
Net income		$	569.0			$	548.0			$	515.3
Weighted-average common shares outstanding		363.8				362.4				361.8
Basic earnings per share		$	1.56			$	1.51			$	1.42
Diluted earnings per share:
Net income		$	569.0			$	548.0			$	515.3
Weighted-average common shares outstanding		363.8				362.4				361.8
Dilutive effect of common share equivalents at average market price		0.9				0.6				0.6
Weighted-average common shares outstanding, assuming dilution		364.7				363.0				362.4
Diluted earnings per share		$	1.56			$	1.51			$	1.42
Weighted-average anti-dilutive common share equivalents		6.5				9.9				11.5

Weighted-average common share equivalents that had an anti-dilutive impact are excluded from the computation of diluted earnings per share.

Note C — Business Combinations

During fiscal 2011, the Company acquired two software-as-a-service (“SaaS”) companies, opening up additional areas of the markets the Company serves. Effective February 8, 2011, the Company acquired SurePayroll, Inc. (“SurePayroll”), a payroll processing provider for small businesses, for $114.9 million, net of cash acquired. The acquisition of SurePayroll allowed the Company entry into a new area of the online market for small businesses, and resulted in $83.9 million of goodwill, which is not tax-deductible.

Effective May 3, 2011, the Company acquired ePlan Services, Inc. (“ePlan”), a provider of recordkeeping and administrative solutions to the defined contribution marketplace, for $15.2 million, net of cash acquired. The ePlan acquisition resulted in $7.4 million of goodwill, which is not tax-deductible.

Upon their respective closing dates, both entities acquired became wholly owned subsidiaries of the Company. The financial results of SurePayroll and ePlan are included in the Company’s consolidated financial statements from their respective dates of acquisition. These acquisitions are not material to the Company’s results of operations, financial position, or cash flows.

Note D — Stock-Based Compensation Plans

The Paychex, Inc. 2002 Stock Incentive Plan, as amended and restated (the “2002 Plan”), effective on October 13, 2010 upon its approval by the Company’s stockholders, authorizes grants of up to 39.1 million shares of the Company’s common stock. As of May 31, 2013, there were 22.0 million shares available for future grants under the 2002 Plan.

All stock-based awards to employees are recognized as compensation costs in the consolidated financial statements based on their fair values measured as of the date of grant. These costs are recognized as an expense in the Consolidated Statements of Income and Comprehensive Income on a straight-line basis over the requisite service period and increase additional paid-in capital.

Stock-based compensation expense was $22.8 million, $22.9 million, and $24.8 million for fiscal years 2013, 2012, and 2011, respectively. Related income tax benefits recognized were $8.5 million, $8.3 million, and $8.4 million for the respective fiscal years. Capitalized stock-based compensation costs related to the development of internal use software for these same fiscal years were not significant.

As of May 31, 2013, the total unrecognized compensation cost related to all unvested stock-based awards was $47.1 million and is expected to be recognized over a weighted-average period of 2.9 years.

Black-Scholes fair value assumptions: The fair value of stock option grants and performance stock options was estimated at the date of grant using a Black-Scholes option pricing model. The weighted-average assumptions used for valuation under the Black-Scholes model are as follows:

		Year ended May 31,
		2013				2012				2013				2012				2011
		Performance stock options								Stock options
Risk-free interest rate		0.7		%		1.9		%		1.0		%		2.2		%		2.2		%
Dividend yield		4.1		%		4.2		%		4.3		%		4.2		%		4.2		%
Volatility factor		.22				.24				.23				.24				.24
Expected option life in years		4.8				5.8				6.4				6.4				6.5
Weighted-average grant-date fair value of stock options granted (per share)		$	3.55			$	4.35			$	3.77			$	4.46			$	4.02

Risk-free interest rates are yields for zero coupon U.S. Treasury notes maturing approximately at the end of the expected option life. The estimated volatility factor is based on a combination of historical volatility, using weekly stock prices over a period equal to the expected option life, and implied market volatility. The expected option life is based on historical exercise behavior.

The Company has determined that the Black-Scholes option pricing model, as well as the underlying assumptions used in its application, are appropriate in estimating the fair value of its stock option grants. The Company periodically assesses its assumptions as well as its choice of valuation model, and will reconsider use of this model if additional information becomes available in the future indicating that another model would provide a more accurate estimate of fair value, or if characteristics of future grants would warrant such a change.

Stock option grants: Stock option grants entitle the holder to purchase, at the end of the vesting term, a specified number of shares of Paychex common stock at an exercise price per share set equal to the closing market price of the common stock on the date of grant. All stock option grants have a contractual life of ten years from the date of the grant and a vesting schedule as established by the Board of Directors (the “Board”). The Company issues new shares of common stock to satisfy stock option exercises. Non-qualified stock option grants to officers and outside directors are typically approved by the Board in July. Non-qualified stock option grants to officers and employees granted prior to July 2010 vest 20% per annum, while grants to the Board prior to October 2010 vest one-third per annum. Grants of non-qualified stock options to officers beginning in July 2010 vest 25% per annum. Grants to members of the Board beginning in October 2010 vest after one-year.

The Company had granted stock options to virtually all non-management employees with at least ninety of service, and shares remain outstanding for the following broad-based stock option grants:

Date of broad-based grant		Shares granted (millions)			Exercise price per share				Shares outstanding as of May 31, 2013 (millions)
April 2004		1.7			$	37.72			0.6
October 2006		2.0			$	37.32			1.0

The following table summarizes stock option activity for the year ended May 31, 2013:

In millions, except per share amounts		Shares subject to options			Weighted-average exercise price per share				Weighted-average remaining contractual term (years)		Aggregate intrinsic value(1)
Outstanding as of May 31, 2012		10.0			$	33.88
Granted		1.0			$	31.73
Exercised		(2.4	)		$	31.91
Forfeited		(0.1	)		$	29.33
Expired		(0.5	)		$	35.70
Outstanding as of May 31, 2013		8.0			$	34.17			4.4		$	26.3
Exercisable as of May 31, 2013		6.1			$	35.29			3.2		$	13.8

(1) Market price of the underlying stock as of May 31, 2013 less the exercise price.

Other information pertaining to stock option grants is as follows:

		Year ended May 31,
In millions, except per share amounts		2013				2012				2011
Total intrinsic value of stock options exercised		$	7.8			$	0.8			$	1.9
Total grant-date fair value of stock options vested		$	3.0			$	10.4			$	20.0

Performance stock options: In July 2011, the Board approved a special award of performance-based stock options under a Long-Term Incentive Plan. Under this award, stock options were granted to officers with vesting dependent on achievement against long-term strategic and financial objectives. The awards will vest in full if performance targets for the fiscal year ending May 31, 2016 are achieved. Acceleration of vesting for up to one-half of the award will occur if performance targets for the fiscal year ending May 31, 2014 are achieved. There also is an opportunity to vest in one-half of the award at threshold performance, which is 95% of target.

The following table summarizes performance stock option activity for the year ended May 31, 2013:

In millions, except per share amounts		Shares subject to options			Weighted-average exercise price per share				Weighted-average remaining contractual term (years)		Aggregate intrinsic value (2)
Outstanding as of May 31, 2012		2.6			$	30.80
Granted(1)		0.2			$	32.99
Exercised		—			$	—
Forfeited		(0.1	)		$	31.63
Expired		—			$	—
Outstanding as of May 31, 2013		2.7			$	30.95			8.3		$	16.8
Exercisable as of May 31, 2013		—			$	—			0.0		$	—

(1)	Performance stock options granted assuming achievement of performance goals at target. Actual amount of shares to be earned may differ from this amount.

(2)	Market price of the underlying stock as of May 31, 2013 less the exercise price.

Restricted stock units: The Board grants restricted stock units (“RSUs”) to non-officer management. For each unit granted, the holder will receive one share of stock at the time of vesting. RSUs do not have voting rights or earn dividend equivalents during the vesting period. These awards vest 20% per annum over five years with a small population of awards vesting on the fourth anniversary of the grant date. The fair value of RSUs is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the vesting period.

The following table summarizes RSU activity for the year ended May 31, 2013:

In millions, except per share amounts		RSUs			Weighted-average grant-date fair value per share				Weighted-average remaining vesting period (years)		Aggregate intrinsic value (1)
Nonvested as of May 31, 2012		1.6			$	25.49
Granted		0.7			$	28.59
Vested		(0.5	)		$	27.10
Forfeited		(0.2	)		$	25.96
Nonvested as of May 31, 2013		1.6			$	26.29			1.6		$	59.9

(1)	An RSU is an agreement to issue shares at the time of vesting with no associated exercise cost. Therefore, intrinsic value for RSUs is the market price of the underlying stock as of May 31, 2013.

Other information pertaining to RSUs is as follows:

		Year ended May 31,
In millions, except per share amounts		2013				2012				2011
Weighted-average grant-date fair value of RSUs granted		$	28.59			$	27.67			$	21.52
Total intrinsic value of RSUs vested		$	15.5			$	11.0			$	7.7
Total grant-date fair value of RSUs vested		$	13.4			$	9.5			$	8.5

Restricted stock awards: The Board has approved grants of restricted stock awards to the Company’s officers and outside directors. All shares underlying awards of restricted stock are restricted in that they are not transferable until they vest. The recipients of the restricted stock have voting rights and earn dividends, which are paid to the recipient at the time of vesting of the awards. If the recipient leaves Paychex prior to the vesting date for any reason, the shares of restricted stock and the dividends accrued on those shares will be forfeited and returned to Paychex.

For restricted stock awards granted to officers prior to July 2010, the shares vest upon the fifth anniversary of the grant date provided the recipient is still an employee of the Company on that date. These awards have a provision for the acceleration of vesting based on achievement of performance targets established by the Board. If the established targets are met for a fiscal year, up to one-third of the award may vest. If all the targets are met for three consecutive years, the award will be fully vested. Beginning in July 2010, time-vested restricted stock awards were granted to officers, which vest one-third per annum over three years. For grants to outside directors prior to October 2010, the shares vest on the third anniversary of the grant date. Beginning in October 2010, restricted stock granted to outside directors vest on the one-year anniversary of the grant date. The fair value of restricted stock awards is equal to the closing market price of the underlying common stock as of the date of grant and is expensed over the requisite service period on a straight-line basis.

The following table summarizes restricted stock activity for the year ended May 31, 2013:

In millions, except per share amounts		Restricted shares			Weighted-average grant-date fair value per share
Nonvested as of May 31, 2012		0.2			$	29.35
Granted		0.1			$	31.76
Vested		(0.1	)		$	31.06
Forfeited		—			$	29.19
Nonvested as of May 31, 2013		0.2			$	29.83

Other information pertaining to restricted stock follows:

		Year ended May 31,
In millions, except per share amounts		2013				2012				2011
Weighted-average grant-date fair value of restricted stock granted		$	31.76			$	30.69			$	26.40
Total grant-date fair value of restricted stock vested		$	2.1			$	3.2			$	2.2

Performance shares: Beginning in July 2010, the Board approved grants of restricted performance shares to officers. These awards have a two year performance period, after which the amount of restricted shares earned will be determined based on achievement against established performance targets. The restricted shares earned will then be subject to a one year service period. Performance shares do not have voting rights or earn dividend equivalents during the performance period. The fair value of performance shares is equal to the closing market price of the underlying common stock as of the date of grant, adjusted for the present value of expected dividends over the performance period.

The following table summarizes performance share activity for the year ended May 31, 2013:

In millions, except per share amounts		Performance shares			Weighted-average grant-date fair value per share
Nonvested as of May 31, 2012		0.2			$	26.83
Granted(1)		0.2			$	29.10
Forfeited		—			$	26.74
Nonvested as of May 31, 2013		0.4			$	27.89

(1)	Performance shares granted assuming achievement of performance goals at target. Actual amount of shares to be earned may differ from this amount.

Non-compensatory employee benefit plan: The Company offers an Employee Stock Purchase Plan to all employees under which the Company’s common stock can be purchased through a payroll deduction with no discount to the market price and no look-back provision. All transactions occur directly through the Company’s transfer agent and no brokerage fees are charged to employees, except for when stock is sold. The plan has been deemed non-compensatory and therefore, no stock-based compensation costs have been recognized for fiscal years 2013, 2012, or 2011 related to this plan.

Note E — Funds Held for Clients and Corporate Investments

Funds held for clients and corporate investments are as follows:

		May 31, 2013
In millions		Amortized cost				Gross unrealized gains				Gross unrealized losses				Fair value
Type of issue:
Funds held for clients money market securities and other cash equivalents		$	1,137.7			$	—			$	—			$	1,137.7
Available-for-sale securities:
General obligation municipal bonds		1,432.9				27.4				(3.5		)		1,456.8
Pre-refunded municipal bonds(1)		201.0				2.9				—				203.9
Revenue municipal bonds		746.1				10.1				(2.2		)		754.0
Variable rate demand notes		1,276.7				—				—				1,276.7
Total available-for-sale securities		3,656.7				40.4				(5.7		)		3,691.4
Other		9.5				1.2				—				10.7
Total funds held for clients and corporate investments		$	4,803.9			$	41.6			$	(5.7	)		$	4,839.8

		May 31, 2012
In millions		Amortized cost				Gross unrealized gains				Gross unrealized losses				Fair value
Type of issue:
Funds held for clients money market securities and other cash equivalents		$	2,157.2			$	—			$	—			$	2,157.2
Available-for-sale securities:
General obligation municipal bonds		1,295.0				39.1				(0.2		)		1,333.9
Pre-refunded municipal bonds(1)		326.8				7.5				—				334.3
Revenue municipal bonds		487.9				13.2				(0.1		)		501.0
Variable rate demand notes		889.8				—				—				889.8
Total available-for-sale securities		2,999.5				59.8				(0.3		)		3,059.0
Other		8.8				0.5				(0.1		)		9.2
Total funds held for clients and corporate investments		$	5,165.5			$	60.3			$	(0.4	)		$	5,225.4

(1)	Pre-refunded municipal bonds are secured by an escrow fund of U.S. government obligations.

Included in money market securities and other cash equivalents as of May 31, 2013 and May 31, 2012 are money market funds and bank demand deposit accounts. Also included in May 31, 2012 were short-term municipal bonds and commercial paper. Within bank demand deposit accounts for funds held for clients, the Company maintained $23.4 million as of May 31, 2013 and $13.7 million as of May 31, 2012 in a separately designated account for tax obligations of a partner’s clients.

Classification of investments on the Consolidated Balance Sheets is as follows:

		May 31,
In millions		2013				2012
Funds held for clients		$	4,072.5			$	4,544.2
Corporate investments		398.2				207.5
Long-term corporate investments		369.1				473.7
Total funds held for clients and corporate investments		$	4,839.8			$	5,225.4

The Company’s available-for-sale securities reflected a net unrealized gain of $34.7 million as of May 31, 2013 compared with a net unrealized gain of $59.5 million as of May 31, 2012. Included in the net unrealized gain as of May 31, 2013 and May 31, 2012, respectively, there were 147 and 35 available-for-sale securities in an unrealized loss position. The securities in an unrealized loss position, were as follows:

	May 31, 2013
	Less than twelve months								More than twelve months								Total
In millions	Gross unrealized losses				Fair value				Gross unrealized losses				Fair Value				Gross unrealized losses				Fair Value
Type of issue:
General obligation municipal bonds	$	(3.5	)		$	349.2			$	—			$	—			$	(3.5	)		$	349.2
Pre-refunded municipal bonds	—				3.1				—				—				—				3.1
Revenue municipal bonds	(2.2		)		225.3				—				2.1				(2.2		)		227.4
Total	$	(5.7	)		$	577.6			$	—			$	2.1			$	(5.7	)		$	579.7

	May 31, 2012
	Less than twelve months								More than twelve months								Total
In millions	Gross unrealized losses				Fair value				Gross unrealized losses				Fair Value				Gross unrealized losses				Fair Value
Type of issue:
General obligation municipal bonds	$	(0.2	)		$	124.4			$	—			$	—			$	(0.2	)		$	124.4
Revenue municipal bonds	(0.1		)		55.6				—				—				(0.1		)		55.6
Total	$	(0.3	)		$	180.0			$	—			$	—			$	(0.3	)		$	180.0

The Company regularly reviews its investment portfolios to determine if any investment is other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns. The Company believes that the investments held as of May 31, 2013 that had unrealized losses of $5.7 million were not other-than-temporarily impaired. The Company believes that it is probable that the principal and interest will be collected in accordance with contractual terms, and that the unrealized losses on these securities were due to changes in interest rates and were not due to increased credit risk or other valuation concerns. A substantial portion of the securities in an unrealized loss position as of May 31, 2013 and May 31, 2012 held an AA rating or better. The Company does not intend to sell these investments until the recovery of their amortized cost basis or maturity, and further believes that it is not more-likely-than-not that it will be required to sell these investments prior to that time. The Company’s assessment that an investment is not other-than-temporarily impaired could change in the future due to new developments or changes in the Company’s strategies or assumptions related to any particular investment.

Realized gains and losses from the sale of available-for-sale securities were as follows:

		Year ended May 31,
In millions		2013				2012				2011
Gross realized gains		$	0.9			$	1.0			$	1.3
Gross realized losses		—				—				—
Net realized gains		$	0.9			$	1.0			$	1.3

The amortized cost and fair value of available-for-sale securities that had stated maturities as of May 31, 2013 are shown below by contractual maturity. Expected maturities can differ from contractual maturities because borrowers may have the right to prepay obligations without prepayment penalties.

		May 31, 2013
In millions		Amortized cost				Fair value
Maturity date:
Due in one year or less		$	274.3			$	276.2
Due after one year through three years		701.2				718.6
Due after three years through five years		693.4				709.7
Due after five years		1,987.8				1,986.9
Total		$	3,656.7			$	3,691.4

VRDNs are primarily categorized as due after five years in the table above as the contractual maturities on these securities are typically 20 to 30 years. Although these securities are issued as long-term securities, they are priced and traded as short-term instruments because of the liquidity provided through the tender feature.

Note F — Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The accounting standards related to fair value measurements include a hierarchy for information and valuations used in measuring fair value that is broken down into three levels based on reliability, as follows:

•	Level 1 valuations are based on quoted prices in active markets for identical instruments that the Company can access at the measurement date.

•	Level 2 valuations are based on inputs other than quoted prices included in Level 1 that are observable for the instrument, either directly or indirectly, for substantially the full term of the asset or liability including the following:

◦	quoted prices for similar, but not identical, instruments in active markets;

◦	quoted prices for identical or similar instruments in markets that are not active;

◦	inputs other than quoted prices that are observable for the instrument; or

◦	inputs that are derived principally from or corroborated by observable market data by correlation or other means.

•	Level 3 valuations are based on information that is unobservable and significant to the overall fair value measurement.

The carrying values of cash and cash equivalents, including money market securities, accounts receivable, net of allowance for doubtful accounts, and accounts payable approximate fair value due to the short maturities of these instruments. Money market securities are included in Level 1 of the fair value hierarchy. Marketable securities included in funds held for clients and corporate investments consist primarily of securities classified as available-for-sale and are recorded at fair value on a recurring basis.

The Company’s financial assets and liabilities measured at fair value on a recurring basis were as follows:

		May 31, 2013
In millions		Carrying value (Fair value)				Quoted prices in active markets (Level 1)				Significant other observable inputs (Level 2)				Significant unobservable inputs (Level 3)
Assets:
Available-for-sale securities:
General obligation municipal bonds		$	1,456.8			$	—			$	1,456.8			$	—
Pre-refunded municipal bonds		203.9				—				203.9				—
Revenue municipal bonds		754.0				—				754.0				—
Variable rate demand notes		1,276.7				—				1,276.7				—
Total available-for-sale securities		$	3,691.4			$	—			$	3,691.4			$	—
Other securities		$	10.7			$	10.7			$	—			$	—
Liabilities:
Other long-term liabilities		$	10.7			$	10.7			$	—			$	—

		May 31, 2012
In millions		Carrying value (Fair value)				Quoted prices in active markets (Level 1)				Significant other observable inputs (Level 2)				Significant unobservable inputs (Level 3)
Assets:
Available-for-sale securities:
General obligation municipal bonds		$	1,333.9			$	—			$	1,333.9			$	—
Pre-refunded municipal bonds		334.3				—				334.3				—
Revenue municipal bonds		501.0				—				501.0				—
Variable rate demand notes		889.8				—				889.8				—
Total available-for-sale securities		$	3,059.0			$	—			$	3,059.0			$	—
Other securities		$	9.2			$	9.2			$	—			$	—
Liabilities:
Other long-term liabilities		$	9.2			$	9.2			$	—			$	—

In determining the fair value of its assets and liabilities, the Company predominately uses the market approach. Available-for-sale securities included in Level 2 are valued utilizing inputs obtained from an independent pricing service. To determine the fair value of the Company’s Level 2 investments, a variety of inputs are utilized, including benchmark yields, reported trades, non-binding broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, new issue data, and monthly payment information. The Company reviews the values generated by the independent pricing service for reasonableness by comparing the valuations received from the independent pricing service to valuations from at least one other

observable source for a sample of securities. The Company has not adjusted the prices obtained from the independent pricing service.

Other securities are mutual fund investments, consisting of participants’ eligible deferral contributions under the Company’s non-qualified and unfunded deferred compensation plans. The related liability is reported as other long-term liabilities. The mutual funds are valued based on quoted market prices in active markets.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

Note G — Property and Equipment, Net of Accumulated Depreciation

The components of property and equipment, at cost, consisted of the following:

		May 31,
In millions		2013				2012
Land and improvements		$	8.1			$	7.0
Buildings and improvements		99.2				96.8
Data processing equipment		175.6				212.3
Software		290.1				263.5
Furniture, fixtures, and equipment		145.2				154.2
Leasehold improvements		99.5				96.0
Construction in progress		32.8				28.2
Total property and equipment, gross		850.5				858.0
Less: Accumulated depreciation and amortization		504.5				533.7
Property and equipment, net of accumulated depreciation		$	346.0			$	324.3

Depreciation expense was $79.2 million, $74.8 million, and $68.4 million for fiscal years 2013, 2012, and 2011, respectively.

Note H — Goodwill and Intangible Assets, Net of Accumulated Amortization

The Company had goodwill balances on its Consolidated Balance Sheets of $533.9 million as of May 31, 2013, and $517.4 million as of May 31, 2012. The increase in goodwill since May 31, 2012 was the result of two immaterial business acquisitions.

The Company has certain intangible assets with finite lives. The components of intangible assets, at cost, consisted of the following:

		May 31,
In millions		2013				2012
Client lists		$	231.0			$	223.6
Other intangible assets		2.4				2.0
Total intangible assets, gross		233.4				225.6
Less: Accumulated amortization		188.2				169.8
Intangible assets, net of accumulated amortization		$	45.2			$	55.8

During fiscal 2013, the Company acquired intangible assets with weighted-average amortization periods as follows: customer lists — 7.8 years; other intangible assets — 6.0 years; and total — 7.7 years. Amortization expense relating to intangible assets was $19.0 million, $23.0 million, and $20.3 million for fiscal years 2013, 2012, and 2011, respectively.

The estimated amortization expense for the next five fiscal years relating to intangible asset balances is as follows:

In millions Year ending May 31,		Estimated amortization expense
2014		$	14.9
2015		10.8
2016		7.7
2017		5.5
2018		3.5

Note I — Income Taxes

The components of deferred tax assets and liabilities are as follows:

		May 31,
In millions		2013				2012
Deferred tax assets:
Compensation and employee benefit liabilities		$	16.3			$	15.8
Other current liabilities		6.3				6.7
Tax credit carry forward		35.3				31.7
Depreciation		8.5				8.0
Stock-based compensation		24.6				28.5
Other		16.6				17.4
Gross deferred tax assets		107.6				108.1
Deferred tax liabilities:
Capitalized software		45.8				39.3
Depreciation		20.2				21.8
Intangible assets		41.0				36.8
Revenue not subject to current taxes		11.7				11.1
Unrealized gains on available-for-sale securities		13.3				21.8
Other		0.6				1.0
Gross deferred tax liabilities		132.6				131.8
Net deferred tax liability		$	(25.0	)		$	(23.7	)

The components of the provision for income taxes are as follows:

		Year ended May 31,
In millions		2013				2012				2011
Current:
Federal		$	274.2			$	259.8			$	234.0
State		62.9				40.8				29.3
Total current		337.1				300.6				263.3
Deferred:
Federal		5.5				9.3				12.0
State		(0.2		)		2.4				1.6
Total deferred		5.3				11.7				13.6
Provision for income taxes		$	342.4			$	312.3			$	276.9

A reconciliation of the U.S. federal statutory tax rate to the Company’s effective income tax rate is as follows:

		Year ended May 31,
		2013			2012			2011
Federal statutory tax rate		35.0	%		35.0	%		35.0	%
Increase/(decrease) resulting from:
State income taxes, net of federal tax benefit		3.0	%		3.3	%		2.5	%
Tax settlement		1.5	%		—	%		—	%
Tax-exempt municipal bond interest		(1.7	)%		(1.8	)%		(2.2	)%
Other items		(0.2	)%		(0.2	)%		(0.3	)%
Effective income tax rate		37.6	%		36.3	%		35.0	%

Uncertain income tax positions: The Company is subject to U.S. federal income tax, numerous local and state tax jurisdictions within the U.S., and income taxes in Germany. The Company maintains a reserve for uncertain tax positions. As of May 31, 2013 and May 31, 2012, the total reserve for uncertain tax positions was $19.8 million and $36.8 million, respectively. As of May 31, 2013 and May 31, 2012, $19.7 million and $35.9 million of the total reserve for uncertain tax positions was included in long-term liabilities on the Consolidated Balance Sheets.

A reconciliation of the beginning and ending amounts of the Company’s gross unrecognized tax benefits, not including interest or other potential offsetting effects, is as follows:

		Year ended May 31,
In millions		2013				2012				2011
Balance as of beginning of fiscal year		$	41.7			$	41.2			$	35.8
Additions for tax positions of the current year		28.5				0.4				6.0
Additions for tax positions of prior years		12.2				1.3				0.1
Reductions for tax positions of prior years		(0.5		)		(0.1		)		(0.1		)
Settlements with tax authorities		(55.0		)		(0.7		)		—
Expiration of the statute of limitations		(0.2		)		(0.4		)		(0.6		)
Balance as of end of fiscal year		$	26.7			$	41.7			$	41.2

In May 2013, the Company executed a closing agreement that resolved tax matters related to the audits by New York State for the fiscal year ended May 31, 2004 ("fiscal 2004") through fiscal 2011. As a result, the reserve for uncertain tax positions was increased by $21.2 million in May 2013. The resolution and execution of the closing agreement in May 2013 on the open tax matters for fiscal 2004 through fiscal 2011 impacted the Company's effective income tax rate for fiscal 2013, as noted in the reconciliation of the U.S. federal statutory rate to the Company's effective income tax rate.

The reserve as of May 31, 2013 substantially relates to uncertain tax positions for state income tax matters. The Company believes the reserve for uncertain tax positions, including interest and net of federal benefits, of $19.8 million as of May 31, 2013 adequately covers open tax years and uncertain tax positions up to and including fiscal 2013 for major taxing jurisdictions. As of May 31, 2013, $14.6 million of the $19.8 million unrecognized tax benefits, if recognized, would impact the Company’s effective income tax rate. As of May 31, 2012, $31.6 million of the $36.8 million unrecognized tax benefits, if recognized, would have impacted the Company’s effective income tax rate.

The Company has concluded all U.S. federal income tax matters through the fiscal year ended May 31, 2010. Fiscal 2011 and fiscal 2012 are still subject to potential audit. With limited exception, state income tax audits by taxing authorities are closed through the fiscal year ended May 31, 2008, primarily due to expiration of the statute of limitations.

The Company continues to follow its policy of recognizing interest and penalties accrued on tax positions as a component of income taxes on the Consolidated Statements of Income and Comprehensive Income. The amount of accrued interest and penalties associated with the Company’s tax positions is immaterial to the Consolidated Balance Sheets. The amount of interest and penalties recognized for fiscal years 2013, 2012, and 2011 was immaterial to the Company’s results of operations.

Note J — Other Comprehensive (Loss)/Income

Other comprehensive (loss)/income results from items deferred on the Consolidated Balance Sheets in stockholders’ equity. The following table sets forth the components of other comprehensive (loss)/income:

		Year ended May 31,
In millions		2013				2012				2011
Unrealized holding (losses)/gains		$	(24.1	)		$	1.3			$	(6.0	)
Income tax benefit/(expense) related to unrealized holding (losses)/gains		9.0				(0.4		)		1.9
Reclassification adjustment for the net gain on sale of available-for-sale securities realized in net income		(0.9		)		(1.0		)		(1.3		)
Income tax expense on reclassification adjustment for the net gain on sale of available-for-sale securities		0.3				0.3				0.5
Other comprehensive (loss)/income		$	(15.7	)		$	0.2			$	(4.9	)

As of May 31, 2013, accumulated other comprehensive income was $22.0 million, which was net of taxes of $12.5 million. As of May 31, 2012, accumulated other comprehensive income was $37.7 million, which was net of taxes of $21.8 million. Accumulated other comprehensive income is comprised of the unrealized gains/losses, net of tax.

Note K — Supplemental Cash Flow Information

Income taxes paid were $371.0 million, $301.4 million, and $255.6 million for fiscal years 2013, 2012, and 2011, respectively.

Lease incentives received in the form of tenant allowances and free rent were $6.4 million, $12.8 million, and $10.5 million for fiscal years 2013, 2012, and 2011, respectively.

Note L — Employee Benefit Plans

401(k) plan: The Company maintains a contributory savings plan that qualifies under section 401(k) of the Internal Revenue Code. The Paychex, Inc. 401(k) Incentive Retirement Plan (the “Plan”) allows all employees to immediately participate in the salary deferral portion of the Plan, contributing up to a maximum of 50% of their salary, subject to Internal Revenue Service limitations. Employees who have completed one year of service are eligible to receive a company matching contribution, when such contribution is in effect. The Company increased the matching contribution in February 2012 to 50% of up to 6% of eligible pay that an employee contributes to the Plan. From January 2011 to February 2012, the Company provided a matching contribution in the amount of 50% of up to 4% of eligible pay that an employee contributed to the Plan. Effective April 2009, the Company suspended its safe harbor matching contribution and no matching contributions were made for pay dates in 2010.

The Plan is 100% participant directed. Plan participants can fully diversify their portfolios by choosing from any or all investment fund choices in the Plan. Transfers in and out of investment funds, including the Paychex, Inc. Employee Stock Ownership Plan (“ESOP”) Stock Fund, are not restricted, with the exception of certain restricted trading periods for individuals designated as insiders as specified in the Company’s Insider Trading Policy. The Company match contribution, when in effect, follows the same fund elections as the employee compensation deferrals.

Company contributions to the Plan for fiscal 2013, fiscal 2012, and fiscal 2011 were $13.1 million, $10.3 million, and $3.5 million, respectively.

Deferred compensation plans: The Company offers non-qualified and unfunded deferred compensation plans to a select group of key employees, executive officers, and outside directors. Eligible employees are provided with the opportunity to defer up to 50% of their annual base salary and bonus and outside directors may defer 100% of their Board cash compensation. Gains and losses are credited based on the participant’s election of a variety of investment choices. The Company does not match any participant deferral or guarantee its return. Distributions are paid at one of the following dates selected by the participant: the participant’s termination date, the date the participant retires from any active employment, or a designated specific date. The amounts accrued under these plans were $10.7 million and $9.2 million as of May 31, 2013 and May 31, 2012, respectively, and are reflected in other long-term liabilities on the accompanying Consolidated Balance Sheets.

Note M — Commitments and Contingencies

Lines of credit: As of May 31, 2013, the Company had unused borrowing capacity available under four uncommitted, secured, short-term lines of credit at market rates of interest with financial institutions as follows:

Financial institution	Amount available	Expiration date
JP Morgan Chase Bank, N.A.	$350 million	February 28, 2014
Bank of America, N.A.	$250 million	February 28, 2014
PNC Bank, National Association	$150 million	February 28, 2014
Wells Fargo Bank, National Association	$150 million	February 28, 2014

The credit facilities are evidenced by promissory notes and are secured by separate pledge security agreements by and between Paychex and each of the financial institutions (the “Lenders”), pursuant to which the Company has granted each of the Lenders a security interest in certain investment securities accounts. The collateral is maintained in a pooled custody account pursuant to the terms of a control agreement and is to be administered under an intercreditor agreement among the Lenders. Under certain circumstances, individual Lenders may require that collateral be transferred from the pooled account into segregated accounts for the benefit of such individual Lenders.

The primary uses of the lines of credit would be to meet short-term funding requirements related to deposit account overdrafts and client fund obligations arising from electronic payment transactions on behalf of clients in the ordinary course of business, if necessary. No amounts were outstanding against these lines of credit during fiscal 2013 or as of May 31, 2013.

The financial institutions are also parties to the Company’s credit facility and irrevocable standby letters of credit, which are discussed below.

Credit facility: In June 2013, the Company entered into a committed, unsecured, five-year syndicated credit facility, expiring on June 21, 2018. Under the credit facility, Paychex of New York LLP (the "Borrower") may, subject to certain restrictions, borrow up to $500 million to meet short-term funding requirements. The obligations under this facility have been guaranteed by the Company and certain of its subsidiaries. The outstanding obligations under this credit facility will bear interest at competitive rates to be elected by the Borrower. Upon expiration of the commitment in June 2018, any borrowings outstanding will mature and be payable on such date.

Certain lenders under this credit facility, and their respective affiliates, have performed, and may in the future perform for the Company and its subsidiaries, various commercial banking, investment banking, underwriting, and other financial advisory services, for which they have received, and will continue to receive in the future, customary fees and expenses.

Letters of credit: The Company had irrevocable standby letters of credit outstanding totaling $36.8 million and $46.8 million as of May 31, 2013 and May 31, 2012, respectively, required to secure commitments for certain insurance policies. The letters of credit expire at various dates between July 2013 and December 2013, and are collateralized by securities held in the Company’s investment portfolios. No amounts were outstanding on these letters of credit during fiscal 2013 or as of May 31, 2013. Subsequent to May 31, 2013, the letter of credit expiring in July 2013 was renewed and will expire in July 2014.

Contingencies: The Company is subject to various claims and legal matters that arise in the normal course of its business. These include disputes or potential disputes related to breach of contract, breach of fiduciary duty, employment-related claims, tax claims, and other matters.

The Company’s management currently believes that resolution of outstanding legal matters will not have a material adverse effect on the Company’s financial position or results of operations. However, legal matters are subject to inherent uncertainties and there exists the possibility that the ultimate resolution of these matters could have a material adverse impact on the Company’s financial position and the results of operations in the period in which any such effect is recorded.

Lease commitments: The Company leases office space and data processing equipment under terms of various operating leases. Rent expense for fiscal years 2013, 2012, and 2011 was $39.9 million, $43.0 million, and $45.4 million, respectively. As of May 31, 2013, future minimum lease payments under various non-cancelable operating leases with terms of more than one year are as follows:

In millions Year ending May 31,	Minimum lease payments
2014	$	36.9
2015	33.1
2016	24.9
2017	19.5
2018	13.4
Thereafter	15.6

Other commitments: As of May 31, 2013, the Company had outstanding commitments under purchase orders and legally binding contractual arrangements with minimum future payment obligations of approximately $89.1 million, including $9.9 million of commitments to purchase capital assets. These minimum future payment obligations relate to the following fiscal years:

In millions Year ending May 31,	Minimum payment obligation
2014	$	59.1
2015	21.2
2016	7.0
2017	1.3
2018	0.1
Thereafter	0.4

In the normal course of business, the Company makes representations and warranties that guarantee the performance of services under service arrangements with clients. Historically, there have been no material losses related to such guarantees. In addition, the Company has entered into indemnification agreements with its officers and directors, which require the Company to defend and, if necessary, indemnify these individuals for certain pending or future claims as they relate to their services provided to the Company.

Paychex currently self-insures the deductible portion of various insured exposures under certain employee benefit plans. The Company’s estimated loss exposure under these insurance arrangements is recorded in other current liabilities on the Consolidated Balance Sheets. Historically, the amounts accrued have not been material. The Company also maintains insurance coverage in addition to its purchased primary insurance policies for gap coverage for employment practices liability, errors and omissions, warranty liability, theft and embezzlement, cyber threat, and acts of terrorism; and capacity for deductibles and self-insured retentions through its captive insurance company.

Note N — Related Parties

During fiscal years 2013, 2012, and 2011, the Company purchased approximately $6.5 million, $2.6 million, and $5.7 million, respectively, of data processing equipment and software from EMC Corporation. The Chairman, President, and Chief Executive Officer of EMC Corporation is a member of the Company’s Board.

During fiscal years 2013, 2012, and 2011, the Company purchased approximately $1.6 million, $1.8 million, and $1.8 million, respectively, of office supplies from Staples, Inc. The President of Staples North American Commercial is a member of the Company’s Board.

Note O — Quarterly Financial Data (Unaudited)

In millions, except per share amounts

		Three Months Ended
Fiscal 2013		August 31				November 30				February 28				May 31(1)				Full Year
Service revenue		$	568.1			$	559.4			$	582.4			$	575.3			$	2,285.2
Interest on funds held for clients		10.1				10.0				10.9				10.0				41.0
Total revenue		578.2				569.4				593.3				585.3				2,326.2
Operating income		238.0				230.0				225.0				211.8				904.8
Investment income, net		1.9				1.9				1.4				1.4				6.6
Income before income taxes		239.9				231.9				226.4				213.2				911.4
Income taxes		86.8				84.0				81.9				89.7				342.4
Net income		$	153.1			$	147.9			$	144.5			$	123.5			$	569.0
Basic earnings per share(2)		$	0.42			$	0.41			$	0.40			$	0.34			$	1.56
Diluted earnings per share(2)		$	0.42			$	0.41			$	0.40			$	0.34			$	1.56
Weighted-average common shares outstanding		363.0				363.6				363.8				364.6				363.8
Weighted-average common shares outstanding, assuming dilution		363.8				364.4				364.6				365.9				364.7
Cash dividends per common share		$	0.32			$	0.33			$	0.66			$	—			$	1.31
Total net realized gains(3)		$	0.2			$	0.1			$	0.6			$	—			$	0.9

		Three Months Ended
Fiscal 2012		August 31				November 30				February 29				May 31				Full Year
Service revenue		$	552.0			$	535.0			$	558.5			$	540.7			$	2,186.2
Interest on funds held for clients		11.1				10.7				11.0				10.8				43.6
Total revenue		563.1				545.7				569.5				551.5				2,229.8
Operating income		229.7				217.9				210.4				195.9				853.9
Investment income, net		1.5				1.5				1.6				1.8				6.4
Income before income taxes		231.2				219.4				212.0				197.7				860.3
Income taxes		82.3				79.0				76.6				74.4				312.3
Net income		$	148.9			$	140.4			$	135.4			$	123.3			$	548.0
Basic earnings per share(2)		$	0.41			$	0.39			$	0.37			$	0.34			$	1.51
Diluted earnings per share(2)		$	0.41			$	0.39			$	0.37			$	0.34			$	1.51
Weighted-average common shares outstanding		362.2				362.4				362.5				362.6				362.4
Weighted-average common shares outstanding, assuming dilution		362.8				362.8				363.1				363.4				363.0
Cash dividends per common share		$	0.31			$	0.32			$	0.32			$	0.32			$	1.27
Total net realized gains(3)		$	0.1			$	0.1			$	0.4			$	0.4			$	1.0

(1)	In the fourth quarter of fiscal 2013, the Company increased its tax provision related to the settlement of a state income tax matter. This reduced diluted earnings per share by approximately $0.04 per share.

(2)	Each quarter is a discrete period and the sum of the four quarters’ basic and diluted earnings per share amounts may not equal the full year amount.

(3)	Total net realized gains on the combined funds held for clients and corporate investment portfolios.

Schedule II — Valuation and Qualifying Accounts

PAYCHEX, INC.

CONSOLIDATED FINANCIAL STATEMENT SCHEDULE

FOR THE YEAR ENDED MAY 31,

(In millions)

Description		Balance as of beginning of fiscal year				Additions charged to expenses				(Deductions from)/ additions to other accounts(1)				Costs and deductions(2)				Balance as of end of fiscal year
2013
Allowance for doubtful accounts		$	1.2			$	1.7			$	—			$	1.9			$	1.0
Reserve for client fund losses		$	2.1			$	2.7			$	—			$	2.4			$	2.4
2012
Allowance for doubtful accounts		$	2.1			$	1.2			$	—			$	2.1			$	1.2
Reserve for client fund losses		$	3.1			$	2.3			$	(0.7	)		$	2.6			$	2.1
2011
Allowance for doubtful accounts		$	1.9			$	1.8			$	0.4			$	2.0			$	2.1
Reserve for client fund losses		$	2.6			$	1.9			$	1.3			$	2.7			$	3.1

(1)	Amounts related to business acquisitions.

(2)	Uncollectible amounts written off, net of recoveries.