ADT 2005 Annual Report Download - page 163

TYCO INTERNATIONAL LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation and Summary of Significant Accounting Policies (Continued)
Research and Development—Research and development expenditures are expensed when incurred
and are included in cost of product sales. Customer-funded research and development are costs
incurred by Tyco that are reimbursed by customers. There is no net impact on research and
development expense on the Consolidated Statements of Income for customer-funded research and
development. Research and development expense in our Consolidated Statements of Income reflects
company-sponsored research and development only. See Note 23.
Advertising—Advertising costs are expensed when incurred and are included in selling, general and
administrative expenses. See Note 23.
Employee Share Option Plans—Tyco measures compensation cost in connection with employee
share option plans using the intrinsic value method and accordingly does not recognize compensation
expense for the issuance of options with an exercise price equal to or greater than the market price at
the date of grant. Had the fair value based method been applied by Tyco, using the Black-Scholes
option pricing model and the assumptions set forth in Note 20, the effect on net income and earnings
per share for 2005, 2004 and 2003 would have been as follows ($ in millions, except per share data):
2005 2004 2003
Net income, as reported ................................. $3,032 $2,879 $ 980
Add: Employee compensation expense for share options included in
reported net income, net of income taxes .................. 10 7 8
Less: Total employee compensation expense for share options
determined under fair value method, net of income taxes ....... (157) (225) (321)
Net income, pro forma ................................. $2,885 $2,661 $ 667
Earnings per share:
Basic—as reported ................................... $ 1.51 $ 1.44 $0.49
Basic—pro forma .................................... 1.43 1.33 0.33
Diluted—as reported ................................. 1.43 1.35 0.49
Diluted—pro forma .................................. 1.37 1.26 0.34
In connection with the adoption of Statement of Financial Accounting Standards No. 123 (Revised
2004), ‘‘Share-Based Payment,’’ (‘‘SFAS No. 123R’’) Tyco will begin expensing stock options in 2006
based on their fair values.
Translation of Foreign Currency—For the Company’s non-U.S. subsidiaries that account in a
functional currency other than U.S. Dollars and do not operate in highly inflationary environments,
assets and liabilities are translated into U.S. Dollars using year-end exchange rates. Revenue and
expenses are translated at the average exchange rates in effect during the year. Foreign currency
translation gains and losses are included as a component of accumulated other comprehensive income
(loss) within shareholders’ equity. For subsidiaries operating in highly inflationary environments,
inventories and property, plant and equipment, including related expenses, are translated at the rate of
exchange in effect on the date the assets were acquired, while other assets and liabilities are translated
at year-end exchange rates. Translation adjustments for the assets and liabilities of these subsidiaries
are included in net income.
2005 Financials 87