Avon 2005 Annual Report Download - page 26

NOTES฀TO฀CONSOLIDATED฀FINANCIAL฀STATEMENTS
Stock Awards
We apply the recognition and measurement principles of
Accounting Principles Board (APB) Opinion 25, “Accounting for
Stock Issued to Employees,” and related interpretations in account-
ing for our long-term stock-based incentive plans, which are
described in Note 8, Long-Term Incentive Plans. No compensation
cost related to grants of stock options was reflected in net income,
as all options granted under the plans had an exercise price equal
to the market value of the underlying common stock on the date
of grant. Compensation cost related to grants of restricted stock
and restricted stock units is measured as the quoted market price of
Avon’s stock at the measurement date and is amortized to expense
over the vesting period. The effect on net income and earnings
per share if we had applied the fair value recognition provisions
of Statement of Financial Accounting Standards (“FAS”) No. 123,
“Accounting for Stock-Based Compensation,” to stock-based com-
pensation for the years ended December 31 was as follows:
2005 2004 2003
Net income, as reported $847.6 $846.1 $ 664.8
Add: compensation expense
recognized for restricted stock and
restricted stock units, net of taxes 6.6 5.7 4.3
Less: stock-based compensation
expense determined under
FAS No. 123, net of taxes (37.7) (32.0) (33.0)
Pro forma net income $816.5 $819.8 $ 636.1
Earnings per share:
Basic – as reported $ 1.82 $ 1.79 $ 1.41
Basic – pro forma $ 1.75 $ 1.74 $ 1.35
Diluted – as reported $ 1.81 $ 1.77 $ 1.39
Diluted – pro forma $ 1.74 $ 1.72 $ 1.33
The fair value for these options granted to employees was
estimated at the grant date using a Black-Scholes option pricing
model with the following weighted-average assumptions:
2005 2004 2003
Risk-free interest rate 4.2% 2.4% 2.4%
Expected life 4 years 4 years 4 years
Expected volatility 25% 30% 45%
Expected dividend yield 1.6% 1.5% 1.6%
The weighted-average grant date fair values per share of options
granted during 2005, 2004 and 2003 were $9.07, $8.54, and
$8.83, respectively.
Financial Instruments
We use derivative financial instruments, including interest rate
swaps, forward foreign currency contracts and options, to man-
age interest rate and foreign currency exposures. We record all
derivative instruments at their fair values on the Consolidated
Balance Sheets as either assets or liabilities.
Research and Development
Research and development costs are expensed as incurred and
amounted to $64.2 in 2005 (2004 – $63.1; 2003 – $56.8).
Research and development costs include all costs related to the
design and development of new products such as salaries and
benefits, supplies and materials and facilities costs.
Advertising
Advertising costs, excluding brochure preparation costs, are
expensed as incurred and amounted to $135.9 in 2005 (2004
– $127.6; 2003 – $108.8). Direct response advertising costs, con-
sisting primarily of brochure preparation, are amortized over the
period during which the benefits are expected, which is typically
the campaign length. At December 31, 2005 and 2004, prepaid
expenses and other included deferred brochure costs of $34.5
and $38.3, respectively.
Deferred Income Taxes
Deferred income taxes have been provided on items recognized
for financial reporting purposes in different periods than for
income tax purposes using tax rates in effect for the year in which
the differences are expected to reverse. A valuation allowance is
provided for deferred tax assets if it is more likely than not these
items will either expire before we are able to realize their benefit,
or that future deductibility is uncertain. U.S. income taxes have
not been provided on approximately $1,487.4 of undistributed
income of subsidiaries that has been or is intended to be perma-
nently reinvested outside the United States. Since we decided to
permanently reinvest a greater portion of foreign earnings off-
shore, we have not repatriated dividends under Internal Revenue
Code Sec. 965(a) as enacted by the American Jobs Creation Act
of 2004.
Shipping and Handling
Shipping and handling costs are expensed as incurred and
amounted to $706.0 in 2005 (2004 – $680.0; 2003 – $599.0).
Shipping and handling costs are included in marketing, distribu-
tion and administrative expenses on the Consolidated Statements
of Income.
Restructuring Reserves
We record severance-related expenses once they are both probable
and estimable in accordance with the provisions of FAS No. 112,
“Employer’s Accounting for Post-Employment Benefits.” One-time
benefit arrangements and disposal costs, primarily contract termina-
tion costs and costs to consolidate or close facilities, are accounted
for under the provisions of FAS No. 146, “Accounting for Costs
Associated with Exit or Disposal Activities.” We evaluate impairment
issues under the provisions of FAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets.”