Adobe 2005 Annual Report Download - page 73

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The assumptions used to value the purchase rights are as follows:
Fiscal Years
2005 2004 2003
Expected life (in years) .........................
.
1.25 1.25 1.25
Volatility ...............................................
.
32 – 37% 34 – 40% 40 – 66%
Risk free interest rate ............................
.
3.03 – 3.58% 1.24 – 1.76% 1.12 – 1.74%
Dividend yield.......................................
.
— 0.093 – 0.125% 0.125%
Advertising Expenses
We expense all advertising costs as incurred and classify these costs under sales and marketing
expense. Advertising expenses for fiscal 2005, 2004 and 2003 were $39.0 million, $31.9 million and $24.0
million, respectively.
Foreign Currency and Other Hedging Instruments
We transact business in foreign countries, in U.S. dollars and in various foreign currencies. In Europe
and Japan, transactions that are denominated in euro and yen subject us to exposure from movements in
foreign currency exchange rates. We hedge our net recognized foreign currency assets and liabilities with
forward foreign exchange contracts to reduce the risk that our earnings and cash flows will be adversely
affected by changes in foreign currency exchange rates. We use options and forward foreign exchange
contracts to reduce our exposure to foreign currency rate changes on non-functional currency denominated
forecasted product licensing revenue, primarily yen-denominated and euro-denominated revenue.
Adobe accounts for its derivative instruments as either assets or liabilities on the balance sheet and
measures them at fair value. Derivatives that are not defined as hedges in Statement of Financial
Accounting Standards No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging
Activities,” must be adjusted to fair value through earnings. As described in Note 15, gains and losses
resulting from changes in fair value are accounted for depending on the use of the derivative and whether it
is designated and qualifies for hedge accounting.
Gains and losses from the forward foreign exchange contracts hedging certain balance sheet positions,
primarily non-functional currency denominated assets, such as trade receivable, and liabilities, such as
accounts payable, are recorded each period in other income (expense) in the consolidated statements of
operations. Forward foreign exchange contracts hedging forecasted non-functional currency denominated
forecasted product licensing revenue, are designated as cash flow hedges under SFAS 133, with gains and
losses recorded net of tax, as a component of other comprehensive income in stockholders’ equity and
reclassified into revenue at the time the forecasted transactions occur.
Income Taxes
We use the asset and liability method of accounting for income taxes. Under this method, income tax
expense is recognized for the amount of taxes payable or refundable for the current year. In addition,
deferred tax assets and liabilities are recognized for expected future tax consequences of temporary
differences between the financial reporting and tax bases of assets and liabilities, and for operating losses
and tax credit carryforwards. We record a valuation allowance to reduce deferred tax assets to an amount
for which realization is more likely than not. We also account for any income tax contingencies in
accordance with Statement of Financial Accounting Standards No. 5 (“SFAS 5”), “Accounting for
Contingencies.”
Recent Accounting Pronouncements
In May 2005 the FASB issued Statement of Financial Accounting Standards No. 154 (“SFAS 154”),
“Accounting Changes and Error Corrections,” which replaces Accounting Principles Board No. 20 (“APB
20”), “Accounting Changes,” and Statement of Financial Accounting Standards No. 3, “Reporting
Accounting Changes in Interim Financial Statements.” SFAS 154 applies to all voluntary changes in
accounting principle, and changes the requirements for accounting for and reporting of a change in
accounting principle. SFAS 154 requires retrospective application to prior periods’ financial statements of a