Eli Lilly 2005 Annual Report Download - page 37

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income and reclassified into earnings in the same period the hedged transaction affects earnings. Hedge inef-
fectiveness is immediately recognized in earnings. Derivative contracts that are not designated as hedging instru-
ments are recorded at fair value with the gain or loss recognized in current earnings during the period of change.
We enter into foreign currency forward and option contracts to reduce the effect of fluctuating currency ex-
change rates (principally the euro and the Japanese yen). Generally, foreign currency derivatives used for hedging
are put in place using the same or like currencies and duration as the underlying exposures. Forward contracts
are principally used to manage exposures arising from subsidiary trade and loan payables and receivables de-
nominated in foreign currency. These contracts are recorded at fair value with the gain or loss recognized in other
income. The purchased option contracts are used to hedge anticipated foreign currency transactions, primarily
intercompany inventory activities expected to occur within the next year. These contracts are designated as cash
flow hedges of those future transactions and the impact on earnings is included in cost of sales. We may enter into
foreign currency forward contracts and currency swaps as fair value hedges of firm commitments. Forward and
option contracts generally have maturities not exceeding 12 months.
In the normal course of business, our operations are exposed to fluctuations in interest rates. These fluctuations
can vary the costs of financing, investing, and operating. We address a portion of these risks through a controlled
program of risk management that includes the use of derivative financial instruments. The objective of controlling
these risks is to limit the impact of fluctuations in interest rates on earnings. Our primary interest rate risk exposure
results from changes in short-term U.S. dollar interest rates. In an effort to manage interest rate exposures, we
strive to achieve an acceptable balance between fixed and floating rate debt and investment positions and may enter
into interest rate swaps or collars to help maintain that balance. Interest rate swaps or collars that convert our fixed
rate debt or investments to a floating rate are designated as fair value hedges of the underlying instruments. Interest
rate swaps or collars that convert floating rate debt or investments to a fixed rate are designated as cash flow hedg-
es. Interest expense on the debt is adjusted to include the payments made or received under the swap agreements.
Goodwill and other intangibles: Other intangibles with finite lives arising from acquisitions and research alliances
are amortized over their estimated useful lives, ranging from 5 to 15 years, using the straight-line method. Goodwill
is not amortized. Goodwill and other intangibles are reviewed to assess recoverability at least annually and when
certain impairment indicators are present. Goodwill and net other intangibles with finite lives were $139.6 million and
$110.3 million, respectively, at December 31, 2005 and 2004, and were included in sundry assets in the consolidated
balance sheets. We currently have no other intangible assets with indefinite lives. No material impairments occurred
with respect to the carrying value of our goodwill or other intangible assets in 2005, 2004, or 2003.
Property and equipment: Property and equipment is stated on the basis of cost. Provisions for depreciation of
buildings and equipment are computed generally by the straight-line method at rates based on their estimated
useful lives (generally 12 to 50 years for buildings and 3 to 18 years for equipment). We review the carrying value of
long-lived assets for potential impairment on a periodic basis, and whenever events or changes in circumstances
indicate the carrying value of an asset may not be recoverable. Impairment is determined by comparing projected
undiscounted cash flows to be generated by the asset to its carrying value. If an impairment is identified, a loss is
recorded equal to the excess of the asset’s net book value over the asset’s fair value, and the cost basis is adjusted.
At December 31, property and equipment consisted of the following:
2005 2004
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 166.8 $ 147.0
Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,584.5 3,569.5
Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,314.1 5,627.2
Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,070.6 2,995.2
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,136.0 12,338.9
Less allowances for depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,223.5 4,788.0
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 7,912.5 $ 7,550.9
Depreciation expense for 2005, 2004, and 2003 was $577.2 million, $495.9 million, and $469.3 million, respec-
tively. Approximately $140.5 million, $111.3 million, and $61.0 million of interest costs were capitalized as part
of property and equipment in 2005, 2004, and 2003, respectively. Total rental expense for all leases, including
contingent rentals (not material), amounted to approximately $294.4 million, $286.8 million, and $268.5 million for
2005, 2004, and 2003, respectively. Capital leases included in property and equipment in the consolidated balance
sheets, capital lease obligations entered into, and future minimum rental commitments are not material.