Eli Lilly 2005 Annual Report Download - page 38

FI NA NCI A L S
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Revenue recognition: We recognize revenue from sales of products at the time title of goods passes to the buyer
and the buyer assumes the risks and rewards of ownership. This is generally at the time products are shipped to
the customer. Provisions for discounts and rebates to customers are established in the same period the related
sales are recorded.
We also generate income as a result of collaboration agreements. Revenue from copromotion services (pri-
marily Actos) is based upon net sales reported by our copromotion partner and, if applicable, the number of sales
calls we perform. We immediately recognize the full amount of milestone payments due to us upon the achieve-
ment of the milestone event if the event is substantive, objectively determinable, and represents an important
point in the development life cycle of the pharmaceutical product. Milestone payments earned by us are generally
recorded in other income-net. Initial fees we receive from the partnering of our compounds under development are
amortized through the expected product approval date. Initial fees received from out-licensing agreements that
include both the sale of marketing rights to our commercialized products and a related commitment to supply the
products are generally recognized as net sales over the term of the supply agreement.
Research and development: We recognize as incurred the cost of directly acquiring assets to be used in the
research and development process that have not yet received regulatory approval for marketing and for which no
alternative future use has been identified. Once the product has obtained regulatory approval, we capitalize the
milestones paid and amortize them over the period benefited. Milestones paid prior to regulatory approval of the
product are generally expensed when the event requiring payment of the milestone occurs.
Income taxes: Deferred taxes are recognized for the future tax effects of temporary differences between financial
and income tax reporting based on enacted tax laws and rates. Federal income taxes are provided on the portion of
the income of foreign subsidiaries that is expected to be remitted to the United States and be taxable. We record a
liability for tax contingencies when we believe it is probable that we will be assessed and the amount of the contin-
gency can be reasonably estimated. The tax contingency reserve is adjusted for changes in facts and circumstanc-
es, and additional uncertainties. See Note 11 regarding the 2004 tax expense associated with the now completed
repatriation of earnings reinvested outside the U.S. pursuant to the American Job Creations Act.
Earnings per share: We calculate basic earnings per share based on the weighted-average number of outstanding
common shares and incremental shares. We calculate diluted earnings per share based on the weighted-average
number of outstanding common shares plus the effect of dilutive stock options and other incremental shares.
Stock-based compensation: As discussed more fully in Note 7, we adopted Statement of Financial Account-
ing Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), effective January 1, 2005. SFAS 123R
requires the recognition of the fair value of stock-based compensation in net income. Stock-based compensation
primarily consists of stock options and performance awards. Stock options are granted to employees at exercise
prices equal to the fair market value of our stock at the dates of grant. Generally, options fully vest three years
from the grant date and have a term of 10 years. Performance awards are granted to officers and key employees
and are payable in shares of our common stock. The number of performance award shares actually issued, if any,
varies depending on the achievement of certain earnings-per-share targets. In general, performance awards fully
vest at the end of the fiscal year of the grant. We recognize the stock-based compensation expense over the requi-
site service period of the individual grantees, which generally equals the vesting period. We provide newly issued
shares and treasury stock to satisfy stock option exercises and for the issuance of performance awards.
Prior to January 1, 2005, we followed Accounting Principles Board (APB) Opinion 25, Accounting for Stock
Issued to Employees, and related interpretations in accounting for our stock options and performance awards.
Under APB 25, because the exercise price of our employee stock options equals the market price of the underlying
stock on the date of grant, no compensation expense was recognized. However, SFAS 123R requires us to present
pro forma information as if we had accounted for our employee stock options and performance awards under the
fair value method of that statement. For purposes of pro forma disclosure, the estimated fair value of the options
and performance awards at the date of the grant is amortized to expense over the requisite service period, which
generally is the vesting period.