Eli Lilly 2006 Annual Report Download - page 35

FINANCIALS
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recognized on the underlying exposure. For derivative contracts that are designated and qualify as cash fl ow hedg-
es, the effective portion of gains and losses on these contracts is reported as a component of other comprehensive
income and reclassifi ed 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 fl uctuating currency ex-
change rates (principally the euro and the Japanese yen). 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 princi-
pally used to manage exposures arising from subsidiary trade and loan payables and receivables denominated in
foreign currencies. 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 fl ow hedges of
those future transactions and the impact on earnings is included in cost of sales. We may enter into foreign curren-
cy forward contracts and currency swaps as fair value hedges of fi rm commitments. Forward and option contracts
generally have maturities not exceeding 12 months.
In the normal course of business, our operations are exposed to fl uctuations in interest rates. These fl uc-
tuations can vary the costs of fi nancing, investing, and operating. We address a portion of these risks through a
controlled program of risk management that includes the use of derivative fi nancial instruments. The objective of
controlling these risks is to limit the impact of fl uctuations 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 fi xed and fl oating rate debt and investment posi-
tions and may enter into interest rate swaps or collars to help maintain that balance. Interest rate swaps or collars
that convert our fi xed rate debt or investments to a fl oating rate are designated as fair value hedges of the under-
lying instruments. Interest rate swaps or collars that convert fl oating rate debt or investments to a fi xed rate are
designated as cash fl ow hedges. 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 fi nite 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. Good-
will 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 fi nite lives were $130.0
million and $139.6 million, respectively, at December 31, 2006 and 2005, and were included in sundry assets in the
consolidated balance sheets. Goodwill is our only intangible asset with an indefi nite life. No material impairments
occurred with respect to the carrying value of our goodwill or other intangible assets in 2006, 2005, or 2004.
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 (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 undiscount-
ed cash fl ows to be generated by the asset to its carrying value. If an impairment is identifi ed, a loss is recorded
equal to the excess of the asset’s net book value over its fair value, and the cost basis is adjusted.
At December 31, property and equipment consisted of the following:
2006 2005
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 168.7 $ 166.8
Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,852.8 4,584.5
Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,718.5 6,314.1
Construction in progress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,976.7 2,070.6
13,716.7 13,136.0
Less allowances for depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,564.4) (5,223.5)
$ 8,152.3 $ 7,912.5
Depreciation expense for 2006, 2005, and 2004 was $627.4 million, $577.2 million, and $495.9 million, respec-
tively. Approximately $106.7 million, $140.5 million, and $111.3 million of interest costs were capitalized as part
of property and equipment in 2006, 2005, and 2004, respectively. Total rental expense for all leases, including