Eli Lilly 2012 Annual Report Download - page 62

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the equity method with our share of earnings or losses reported in other—net, (income) expense. We own no
investments that are considered to be trading securities.
Risk-management instruments
Our derivative activities are initiated within the guidelines of documented corporate risk-management policies
and do not create additional risk because gains and losses on derivative contracts offset losses and gains on
the assets, liabilities, and transactions being hedged. As derivative contracts are initiated, we designate the
instruments individually as either a fair value hedge or a cash flow hedge. Management reviews the
correlation and effectiveness of our derivatives on a quarterly basis.
For derivative contracts that are designated and qualify as fair value hedges, the derivative instrument is
marked to market with gains and losses recognized currently in income to offset the respective losses and
gains recognized on the underlying exposure. For derivative contracts that are designated and qualify as cash
flow hedges, the effective portion of gains and losses on these contracts is reported as a component of
accumulated other comprehensive income (loss) and reclassified into earnings in the same period the hedged
transaction affects earnings. Hedge ineffectiveness is immediately recognized in earnings. Derivative
contracts that are not designated as hedging instruments are recorded at fair value with the gain or loss
recognized in current earnings during the period of change.
We may enter into foreign currency forward contracts to reduce the effect of fluctuating currency exchange
rates (principally the euro, the British pound, 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 principally 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—net, (income) expense. We may enter into foreign currency forward contracts and
currency swaps as fair value hedges of firm commitments. Forward 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 hedges. Interest expense on the debt is
adjusted to include the payments made or received under the swap agreements.
We may enter into forward contracts and designate them as cash flow hedges to limit the potential volatility of
earnings and cash flow associated with forecasted sales of available-for-sale securities.
Goodwill and other intangibles
Goodwill results from excess consideration in a business combination over the fair value of identifiable net
assets acquired. Goodwill is not amortized.
Intangible assets with finite lives are capitalized and are amortized over their estimated useful lives, ranging
from 3 to 20 years.
The cost of in-process research and development (IPR&D) projects acquired directly in a transaction other
than a business combination is capitalized if the projects have an alternative future use; otherwise, they are
expensed. The fair values of IPR&D projects acquired in business combinations are capitalized as other
intangible assets. Several methods may be used to determine the estimated fair value of the IPR&D acquired
in a business combination. We utilize the “income method,” which applies a probability weighting that
considers the risk of development and commercialization, to the estimated future net cash flows that are
derived from projected sales revenues and estimated costs. These projections are based on factors such as