UPS 2004 Annual Report Download - page 51

Notes to consolidated financial statements 49
Foreign Currency Translation
We translate the results of operations of our foreign subsidiaries
using average exchange rates during each period, whereas bal-
ance sheet accounts are translated using exchange rates at the
end of each period. Balance sheet currency translation adjust-
ments are recorded in OCI. Net currency transaction gains and
losses included in other operating expenses were pre-tax gains of
$44, $21, and $27 million in 2004, 2003 and 2002, respectively.
Stock-Based Compensation
Effective January 1, 2003, we adopted the fair value measure-
ment provisions of FASB Statement No. 123 “Accounting for
Stock-Based Compensation” (“FAS 123”). In years prior to
2003, we used the intrinsic value method prescribed by
Accounting Principles Board Opinion No. 25, “Accounting for
Stock Issued to Employees” (“APB 25”). Under APB 25, we did
not have to recognize compensation expense for our stock
option grants and our discounted stock purchase plan, however
we did recognize compensation expense for our management
incentive awards and certain other stock awards (see Note 11
for a description of these plans).
Under the provisions of FASB Statement No. 148
“Accounting for Stock-Based Compensation — Transition and
Disclosure,” we have elected to adopt the measurement provi-
sions of FAS 123 using the prospective method. Under this
approach, all stock-based compensation granted subsequent to
January 1, 2003 will be expensed to compensation and benefits
over the vesting period based on the fair value at the date the
stock-based compensation is granted. Stock compensation
awards granted to date include stock options, management
incentive awards, restricted performance units, and employer
matching contributions (in shares of UPS stock) for a defined
contribution benefit plan. The adoption of the measurement pro-
visions of FAS 123 reduced 2004 and 2003 net income by $35
million ($0.03 per diluted share) and $20 million ($0.02 per
diluted share), respectively.
The following provides pro forma information as to the
impact on net income and earnings per share if we had used the
fair value measurement provisions of FAS 123 to account for all
stock-based compensation awards granted prior to January 1,
2003 (in millions, except per share amounts).
2004 2003 2002
Net income $ 3,333 $ 2,898 $ 3,182
Add: Stock-based employee
compensation expense
included in net income,
net of tax effects 563 456 391
Less: Total pro forma
stock-based employee
compensation expense,
net of tax effects (588) (507) (459)
Pro forma net income $ 3,308 $2,847 $3,114
Basic earnings per share
As reported $ 2.95 $ 2.57 $ 2.84
Pro forma $ 2.93 $ 2.52 $ 2.78
Diluted earnings per share
As reported $2.93 $2.55 $2.81
Pro forma $ 2.91 $ 2.50 $ 2.75
The fair value of each option grant is estimated using the
Black-Scholes option pricing model. Compensation cost is also
measured for the fair value of employees’ purchase rights under
our discounted stock purchase plan using the Black-Scholes
option pricing model. The weighted average assumptions used,
by year, and the calculated weighted average fair value of
options and employees’ purchase rights granted, are as follows:
2004 2003 2002
Stock options:
Expected dividend yield 1.50% 1.22% 1.10%
Risk-free interest rate 4.31% 3.70% 4.67%
Expected life in years 785
Expected volatility 15.69% 19.55% 20.24%
Weighted average fair value
of options granted $ 16.24 $ 17.02 $ 21.27
Discounted stock purchase plan:
Expected dividend yield 1.42% 1.12% 1.10%
Risk-free interest rate 1.18% 1.06% 1.70%
Expected life in years 0.25 0.25 0.25
Expected volatility 16.83% 19.79% 20.45%
Weighted average fair value
of purchase rights* $ 9.56 $ 8.53 $ 8.20
*Includes the 10% discount from the market price (see Note 11).