MCCORMICK & COMPANY 2004 ANNUAL REPORT reduces revenue for estimated product returns, allowances and price discounts based on historical experience.  notes to consolidated financial statements Trade allowances, consisting primarily of customer pricing allowances, merchandising funds and consumer coupons, are offered through various programs to customers and consumers. Revenue is recorded net of trade allowances. Receivables consist of amounts billed and currently due from customers. The Company has an allowance for doubt- ful accounts to reduce its receivables to their net realizable value. Management estimates the allowance for doubtful accounts based on factors including aging of receivables and historical collection experience.  Shipping and Handling Research and Development Recently Issued Accounting Pronouncements Advertising Stock-Based Compensation 42 In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” an amendment to ARB No. 43, Chapter 4,“Inventory Pricing.” FAS No. 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company believes there will be no material effect upon adoption of this statement. In May 2004, the FASB issued Staff Position 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug Improvement and Modernization Act of 2003” which provides guidance on the accounting for the effects of the Act. FASB Staff Position 106-2 is effective for the first interim or annual period beginning after June 15, 2004. The Company adopted FASB Staff Position 106-2 in the third quarter of 2004. See Note 10 for impact of adoption. The Company uses the intrinsic value method as defined in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” to account for stock options issued to employees and directors. Accordingly, no compen- sation expense is recognized for these stock options since all options granted have an exercise price equal to the market value of the underlying stock on the grant date. During 2003, the Company recorded $1.2 million (net of income taxes of $0.5 million) of stock compensation expense in discontinued operations as a result of accelerated vesting of certain options related to the employees of the discontinued operations. The following table illustrates the effect on net income and earn- ings per common share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.  Advertising costs, which include the development and produc- tion of advertising materials and the communication of this material through various forms of media, are expensed in the period the advertising first takes place. Advertising expense is included in the selling, general and administrative expense caption in the consolidated statement of income. Advertising expense was $49.2 million, $34.5 million, and $27.4 million for the years ended November 30, 2004, 2003 and 2002, respectively. In January 2003, the FASB issued and subsequently revised Interpretation No. 46, “Consolidation of Variable Interest Entities.” The Company adopted Interpretation No. 46 as it relates to special purpose entities in the fourth quarter of 2003. As a result, the Company consolidated the lessor of a leased distribution center used by the Company and recorded a cumulative effect of an accounting change of $2.1 million (net of income tax benefit of $1.2 million). Consolidation of this entity increased assets by $11.2 million, long-term debt by $14.0 million and minority interest by $0.5 million. The effect of consolidation of this entity in prior years would have reduced net income in 2002 by $0.3 million. In 2004, the Company adopted the remaining provisions of Interpretation No. 46 and there was no material effect on the consolidated financial statements.  Research and development costs are expensed as incurred and are included in the selling, general and administrative expense caption in the consolidated statement of income. Research and development expense was $39.3 million, $33.2 million, and $31.4 million for the years ended November 30, 2004, 2003 and 2002, respectively. Shipping and handling costs are included in the selling, general and administrative expense caption in the consoli- dated statement of income. Shipping and handling expense was $75.3 million, $60.9 million, and $52.4 million for the years ended November 30, 2004, 2003 and 2002, respectively. The per share weighted-average fair value of options granted was $6.79, $4.70, and $4.99 in 2004, 2003 and 2002, respectively. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following range of assumptions for the Company’s various stock option plans and Employee Stock Purchase Plans: (millions except per share data) 2004 2003 2002 Net income as reported $214.5 $210.8 $179.8 Add: stock-based employee  compensation recorded, net of tax .3 1.2 – Deduct: stock-based employee compensation expense, net of tax (15.5) (12.7) (9.2) Pro forma net income $199.3 $199.3 $170.6 Earnings per common share: Basic – as reported $ 1.57 $ 1.51 $ 1.29 Basic – pro forma 1.45 1.43 1.22 Diluted – as reported 1.52 1.48 1.26 Diluted – pro forma 1.41 1.40 1.20 2004 2003 2002 Risk-free interest rates 3.3 - 3.8% 1.7 - 3.3% 4.5% Dividend yield 1.8% 2.0% 2.0% Expected volatility 21.75% 19.1 - 22.3% 21.6% Expected lives 5.0 - 6.0 years 1.6 - 6.0 years 6.0 years