Notes to Consolidated Financial Statements (in thousands, except share and per share data) Foreign Currency Translation. The assets and liabilities of the Company’s subsidiaries other than the Company’s Indian subsidiary (“Cognizant India”), are translated into U.S. dollars from local curren- cies at current exchange rates and revenues and expenses are trans- lated from local currencies at average monthly exchange rates. The resulting translation adjustments are recorded in a separate compo- nent of stockholders’ equity. For Cognizant India, the functional cur- rency is the U.S. dollar, since its sales are made primarily in the United States, the sales price is predominantly in U.S. dollars and there is a high volume of intercompany transactions denominated in U.S. dollars between Cognizant India and its U.S. affiliates. Non-monetary assets and liabilities are translated at historical exchange rates, while monetary assets and liabilities are translated at current exchange rates. The resulting gain (loss) is included in the caption other income (expense), net on the Company’s consolidated statements of opera- tions and comprehensive income. Currency transaction gains and losses, which are included in the results of operations, are immaterial for all periods presented. Gains and losses from balance sheet transla- tion are included in accumulated other comprehensive income on the consolidated statement of financial position and represents the only item included in such caption. Foreign Currency Forward Contract. In July 2004, the Company entered into a foreign currency forward contract, with a six-month term and notional amount of $12,500, to sell the Indian Rupee for U.S. dollars. The counterparty is a credit worthy major financial institu- tion. The Company entered into this forward contract to manage a portion of its foreign currency risk related to Indian Rupee denominat- ed net asset balances, primarily cash investments of Cognizant India. Movement in the exchange rate for the Indian Rupee results in for- eign currency gains or losses upon remeasurement of Cognizant India’s financial statements into its functional currency, the U.S. dollar. The Company’s objective is to reduce foreign currency exposure to appreciation or depreciation in the value of the Indian Rupee by off- setting a portion of such exposure with gains or losses on the forward contract, referred to above. The Company is accounting for this financial derivative in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. This foreign currency contract does not qualify for hedge accounting under SFAS No. 133. Accordingly, the foreign currency forward contract is marked-to-market and recorded at fair value with unrealized gains and losses reported along with foreign currency gains or losses in the caption “other income (expense), net” on the Company’s consolidated statements of opera- tions and comprehensive income. At December 31, 2004, the fair value of the foreign currency forward contract was a liability of $989. For the year ended December 31, 2004, the unrealized loss on the foreign currency forward contract has been recorded as part of net foreign currency transaction gains of $73. Exit Activities. One-time termination benefits are recognized and measured at fair value at the communication date if the employee would not be retained beyond a minimum retention period (i.e., either a legal notification period or 60 days, if no legal requirement exists). For employees that will be retained beyond the minimum retention period, a liability is accrued ratably over the future service period. On June 29, 2004, the Company announced that it plans to wind- down operations at its development center located in Limerick, Ireland and close the facility by March 31, 2005. The Company expects to incur during 2004 and 2005 aggregate incremental costs of approximately $1,600 associated with the closure of this facility. In 2004, the Company has recorded expenses of approximately $1,500 primarily for severance, retention bonuses and an obligation to repay funds previously received through local job grant programs and made payments of approximately $1,000. Retention bonuses are being expensed over each eligible employee’s future service period. As of December 31, 2004, the Company had an accrual of approximately $500 for wind-down costs. Fixed assets related to this facility are not material and will be depreciated ratably through March 31, 2005. Approximately 50 employees are affected by the closure. Use of Estimates. The preparation of financial statements in accor- dance with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including the recoverability of tangible and intangible assets, disclo- sure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. On an on-going basis, management reevaluates these estimates. The most significant estimates relate to the recognition of revenue and profits based on the percentage of completion method of accounting for certain fixed-bid contracts, the allowance for doubtful accounts, income taxes and related deferred tax assets and liabilities, valuation of goodwill and other long-lived assets, contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The actual amounts may vary from the estimates used in the preparation of the accompanying consolidated financial statements. Risks and Uncertainties. Principally, all of the Company’s IT develop- ment centers, including a majority of its employees are located in India. As a result, the Company may be subject to certain risks associ- ated with international operations, including risks associated with foreign currency exchange rate fluctuations and risks associated with the application and imposition of protective legislation and regula- tions relating to import and export or otherwise resulting from foreign policy or the variability of foreign economic or political conditions. From time to time, the Company will engage in hedging transactions to mitigate its risks relating to foreign currency exchange rate 35 COGNIZANT ANNUAL REPORT 2004