Note 1 – Significant Accounting Policies (continued) 49 THE TIMKEN COMPANY FINANCIAls ANd FOOTNOTEs Goodwill and Other Intangible Assets:  Intangible assets subject to amortization are amortized on a straight-line method over their  legal or estimated useful lives, with useful lives ranging from two years to 20 years. Goodwill and indefinite-lived intangible assets not  subject to amortization are tested for impairment at least annually. The Company performs its annual impairment test on the first day  of the fourth quarter after the annual forecasting process is completed. Furthermore, goodwill and indefinite-lived intangible assets  are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable  in accordance with accounting rules related to goodwill and other intangible assets. Effective October 1, 2011, the Company adopted  the provisions of Accounting Standards Update (ASU) No. 2011-08, “Intangibles–Goodwill and Other (Topic 350): Testing Goodwill  for Impairment,” which allows companies to assess qualitative factors to determine if goodwill might be impaired and whether it is  necessary to perform the two-step goodwill impairment test. Income Taxes:  The Company accounts for income taxes in accordance with Accounting Standards Codification (ASC) No. 740, “Income  Taxes.” Deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between financial  statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as net operating loss and tax credit  carryforwards. The Company recognizes valuation allowances against deferred tax assets by tax jurisdiction when it is more likely than  not that such assets will not be realized. Accruals for uncertain tax positions are provided for in accordance with ASC No. 740-10. The  Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. Foreign Currency Translation:  Assets and liabilities of subsidiaries, other than those located in highly inflationary countries, are  translated at the rate of exchange in effect on the balance sheet date; income and expenses are translated at the average rates of  exchange prevailing during the year. The related translation adjustments are reflected as a separate component of accumulated other  comprehensive loss. Gains and losses resulting from foreign currency transactions and the translation of financial statements of  subsidiaries in highly inflationary countries are included in the Consolidated Statements of Income. The Company realized foreign  currency exchange losses of $1.4 million in 2011 and foreign currency gains of $4.3 million and $8.2 million in 2010 and 2009, respectively. Pension and Other Postretirement Benefits:  The Company recognizes an overfunded status or underfunded status (i.e., the  difference between the fair value of plan assets and the benefit obligations) as either an asset or a liability for its defined benefit  pension and postretirement benefit plans on the Consolidated Balance Sheets, with a corresponding adjustment to accumulated other  comprehensive loss, net of tax. The adjustment to accumulated other comprehensive loss represents the current year net unrecognized  actuarial gains and losses and unrecognized prior service costs. These amounts will be recognized in future periods as net periodic  benefit cost. Stock-Based Compensation:  The Company recognizes share-based compensation expense based on the grant date fair value of the  share-based awards over their required vesting period. Stock options are issued with an exercise price equal to the closing market price  of Timken common shares on the date of grant. The fair value of stock options is determined using a Black-Scholes option pricing model,  which incorporates assumptions regarding the expected volatility, the expected option life, the risk-free interest rate and the expected  dividend yield. The fair value of restricted stock is based on the closing market price of Timken common stock on the grant date. Earnings Per Share:  Unvested restricted shares of common stock provide for the payment of nonforfeitable dividends. The Company  considers these awards as participating securities. Earnings per share are computed using the two class method. Basic earnings  per share are computed by dividing net income less undistributed earnings allocated to unvested restricted stock by the weighted  average number of common shares outstanding during the year. Diluted earnings per share are computed by dividing net income less  undistributed earnings allocated to unvested restricted stock by the weighted average number of common shares outstanding, adjusted  for the dilutive impact of outstanding share-based awards. Derivative Instruments:  The Company recognizes all derivatives on the Consolidated Balance Sheets at fair value. Derivatives that  are not designated as hedges must be adjusted to fair value through earnings. If the derivative is designated and qualifies as a hedge,  depending on the nature of the hedge, changes in the fair value of the derivatives are either offset against the change in fair value of  the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive loss until the hedged item is  recognized in earnings. The Company’s holdings of forward foreign currency exchange contracts qualify as derivatives pursuant to the  criteria established in derivative accounting guidance, and the Company has designated certain of those derivatives as hedges.