COGNIZANT ANNUAL REPORT 2004 34 Notes to Consolidated Financial Statements (in thousands, except share and per share data) unit of accounting based on the Company’s revenue recognition policy described above. The adoption of EITF 00-21 did not have a material impact on the Company’s financial position, results of opera- tions or cash flows. Fixed-price contracts are cancelable subject to a specified notice peri- od. All services provided by the Company through the date of cancel- lation are due and payable under the contract terms. The Company issues invoices related to fixed-price contracts based upon achieve- ment of milestones during a project or other contractual terms. Differences between the timing of billings, based upon contract mile- stones or other contractual terms, and the recognition of revenue, based upon the percentage-of-completion method of accounting, are recognized as either unbilled or deferred revenue. Estimates of certain fixed-price contracts are subject to adjustment as a project progresses to reflect changes in expected completion costs. The cumulative impact of any revision in estimates is reflected in the finan- cial reporting period in which the change in estimate becomes known and any anticipated losses on contracts are recognized immediately. Warranty provisions generally exist under such contracts for a period of ninety days past contract completion and costs related to such provisions are accrued at the time the related revenues are recorded. Revenues related to services performed without a signed agreement or work order are not recognized until there is evidence of an arrangement, such as when agreements or work orders are signed or payment is received; however, the cost related to the performance of such work is recognized in the period the services are rendered. For all services, revenue is recognized when, and if, evidence of an arrangement is obtained and the other criteria to support revenue recognition are met, including the price is fixed or determinable, services have been rendered and collectibility is assured. The Company accounts for reimbursement of out-of-pocket expenses as revenues. Cost of revenues is exclusive of depreciation and amortization of property and equipment. Accounting for Stock-Based Employee Compensation Plans. In the first quarter of 2003, the Company adopted the interim disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation” (SFAS No. 148) which amended SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123). SFAS No. 148 provides alternative methods to transition for a voluntary change to fair value-based method of accounting for stock-based employee compensation and requires disclosures in annual and inter- im financial statements of the effects of stock-based compensation as reflected below. The Company continues to account for its stock- based employee compensation plans (as more fully described in Note 8) under the recognition and measurement principles of APB No. 25. Except for approximately $488 calculated in accordance with APB No. 25 related to the retention, acceleration and extended life of Cognizant common stock options by two former Directors of Cognizant included in Split-Off Costs and one grant in 1998, no employee stock-based compensation cost is reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant and for the stock purchase plan the discount does not exceed 15%. Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, consistent with the method prescribed by SFAS No. 123, as amended by SFAS No. 148, the Company’s net income and net income per share would have been reduced to the pro forma amounts indicated below: The pro forma disclosures shown above are not representative of the effects on net income and earnings per share in future years. For purposes of pro forma disclosures only, the fair value for all Company options was estimated at the date of grant using the Black-Scholes option model with the following weighted average assumptions: See Note 8 for additional information relating to the Company’s stock plans. Net income, as reported $ 100,243 $ 57,365 $ 34,562 Add: Stock-based compensation expense, net of related tax benefit, included in net income – 488 – Deduct: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax benefits 15,193 15,495 11,562 Pro forma net income $ 85,050 $ 42,358 $ 23,000 Earnings per share: Basic earnings per share, as reported $ 0.77 $ 0.46 $ 0.29 Pro forma-basic earnings per share $ 0.65 $ 0.34 $ 0.19 Diluted earnings per share, as reported $ 0.70 $ 0.42 $ 0.27 Pro forma-diluted earnings per share $ 0.60 $ 0.31 $ 0.18 December 31, 2004 2003 2002 Dividend yield 0% 0% 0% Volatility factor 46% 45% 65% Expected life (in years): Options 4.0 4.0 2.9 Stock purchase plans .25 .25 .25 Weighted average risk-free interest rate: Options 3.11% 2.70% 2.71% Employee stock purchase plans 1.26% 0.96% 1.60% Weighted average fair value: Options $ 10.06 $ 4.40 $ 3.34 Employee stock purchase plans $ 5.03 $ 2.59 $ 1.62 Years ended December 31, 2004 2003 2002