Financial Review 2004 Notes to  Consolidated Financial Statements Changes in the fair value of derivatives that are highly effec- tive and that are designated and qualify as cash flow hedges  are recorded in other comprehensive income until earnings are  affected by the variability in cash flows of the designated hedged  item. Where applicable, we discontinue hedge accounting pro- spectively when it is determined that the derivative is no longer  effective in offsetting changes in the cash flows of the hedged  item or the derivative is terminated. Any changes in the fair value  of a derivative where hedge accounting has been discontinued or  is ineffective are recognized immediately in earnings. Cash flows  related to derivatives are included in operating activities. Non-capital expenditures associated with opening new restaurants  are expensed as incurred.  Production costs of commercials are charged to operations in the fiscal period the advertising is first aired. The costs of programming  and other advertising, promotion, and marketing programs are  charged to operations in the fiscal period incurred. Advertising  expense amounted to $210,989, $200,020, and $184,163, in fiscal  2004, 2003, and 2002, respectively.  SFAS No. 123, “Accounting for Stock-Based Compensation,”  encourages the use of a fair-value method of accounting for stock- based awards under which the fair value of stock options is deter- mined on the date of grant and expensed over the vesting period.  As allowed by SFAS No. 123, we have elected to account for our  stock-based compensation plans under an intrinsic value method  that requires compensation expense to be recorded only if, on  the date of grant, the current market price of our common stock  exceeds the exercise price the employee must pay for the stock.  Our policy is to grant stock options at the fair market value of our  underlying stock on the date of grant. Accordingly, no compensa- tion expense has been recognized for stock options granted under  any of our stock plans because the exercise price of all options  granted was equal to the current market value of our stock on the  grant date. In December 2002, the FASB issued SFAS No. 148,  “Accounting for Stock-Based Compensation.” SFAS No. 148 pro- vides alternative methods of transition for voluntary change to the  fair value method of accounting for stock-based compensation.  To determine pro forma net earnings, reported net earnings  have been adjusted for compensation expense associated with stock  options granted that are expected to eventually vest. The preceding  pro forma results were determined using the Black Scholes option- pricing model, which values options based on the stock price at the  grant date, the expected life of the option, the estimated volatility  of the stock, expected dividend payments, and the risk-free inter- est rate over the expected life of the option. The dividend yield  was calculated by dividing the current annualized dividend by the  option exercise price for each grant. The expected volatility was  determined considering stock prices for the fiscal year the grant  occurred and prior fiscal years, as well as considering industry  volatility data. The risk-free interest rate was the rate available on  zero coupon U.S. government obligations with a term equal to the  expected life of each grant. The expected life of the option was esti- mated based on the exercise history from previous grants. In addition, SFAS No. 148 requires more prominent disclosures  in both annual and interim financial statements about the method  of accounting for stock-based compensation and the effect of the  method used on reported results. Had we determined compensation expense for our stock options  based on the fair value at the grant date as prescribed under SFAS  No. 123, our net earnings and net earnings per share would have  been reduced to the pro forma amounts indicated below: Pre-Opening Expenses Advertising Stock-Based Compensation Fiscal Year 2004  2003  2002 Net earnings, as reported  $231,462  $232,260 $ 237,788 Add: Stock-based compensation expense included in reported net earnings, net of related tax effects  3,158  2,642  2,695 Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects  (17,980)  (19,801)  (18,386) Pro forma  $216,640  $215,101 $222,097 Basic net earnings per share  As reported  $ 1.42  $ 1.36 $ 1.36 Pro forma  $ 1.33  $ 1.26 $ 1.27 Diluted net earnings per share  As reported  $ 1.36 $ 1.31 $ 1.30 Pro forma  $ 1.28 $ 1.22 $ 1.21 40  Darden Restaurants