Notes to Consolidated Financial Statements
   
1. Summary of Significant Accounting Policies

Principles of Consolidation: The accompanying Consolidated Financial Statements include the accounts of American Home Products Corporation and its majority-owned subsidiaries (the Company). The financial statements have been prepared in accordance with accounting principles generally accepted in the United States and necessarily include amounts based on judgments and estimates made by management.

Effective January 1, 2000, the financial results of certain pharmaceutical subsidiaries in Japan and India, which previously were included on an equity basis, were consolidated in the financial results of the Company due to changes which gave the Company the ability to exercise control over the operations of these affiliates. Also, effective January 1, 2000, the financial results of Immunex Corporation (Immunex), which previously were consolidated, were deconsolidated and included on an equity basis in the results of operations of the Company (see Note 2).

Prior to 2000, certain of the Company's international affiliates reported their results of operations on a one-month lag (year ended November 30), which allowed more time to compile results. In December 2000, the one-month lag was eliminated, primarily to reflect the results of these operations on a more timely basis. As a result, December 2000 income from continuing operations for these entities of $53,171,000 was recorded directly to stockholders' equity.

Description of Business: The Company is a U.S.-based multinational corporation engaged in the discovery, development, manufacture, distribution and sale of a diversified line of products in two primary businesses: Pharmaceuticals and Consumer Health Care. Pharmaceuticals include branded and generic human ethical pharmaceuticals, biologicals, nutritionals, and animal biologicals and pharmaceuticals. Principal products include women's health care products, infant nutritionals, cardiovascular products, neuroscience therapies, gastroenterology drugs, anti-infectives, vaccines, biopharmaceuticals, oncology therapies, musculoskeletal therapies and transplantation products. Principal animal health products include vaccines, pharmaceuticals, endectocides and growth implants. Consumer Health Care products include analgesics, cough/cold/allergy remedies, nutritional supplements, herbal products, and hemorrhoidal, antacid, asthma and other relief items sold over-the-counter. The Company sells its diversified line of products to wholesalers, pharmacies, hospitals, physicians, retailers and other health care institutions located in various markets in more than 150 countries throughout the world. The Company is not dependent on any single customer or major group of customers for its sales.

The Company is not dependent on any one patent-protected product or line of products for a substantial portion of its net revenue or results of operations. However, Premarin, one of the Company's conjugated estrogens products, which has not had patent protection for many years, contributes significantly to net revenue and results of operations. See "Competition" in "Management's Discussion and Analysis of Financial Condition and Results of Operations" on page 57 for further details.

Equity Method of Accounting: The Company accounts for its investments in 20%- to 50%-owned companies using the equity method. Accordingly, the Company's share of the earnings of these companies is included in Other income, net. The related equity investment is included in Other assets including deferred taxes. At December 31, 2000, Immunex was the Company's only material equity investment. Immunex is a biopharmaceutical company that discovers, manufactures and markets therapeutic products for the treatment of cancer and musculoskeletal disorders such as rheumatoid arthritis. See Note 2 for the discussion of Immunex common stock sold in 2000.

Cash Equivalents consist primarily of certificates of deposit, time deposits and other short-term, highly liquid securities with original maturities of three months or less and are stated at cost, which approximates fair value. The carrying value of cash equivalents approximates fair value due to the short-term, highly liquid nature of cash equivalents.

Marketable Securities consist of U.S. government or agency issues, commercial paper, time deposits and corporate bonds and are stated at fair value, which approximates cost due to the short-term, highly liquid nature of these securities (less than six months). All marketable securities are available-for-sale investments. The fair values are estimated based on current market prices.

Inventories are valued at the lower of cost or market. Inventories valued under the last-in, first-out (LIFO) method amounted to $325,059,000 and $407,668,000 at December 31, 2000 and 1999, respectively. The current value exceeded the LIFO value by $59,658,000 and $66,879,000 at December 31, 2000 and 1999, respectively. The remaining inventories are valued under the first-in, first-out (FIFO) method or the average cost method.

Inventories at December 31 consisted of:

(In thousands)
2000
1999
Finished goods
$ 585,123
$ 753,831
Work in progress
586,656
471,327
Materials and supplies
359,948
382,802
 
$1,531,727
$1,607,960

Property, Plant and Equipment is carried at cost. Depreciation is provided over the estimated useful lives of the related assets placed into service, principally on the straight-line method.

Goodwill and Other Intangibles: The excess of cost over the fair value of net assets acquired is amortized using the straight-line method over various periods ranging from 15 to 40 years for goodwill and three to 10 years for other intangibles. The Company continually reviews goodwill and other intangibles to evaluate whether changes have occurred that would suggest such assets may be impaired. If circumstances suggest an impairment, undiscounted future cash flows of the assets acquired or purchased are estimated. If this estimate indicates that the remaining estimated useful life of goodwill or other intangibles requires revision or that the associated costs are not recoverable, the carrying value of the goodwill or other intangibles is reduced to fair value by the estimated shortfall of future cash flows on a discounted basis.

Foreign Currency Agreements: The Company enters into short- term foreign currency agreements to manage specifically identifiable risks. Short-term (approximately 30 days) foreign exchange forward contracts are part of the Company's management of foreign currency balance sheet exposures. Foreign currency agreements are accounted for under the fair value method. The fair value of foreign currency agreements is based on current market prices. The fair value represents the estimated amount the Company would receive or pay to terminate the agreements, taking into consideration current foreign currency exchange rates. The fair value of the foreign currency agreements is carried on the Consolidated Balance Sheets with changes in the fair value recognized in results of operations offsetting any gains and losses recognized on the underlying transactions.

In 2000, the Company established a cash flow hedging program to cover currency risk related to intercompany inventory sales denominated in foreign currencies. The exposures are managed using purchased foreign currency put options. Put options provide the Company with the right, but not the obligation, to sell foreign currencies at a predetermined price. Net gains on exercised option contracts are deferred on the Consolidated Balance Sheets and are reclassified into earnings in the same period that the underlying exposure is reflected in results of operations. There were no option contracts outstanding as of December 31, 2000. The net impact of foreign currency programs on the results of operations for 2000 was not material.

Currency Translation: The majority of the Company's international operations are translated into U.S. dollars using current foreign currency exchange rates with currency translation adjustments reflected in Accumulated other comprehensive loss in stockholders' equity. Currency translation adjustments comprise the majority of Accumulated other comprehensive loss on the Consolidated Balance Sheets and the Consolidated Statements of Changes in Stockholders' Equity. Currency translation adjustments related to international operations in highly inflationary economies are included in the results of operations.

Revenue Recognition: Revenue from the sale of Company products is recognized in Net revenue upon shipment to customers. Provisions for certain rebates, product returns and discounts to customers are provided for as reductions in determining Net revenue in the same period the related sales are recorded.

Revenue under co-promotion agreements from the sale of products developed by other companies, such as the Company's arrangement with Immunex to co-promote Enbrel, is recorded as alliance revenue and is included in Net revenue. Such alliance revenue is earned when the co-promoting company ships the product to a third party. Selling and marketing expenses related to alliance revenue are included in Selling, general and administrative expenses.

Shipping and Handling Costs, which include transportation to customers, transportation to distribution points, warehousing and handling costs, are included in Selling, general and administrative expenses. The Company typically does not charge customers for shipping and handling costs. Shipping and handling costs were $212,493,000, $204,508,000 and $204,866,000 in 2000, 1999 and 1998, respectively.

Rebates and Sales Incentives are offered to customers based upon volume purchases, the attainment of market share levels, sales support, government mandates, coupons and consumer discounts. Rebates and sales incentives included in Accrued expenses at December 31, 2000 and 1999 were $482,666,000 and $434,490,000, respectively.

Earnings (Loss) per Share: The following table sets forth the computations of basic earnings (loss) per share and diluted earnings (loss) per share:

(In thousands except per share amounts)
       
Years Ended December 31,
2000
1999
 1998
 
 
Income (loss) from continuing operations less preferred dividends
$ (901,086)
$(1,207,293)
$2,152,290 
Income (loss) from discontinued operations
(1,469,647)
(19,878)
321,994 
Net income (loss) less preferred dividends
$(2,370,733)
$(1,227,171)
$2,474,284 
Denominator:      
Weighted average common shares outstanding
1,306,474 
1,308,876 
1,314,580 
Basic earnings (loss) per share from continuing operations
$ (0.69)
$ (0.92)
$ 1.64 
Basic earnings (loss) per share from discontinued operations
(1.12)
(0.02)
0.24 
Basic earnings (loss) per share
$ (1.81)
$ (0.94)
$ 1.88 
Income (loss) from continuing operations
$ (901,040)
$(1,207,243)
$2,152,344 
Income (loss) from discontinued operations
(1,469,647)
(19,878)
321,994 
Net income (loss)
$(2,370,687)
$(1,227,121)
$2,474,338 
Denominator:      
   Weighted average common shares outstanding
1,306,474 
1,308,876 
1,314,580 
   Common share equivalents of outstanding stock options
    and deferred contingent common stock awards*
- 
- 
22,061 
Total shares*
1,306,474 
1,308,876 
1,336,641 
Diluted earnings (loss) per share from continuing operations*
$ (0.69)
$ (0.92)
$ 1.61 
Diluted earnings (loss) per share from discontinued operations*
(1.12)
(0.02)
0.24 
Diluted earnings (loss) per share*
$ (1.81)
$ (0.94)
$ 1.85 
* The total weighted average common shares outstanding for diluted loss per share for 2000 and 1999 did not include common share equivalents, as the effect would have been antidilutive.

Recently Issued Accounting Standards: In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." In June 2000, the FASB issued SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment of FASB Statement No. 133." SFAS No. 138 was issued to address a limited number of issues causing implementation difficulties for entities that apply SFAS No. 133. SFAS Nos. 133 and 138 require that all derivatives be measured at fair value and be recognized as assets or liabilities on the balance sheet. Changes in the fair value of derivatives should be recognized in either net income (loss) or comprehensive income (loss), depending on the designated purpose of the derivative. The Company will adopt SFAS Nos. 133 and 138 in the 2001 first quarter. Based on the Company's current activities, the Company does not believe that adoption of these pronouncements will have a material impact on the Company's financial position, results of operations or cash flows.

In May 2000, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-14, "Accounting for Certain Sales Incentives." EITF No. 00-14 addresses the recognition, measurement and Consolidated Statements of Operations classification for sales incentives offered voluntarily to customers. This guidance is required to be implemented by the Company no later than the 2001 second quarter. The Company currently is in compliance with the recognition and measurement aspects of EITF No. 00-14. The Company does not believe that the Consolidated Statements of Operations classification requirement will have a material impact on net revenue.

Reclassifications: Certain reclassifications have been made to the December 31, 1999 and 1998 Consolidated Financial Statements to conform with the December 31, 2000 presentation.