notes to consolidated financial statements

Principles of Consolidation
The consolidated financial statements include the accounts of the company and all majority-owned subsidiaries. Prior to November 30, 2001, the company accounted for its investment in Henkel-Ecolab under the equity method of accounting. As discussed further in Note 5, on November 30, 2001, the company acquired the remaining 50 percent interest of the European joint venture that it did not previously own, and Henkel-Ecolab became a wholly-owned subsidiary of the company. Because the company consolidates its international operations on the basis of their November 30 fiscal year ends, the balance sheet of the European operations was consolidated with the company's balance sheet beginning with year-end 2001. The income statement for the European operations was consolidated with the company's operations beginning in 2002. International subsidiaries are included in the financial statements on the basis of their November 30 fiscal year-ends to facilitate the timely inclusion of such entities in the company's consolidated financial reporting. All intercompany transactions and profits are eliminated in consolidation.

Foreign Currency Translation
Financial position and results of operations of the company's international subsidiaries generally are measured using local currencies as the functional currency. Assets and liabilities of these operations are translated at the exchange rates in effect at each fiscal year end. The translation adjustments related to assets and liabilities that arise from the use of differing exchange rates from period to period are included in accumulated other comprehensive income (loss) in shareholders' equity. The cumulative translation gain as of year-end 2003 was $16,064,000. The cumulative translation loss as of year-end 2002 and 2001 was $74,537,000 and $95,037,000, respectively. Income statement accounts are translated at the average rates of exchange prevailing during the year. The different exchange rates from period to period impact the amount of reported income from the company's international operations.

Cash and Cash Equivalents
Cash equivalents include highly-liquid investments with a maturity of three months or less when purchased.

Inventory Valuations
Inventories are valued at the lower of cost or market. Domestic chemical inventory costs are determined on a last-in, first-out (lifo) basis. Lifo inventories represented 29 percent, 30 percent and 29 percent of consolidated inventories at year-end 2003, 2002 and 2001, respectively. All other inventory costs are determined on a first-in, first-out (fifo) basis.

Property, Plant and Equipment
Property, plant and equipment are stated at cost. Merchandising equipment consists principally of various systems that dispense the company's cleaning and sanitizing products and dishwashing machines. The dispensing systems are accounted for on a mass asset basis, whereby equipment is capitalized and depreciated as a group and written off when fully depreciated. Depreciation is charged to operations using the straight-line method over the assets' estimated useful lives ranging from 5 to 50 years for buildings, 3 to 7 years for merchandising equipment and 3 to 11 years for machinery and equipment.

Goodwill and Other Intangible Assets
Goodwill and other intangible assets arise principally from business acquisitions. Goodwill represents the excess of the purchase price over the fair value of identifiable net assets acquired. Other intangible assets include primarily customer relationships, trademarks, patents and other technology. Other intangible assets are amortized on a straight-line basis over their estimated economic lives. The weighted-average useful life of other intangible assets was 12 years as of December 31, 2003.

The straight-line method of amortization reflects an appropriate allocation of the cost of the intangible assets to earnings in proportion to the amount of economic benefits obtained by the company in each reporting period. Total amortization expense related to other intangible assets during the years ended December 31, 2003, 2002 and 2001 was approximately $21.2 million, $16.9 million and $5.1 million, respectively. As of December 31, 2003, future estimated amortization expense related to amortizable other identifiable intangible assets for each of the next five years will be:

(thousands)
2004	$21,341
2005	19,696
2006	19,236
2007	18,692
2008	17,266

Long-Lived Assets
The company periodically reviews its long-lived assets for impairment and assesses whether significant events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. An impairment loss is recognized when the carrying amount of an asset exceeds the anticipated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded, if any, is calculated by the excess of the asset's carrying value over its fair value.

Revenue Recognition
The company recognizes revenue as services are performed or on product sales at the time title transfers to the customer. The company records estimated reductions to revenue for customer programs and incentive offerings, including pricing arrangements, promotions and other volume-based incentives at the time of sale.

Income Per Common Share
The computations of the basic and diluted income from continuing operations per share amounts were as follows:

(thousands, except per share)	2003	2002	2001
Income from continuing    operations before change    in accounting	$277,348	$211,890	$188,170
Weighted-average common    shares outstanding    Basic	259,454	258,147	254,832
Effect of dilutive stock       options and awards	3,283	3,427	5,023
Diluted	262,737	261,574	259,855
Income from continuing    operations before change in    accounting per common share    Basic	$       1.07	$       0.82	$       0.74
Diluted	$       1.06	$       0.81	$       0.72

All number of share and per share data for all periods presented have been adjusted to reflect the two-for-one stock split described in Note 9.

Restricted stock awards of approximately 52,800 shares for 2003, 203,550 shares for 2002 and 347,100 shares for 2001 were excluded from the computation of basic weighted-average shares outstanding because such shares were not yet vested at those dates.

Stock options to purchase approximately 4.3 million shares for 2003, 8.4 million shares for 2002 and 7.9 million shares for 2001 were not dilutive and, therefore, were not included in the computations of diluted common shares outstanding.

Stock-Based Compensation
The company measures compensation cost for its stock incentive and option plans using the intrinsic value-based method of accounting.

Had the company used the fair value-based method of accounting to measure compensation expense for its stock incentive and option plans and charged compensation cost against income, over the vesting periods, based on the fair value of options at the date of grant, net income and the related basic and diluted per common share amounts for 2003, 2002 and 2001 would have been reduced to the pro forma amounts in the following table:

(thousands, except per share)	2003	2002	2001
Net income, as reported	$277,348	$209,770	$188,170
Add: Stock-based employee   compensation expense   included in reported net   income, net of tax	941	1,688	2,542
Deduct: Total stock-based employee   compensation expense under fair   value-based method, net of tax	(17,699)	(15,145)	(13,172)
Pro forma net income	$260,590	$196,313	$177,540
Basic net income   per common share     As reported	$       1.07	$       0.81	$       0.74
Pro forma	1.00	0.76	0.70
Diluted net income   per common share     As reported	1.06	0.80	0.72
Pro forma	$       0.99	$       0.75	$       0.68

Note 10 to the consolidated financial statements contains the significant assumptions used in determining the underlying fair value of options.

Comprehensive Income
For the company, comprehensive income includes net income, foreign currency translation adjustments, minimum pension liabilities, gains and losses on derivative instruments designated and effective as cash flow hedges and nonderivative instruments designated and effective as foreign currency net investment hedges that are charged or credited to the accumulated other comprehensive income (loss) account in shareholders' equity.

Derivative Instruments and Hedging Activities
The company uses foreign currency forward contracts, interest rate swaps and foreign currency debt to manage risks generally associated with foreign exchange rates, interest rates and net investments in foreign operations. The company does not hold derivative financial instruments of a speculative nature. On the date that the company enters into a derivative contract, it designates the derivative as (1) a hedge of (a) the fair value of a recognized asset or liability or (b) an unrecognized firm commitment (a “fair value” hedge), (2) a hedge of (a) a forecasted transaction or (b) the variability of cash flows that are to be received or paid in connection with a recognized asset or liability (a “cash flow” hedge); or (3) a foreign-currency fair-value or cash flow hedge (a “foreign currency” hedge). The company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. The company also formally assesses (both at the hedge's inception and on an ongoing basis) whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative is not (or has ceased to be) highly effective as a hedge, the company will discontinue hedge accounting prospectively. The company believes that on an ongoing basis its portfolio of derivative instruments will generally be highly effective as hedges. Hedge ineffectiveness during the years ended December 31, 2003, 2002 and 2001 was not significant.

All of the company's derivatives are recognized on the balance sheet at their fair value. The earnings impact resulting from the change in fair value of the derivative instruments is recorded in the same line item in the consolidated statement of income as the underlying exposure being hedged.

Use of Estimates
The preparation of the company's financial statements requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.

New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”). FIN 46 was subsequently revised in December 2003 by the issuance of FIN 46R to provide additional guidance on the application and scope of FIN 46. FIN 46 and FIN 46R provide accounting requirements for a business enterprise to consolidate related entities in which it is determined to be the primary beneficiary as a result of its variable economic interests. The interpretation provides guidance in judging multiple economic interests in an entity and in determining the primary beneficiary.

The interpretations outline consolidation and disclosure requirements for variable interest entities (“VIEs”). The company has reviewed the consolidation and disclosure requirements of FIN 46 and FIN 46R and determined that they have no current impact on the company.

In April 2003, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No.133, Accounting for Derivative Instruments and Hedging Activities. The company has reviewed the requirements of this standard and it has no current impact on the company.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. This statement established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The company does not have any financial instruments subject to SFAS No. 150 as of December 31, 2003.

In December 2003, the FASB issued a revision to SFAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits, which requires additional disclosures about the assets, obligations, cash flows, and periodic benefit costs of defined benefit pension plans and other defined benefit postretirement plans. Note 15 presents the new disclosure requirements for the company's domestic plans. Disclosure of additional information about foreign plans is not required until the company's next fiscal year.

Reclassifications
The consolidated balance sheet as of December 31, 2002 includes a reclassification of $12,522,000 of accumulated amortization to a longlived asset that was previously classified as an other current liability to be consistent with the current period presentation.