NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation
The accompanying consolidated financial statements include the accounts of The Estée Lauder Companies Inc. and its subsidiaries (collectively, the "Company") as continuing operations, with the exception of the operating results of its reporting unit that marketed and sold Stila brand products, which have been reflected as discontinued operations for fiscal 2006, 2005 and 2004 and the reporting unit that sold jane brand products, which have been reflected as discontinued operations for fiscal 2004 (see Note 4). All significant intercompany balances and transactions have been eliminated.

Certain amounts in the consolidated financial statements of prior years have been reclassified to conform to current year presentation for comparative purposes.

Net Earnings Per Common Share
For the years ended June 30, 2006, 2005 and 2004, net earnings per common share ("basic EPS") is computed by dividing net earnings by the weighted average number of common shares outstanding and contingently issuable shares (which satisfy certain conditions). Net earnings per common share assuming dilution ("diluted EPS") is computed by reflecting potential dilution from stock-based awards.

A reconciliation between the numerators and denominators of the basic and diluted EPS computations is as follows:

YEAR ENDED JUNE 30 2006 2005 2004
(In millions, except per share data)
Numerator:
Net earnings from continuing operations $ 324.5 $ 409.9 $ 378.5
Discontinued operations, net of tax (80.3 ) (3.8 ) (36.4 )
Net earnings attributable to common stock $ 244.2 $ 406.1 $ 342.1
Denominator:
Weighted average common shares outstanding-Basic 215.0 225.3 228.2
Effect of dilutive securities: Stock options and restricted share units 2.4 3.3 3.4
Weighted average common shares outstanding-Diluted 217.4 228.6 231.6
Basic net earnings per common share:
Net earnings from continuing operations $ 1.51 $ 1.82 $ 1.66
Discontinued operations, net of tax (.37 ) (.02 ) (.16 )
Net earnings $ 1.14 $ 1.80 $ 1.50
Diluted net earnings per common share:
Net earnings from continuing operations $ 1.49 $ 1.80 $ 1.64
Discontinued operations, net of tax (.37 ) (.02 ) (.16 )
Net earnings $ 1.12 $ 1.78 $ 1.48

As of June 30, 2006, 2005 and 2004, options to purchase 13.6 million, 12.5 million and 6.6 million shares, respectively, of Class A Common Stock were not included in the computation of diluted EPS because the exercise prices of those options were greater than the average market price of the common stock and their inclusion would be anti-dilutive. The options were still outstanding at the end of the applicable periods.

Cash and Cash Equivalents
Cash and cash equivalents include $66.2 million and $332.9 million of short-term time deposits at June 30, 2006 and 2005, respectively. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents.

Accounts Receivable
Accounts receivable is stated net of the allowance for doubtful accounts and customer deductions of $27.1 million and $28.9 million as of June 30, 2006 and 2005, respectively.

Currency Translation and Transactions
All assets and liabilities of foreign subsidiaries and affiliates are translated at year-end rates of exchange, while revenue and expenses are translated at weighted average rates of exchange for the year. Unrealized translation gains or losses are reported as cumulative translation adjustments through other comprehensive income. Such adjustments amounted to $27.0 million, $8.2 million and $36.5 million of unrealized translation gains in fiscal 2006, 2005 and 2004, respectively.

The Company enters into forward foreign exchange contracts and foreign currency options to hedge foreign currency transactions for periods consistent with its identified exposures. Accordingly, the Company categorizes these instruments as entered into for purposes other than trading.

The accompanying consolidated statements of earnings include net exchange gains of $4.0 million in fiscal 2006 and net exchange losses of $15.8 million and $14.5 million in fiscal 2005 and 2004, respectively.

Inventory and Promotional Merchandise
Inventory and promotional merchandise only includes inventory considered saleable or usable in future periods, and is stated at the lower of cost or fair-market value, with cost being determined on the first-in, first-out method. Cost components include raw materials, componentry, direct labor and overhead (e.g., indirect labor, utilities, depreciation, purchasing, receiving, inspection and warehousing) as well as inbound freight. Promotional merchandise is charged to expense at the time the merchandise is shipped to the Company's customers.

JUNE 30 2006 2005
(In millions)
Inventory and promotional merchandise consists of:
    Raw materials $ 151.0 $ 149.9
    Work in process 44.2 43.2
    Finished goods 407.1 403.4
    Promotional merchandise 164.0 171.8
$ 766.3 $ 768.3

Property, Plant and Equipment
Property, plant and equipment, including leasehold and other improvements that extend an asset's useful life or productive capabilities, are carried at cost less accumulated depreciation and amortization. For financial statement purposes, depreciation is provided principally on the straight-line method over the estimated useful lives of the assets ranging from 3 to 40 years. Leasehold improvements are amortized on a straight-line basis over the shorter of the lives of the respective leases or the expected useful lives of those improvements.

JUNE 30 2006 2005
(In millions)
Asset (Useful Life)
Land $ 13.7 $ 13.6
Buildings and improvements (10 to 40 years) 161.7 160.8
Machinery and equipment (3 to 10 years) 803.0 721.2
Furniture and fixtures (5 to 10 years) 108.2 109.1
Leasehold improvements 790.8 703.9
1,877.4 1,708.6
Less accumulated depreciation and amortization 1,119.4 1,014.4
$ 758.0 $ 694.2

Depreciation and amortization of property, plant and equipment was $189.9 million, $186.3 million and $175.1 million in fiscal 2006, 2005 and 2004, respectively. Depreciation and amortization related to the Company's manufacturing process is included in cost of sales and all other depreciation and amortization is included in selling, general and administrative expenses in the accompanying consolidated statements of earnings.

Goodwill and Other Intangible Assets
The Company follows the provisions of Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." These statements established financial accounting and reporting standards for acquired goodwill and other intangible assets. Specifically, the standards address how acquired intangible assets should be accounted for both at the time of acquisition and after they have been recognized in the financial statements. In accordance with SFAS No. 142, intangible assets, including purchased goodwill, must be evaluated for impairment. Those intangible assets that will continue to be classified as goodwill or as other intangibles with indefinite lives are no longer amortized.

In accordance with SFAS No. 142, the impairment testing is performed in two steps: (i) the Company determines impairment by comparing the fair value of a reporting unit with its carrying value, and (ii) if there is an impairment, the Company measures the amount of impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill. To determine fair value, the Company relied on three valuation models: guideline public companies, acquisition analysis and discounted cash flow. For goodwill valuation purposes only, the revised fair value of a reporting unit would be allocated to the assets and liabilities of the business unit to arrive at an implied fair value of goodwill, based upon known facts and circumstances, as if the acquisition occurred at that time.

During fiscal 2006, the Company sold certain assets and operations of its reporting unit that marketed and sold Stila brand products. In conjunction with the sale, the Company reduced its goodwill by $91.3 million, which is reported as a component of discontinued operations in the accompanying consolidated statements of earnings.

In February 2004, the Company sold the assets and operations of its reporting unit that sold jane brand products. Based on an assessment of the tangible and intangible assets of this business, the Company determined that the carrying amount of these assets as then reflected on the Company's consolidated balance sheet exceeded their estimated fair value. In accordance with the assessment, the Company recorded a goodwill impairment charge in the amount of $26.4 million for fiscal 2004, which is reported as a component of discontinued operations in the accompanying consolidated statements of earnings.

Goodwill
The Company assigns goodwill of a reporting unit to the product category in which that reporting unit predominantly operates at the time of its acquisition. The change in the carrying amount of goodwill, including the effect of foreign exchange rates is as follows:

YEAR ENDED OR AT JUNE 30 2004 Additions Reductions 2005 Additions Reductions 2006
(In millions)
Skin Care $ 15.0      $ 4.0      $ - $ 19.0      $ 1.3      $ - $ 20.3
Makeup 315.8 2.8 - 318.6 - 91.3 227.3
Fragrance 15.5 39.7 - 55.2 - 1.3 53.9
Hair Care 326.0 1.8 - 327.8 6.5 - 334.3
Total $ 672.3      $ 48.3 $ - $ 720.6 $ 7.8 $ 92.6 $ 635.8

The reduction of goodwill in fiscal 2006 related to the sale of the Stila brand. Included in fiscal 2005 additions to goodwill was $37.7 million related to a payment made in fiscal 2006 to satisfy an earn-out provision related to the Company's acquisition of Jo Malone Limited in October 1999.

Other Intangible Assets
Other intangible assets include trademarks and patents, as well as license agreements and other intangible assets resulting from or related to businesses purchased by the Company. Indefinite lived assets (e.g., trademarks) are not subject to amortization and are evaluated annually for impairment or sooner if certain events or circumstances indicate a potential impairment. Patents are amortized on a straight-line basis over the shorter of the legal term or the useful life of the patent, approximately 20 years. Other intangible assets (e.g., non-compete agreements, customer lists) are amortized on a straight-line basis over their expected period of benefit, approximately 2 years to 10 years. Intangible assets related to license agreements are amortized on a straight-line basis over their useful lives based on the terms of their respective agreements, currently approximately 10 years to 16 years, and are subject to impairment testing if certain events or circumstances indicate a potential impairment.

Other intangible assets consist of the following:

JUNE 30, 2006 Gross
Carrying
Value		 Accumulated
Amortization		 Total
Net Book
Value
(In millions)
License agreements   $ 42.9         $ 19.7            $ 23.2  
Trademarks and other 148.6    95.0       53.6  
Patents 0.5    0.3       0.2  
Total $ 192.0         $ 115.0            $ 77.0  

JUNE 30, 2005 Gross
Carrying
Value		 Accumulated
Amortization		 Total
Net Book
Value
(In millions)
License agreements   $ 42.9         $ 15.5            $ 27.4  
Trademarks and other 138.0    93.8       44.2  
Patents 0.5    0.3       0.2  
Total $ 181.4         $ 109.6            $ 71.8  

The aggregate amortization expenses related to amortizable intangible assets for the years ended June 30, 2006, 2005 and 2004 were $5.5 million, $4.6 million and $4.0 million, respectively. The estimated aggregate amortization expense for each of the next five fiscal years is as follows:

ESTIMATED EXPENSE IN FISCAL 2007 2008 2009 2010 2011
(In millions)
Aggregate amortization expense $5.1 $4.9 $3.5 $3.5 $3.5

Long-Lived Assets
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets in question may not be recoverable. An impairment would be recorded in circumstances where undiscounted cash flows expected to be generated by an asset are less than the carrying value of that asset.

Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income ("OCI") included in the accompanying consolidated balance sheets consist of the following:

YEAR ENDED JUNE 30 2006 2005 2004
(In millions)
Net unrealized investment gains, beginning of year $ 0.4 $ 0.1 $ 0.7
Unrealized investment gains (losses) 0.1 0.5 (1.0 )
Benefit (provision) for deferred income taxes - (0.2 ) 0.4
Net unrealized investment gains, end of year 0.5 0.4 0.1
Net derivative instruments, beginning of year 12.0 10.2 (1.5 )
Gain (loss) on derivative instruments 5.2 (9.1 ) 1.6
Benefit (provision) for deferred income taxes on derivative instruments (1.7 ) 3.0 (1.4 )
Reclassification to earnings during the year (8.3 ) 11.8 17.2
Benefit (provision) for deferred income taxes on reclassification 3.1 (3.9 ) (5.7 )
Net derivative instruments, end of year 10.3 12.0 10.2
Net minimum pension liability adjustments, beginning of year (36.0 ) (24.6 ) (40.6 )
Minimum pension liability adjustments 41.4 (15.5 ) 26.6
Benefit (provision) for deferred income taxes (11.5 ) 4.1 (10.6 )
Net minimum pension liability adjustments, end of year (6.1 ) (36.0 ) (24.6 )
Cumulative translation adjustments, beginning of year 33.0 24.8 (11.7 )
Translation adjustments 27.0 8.2 36.5
Cumulative translation adjustments, end of year 60.0 33.0 24.8
Accumulated other comprehensive income $ 64.7 $ 9.4 $ 10.5

Of the $10.3 million, net of tax, derivative instrument gain recorded in OCI at June 30, 2006, $12.0 million, net of tax, related to the October 2003 gain from the settlement of the treasury lock agreements upon the issuance of the 5.75% Senior Notes due October 2033, which will be reclassified to earnings as an offset to interest expense over the life of the debt. This was offset by $1.7 million in losses, net of tax, related to forward and option contracts which the Company will reclassify to earnings during the next twelve months.

Revenue Recognition
Revenues from merchandise sales are recognized upon transfer of ownership, including passage of title to the customer and transfer of the risk of loss related to those goods. In the Americas region, sales are generally recognized at the time the product is shipped to the customer and, in the Europe, Middle East & Africa and Asia/Pacific regions, sales are generally recognized based upon the customer's receipt. In certain circumstances, transfer of title takes place at the point of sale (e.g., at the Company's retail stores).

Sales are reported on a net sales basis, which is computed by deducting from gross sales the amount of actual product returns received, discounts, incentive arrangements with retailers and an amount established for anticipated product returns. The Company's practice is to accept product returns from retailers only if properly requested, authorized and approved. In accepting returns, the Company typically provides a credit to the retailer against accounts receivable from that retailer. As a percentage of gross sales, returns were 5.0% in fiscal 2006 and 4.6% in fiscal 2005 and 2004.

Payments to Customers
The Company is subject to the provisions of Emerging Issues Task Force ("EITF") Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)." In accordance with this guidance, the Company has recorded the revenues generated from purchase with purchase promotions as sales and the costs of its purchase with purchase and gift with purchase promotions as cost of sales. Certain other incentive arrangements require the payment of a fee to customers based on their attainment of pre-established sales levels. These fees have been recorded as a reduction of net sales in the accompanying consolidated statements of earnings and were not material to the results of operations in any period presented.

The Company enters into transactions related to advertising, product promotions and demonstrations, some of which involve cooperative relationships with customers. These activities may be arranged either with unrelated third parties or in conjunction with the customer. The Company's share of the cost of these transactions (regardless of to whom they were paid) are reflected in selling, general and administrative expenses in the accompanying consolidated statements of earnings and were approximately $912 million, $898 million and $838 million in fiscal 2006, 2005 and 2004, respectively.

Advertising and Promotion
Costs associated with advertising are expensed during the year as incurred. Global net advertising and promotion expenses, which primarily include television, radio and print media, and promotional expenses, such as products used as sales incentives, were $1,793.1 million, $1,793.7 million and $1,595.5 million in fiscal 2006, 2005 and 2004, respectively. These amounts include activities relating to purchase with purchase and gift with purchase promotions that are reflected in net sales and cost of sales. Advertising, merchandising and sampling expenses included in operating expenses were $1,586.3 million, $1,577.1 million and $1,410.4 million in fiscal 2006, 2005 and 2004, respectively.

Research and Development
Research and development costs are included in advertising, merchandising and sampling and amounted to $72.0 million, $72.3 million and $67.2 million in fiscal 2006, 2005 and 2004, respectively. Research and development costs are expensed as incurred.

Operating Leases
The Company recognizes rent expense from operating leases with periods of free and scheduled rent increases on a straight-line basis over the applicable lease term. The Company considers lease renewals in the useful life of its leasehold improvements when such renewals are reasonably assured. From time to time, the Company may receive capital improvement funding from its lessors. These amounts are recorded as deferred liabilities and amortized over the remaining lease term as a reduction of rent expense.

Related Party Royalties
On April 24, 2004, Mrs. Estée Lauder passed away. As a result, the royalty payments previously made to her since 1969 in connection with the Company's purchase of the "Estée Lauder" trademark outside the United States ceased to accrue. Royalty payments totaling $18.8 million were charged to expense in fiscal 2004.

License Arrangements
The Company's license agreements provide the Company with worldwide rights to manufacture, market and sell beauty and beauty-related products (or particular categories thereof) using the licensors' trademarks. The licenses typically have an initial term of approximately 2 years to 11 years, and are renewable subject to the Company's compliance with the license agreement provisions. The remaining terms, including the potential renewal periods, range from approximately 2 years to 24 years. Under each license, the Company is required to pay royalties to the licensor, at least annually, based on net sales to third parties.

Most of the Company's licenses were entered into to create new business. In some cases, the Company acquired, or entered into, a license where the licensor or another licensee was operating a pre-existing beauty products business. In those cases, intangible assets are capitalized and amortized over their useful lives based on the terms of the agreement and are subject to impairment testing if certain events or circumstances indicate a potential impairment.

Stock-Based Compensation
As of June 30, 2006, the Company had established a number of share incentive programs as discussed in more detail in Note 13-Stock Programs. Prior to fiscal 2006, the Company applied the intrinsic value method as outlined in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and related interpretations in accounting for stock options and share units granted under these programs. Under the intrinsic value method, no compensation expense was recognized if the exercise price of the Company's employee stock options equaled the market price of the underlying stock on the date of the grant. Accordingly, no compensation cost was recognized in the accompanying consolidated statements of earnings prior to fiscal year 2006 on stock options granted to employees, since all options granted under the Company's share incentive programs had an exercise price equal to the market value of the underlying common stock on the date of grant.

Effective July 1, 2005, the Company adopted SFAS No. 123(R), "Share-Based Payment" ("SFAS No. 123(R)"). This statement replaces SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and supersedes APB No. 25. SFAS No. 123(R) requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the fair value of the award. This statement was adopted using the modified prospective method of application, which requires the Company to recognize compensation expense on a prospective basis. Therefore, prior years' financial statements have not been restated. Under this method, in addition to reflecting compensation expense for new share-based awards, expense is also recognized to reflect the remaining service period of awards that had been included in pro-forma disclosures in prior years. SFAS No. 123(R) also requires that excess tax benefits related to stock option exercises be reflected as financing cash inflows instead of operating cash inflows.

Concentration of Credit Risk
The Company is a worldwide manufacturer, marketer and distributor of skin care, makeup, fragrance and hair care products. Domestic and international sales are made primarily to department stores, perfumeries and specialty retailers. The Company grants credit to all qualified customers and does not believe it is exposed significantly to any undue concentration of credit risk.

During fiscal 2006, Federated Department Stores, Inc. acquired The May Department Stores Company, resulting in the merger of the Company's previous two largest customers. This customer sells products primarily within North America and accounted for $1,005.8 million, or 16%, of the Company's consolidated net sales in fiscal 2006 and $105.4 million, or 14%, of its accounts receivable at June 30, 2006. No single customer accounted for more than 10% of the Company's net sales or accounts receivable during fiscal 2005, or 2004.

Management Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. Actual results could differ from those estimates and assumptions.

Derivative Financial Instruments
The Company accounts for derivative financial instruments in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133 also requires the recognition of all derivative instruments as either assets or liabilities on the balance sheet and that they be measured at fair value.

Recently Issued Accounting Standards
In June 2006, the FASB issued FASB Interpretation Number ("FIN") 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 establishes a recognition threshold and measurement for income tax positions recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 also prescribes a two-step evaluation process for tax positions. The first step is recognition and the second is measurement. For recognition, an enterprise judgmentally determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more-likely-than-not recognition threshold it is measured and recognized in the financial statements as the largest amount of tax benefit that is greater than 50% likely of being realized. If a tax position does not meet the more-likely-than-not recognition threshold, the benefit of that position is not recognized in the financial statements.

Tax positions that meet the more-likely-than-not recognition threshold at the effective date of FIN 48 may be recognized or, continue to be recognized, upon adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 shall be reported as an adjustment to the opening balance of retained earnings for that fiscal year. FIN 48 will apply to fiscal years beginning after December 15, 2006, with earlier adoption permitted. The Company is currently evaluating the impact FIN 48 will have on its consolidated financial statements when it becomes effective for the Company in fiscal 2008 and is unable, at this time, to quantify the impact, if any, to retained earnings at the time of adoption.

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