Notes to Consolidated Financial Statements 42 New accounting pronouncements  In January 2003  the Financial  Accounting Standards Board (FASB) issued Interpretation (FIN) No.  46  “Consolidation of Variable Interest Entities  an Interpretation of  ARB No. 51 ” which was revised in December 2003. FIN No. 46R  requires that the assets  liabilities and results of the activity of vari- able interest entities be consolidated into the financial statements of  the entity that has the controlling financial interest. FIN No. 46R also  provides the framework for determining whether a variable interest  entity should be consolidated. For the Company  this Interpretation   as revised  was effective January 1  2004. The Company has no  variable interest entities required to be consolidated as a result of  adopting FIN No. 46R. In December 2003  the Medicare Prescription Drug Improvement  and Modernization Act of 2003 (Medicare Act) introduced a pre- scription drug benefit under Medicare  as well as a federal subsidy  to sponsors of retiree health care benefit plans. In January 2004   the FASB issued FASB Staff Position (FSP) No. 106-1  “Accounting  Disclosure Requirements Related to the Medicare Prescription Drug   Improvement  and Modernization Act of 2003.” FSP 106-1 permits  a sponsor of a post retirement health care plan that provides a pre- scription drug benefit to make a one-time election to defer account- ing for the effects of the Medicare Act if there is insufficient data   time or guidance available to ensure appropriate accounting. The  Company is a sponsor of post retirement health care plans that pro- vide prescription benefits and  in accordance with the one-time elec- tion under FSP 106-1  elected to defer accounting for the Medicare  Act. In May 2004  the FASB issued FSP No. 106-2  “Accounting and  Disclosure Requirements Related to the Medicare Prescription Drug   Improvement and Modernization Act of 2003 ” which supersedes  FSP 106-1  to address the accounting and disclosure requirements  related to the Medicare Act. The FSP was effective for the Company  beginning with its third quarter ended September 30  2004. The  effect of the adoption was to reduce the Company’s 2004 post retire- ment benefits expense by $6.8 million.  In November 2004  the FASB issued Statement of Financial Accounting  Standards (SFAS) No. 151  “Inventory Costs” which is an amendment  of ARB No.43  Chapter 4. This statement provides clarification of  accounting for abnormal amounts of idle facility expense  freight   handling costs and wasted material. Generally  this statement requires that those items be recognized as current period charges.  SFAS 151 will be effective for the Company on January 1  2006. The  Company is currently evaluating the impact that the adoption of SFAS  151 will have on its consolidated financial position  results of opera- tions and cash flows. In December 2004  the FASB issued FSP 109-1  “Application of  FASB Statement No. 109  Accounting for Income Taxes  to the Tax  Deduction on Qualified Production Activities Provided by the American  Jobs Creation Act of 2004” (AJCA)  and FAS 109-2 “Accounting and  Disclosure Guidance for the Foreign Earnings Repatriation Provision  within the AJCA”. These two FSPs provide guidance on the applica- tion of the new provisions of the AJCA  which was signed into law on  October 22  2004. The AJCA provides a deduction for income from qualified domestic  production activities  which will be phased in from 2005 through  2010. In return  the AJCA provides for a two-year phase-out of the  existing extra-territorial income exclusion (ETI) for foreign sales that  was viewed to be inconsistent with international trade protocols by  the European Union. Under the guidance in FSP 109-1  the deduction  will be treated as a “special deduction” as described in SFAS 109.  As such  the special deduction has no effect on deferred tax assets  and liabilities existing at the enactment date. Rather  the impact of  this deduction will be reported in the period in which the deduction is  claimed on our tax return. The Company expects the net effect of the  phase out of the ETI and the phase in of this new deduction will not  have a material impact on its effective tax rate. FSP 109-2 provides guidance on the accounting for the deduction of  85% of certain foreign earnings that are repatriated  as defined in the  AJCA. The Company may elect to apply this provision to qualifying  earnings repatriations in 2005. Under guidance set forth in FAS 109-2   the Company is allowed time beyond the financial reporting period of  enactment to evaluate the effect of the AJCA on its plan for reinvest- ment or repatriation of foreign. The Company has started an evalua- tion of the effects of the repatriation provision; however  the Company  does not expect to be able to complete this evaluation until after  the U.S. Congress or the Treasury Department provides additional  clarifying language on key elements of the provision. The Company  expects to complete its evaluation of the effects of the repatriation  provision within a reasonable period of time following the publication  of the additional clarifying language. The range of possible amounts  that the Company is considering for repatriation under this provision is  between zero and $74 million. The related range of income tax effects  of such repatriation cannot be reasonably estimated until guidance is  issued by Congress or the Treasury Department. In December 2004  the FASB issued SFAS No. 123R  “Shared-Based  Payment” which requires companies to measure and recognize com- pensation expense for all share-based payments at fair value. Share- based payments include stock option grants and certain transactions  under other Company stock plans. The Company grants options to  purchase common stock of the Company to some of its employees  and directors under various plans at prices equal to the market value  of the stock on the dates the options are granted. SFAS 123R will be  effective for the Company beginning July 1  2005. The Company is  currently evaluating the impact that the adoption of SFAS 123R will  have on its consolidated financial position  results of operations and  cash flows. Reclassification  Certain prior period amounts have been reclassi- fied to conform to the current year’s presentation and are not mate- rial to the Company’s Consolidated Financial Statements.  BorgWarner Inc.  and Consolidated Subsidiaries NOTE 2 RESEARCH AND DEVELOPMENT COSTS NOTE 3 OTHER INCOME 43 The Company spent approximately $123.1 million  $118.2 million   and $109.1 million in 2004  2003 and 2002  respectively  on  research and development (R&D) activities. R&D costs are included  primarily in the selling  general  and administrative expenses of  the Consolidated Statements of Operations. Not included in these  amounts were customer-sponsored R&D activities of approximately  $31.8 million  $22.3 million  and $14.2 million in 2004  2003  and  2002  respectively. Items included in other income consist of: Earnings before income taxes and the provision for income taxes are presented in the following table. The earnings before income taxes amounts  for 2003 and 2002 have been presented to conform to the 2004 U.S. versus non-U.S. presentation. INCOME TAXES NOTE 4 millions of dollars Year Ended December 31   2004 2003 2002 Gain on sale of business  $ —  $ 0.5  $ — Interest income  0.7 0.8 1.7 Loss on asset disposals  net  (3.5) (1.7) (1.5) Other  (0.2)  0.5 0.7 $(3.0) $ 0.1  $0.9 2004 2003  2002 millions of dollars   U.S. Non-U.S.  Total  U.S.  Non-U.S.  Total  U.S. Non-U.S.  Total Earnings before taxes  $117.8 $190.8 $308.6 $120.5 $136.2 $256.7 $163.7 $70.1 $233.8 Provision for income taxes:  Current: Federal/foreign 1.4 63.8 65.2 18.5 13.1 31.6 11.1 10.6 21.7 State 2.2 — 2.2 1.6 — 1.6 3.1 — 3.1 3.6 63.8 67.4 20.1 13.1 33.2 14.2 10.6 24.8 Deferred 11.1 2.7 13.8 18.5 21.5 40.0 44.8 7.6 52.4 Total provision for income taxes  $ 14.7  $ 66.5  $ 81.2 $ 38.6  $ 34.6  $ 73.2  $ 59.0  $18.2  $ 77.2 Effective tax rate  12.4% 34.9% 26.3% 32.0% 25.4% 28.5% 36.0% 26.0% 33.0% millions of dollars  2004 2003 2002 Income taxes at U.S. statutory rate of 35%  $108.0 $ 89.8  $81.8 Increases (decreases) resulting from: Income from non-U.S. sources including withholding taxes 3.6 (8.5) (2.2) Business tax credits  net  (6.2) (6.3) (4.7) Affiliate earnings (10.2) (7.0)  (6.8) Non-temporary differences and other  (14.0) 5.2 9.1 Provision for income taxes as reported  $ 81.2 $ 73.2  $77.2 The provision for income taxes resulted in an effective tax rate for  2004 of 26.3% compared with rates of 28.5% in 2003 and 33.0%  in 2002. Our effective tax rates have been lower than the standard  federal and state tax rates due to the realization of certain R&D and  foreign tax credits; foreign rates  which differ from those in the U.S.;  and offset by non-deductible expenses. In addition  the Company made  an $11.4 million year-end adjustment to various tax accounts due  to changes in circumstances related to various tax items  including  changes in tax laws. The year-end adjustment resulted in a reduction in  the U.S. effective tax rate for 2004. The analysis of the variance of income taxes as reported from income  taxes computed at the U.S. statutory rate for consolidated opera- tions is as follows: