STOCK-BASED COMPENSATION

The following table summarizes the stock-based compensation expenses included in our Consolidated Statements of Income (in thousands):



	Year Ended December 31,
	2013			2012			2011
Cost of goods sold	$	6,809		$	7,061		$	8,433
Research and development expenses	108,772			187,100			73,490
Selling, general and administrative expenses	136,630			208,501			110,455
Stock-based compensation expense included in total costs and expenses	252,211			402,662			192,378
Income tax effect	(66,909		)	(55,957		)	(47,325		)
Stock-based compensation expense, net of tax	$	185,302		$	346,705		$	145,053

We capitalized stock-based compensation costs to inventory totaling $9.1 million in 2013, $6.9 million in 2012 and $8.6 million in 2011. The capitalized stock-based compensation costs remaining in inventory were $4.2 million as of December 31, 2013, $1.9 million as of December 31, 2012 and $2.0 million as of December 31, 2011. Total stock-based compensation for the year ended December 31, 2012 included $100.1 million and $93.8 million in R&D and SG&A expenses, respectively, related to the acceleration of unvested stock options in connection with the acquisition of Pharmasset, which closed during the first quarter of 2012.

Stock-based compensation is recognized as expense over the requisite service periods in our Consolidated Statements of Income using a graded vesting expense attribution approach for unvested stock options granted prior to January 1, 2006, and using the straight-line expense attribution approach for stock options granted after our adoption of new guidance for share-based payments to employees and directors on January 1, 2006. As stock-based compensation expenses related to stock options recognized on adoption of the new guidance is based on awards ultimately expected to vest, gross expense has been reduced for estimated forfeitures. The guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We estimated forfeitures based on our historical experience. Prior to the adoption of this guidance, pro forma information that was required to be disclosed included forfeitures as they occurred. As a result of the guidance adopted on January 1, 2006, we only recognize a tax benefit from stock-based compensation in APIC if an incremental tax benefit is realized after all other tax attributes currently available to us have been utilized. In addition, we have elected to account for the indirect benefits of stock-based compensation on the research tax credit and the extraterritorial income deduction through the Consolidated Statements of Income rather than through APIC.

Valuation Assumptions

Fair values of options granted under our 2004 Plan and purchases under our ESPP were estimated at grant or purchase dates using a Black-Scholes option valuation model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including expected stock price volatility and expected award life. We used the following assumptions to calculate the estimated fair value of the awards:



	Year Ended December 31,
	2013		2012		2011
Expected volatility:
Stock options	29	%	30	%	29	%
ESPP	31	%	32	%	30	%
Expected term in years:
Stock options	5.7		5.9		5.6
ESPP	1.2		1.3		1.4
Risk-free interest rate:
Stock options	1.1	%	1.1	%	2.2	%
ESPP	1.1	%	0.7	%	0.8	%
Expected dividend yield	—	%	—	%	—	%

The fair value of stock options granted was calculated using the single option approach. We use a blend of historical volatility along with implied volatility for traded options on our common stock to determine our expected volatility. The expected term of stock-based awards represents the weighted-average period the awards are expected to remain outstanding. We estimate the weighted-average expected term based on historical cancellation and historical exercise data related to our stock options as well as the contractual term and vesting terms of the awards. The risk-free interest rate is based upon observed interest rates appropriate for the term of the stock-based awards. The dividend yield is based on our history and expectation of dividend payouts.