3M 2012 Annual Report Download - page 96
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NOTE 11. Derivatives
The Company uses interest rate swaps, currency swaps, commodity price swaps, and forward and option contracts to
manage risks generally associated with foreign exchange rate, interest rate and commodity price fluctuations. The
information that follows explains the various types of derivatives and financial instruments used by 3M, how and why 3M
uses such instruments, how such instruments are accounted for, and how such instruments impact 3M’s financial position
and performance.
Additional information with respect to the impacts on other comprehensive income of nonderivative hedging and derivative
instruments is included in Note 5. Additional information with respect to the fair value of derivative instruments is included
in Note 12. References to information regarding derivatives and/or hedging instruments associated with the Company’s
long-term debt are also made in Note 9.
Types of Derivatives/Hedging Instruments and Inclusion in Income/Other Comprehensive Income
Cash Flow Hedges:
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on
the derivative is reported as a component of other comprehensive income and reclassified into earnings in the same
period during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge
ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
Cash Flow Hedging - Foreign Currency Forward and Option Contracts: The Company enters into foreign exchange
forward and option contracts to hedge against the effect of exchange rate fluctuations on cash flows denominated in
foreign currencies and certain intercompany financing transactions. These transactions are designated as cash flow
hedges. The settlement or extension of these derivatives will result in reclassifications (from accumulated other
comprehensive income) to earnings in the period during which the hedged transactions affect earnings. Generally, 3M
dedesignates these cash flow hedge relationships in advance of the occurrence of the forecasted transaction. The portion
of gains or losses on the derivative instrument previously accumulated in other comprehensive income for dedesignated
hedges remains in accumulated other comprehensive income until the forecasted transaction occurs. Changes in the
value of derivative instruments after dedesignation are recorded in earnings and are included in the Derivatives Not
Designated as Hedging Instruments section below. Hedge ineffectiveness and the amount excluded from effectiveness
testing recognized in income on cash flow hedges were not material for 2012, 2011 and 2010. The maximum length of
time over which 3M hedges its exposure to the variability in future cash flows for a majority of the forecasted transactions
is 12 months and, accordingly, at December 31, 2012, the majority of the Company’s open foreign exchange forward and
option contracts had maturities of one year or less. The dollar equivalent gross notional amount of the Company’s foreign
exchange forward and option contracts designated as cash flow hedges at December 31, 2012 was approximately $5.8
billion.
Cash Flow Hedging - Commodity Price Management: The Company manages commodity price risks through negotiated
supply contracts, price protection agreements and forward physical contracts. The Company uses commodity price swaps
relative to natural gas as cash flow hedges of forecasted transactions to manage price volatility. The related mark-to-
market gain or loss on qualifying hedges is included in other comprehensive income to the extent effective, and
reclassified into cost of sales in the period during which the hedged transaction affects earnings. Generally, the length of
time over which 3M hedges its exposure to the variability in future cash flows for its forecasted natural gas transactions is
12 months. No significant commodity cash flow hedges were discontinued and hedge ineffectiveness was not material for
2012, 2011 and 2010. The dollar equivalent gross notional amount of the Company’s natural gas commodity price swaps
designated as cash flow hedges at December 31, 2012 was $18 million.
Cash Flow Hedging – Forecasted Debt Issuance: In August 2011, in anticipation of the September 2011 issuance of $1
billion in five-year fixed rate notes, 3M executed a pre-issuance cash flow hedge on a notional amount of $400 million by
entering into a forward-starting five-year floating-to-fixed interest rate swap. Upon debt issuance in September 2011, 3M
terminated the floating-to-fixed interest rate swap. The termination of the swap resulted in a $7 million pre-tax loss ($4
million after-tax) that will be amortized over the five-year life of the note and, when material, is included in the tables below
as part of the loss recognized in income on the effective portion of derivatives as a result of reclassification from
accumulated other comprehensive income.
As of December 31, 2012, the Company had a balance of $23 million associated with the after tax net unrealized loss
associated with cash flow hedging instruments recorded in accumulated other comprehensive income. This includes a $3
million balance (loss) related to a floating-to-fixed interest rate swap (discussed in the preceding paragraph), which will be