ADT 2005 Annual Report Download - page 192

TYCO INTERNATIONAL LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Guarantees (Continued)
Settlements include spending of $63 million by Engineered Products and Services in connection
with a Voluntary Replacement Program (‘‘VRP’’) associated with the acquisition of Central Sprinkler.
The VRP was initiated in 2001 and relates to the recall of certain Model GB fire sprinkler heads which
were originally manufactured by Central Sprinkler. Identification and investigation of problems with the
sprinkler heads commenced prior to Tyco’s acquisition. Affected sprinkler heads are replaced over a
5-7 year period free of charge to property owners.
16. Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, accounts
receivable, investments, accounts payable, debt and derivative financial instruments. The fair value of
cash and cash equivalents, accounts receivable, investments, accounts payable and derivative financial
instruments approximated book value at September 30, 2005 and 2004. See Note 14 for the fair value
estimates of debt.
All derivative financial instruments are reported on the Consolidated Balance Sheets at fair value,
and changes in a derivative’s fair value are recognized currently in earnings unless specific hedge
criteria are met. Fair value estimates are based on relevant market information, including current
market rates and prices, assuming adequate market liquidity. Fair value estimates for interest rate and
cross-currency swaps are calculated by the Company or are provided to the Company by high-quality,
third-party financial institutions known to be high volume participants in this market.
The Company uses derivative financial instruments to manage exposures to foreign currency and
interest rate risks. The Company’s objective for utilizing derivatives is to manage these risks using the
most effective methods to eliminate or reduce the impacts of these exposures. For those transactions
that are designated as hedges, the Company documents relationships between hedging instruments and
hedged items, and links derivatives designated as fair value, cash flow or foreign currency hedges to
specific assets and liabilities on the Consolidated Balance Sheets or to specific firm commitments or
forecasted transactions. For transactions designated as hedges, the Company also assesses and
documents, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are
used in hedging transactions are effective in offsetting changes in fair values or cash flows associated
with the hedged items.
As part of managing the exposure to changes in market interest rates, the Company enters into
various interest rate swap transactions with financial institutions acting as principal counterparties. To
ensure both appropriate use as a hedge and hedge accounting treatment, all derivatives entered into
are designated according to a hedge objective against specified forecasted interest payments specifically
underwritten debt issuances. The Company’s primary hedge objectives include the conversion of
fixed-rate liabilities to variable rates. The derivative financial instruments associated with these
objectives are designated and accounted for as fair value hedges.
As part of managing the exposure to changes in foreign currency exchange rates, the Company
utilizes forward and option contracts with financial institutions acting as principal counterparties. The
objective of these hedging contracts is to minimize impacts to cash flows due to changes in foreign
currency exchange rates on intercompany loans, booked accounts and notes receivable and accounts
payable, and forecasted transactions. Only in very limited circumstances is hedge accounting designated.
The remaining hedges are marked to market with changes in the derivatives fair value recognized
currently in earnings.
116 2005 Financials