ADT 2006 Annual Report Download - page 190

TYCO INTERNATIONAL LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. Guarantees (Continued)
was reflected in cost of sales. Settlements during 2006 include cash expenditures of $37 million related
to the VRP.
17. 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 29, 2006 and September 30, 2005. See Note 15 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 on
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, notes receivable and accounts payable, and forecasted
transactions. The Company has designated certain forward contracts and certain foreign currency
denominated debt issuances to hedge its net investments in foreign operations. The remaining hedges
are marked to market with changes in the derivatives’ fair value recognized in the income statement.
The Company’s derivative financial instruments present certain market and counterparty risks;
however, concentration of counterparty risk is mitigated as Tyco deals with a variety of major banks
worldwide with long-term Standard & Poor’s and Moody’s credit ratings of A/A2 or higher. In addition,
only conventional derivative financial instruments are utilized, thereby affording optimum clarity as to
the market risk. None of the Company’s derivative financial instruments outstanding at year end would
128 2006 Financials