Archer Daniels Midland 2006 Annual Report Download - page 34

32 Archer Daniels Midland Company
MANAGEMENT’S DISCUSSION OF
OPERATIONS AND FINANCIAL CONDITION - JUNE 30, 2006 (CONTINUED)
At June 30, 2006, the Company estimates it will spend approximately
$3.1 billion over the next four years to complete approved capital
projects and acquisitions. The Company is a limited partner in
various private equity funds which invest primarily in emerging
markets. At June 30, 2006, the Company’s carrying value of these
limited partnership investments was $224 million. The Company
has future capital commitments related to these partnerships of
$138 million and expects the majority of these additional capital
commitments, if called for, to be funded by cash flows generated by
the partnerships. The Company also has outstanding letters of credit
and surety bonds of $334 million at June 30, 2006.
In addition, the Company has entered into agreements, primarily
debt guarantee agreements related to equity-method investees,
which could obligate the Company to make future payments. The
Company’s liability under these agreements arises only if the primary
entity fails to perform its contractual obligation. The Company
has collateral for a portion of these contingent obligations. At
June 30, 2006, these contingent obligations totaled approximately
$250 million. Amounts outstanding under these contingent
obligations were $159 million at June 30, 2006.
Critical Accounting Policies
The process of preparing financial statements requires management
to make estimates and judgments that affect the carrying values
of the Company’s assets and liabilities as well as the recognition
of revenues and expenses. These estimates and judgments are
based on the Company’s historical experience and management’s
knowledge and understanding of current facts and circumstances.
Certain of the Company’s accounting policies are considered critical,
as these policies are important to the depiction of the Company’s
financial statements and require significant or complex judgment
by management. Management has discussed with the Company’s
Audit Committee the development, selection, disclosure, and
application of these critical accounting policies. Following are the
accounting policies management considers critical to the Company’s
financial statements.
Inventories and Derivatives
Certain of the Company’s merchandisable agricultural commodity
inventories, forward fixed-price purchase and sale contracts, and
exchange-traded futures and options contracts are valued at estimated
market values. These merchandisable agricultural commodities are
freely traded, have quoted market prices, and may be sold without
significant additional processing. Management estimates market
value based on exchange-quoted prices, adjusted for differences in
local markets. Changes in the market values of these inventories and
contracts are recognized in the statement of earnings as a component
of cost of products sold. If management used different methods or
factors to estimate market value, amounts reported as inventories and
cost of products sold could differ. Additionally, if market conditions
change subsequent to year-end, amounts reported in future periods
as inventories and cost of products sold could differ.
The Company, from time to time, uses derivative contracts to fix
the purchase price of anticipated volumes of commodities to be
purchased and processed in a future month, to fix the purchase
price of the Company’s anticipated natural gas requirements for
certain production facilities, and to fix the sales price of anticipated
volumes of ethanol. These derivative contracts are designated as
cash flow hedges. The change in the market value of such derivative
contracts has historically been, and is expected to continue to be,
highly effective at offsetting changes in price movements of the
hedged item. Gains and losses arising from open and closed hedging
transactions are deferred in other comprehensive income, net of
applicable income taxes, and recognized as a component of cost of
products sold in the statement of earnings when the hedged item is
recognized. If it is determined that the derivative instruments used
are no longer effective at offsetting changes in the price of the hedged
item, then the changes in the market value of these exchange-traded
futures contracts would be recorded in the statement of earnings as a
component of cost of products sold.