Archer Daniels Midland 2007 Annual Report Download - page 41

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
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.
Employee Benefit Plans
The Company provides substantially all domestic employees and employees at certain international subsidiaries
with pension benefits. The Company also provides substantially all domestic salaried employees with
postretirement health care and life insurance benefits. In order to measure the expense and funded status of these
employee benefit plans, management makes several estimates and assumptions, including interest rates used to
discount certain liabilities, rates of return on assets set aside to fund these plans, rates of compensation increases,
employee turnover rates, anticipated mortality rates, and anticipated future health care costs. These estimates and
assumptions are based on the Company’s historical experience combined with management’s knowledge and
understanding of current facts and circumstances. Management also uses third-party specialists to assist in
measuring the expense and funded status of these employee benefit plans. If management used different estimates
and assumptions regarding these plans, the funded status of the plans could vary significantly, and the Company
could recognize different amounts of expense over future periods.
Income Taxes
The Company frequently faces challenges from domestic and foreign tax authorities regarding the amount of taxes
due. These challenges include questions regarding the timing and amount of deductions and the allocation of
income among various tax jurisdictions. In evaluating the exposure associated with various tax filing positions, the
Company records reserves for probable exposures. Deferred tax assets represent items to be used as tax deductions
or credits in future tax returns, and the related tax benefit has already been recognized in the Company’s income
statement. Realization of certain deferred tax assets reflects the Company’s tax planning strategies. Valuation
allowances related to these deferred tax assets have been established to the extent the realization of the tax benefit is
not probable. Based on management’s evaluation of the Company’s tax position, it is believed the amounts related
to these tax exposures are appropriately accrued. To the extent the Company were to favorably resolve matters for
which accruals have been established or be required to pay amounts in excess of the aforementioned reserves, the
Company’s effective tax rate in a given financial statement period may be impacted.