Avon 2004 Annual Report Download - page 43

As a result of worldwide tax audit settlements, pay-
ments, net of associated benefits and refunds, of $45.1
were made during 2003. In addition, a payment of $68.7
was made during January 2004 with respect to another
tax audit settlement recorded in 2003. The cash flow
impact of this January 2004 payment was partially offset
by the tax benefit on the interest portion of the payment.
These settlements resulted in a favorable impact on the
effective tax rate of 2.5% in 2003.
7Financial Instruments and
Risk Management
Avon operates globally, with manufacturing and distri-
bution facilities in various locations around the world.
Avon may reduce its exposure to fluctuations in earn-
ings and cash flows associated with changes in interest
rates and foreign exchange rates by creating offsetting
positions through the use of derivative financial instru-
ments. Since Avon uses foreign currency-rate sensitive
and interest-rate sensitive instruments to hedge a cer-
tain portion of its existing and forecasted transactions,
Avon expects that any gain or loss in value for the hedge
instruments generally would be offset by decreases or
increases in the value of the underlying transactions.
Avon does not enter into derivative financial instru-
ments for trading or speculative purposes, nor is Avon a
party to leveraged derivatives. The master agreements
governing Avon’s derivative contracts generally contain
standard provisions that could trigger early termination
of the contracts in certain circumstances, including if
Avon were to merge with another entity and the credit-
worthiness of the surviving entity were to be “materially
weaker” than that of Avon prior to the merger.
Accounting Policies
Derivatives are recognized on the balance sheet at
their fair values. When Avon becomes a party to a
derivative instrument, Avon designates the instrument
as either a fair value hedge, a cash flow hedge, a net
investment hedge, or a non-qualifying hedge. The
accounting for changes in fair value (gains or losses)
of a derivative instrument depends on whether it has
been designated by Avon and qualifies as part of a
hedging relationship and further, on the type of
hedging relationship.
• Changes in the fair value of a derivative that is des-
ignated as a fair value hedge, along with the loss or
gain on the hedged asset or liability that is attribu-
table to the hedged risk are recorded in earnings.
• Changes in the fair value of a derivative that is des-
ignated as a cash flow hedge are recorded in other
comprehensive income (“OCI”) to the extent effec-
tive and reclassified into earnings in the same
period or periods during which the transaction
hedged by that derivative also affects earnings.
• Changes in the fair value of a derivative that is des-
ignated as a hedge of a net investment in a foreign
operation are recorded in foreign currency transla-
tion adjustments within OCI to the extent effective
as a hedge.
• Changes in the fair value of a derivative not des-
ignated as a hedging instrument are recognized
in earnings in other expense (income), net on the
Consolidated Statements of Income.
Realized gains and losses on a derivative are reported
on the Consolidated Statements of Cash Flows consis-
tent with the underlying hedged item.
Avon assesses, both at the hedge’s inception and on an
ongoing basis, whether the derivatives that are used in
hedging transactions are highly effective in offsetting
changes in fair values or cash flows of hedged items.
Highly effective means that cumulative changes in the
fair value of the derivative are between 80%–125% of
the cumulative changes in the fair value of the hedged
item. The ineffective portion of the derivative’s gain or
loss, if any, is recorded in earnings in other expense
Avon uses foreign currency forward contracts
and options to hedge portions of its forecasted
foreign currency cash flows where there is a
high probability that anticipated exposures
will materialize.