Graco 2012 Annual Report Download - page 65

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Product Liability Reserves
The Company has a self-insurance program for product liability that includes reserves for self-retained losses and certain excess
and aggregate risk transfer insurance. The Company uses historical loss experience combined with actuarial evaluation methods,
review of significant individual files and the application of risk transfer programs in determining required product liability reserves.
The Company’s actuarial evaluation methods take into account claims incurred but not reported when determining the Company’s
product liability reserve. While the Company believes that it has adequately reserved for these claims, the ultimate outcome of
these matters may exceed the amounts recorded by the Company, and such additional losses may be material to the Company’s
Consolidated Financial Statements.
Product Warranties
In the normal course of business, the Company offers warranties for a variety of its products. The specific terms and conditions
of the warranties vary depending upon the specific product and markets in which the products were sold. The Company accrues
for the estimated cost of product warranty at the time of sale based on historical experience.
Advertising Costs
The Company expenses advertising costs as incurred. Cooperative advertising with customers is recorded in the Consolidated
Financial Statements as a reduction of net sales and totaled $118.5 million, $120.9 million and $107.6 million for 2012, 2011 and
2010, respectively. All other advertising costs are recorded in selling, general and administrative expenses and totaled $146.8
million, $158.3 million and $152.9 million in 2012, 2011 and 2010, respectively.
Research and Development Costs
Research and development costs relating to both future and current products are charged to selling, general and administrative
expenses as incurred. These costs totaled $125.4 million, $130.1 million and $128.8 million in 2012, 2011 and 2010, respectively.
Derivative Financial Instruments
Derivative financial instruments are generally used to manage certain commodity, interest rate and foreign currency risks. These
instruments primarily include interest rate swaps, forward exchange contracts and options. The Company’s forward exchange
contracts and options do not subject the Company to exchange rate risk because gains and losses on these instruments generally
offset gains and losses on the assets, liabilities, and other transactions being hedged. However, these instruments, when settled,
impact the Company’s cash flows from operations to the extent the underlying transaction being hedged is not simultaneously
settled due to an extension, a renewal or otherwise.
On the date when the Company enters into a derivative, the derivative is designated as a hedge of the identified exposure. The
Company measures effectiveness of its hedging relationships both at hedge inception and on an ongoing basis.
Interest Rate Risk Management
Gains and losses on interest rate swaps designated as cash flow hedges, to the extent that the hedge relationship has been effective,
are deferred in other comprehensive income (loss) and recognized in interest expense over the period in which the Company
recognizes interest expense on the related debt instrument. The fair value of interest rate swaps on long-term debt designated as
fair value hedges, to the extent the hedge relationship is effective, are recorded as an asset or liability with a corresponding
adjustment to the carrying value of the debt. Any ineffectiveness on these instruments is immediately recognized in interest expense
in the period that the ineffectiveness occurs.
Gains or losses resulting from the early termination of interest rate swaps previously designated as fair value hedges are deferred
as an increase or decrease to the carrying value of the related debt and amortized as an adjustment to the yield of the related debt
instrument over the remaining period originally covered by the swap. The cash received or paid relating to the termination of
interest rate swaps is included in accrued liabilities and other as an operating activity in the Consolidated Statements of Cash
Flows.
Foreign Currency Management
The Company utilizes forward exchange contracts and options to manage foreign exchange risk related to both known and
anticipated intercompany transactions and third-party commercial transaction exposures of approximately one year in duration or
less. For instruments designated as cash flow hedges, the effective portion of the changes in fair value of these instruments is
reported in other comprehensive income (loss) and reclassified into earnings in the same period or periods in which the hedged
transactions affect earnings. Any ineffective portion is immediately recognized in earnings. For instruments designated as fair