IBM 2006 Annual Report Download - page 71

Black
MAC
CG10
Inventories, plant, rental machines and other property—net, and
other non-monetary assets and liabilities of non-U.S. subsidiaries and
branches that operate in U.S. dollars are translated at approximate
exchange rates prevailing when the company acquired the assets or
liabilities. All other assets and liabilities denominated in a currency
other than U.S. dollars are translated at year-end exchange rates with
the transaction gain or loss recognized in Other (income) and expense.
Cost of sales and depreciation are translated at historical exchange
rates. All other income and expense items are translated at the
weighted-average rates of exchange prevailing during the year. These
translation gains and losses are included in net income for the period
in which exchange rates change.
DERIVATIVES
All derivatives are recognized in the Consolidated Statement of
Financial Position at fair value and are reported in Prepaid expenses
and other current assets, Investments and sundry assets, Other accrued
expenses and liabilities or Other liabilities. Classification of each deriva-
tive as current or non-current is based upon whether the maturity of
the instrument is less than or greater than 12 months. To qualify for
hedge accounting in accordance with SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” as amended by SFAS
No. 138, “Accounting for Certain Derivative Instruments and Certain
Hedging Activities,” and SFAS No. 149, “Amendment of Statement
133 on Derivative Instruments and Hedging Activities,” (collectively,
“SFAS No. 133”), the company requires that the instruments be effec-
tive in reducing the risk exposure that they are designated to hedge.
For instruments that hedge cash flows, hedge effectiveness criteria also
require that it be probable that the underlying transaction will occur.
Instruments that meet established accounting criteria are formally
designated as hedges. These criteria demonstrate that the derivative is
expected to be highly effective at offsetting changes in fair value or
cash flows of the underlying exposure both at inception of the hedging
relationship and on an ongoing basis. The method of assessing hedge
effectiveness and measuring hedge ineffectiveness is formally docu-
mented at hedge inception. The company assesses hedge effectiveness
and measures hedge ineffectiveness at least quarterly throughout the
designated hedge period.
The company applies hedge accounting in accordance with SFAS
No. 133, whereby the company designates each derivative as a hedge
of: (1) the fair value of a recognized financial asset or liability or of an
unrecognized firm commitment (“fair value” hedge); (2) the variabil-
ity of anticipated cash flows of a forecasted transaction or the cash
flows to be received or paid related to a recognized financial asset or
liability (“cash flow” hedge); or (3) a hedge of a long-term investment
(“net investment” hedge) in a foreign operation. From time to time,
however, the company may enter into derivative contracts that eco-
nomically hedge certain of its risks, even though hedge accounting
does not apply or the company elects not to apply hedge accounting
under SFAS No. 133. In these cases, there exists a natural hedging
relationship in which changes in the fair value of the derivative, which
are recognized currently in net income, act as an economic offset to
changes in the fair value of the underlying hedged item(s).
Changes in the fair value of a derivative that is designated as a fair
value hedge, along with offsetting changes in the fair value of the
underlying hedged exposure, are recorded in earnings each period. For
hedges of interest rate risk, the fair value adjustments are recorded as
adjustments to Interest expense and Cost of Global Financing in the
Consolidated Statement of Earnings. For hedges of currency risk asso-
ciated with recorded financial assets or liabilities, derivative fair value
adjustments are recognized in Other (income) and expense in the
Consolidated Statement of Earnings. Changes in the fair value of a
derivative that is designated as a cash flow hedge are recorded, net of
applicable taxes, in the Accumulated gains and (losses) not affecting
retained earnings, a component of Stockholders’ equity. When net
income is affected by the variability of the underlying cash flow, the
applicable offsetting amount of the gain or loss from the derivative that
is deferred in Stockholders’ equity is released to net income and
reported in Interest expense, Cost, SG&A expense or Other (income)
and expense in the Consolidated Statement of Earnings based on the
nature of the underlying cash flow hedged. Effectiveness for net invest-
ment hedging derivatives is measured on a spot-to-spot basis. The
effective portion of changes in the fair value of net investment hedging
derivatives and other non-derivative risk management instruments
designated as net investment hedges are recorded as foreign currency
translation adjustments, net of applicable taxes, in the Accumulated
gains and (losses) not affecting retained earnings section of the
Consolidated Statement of Stockholders’ Equity. Changes in the fair
value of the portion of a net investment hedging derivative excluded
from the effectiveness assessment are recorded in Interest expense.
When the underlying hedged item ceases to exist, all changes in the
fair value of the derivative are included in net income each period until
the instrument matures. When the derivative transaction ceases to
exist, a hedged asset or liability is no longer adjusted for changes in its
fair value except as required under other relevant accounting stan-
dards. Derivatives that are not designated as hedges, as well as changes
in the fair value of derivatives that do not effectively offset changes in
the fair value of the underlying hedged item throughout the designated
hedge period (collectively, “ineffectiveness”), are recorded in net
income each period and are reported in Other (income) and expense.
The company reports cash flows arising from the company’s
derivative financial instruments consistent with the classification of
cash flows from the underlying hedged items that the derivatives are
hedging. Accordingly, the majority of cash flows associated with the
company’s derivative programs are classified in Cash flows from oper-
ating activities in the Consolidated Statement of Cash Flows. Cash
flow from derivatives that do not qualify as hedges is reported in
investing activities. For currency swaps designated as hedges of foreign
currency denominated debt (included in the company’s debt risk man-
agement program as addressed in note L, “Derivatives and Hedging
Transactions,” on pages 83 through 86), cash flows directly associated
with the settlement of the principal element of these swaps are
reported in Payments to settle debt in the Cash Flow from Financing
Activities from Continuing Operations section of the Consolidated
Statement of Cash Flows.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
INTERNATIONAL BUSINESS MACHINES CORPORATION AND SUBSIDIARY COMPANIES
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