IBM 2010 Annual Report Download - page 77

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies 75
The company recognizes tax liabilities when, despite the
company’s belief that its tax return positions are supportable, the
company believes that certain positions may not be fully sustained
upon review by tax authorities. Benefits from tax positions are
measured at the largest amount of benefit that is greater than 50
percent likely of being realized upon settlement. The current
portion of tax liabilities is included in taxes and the noncurrent
portion of tax liabilities is included in other liabilities in the
Consolidated Statement of Financial Position. To the extent that
new information becomes available which causes the company
to change its judgment regarding the adequacy of existing tax
liabilities, such changes to tax liabilities will impact income tax
expense in the period in which such determination is made. Interest
and penalties, if any, related to accrued liabilities for potential tax
assessments are included in income tax expense.
Translation of Non-U.S. Currency Amounts
Assets and liabilities of non-U.S. subsidiaries that have a local
functional currency are translated to United States (U.S.) dollars at
year-end exchange rates. Translation adjustments are recorded in
accumulated other comprehensive income/(loss) in the Consolidated
Statement of Changes in Equity. Income and expense items are
translated at weighted-average rates of exchange prevailing during
the year.
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 the
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.
Derivative Financial Instruments
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 derivative as current or noncurrent is based upon whether the
maturity of the instrument is less than or greater than 12 months.
To qualify for hedge accounting, the instruments must be effective
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 deriva-
tive 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 ineffective-
ness is formally documented at hedge inception. The company
assesses hedge effectiveness and measures hedge ineffectiveness
at least quarterly throughout the designated hedge period.
Where the company applies hedge accounting, 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 variability 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. In addition, the company
may enter into derivative contracts that economically hedge certain
of its risks, even though hedge accounting does not apply or the
company elects not to apply hedge accounting. 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).