IBM 2014 Annual Report Download - page 94

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
93
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 sus-
tained 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 por-
tion of tax liabilities is included in other liabilities in the Consolidated
Statement of Financial Position. To the extent that new informa-
tion 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 OCI. Income and expense items are translated at weighted-aver-
age rates of exchange prevailing during the year.
Inventories, property, plant and equipment—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 approxi-
mate 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. Income and expense items are trans-
lated 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
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 company
requires that the instruments be effective in reducing the risk
exposure that they are designated to hedge. For instruments that
hedge cash flows, hedge designation 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 ineffective-
ness is formally documented at hedge inception. The company
assesses hedge effectiveness and measures hedge ineffective-
ness 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 attributable to interest rate or for-
eign currency risk); (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
attributable to interest rate or foreign currency risk); or (3) a hedge
of a long-term investment (net investment hedge) in a foreign oper-
ation. 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).
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
financing in the Consolidated Statement of Earnings. For hedges
of currency risk associated with recorded financial assets or lia-
bilities, 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 OCI, in
the Consolidated Statement of Comprehensive Income. 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 AOCI 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
investment 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 financial
instruments designated as net investment hedges are recorded
as foreign currency translation adjustments in OCI. Changes in
the fair value of the portion of a net investment hedging derivative
excluded from the effectiveness assessment are recorded in inter-
est expense. If the underlying hedged item in a fair value hedge
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 standards. 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 for each period and are primarily reported in other (income)