IBM 2015 Annual Report Download - page 91

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
89
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-av-
erage 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 approx-
imate 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 expo-
sure that they are designated to hedge. For instruments that hedge
cash flows, hedge designation criteria also require that it be prob-
able 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 for-
mally 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 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) and expense. When a cash flow hedging relation-
ship is discontinued, the net gain or loss in AOCI must generally
remain in AOCI until the item that was hedged affects earnings.
However, when it is probable that a forecasted transaction will not
occur by the end of the originally specified time period or within
an additional two-month period thereafter, the net gain or loss in
AOCI must be reclassified into earnings immediately.
The company reports cash flows arising from derivative finan-
cial instruments designated as fair value or cash flow hedges
consistent with the classification of cash flows from the underlying
hedged items that these derivatives are hedging. Accordingly, the
cash flows associated with derivatives designated as fair value
or cash flow hedges are classified in cash flows from operating
activities in the Consolidated Statement of Cash Flows. Cash
flows from derivatives designated as net investment hedges and
derivatives that do not qualify as hedges are reported in cash
flows from investing activities in the Consolidated Statement of
Cash Flows. For currency swaps designated as hedges of foreign