IBM 2015 Annual Report Download - page 92

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
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currency denominated debt (included in the company’s debt risk
management program as addressed in noteD, “Financial Instru-
ments,” on pages 101 through 105), cash flows directly associated
with the settlement of the principal element of these swaps are
reported in payments to settle debt in cash flows from financing
activities in the Consolidated Statement of Cash Flows.
Financial Instruments
In determining the fair value of its financial instruments, the com-
pany uses a variety of methods and assumptions that are based
on market conditions and risks existing at each balance sheet
date. See noteD, “Financial Instruments,” on pages 100 to 101
for further information. All methods of assessing fair value result
in a general approximation of value, and such value may never
actually be realized.
Fair Value Measurement
Accounting guidance defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
Under this guidance, the company is required to classify certain
assets and liabilities based on the following fair value hierarchy:
• Level1—Quoted prices (unadjusted) in active markets
for identical assets or liabilities that can be accessed at the
measurement date;
• Level2—Inputs other than quoted prices included within
Level1 that are observable for the asset or liability, either
directly or indirectly; and
• Level3—Unobservable inputs for the asset or liability.
The guidance requires the use of observable market data if such
data is available without undue cost and effort.
When available, the company uses unadjusted quoted market
prices in active markets to measure the fair value and classifies
such items within Level1. If quoted market prices are not available,
fair value is based upon internally developed models that use cur-
rent market-based or independently sourced market parameters
such as interest rates and currency rates. Items valued using inter-
nally generated models are classified according to the lowest level
input or value driver that is significant to the valuation.
The determination of fair value considers various factors includ-
ing interest rate yield curves and time value underlying the financial
instruments. For derivatives and debt securities, the company uses
a discounted cash flow analysis using discount rates commensu-
rate with the duration of the instrument.
In determining the fair value of financial instruments, the com-
pany considers certain market valuation adjustments to the “base
valuations” calculated using the methodologies described below
for several parameters that market participants would consider in
determining fair value:
• Counterparty credit risk adjustments are applied to financial
instruments, taking into account the actual credit risk of a
counterparty as observed in the credit default swap market
to determine the true fair value of such an instrument.
• Credit risk adjustments are applied to reflect the company’s
own credit risk when valuing all liabilities measured at fair
value. The methodology is consistent with that applied in
developing counterparty credit risk adjustments, but incor-
porates the company’s own credit risk as observed in the
credit default swap market.
As an example, the fair value of derivatives is derived utilizing a
discounted cash flow model that uses observable market inputs
such as known notional value amounts, yield curves, spot and
forward exchange rates as well as discount rates. These inputs
relate to liquid, heavily traded currencies with active markets which
are available for the full term of the derivative.
Certain financial assets are measured at fair value on a non-
recurring basis. These assets include equity method investments
that are recognized at fair value at the measurement date to the
extent that they are deemed to be other-than-temporarily impaired.
Certain assets that are measured at fair value on a recurring basis
can be subject to nonrecurring fair value measurements. These
assets include available-for-sale equity investments that are
deemed to be other-than-temporarily impaired. In the event of an
other-than-temporary impairment of a financial instrument, fair
value is measured using a model described above.
Accounting guidance permits the measurement of eligible
financial assets, financial liabilities and firm commitments at fair
value, on an instrument-by-instrument basis, that are otherwise not
permitted to be accounted for at fair value under other account-
ing standards. This election is irrevocable. The company has not
applied the fair value option to any eligible assets or liabilities.
Cash Equivalents
All highly liquid investments with maturities of three months or
less at the date of purchase are considered to be cash equivalents.
Marketable Securities
Debt securities included in current assets represent securities that
are expected to be realized in cash within one year of the balance
sheet date. Long-term debt securities that are not expected to be
realized in cash within one year and alliance equity securities are
included in investments and sundry assets. Debt and marketable
equity securities are considered available for sale and are reported
at fair value with unrealized gains and losses, net of applicable
taxes, in OCI. The realized gains and losses for available-for-sale
securities are included in other (income) and expense in the Con-
solidated Statement of Earnings. Realized gains and losses are
calculated based on the specific identification method.
In determining whether an other-than-temporary decline in
market value has occurred, the company considers the duration
that, and extent to which, the fair value of the investment is below
its cost, the financial condition and near-term prospects of the
issuer or underlying collateral of a security; and the company’s
intent and ability to retain the security in order to allow for an antic-
ipated recovery in fair value. Other-than-temporary declines in fair
value from amortized cost for available-for-sale equity and debt